fsbw_Current_Folio_10Q

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10‑Q

(Mark One)

[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2018              OR

[   ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                    

Commission File Number:   001‑35589

FS BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Washington

 

45‑4585178

(State or other jurisdiction of incorporation or organization)

 

(IRS Employer Identification No.)

 

6920 220th Street SW, Mountlake Terrace, Washington  98043

(Address of principal executive offices; Zip Code)

(425) 771‑5299

(Registrant’s telephone number, including area code)

None

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes [X]          No [   ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes [X]          No [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b‑2 of the Exchange Act.

 

 

 

Large accelerated filer [   ]

 

Accelerated filer [ X ]

Non-accelerated filer [   ] (Do not check if a smaller reporting company)

 

Smaller reporting company [  ]

Emerging growth company [  ]

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act).    Yes [   ]          No [X]

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  As of May 4, 2018, there were 3,695,952 outstanding shares of the registrant’s common stock.

 

 

 

 


 

Table of Contents

FS Bancorp, Inc.

Form 10‑Q

Table of Contents

 

 

 

 

 

 

    

 

    

Page Number

PART I

 

FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1. 

 

Financial Statements

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheets at March 31, 2018 and December 31, 2017 (Unaudited)

 

 

 

 

 

 

 

 

Consolidated Statements of Income for the Three Months Ended March 31, 2018 and 2017 (Unaudited)

 

 

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2018 and 2017 (Unaudited)

 

 

 

 

 

 

 

 

Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2018 and 2017 (Unaudited)

 

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2018 and 2017 (Unaudited)

 

7 - 8 

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements

 

9 - 38 

 

 

 

 

 

Item 2. 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

39 - 47 

 

 

 

 

 

Item 3. 

 

Quantitative and Qualitative Disclosures About Market Risk

 

47 

 

 

 

 

 

Item 4. 

 

Controls and Procedures

 

47 

 

 

 

 

 

PART II 

 

OTHER INFORMATION

 

49 

 

 

 

 

 

Item 1. 

 

Legal Proceedings

 

49 

 

 

 

 

 

Item 1A. 

 

Risk Factors

 

49 

 

 

 

 

 

Item 2. 

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

49 

 

 

 

 

 

Item 3. 

 

Defaults Upon Senior Securities

 

49 

 

 

 

 

 

Item 4. 

 

Mine Safety Disclosures

 

49 

 

 

 

 

 

Item 5. 

 

Other Information

 

49 

 

 

 

 

 

Item 6. 

 

Exhibits

 

50 

 

 

 

 

 

SIGNATURES 

 

 

 

52 

 

As used in this report, the terms “we,” “our,” “us,” “Company” and “FS Bancorp” refer to FS Bancorp, Inc. and its consolidated subsidiary, 1st Security Bank of Washington, unless the context indicates otherwise. When we refer to “Bank” in this report, we are referring to 1st Security Bank of Washington, the wholly owned subsidiary of FS Bancorp.

 

 

2


 

Table of Contents

Item 1. Financial Statements

FS BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share amounts) (Unaudited)

 

 

 

 

 

 

 

 

 

    

March 31, 

    

December 31, 

ASSETS

 

2018

 

2017

Cash and due from banks

 

$

3,532

 

$

3,043

Interest-bearing deposits at other financial institutions

 

 

22,108

 

 

15,872

Total cash and cash equivalents

 

 

25,640

 

 

18,915

Certificates of deposit at other financial institutions

 

 

17,611

 

 

18,108

Securities available-for-sale, at fair value

 

 

91,371

 

 

82,480

Loans held for sale, at fair value

 

 

51,315

 

 

53,463

Loans receivable, net

 

 

805,632

 

 

761,558

Accrued interest receivable

 

 

3,693

 

 

3,566

Premises and equipment, net

 

 

15,798

 

 

15,458

Federal Home Loan Bank (“FHLB”) stock, at cost

 

 

4,308

 

 

2,871

Bank owned life insurance (“BOLI”), net

 

 

