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| FSBW > SEC Filings for FSBW > Form 10-Q on 25-Jun-2012 | All Recent SEC Filings |
25-Jun-2012
Quarterly Report
Forward-Looking Statements
This report may contain 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 goals, intentions and expectations;
· statements regarding our business plans, prospects, growth and operating 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 based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:
· general economic conditions, either nationally or in our market area, that are worse than expected;
· the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;
· fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market area;
· increases in premiums for deposit insurance;
· the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;
· changes in the interest rate environment that reduce our interest margins or reduce the fair value of financial instruments;
· increased competitive pressures among financial services companies;
· our ability to execute our plans to grow our residential construction lending, our mortgage banking operations and our warehouse lending and the geographic expansion of our indirect home improvement lending;
· our ability to attract and retain deposits;
· our ability to control operating costs and expenses;
· changes in consumer spending, borrowing and savings habits;
· our ability to successfully manage our growth;
· legislative or regulatory changes that adversely affect our business, including the effect of the Dodd-Frank Act, changes in regulation policies and principles, or the interpretation of regulatory capital or other rules;
· adverse changes in the securities markets;
· changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board;
· costs and effects of litigation, including settlements and judgments;
· inability of key third-party vendors to perform their obligations to us;
· statements with respect to our intentions regarding disclosure and other changes resulting from the Jumpstart Our Business Startups Act ("JOBS Act"); and
· other economic, competitive, governmental, regulatory and technical factors affecting our operations, pricing, products and services and other risks described elsewhere in this report.
Any of the forward-looking statements that we make in this report and in other public statements we make 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. Any of the forward-looking statements are based upon management's beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements 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.
Overview
1st Security Bank of Washington has been serving the Puget Sound area since 1936. Originally chartered as a credit union, previously known as Washington's Credit Union, we served various select employment groups. On April 1, 2004, we converted from a credit union to a Washington state-chartered mutual savings bank. On July 10, 2008, our board of directors unanimously adopted a plan of conversion from the mutual to the stock form of organization. Due to market conditions and regulatory issues, the process was put on hold. On August 18, 2011, the board of directors voted to move forward with the conversion, which is currently in process. Pursuant to the plan of conversion, 1st Security Bank of Washington will convert from the mutual form of organization (meaning no shareholders) to the stock form of organization and will become the wholly owned subsidiary of FS Bancorp, a new Washington corporation. FS Bancorp will own all of the capital stock of 1st Security upon completion of the conversion. All of the common stock of FS Bancorp will be owned by public shareholders and our tax qualified employee benefit plans.
We are a relationship-driven community bank. We deliver banking and financial services to local families, local and regional businesses and industry niches within distinct Puget Sound area communities. We emphasize long-term relationships with families and businesses within the communities we serve, working with them to meet their financial needs. We are also actively involved in community activities and events within these market areas, which further strengthens our relationships within these markets.
1st Security Bank of Washington is a diversified lender with a focus on the origination of home improvement loans, commercial real estate mortgage loans, commercial business loans and second mortgage/home equity loan products. Consumer loans, in particular indirect home improvement loans to finance window replacement, gutter replacement, siding replacement, and other improvement renovations, represent the largest portion of the loan portfolio and have traditionally been the mainstay of our lending strategy. As of March 31, 2012, consumer loans represented 47.7% of our total portfolio, with indirect home improvement loans representing 70.7% of the total consumer loan portfolio.
Our indirect home improvement lending is reliant on our relationships with home improvement contractors and dealers. Our indirect home improvement contractor/dealer network is currently comprised of approximately 160 active contractors and dealers with businesses located throughout Washington and Oregon, with approximately 10 contractors/dealers responsible for more than half of this loan volume. As a result of the recent economic downturn and contraction of credit to both contractors/dealers and their customers, there has been an increase in business closures and our existing contractor/dealer base has experienced decreased sales and loan volume. In order to maintain our indirect home improvement loan volume, we are considering expanding this line of business into the State of California. We are currently testing the California market with a limited number of contractors/dealers with whom our lenders have had previous experience. To the extent we determine to move forward with our indirect home improvement lending program in California, we anticipate that these California loans
will represent no more than 20% of the total consumer loan portfolio. As of March 31, 2012, no indirect home improvement loans were originated through the California dealers.
