FS Bancorp, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; unaudited consolidated results for FS Bancorp and 1st Security Bank of Washington. The company operates as a community bank focused on the Puget Sound region and also originates consumer and mortgage loans across other markets.
Financial performance and position
Amounts are in millions of dollars except per-share data and ratios.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $8.75 | $7.14 | $24.67 | $20.30 |
| Noninterest income | $7.25 | $4.38 | $18.13 | $13.73 |
| Net income | $3.46 | $2.00 | $7.95 | $6.86 |
| Diluted EPS | $1.18 | $0.66 | $2.66 | $2.28 |
| Net interest margin | 4.55% | 4.97% | 4.36% | 5.06% |
| Efficiency ratio | 64.5% | 68.0% | 67.4% | 63.8% |
- Revenue and earnings: Q3 net income increased 73.3% year over year; nine-month net income rose 15.9%. Growth reflected higher net interest income and noninterest income, partly offset by higher operating expenses. Loan-sale gains were $5.92 million in Q3 and $14.72 million for nine months.
- Margins and costs: NIM declined year over year in both periods, which management attributed to more overnight cash and growth in lower-yielding real estate and commercial loans. Lower deposit funding costs helped offset higher interest expense, including interest on the subordinated note.
- Balance sheet at September 30: Assets were $827.5 million, up 22.1% from year-end 2015; net loans were $592.8 million, deposits $703.2 million, and stockholders’ equity $79.6 million. Loans held for sale were $77.1 million. Cash and cash equivalents were $16.5 million, down from $24.5 million at year-end.
- Debt and liquidity: Borrowings were $21.0 million and subordinated debt net of issuance costs was $9.8 million. The Bank reported $195.0 million of unused FHLB capacity, an $83.9 million Federal Reserve borrowing line, and $40.0 million in correspondent Fed Funds lines; none of the latter two facilities was drawn at quarter-end. Brokered deposits were $47.1 million.
- Cash flow, nine months: Operating activities used $23.3 million, investing activities provided $61.0 million, and financing activities used $45.7 million. Investing cash flow included $180.4 million received in the branch acquisition. The operating cash outflow reflects the mortgage origination-and-sale business and related working-capital movements.
- Credit quality and capital: Allowance for loan losses was $9.6 million, or 1.6% of gross loans excluding loans held for sale, versus $7.8 million, or 1.5%, at year-end 2015. Nonperforming loans were $594,000 (0.1% of gross loans); substandard loans increased to $3.7 million, mainly after four commercial credit lines were downgraded. The Bank remained well capitalized, with a 13.5% total risk-based capital ratio.
Material changes and management commentary
- In January 2016, the Bank acquired four Bank of America branches, assuming $186.4 million of deposits and paying a 2.5% deposit premium. Approximately $171.0 million of acquired deposits remained at September 30. The transaction added $2.3 million of goodwill and a $2.2 million core deposit intangible.
- Deposit growth and acquisition cash supported asset expansion and repayment of FHLB advances. Loans increased 18.0% from year-end, with growth in real estate, warehouse lending, consumer, and commercial and industrial balances.
- Mortgage banking activity expanded: Q3 one-to-four-family originations, including brokered loans, rose 40.8% year over year to $232.9 million. Nine-month mortgage originations were $584.1 million, with $471.7 million sold to investors.
- Noninterest expense rose 31.7% in Q3 and 32.9% for nine months, reflecting growth, the branch purchase, loan-production commissions and incentives, and other operating costs. The nine-month efficiency ratio weakened from the prior year.
- The company repurchased approximately 198,000 shares during the first nine months for $4.9 million. The repurchase plan ended August 31, 2016; no replacement plan was authorized.
Outlook, risks and contingencies
- No specific earnings or financial guidance was provided. Management’s stated priorities include diversifying and growing loans, maintaining asset quality, attracting lower-cost relationship deposits, and expanding customer relationships. Management cautioned that interim results are not necessarily indicative of full-year or future results.
- Key disclosed risks include economic and credit deterioration, interest-rate and margin changes, mortgage secondary-market conditions, deposit retention, competition, controlling expenses, growth and acquisition integration, regulatory changes, and valuation uncertainty in servicing rights and other fair-value estimates.
- Interest-rate lock commitments, loan-sale forwards, and TBA securities are used as economic hedges; derivative values and mortgage servicing rights are sensitive to market rates, loan pull-through, and prepayment assumptions. Management warns that actual experience may differ materially from assumptions.
- Commitments to extend credit totaled $294.5 million. Reserves were $166,000 for estimated losses on unfunded commitments and $825,000 for potential repurchases or indemnification on sold mortgage loans. Management reported no material pending legal actions and did not expect ordinary-course proceedings to materially affect financial condition.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter. No material changes to the 2015 Form 10-K risk factors were reported.
Important facts for investors to verify
- Whether acquired deposits remain stable and the four-branch purchase delivers expected customer and revenue benefits.
- Whether loan-sale gains and mortgage production are sustainable, and how much earnings depend on mortgage banking versus recurring net interest income.
- Trends in NIM, expense growth, and the efficiency ratio as the loan and deposit mix evolves.
- Credit migration in commercial lines and consumer lending, charge-offs, and adequacy of the allowance as the portfolio grows.
- Liquidity under potential commitment draws and deposit outflows, including reliance on brokered deposits and secured borrowing capacity.
- Sensitivity of servicing-rights valuations and loan-sale contingencies to prepayments, interest rates, and repurchase claims.