FS BANCORP, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
Forward-looking statements
This report contains forward-looking statements, which can be identified by the use of words such as “believes”, “expects”, “anticipates”, “estimates” or similar expressions. Forward-looking statements include, but are not limited to:
? statements of our objectives, intentions and expectations;
? statements regarding our business plans, prospects, growth and operations
strategies;
? statements regarding the quality of our loan and investment portfolios; and
? estimates of our risks and future costs and benefits.
These forward-looking statements are subject to significant risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements due to, among other things, the following factors:
the potential negative impacts on the economic conditions of our local markets,
other markets where the Company has loan relationships, or other aspects of ? the business operations or financial markets of the Company, in general, resulting
the ongoing 2019 novel coronavirus (“COVID-19”) and any government or
societal responses to them;
? general economic conditions, either nationally or in our market area, which are
worse than expected;
credit risks of lending activities, including level changes and ? trend of delinquent loans, write-offs, changes in our provision for credit
Loan Losses (“ACLL”) and Allowance for Loan Losses that may be
impacted by the deterioration of the housing and commercial real estate markets;
? secondary market conditions and our ability to offer loans for sale and
sell loans on the secondary market;
? fluctuations in the demand for loans, the number of houses, land and
other properties and fluctuations in real estate values in our market area;
fluctuations in staffing in response to demand for products or the implementation of? business strategies that affect our workforce and associated potential
charges;
the use of estimates to determine the fair value of some of our assets, which ones? estimates may turn out to be incorrect and result in significant decreases in
Evaluation;
? changes in the interest rate environment that reduce our interest margins or
reduce the fair value of financial instruments;
uncertainty about the future of the London Interbank Offered Rate? (“LIBOR”), and the transition from LIBOR to a new interest rate
landmarks ;
? increased competitive pressures among financial services companies;
our ability to execute our home construction loan growth plans, ? our home loan operations, warehouse loans and geography
expanding our indirect home improvement loans;
? our ability to attract and retain deposits;
our ability to successfully integrate all assets, liabilities, customers, ? systems, and management personnel that we may acquire in the future in our
operations and our ability to achieve revenue and cost synergies
the savings made within the expected timeframes and any related goodwill charges;
? our ability to control operating costs and expenses;
? our ability to retain key members of our management team;
? changes in consumer spending, borrowing and saving habits;
? our ability to successfully manage our growth;
legislative or regulatory changes that adversely affect our business, including? changes in regulatory policies and principles, or the interpretation of
regulatory capital or other rules, including changes resulting from COVID-19;
? adverse changes in the securities markets;
changes in accounting policies and practices, as they may be adopted by the bank? regulatory bodies,
? the costs and effects of litigation, including settlements and judgments;
disruptions, security breaches or other adverse events, failures or? interruptions or attacks on our computer systems or
third-party vendors who perform many of our critical processing functions;
? failure of major third-party vendors to perform their obligations to us; and
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other economic, competitive, governmental, regulatory and technical factors? affecting our operations, prices, products and services, and other risks
described elsewhere in this Form 10-Q and our other reports filed with the
Any of the forward-looking statements made in this Form 10-Q and in other public statements may turn out to be wrong because of inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot foresee. Forward-looking statements are based upon management's beliefs and assumptions at the time they are made. The Company undertakes no obligation to update or revise any forward-looking statement included in this report or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur and you should not put undue reliance on any forward-looking statements.
Insight
FS Bancorp, Inc. and its subsidiary bank,1st Security Bank of Washington have been serving thePuget Sound area since 1907. Originally chartered as a credit union, known asWashington's Credit Union , the credit union served various select employment groups. OnApril 1, 2004 , the credit union converted to aWashington state -chartered mutual savings bank. OnJuly 9, 2012 , the Bank converted from mutual to stock ownership and became the wholly owned subsidiary ofFS Bancorp, Inc. The Company is relationship-driven, delivering banking and financial services to local families, local and regional businesses and industry niches within distinctWestern Washington communities, predominately thePuget Sound area, one loan production office located in the Tri-Cities, and our newest loan production office inVancouver, Washington . The Company also maintains its long-standing indirect consumer lending platform which operates primarily throughout theWest Coast . The Company emphasizes long-term relationships with families and businesses within the communities served, working with them to meet their financial needs. The Company is also actively involved in community activities and events within these market areas, which further strengthens our relationships within those markets. The Company focuses on diversifying revenues, expanding lending channels, and growing the banking franchise. Management remains focused on building diversified revenue streams based upon credit, interest rate, and concentration risks. Our business plan remains as follows:
? Develop and diversify our loan portfolio;
? Maintain strong asset quality;
? Focus on lower cost core deposits to lower our loan funding costs
growth;
Capture the full relationship of our customers by offering a wide range of products? and services by building on our well-established involvement in our communities
and by selectively emphasizing products and services designed to meet our
customers’ banking needs; and
? Expand the Company’s markets.
The Company is a diversified lender with a focus on the origination of
one-to-four-family loans, commercial real estate mortgage loans, second mortgage
or home equity loan products, consumer loans including indirect home improvement
("fixture secured") loans which also include solar-related home improvement
loans, marine lending, and commercial business loans. As part of our expanding
lending products, the Company experienced growth in residential mortgage and
commercial construction warehouse lending consistent with our business plan to
further diversify revenues. Historically, consumer loans, in particular,
fixture secured loans had represented the largest portion of the Company's loan
portfolio and had traditionally been the mainstay of the Company's lending
strategy. At March 31, 2022 consumer loans represented 24.4% of the Company's
total gross loan portfolio, compared to 24.1% at March 31, 2021 . In recent
years, the Company has placed more of an emphasis on real estate lending
products, such as one-to-four-family loans, commercial real estate loans,
including speculative residential construction loans, as well as commercial
business loans, while growing the current size of the consumer loan portfolio.
