FS Bancorp, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual report, not a standalone fourth-quarter report. FS Bancorp is the holding company for 1st Security Bank of Washington, a community bank serving Washington’s Puget Sound region. The November 15, 2018 acquisition of Anchor Bancorp materially expanded the company’s footprint; 2018 results include Anchor only after the acquisition date.
Financial performance and condition
| Metric | 2018 | 2017 |
|---|---|---|
| Total assets, year-end | $1.62 billion | $981.8 million |
| Gross loans, year-end | $1.33 billion | $773.4 million |
| Deposits, year-end | $1.27 billion | $829.8 million |
| Net interest income | $52.1 million | $41.2 million |
| Net income | $24.3 million | $14.1 million |
| Diluted earnings per share | $6.29 | $4.28 |
| Net interest margin | 4.61% | 4.65% |
| Operating cash flow | $21.4 million | $15.1 million |
| Stockholders’ equity, year-end | $180.0 million | $122.0 million |
- Profitability: Net income rose 72.9%. Net interest income increased 26.3%, as average loans and loan interest income grew. The efficiency ratio improved to 61.9% from 67.4%.
- Margins and funding costs: Net interest margin edged down four basis points. Average cost of interest-bearing liabilities increased to 1.22% from 0.76%; higher deposit and borrowing costs partly offset asset growth and improved yields.
- Cash flows: Investing activities used $187.0 million, largely reflecting net loan growth. Financing activities provided $179.4 million. Cash and cash equivalents increased $13.9 million to $32.8 million.
- Debt and liquidity: Year-end FHLB advances were $137.1 million, versus $7.5 million a year earlier; the company also had a $10.0 million subordinated note due in 2025. It reported $120.0 million of unused FHLB capacity, $127.7 million of Federal Reserve borrowing capacity, and $51.0 million of unsecured Fed Funds lines, none drawn at year-end. Brokered deposits were $116.7 million, or 9.2% of deposits.
- Credit and capital: Nonperforming assets were $4.6 million, or 0.28% of assets, versus $1.0 million, or 0.11%, in 2017. The allowance for loan losses was $12.3 million, 0.93% of gross loans. The Bank was categorized as well capitalized, with total risk-based capital of 13.52% and Tier 1 leverage capital of 10.67%.
Material changes versus 2017
- The Anchor acquisition added nine branches and brought $357.9 million of deposits and $361.6 million of loans at acquisition-date values. It contributed a $7.4 million bargain purchase gain and $1.4 million of acquisition costs. The filing says Anchor’s revenue and earnings contribution since closing could not practicably be disclosed separately.
- Year-end assets increased 65.2%, net loans 72.3%, and deposits 53.5%; these increases reflect the acquisition as well as organic growth. Real estate loans rose to 63.8% of gross loans from 56.9%, while consumer loans fell to 20.8% from 27.0% of the larger portfolio.
- Construction and development loans grew to $247.3 million from $143.1 million. The company reported $140.6 million of speculative one-to-four-family construction loans in its risk discussion; construction exposure and concentration are notable given the portfolio’s rapid expansion.
- Nonperforming loans increased to $3.9 million from $1.0 million, and the company recorded $689,000 of acquired real estate owned. Net recoveries were $53,000 in 2018, compared with $205,000 of net charge-offs in 2017.
- Mortgage loan originations and sales were lower: one-to-four-family originations declined 12.3%, and gain on sale of loans fell to $14.9 million from $18.0 million. A $702,000 net derivative valuation loss compared with a $2.3 million gain in 2017.
Outlook, risks and notable items
- Management strategy: Continue diversifying lending, expanding commercial real estate, construction, commercial business and home lending, growing core relationship deposits, and maintaining asset quality. Management expected construction and development lending to remain an important portfolio component. The filing provides no quantified earnings or revenue guidance.
- Key credit risks: Construction and commercial real estate concentrations, speculative building, borrower cash-flow dependence, and the rapid growth and limited seasoning of portions of the commercial portfolio. The Bank’s construction, land development and land loans equaled 131.2% of regulatory capital; broader CRE exposure was reported at 300.0% of capital under the cited supervisory definitions.
- Other risks: Rising funding costs and interest-rate sensitivity; reliance on mortgage banking and secondary-market execution; consumer lending exposure to dealer concentration and collateral limitations; deposit competition and brokered funding; Anchor integration; and cybersecurity, vendor, regulatory and regional economic risks. The company also disclosed uncertainty around the post-2021 transition from LIBOR.
- Accounting and controls: CECL was expected to take effect for the company in 2020; management had not determined its impact. The company expected lease accounting adoption in 2019 to add approximately $5.0 million of right-of-use assets and lease liabilities. The auditor concluded financial statements were fairly presented and internal control over financial reporting was effective; management excluded non-integrated Anchor operations representing 24.8% of loans and 27.9% of deposits from its control assessment.
- Contingencies: The company reported ordinary-course legal matters that management did not expect to materially affect financial position, a $1.0 million reserve for mortgage loan repurchase and indemnity exposure, and $295.8 million of commitments to extend credit.
Important facts for investors to verify
- How much of reported earnings growth came from recurring operations versus the $7.4 million bargain purchase gain, acquisition-related effects, and the lower effective tax rate.
- Post-acquisition loan and deposit performance, integration progress, and realized cost savings; separately reported Anchor operating results are unavailable in this filing.
- Credit quality trends in construction, CRE, commercial business and acquired loans, including the adequacy of reserves given that acquired loans were recorded at fair value with a $5.3 million discount rather than an acquisition-date loan-loss allowance.
- Whether deposit pricing, brokered funding and FHLB borrowing costs continue to pressure net interest margin and liquidity as certificates mature.
- The effect of CECL adoption on the allowance, retained earnings and regulatory capital, and the company’s ability to manage its CRE concentration and growth.