13,410

 

 

10,328

Servicing rights, held at the lower of cost or fair value

 

 

7,515

 

 

6,795

Goodwill

 

 

2,312

 

 

2,312

Core deposit intangible, net

 

 

1,240

 

 

1,317

Other assets

 

 

3,767

 

 

4,612

TOTAL ASSETS

 

$

1,043,612

 

$

981,783

LIABILITIES

 

 

  

 

 

  

Deposits:

 

 

  

 

 

  

Noninterest-bearing accounts

 

$

190,301

 

$

186,890

Interest-bearing accounts

 

 

667,177

 

 

642,952

Total deposits

 

 

857,478

 

 

829,842

Borrowings

 

 

39,529

 

 

7,529

Subordinated note:

 

 

 

 

 

 

Principal amount

 

 

10,000

 

 

10,000

Unamortized debt issuance costs

 

 

(150)

 

 

(155)

Total subordinated note less unamortized debt issuance costs

 

 

9,850

 

 

9,845

Deferred tax liability, net

 

 

137

 

 

607

Other liabilities

 

 

11,176

 

 

11,958

Total liabilities

 

 

918,170

 

 

859,781

COMMITMENTS AND CONTINGENCIES (NOTE 7)

 

 

  

 

 

  

STOCKHOLDERS’ EQUITY

 

 

  

 

 

  

Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued or outstanding

 

 

 —

 

 

 —

Common stock, $.01 par value; 45,000,000 shares authorized; 3,695,552 and 3,680,152 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively

 

 

37

 

 

37

Additional paid-in capital

 

 

55,823

 

 

55,135

Retained earnings

 

 

72,349

 

 

68,422

Accumulated other comprehensive loss, net of tax

 

 

(1,716)

 

 

(475)

Unearned shares – Employee Stock Ownership Plan (“ESOP”)

 

 

(1,051)

 

 

(1,117)

Total stockholders’ equity

 

 

125,442

 

 

122,002

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

1,043,612

 

$

981,783

 

See accompanying notes to these consolidated financial statements.

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Table of Contents

FS BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except share amounts) (Unaudited)

 

 

 

 

 

 

 

 

    

Three Months Ended

 

 

March 31, 

 

    

2018

    

2017

INTEREST INCOME

 

 

 

 

Loans receivable, including fees

 

$

12,256

 

$

9,372

Interest and dividends on investment securities, cash and cash equivalents, and certificates of deposit at other financial institutions

 

 

732

 

 

661

Total interest and dividend income

 

 

12,988

 

 

10,033

INTEREST EXPENSE

 

 

 

 

 

 

Deposits

 

 

1,244

 

 

852

Borrowings

 

 

80

 

 

39

Subordinated note

 

 

167

 

 

167

Total interest expense

 

 

1,491

 

 

1,058

NET INTEREST INCOME

 

 

11,497

 

 

8,975

PROVISION FOR LOAN LOSSES

 

 

350

 

 

 —

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

 

 

11,147

 

 

8,975

NONINTEREST INCOME

 

 

 

 

 

 

Service charges and fee income

 

 

659

 

 

861

Gain on sale of loans

 

 

3,978

 

 

4,355

Gain on sale of investment securities

 

 

113

 

 

 —

Earnings on cash surrender value of BOLI

 

 

82

 

 

69

Other noninterest income

 

 

192

 

 

135

Total noninterest income

 

 

5,024

 

 

5,420

NONINTEREST EXPENSE

 

 

 

 

 

 

Salaries and benefits

 

 

7,048

 

 

6,118

Operations

 

 

1,359

 

 

1,486

Occupancy

 

 

648

 

 

643

Data processing

 

 

641

 

 

568

Loan costs

 

 

629

 

 

709

Professional and board fees

 

 

444

 

 

480

Federal Deposit Insurance Corporation (“FDIC”) insurance

 

 

41

 

 

134

Marketing and advertising

 

 

149

 

 

138

Amortization of core deposit intangible

 

 

77

 

 

100

Impairment on servicing rights

 

 

 —

 

 

 1

Total noninterest expense

 

 

11,036

 

 

10,377

INCOME BEFORE PROVISION FOR INCOME TAXES

 

 

5,135

 

 

4,018

PROVISION FOR INCOME TAXES

 

 

813

 

 

1,425

NET INCOME

 

$

4,322

 

$

2,593

Basic earnings per share

 

$

1.22

 

$

0.90

Diluted earnings per share

 

$

1.15

 

$

0.85

 

See accompanying notes to these consolidated financial statements.