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Fixture secured loans to finance window, gutter, siding replacement, solar panels, pools, and other improvement renovations are a large and regionally expanding segment of the consumer loan portfolio. These fixture secured consumer loans are dependent on the Bank's contractor/dealer network of 99 active dealers located throughoutWashington ,Oregon ,California ,Idaho ,Colorado ,Nevada ,Arizona , andMinnesota with four contractor/dealers responsible for 48.1% of the funded loans dollar volume for the three months endedMarch 31, 2022 . The Company funded$68.9 million , or approximately 3,000 loans during the quarter endedMarch 31, 2022 . The following table details fixture secured loan originations by state for the periods indicated: For the Three Months Ended For the Year Ended March 31, 2022 December 31, 2021 State Amount Percent Amount Percent Washington$ 22,991 33.4 %$ 103,970 42.0 % Oregon 14,929 21.7 54,301 22.0 California 12,421 18.0 49,053 19.8 Idaho 5,437 7.9 19,790 8.0 Colorado 3,004 4.4 7,957 3.2 Arizona 998 1.4 4,294 1.7 Nevada 1,490 2.2 3,664 1.5 Minnesota 7,582 11.0 4,418 1.8 Total consumer loans$ 68,852 100.0 %$ 247,447 100.0 % The Company originates one-to-four-family residential mortgage loans through referrals from real estate agents, financial planners, builders, and from existing customers. Retail banking customers are also an important source of the Company's loan originations. The Company originated$245.1 million of one-to-four-family loans which includes loans held for sale, loans held for investment, and fixed seconds in addition to loans brokered to other institutions of$2.0 million through the home lending segment during the three months endedMarch 31, 2022 , of which$301.1 million were sold to investors. Of the loans sold to investors,$236.4 million were sold to theFNMA , FHLMC, FHLB, and/or GNMA with servicing rights retained for the purpose of further developing these customer relationships. AtMarch 31, 2022 , one-to-four-family residential mortgage loans held for investment, which excludes loans held for sale of$42.1 million , totaled$364.0 million , or 20.0%, of the total gross loan portfolio. For the three months endedMarch 31, 2022 , there were more one-to-four-family loans originated to finance home purchases, reflecting increased sales of one-to-four-family homes, and decreased refinance activity, compared to the same period in the prior year as refinances surged due to the lowering of market interest rates in response to COVID-19. Residential construction and development lending, while not as common as other options like one-to-four-family loans, will continue to be an important element in our total loan portfolio, and we will continue to take a disciplined approach by concentrating our efforts on loans to builders and developers in our market areas known to us. These short-term loans typically mature in six to twelve months. In addition, the funding is usually not fully disbursed at origination, thereby reducing our net loans receivable in the short term. The Company is significantly affected by prevailing economic conditions, as well as government policies and regulations concerning, among other things, monetary and fiscal affairs. Deposit flows are influenced by a number of factors, including interest rates paid on time deposits, other investments, account maturities, and the overall level of personal income and savings. Lending activities are influenced by the demand for funds, the number and quality of lenders, and regional economic cycles. Sources of funds for lending activities include primarily deposits, including brokered deposits, borrowings, payments on loans, and income provided from operations. The Company's earnings are primarily dependent upon net interest income, the difference between interest income and interest expense. Interest income is a function of the balances of loans and investments outstanding during a given period and the yield earned on these loans and investments. Interest expense is a function of the amount of deposits and borrowings outstanding during the same period and interest rates paid on these deposits and borrowings. 47
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Another significant influence on the Company's earnings is fee income from mortgage banking activities. The Company's earnings are also affected by the provision for loan losses, service charges and fees, gains from sales of assets, operating expenses and income taxes. The Company recorded a provision for credit losses on loans of$1.0 million for the three months endedMarch 31, 2022 , compared to a provision for loan losses of$1.5 million for the same period one year ago, reflecting improved economic factors on credit-deterioration utilized to calculate the ACLL atMarch 31, 2022 , primarily related to the COVID-19 pandemic and the adoption of CECL. The provision for credit losses on loans also reflects the increase in total loans receivable, partially offset by improvements in classified loans that were downgraded based on the COVID-19 pandemic and have shown loan-level improvements atMarch 31, 2022 .
Summary of Significant Accounting Policies and Estimates
Certain of the Company's accounting policies are important to the portrayal of
the Company's financial condition, since they require management to make
difficult, complex, or subjective judgments, some of which may relate to matters
that are inherently uncertain. Estimates associated with these policies are
susceptible to material changes as a result of changes in facts and
circumstances. Facts and circumstances which could affect these judgments
include, but are not limited to, changes in interest rates, changes in the
performance of the economy, and changes in the financial condition of borrowers.
