FS Bancorp, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. FS Bancorp is the holding company for 1st Security Bank of Washington, a community bank serving Washington and Oregon markets, with commercial and consumer banking and home lending segments. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless otherwise noted.
Financial performance
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Net interest income | $31.6 | $24.7 | $62.2 | $47.5 |
| Provision for credit losses | $0.7 | $1.9 | $2.8 | $2.9 |
| Noninterest income | $4.8 | $4.4 | $10.1 | $10.2 |
| Noninterest expense | $24.2 | $18.9 | $47.7 | $38.0 |
| Net income | $9.1 | $6.7 | $17.3 | $13.6 |
| Diluted earnings per share | $1.16 | $0.83 | $2.19 | $1.66 |
| Net interest margin | 4.66% | 4.39% | 4.68% | 4.32% |
| Efficiency ratio | 66.52% | 65.08% | 66.04% | 65.87% |
Q2 net income rose 36% year over year, supported by higher net interest income and lower provision expense, partly offset by higher operating costs. Loan interest income benefited from portfolio growth and higher rates; funding costs also rose sharply. Q2 interest expense increased to $9.3 million from $2.2 million, and the average cost of interest-bearing liabilities rose to 2.04% from 0.60%. Six-month gain on sale of loans declined to $3.4 million from $5.9 million as mortgage origination and sale volumes fell.
Financial position, cash flow and asset quality
- Scale and growth: Total assets were $2.91 billion at June 30, up $272.7 million from year-end 2022. Net loans were $2.34 billion, up $151.6 million; gross loans were $2.37 billion.
- Funding and liquidity: Deposits totaled $2.37 billion, up $237.6 million from year-end, principally reflecting the February branch purchase. Cash and cash equivalents were $132.1 million, versus $41.4 million at year-end. Six-month operating cash flow was $42.2 million, compared with $129.0 million in 2022; net cash increased $90.7 million. The company reported $598.2 million of unused FHLB capacity and a $310.7 million Federal Reserve line limit, plus $101.0 million in correspondent bank lines. The Bank Term Funding Program limit was $90.0 million and was fully drawn.
- Debt: Borrowings were $199.9 million, versus $186.5 million at year-end; subordinated notes, net of issuance costs, were $49.5 million. Q2-end borrowings included $106.0 million of overnight funding, $90.0 million from the Federal Reserve’s Term Funding Program and $3.9 million of FHLB advances.
- Credit quality: The loan allowance for credit losses was $30.4 million, or 1.28% of gross loans, compared with $28.0 million, or 1.26%, at year-end. Six-month net loan charge-offs were $1.1 million versus $0.3 million. Nonperforming loans were $9.3 million, or 0.39% of gross loans, unchanged as a percentage from year-end. Classified substandard loans declined to $16.4 million from $20.2 million.
- Capital and equity: Stockholders’ equity was $249.9 million, up from $231.7 million; book value per common share was $32.71 versus $30.42. The Bank was reported well capitalized, with Tier 1 leverage, Tier 1 risk-based, total risk-based and CET1 ratios of 10.3%, 11.7%, 12.9% and 11.7%, respectively.
- Investment securities: Available-for-sale securities had a $40.2 million pretax unrealized loss at June 30. Management attributed losses to market conditions, stated it did not intend to sell and was not likely to be required to sell before recovery or maturity, and recorded no credit impairment for the period.
Material changes and unusual items
- On February 24, 2023, the Bank acquired seven Columbia State Bank branches in Washington and Oregon, including approximately $424.9 million of deposits and $63.2 million fair value of performing loans. The transaction added $17.4 million of core deposit intangible and $1.3 million of goodwill. Acquired-branch revenue and expenses were not separately available, and acquisition fair values remain preliminary.
- The acquisition contributed to higher salaries, operating costs, FDIC insurance expense and core deposit intangible amortization. Six-month noninterest expense also included $1.6 million of acquisition costs.
- A $3.5 million C&I loan was restructured in Q1: its term was extended 60 months and its rate reduced from 7.5% to 4.1%. It was current but classified nonaccrual at June 30 and individually evaluated for its allowance.
- Q2 other comprehensive income was $0.3 million; six-month other comprehensive income was $3.2 million, principally reflecting changes in securities and hedge values. Accumulated other comprehensive loss remained $22.4 million at quarter-end.
- The quarterly dividend was $0.25 per share. The share repurchase program expired June 30, 2023; approximately $0.9 million had remained available at expiration.
Outlook, commentary and risks
The filing provides no specific earnings or financial guidance. Management says it remains focused on loan growth and diversification, asset quality, lower-cost core deposits, customer relationships and expansion of its markets. It expects to continue the current quarterly dividend practice, subject to board discretion.
Key disclosed risks include higher funding costs and deposit competition, interest-rate changes that may pressure margins or asset values, local economic deterioration and credit losses, real estate market weakness, mortgage secondary-market conditions, concentration among indirect home-improvement dealers, and execution and integration risks from the branch purchase. Management also cites inflation, a potential recession, industry-wide depositor sentiment, regulatory changes, technology and third-party disruptions, and fair-value estimation uncertainty. No material changes to previously disclosed risk factors or market-risk disclosures were reported. Management reported disclosure controls were effective and no significant quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether acquired-branch deposits remain stable and the expected revenue, expense savings and integration benefits are realized; acquired-branch standalone results were not provided.
- Deposit mix, deposit pricing and uninsured deposit exposure: uninsured deposits were $587.6 million, or 24.8% of total deposits, while certificates of deposit totaled $918.8 million.
- Loan performance and allowance assumptions, particularly rising consumer charge-offs and the nonaccrual restructured C&I loan.
- Margin sensitivity as deposit and borrowing costs reprice, including the impact of the $90.0 million Federal Reserve facility and other borrowings.
- Potential effects of the $40.2 million pretax unrealized securities loss and the company’s capacity to maintain liquidity without selling securities at a loss.
- Reliance on five dealers for 67.1% of Q2 funded indirect home-improvement loan volume, and the performance of that portfolio across its wider geographic footprint.