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Table of Contents

FS BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)  (Unaudited)

 

 

 

 

 

 

 

 

 

    

Three Months Ended

 

 

 

March 31, 

 

 

 

2018

 

2017

 

Net Income

 

$

4,322

 

$

2,593

 

Other comprehensive (loss) income, before tax:

 

 

  

 

 

  

 

Securities available-for-sale:

 

 

  

 

 

  

 

Unrealized holding (loss) gain during year

 

 

(1,468)

 

 

163

 

Income tax benefit (provision) related to unrealized holding (loss) gain

 

 

316

 

 

(57)

 

Reclassification adjustment for realized gain included in net income

 

 

(113)

 

 

 —

 

Income tax provision related to reclassification for realized gain

 

 

24

 

 

 —

 

Other comprehensive (loss) income, net of tax

 

 

(1,241)

 

 

106

 

COMPREHENSIVE INCOME

 

$

3,081

 

$

2,699

 

 

See accompanying notes to these consolidated financial statements.

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FS BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Dollars in thousands, except share amounts) (Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

 

    

 

 

    

 

 

    

Accumulated

    

 

 

    

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

Comprehensive

 

Unearned

 

Total

 

 

Common Stock

 

Paid-in

 

Retained

 

(Loss) Income,

 

ESOP

 

Stockholders’

 

 

Shares

 

Amount

 

Capital

 

Earnings

 

Net of Tax

 

Shares

 

Equity

BALANCE, January 1, 2017

 

3,059,503

 

$

31

 

$

27,334

 

$

55,584

 

$

(536)

 

$

(1,380)

 

$

81,033

Net income

 

 —

 

$

 —

 

 

 —

 

 

2,593

 

 

 —

 

 

 —

 

$

2,593

Dividends paid ($0.10 per share)

 

 —

 

$

 —

 

 

 —

 

 

(293)

 

 

 —

 

 

 —

 

$

(293)

Share-based compensation

 

 —

 

$

 —

 

 

191

 

 

 —

 

 

 —

 

 

 —

 

$

191

Stock options exercised

 

5,763

 

$

 —

 

 

97

 

 

 —

 

 

 —

 

 

 —

 

$

97

Other comprehensive income, net of tax

 

 —

 

$

 —

 

 

 —

 

 

 —

 

 

106

 

 

 —

 

$

106

ESOP shares allocated

 

 —

 

$

 —

 

 

171

 

 

 —

 

 

 —

 

 

66

 

$

237

BALANCE, March 31, 2017

 

3,065,266

 

$

31

 

$

27,793

 

$

57,884

 

$

(430)

 

$

(1,314)

 

$

83,964

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE, January 1, 2018

 

3,680,152

 

$

37

 

$

55,135

 

$

68,422

 

$

(475)

 

$

(1,117)

 

$

122,002

Net income

 

 —

 

$

 —

 

 

 —

 

 

4,322

 

 

 —

 

 

 —

 

$

4,322

Dividends paid ($0.11 per share)

 

 —

 

$

 —

 

 

 —

 

 

(395)

 

 

 —

 

 

 —

 

$

(395)

Share-based compensation

 

 —

 

$

 —

 

 

135

 

 

 —

 

 

 —

 

 

 —

 

$

135

Stock options exercised

 

15,400

 

$

 —

 

 

260

 

 

 —

 

 

 —

 

 

 —

 

$

260

Other comprehensive loss, net of tax

 

 —

 

$

 —

 

 

 —

 

 

 —

 

 

(1,241)

 

 

 —

 

$

(1,241)

ESOP shares allocated

 

 —

 

$

 —

 

 

293

 

 

 —

 

 

 —

 

 

66

 

$

359

BALANCE, March 31, 2018

 

3,695,552

 

$

37

 

$

55,823

 

$

72,349

 

$

(1,716)

 

$

(1,051)

 

$

125,442

 

See accompanying notes to these consolidated financial statements.

