FS Bancorp, Inc. annual report, FY2023

Full document

FS Bancorp, Inc. — FY2023 Form 10-K

Business context and period. Annual report for the fiscal year ended December 31, 2023; comparisons are primarily with FY2022, not a stand-alone fourth quarter. FS Bancorp is the holding company for 1st Security Bank, a community bank serving Washington and Oregon. It completed its acquisition of seven Columbia State Bank branches on February 24, 2023, adding approximately $425.5 million of deposits and $66.1 million of loans.

Financial performance and position

  • Earnings: Net income was $36.1 million, up 21.6% from $29.6 million. Diluted EPS was $4.56 versus $3.70. Income before taxes was $45.3 million; income tax expense was $9.2 million (20.4% effective tax rate).
  • Interest income and margins: Net interest income rose 18.2% to $123.3 million. Net interest margin edged up to 4.48% from 4.46%, while net interest spread narrowed to 3.75% from 4.15%. Interest expense increased to $43.9 million from $14.4 million as deposit and borrowing costs rose.
  • Other income and expenses: Noninterest income increased 13.2% to $20.5 million; gain on loan sales declined 15.2% to $6.7 million. Noninterest expense rose 18.4% to $93.7 million, including higher personnel, acquisition, FDIC insurance, and core-deposit-intangible amortization costs. The efficiency ratio improved to 62.47% from 64.70%.
  • Cash flow: Net cash from operating activities was $77.7 million, compared with $184.9 million in FY2022. Investing activities provided $77.7 million, principally reflecting $336.2 million of net cash from the branch acquisition, partly offset by loan growth and securities purchases. Financing activities used $131.1 million. Cash and cash equivalents ended the year at $65.7 million, up from $41.4 million.
  • Loans and credit: Gross loans increased 9.7% to $2.43 billion; net loans were $2.40 billion. The allowance for credit losses on loans was $31.5 million, or 1.30% of gross loans, versus $28.0 million, or 1.26%. Net charge-offs increased to $2.2 million from $1.4 million. Nonaccrual loans rose to $11.0 million (0.45% of gross loans) from $8.7 million (0.39%). No OREO remained at year-end.
  • Balance sheet and capital: Total assets were $2.97 billion, up $339.8 million; deposits were $2.52 billion, up $394.6 million; and stockholders’ equity was $264.5 million, up from $231.7 million. Book value per share was $34.36. The Bank was well capitalized, with a 13.37% total risk-based capital ratio and 10.39% leverage ratio.
  • Funding and liquidity: Certificates of deposit were 43.5% of deposits; brokered deposits were $431.5 million, or 17.1%. Estimated uninsured deposits were $606.5 million, or 24.0%. Borrowings totaled $93.7 million, including an $89.9 million Federal Reserve Bank Term Funding Program advance and $3.9 million of FHLB advances. Management reported $391.2 million of liquid assets and said liquidity sources were adequate for obligations over at least the next 12 months.

Material changes and unusual items

  • The branch acquisition expanded the bank’s Washington and Oregon footprint and materially increased deposits, assets, staffing, and acquisition-related intangible amortization. Branch-level post-acquisition revenue and expense data were not available in the filing.
  • Higher rates supported loan yields and interest income, but also sharply raised funding costs. Average cost of interest-bearing liabilities rose to 2.32% from 0.92%; average cost of total interest-bearing deposits rose to 2.12% from 0.66%.
  • Residential mortgage originations fell 34.4% to $543.6 million, and loan sales fell to $408.0 million from $715.6 million, which management attributed to higher interest rates and reduced purchase/refinance activity.
  • Available-for-sale securities had $36.7 million of gross unrealized losses at year-end; management attributed these losses to market conditions, reported no credit impairment, and said it did not intend or expect to be required to sell the securities before recovery.
  • After year-end, on January 31, 2024, the Company sold mortgage servicing rights on approximately $1.29 billion of loans for about $16.6 million, subject to customary holdbacks and adjustments. The sold rights represented approximately 45.6% of the MSR portfolio.
  • The filing reports correction of prior-period EPS: FY2021 basic and diluted EPS were revised to $4.48 and $4.37, respectively, from $4.42 and $4.32, due to improper inclusion of certain unvested shares in the share-count denominator. The filing indicates the correction was not a restatement requiring an incentive-compensation recovery analysis.

Outlook, risks, and contingencies

Management’s strategy is to grow and diversify lending, maintain asset quality, build lower-cost core deposits, deepen customer relationships, and selectively expand markets. The Company expects to continue its current quarterly cash dividend of $0.26 per share, subject to Board discretion and regulatory constraints; it provided no quantified earnings or margin guidance.

  • Key risks include rising or persistently high rates, deposit repricing and competition, concentration in consumer home-improvement lending, dealer dependence, construction and speculative real-estate exposure, and sensitivity of commercial real-estate borrowers to property cash flows and refinancing conditions.
  • Five home-improvement dealers accounted for 65.9% of fixture-secured loan volume. Consumer loans were 26.6% of gross loans; commercial real-estate loans, including multifamily, totaled $590.1 million. Construction and development loans were $303.1 million, including $131.3 million of speculative vertical residential construction.
  • Credit quality weakened on certain measures: nonaccrual loans, classified assets, and net charge-offs increased. Management considered the allowance adequate but cautioned that economic deterioration could require additional provisions.
  • Interest-rate risk modeling estimated a 3.32% decline in next-12-month net interest income under an instantaneous +300-basis-point shock and a 1.55% decline under a -300-basis-point shock; actual results may differ from model assumptions.
  • Commitments to extend credit totaled $535.0 million, including $154.6 million of undisbursed construction and development commitments. Loan-sale representations and warranties were supported by a $2.1 million holdback reserve. Management said ordinary-course legal claims were not expected to materially affect financial position and reported no material pending legal actions at year-end.
  • The independent auditor gave unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective. The auditor identified the loan-loss allowance and branch-acquisition valuations as critical audit matters.

Most important facts for investors to verify

  • Whether deposit growth and the acquired branches translate into durable, lower-cost funding, given the high CD share, brokered deposits, and uninsured balances.
  • Trends in nonaccrual loans, consumer charge-offs, construction exposures, classified assets, and the adequacy of the $31.5 million loan-loss allowance.
  • The effect of deposit repricing, rates, and the post-year-end MSR sale on net interest margin, mortgage-servicing revenue, and earnings.
  • Acquisition integration costs, core deposit intangible amortization, and branch-level operating performance, which the filing does not separately quantify.
  • Cash-flow classification and liquidity assumptions, including the maturity of $863.4 million of certificates of deposit during 2024 and the Company’s reliance on available borrowing facilities.