FS Bancorp, Inc. — Q2 2015 Form 10-Q
Business context and reporting period. This unaudited filing covers the quarter and six months ended June 30, 2015. FS Bancorp is the holding company for 1st Security Bank of Washington, a community bank serving the Puget Sound area and the Tri-Cities, with indirect consumer lending extending across the West Coast. Amounts below are in U.S. dollars; financial figures are rounded to millions unless otherwise noted.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net interest income | $6.9m | $5.2m | $13.2m | $10.1m |
| Noninterest income | $5.3m | $2.5m | $9.3m | $4.5m |
| Provision for loan losses | $0.6m | $0.45m | $1.2m | $0.9m |
| Noninterest expense | $7.3m | $5.7m | $13.9m | $10.9m |
| Net income | $2.8m | $1.0m | $4.9m | $1.9m |
| Diluted earnings per share | $0.93 | $0.33 | $1.63 | $0.62 |
| Net interest margin | 5.14% | 5.08% | 5.12% | 5.02% |
| Efficiency ratio | 59.7% | 74.7% | 61.6% | 74.7% |
Balance sheet at June 30, 2015: Total assets were $568.6m, up 11.5% from December 31, 2014. Net loans were $432.3m, gross loans $440.0m, and loans held for sale $41.0m. Deposits were $470.5m, borrowings $20.3m, and stockholders’ equity $70.9m. The allowance for loan losses was $6.9m, or 1.6% of gross loans.
Cash flow and liquidity: Cash and cash equivalents declined $9.3m in the first half to $6.3m. Operating cash flow was negative $10.4m, principally reflecting mortgage-loan origination and sale activity; investing cash flow was negative $51.8m and financing cash flow positive $53.0m. The Bank reported $88.7m of unused FHLB borrowing capacity, a $74.9m Federal Reserve borrowing line and $40.0m in correspondent-bank Fed Funds lines; no borrowings were outstanding on the latter facilities. Approved loan commitments, including unused lines, totaled $211.9m.
Capital: The Bank was categorized as well capitalized. At June 30, its Tier 1 leverage, Tier 1 risk-based, total risk-based and common equity Tier 1 ratios were 10.9%, 12.3%, 13.6% and 12.3%, respectively.
Material changes versus comparable periods
- Q2 net income rose 183.4% year over year; first-half net income rose 161.4%. Growth was driven by higher loan interest income and especially mortgage loan-sale gains.
- Gain on sale of loans increased to $4.6m in Q2 from $1.8m, and to $7.9m in the first half from $3.3m. First-half one-to-four-family mortgage originations were $299.3m, with $257.7m sold to investors.
- Net interest margin improved 6 basis points for Q2 and 10 basis points for the first half. Management attributed this to loan growth and a shift in asset mix; it cautioned that a greater share of lower-yielding real estate and business loans could pressure future margins.
- Loan growth was broad: net loans increased $45.1m since year-end, including $35.3m in real estate and $12.7m in consumer loans. Deposits rose $50.1m and borrowings increased $3.2m.
- Noninterest expense rose 27.1% in Q2 and 27.2% in the first half, including higher compensation, loan-production commissions, operations and professional fees. The efficiency ratio nevertheless improved, mainly because noninterest income grew faster.
Outlook, commentary and risks
- The filing gives no quantified earnings or financial guidance. Management’s stated priorities are loan-portfolio diversification and growth, asset quality, lower-cost core deposits, broader customer relationships and selective expansion.
- Credit metrics weakened from year-end: nonperforming loans rose to $1.0m from $0.4m, and substandard loans to $3.9m from $2.2m. Management linked downgrades to one commercial real estate loan and two commercial business loans. Net charge-offs were $0.36m in the first half, down from $0.44m a year earlier; there were no loans 90 days past due and still accruing, and no OREO at June 30.
- Mortgage banking results depend on origination volumes and secondary-market conditions. Fair-value changes on derivatives contributed $1.5m to income in the first half. Four contractors/dealers accounted for 49.1% of Q2 indirect home-improvement loan funding; management limits California-originated loans to 20% of consumer loans.
- Brokered certificates of deposit were $30.5m. The filing also reports $481,000 of reserves for potential repurchases or indemnification on sold one-to-four-family loans. Commitments and contingent exposures, deposit retention, interest-rate movements, credit quality, and local economic conditions are relevant risks.
- Management said there were no material changes to the risk factors in the 2014 Form 10-K, ordinary-course legal matters were not expected to have a material adverse effect, and disclosure controls were effective. No material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether the sharp increase in loan-sale gains and mortgage originations is sustainable, and how much earnings depend on mortgage volume and derivative fair-value movements.
- Whether the increases in substandard and nonperforming loans lead to higher provisions, charge-offs or further allowance needs.
- The quality and durability of deposit growth, including brokered deposits, certificate maturities and funding costs.
- Whether loan growth, mortgage pipeline exposure, and $211.9m of commitments can be funded while maintaining liquidity and capital levels.
- Potential loan repurchase exposure relative to the $481,000 reserve and the concentration of indirect lending among a small number of contractors/dealers.