 

 

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FS BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands) (Unaudited)

 

 

 

 

 

 

 

 

 

     

Three Months Ended March 31, 

 

    

2018

     

2017

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

Net income

 

$

4,322

 

$

2,593

Adjustments to reconcile net income to net cash from operating activities

 

 

  

 

 

  

Provision for loan losses

 

 

350

 

 

 —

Depreciation, amortization and accretion

 

 

1,139

 

 

1,248

Compensation expense related to stock options and restricted stock awards

 

 

135

 

 

191

ESOP compensation expense for allocated shares

 

 

359

 

 

237

Increase in cash surrender value of BOLI

 

 

(82)

 

 

(69)

Gain on sale of loans held for sale

 

 

(3,896)

 

 

(4,355)

Gain on sale of portfolio loans

 

 

(82)

 

 

 —

Gain on sale of investment securities

 

 

(113)

 

 

 —

Origination of loans held for sale

 

 

(147,603)

 

 

(124,234)

Proceeds from sale of loans held for sale

 

 

152,419

 

 

140,125

Impairment of servicing rights

 

 

 —

 

 

 1

Changes in operating assets and liabilities

 

 

  

 

 

  

Accrued interest receivable

 

 

(107)

 

 

(232)

Other assets

 

 

845

 

 

246

Other liabilities

 

 

(912)

 

 

3,944

Net cash from operating activities

 

 

6,774

 

 

19,695

CASH FLOWS USED BY INVESTING ACTIVITIES

 

 

  

 

 

  

Activity in securities available-for-sale:

 

 

  

 

 

  

Proceeds from sale of investment securities

 

 

5,305

 

 

 —

Maturities, prepayments, sales, and calls

 

 

2,340

 

 

2,019

Purchases

 

 

(18,145)

 

 

(27,404)

Maturities of certificates of deposit at other financial institutions

 

 

496

 

 

 —

Purchase of certificates of deposit at other financial institutions

 

 

 —

 

 

(2,365)

Loan originations and principal collections, net

 

 

(32,911)

 

 

(21,432)

Purchase of portfolio loans

 

 

(17,000)

 

 

(3,132)

Proceeds from sale of  portfolio loans

 

 

5,551

 

 

 —

Purchase of premises and equipment, net

 

 

(749)

 

 

(225)

Purchase of BOLI

 

 

(3,000)

 

 

 —

FHLB stock, net

 

 

(1,437)

 

 

(382)

Net cash used by investing activities

 

 

(59,550)

 

 

(52,921)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

  

 

 

  

Net increase in deposits

 

 

27,636

 

 

45,421

Proceeds from borrowings

 

 

166,505

 

 

 —

Repayments of borrowings

 

 

(134,505)

 

 

(2,400)

Dividends paid

 

 

(395)

 

 

(293)

Proceeds from stock options exercised

 

 

260

 

 

97

Net cash from financing activities

 

 

59,501

 

 

42,825

NET INCREASE IN CASH AND CASH EQUIVALENTS

 

 

6,725

 

 

9,599

CASH AND CASH EQUIVALENTS, beginning of period

 

 

18,915

 

 

36,456

CASH AND CASH EQUIVALENTS, end of period

 

$

25,640

 

$

46,055

 

 

 

 

 

 

 

SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION

 

 

  

 

 

  

Cash paid during the period for:

 

 

  

 

 

  

Interest

 

$

1,416

 

$

1,051

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Table of Contents

FS BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(In thousands) (Unaudited)