Management believes that its critical accounting policies include the following:
Allowance for Credit Losses on Loans ("ACLL"). The ACLL is the amount estimated
by management as necessary to cover expected losses inherent in the loan
portfolio at the balance sheet date. The ACLL is established through the
provision for loan losses, which is charged to income. A high degree of judgment
is necessary when determining the amount of the ACLL. Among the material
estimates required to establish the ACLL are: loss exposure at default; the
amount and timing of future cash flows on impacted loans; value of collateral;
and determination of loss factors to be applied to the various elements of the
portfolio. All of these estimates are susceptible to significant change.
Management reviews the level of the ACLL at least quarterly and establishes the
provision for loan losses based upon an evaluation of the portfolio, past loss
experience, current economic conditions, reasonable and supportable forecasts,
and other factors related to the collectability of the loan portfolio. Although
the Company believes that use of the best information available currently
establishes the ACLL, future adjustments to the ACLL may be necessary if
economic conditions differ substantially from the assumptions used in making the
evaluation. As the Company adds new products to the loan portfolio and expands
the Company's market area, management intends to enhance and adapt the
methodology to keep pace with the size and complexity of the loan portfolio.
Changes in any of the above factors could have a significant effect on the
calculation of the ACLL in any given period. Management believes that its
systematic methodology continues to be appropriate. In June 2016 , the FASB
issued ASU No. 2016-13, Measurement of Credit Losses on Financial
Instruments, referred to as the Current Expected Credit Loss or CECL model,
which was early adopted by the Company and effective January 1, 2022 . For
additional information on CECL see "Note 1 - Basis of Presentation and Summary
of Significant Accounting Policies - Application of New Accounting Guidance
Adopted in 2022" of the Notes to the Consolidated Financial Statements included
in Part I. Item 1 of this report.
Servicing Rights. Servicing assets are recognized as separate assets when rights
are acquired through the purchase or through the sale of financial assets.
Generally, purchased servicing rights are capitalized at the cost to acquire the
rights. For sales of mortgage loans, the value of servicing is capitalized
during the month of sale. Fair value is based on market prices for comparable
mortgage contracts, when available, or alternatively, is based on a valuation
model that calculates the present value of estimated future net servicing
income. The valuation model incorporates assumptions that market participants
would use in estimating future net servicing income, such as the cost to
service, the discount rate, the custodial earnings rate, an inflation rate,
ancillary income, prepayment speeds, and default rates and losses.
Servicing assets are evaluated quarterly for impairment based upon the fair
value of the rights as compared to amortized cost. Impairment is determined by
stratifying rights into tranches based on predominant characteristics, such as
interest rate, loan type, and investor type. Impairment is recognized through a
valuation allowance for an individual tranche, to the extent that fair value is
less than the capitalized amount for the tranches. If the Company later
determines that all or a portion of the impairment no longer exists for a
particular tranche, a reduction of the allowance may be recorded as a recovery
and an increase to income. Capitalized servicing rights are stated separately on
the Consolidated Balance Sheets and are amortized into noninterest income in
proportion to, and over the period of, the estimated future net servicing income
of the underlying financial assets.
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Derivatives and Hedging Activity. ASC 815, "Derivatives and Hedging," requires that derivatives of the Company be recorded in the consolidated financial statements at fair value. Management considers its accounting policy for derivatives to be a critical accounting policy because these instruments have certain interest rate risk characteristics that change in value based upon changes in the capital markets. Fair values for derivative assets and liabilities are measured on a recurring basis. The Company's primary use of derivative instruments are related to the mortgage banking activities in the form of commitments to extend credit, commitments to sell loans, TBA mortgage-backed securities trades and option contracts to mitigate the risk of the commitments to extend credit. Estimates of the percentage of commitments to extend credit on loans to be held for sale that may not fund are based upon historical data and current market trends. The fair value adjustments of the derivatives are recorded in the Consolidated Statements of Income with offsets to other assets or other liabilities on the Consolidated Balance Sheets. Derivative instruments not related to mortgage banking activities primarily relate to interest rate swap agreements accounted for as cash flow hedges. To qualify for hedge accounting, derivatives must be highly effective at reducing the risk associated with the exposure being hedged and must be designated as a hedge at the inception of the derivative contract. If derivative instruments are designated as cash flow hedges, fair value adjustments related to the effective portion are recorded in other comprehensive income and are reclassified to earnings when the hedged transaction is reflected in earnings. Ineffective portions of cash flow hedges are reflected in earnings as they occur. Actual cash receipts and/or payments and related accruals on derivatives related to hedges are recorded as adjustments to the interest income or interest expense associated with the hedged item. During the life of the hedge, the Company formally assesses whether derivatives designated as hedging instruments continue to be highly effective in offsetting changes in the fair value or cash flows of hedged items. If it is determined that a hedge has ceased to be highly effective, the Company will discontinue hedge accounting prospectively. At such time, previous adjustments to the carrying value of the hedged item are reversed into current earnings and the derivative instrument is reclassified to a trading position recorded at fair value. For derivatives not designated as hedges, changes in fair value are recognized in earnings, in noninterest income. Fair Value. ASC 820, "Fair Value Measurements and Disclosures," establishes a hierarchical disclosure framework associated with the level of pricing observability utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no pricing observability and a higher degree of judgment utilized in measuring fair value. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction. The objective of a fair value measurement is to estimate the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants at the measurement date under current market conditions (that is, an exit price at the measurement date from the perspective of a market participant that holds the asset or owes the liability). For additional details, see "Note 10 - Fair Value Measurements" of the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report. Income Taxes. Income taxes are reflected in the Company's consolidated financial statements to show the tax effects of the operations and transactions reported in the consolidated financial statements and consist of taxes currently payable plus deferred taxes. ASC 740, "Accounting for Income Taxes," requires the asset and liability approach for financial accounting and reporting for deferred income taxes. Deferred tax assets and liabilities result from temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. They are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled and are determined using the assets and liability method of accounting. The deferred income provision represents the difference between net deferred tax asset/liability at the beginning and end of the reported period. In formulating the deferred tax asset, the Company is required to estimate income and taxes in the jurisdiction in which the Company operates. This process involves estimating the actual current tax exposure for the reported period together with assessing temporary differences resulting from differing treatment of items, such as depreciation and the provision for loan losses, for tax and financial reporting purposes.