Going forward, an emphasis will be placed on diversifying our lending products by expanding our commercial real estate, commercial business and residential construction lending, while maintaining the current size of our consumer loan portfolio. Further, as a result of demand by depository customers, we reintroduced in-house originations of residential mortgage loans during the fourth quarter of 2011, primarily for sale into the secondary market, through a mortgage banking program. Our lending strategies are intended to take advantage of: (1) our historical strength in indirect consumer lending, (2) recent market dislocation that has created new lending opportunities and the availability of experienced bankers, and (3) our strength in relationship lending. Retail deposits will continue to serve as a primary funding source.
1st Security Bank of Washington 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 of 1st Security Bank of Washington include primarily deposits, including brokered deposits, borrowings, payments on loans and income provided from operations.
Our earnings are primarily dependent upon our 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. Our earnings are also affected by our provision for loan losses, service charges and fees, gains from sales of assets, operating expenses and income taxes.
On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (JOBS Act), which establishes a new category of issuer called an emerging growth company. Under the JOBS Act, an emerging growth company is defined as an issuer with total annual gross revenues less than $1 billion during its most recently completed fiscal year. An issuer continues to be eligible for emerging growth company status for up to five years following its initial public offering, or until the earliest of (1) the last day of the fiscal year during which it had total annual gross revenues of $1 billion or more (indexed for inflation), (2) the date on which it became a large accelerated filer as defined in Rule 12b-2 of the Securities Exchange Act of 1934, or (3) the date on which it issued more than $1 billion in non-convertible debt in the previous three-year period.
Among other requirements, the JOBS Act permits an emerging growth company to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. The Holding Company has elected to "opt out" of this provision and, as a result, will comply with new or revised accounting standards as required when they are adopted. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.
We are an "emerging growth company" as defined under the JOBS Act. We will
remain an emerging growth company for up to five years, or until the earliest of
(i) the last day of the first fiscal year in which our total annual gross
revenues exceed $1 billion, (ii) the date that we become a "large accelerated
filer" as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as
amended (the "Exchange Act") which would occur if the market value of our common
stock that is held by non-affiliates exceeds $700 million as of the last
business day of our most recently completed second fiscal
quarter or (iii) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three year period.
As an emerging growth company, we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not "emerging growth companies" including, but not limited to:
· not being required to comply with the auditor attestation requirements of
Section 404(b) of the Sarbanes-Oxley Act of 2002 (we also will not be subject
to the auditor attestation requirements of Section 404(b) as long as we are a
"smaller reporting company," which includes issuers that had a public float of
less than $75 million as of the last business day of their most recently
completed second fiscal quarter);
· reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements; and
· exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved.
In addition, Section 107 of the JOBS Act provides that an emerging growth
company can take advantage of the extended transition period provided in
Section 7(a)(2)(B) of the Securities Act of 1933, as amended (the "Securities
Act") for complying with new or revised accounting standards. Under this
provision, an emerging growth company can delay the adoption of certain
accounting standards until those standards would otherwise apply to private
companies. However, we are choosing to "opt out" of such extended transition
period, and as a result, we will comply with new or revised accounting standards
on the relevant dates on which adoption of such standards is required for
non-emerging growth companies. Section 107 of the JOBS Act provides that our
decision to opt out of the extended transition period for complying with new or
revised accounting standards is irrevocable.
Critical Accounting Policies and Estimates
Certain of our accounting policies are important to the portrayal of our 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 determining the allowance for loan losses, the fair value of other real estate owned and the need for a valuation allowance related to the deferred tax asset. Our accounting policies are discussed in detail in Note 1 to the Financial Statements in this report and in detail in our Registration Statement on Form S-1 filed with the SEC (SEC Registration No. 333-177125).
Allowance for Loan Loss. The allowance for loan losses is the amount estimated
by management as necessary to cover probable losses inherent in the loan
portfolio at the balance sheet date. The allowance is established through the
provision for loan losses, which is charged to income. Determining the amount of
the allowance for loan losses necessarily involves a high degree of
judgment. Among the material estimates required to establish the allowance 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 allowance at least
quarterly and establishes the provision
for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectability of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. As we add new products, increase the complexity of the loan portfolio, and expand our market area, we intend to enhance and adapt our 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 allowance for loan losses in any given period. Management believes that its systematic methodology continues to be appropriate given our size and level of complexity.
