FS Bancorp, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. FS Bancorp is the holding company for 1st Security Bank of Washington, a community bank operating primarily in Washington. The November 2018 Anchor Bancorp acquisition materially expanded the business; year-over-year comparisons therefore reflect a larger company as well as organic performance. Dollar amounts below are in millions unless otherwise noted.
Key financial metrics
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $17.7 | $12.9 | $53.0 | $36.3 |
| Provision for loan losses | $0.6 | $0.5 | $2.2 | $1.3 |
| Noninterest income | $6.7 | $4.8 | $17.4 | $15.4 |
| Noninterest expense | $14.7 | $11.8 | $46.6 | $35.0 |
| Net income | $7.1 | $4.1 | $16.8 | $12.6 |
| Diluted earnings per share | $1.58 | $1.07 | $3.71 | $3.35 |
| Net interest margin | 4.54% | 4.55% | 4.61% | 4.62% |
| Efficiency ratio | 60.1% | 67.0% | 66.2% | 67.7% |
At September 30, 2019, total assets were $1.695 billion, net loans $1.311 billion, deposits $1.387 billion, borrowings $76.9 million, subordinated debt net of issuance costs $9.9 million, and stockholders’ equity $194.3 million. Cash and cash equivalents were $62.9 million, up from $32.8 million at December 31, 2018.
For the nine months, net cash used in operating activities was $3.6 million, compared with $18.4 million provided in the prior-year period; investing activities used $11.8 million, versus $214.8 million; financing activities provided $45.6 million, versus $192.7 million. The filing’s operating cash-flow result includes substantial mortgage-loan originations and sales.
The Bank was well capitalized: September 30 ratios included 11.6% Tier 1 leverage, 13.6% Tier 1 risk-based, 14.5% total risk-based, and 13.6% CET1. Management reported $368.8 million of unused FHLB borrowing capacity; $76.9 million of FHLB advances were outstanding. The Bank also had a $149.6 million Federal Reserve borrowing limit and $51.0 million of correspondent federal funds lines, with no borrowings against either at quarter-end.
Material changes versus comparable periods
- Q3 net income rose 76.3% year over year; nine-month net income rose 33.0%. Higher net interest income after loan-loss provision was the principal earnings driver.
- Loan interest income benefited from materially higher average loan balances, in part from Anchor, and higher loan yields. Deposit costs rose: nine-month interest expense on deposits increased to $12.0 million from $4.5 million, and average deposit cost increased to 1.20% from 0.70%. Net interest margin was nearly unchanged.
- At quarter-end, deposits had grown $112.4 million from year-end, while borrowings declined $60.3 million. Transactional relationship deposits increased, but money-market and savings balances fell; time deposits increased.
- Net loans were approximately flat from year-end, but composition shifted: consumer loans increased $42.5 million, while real estate loans declined $27.3 million and commercial business loans declined $15.2 million. Construction and development loans fell $46.6 million.
- Loans held for sale rose 57.5% to $80.6 million, amid increased refinance activity. Nine-month one-to-four-family originations rose 15.0%, while the reported cash margin on loans sold fell to 1.71% from 2.50%.
- Nonperforming loans declined to $2.2 million, or 0.17% of gross loans, from $3.9 million, or 0.31%, at year-end. The allowance for loan losses increased to $12.8 million, 0.96% of gross loans excluding loans held for sale, from $12.3 million, or 0.93%.
- Expenses increased with acquisition-related costs and expanded operations. Nine-month acquisition costs were $1.9 million versus $0.4 million in 2018. The quarter’s efficiency ratio improved as revenue grew faster than expenses.
Outlook, risks and unusual items
Management described continued focus on diversifying loan production, maintaining asset quality, growing lower-cost core deposits, and expanding markets. It expects residential construction and development lending to remain an important portfolio component and described a disciplined focus on experienced builders in its markets. The filing provides no quantified earnings or revenue guidance; management cautioned that interim results are not necessarily indicative of full-year or future results.
- Key exposures include economic and real estate conditions in Western Washington, borrower credit quality, interest-rate and deposit-cost changes, mortgage secondary-market conditions, and the ability to attract deposits and manage growth. Fixture-secured consumer lending relies on 95 active dealers; four accounted for 47.2% of funded loan dollar volume.
- Management identified $1.8 million of nine-month net loan charge-offs, including a $1.2 million commercial line charge-off and $0.4 million related to one commercial business relationship. The allowance depends on estimates and could require adjustment if conditions differ from assumptions.
- Mortgage servicing rights are sensitive to prepayment assumptions; the company recorded $0.3 million of servicing-rights impairment during the first nine months. Management reported no other-than-temporary impairment on securities and considered unrealized losses temporary.
- Off-balance-sheet commitments to extend credit totaled $344.4 million. Reserves for estimated losses on unfunded commitments were $0.3 million. A $1.3 million reserve covered potential repurchase or indemnification exposure on sold one-to-four-family loans. Management reported no material pending legal actions.
- The company adopted lease accounting in January 2019, recognizing operating lease right-of-use assets of $4.8 million and liabilities of $5.0 million at adoption. The expected CECL adoption date was extended to fiscal years beginning after December 15, 2022; management expects an increase to the allowance through a one-time retained-earnings adjustment but had not quantified it.
Important facts for investors to verify
- How much of the earnings growth reflects the Anchor acquisition and acquired-loan accretion versus sustainable organic growth?
- Whether the higher cost of deposits and rising time-deposit balances pressure future net interest margin, and how deposit retention and brokered funding evolve.
- Whether recent charge-offs, loan grades, allowance coverage, and credit performance in commercial, construction, and consumer portfolios indicate changing risk.
- Whether mortgage refinance volume, loan-sale margins, servicing-rights valuation, and mortgage production remain supportive of earnings.
- The concentration and performance of indirect fixture-secured lending, including dealer exposure, and the company’s capacity to fund commitments while maintaining liquidity and capital.