SUPPLEMENTARY DISCLOSURES OF NONCASH OPERATING, INVESTING AND FINANCING ACTIVITIES

 

 

 

 

 

  

Change in unrealized (loss) gain on investment securities

 

$

(1,581)

 

$

163

Retention of gross mortgage servicing rights from loan sales

 

$

1,138

 

$

990

 

See accompanying notes to these consolidated financial statements

 

 

 

 

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Table of Contents

NOTE 1 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations - FS Bancorp, Inc. (the “Company”) was incorporated in September 2011 as the proposed holding company for 1st Security Bank of Washington (the “Bank” or “1st Security Bank”) in connection with the Bank’s conversion from the mutual to stock form of ownership which was completed on July 9, 2012. The Bank is a community-based savings bank with 12 branches, including the newly opened Silverdale, Washington branch which opened on April 12, 2018, and seven loan production offices in suburban communities in the greater Puget Sound area within Snohomish, King, Pierce, Jefferson, Kitsap, and Clallam counties, and one loan production office in the market area of the Tri-Cities, Washington. The Bank provides loan and deposit services to customers who are predominantly small- and middle-market businesses and individuals. The Company and its subsidiary are subject to regulation by certain federal and state agencies and undergo periodic examination by these regulatory agencies.

Pursuant to the Plan of Conversion (the “Plan”), the Company’s Board of Directors adopted an employee stock ownership plan (“ESOP”) which purchased 8% of the common stock in the open market or 259,210 shares. As provided for in the Plan, the Bank also established a liquidation account in the amount of retained earnings at December 31, 2011. The liquidation account is maintained for the benefit of eligible savings account holders at June 30, 2007, and supplemental eligible account holders as of March 31, 2012, who maintain deposit accounts at the Bank after the conversion. The conversion was accounted for as a change in corporate form with the historic basis of the Company’s assets, liabilities, and equity unchanged as a result.

Financial Statement Presentation - The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and in accordance with the instructions to Form 10‑Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”). It is recommended that these unaudited interim consolidated financial statements be read in conjunction with the Company’s Annual Report on Form 10‑K with all of the audited information and footnotes required by U.S. GAAP for complete financial statements for the year ended December 31, 2017, as filed with the SEC on March 16, 2018. In the opinion of management, all normal adjustments and recurring accruals considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included.

The results for the three months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018, or any other future period. The preparation of financial statements, in conformity with U.S. GAAP, requires management to make estimates and assumptions that affect amounts reported in the financial statements. Actual results could differ from these estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan and lease losses, fair value of financial instruments,   the valuation of servicing rights, and the deferred income taxes.

Amounts presented in the consolidated financial statements and footnote tables are rounded and presented in thousands of dollars except per share amounts. In the narrative footnote discussion, amounts are rounded and presented in millions of dollars to one decimal point if the amounts are above $1.0 million. Amounts below $1.0 million are rounded and presented in dollars to the nearest thousands. Certain prior year amounts have been reclassified to conform to the 2018 presentation with no change to consolidated net income or stockholders’ equity previously reported.

Principles of Consolidation - The consolidated financial statements include the accounts of FS Bancorp, Inc. and its wholly owned subsidiary, 1st Security Bank of Washington. All material intercompany accounts have been eliminated in consolidation.

Segment Reporting - The Company operates in two business segments through the Bank: commercial and consumer banking and home lending. The Company’s business segments are determined based on the products and services provided, as well as the nature of the related business activities, and they reflect the manner in which financial information is regularly reviewed for the purpose of allocating resources and evaluating performance of the Company’s businesses. The results for these business segments are based on management’s accounting process, which assigns income statement items and assets to each responsible operating segment. This process is dynamic and is based on management’s view of the Company’s operations. See “Note 13 - Business Segments”.

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Subsequent Events - The Company has entered into a five year lease with two five year option renewals for a new retail branch location in Silverdale, Washington, which opened April 12, 2018.

