FS Bancorp, Inc. — Q3 2013 Form 10-Q
Business context and reporting period. FS Bancorp is the holding company for 1st Security Bank of Washington, a community bank with seven branches in the Puget Sound area. The unaudited quarter and nine-month periods ended September 30, 2013; balance-sheet comparisons are with December 31, 2012. Amounts below are in millions unless noted.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Interest income | $5.60 | $4.84 | $16.21 | $13.64 |
| Net interest income | $5.04 | $4.27 | $14.63 | $11.81 |
| Noninterest income | $2.16 | $1.48 | $7.36 | $3.32 |
| Noninterest expense | $5.04 | $4.12 | $15.11 | $11.54 |
| Provision for loan losses | $0.52 | $0.63 | $1.72 | $1.70 |
| Pre-tax income | $1.64 | $1.00 | $5.16 | $1.90 |
| Income tax expense (benefit) | $0.58 | $(2.32) | $1.77 | $(2.32) |
| Net income | $1.06 | $3.33 | $3.38 | $4.22 |
| Basic and diluted EPS | $0.35 | $1.03 | $1.12 | Not available |
Year-to-date net interest margin was 5.42%, versus 5.39% in 2012; the average cost of funds declined 22 basis points to 0.76%. The efficiency ratio improved to 70.0% for Q3 from 71.6%, and to 68.7% year to date from 76.3%.
- Balance sheet at September 30: assets $396.1, up 10.3% from year-end 2012; net loans $283.8, up 3.2%; deposits $316.9, up 9.7%; borrowings $13.7, versus $6.8; and stockholders’ equity $62.2, versus $59.9.
- Cash and funding: cash and interest-bearing deposits were $27.3, versus $9.4 at December 31, 2012. Nine-month operating cash flow was $7.3, investing cash outflow $23.8, and financing cash inflow $34.4; cash and cash equivalents ended at $24.7.
- Credit quality: allowance for loan losses was $5.31, or 1.8% of gross loans, versus $4.70, or 1.7%, at year-end. Nine-month net charge-offs were $1.11, down from $1.68. Nonperforming loans were $1.52, or 0.5% of gross loans, versus $1.91, or 0.7%, at year-end. OREO was $2.26.
- Capital: the Bank was categorized as well capitalized, with Tier 1 leverage, Tier 1 risk-based, and total risk-based ratios of 12.7%, 15.6%, and 16.9%, respectively. The Company’s corresponding ratios were 15.9%, 19.3%, and 20.6%.
Material changes versus comparable periods
- Net income fell to $1.06 in Q3 and $3.38 year to date, despite higher pre-tax income. The comparisons are affected by a $2.32 tax benefit in 2012, when the Company reversed substantially all of its deferred-tax-asset valuation allowance; 2013 recorded ordinary tax expense.
- Net interest income rose 18.0% in Q3 and 23.9% year to date, reflecting larger average loan balances and lower funding costs. Noninterest income increased, primarily due to mortgage-loan sale gains: $1.54 in Q3 versus $0.92, and $5.32 year to date versus $1.47.
- Higher lending volume and channel expansion raised noninterest expense 22.4% in Q3 and 30.9% year to date. Nine-month salaries and benefits rose 43.1%, including loan-volume-related commissions and added staff; loan costs and professional fees also increased.
- Loan mix shifted: real estate loans increased to $120.2 and consumer loans to $124.1, while commercial business loans declined to $45.1 from $73.5 at year-end, reflecting reduced warehouse-line usage and planned runoff of larger participations.
- Accumulated other comprehensive income declined by $1.08 during the first nine months, principally reflecting unrealized losses on available-for-sale securities; securities fair value was $47.1 at quarter-end.
Outlook, commentary, and risks
No quantified earnings or financial guidance is provided. Management intends to diversify lending by expanding commercial real estate, home, commercial business, and residential construction lending while maintaining the current size of the consumer portfolio; relationship deposits remain a primary funding source. Management said rising mortgage rates had reduced refinancing activity, mortgage originations, and usage of warehouse lines.
- Consumer loans were 42.9% of the portfolio; indirect home-improvement loans were 80.5% of consumer loans. Four contractors/dealers generated 64.1% of indirect home-improvement loan volume during Q3. California indirect lending had $9.4 outstanding, against a management limit of 20% of the consumer portfolio.
- Liquidity sources include deposits, securities, loan collections, and borrowing lines. The Bank reported $22.4 of unused FHLB capacity, a Federal Reserve borrowing limit of $78.8, and a $6.0 overnight line; none was drawn on the latter two lines at quarter-end. Brokered deposits were $16.9, within the stated policy limit of 20% of deposits.
- Outstanding loan commitments, including unused lines, totaled $130.1. Potential loan-sale recourse includes a $0.159 reserve for secondary-market representations and warranties and a $0.042 reserve on a consumer-loan sale with limited recourse. Management stated ordinary-course legal proceedings were not expected to materially affect financial condition.
- Key stated risks include credit deterioration, interest-rate changes and fair-value estimates, competition, execution of growth and branch strategies, deposit attraction, expense control, regulatory changes, and reliance on third-party vendors. The Company reported no material change to the risk factors in its 2012 Form 10-K.
Important facts for investors to verify
- Assess earnings excluding the unusual 2012 deferred-tax benefit, and whether mortgage-loan sale gains and related origination expenses are sustainable.
- Track the allowance, charge-offs, nonperforming loans, OREO, and performance of the growing indirect consumer and construction portfolios.
- Monitor concentration in a small number of home-improvement dealers, California lending, regional borrowers, and brokered deposits.
- Review the effects of interest rates on mortgage production, warehouse lending, securities values, and net interest margin.
- Confirm capacity to fund $130.1 of commitments while managing deposit maturities, borrowings, and regulatory capital.