Deferred tax assets and liabilities arise when taxable income is greater or less than the income reported in the income statements due to accounting valuation methods that differ from tax, as well as estimates of tax rates and payments made quarterly and adjusted to actual at the end of the year . Deferred tax assets and liabilities are temporary differences
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deductible or payable in future periods. The Company had net deferred tax assets of
Comparison of the financial situation at
Assets. Total assets decreased$12.5 million to$2.27 billion atMarch 31, 2022 , compared to$2.29 billion atDecember 31, 2021 , primarily due to decreases in loans held for sale of$83.7 million , securities available-for-sale of$8.1 million , and certificates of deposit at other financial institutions of$2.4 million , partially offset by increases in loans receivable, net of$69.1 million , other assets of$5.4 million , total cash and cash equivalents of$3.1 million , deferred tax asset, net of$2.6 million , and servicing rights of$1.1 million . Loans receivable, net increased$69.1 million to$1.80 billion atMarch 31, 2022 , from$1.73 billion atDecember 31, 2021 . Total real estate loans increased$40.3 million , including increases in multi-family loans of$18.8 million , construction and development loans of$18.1 million , commercial real estate loans of$5.1 million , and home equity loans of$3.4 million , partially offset by a decrease in one-to-four-family loans of$5.1 million . Undisbursed construction and development loan commitments increased$35.0 million to$217.3 million atMarch 31, 2022 , as compared to$182.3 million atDecember 31, 2021 . Consumer loans increased$23.0 million , primarily due to an increase of$23.2 million in indirect home improvement loans, partially offset by a decrease of$218,000 in marine loans. Commercial business loans increased$3.6 million , as a result of an increase in warehouse lending of$4.7 million . Loans held for sale, consisting of one-to-four-family loans, decreased by$83.7 million , or 66.6%, to$42.1 million atMarch 31, 2022 , from$125.8 million atDecember 31, 2021 . The Company continues to invest its home lending operations and strategically add production staff in the markets we serve. One-to-four-family loan originations for the three months endedMarch 31, 2022 , included$211.5 million of loans originated for sale,$31.6 million of portfolio loans including first and second liens, and$2.0 million of loans brokered to other institutions. The decrease in purchase and refinance activity compared to the prior quarter reflects a limited available inventory of homes for sale and increased market interest rates adversely impacting refinance activity.
The one to four family loan packages for the purchase and refinancing of a home for the periods indicated are as follows:
For the Three Months Ended For the Three Months Ended Year Year
March 31, 2022 March 31, 2021 over Year over Year
Amount Percent Amount Percent $ Change % Change
Purchase $ 152,950 62.4 % $ 185,461 42.7 % $ (32,511) (17.5)
Refinance 92,164 37.6 248,992 57.3 (156,828) (63.0)
Total $ 245,114 100.0 % $ 434,453 100.0 % $ (189,339) (43.6)
During the three months ended March 31, 2022 , the Company sold $301.1 million of
one-to-four-family loans compared to sales of $414.0 million for the same period
one year ago. Gross margins on home loan sales decreased to 2.94% for the
three months ended March 31, 2022 , compared to 4.60% for the three months ended
March 31, 2021 . Gross margins are defined as the margin on loans sold (cash
sales) without the impact of deferred costs.
The ACLL was $23.4 million , or 1.28% of gross loans receivable, excluding loans
held for sale at March 31, 2022 , compared to $25.6 million , or 1.46% of gross
loans receivable, excluding loans held for sale at December 31, 2021 . The
decrease was primarily due to the one-time cumulative-effect adjustment of $2.9
million as of the CECL adoption date. The allowance for credit losses - unfunded
loan commitments increased $2.6 million to $3.1 million at March 31, 2022 , from
$499,000 at December 31, 2021 , primarily due to the one-time cumulative-effect
adjustment of $2.4 million as of the CECL adoption date and increases in
unfunded commitments during the quarter ended March 31, 2022 .