Other Real Estate Owned. Property acquired by foreclosure or deed in lieu of foreclosure is recorded at fair value, less cost to sell. Development and improvement costs relating to the property are capitalized. The carrying value of the property is periodically evaluated by management and, if necessary, allowances are established to reduce the carrying value to net realizable value. Gains or losses at the time the property is sold are charged or credited to operations in the period in which they are realized. The amounts that we will ultimately realize from the sale of other real estate owned may differ substantially from the carrying value of the assets because of market factors beyond our control or because of changes in management's strategies for recovering the investment.
Income Taxes. Income taxes are reflected in our financial statements to show the tax effects of the operations and transactions reported in the financial statements and consist of taxes currently payable plus deferred taxes. Accounting Standards Codification, 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 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 our deferred tax asset, we are required to estimate our income and taxes in the jurisdiction in which we operate. This process involves estimating our 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 are attributable to deductible temporary differences and carryforwards. After the deferred tax asset has been measured using the applicable enacted tax rate and provisions of the enacted tax law, it is then necessary to assess the need for a valuation allowance. A valuation allowance is needed when, based on the weight of the available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. As required by generally accepted accounting principles, available evidence is weighted heavily on cumulative losses with less weight placed on future projected profitability. Realization of the deferred tax asset is dependent on whether there will be sufficient future taxable income of the appropriate character in the period during which deductible temporary differences reverse or within the carryback and carryforward periods available under tax law. Based upon the available evidence, management determined that a full valuation allowance to offset the net deferred tax assets at March 31, 2012 and December 31, 2011 was required.
Comparison of Financial Condition at March 31, 2012 and December 31, 2011
Assets. Total assets increased $17.0 million, or 6.0%, to $300.8 million at March 31, 2012 from $283.8 million at December 31, 2011, primarily as a result of a $15.3 million, or 7.1%, increase in net loans receivable and a $5.0 million, or 18.5%, increase in securities available-for-sale. The increase in assets during the period was partially offset by a $3.8 million, or 22.6%, decrease in interest-bearing deposits at other financial institutions from $16.9 million to $13.1 million.
Loans receivable, net, increased $15.3 million, or 7.1%, to $232.5 million at March 31, 2012 from $217.1 million at December 31, 2011, primarily due to increases in residential construction and commercial business lending. Real estate secured loans increased $8.4 million, or 13.2%, to $71.9 million at March 31, 2012 from $63.5 million at December 31, 2011, primarily as a result of a $4.8 million, or 47.8%, increase in residential construction lending and a $1.9 million, or 6.5%, increase in commercial real estate loans. Consumer loans decreased $1.5 million, or 1.4%, to $112.7 million at March 31, 2012 from $114.2 million at December 31, 2011, as a result of a $1.5 million, or 1.9%, decrease in indirect home improvement loans and a $1.1 million, or 18.2%, decrease in automobile loans, partially offset by $1.3 million, or 5.5% increase in recreational loans. Commercial business loans increased $8.5 million, or 19.6%, to $51.8 million at March 31, 2012 from $43.3 million at December 31, 2011. The increase in commercial business loans was attributable to lower interest rates, which drove refinance activity at our warehouse lending borrowers.
Our allowance for loan losses at March 31, 2012 was $4.2 million, or 1.8% of gross loans receivable, compared to $4.3 million, or 2.0% of gross loans receivable, at December 31, 2011. Non-performing loans, consisting of non-accruing loans, decreased to $1.9 million at March 31, 2012 from $2.2 million at December 31, 2011. During the three months ended March 31, 2012, net charge-offs totaled $660,000 compared to $1.2 million during the fourth quarter of 2011. At March 31, 2012, our non-performing loans consisted of $629,000 of construction and development loans, $386,000 of one- to four-family loans, $282,000 of home equity loans, $323,000 of consumer loans and $329,000 of commercial business loans. Non-performing loans to total loans decreased to 0.8% at March 31, 2012 from 1.0% at December 31, 2011. Other real estate owned totaled $2.8 million at March 31, 2012, compared to $4.6 million at December 31, 2011. The $1.8 million or 39.2% reduction in other real estate owned reflects the sale of $1.4 million in other real estate owned and write-downs to fair value of $379,000 during the period. At March 31, 2012, we also had $3.2 million in restructured loans of which $3.1 million were performing in accordance with their modified terms and $133,000 was on non-accrual.
