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FSBW > SEC Filings for FSBW > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for FS BANCORP, INC.

Form 10-Q for FS BANCORP, INC.


13-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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 or increase capital requirements, including the effect of the Dodd-Frank Act, changes in regulation policies and principles, or the interpretation of regulatory capital or other rules including Basel III;

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


FS BANCORP, INC. AND SUBSIDIARY


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 the Bank makes in this report 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 Bank undertakes 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

FS Bancorp, Inc. and its subsidiary bank, 1st Security Bank of Washington have been serving the Puget Sound area since 1936. Originally chartered as a credit union, previously known as Washington's Credit Union, the Bank served various select employment groups. On April 1, 2004, the credit union converted to a Washington state-chartered mutual savings bank. On July 9, 2012, the Bank converted from mutual to stock form and became the wholly owned subsidiary of the Company.

The Company is a relationship-driven community bank. The Bank delivers banking and financial services to local families, local and regional businesses and industry niches within distinct Puget Sound area communities. The Company emphasizes long-term relationships with families and businesses within the communities served, working with them to meet their financial needs. The Bank is also actively involved in community activities and events within these market areas, which further strengthens our relationships within these markets.

The Company 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 September 30, 2012, consumer loans represented 44.9% of the Bank's total portfolio, down from 51.7% at December 31, 2011 due to growth in other lending channels, with indirect home improvement loans representing 69.6% of the total consumer loan portfolio.

The indirect home improvement lending is reliant on relationships with home improvement contractors and dealers. The Bank's indirect home improvement contractor/dealer network is currently comprised of approximately 200 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 indirect home improvement loan volume, the Bank is considering expanding this line of business into the State of California. The Bank is currently preparing to test the California market with a limited number of contractors/dealers with whom the Bank's lenders have had previous experience. To the extent management determines to move forward with the indirect home improvement lending program in California, management anticipates that these California loans will represent no more than 20% of the total consumer loan portfolio. As of September 30, 2012, the Company had not originated any indirect home improvement loans through the California dealers.


FS BANCORP, INC. AND SUBSIDIARY


Going forward, an emphasis will be placed on diversifying lending products by expanding commercial real estate, commercial business and residential construction lending, while maintaining the current size of the Bank's consumer loan portfolio. Further, as a result of demand by depository customers, management reintroduced Bank originations of residential mortgage loans during the fourth quarter of 2011, primarily for sale into the secondary market, through a mortgage banking program. The Company's lending strategies are intended to take advantage of: (1) the Bank's historical strength in indirect consumer lending, (2) recent market dislocation that has created new lending opportunities and the availability of experienced bankers, and (3) strength in relationship lending. Retail deposits will continue to serve as a primary funding source.

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.

Earnings are primarily dependent upon the Bank's 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. The Bank'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.

On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (JOB Act), which establishes a new category of issuer called an emerging growth company. The Company is an "emerging growth company" as defined under the JOBS Act. The Company 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 the Company's common stock that is held by non-affiliates exceeds $700 million as of the last business day of the most recently completed second fiscal quarter or (iii) the date on which the Company has issued more than $1 billion in non-convertible debt during the preceding three year period.

As an emerging growth company, the Company 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 (the Company also will not be subject to the auditor attestation requirements of Section 404(b) as long as the Company is 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 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.


FS BANCORP, INC. AND SUBSIDIARY


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, the Company has elected to "opt out" of such extended transition period, and as a result, the Company 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. Management's 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 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 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.

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 the Bank believes 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 the Bank adds new products, increase the complexity of the loan portfolio, and expand the Bank's market area, management intends 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 will be 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.


FS BANCORP, INC. AND SUBSIDIARY


Income Taxes. Income taxes are reflected in the 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 the deferred tax asset, the Bank is required to estimate the income and taxes in the jurisdiction in which the Bank operates. This process involves estimating 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.

Comparison of Financial Condition at September 30, 2012 and December 31, 2011

Assets. Total assets increased $57.4 million, or 20.2%, to $341.2 million at September 30, 2012 from $283.8 million at December 31, 2011, primarily as a result of a $42.0 million, or 19.4% increase in net loans receivable, an $11.9 million, or 44.2%, increase in securities available-for-sale, an $8.5 million, or 100%, increase in loans held for sale and an $2.7 million increase in the deferred tax asset due to the reversal of the allowance. Cash and equivalents decreased $7.1 million, or 36.8% to $12.2 million at September 30, 2012 from $19.3 million at December 31, 2011. The increase in investments is in line with the Bank's business plan, and the increase in loans is tied to the low interest rate environment.

Loans receivable, net increased $42.0 million, or 19.4%, to $259.2 million at September 30, 2012 from $217.1 million at December 31, 2011. Real estate secured loans increased $20.2 million, or 31.8%, to $83.7 million at September 30, 2012 from $63.5 million at December 31, 2011, primarily as a result of a $14.3 million, or 141.3%, increase in residential construction lending, a $3.8 million, or 13.3% increase in commercial real estate loans and a $1.6 million, or 18.1%, increase in one-to-four family loans. Consumer loans increased $4.0 million, or 3.5%, to $118.2 million at September 30, 2012 from $114.2 million at December 31, 2011, as a result of a $6.3 million, or 25.8% increase in recreational loans and a $1.0 million, or 1.3%, increase in indirect home improvement loans partially offset by a $2.8 million, or 47.6%, decrease in automobile loans. Commercial business loans increased $18.2 million, or 41.9%, to $61.5 million at September 30, 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 and loan volume to the Bank's warehouse lending borrowers.