Loans classified as substandard decreased $5.0 million to $13.1 million at March
31, 2022 , compared to $18.1 million at December 31, 2021 . The decrease was
primarily due to decreases of $2.3 million in commercial and industrial loans
and $1.7 million in one-to-four-family loans, and $916,000 in commercial real
estate loans. Nonperforming loans, consisting solely of nonaccruing loans
90-days or more past due, increased $968,000 to $6.8 million at March 31, 2022 ,
from $5.8
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million at December 31, 2021 . The ratio of nonperforming loans to total gross
loans was 0.37% atMarch 31, 2022 , compared to 0.33% atDecember 31, 2021 . There were no OREO properties atMarch 31, 2022 , orDecember 31, 2021 . Liabilities. Total liabilities remained relatively unchanged at$2.04 billion atMarch 31, 2022 andDecember 31, 2021 , decreasing$901,000 primarily due to decreases of$7.0 million in borrowings and$1.2 million in deferred tax liability, partially offset by increases of$4.0 million in deposits and$2.6 million in other liabilities. Total deposits increased$4.0 million to$1.92 billion atMarch 31, 2022 , fromDecember 31, 2021 . The increase in deposits was primarily driven by growth in certificates of deposit ("CDs"). Time deposits increased$10.4 million to$371.1 million atMarch 31, 2022 , from$360.7 million atDecember 31, 2021 . Nonretail CDs which include brokered CDs, online CDs, and public funds increased$30.0 million to$144.2 million atMarch 31, 2022 , compared to$114.2 million atDecember 31, 2021 , primarily due to a$30.0 million increase in brokered CDs. Transactional accounts (noninterest-bearing checking, interest-bearing checking, and escrow accounts) decreased$3.7 million to$805.1 million atMarch 31, 2022 , from$808.8 million atDecember 31, 2021 , primarily due to a decrease of$19.3 million in interest-bearing checking which included a$30.0 million decrease in brokered deposits, partially offset by increases of$9.7 million in escrow accounts related to mortgages serviced and$5.9 million in noninterest-bearing checking. Money market and savings accounts decreased$2.7 million to$743.6 million atMarch 31, 2022 , from$746.3 million atDecember 31, 2021 .
The deposits are summarized as follows on the dates indicated:
March 31, December 31,
2022 (1)(2) 2021 (1)(2)
Noninterest-bearing checking $ 449,075 $ 443,133
Interest-bearing checking (3) 329,938 349,251
Savings 198,184 193,922
Money market (4) 545,442 552,357
Certificates of deposit less than$100,000 (5) 210,984
186,974
Certificates of deposit of$100,000 through$250,000 107,429
116 206
Certificates of deposit of$250,000 and over (6) 52,669 57,512 Escrow accounts related to mortgages serviced 26,067
16,389 Total$ 1,919,788 $ 1,915,744 __________________________
(1) Includes
Buy and
(2) Includes
(3) Includes
2022 and
(4) Includes
(5) Includes
2022 and
(6) Term deposits that meet or exceed the
Borrowings comprised of FHLB advances decreased$7.0 million to$35.5 million atMarch 31, 2022 , from$42.5 million atDecember 31, 2021 , primarily related to repayments. Management entered into two liability interest rate swap arrangements designated as cash flow hedges in the first quarter of 2020 and one liability interest rate swap arrangement in the third quarter of 2020 to lock the expense costs associated with$90.0 million in brokered deposits and borrowings. The average cost of these$90.0 million in notional pay fixed interest rate swap agreements was 73 basis points for which the Bank will pay a fixed rate of 73 basis points to the interest rate swap counterparty, compared to the quarterly reset of three-month LIBOR that will adjust quarterly. Management will continue to implement processes to match balance sheet funding duration and minimize interest rate risk and costs. Stockholders' Equity. Total stockholders' equity decreased$11.6 million to$236.0 million atMarch 31, 2022 , from$247.5 million atDecember 31, 2021 . The decrease in stockholders' equity during the three months endedMarch 31, 2022 , was primarily due to net unrealized losses in securities available-for-sale of$16.5 million , net of tax, reflecting increases in market interest rates during the quarter, share repurchases totaling$3.5 million , and dividends paid of
$1.6 million , 51 Table of Contents partially offset by net income of$6.9 million , and unrealized gains on cash flow hedges of$2.3 million , net of tax. In addition, the adoption of CECL onJanuary 1, 2022 , resulted in a$297,000 increase to retained earnings reflecting the combined impact of the$2.9 million decrease to our ACLL and a$2.4 million increase to the allowance for credit losses on unfunded commitments as of the adoption date. The Company repurchased 115,356 shares of its common stock during the three months endedMarch 31, 2022 , at an average price of$31.45 per share. Book value per common share was$29.70 atMarch 31, 2022 , compared to$30.75 atDecember 31, 2021 . We calculated book value based on common shares outstanding of 8,067,211 atMarch 31, 2022 , less 121,672 unvested restricted stock shares for the reported common shares outstanding of 7,945,539. Common shares outstanding was calculated using 8,169,887 shares atDecember 31, 2021 , less 121,672 unvested restricted stock shares for the reported common shares outstanding of 8,048,215.
Comparison of operating results for the three months ended
and 2021
General. Net income was$6.9 million for the three months endedMarch 31, 2022 , and$11.9 million for the three months endedMarch 31, 2021 . The decrease in net income for the three months endedMarch 31, 2022 was primarily due to a$7.2 million , or 54.9% decrease in noninterest income and a$2.7 million increase in noninterest expenses, partially offset by a$2.6 million increase in net interest income, and a$1.8 million decrease in the provision for income tax. 52 Table of Contents
Average balances, interest and average returns/costs
The following table sets forth for the periods indicated, information regarding
average balances of assets and liabilities, as well as the total dollar amounts
of interest income from average interest-earning assets and interest expense on
average interest-bearing liabilities, resultant yields, interest rate spread,
net interest margin (otherwise known as net yield on interest-earning assets),
and the ratio of average interest-earning assets to average interest-bearing
liabilities. Also presented is the weighted average yield on interest-earning
assets, rates paid on interest-bearing liabilities and the resultant spread at
for the periods presented. Income and all average balances are monthly average
balances. Nonaccruing loans have been included in the table as loans carrying a
zero yield. The yields on tax-exempt municipal bonds have not been computed on
a tax equivalent basis.