Liabilities. Total liabilities increased $16.8 million, or 6.5%, to $273.8 million at March 31, 2012, from $257.0 million at December 31, 2011. Deposits increased $18.1 million, or 7.3%, to $264.5 million at March 31, 2012 from $246.4 million at December 31, 2011. The increase in deposits was due to a $5.9 million, or 19.1%, increase in time deposits, a $6.1 million, or 31.0%, increase in interest-bearing and noninterest-bearing checking accounts, a $1.5 million, or 12.7%, increase in savings accounts, and a $4.5 million, or 4.6%, increase in money market accounts. The increase in checking, savings and money market accounts was primarily the result of our continued emphasis on increasing core deposits, which included increased deposits associated with our commercial lending relationships, while the increase in time deposits was primarily as a result of a $4.0 million increase in brokered deposits.
Our total borrowings, which consisted of Federal Home Loan Bank advances, decreased $1.1 million, or 12.4%, to $7.8 million at March 31, 2012 from $8.9 million at December 31, 2011. The decrease in borrowings was related to our continued focus on reducing non-core funding and the success of our customer retention programs and new promotions which increased core deposits.
Equity. Total equity increased $271,000, or 1.0%, to $27.0 million at March 31, 2012 from $26.8 million at December 31, 2011. The increase primarily was a result of net income of $277,000 for the three months ended March 31, 2012.
Comparison of Results of Operation for the Three Months Ended March 31, 2012 and 2011
General. Net income for the three months ended March 31, 2012 was $277,000 compared to net income of $564,000, for the three months ended March 31, 2011. The decrease in net income was primarily attributable to a $707,000, or 24.6% increase in noninterest expense, partially offset by a
$290,000, or 8.6%, increase in net interest income and a $180,000, or 33.2%, increase in noninterest income.
Net Interest Income. Net interest income increased $290,000, or 8.6%, to $3.7 million for the three months ended March 31, 2012, from $3.4 million for the three months ended March 31, 2011. The increase in net interest income was attributable to a $186,000 decrease in interest expenses, primarily due to a reduction of our overall cost of funds and an increase in interest income resulting from a shift of funds from lower yielding cash and cash equivalents to higher yielding investment securities, as well as an increase in the average balance of our loan portfolio.
Our net interest margin increased 14 basis points to 5.35% for the three months ended March 31, 2012, from 5.21% for the same quarter the prior year, primarily due to a shift in funds from lower yielding cash and cash equivalents into higher yielding investment securities and a lower level of non-performing loans, coupled with a 38 basis point decline in our overall cost of funds.
Interest Income. Interest and dividend income for the three months ended March 31, 2012 increased $104,000, or 2.5%, to $4.3 million, from $4.2 million for the three months ended March 31, 2011. The increase during the period was primarily attributable to the increase in the average balance of our investment and mortgage-backed securities during the three months ended March 31, 2012 compared to the same period last year, partially offset by a seven basis point decrease in the yield earned on loans.
Interest Expense. Interest expense decreased $186,000, or 22.3%, to $649,000 for the three months ended March 31, 2012, from $835,000 for the three months ended March 31, 2011. As a result of general market rate decreases, the average cost of funds for total interest-bearing liabilities decreased 38 basis points to 1.08% for the three months ended March 31, 2012, compared to 1.46% for the three months ended March 31, 2011. The decrease was due to a decline in rates paid on our certificates of deposit, partially offset by the higher average balances for savings and money market accounts which carry a lower cost of funds. The average balance of total interest-bearing liabilities increased $11.2 million, or 4.9%, to $240.3 million for the three months ended March 31, 2012, from $229.1 million for the three months ended March 31, 2011.
Provision for Loan Losses. In connection with our analysis of the loan portfolio, we recorded a provision for loan losses of $515,000 for the three months ended March 31, 2012, compared to $465,000 for the three months ended March 31, 2011. The $50,000 increase in the provision primarily relates to the $15.3 million increase in net loans in the first quarter of 2012. Non-performing loans were $1.9 million or 0.8% of total loans at March 31, 2012, compared to . . .
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