FS Bancorp, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Dollar amounts are in millions unless noted. FS Bancorp is the parent of 1st Security Bank of Washington, a community bank serving Washington and operating commercial and consumer banking and home-lending businesses. The November 2018 Anchor Bancorp acquisition materially affects year-over-year comparisons.
Key financial results
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net interest income | $17.5 | $11.9 | $35.2 | $23.4 |
| Provision for loan losses | $0.9 | $0.5 | $1.7 | $0.8 |
| Noninterest income | $6.1 | $5.6 | $10.6 | $10.6 |
| Noninterest expense | $17.1 | $12.1 | $31.9 | $23.2 |
| Net income | $4.5 | $4.3 | $9.7 | $8.6 |
| Diluted EPS | $0.98 | $1.13 | $2.12 | $2.28 |
| Net interest margin | 4.60% | 4.58% | 4.65% | 4.66% |
| Efficiency ratio | 72.3% | 69.2% | 69.5% | 68.1% |
Q2 net income rose 4.8% and first-half net income rose 12.5%. Higher net interest income was partly offset by increased operating costs, loan-loss provisions and taxes. Diluted EPS declined despite higher net income; weighted-average diluted shares increased to 4.53 million from 3.77 million in Q2 2018.
Balance sheet, cash flow and liquidity
- At June 30, total assets were $1.64 billion, net loans $1.28 billion, deposits $1.33 billion, borrowings $83.2 million and stockholders’ equity $189.4 million. From year-end 2018, deposits increased $60.0 million, borrowings declined $53.9 million and net loans declined $30.4 million.
- Cash and cash equivalents were $59.6 million, up $26.8 million from year-end. First-half operating cash flow was negative $5.0 million, compared with positive $12.4 million a year earlier; investing cash flow was positive $29.2 million and financing cash flow positive $2.5 million. Operating cash flow reflects, among other items, mortgage-loan originations and sales.
- The Bank reported $390.3 million of unused FHLB borrowing capacity, a $144.8 million Federal Reserve borrowing limit and $51.0 million in correspondent federal-funds lines; none of the latter two facilities was drawn. Brokered deposits were $114.6 million. Management said liquidity was adequate.
- The Bank was categorized as well capitalized. Its June 30 ratios included 11.4% Tier 1 leverage, 13.8% Tier 1 risk-based, 14.7% total risk-based and 13.8% CET1 capital.
Material changes and operating trends
- Anchor acquisition-related scale lifted average Q2 loans to $1.34 billion from $899.7 million a year earlier. Loan interest income rose, while deposit costs and overall funding costs also increased. The Q2 net interest margin benefited from 20 basis points of accretion on acquired loans; first-half margin was down one basis point year over year.
- Q2 service charges and fee income increased to $1.9 million from $0.7 million, while gain on sale of loans decreased to $3.6 million from $4.7 million. First-half noninterest income was flat: higher service charges and other income were offset principally by a $2.7 million reduction in loan-sale gains, including lower sale margins.
- Acquisition and integration costs were $1.2 million in Q2 and $1.6 million in the first half, primarily related to the Anchor core-system conversion completed June 15, 2019. Management attributed much of the expense increase to the acquisition and operating growth.
- Net loans declined from year-end, with lower construction/development and warehouse balances partly offset by consumer-loan growth. Indirect home-improvement and marine loans increased by $20.5 million and $8.2 million, respectively.
- Net charge-offs were $1.7 million in the first half, versus net recoveries of $15,000 in the prior-year period, including a $1.2 million commercial line charge-off in Q1 and $431,000 related to a commercial relationship in Q2. Nonperforming loans fell to $1.6 million, or 0.1% of gross loans, from $3.9 million, or 0.3%, at year-end; management cited charge-offs as a principal reason. The allowance was $12.3 million, approximately 1.0% of gross loans excluding loans held for sale.
Outlook, risks and contingencies
- No specific earnings or financial guidance was provided. Management said residential construction and development lending should remain an important portfolio component and described a disciplined focus on known builders and developers. It also noted higher refinance activity and lower home-purchase production compared with the prior-year period.
- Risks highlighted include local economic and real-estate conditions, credit quality and loan-loss estimates, interest-rate and funding-cost changes, mortgage secondary-market conditions and loan-sale margins, deposit retention, competition, integration and cost control, and operational or cybersecurity disruptions. Management stated there had been no material change to previously disclosed risk factors or market-risk disclosures.
- Customer commitments to extend credit totaled $340.2 million. The filing notes potential loan repurchase or indemnification exposure on sold loans; a $1.2 million reserve was recorded for related guarantees. The Bank also had a $680,000 credit-enhancement obligation associated with certain loans sold to the FHLB, with a $68,000 holdback.
- Management reported no material pending legal actions and believed ordinary-course claims would not materially affect financial condition. Visa Class B shares remain unmarketable pending conclusion of litigation, which the filing says cannot be determined. The Company was evaluating CECL adoption; the expected allowance increase was not yet quantified. Lease accounting adoption added ROU assets and lease liabilities in 2019.
Important facts for investors to verify
- How much of earnings and reported growth is sustainable after separating Anchor-related scale, acquired-loan accretion and acquisition/integration costs from underlying performance.
- Whether deposit repricing and funding costs continue to pressure margins, and whether deposit growth remains weighted toward lower-cost relationship accounts.
- Credit trends behind elevated first-half charge-offs, including commercial exposures, consumer-loan performance and the effect of charge-offs on the lower reported nonperforming-loan balance.
- Returns and credit performance of indirect home-improvement lending, including the filing’s disclosure that four dealers generated 49.2% of funded loan volume.
- The eventual CECL adoption impact, contingent repurchase exposure on sold loans, and the use of the remaining 172,378 shares authorized for repurchase.