FS Bancorp, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; balance sheet comparisons are to December 31, 2017. FS Bancorp is the holding company for 1st Security Bank of Washington, a community bank serving the Puget Sound region, with commercial and consumer banking and home lending segments. Amounts below are in millions unless noted.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Interest income | $14.0 | $11.1 | $27.0 | $21.2 |
| Net interest income | $11.9 | $10.0 | $23.4 | $18.9 |
| Provision for loan losses | $0.45 | $0 | $0.80 | $0 |
| Noninterest income | $5.6 | $7.0 | $10.6 | $12.4 |
| Noninterest expense | $12.1 | $10.9 | $23.2 | $21.3 |
| Net income | $4.26 | $4.36 | $8.58 | $6.95 |
| Diluted EPS | $1.13 | $1.41 | $2.28 | $2.25 |
| Net interest margin | 4.58% | 4.63% | 4.66% | 4.59% |
- Q2 net income fell 2.3% year over year, while first-half net income increased 23.4%. First-half diluted EPS rose from $2.25 to $2.28; basic EPS was $2.40 in both periods.
- Q2 margin narrowed five basis points as higher-cost time deposits and borrowings funded asset growth. First-half margin improved seven basis points, supported by a larger share of higher-yielding loans.
- At June 30, assets were $1.133 billion, up 15.4% from year-end. Net loans were $881.2 million, up 15.7%; available-for-sale securities were $98.5 million.
- Deposits were $870.1 million, up $40.3 million from year-end. Borrowings increased to $106.5 million from $7.5 million, primarily to fund short-term business lending and growth.
- Stockholders’ equity was $129.4 million, versus $122.0 million at year-end. Book value per share was $35.94, versus $34.47.
- First-half operating cash flow was $12.4 million, versus $1.7 million in 2017; investing cash outflow was $148.0 million and financing cash inflow was $138.7 million. Cash and cash equivalents ended at $22.0 million.
Material changes and asset quality
- Gross loans grew across commercial business, real estate, and consumer categories. Commercial business loans increased $52.9 million and consumer loans increased $31.2 million from year-end; construction and development lending was a significant part of real estate growth.
- The allowance for loan losses was $11.6 million, or 1.3% of gross loans excluding loans held for sale, compared with $10.8 million, or 1.4%, at year-end. First-half net recoveries were $15,000, compared with $68,000 of net charge-offs in the prior-year period.
- Nonperforming loans were $627,000, or 0.1% of gross loans, down from $1.0 million at year-end. Substandard loans were $5.8 million, down from $6.5 million. No other real estate owned was reported.
- Q2 noninterest income declined mainly because the prior-year quarter included a $958,000 gain on sale of mortgage servicing rights and a $237,000 securities-sale gain. Q2 salaries and benefits rose $755,000 year over year. The Q2 efficiency ratio increased to 69.2% from 64.7%; the first-half ratio was 68.1% in both years.
- The effective tax rate was 13.9% in Q2 and 14.9% for the first half, compared with 27.1% and 30.5% in 2017. The filing attributes the reduction to the lower federal corporate tax rate and tax benefits from stock-based compensation accounting.
Liquidity, capital, outlook and risks
- Management reported $132.8 million of unused FHLB borrowing capacity; the Bank also had a $108.6 million Federal Reserve line and $43.0 million of correspondent Fed Funds lines, with no amounts outstanding on those latter facilities. Parent-company unrestricted cash was $5.2 million.
- Brokered deposits totaled $90.6 million. The Bank’s policy permits brokered deposits up to 20% of deposits, or $175.1 million at quarter-end. Loan commitments, including unused lines, totaled $279.5 million; certificates of deposit maturing within three months totaled $60.7 million.
- The Bank was classified as well capitalized. At June 30, its total risk-based capital ratio was 15.57%, Tier 1 leverage ratio 12.23%, and CET1 ratio 14.32%. Management gave no numeric earnings guidance.
- Management expects construction and development lending to remain a strong part of the loan portfolio and says it will continue a disciplined approach focused on known local builders and developers. Its stated priorities include diversified loan growth, asset quality, lower-cost core deposits, and market expansion.
- On July 17, 2018, the Company agreed to acquire Anchor Bancorp for approximately $77 million in stock and cash, subject to regulatory and shareholder approvals and other closing conditions. The expected closing was Q4 2018 or early Q1 2019. Anchor reported $469.6 million in assets, $397.4 million in loans, and $359.0 million in deposits at June 30; its shareholders would own approximately 16% of the combined company. The filing cautions that approvals, integration, expected synergies, and transaction timing are uncertain.
- Other risks include interest-rate and funding-cost changes, loan and real-estate credit conditions, loan-sale market conditions, deposit retention, growth and expense management, and reliance on indirect-lending dealer relationships. Ten dealers generated 65% of Q2 indirect home-improvement loan funding by dollar volume.
- The Company recorded no material pending legal actions and stated that there were no material changes to previously disclosed risk factors or market-risk disclosures. Management concluded disclosure controls were effective and reported no significant quarterly changes in internal control over financial reporting.
Important facts for investors to verify
- Whether loan and deposit growth can be sustained without further margin compression as funding costs rise.
- Credit performance and allowance adequacy as the portfolio expands, particularly in commercial business, construction, consumer, and indirect home-improvement lending.
- Liquidity and funding mix, including the increase in borrowings, brokered deposits, and near-term certificate maturities.
- Completion terms, regulatory and shareholder approvals, integration costs, and realized benefits of the Anchor Bancorp acquisition.
- Exposure to dealer concentration and mortgage banking volumes, servicing-right valuations, and secondary-market conditions.