FS Bancorp, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are with December 31, 2016. FS Bancorp is the parent of 1st Security Bank of Washington, a community bank serving the Puget Sound region and other Washington markets, with home lending and consumer lending operations extending beyond its branch footprint.
Financial performance and position
| Metric | Q1 2017 / March 31, 2017 | Comparable period / prior year-end |
|---|---|---|
| Interest income | $10.0 million | $8.9 million in Q1 2016 |
| Net interest income | $9.0 million | $7.8 million in Q1 2016 |
| Net interest margin | 4.54% | 4.19% in Q1 2016 |
| Noninterest income | $5.4 million | $4.3 million in Q1 2016 |
| Noninterest expense | $10.4 million | $8.9 million in Q1 2016 |
| Net income | $2.6 million; diluted EPS $0.85 | $1.7 million; diluted EPS $0.55 in Q1 2016 |
| Total assets | $877.9 million | $827.9 million at December 31, 2016 |
| Loans receivable, net | $617.8 million | $593.3 million at December 31, 2016 |
| Deposits | $758.0 million | $712.6 million at December 31, 2016 |
| Cash and cash equivalents | $46.1 million | $36.5 million at December 31, 2016 |
- Net income increased 56.1% year over year. Net interest income rose 14.7%; noninterest income rose 25.4%, led by loan-sale gains of $4.4 million. The effective tax rate was 35.5%, compared with 36.7% in Q1 2016.
- Noninterest expense increased 16.3%, mainly from higher salaries and benefits. The efficiency ratio improved to 72.1% from 73.5%.
- No loan-loss provision was recorded, versus $600,000 in Q1 2016. The allowance was $10.1 million, or 1.6% of gross loans excluding loans held for sale. Net charge-offs were $64,000.
- Gross loans were $629.9 million. Growth included construction and development and one-to-four-family loans held for investment; warehouse lending balances declined. Loans held for sale were $40.0 million, down from $52.6 million at year-end.
- Operating cash flow was $19.7 million, compared with cash used of $20.0 million in Q1 2016. Cash and cash equivalents increased $9.6 million during the quarter; investing activities used $52.9 million and financing activities provided $42.8 million.
- Borrowings were $10.3 million, down from $12.7 million; the subordinated note remained at $10.0 million principal, with a $9.8 million carrying amount. Stockholders’ equity was $84.0 million.
- The Bank was classified as well capitalized: total risk-based capital 13.77%, Tier 1 risk-based capital 12.52%, Tier 1 leverage 10.38%, and CET1 12.52%.
Material changes and management commentary
- Assets grew 6.0% from year-end, with higher securities, loans, cash, and deposits. Management said securities purchases were intended to improve yield relative to holding excess cash.
- Deposits increased 6.4%; relationship-based transaction accounts and savings/money-market accounts grew. Brokered deposits were $42.1 million. FHLB advances declined as deposits grew.
- Home-loan originations were $142.6 million, down year over year as higher rates reduced refinancing, partly offset by stronger purchase activity. The purchase share of originations rose to 73.6% from 63.6% a year earlier. Loan-sale margins increased to 2.98% from 2.35%.
- Nonperforming loans were $790,000, or 0.1% of gross loans, versus $721,000 at year-end. Substandard loans increased to $8.4 million from $8.0 million. The company reported no other real estate owned and one performing troubled debt restructuring of $56,000.
- Management’s stated priorities include loan and market diversification, asset quality, lower-cost core deposits, customer relationships, and selective market expansion. The filing provides no specific earnings or growth guidance and cautions that interim results are not necessarily indicative of full-year results.
Risks, contingencies, and unusual items
- Mortgage servicing rights: The servicing asset had a carrying value of $8.9 million and estimated fair value of $12.6 million. Because MSAs are subject to a 10% CET1 regulatory capital limit, management was preliminarily evaluating a possible sale of part of the asset; no amount or timing had been determined. A sale could reduce servicing-fee income. Valuation is sensitive to prepayment and interest-rate assumptions.
- Credit and concentration exposure: Credit quality, real estate conditions, loan growth, and consumer lending are risks. Four home-improvement contractors/dealers accounted for 51.3% of funded indirect home-improvement loan volume in the quarter. California-originated consumer loans totaled $37.9 million against a stated concentration limit of $95.4 million.
- Commitments and recourse: Commitments to extend credit totaled $316.4 million. The company also had limited recourse obligations on certain loans sold and reserves for loan-sale representations and warranties of $886,000.
- Liquidity: Unused FHLB borrowing capacity was $179.8 million; additional Federal Reserve and correspondent Fed Funds lines were available. The filing reports $33.6 million of certificates of deposit maturing within three months.
- Management cited sensitivity to interest rates, loan-sale market conditions, deposit retention, competition, regulatory changes, operating costs, and the ability to manage growth. It reported no material pending legal actions, no material changes to the prior year’s risk factors, and effective disclosure controls.
Most important facts for investors to verify
- Whether higher net interest margin and loan-sale gains can persist as rates, loan mix, and refinancing activity change.
- Whether zero provision remains appropriate given loan growth and the increase in substandard loans; review allowance methodology and subsequent credit performance.
- Whether the company sells MSAs to meet regulatory limits, and the resulting effects on capital and recurring servicing income.
- Exposure to indirect lending channels, contractor/dealer concentration, California lending, and the $316.4 million of credit commitments.
- Deposit mix and retention, brokered deposit levels, upcoming maturities, and use of borrowing facilities to fund growth.