For the Three Months Ended For the Three Months Ended
March 31, 2022 March 31, 2021
Average Interest Average Interest
Balance Earned/ Balance Earned/
Average Balances Outstanding
Payed Yield/ Rate Outstandings Payed Yield/ Rate ASSETS Loans receivable, net and loans held for sale (1)
91,678 446 1.97% 64,549 353 2.22% Taxable AFS investment securities 60,422 321 2.15% 46,127 241 2.12% Tax-exempt AFS investment securities 126,508 587 1.88% 73,043 363 2.02% Taxable HTM investment securities 7,500 95 5.14% 7,500 95 5.14% FHLB stock 4,302 45 4.24% 7,247 84 4.70% Interest-bearing deposits at other financial institutions 48,672 85 0.71% 127,382 114 0.36% Total interest-earning assets 2,173,525
24,626 4.59% 2,042,898 22,784 4.52% Noninterest-earning assets 96,746 87,700 Total assets$ 2,270,271 $ 2,130,598 LIABILITIES AND STOCKHOLDERS' EQUITY Savings and money market$ 738,597 $ 383 0.21%$ 604,917 $ 468 0.31% Interest-bearing checking 351,061 161 0.19% 230,106 50 0.09% Certificates of deposit 354,722 741 0.85% 491,306 1,464 1.21% Borrowings 31,006 133 1.74% 130,174 446 1.39% Subordinated notes 49,400 486 3.99% 28,248 256 3.68%
Total interest-bearing liabilities 1,524,786
1,904 0.51% 1,484,751 2,684 0.73% Non-interest bearing accounts
462,808 387,918 Other noninterest-bearing liabilities 31,355 28,519 Stockholders' equity 251,322 229,410 Total liabilities and stockholders' equity$ 2,270,271
$ 2,130,598 Net interest income$ 22,722 $ 20,100 Net interest rate spread 4.08% 3.79% Net earning assets$ 648,739 $ 558,147 Net interest margin 4.24% 3.99% Average interest-earning assets to average interest-bearing liabilities 142.55%
137.59% _________________________
(1) Includes recognized “net” deferred PPP costs.
Net Interest Income. Net interest income increased$2.6 million to$22.7 million for the three months endedMarch 31, 2022 , from$20.1 million for the three months endedMarch 31, 2021 . This comparable quarter over quarter increase was primarily the result of an improved mix of loans versus other interest-earning assets and increased balances in higher 53
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yielding loans funded by lower cost deposits. Interest income increased$1.8 million , primarily due to an increase of$1.5 million in interest income on loans receivable, including fees, impacted primarily by loan growth and net deferred fees recognized uponSmall Business Administration ("SBA") forgiveness of PPP loans. Interest expense decreased$780,000 , primarily as a result of repricing deposit rates and a reduction in higher cost borrowings. For the three months endedMarch 31, 2022 , the total recognition of net deferred fees on forgiven and amortizing PPP loans was$264,000 , as compared to$653,000 for the three months endedMarch 31, 2021 . The net interest margin ("NIM") increased 25 basis points to 4.24% for the three months endedMarch 31, 2022 , from 3.99% for the same period in the prior year. The comparable quarter over quarter increase in NIM was impacted by an improved mix of interest-bearing assets, including a higher balance of higher yielding portfolio loans and investment securities instead of interest-bearing cash, earning a nominal yield combined with declining deposit and borrowing costs.
Interest income. Interest income for the three months ended
The following table compares average earning asset balances, associated yields, and resulting changes in interest income for the three months endedMarch 31, 2022 and 2021: Three Months Ended March 31, 2022 2021 Increase/ Average Average (Decrease) Balance Yield/ Balance Yield/ in Interest (Dollars in thousands) Outstanding Rate Outstanding Rate Income Loans receivable, net and loans held for sale$ 1,834,443 5.10 %$ 1,717,050 5.09 %$ 1,513 Taxable mortgage-backed securities 91,678 1.97 64,549 2.22 93 Taxable AFS investment securities 60,422 2.15 46,127 2.12 80 Tax-exempt AFS investment securities 126,508 1.88 73,043 2.02 224 Taxable HTM investment securities 7,500 5.14 7,500 5.14 - FHLB stock 4,302 4.24 7,247 4.70 (39) Interest-bearing deposits at other financial institutions 48,672 0.71 127,382 0.36 (29) Total interest-earning assets$ 2,173,525 4.59 % $
2,042,898 4.52%
Interest Expense. Interest expense decreased$780,000 , to$1.9 million for the three months endedMarch 31, 2022 , from$2.7 million for the same prior year quarter, primarily due to a decrease of interest expense on deposits of$697,000 . The average cost of funds for total interest-bearing liabilities decreased 22 basis points to 0.51% for the three months endedMarch 31, 2022 , from 0.73% for the three months endedMarch 31, 2021 . The decrease was predominantly due to the decrease in cost for market rate deposits and decreased borrowing costs reflecting a decrease in average borrowings from the same quarter in the prior year. The average cost of total interest-bearing deposits decreased 25 basis points to 0.36%, for the three months endedMarch 31, 2022 , compared to 0.61%, for the three months endedMarch 31, 2021 , predominantly due to the decrease in cost for market rate deposits as well as a strategic shift away from higher cost CDs. The average cost of funds, including noninterest-bearing checking, decreased 19 basis points to 0.39% for the three months endedMarch 31, 2022 , from 0.58% for the three months endedMarch 31, 2021 . 54 Table of Contents
The following table details the average cost of funds balances on interest bearing liabilities and the change in interest expense for the three months ended
Three Months Ended March 31,
2022 2021 (Decrease)/
Average Average Increase
Balance Yield/ Balance Yield/ in Interest
(Dollars in thousands) Outstanding Rate Outstanding Rate Expense
Savings and money market $ 738,597 0.21 % $ 604,917 0.31 % $ (85)
Interest-bearing checking 351,061 0.19 230,106 0.09 111
Certificates of deposit 354,722 0.85 491,306 1.21 (723)
Borrowings 31,006 1.74 130,174 1.39 (313)
Subordinated note 49,400 3.99 28,248 3.68 230
Total interest-bearing liabilities
