FS Bancorp, Inc. — Q3 2021 Form 10-Q
Business context and period. FS Bancorp is the holding company for 1st Security Bank of Washington, a community bank serving Western Washington and the Tri-Cities, with home-lending and commercial and consumer banking segments. This unaudited quarterly report covers the three and nine months ended September 30, 2021; balance-sheet comparisons are to December 31, 2020. Amounts below are in millions unless otherwise noted.
Financial performance and position
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Interest income | $25.0 | $22.2 | $71.6 | $65.9 |
| Net interest income | $22.7 | $18.9 | $64.0 | $54.3 |
| Provision for loan losses | $0 | $3.1 | $1.5 | $11.4 |
| Noninterest income | $8.4 | $17.5 | $29.6 | $40.6 |
| Noninterest expense | $20.0 | $17.2 | $55.3 | $48.0 |
| Net income | $8.3 | $12.7 | $28.8 | $27.9 |
| Diluted EPS | $0.97 | $1.47 | $3.30 | $3.19 |
| Net interest margin | 4.23% | 3.92% | 4.11% | 4.03% |
| Efficiency ratio | 64.46% | 47.11% | 59.07% | 50.61% |
Balance sheet and liquidity at September 30, 2021: Assets were $2.23 billion, up $115.5 million from year-end 2020. Net loans were $1.68 billion, up $133.1 million; deposits were $1.86 billion, up $189.6 million. Cash and cash equivalents were $28.3 million, down from $91.6 million. Available-for-sale securities were $268.8 million, compared with $178.0 million at year-end.
Borrowings declined to $42.5 million from $165.8 million; subordinated notes increased to $49.4 million net of issuance costs, following issuance of $50 million principal notes and repayment of $10 million of prior notes. Stockholders’ equity was $240.5 million. The Bank’s CBLR leverage ratio was 11.9% and it was categorized as well capitalized. Unused FHLB borrowing capacity was $457.4 million; total borrowing capacity was $505.8 million. The company reported $18.0 million of unrestricted holding-company cash.
Cash flow for the first nine months: Operating activities provided $99.5 million, investing activities used $250.0 million, and financing activities provided $87.2 million. Cash and cash equivalents decreased $63.2 million to $28.3 million. Operating cash flow includes substantial mortgage-loan originations and sale proceeds.
Material changes versus comparable periods
- Quarterly net income declined to $8.3 million from $12.7 million, chiefly as loan-sale gains fell $9.3 million and expenses rose $2.8 million. Lower credit-loss provision and higher net interest income partly offset those pressures.
- Nine-month net income increased modestly to $28.8 million from $27.9 million. Net interest income rose $9.7 million and the loan-loss provision fell $9.9 million, but noninterest income declined $11.0 million and expenses increased $7.3 million.
- Loan-sale gains were $6.9 million in Q3 versus $16.2 million a year earlier, reflecting reduced refinance volume and lower home-loan sale margins. Nine-month gains were $25.0 million versus $35.5 million.
- Average funding costs fell and net interest margin improved year over year. For the nine-month period, however, average earning-asset yield declined to 4.59% from 4.89%; lower funding costs more than offset that decline in net interest income.
- The loan portfolio expanded, particularly in one-to-four-family, multifamily, construction and development, and indirect home-improvement lending. Commercial business loans contracted, partly because PPP balances declined.
Outlook, commentary, risks, and unusual items
- Management said the low-rate environment and COVID-19-related uncertainty could continue to pressure net interest income and margin during 2021 and possibly longer. The filing gives no quantified earnings or revenue guidance.
- Management attributed lower loan-loss provisioning to improved economic factors and improvements in previously watch-classified loans. The allowance was $26.9 million, or 1.57% of gross loans excluding loans held for sale, versus $26.2 million, or 1.66%, at year-end 2020. Nonperforming loans were $5.9 million, or 0.35% of gross loans, down from $7.8 million, or 0.49%.
- COVID-19 payment-relief agreements remained on $6.9 million of commercial real estate loans and $5.4 million of commercial business loans. Of the latter, $4.5 million was nonaccrual but current on contractual payments. No loans were reported as TDRs.
- Mortgage banking remains an important source of fee income, but results are exposed to refinance and housing-market volumes, sale pricing, and mortgage-servicing-right valuations. Servicing rights’ reported fair value was $24.9 million; management cautioned that assumptions about prepayments and interest rates make the estimate sensitive.
- Other material risks identified include credit deterioration, economic and real-estate conditions, interest-rate changes, deposit retention and competition, execution of growth plans, operating expenses, and technology or third-party disruptions. The company reported no material change in previously disclosed risk factors and no material pending legal actions.
- During the first nine months, the company repurchased 486,195 shares for $12.7 million at an average $34.43 per share and paid $3.4 million in dividends. A new repurchase authorization permits up to $10 million of purchases through June 30, 2022, in addition to remaining authorization under the prior plan. A two-for-one stock split took effect July 14, 2021.
- The company noted a correction to diluted EPS reported in its October 28, 2021 press release: nine-month 2021 diluted EPS is $3.30 after updating the stock-split-adjusted diluted share calculation, rather than the previously announced $3.27.
Important facts for investors to verify
- Whether loan-sale income and home-lending margins remain pressured as refinance activity changes, and how much earnings depend on mortgage banking.
- Trends in loan quality, especially commercial business exposures, COVID-19 relief loans, consumer charge-offs, and the allowance for loan losses.
- Deposit mix, funding costs, liquidity use, and the company’s ability to fund $570.0 million of outstanding loan commitments and lines of credit.
- Servicing-right valuation assumptions and sensitivity to prepayment speeds and interest rates; the filing estimates that a 100-basis-point adverse rate change affecting prepayment assumptions could reduce MSR fair value to $14.2 million from $24.9 million.
- The impact of higher personnel and operating costs, the share-repurchase program, subordinated debt expense, and the stated transition to CECL; the filing text describes the expected adoption timing and impact in a way investors may wish to confirm.