FS Bancorp, Inc. — Q2 2020 Form 10-Q
Business context and period. FS Bancorp is the holding company for 1st Security Bank of Washington, a community bank serving the Puget Sound region and other Western markets. It operates commercial and consumer banking and home lending businesses. This unaudited filing covers the quarter and six months ended June 30, 2020; amounts below are in millions unless stated otherwise.
Financial performance and condition
- Q2 earnings: Net income was $10.0 million, versus $4.5 million in Q2 2019; diluted EPS was $2.30 versus $0.98. Six-month net income was $15.2 million versus $9.7 million; diluted EPS was $3.42 versus $2.12.
- Revenue and margins: Q2 net interest income increased to $17.9 million from $17.5 million, but net interest margin fell to 3.91% from 4.60%. For the first half, net interest income was $35.3 million versus $35.2 million and margin was 4.09% versus 4.65%. Lower asset yields, elevated cash balances, rate cuts, and lower-yielding PPP loans weighed on margin; lower deposit and borrowing costs partly offset this.
- Credit costs: Loan-loss provision was $4.6 million in Q2 and $8.3 million for the first half, compared with $0.9 million and $1.7 million in the respective 2019 periods. The allowance was $21.5 million, or 1.47% of gross loans excluding loans held for sale, versus $13.2 million, or 0.98%, at year-end 2019. Nonperforming loans rose to $7.9 million (0.54% of gross loans) from $3.0 million (0.22%).
- Noninterest income and expenses: Q2 noninterest income rose to $14.1 million from $6.1 million, mainly on loan-sale gains of $13.4 million versus $3.6 million. First-half noninterest income was $23.0 million versus $10.6 million, including a $1.5 million one-time Visa stock sale. Noninterest expense fell to $14.6 million in Q2 from $17.1 million and to $30.8 million for the first half from $31.9 million. The efficiency ratio improved to 45.71% for Q2 and 52.79% for the first half, from 72.28% and 69.49%.
- Balance sheet and funding: Assets grew 17.3% from year-end to $2.01 billion. Net loans were $1.44 billion; loans held for sale were $139.4 million. Deposits increased to $1.61 billion from $1.39 billion. Borrowings were $150.3 million, including $63.0 million under the PPP Liquidity Facility; the subordinated note was $9.9 million. Cash and cash equivalents totaled $126.1 million, up from $45.8 million at year-end.
- Cash flow: For the six months, operating cash flow was negative $36.6 million, reflecting substantial mortgage-loan originations for sale; investing cash flow was negative $152.8 million, and financing cash flow was positive $269.7 million, primarily from deposit growth and net borrowings. Cash increased $80.3 million to $126.1 million.
- Capital and shareholder returns: Bank Tier 1 leverage ratio was 10.8%, and the Bank reported it was well capitalized under the elected community bank leverage ratio framework. Equity was $208.6 million. The company repurchased 223,398 shares for approximately $8.6 million during the first half and paid $1.8 million in dividends.
Material changes versus comparable periods
- Mortgage banking activity expanded sharply: first-half one-to-four-family originations were $764.0 million versus $351.7 million, and loan-sale gains reached $19.3 million versus $6.0 million. Loans sold during the first half were $639.4 million versus $304.3 million.
- Credit provisioning increased materially amid COVID-19 uncertainty. Management identified $126.8 million of loans in potentially affected industries and reported pandemic-related risk downgrades, including $108.5 million to Watch, $11.8 million to Special Mention, and $6.5 million to Substandard.
- Funding and liquidity expanded: deposits rose by $214.5 million and borrowings by $65.4 million from year-end. The Bank reported $480.0 million of unused FHLB capacity, a $159.5 million FRB line, and $101.0 million of correspondent federal-funds lines; no FRB or federal-funds advances were outstanding at June 30.
- Servicing-rights impairment increased: $0.8 million in Q2 and $1.3 million for the first half, versus $0.1 million and $0.1 million in 2019, respectively. The filing attributes pressure to lower rates and higher mortgage payoffs.
Outlook, risks, and contingencies
- Management expects net interest income and margin to be adversely affected in 2020 and potentially longer, given low rates, increased cash balances, loan repricing, and pandemic effects. The filing gives no numerical earnings or margin guidance.
- The Bank had modified 355 portfolio loans totaling $103.6 million under COVID-19 relief programs through June 30; most involved short-term payment deferrals or interest-only periods. Separately, the company had funded 463 PPP loans totaling $75.3 million. Management anticipated additional modifications in Q3 and warned that delinquencies, defaults, and credit losses could rise.
- Loan commitments totaled $536.8 million. The company also had limited-recourse exposure on certain sold loans and a $1.5 million reserve for loan-sale representations and warranties. Management reported no material pending legal actions and considered ordinary-course legal liabilities not material.
- Key risks include pandemic duration and recovery, borrower performance and collateral values, loan-sale market conditions, interest-rate and LIBOR transition risks, deposit retention, mortgage servicing-rights valuations, and possible goodwill impairment if adverse economic and market conditions persist. Management said disclosure controls were effective and reported no significant Q2 change in internal control over financial reporting.
Important facts for investors to verify
- Whether modified borrowers resume contractual payments and whether pandemic-related downgrades translate into higher nonperforming loans, charge-offs, or allowance needs.
- Whether mortgage origination volumes and loan-sale gains remain sustainable, and how refinancing activity affects servicing-rights values and impairment.
- How deposit growth, cash balances, brokered deposits, and PPPLF/FHLB funding evolve, including the effect on funding costs and net interest margin.
- PPP loan forgiveness processing, related fee recognition, and repayment of PPPLF advances as PPP loans are forgiven or repaid.
- The effect of economic conditions on capital, goodwill, and the company’s ability to maintain its stated well-capitalized status.