FS Bancorp, Inc. quarterly report, Q3 FY2022

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FS Bancorp, Inc. — Q3 2022 Form 10-Q

Business context and period. FS Bancorp is the holding company for 1st Security Bank of Washington, a community bank serving the Pacific Northwest through 21 branches and lending offices. It reports commercial and consumer banking and home lending segments. This unaudited filing covers the three and nine months ended September 30, 2022; balance-sheet comparisons are with December 31, 2021. Dollar amounts below are in millions unless stated otherwise.

Financial results and condition

  • Third-quarter earnings: Net income was $8.46 million, versus $8.33 million a year earlier. Diluted EPS was $1.08, versus $0.98. Net interest income increased 21.5% to $27.5 million; net interest margin rose to 4.54% from 4.23%.
  • Nine-month earnings: Net income declined to $22.0 million from $28.8 million; diluted EPS was $2.73 versus $3.31. Net interest income increased to $75.0 million from $64.0 million, and net interest margin improved to 4.39% from 4.11%.
  • Revenue and expenses: Q3 noninterest income fell to $4.2 million from $8.4 million, mainly from lower loan-sale gains; noninterest expense declined to $19.3 million from $20.0 million. For nine months, noninterest income fell to $14.4 million from $29.6 million, while expenses increased to $57.3 million from $55.3 million. The efficiency ratio was 60.99% for Q3 and 64.14% year to date, compared with 64.46% and 59.07%, respectively.
  • Assets and lending: Total assets rose to $2.65 billion from $2.29 billion. Net loans increased to $2.08 billion from $1.73 billion, led by real estate and indirect home-improvement lending. Gross loans were $2.11 billion. Loans held for sale decreased to $23.4 million from $125.8 million.
  • Credit quality: The provision for credit losses was $1.7 million in Q3 and $4.6 million for nine months, versus none and $1.5 million, respectively, in 2021. The allowance for loan losses was $26.4 million, or 1.25% of gross loans excluding loans held for sale. Nonperforming loans were $8.2 million, or 0.39% of gross loans, versus $5.8 million and 0.33% at year-end 2021. Two nonaccrual troubled-debt-restructured commercial loans totaled $3.8 million.
  • Funding and liquidity: Deposits increased to $2.08 billion from $1.92 billion, while borrowings rose to $260.8 million from $42.5 million. Growth included increased CDs and brokered deposits; brokered deposits totaled $324.6 million. Cash and cash equivalents were $159.8 million, versus $26.5 million. The Bank reported $297.7 million of unused FHLB capacity, a $196.0 million Federal Reserve line, and $101.0 million in correspondent-bank lines. Management reported $5.4 million of unrestricted cash at the holding company.
  • Cash flow, nine months: Operating activities provided $163.9 million; investing activities used $395.3 million; financing activities provided $364.7 million. Cash and cash equivalents increased by $133.3 million.
  • Capital and equity: Stockholders’ equity declined to $220.5 million from $247.5 million, principally reflecting securities-related unrealized losses and share repurchases, partly offset by earnings. The Bank was categorized as well capitalized; its total risk-based capital ratio was 13.73%, Tier 1 leverage ratio 11.54%, and CET1 ratio 12.48%. The company repurchased 550,680 shares for $16.4 million during the nine months and paid $0.70 per share in dividends.

Material changes, outlook and risks

  • Interest rates and securities: Available-for-sale securities had $47.9 million of gross unrealized losses at September 30, compared with $4.1 million at year-end 2021. Accumulated other comprehensive loss was $29.3 million, net of tax. Management attributed the securities losses to changing market rates, stated it did not intend to sell and was not likely to be required to sell before recovery, and recorded no credit impairment. Derivative gains partly offset the securities-related equity impact.
  • Home lending: Nine-month one-to-four-family purchase and refinance originations fell 42.4% year over year; refinance originations fell 72.0%. Loan-sale gains and gross margins declined as origination and sale volumes contracted. Management cited higher interest rates and limited home inventory.
  • Management outlook and risks: Management described plans to grow and diversify lending, maintain asset quality, emphasize core deposits, and expand markets, but provided no quantitative earnings or balance-sheet guidance. It identified risks including inflation, slower growth or recession, interest-rate changes, credit deterioration, deposit competition, secondary mortgage-market conditions, and operational, regulatory, and technology risks. It cautioned that interim results are not necessarily indicative of full-year results.
  • Subsequent event: On November 5, 2022, the Bank agreed to acquire seven branches with approximately $510 million of deposits and $76 million of associated loans. Closing was expected in Q1 2023, subject to regulatory approval and other conditions.
  • Other notable items: The company adopted CECL on January 1, 2022; adoption increased retained earnings by $297,000 net of tax. It also corrected prior comparative EPS and deposit classifications, concluding both errors were immaterial and did not affect net income, assets, or cash flows. Management reported effective disclosure controls, no material change in risk factors, and no material pending legal actions.

Important facts for investors to verify

  1. Whether loan growth and credit performance remain sound, particularly in construction, commercial business, and indirect home-improvement lending; monitor nonaccrual loans, charge-offs, and allowance adequacy.
  2. How rising funding costs, brokered-deposit reliance, and higher borrowings affect net interest margin and liquidity as deposits mature.
  3. Whether mortgage origination and sale volumes, gains, and margins stabilize, and how servicing-right valuations respond to rates and prepayment assumptions.
  4. The recovery, sale, or further decline in value of the securities portfolio, and the effects of unrealized losses on equity and regulatory capital.
  5. Whether the seven-branch acquisition receives approval and closes on the expected terms and timetable, and its effects on deposits, lending, capital, and integration costs.
  6. The sustainability of dividends and repurchases in light of capital, liquidity needs, and the Bank’s capital-conservation requirements.