FS Bancorp, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; balance sheet comparisons are with December 31, 2018. FS Bancorp is the holding company for 1st Security Bank of Washington, a community bank serving Washington and operating home-lending and consumer-lending businesses. The November 2018 Anchor Bancorp acquisition materially enlarged the company; year-over-year comparisons therefore include a larger combined company in 2019 and are not purely organic.
Financial performance and condition
| Metric | Q1 2019 / March 31, 2019 | Comparable period / prior year-end |
|---|---|---|
| Interest income | $22.3 million | $13.0 million in Q1 2018 |
| Net interest income | $17.7 million | $11.5 million in Q1 2018 |
| Provision for loan losses | $0.75 million | $0.35 million in Q1 2018 |
| Noninterest income | $4.6 million | $5.0 million in Q1 2018 |
| Noninterest expense | $14.8 million | $11.0 million in Q1 2018 |
| Net income | $5.2 million; diluted EPS $1.15 | $4.3 million; diluted EPS $1.15 in Q1 2018 |
| Net interest margin | 4.70% | 4.76% in Q1 2018 |
| Efficiency ratio | 66.5% | 66.8% in Q1 2018 |
| Total assets | $1.626 billion | $1.622 billion at December 31, 2018 |
| Loans receivable, net | $1.284 billion | $1.313 billion at December 31, 2018 |
| Deposits | $1.322 billion | $1.274 billion at December 31, 2018 |
| Borrowings | $86.8 million | $137.1 million at December 31, 2018 |
| Stockholders’ equity | $186.0 million | $180.0 million at December 31, 2018 |
Interest expense rose to $4.6 million from $1.5 million in Q1 2018. The average cost of funds increased to 1.60% from 0.86%; management attributed margin pressure primarily to higher deposit and borrowing costs. The effective tax rate was 22.5%, versus 15.8%.
Cash and cash equivalents ended the quarter at $63.1 million, up $30.3 million. Operating cash flow was $6.9 million, investing cash flow was positive $27.4 million, and financing cash flow was negative $4.0 million. The filing reports $6.8 million of unrestricted cash at the holding company.
At March 31, gross loans were $1.297 billion and the allowance for loan losses was $11.8 million, or 0.9% of gross loans excluding loans held for sale. Nonperforming loans were $3.0 million (0.2% of gross loans), down from $3.9 million (0.3%) at year-end. The quarter included $1.3 million of net charge-offs, mainly a $1.2 million commercial line-of-credit charge-off.
The Bank was reported as well capitalized: total risk-based capital was 14.73%, Tier 1 risk-based capital 13.81%, Tier 1 leverage 11.01%, and common equity Tier 1 13.81%. The Bank had $337.2 million of unused FHLB borrowing capacity; no Federal Reserve line or correspondent federal-funds lines were drawn. Brokered deposits were $129.7 million, within the stated policy limit of 20% of deposits.
Material changes and management commentary
- Net income increased 20.1% year over year. Management attributed the improvement chiefly to a $6.2 million increase in net interest income, partially offset by higher provision, operating costs, and taxes.
- Average loans rose substantially year over year, largely reflecting the Anchor acquisition. Interest income benefited from loan growth and a higher average loan yield; deposit and borrowing costs rose faster, and NIM declined six basis points.
- Compared with year-end, deposits increased $47.3 million while borrowings fell $50.3 million, primarily as deposit growth funded repayment of FHLB funding. Net loans declined $28.6 million, including lower construction and warehouse lending, partly offset by growth in consumer and one-to-four-family loans.
- Noninterest income declined $0.5 million year over year, principally because gains on loan sales were lower, partly offset by increased service charges and fees. Noninterest expense increased $3.8 million, including acquisition/integration costs and higher staffing, operations, data processing, and occupancy expenses. Integration of Anchor’s core processing platform was scheduled for Q2 2019.
- Management’s stated priorities include diversifying and growing lending, maintaining asset quality, building lower-cost relationship deposits, and expanding the company’s markets. Management said construction and development lending was expected to remain an important portfolio component, while emphasizing disciplined lending to known builders and developers in its markets. No numerical earnings or balance-sheet guidance was provided.
Outlook, risks, contingencies, and unusual items
- Management cautioned that Q1 results are not necessarily indicative of full-year or future results. Forward-looking risks include Anchor integration and realization of expected benefits, credit quality and regional real estate conditions, interest-rate and funding-cost changes, loan-sale market conditions, competition, deposit retention, operating costs, growth execution, regulation, and technology or third-party service disruptions.
- Credit concentration merits attention: four of 94 active indirect home-improvement dealers generated 47.2% of funded loan volume. The company funded $27.6 million of consumer loans in the quarter.
- Outstanding commitments to extend credit totaled $301.0 million. Other exposures include loan-sale repurchase/indemnification obligations, a $1.0 million reserve for related guarantees, and limited recourse obligations on loans sold to the FHLB. Management reported no material pending legal actions and said ordinary-course claims were not expected to materially affect financial condition.
- The company adopted lease accounting on January 1, 2019, recording $4.8 million of operating-lease right-of-use assets and $5.0 million of lease liabilities. The company was evaluating the upcoming CECL credit-loss standard and anticipated an increase in its allowance through a one-time retained-earnings adjustment; the amount was not yet known.
- Available-for-sale securities had $0.9 million of unrealized losses at quarter-end. Management considered these temporary, cited no intent or expected requirement to sell before maturity, and recorded no other-than-temporary impairment.
- The quarter included a $1.2 million commercial credit charge-off, $0.4 million of acquisition costs, and $0.085 million gain on sale of OREO. The $7.4 million bargain-purchase gain from the Anchor acquisition was recorded in 2018, not Q1 2019.
Important facts for investors to verify
- How much of the year-over-year earnings and balance-sheet growth reflects the Anchor acquisition versus underlying organic performance, and whether integration proceeds as planned.
- Whether higher deposit costs and borrowing costs continue to pressure NIM, and whether management achieves its stated goal of growing lower-cost relationship deposits.
- Credit performance following the large commercial line-of-credit charge-off, including trends in classified loans, delinquency, net charge-offs, and the adequacy of the allowance.
- Exposure to indirect consumer lending and dealer concentration, as well as construction, commercial real estate, and warehouse lending commitments.
- The impact and timing of CECL adoption; the filing did not quantify the expected allowance increase.
- Liquidity and funding mix, including brokered-deposit reliance, upcoming certificate maturities, and availability of borrowing capacity.