FS Bancorp, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; unaudited. FS Bancorp operates through 1st Security Bank of Washington, serving the Puget Sound region and other Western markets. Its principal businesses are commercial and consumer banking and home lending. Amounts below are in millions unless noted.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $12.86 | $11.02 | $36.28 | $29.96 |
| Provision for loan losses | $0.45 | $0.45 | $1.25 | $0.45 |
| Noninterest income | $4.80 | $6.43 | $15.44 | $18.80 |
| Noninterest expense | $11.84 | $11.59 | $35.02 | $32.91 |
| Income before tax | $5.37 | $5.41 | $15.45 | $15.41 |
| Net income | $4.05 | $3.45 | $12.63 | $10.41 |
| Diluted earnings per share | $1.07 | $1.07 | $3.35 | $3.31 |
| Net interest margin | 4.55% | 4.70% | 4.62% | 4.63% |
- Q3 net income rose 17.3%; nine-month net income rose 21.4%. Higher net interest income and lower income-tax expense drove the increases, partly offset by lower noninterest income and higher expenses.
- Q3 average earning-asset yield increased to 5.52% from 5.27%, while average funding cost rose to 1.30% from 0.77%. The resulting margin compression reflects higher deposit and borrowing costs.
- Noninterest income declined year over year, chiefly because of lower gains on loan sales and the absence of the prior-year mortgage servicing rights sale. Nine-month noninterest income also reflected lower service-charge income following that sale.
- Effective tax rates were 24.6% for Q3 and 18.3% year to date, versus 36.2% and 32.5% in 2017, respectively, reflecting the lower federal corporate tax rate and other tax effects.
Financial position, cash flow and asset quality
- Total assets were $1.191 billion at September 30, up 21.3% from year-end 2017. Net loans increased 24.4% to $947.6 million; deposits rose 13.8% to $944.5 million.
- Loan growth was broad-based: real estate loans increased $82.3 million, commercial business loans $56.6 million, and consumer loans $48.8 million. Construction and development loans reached $191.2 million.
- Cash and cash equivalents were $15.2 million, down from $18.9 million at year-end. For the nine months, operating cash flow was $18.4 million, investing cash use was $214.8 million, and financing cash flow was $192.7 million; cash decreased $3.7 million.
- Borrowings increased to $86.5 million from $7.5 million at year-end, primarily to fund loan growth. The company also had a $9.9 million subordinated note. Total stockholders’ equity was $133.1 million, up from $122.0 million.
- Liquidity resources included $149.9 million of unused FHLB borrowing capacity, a $121.1 million Federal Reserve borrowing line, and $51.0 million of correspondent-bank federal funds lines; there were no outstanding draws on the latter two facilities. Brokered deposits totaled $123.6 million, within the Bank’s stated $190.0 million limit.
- The Bank was categorized as well capitalized. Its total risk-based, Tier 1 risk-based, leverage and common equity Tier 1 ratios were 15.2%, 14.0%, 11.7% and 14.0%, respectively.
- The allowance for loan losses was $12.0 million, or 1.3% of gross loans excluding loans held for sale. Nonperforming loans rose to $2.2 million, or 0.23% of gross loans, from $1.0 million, or 0.13%, at year-end; the increase was primarily associated with a $1.4 million nonperforming commercial-and-industrial loan. Nine-month net recoveries were $39,000.
- Available-for-sale securities had $3.4 million of gross unrealized losses at quarter-end, versus $0.9 million at year-end 2017. Management considered the losses temporary and recorded no other-than-temporary impairment. Year-to-date other comprehensive loss, net of tax, was $2.2 million.
Material changes and unusual items
- Noninterest expense included $443,000 of costs related to the proposed Anchor Bancorp merger. The nine-month provision for loan losses also increased to $1.25 million from $450,000 in 2017, primarily reflecting loan growth.
- The company’s servicing portfolio grew: permanent loans serviced for others totaled $1.0 billion at September 30, compared with $778.9 million at December 31, 2017. Servicing rights had a $9.2 million carrying value and $13.5 million estimated fair value; valuation is sensitive to prepayment assumptions and interest rates.
- FS Bancorp adopted the new revenue-recognition standard in 2018; management reported no material financial-statement impact. The company expects the lease standard, effective in 2019, to increase reported assets and liabilities; its estimate based on year-end 2017 leases was approximately $4.7 million for each.
Outlook, merger and risks
- The filing gives no numerical earnings or financial guidance. Management said construction and development lending was expected to remain an important part of the loan portfolio and described continued emphasis on diversified lending, asset quality, relationship-based deposits and market expansion.
- FS Bancorp agreed to acquire Anchor Bancorp for approximately $73.3 million in a stock-and-cash transaction. Regulatory approval had been received; Anchor shareholder approval was scheduled for November 13, 2018, and management anticipated closing shortly afterward. Completion, integration, expected synergies and cost savings remain subject to risks.
- Key disclosed risks include credit deterioration, real estate and economic conditions, rising funding costs and interest-rate exposure, competition for deposits, loan-sale and mortgage-banking conditions, growth and integration execution, and technology or third-party service disruptions. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter. No material pending legal actions were reported.
Important facts for investors to verify
- Whether Anchor shareholders approved the transaction and whether the merger closed on expected terms, timing and economics.
- Whether deposit growth remains sustainable and lower-cost relationship deposits can fund loan expansion, given increased borrowings and brokered certificates of deposit.
- Trends in net interest margin and funding costs as interest rates change.
- Credit quality in commercial-and-industrial, construction, consumer and other expanding loan categories, including the performance of the $1.4 million nonperforming C&I loan and adequacy of the allowance.
- Mortgage originations, loan-sale gains and servicing-right valuations, which depend on secondary-market conditions and prepayment assumptions.
- The eventual effect of CECL adoption on the allowance and retained earnings; management expected a one-time retained-earnings adjustment but had not quantified it.