FS Bancorp, Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Unaudited consolidated results include 1st Security Bank of Washington. The bank operates in the Puget Sound and Tri-Cities markets and also has an indirect consumer-lending platform.
Financial results and condition
- Q3 earnings: Net income was $2.0 million, up 74% from $1.1 million; diluted EPS was $0.66 versus $0.39. For the first nine months, net income was $6.9 million, up 128%, and diluted EPS was $2.28 versus $1.00.
- Revenue and margins: Q3 net interest income rose 22% to $7.1 million; nine-month net interest income rose 27% to $20.3 million. Net interest margin was 4.97% for Q3 (down 31 basis points) and 5.06% year to date (down 5 basis points). Q3 noninterest income was $4.4 million, including $3.6 million in loan-sale gains; nine-month noninterest income was $13.7 million, including $11.6 million in loan-sale gains.
- Expenses and credit costs: Q3 noninterest expense increased 29% to $7.8 million, including $432,000 of branch-acquisition costs. The efficiency ratio improved to 68.0% from 73.8%. Loan-loss provision was $600,000 for Q3 and $1.8 million year to date; nine-month net charge-offs were $502,000.
- Balance sheet: Total assets were $642.0 million, up 25.9% from year-end 2014. Net loans were $482.6 million, up 24.6%; loans held for sale were $53.3 million. Deposits were $499.9 million, up 18.9%, and borrowings were $59.3 million, versus $17.0 million at year-end. Stockholders’ equity was $73.2 million.
- Credit quality: Allowance for loan losses was $7.4 million, or 1.5% of gross loans. Nonperforming loans were $841,000, or 0.2% of gross loans, versus $433,000 and 0.1% at year-end. Substandard loans were $2.8 million, including a $2.0 million commercial business loan downgraded due to borrower performance. The company reported no OREO.
- Cash flow and liquidity: Nine-month operating cash flow was negative $17.2 million, investing cash flow negative $114.0 million, and financing cash flow positive $121.1 million; cash and cash equivalents declined $10.1 million to $5.4 million. The bank had $66.3 million of unused FHLB borrowing capacity and additional Federal Reserve and correspondent-bank lines; no balances were outstanding on those latter lines. Approved loan commitments, including unused lines, totaled $235.3 million.
- Capital: The bank was categorized as well capitalized. At September 30, its Tier 1 leverage, Tier 1 risk-based, total risk-based, and common equity Tier 1 ratios were 11.4%, 12.6%, 13.9%, and 12.6%, respectively.
Material changes and management commentary
- Growth in lending and mortgage banking drove higher interest income and loan-sale gains. Average loans increased substantially, while the shift toward lower-yielding real estate and commercial loans pressured net interest margin; consumer loans fell to 31.5% of gross loans from 34.7% at year-end 2014.
- Management’s stated priorities include diversifying loan products and revenue, maintaining asset quality, growing lower-cost relationship deposits, and selectively expanding the franchise. No specific earnings or margin guidance was provided.
- On September 1, the bank agreed to acquire four Bank of America branches in Washington, with approximately $268 million of deposits and less than $1 million of loans. Closing was expected in Q1 2016, subject to regulatory approval and other conditions. Acquisition costs were expected to continue through that quarter.
- On October 15, after quarter-end, FS Bancorp issued a $10 million unsecured subordinated note due in 2025 at 6.5%. Net proceeds of approximately $9.8 million were intended for general working capital and operating expenses; the note is intended to qualify as Tier 2 capital.
- Key risks cited include credit deterioration, interest-rate and margin changes, mortgage secondary-market conditions, deposit retention, growth and cost management, competition, regulation, litigation, and reliance on third-party vendors. Management said there were no material changes to the risk factors in its 2014 Form 10-K. Legal matters in the ordinary course were not expected by management to have a material adverse effect.
Important facts for investors to verify
- Whether the four-branch acquisition closed on schedule, its final deposit mix and costs, and its effect on liquidity and profitability.
- Performance and collateral status of the downgraded $2.0 million commercial loan, and trends in nonperforming and substandard loans and the allowance.
- Sustainability of mortgage production and loan-sale gains, and sensitivity of servicing-rights values to prepayments and interest rates.
- Funding costs and liquidity as loans, deposits, and borrowings grow; note the $30.5 million in brokered deposits at quarter-end.
- Use and capital treatment of the post-quarter $10 million subordinated note, including any contribution of proceeds to the bank.
- Operating cash-flow movements, which were materially affected by mortgage loan originations and sales, and the company’s relatively low reported cash balance.