Provision for Credit Losses. For the three months endedMarch 31, 2022 , the provision for credit losses on loans was$852,000 , compared to a provision for loan losses of$1.5 million for the three months endedMarch 31, 2021 as calculated under the prior incurred loss methodology. The provision for credit losses on loans reflects the increase in total loans receivable partially offset by a decrease in classified loans that were downgraded based on the COVID-19 pandemic and improved economic factors on credit-deterioration used to calculate the ACLL primarily related to the COVID-19 pandemic as compared to the same time last year. For the three months endedMarch 31, 2022 , the provision for credit losses on unfunded commitments was$191,000 , compared to a recovery of reserves for unfunded commitments of$9,000 for the three months endedMarch 31, 2021 . The increase was attributable to a change in methodology as a result of the adoption of CECL, as well as increases in total unfunded commitments during the quarter. During the three months endedMarch 31, 2022 , net loan charge-offs totaled$263,000 , compared to$297,000 during the three months endedMarch 31, 2021 . The decrease in net charge-offs was primarily due to decreased commercial business loan charge-offs. A further decline in national and local economic conditions, as a result of the COVID-19 pandemic or other factors, could result in a material increase in the ACL and may adversely affect the Company's financial condition and results of operations. Noninterest Income. Noninterest income decreased$7.2 million , to$5.9 million for the three months endedMarch 31, 2022 , from$13.0 million for the three months endedMarch 31, 2021 . The decrease during the period primarily reflects a$7.8 million , or 67.0% decrease in gain on sale of loans due primarily to a reduction in origination and sales volume of loans held for sale and a reduction in gross margins of sold loans, partially offset by a$419,000 increase in other noninterest income, primarily due to proceeds from a bank owned life insurance policy of$482,000 , a$248,000 increase in service charges and fee income as a result of less MSR amortization reflecting increased market interest rates and increased servicing fees from nonportfolio loans. Refinance originations were$92.2 million for the three months endedMarch 31, 2022 compared to$249.0 million for the same period last year. Gross margins on home loan sales decreased to 2.94% for the three months endedMarch 31, 2022 , from 4.60% for the three months endedMarch 31, 2021 . Noninterest Expense. Noninterest expense increased$2.7 million to$19.1 million for the three months endedMarch 31, 2022 , from$16.3 million for the three months endedMarch 31, 2021 . The increase in noninterest expense primarily reflects a$2.0 million decrease in the recovery of servicing rights, to$1,000 the first quarter of 2022 from$2.1 million in the first quarter of 2021.
Additional non-interest expense increases include
The efficiency ratio, which is noninterest expense as a percentage of net interest income and noninterest income, rose to 66.67% for the three months endedMarch 31, 2022 , compared to 49.34% for the three months endedMarch 31, 2021 , primarily representing the decrease in noninterest income, as well as the increase in noninterest expense noted above. Provision for Income Tax. For the three months endedMarch 31, 2022 , the Company recorded a provision for income tax expense of$1.6 million as compared to$3.4 million for the three months endedMarch 31, 2021 . The decrease in the tax provision is primarily due to a$6.8 million decrease in pre-tax income during the three months endedMarch 31, 2022 , as compared to the same quarter last year. The effective corporate income tax rates for the three months endedMarch 31, 2022 and 2021 were 19.1% and 22.3%, respectively. The decrease in the effective corporate income tax rate was primarily 55
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due to increases in tax exempt municipal securities income, and a reduction in nondeductible expenses from the prior quarter due to the end of the ESOP plan and reductions in nondeductible compensation cost attributable to Internal Revenue Code Section 162(m) limitations.
Liquidity
Management maintains a liquidity position that it believes will adequately provide funding for loan demand and deposit runoff that may occur in the normal course of business. The Company relies on a number of different sources in order to meet potential liquidity demands. The primary sources are increases in deposit accounts, FHLB advances, purchases of federal funds, sale of securities available-for-sale, cash flows from loan payments, sales of one-to-four-family loans held for sale, and maturing securities. While the maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The Bank must maintain an adequate level of liquidity to ensure the availability of sufficient funds to fund its operations. The Bank generally maintains sufficient cash and short-term investments to meet short-term liquidity needs. AtMarch 31, 2022 , the Bank's total borrowing capacity was$520.2 million with the FHLB ofDes Moines , with unused borrowing capacity of$478.8 million . The FHLB borrowing limit is based on certain categories of loans, primarily real estate loans that qualify as collateral for FHLB advances. AtMarch 31, 2022 , the Bank held approximately$750.6 million in loans that qualify as collateral for FHLB advances. In addition to the availability of liquidity from the FHLB ofDes Moines , the Bank maintained a short-term borrowing line with the FRB, with a current limit of$189.6 million , and a combined credit limit of$101.0 million in written federal funds lines of credit through correspondent banking relationships atMarch 31, 2022 . The FRB borrowing limit is based on certain categories of loans, primarily consumer loans that qualify as collateral for FRB line of credit.
