FS Bancorp, Inc. — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. FS Bancorp is the holding company for 1st Security Bank of Washington, a community bank focused primarily on the Puget Sound region. The financial statements were audited by Moss Adams LLP, which issued an unqualified opinion.
Financial performance and condition
| Metric | 2016 | 2015 |
|---|---|---|
| Total assets, year-end | $827.9 million | $677.6 million |
| Loans receivable, net, year-end | $593.3 million | $502.5 million |
| Deposits, year-end | $712.6 million | $485.2 million |
| Net interest income | $33.9 million | $28.0 million |
| Net income | $10.5 million | $8.9 million |
| Diluted earnings per share | $3.51 | $2.93 |
| Net interest margin | 4.43% | 5.01% |
| Return on assets / return on equity | 1.31% / 13.84% | 1.52% / 12.73% |
- Net income rose 18.3%. Net interest income increased 20.7%, while noninterest income grew 34.0% to $23.6 million, including $19.1 million of gains on loan sales.
- Interest expense increased 13.8% to $4.2 million. The average yield on interest-earning assets fell from 5.67% to 4.97%; management attributed the lower margin primarily to growth in diversified, lower-yielding assets.
- Noninterest expense rose 31.3% to $38.9 million, reflecting growth, the branch acquisition, staffing and loan-production costs. The efficiency ratio increased to 67.8% from 65.0%.
- Cash flows: operating activities provided $3.6 million, investing activities provided $53.3 million, and financing activities used $44.8 million; cash and cash equivalents increased $12.0 million. Investing cash flow included $180.4 million received in the branch transaction. The cash-flow statement’s $47.1 million net deposit increase excludes the acquired deposits, so it does not equal the full balance-sheet deposit increase.
- Year-end debt comprised $12.7 million of borrowings and $9.8 million net subordinated debt, down from $108.6 million combined in 2015, principally as acquired-branch cash was used to repay FHLB advances. The subordinated note has $10.0 million principal, a 6.50% rate and an October 2025 maturity.
- Liquidity included $36.5 million cash and cash equivalents, $177.5 million of unused FHLB borrowing capacity, an $85.9 million Federal Reserve borrowing line and $40.0 million of Fed Funds lines, none outstanding at year-end. Brokered deposits were $47.1 million, or 6.6% of deposits.
- Stockholders’ equity was $81.0 million; book value per common share was $28.32. The Bank was well capitalized, with a 13.87% total risk-based capital ratio and 10.33% leverage ratio.
Material changes and business developments
- In January 2016, the Bank acquired four Bank of America branches on the Olympic Peninsula, assuming $186.4 million of deposits. About $162.2 million of those deposits remained at year-end. The acquisition added $2.3 million goodwill and a $2.2 million core deposit intangible.
- Total assets increased 22.2%, loans receivable net increased 18.1%, and deposits increased 46.9%. The loan mix continued shifting toward real estate and commercial lending: real estate loans were 54.8% of gross loans versus 53.3% in 2015; consumer loans were 28.9% versus 31.0%.
- Mortgage production expanded: the Company originated $770.2 million of one-to-four-family mortgages and sold $711.7 million during 2016. Loans serviced for others reached $977.1 million, and servicing rights had a carrying value of $8.5 million and estimated fair value of $11.7 million.
- Credit quality was mixed. Nonperforming loans declined to $721,000 from $1.0 million, and nonperforming assets were 0.09% of assets. However, classified substandard assets increased to $8.0 million from $3.0 million, largely due to downgrades of commercial lines of credit. The allowance was $10.2 million, or 1.69% of gross loans, versus $7.8 million, or 1.52%.
Outlook, risks and unusual items
- No quantified earnings or growth guidance is provided. Management’s stated strategy is to diversify lending and revenue, grow commercial and residential lending, maintain asset quality, expand core relationship deposits and selectively expand markets.
- Key exposures include consumer and indirect home-improvement lending, dependence on a small number of dealers (four generated 50.5% of indirect home-improvement loan volume), California solar lending, and growing commercial real estate, construction and commercial business portfolios. Construction loans included $57.0 million of speculative one-to-four-family projects.
- Management highlighted sensitivity to interest rates, deposit retention and funding costs, mortgage production and sale economics, real estate values, local economic conditions, competition, regulatory changes, cyber and third-party operational risks, and the ability to manage growth and integrate acquired branches.
- The allowance for loan losses is based on estimates and may require adjustment. The Company expects the CECL standard, effective for it after December 15, 2019, to increase the allowance, but had not quantified the effect. The 2016 net gain on loan sales included $3.1 million of derivative fair-value gains, compared with $1.9 million in 2015.
- Commitments to extend credit totaled $255.0 million. Reserves for potential losses on unfunded commitments were $179,000. Reserves for loan-sale repurchase and indemnification exposure were $955,000. Management said ordinary-course legal claims were not expected to materially affect financial position and reported no material pending legal actions.
- The Company paid $0.36 per share in 2016 dividends and repurchased approximately 198,000 shares for $4.9 million. Future dividends are not assured and depend on earnings, capital, regulatory limits and other conditions.
Important facts for investors to verify
- Whether the acquired branches retain deposits and produce earnings sufficient to offset integration costs and intangible amortization.
- Whether the rise in substandard commercial exposures leads to higher delinquencies, charge-offs or provisions, especially as commercial and construction lending grows.
- Whether mortgage-sale gains, including derivative valuation effects, and servicing-right valuations are sustainable under changing rates and prepayment behavior.
- How deposit costs, brokered funding and liquidity evolve if rates rise or acquired deposits leave; also verify capacity to meet $83.9 million of certificates maturing in 2017 and $255.0 million of credit commitments.
- Whether the loan-loss allowance remains adequate as the portfolio expands and CECL implementation approaches; monitor capital ratios, dividends and repurchases against regulatory and growth needs.