FS Bancorp, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. FS Bancorp is the holding company for 1st Security Bank of Washington, a community bank concentrated in the Puget Sound region. Amounts below are in millions unless otherwise stated.
Business context and material developments
On January 22, 2016, the Bank acquired four Bank of America branches on Washington’s Olympic Peninsula, assuming $186.4 million of deposits. About $171.3 million of those deposits remained at June 30. The transaction added $2.3 million of goodwill and a $2.2 million core deposit intangible.
The Bank originates real estate, consumer, and commercial business loans, as well as residential mortgages for sale. Its consumer portfolio includes indirect home-improvement and solar lending; mortgage banking income is an important revenue source.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net interest income | $8.1 | $6.9 | $15.9 | $13.2 |
| Provision for loan losses | $0.6 | $0.6 | $1.2 | $1.2 |
| Noninterest income | $6.6 | $5.3 | $10.9 | $9.3 |
| Noninterest expense | $9.6 | $7.3 | $18.5 | $13.9 |
| Net income | $2.8 | $2.8 | $4.5 | $4.9 |
| Diluted EPS | $0.96 | $0.93 | $1.50 | $1.63 |
- Q2 net income was essentially unchanged. Higher net interest income and noninterest income were largely offset by a 32.3% increase in noninterest expense. First-half net income declined 7.6%, primarily because expenses rose 33.5%.
- Net interest margin fell to 4.34% from 5.14% in Q2 and to 4.26% from 5.12% for the first half. Management attributed the pressure to higher overnight cash and growth in lower-yielding real estate and commercial loans. Lower funding costs partly offset reduced asset yields.
- Loan-sale gains were $5.4 million in Q2 and $8.8 million for the first half. Service charges and fees also increased, partly reflecting the acquired branches and growth in loans serviced.
Financial position, cash flow, and asset quality
- At June 30, total assets were $783.9 million, up 15.7% from year-end 2015. Net loans were $550.1 million, up 9.5%; loans held for sale were $63.7 million, and available-for-sale securities were $97.7 million.
- Deposits increased 37.3% to $666.1 million, largely due to the branch acquisition. Borrowings fell to $19.7 million from $98.8 million as acquisition-related cash was used to repay FHLB advances. Including the $9.8 million subordinated note, debt was approximately $29.5 million.
- Cash and cash equivalents were $14.9 million, down from $24.5 million at year-end. First-half operating cash flow was negative $15.1 million; investing cash flow was positive $89.3 million, including $180.4 million net cash received in the branch acquisition; financing cash flow was negative $83.8 million.
- The allowance for loan losses was $9.0 million, or 1.6% of gross loans excluding loans held for sale. First-half net charge-offs were $34,000. Nonperforming loans were $620,000 (0.1% of gross loans), down from $1.0 million at year-end. Substandard loans were $3.1 million.
- Stockholders’ equity was $76.1 million; book value per share was $26.73. The Company repurchased about 192,000 shares in the first half for $4.9 million and paid $0.17 per share in dividends.
- The Bank reported well-capitalized ratios at June 30: 10.1% Tier 1 leverage, 12.8% Tier 1 risk-based, 14.0% total risk-based, and 12.8% CET1. Unused FHLB borrowing capacity was $159.4 million; additional Federal Reserve and correspondent lines were available. Outstanding loan commitments totaled $285.1 million.
Outlook, commentary, and risks
The filing provides no specific earnings or financial guidance. Management’s stated priorities are to diversify and grow lending, maintain asset quality, expand lower-cost relationship deposits, and develop customer relationships. Management said the branch purchase expanded its Olympic Peninsula footprint and that it would continue expanding home lending and selling residential mortgages into the secondary market.
- Acquisition-related costs, higher staffing and operating costs, core deposit intangible amortization, and servicing-rights impairment weighed on expense growth. First-half acquisition costs were $389,000; Q2 included a $150,000 gain on disposal of OREO.
- Credit, regional economic, interest-rate, deposit-retention, mortgage secondary-market, integration, and expense-control risks are identified. Four contractors/dealers accounted for 53.7% of Q2 indirect home-improvement loan funding; California solar exposure was $33.1 million, within management’s stated concentration limit.
- Servicing-rights values are sensitive to prepayment assumptions; the Company recorded $214,000 of servicing-rights impairment in the first half. Mortgage loan repurchase/indemnification reserves were $700,000.
- Commitments include $285.1 million to extend credit. Management reported no material pending legal actions and said there were no material changes to the risk factors in the 2015 Form 10-K. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether acquired deposits remain stable and the branch transaction delivers expected relationship growth and operating benefits.
- Whether net interest margin stabilizes as the loan and securities mix changes, and how rate movements affect funding costs and asset yields.
- Whether elevated expense growth moderates and improves the efficiency ratio, which increased to 65.6% for Q2 and 69.2% for the first half.
- Trends in commercial borrower grades, consumer loan losses, California solar exposure, contractor/dealer concentration, and the adequacy of the allowance.
- Mortgage origination and sale volumes, servicing-rights valuation, and potential repurchase claims; also monitor liquidity against deposit maturities and outstanding commitments.