To
March 31, 2022 , the Bank held approximately$451.8 million in loans that qualify as collateral for the FRB line of credit. Subject to market conditions, we expect to utilize these borrowing facilities from time to time in the future to fund loan originations and deposit withdrawals, to satisfy other financial commitments, repay maturing debt and to take advantage of investment opportunities to the extent feasible. The Bank's Asset and Liability Management Policy permits management to utilize brokered deposits up to 20% of deposits or$387.4 million atMarch 31, 2022 . Total brokered deposits atMarch 31, 2022 were$187.8 million . Management utilizes brokered deposits to mitigate interest rate risk and liquidity risk exposure when appropriate. Liquidity management is both a daily and long-term function of the Company's management. Excess liquidity is generally invested in short-term investments, such as overnight deposits and federal funds. On a longer-term basis, a strategy is maintained of investing in various lending products and investment securities, includingU.S. Government obligations andU.S. agency securities. The Company uses sources of funds primarily to meet ongoing commitments, pay maturing deposits, fund withdrawals, and to fund loan commitments. AtMarch 31, 2022 , the approved outstanding loan commitments, including unused lines of credit amounted to$616.2 million . Securities purchased during the three months endedMarch 31, 2022 and 2021 totaled$16.8 million and$32.7 million , respectively, and securities repayments, maturities and sales in those quarters were$3.3 million and$6.9 million , respectively.
The Bank’s liquidity is also affected by the volume of loans sold and loan principal repayments. In the three months ended
The Bank's liquidity has been positively impacted by increases in deposit levels. Total deposits increased$4.0 million during the three months endedMarch 31, 2022 primarily driven by growth in CDs. CDs scheduled to mature in three months or less atMarch 31, 2022 , totaled$92.0 million . It is management's policy to offer deposit rates that are competitive with other local financial institutions. Based on this management strategy, the Company believes that a majority of maturing relationship deposits will remain with the Bank. As a separate legal entity from the Bank,FS Bancorp, Inc. must provide for its own liquidity. Sources of capital and liquidity forFS Bancorp, Inc. include distributions from the Bank and the issuance of debt or equity securities. Dividends and other capital distributions from the Bank are subject to regulatory notice. The Company currently expects to continue 56
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the current practice of paying quarterly cash dividends on common stock subject to the Board of Directors' discretion to modify or terminate this practice at any time and for any reason without prior notice. Our current quarterly common stock dividend rate is$0.20 per share, as approved by our Board of Directors, which we believe is a dividend rate per share which enables us to balance our multiple objectives of managing and investing in the Bank, and returning a substantial portion of our cash to our shareholders. Assuming continued payment during 2022 at this rate of$0.20 per share, our average total dividend paid each quarter would be approximately$1.1 million based on the number of our current outstanding shares (which assumes no increases or decreases in the number of shares, except in connection with the anticipated vesting of currently outstanding equity awards). AtMarch 31, 2022 ,FS Bancorp, Inc. had$17.0 million in unrestricted cash to meet liquidity needs.
Capital resources
The Bank is subject to minimum capital requirements imposed by theFDIC . Based on its capital levels atJune 30, 2021 , the Bank exceeded these requirements as of that date. Consistent with our goals to operate a sound and profitable organization, our policy is for the Bank to maintain a well capitalized status under the capital categories of theFDIC . Based on capital levels atMarch 31, 2022 , the Bank was considered to be well capitalized. EffectiveJanuary 1, 2022 , a bank that elects to use the Community Bank Leverage Ratio ("CBLR") will generally be considered well-capitalized and to have met the risk-based and leverage capital requirements of the capital regulations if it has a leverage ratio greater than 9.0%. AtMarch 31, 2022 , the Bank qualified and elected to use the CBLR to measure capital adequacy. The Tier 1 leverage-based capital ratio calculated for the Bank atMarch 31, 2022 was 12.2%. As a bank holding company registered with theFederal Reserve , the Company is subject to the capital adequacy requirements of theFederal Reserve. Bank holding companies with less than$3.0 billion in assets are generally not subject to compliance with theFederal Reserve's capital regulations, which are generally the same as the capital regulations applicable to the Bank. TheFederal Reserve has a policy that a bank holding company is required to serve as a source of financial and managerial strength to the holding company's subsidiary bank and theFederal Reserve expects the holding company's subsidiary bank to be well capitalized under the prompt corrective action regulations.
Yes
FS Bancorp, Inc. were subject to regulatory capital guidelines for bank holding companies with$3.0 billion or more in assets atMarch 31, 2022 ,FS Bancorp, Inc. would have exceeded all regulatory capital requirements. For informational purposes, the Tier 1 leverage-based capital ratio calculated forFS Bancorp, Inc. atMarch 31, 2022 was 10.8%. For additional information regarding regulatory capital compliance, see the discussion included in "Note 14 -Regulatory Capital " to the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report.
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