FS Bancorp, Inc. — Q1 2020 Form 10-Q
Business context and reporting period. The filing covers the three months ended March 31, 2020, for FS Bancorp and its subsidiary, 1st Security Bank of Washington. The community bank operates in Washington, with commercial and consumer banking and home lending businesses. Results reflect the early effects of the COVID-19 pandemic.
Financial results and position
- Profit and revenue: Net income was $5.17 million, compared with $5.19 million in Q1 2019. Diluted EPS was $1.14 versus $1.15. Interest income was $21.95 million and noninterest income was $8.89 million.
- Net interest and margins: Net interest income declined 1.2% to $17.47 million. Net interest margin fell 40 basis points to 4.30% from 4.70%; the net interest rate spread declined to 3.94% from 4.34%.
- Credit costs: The loan-loss provision rose to $3.69 million from $750,000. Net charge-offs were $43,000, versus $1.25 million in Q1 2019. The allowance was $16.87 million, or 1.20% of gross loans excluding loans held for sale, versus $13.23 million, or 0.98%, at year-end 2019.
- Expenses and efficiency: Noninterest expense increased 9.4% to $16.18 million. The efficiency ratio improved to 61.39% from 66.52%, reflecting higher noninterest income.
- Balance sheet: Total assets increased 7.8% from year-end to $1.85 billion. Net loans were $1.39 billion, loans held for sale were $115.63 million, and available-for-sale securities were $156.47 million. Deposits rose to $1.45 billion from $1.39 billion; borrowings increased to $159.11 million from $84.86 million. Stockholders’ equity was $200.83 million.
- Cash flow: Cash and cash equivalents ended at $48.92 million, up $3.14 million during the quarter. Operating cash flow was negative $29.98 million and investing cash flow was negative $88.96 million; financing cash flow was positive $122.08 million, including net deposit growth and borrowing activity.
- Liquidity and capital: The Bank reported $356.6 million of unused FHLB borrowing capacity and $160.3 million of Federal Reserve borrowing capacity; no Federal Reserve or correspondent federal-funds advances were outstanding. The Bank’s Tier 1 leverage ratio was 11.3% and it qualified as well capitalized under the Community Bank Leverage Ratio framework.
Material changes versus the prior comparable period
- Net income was nearly flat despite a $2.94 million increase in the loan-loss provision and a $1.39 million increase in noninterest expense.
- Noninterest income rose 95.2% to $8.89 million, driven by higher mortgage loan-sale gains and a one-time $1.5 million gain from the sale of Visa Class B shares. Mortgage loan-sale gains were $5.90 million versus $2.40 million.
- Net interest income decreased $216,000, as the lower yield on earning assets more than offset lower borrowing costs. Average earning-asset yield fell to 5.40% from 5.93%.
- Mortgage production and refinancing increased substantially: one-to-four-family originations were $285.6 million, up 98.8%, and loan sales were $212.4 million versus $130.9 million.
- Loan balances and deposits grew, while borrowings increased by $74.3 million from year-end. The Company repurchased 136,243 shares for $5.0 million during the quarter.
Outlook, commentary, risks and unusual items
- Management expected COVID-19 and the reduction in market interest rates to adversely affect net interest income and margin in 2020 and possibly longer. It anticipated higher borrower hardship, delinquencies, defaults and credit losses as the economic effects developed.
- At March 31, the Bank had modified 66 loans totaling $12.5 million. Separately, as of May 5, 2020, it reported $59.1 million of serviced one-to-four-family loans and $20.7 million of portfolio loans in forbearance, plus $8.2 million of consumer loans under skip-pay or interest-deferral arrangements.
- As of May 5, the Bank reported 433 PPP approvals and 414 fundings, with more than $72 million funded. It had borrowed $63.3 million through the Federal Reserve’s PPP Liquidity Facility and reported $9.6 million of additional capacity.
- Management downgraded $84.4 million of loans by industry exposure to COVID-19: $76.3 million to Watch, $6.8 million to Special Mention and $1.3 million to Substandard. The filing cautions that the pandemic’s duration and economic impact were uncertain.
- Other notable items included $514,000 of servicing-rights impairment, associated with mortgage prepayments and valuation changes, and the one-time Visa share-sale gain. Management warned that worsening economic conditions could require additional loan-loss provisions or goodwill impairment.
- Contingencies include $505.1 million of commitments to extend credit and loan-sale representations and warranties. Management stated that no material legal actions were pending at March 31, 2020.
Most important facts for investors to verify
- Whether the sharp increase in the provision and COVID-related risk-rating downgrades translate into higher delinquencies, charge-offs or further reserve needs.
- How much of reported earnings and noninterest income depends on mortgage activity and the nonrecurring $1.5 million Visa gain.
- Whether the increase in borrowings, alongside deposit trends and $505.1 million of credit commitments, changes the Bank’s liquidity or funding costs.
- How PPP loan performance, forgiveness, facility funding and potential SBA guarantee or litigation issues develop.
- Whether loan forbearance borrowers resume payments and how the pandemic affects mortgage servicing-rights values, net interest margin and capital.