The allowance for loan losses at September 30, 2012 was $4.4 million, or 1.7% 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 $2.1 million at September 30, 2012 from $2.2 million at December 31, 2011. At September 30, 2012, non-performing loans consisted of $877,000 of commercial real estate loans, $362,000 of one-to-four family loans, $197,000 of home equity loans, and $394,000 of consumer loans and $266,000 of commercial business loans. Non-performing loans to total loans decreased to 0.8% at September 30, 2012 from 1.0% at December 31, 2011. Other real estate owned totaled $2.3 million at September 30, 2012, compared to $4.6 million at December 31, 2011. The $2.3 million or 49.4% reduction in other real estate owned reflects the sale of $2.5 million in other real estate owned and write-downs to fair value of $693,000 during the nine months ended September 30, 2012. At September 30, 2012, the Bank also had $3.1 million in restructured loans of which $2.1 million were performing in accordance with their modified terms and $1.0 million was on non-accrual.


                        FS BANCORP, INC. AND SUBSIDIARY

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A summary of non-performing assets as of September 30, 2012 and December 31,
2011:

                                 September 30,      December 31,
                                     2012               2011
Non-performing assets-
Non-accrual loans               $         2,096     $       2,227
Other real estate owned                   2,321             4,589
Repossessed consumer property                25                78
Total non-performing assets               4,442     $       6,894

Liabilities. Total liabilities increased $24.8 million, or 9.7%, to $281.8 million at September 30, 2012, from $257.0 million at December 31, 2011. Deposits increased $28.4 million, or 11.5%, to $274.8 million at September 30, 2012 from $246.4 million at December 31, 2011. The increase in deposits was due to a $16.4 million, or 41.1%, increase in interest-bearing and noninterest-bearing checking accounts with management's continued focus on deposit growth efforts on relationship deposits with new and existing customers, a $10.2 million, or 9.2%, increase in money market and savings accounts, and a $1.8 million, or 1.9%, increase in time deposits. The increase in money market accounts was related to the funds received during the IPO that were substantially converted to equity capital.

Total borrowings, which consisted of FHLB advances, decreased $4.8 million, or 53.9%, to $4.1 million at September 30, 2012 from $8.9 million at December 31, 2011. The decrease in borrowings was related to the Bank's continued focus on reducing non-core funding and the success of our customer retention programs.

Equity. Total equity increased $32.6 million, or 121.8%, to $59.4 million at September 30, 2012 from $26.8 million at December 31, 2011. The increase in equity was predominantly a result of the $32.4 million in gross proceeds raised in the IPO and net income year to date. Book value per common share was $18.32 as of September 30, 2012.

Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2012 and 2011

General. Net income for the three months ended September 30, 2012 was $3.3 million and includes a $2.3 million net tax impact from deferred tax asset provision reversal compared to net income of $225,000 for the three months ended September 30, 2011. The increase in net income was primarily attributable to a $925,000, or 27.7%, increase in net interest income and an $874,000, or 144.5%, increase in noninterest income partially offset by a $1.0 million, or 32.7% increase in noninterest expense. The increase in noninterest income was primarily impacted by $915,000 in gains on sale of loans from the Bank's new residential mortgage banking operations. The increase in noninterest expense was related to investments in new lending channels.

Net income for the nine months ended September 30, 2012 was $4.2 million including a $2.3 million net tax benefit compared to net income of $1.2 million for the nine months ended September 30, 2011. The increase in net income was primarily attributable to a $2.7 million, or 31.1%, increase in noninterest expense partially offset by a $1.8 million, or 18.3%, increase in net interest income and a $1.6 million, or 95.0%, increase in noninterest income. The increase in noninterest income was


FS BANCORP, INC. AND SUBSIDIARY


primarily impacted by $1.5 million in gains on sale of loans from the Bank's new residential mortgage banking operations.

Net Interest Income. Net interest income increased $925,000, or 27.7%, to $4.3 million for the three months ended September 30, 2012, from $3.3 million for the three months ended September 30, 2011. The increase in net interest income was attributable to a $796,000 increase in interest income resulting from a shift of funds during the period from lower yielding cash and cash equivalents to higher yielding investment securities, as well as an increase in the average balance of the loan portfolio, and a $129,000 decrease in interest expense, primarily due to a reduction of the overall cost of funds.

Net interest income increased $1.8 million, or 18.3%, to $11.8 million for the nine months ended September 30, 2012, from $10.0 million for the nine months ended September 30, 2011. The increase in net interest income was attributable to a $494,000 decrease in interest expense, primarily due to a reduction in the overall cost of funds and an increase in interest income resulting from a shift of funds during the period from lower yielding cash and cash equivalents to higher yielding investment securities, as well as an increase in the average balance of the loan portfolio.

The net interest margin increased 19 basis points to 5.39% for the nine months ended September 30, 2012, from 5.20% for the same period of the prior year, primarily due to a shift in funds during the period 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 the cost of funds.

Interest Income. Interest income for the three months ended September 30, 2012 increased $796,000, or 19.7%, to $4.8 million, from $4.0 million for the three months ended September 30, 2011. The increase during the period was primarily attributable to the increase in the average balance of the loan portfolio as well as a shift of funds during the period from lower yielding cash and cash equivalents to higher yielding investment securities during the three months ended September 30, 2012 compared to the same period last year.

Interest income for the nine months ended September 30, 2012 increased $1.3 million, or 10.8%, to $13.6 million, from $12.3 million for the nine months ended September 30, 2011. The increase during the period was attributable to a $990,000 increase in interest income from loans and a $345,000 increase in investment income during the nine months ended September 30, 2012 compared to the same period last year.

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