RECENT ACCOUNTING PRONOUNCEMENTS

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016‑02, Leases (Topic 842). ASU No. 2016‑02 requires lessees to recognize on the balance sheet the assets and liabilities arising from operating leases. A lessee should recognize a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. A lessee should include payments to be made in an optional period only if the lessee is reasonably certain to exercise an option to extend the lease or not to exercise an option to terminate the lease. For a finance lease, interest payments should be recognized separately from amortization of the right-of-use asset in the statement of comprehensive income. For operating leases, the lease cost should be allocated over the lease term on a generally straight-line basis. The amendments in ASU 2016‑02 are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application of the amendments in the ASU is permitted. Once adopted, we expect to report higher assets and liabilities as a result of including right-of-use assets and lease liabilities related to certain banking offices and certain equipment under noncancelable operating lease agreements. As of December 31, 2017, we would have reported an increase of approximately $4.7 million in both assets and liabilities in the Consolidated Balance Sheets based on management’s estimate assuming the early adoption of this ASU.

In June 2016, the FASB issued ASU No. 2016‑13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ASU is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. The ASU requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently evaluating the impact of this ASU on the Company’s consolidated financial statements. Once adopted, we anticipate our allowance for loan losses to increase through a one‑time adjustment to retained earnings, however, until our evaluation is complete the magnitude of the increase will be unknown.

In March 2017, the FASB issued ASU No. 2017‑08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310‑20):  Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable debt securities held at a premium. The ASU will take effect for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The adoption of ASU No. 2017‑08 is not expected to have a material impact on the Company’s consolidated financial statements.

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This ASU amends the hedge accounting recognition and presentation requirements in ASC 815 to (1) improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities and (2) reduce the complexity of and simplify the application of hedge accounting by preparers. The amendments in this ASU permit hedge accounting for hedging relationships involving nonfinancial risk and interest rate risk by removing certain limitations in cash flow and fair value hedging relationships. In addition, the ASU requires an entity to present the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported. The amendments in this ASU are effective for annual periods,

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and interim periods within those annual periods, beginning after December 15, 2018 and early adoption is permitted. The adoption of ASU No. 2017-12 is not expected to have a material impact on the Company's consolidated financial statements.

In March 2018, the FASB issued ASU No. 2018-05, Income Taxes (Topic 740). This ASU was issued to provide guidance on the income tax accounting implications of the Tax Cuts and Jobs Act (“Tax Act”) and allows for entities to report provisional amounts for specific income tax effects of the Act for which the accounting under Topic 740 was not yet complete but a reasonable estimate could be determined. A measurement period of one-year is allowed to complete the accounting effects under Topic 740 and revise any previous estimates reported. Any provisional amounts or subsequent adjustments included in an entity’s financial statements during the measurement period should be included in income from continuing operations as an adjustment to tax expense in the reporting period the amounts are determined. The Company adopted this ASU with the provisional adjustments as reported in the Consolidated Financial Statements on Form 10-K as of December 31, 2017. As of March 31, 2018, the Company did not incur any adjustments to the provisional recognition.

Application of New Accounting Guidance

On January 1, 2018, the Company adopted FASB issued ASU No. 2014‑09, Revenue from Contracts with Customers and all subsequent amendments to the ASU (collectively “ASC 606”),  which created Topic 606 and supersedes Topic 605, Revenue Recognition. In August 2015, FASB issued ASU No. 2015‑14, Revenue from Contracts with Customers (Topic 606), which postponed the effective date of 2014‑09. The core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In general, the new guidance requires companies to use more judgment and make more estimates than under past guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. For financial reporting purposes, the Company utilized the modified retrospective approach, meaning the ASU is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. As a bank holding company, key revenue sources, such as interest income on loans, investment securities and deposits, as well as other sources of income including loan fees, security sales, and derivatives have been identified as out of the scope of this new guidance. Management conducted an assessment of the revenue streams that were affected by the new guidance and identified those considered material and in scope to ensure compliance with the new guidance concluding those related to credit and debit card fees, and service charges and fees on deposit accounts.  No additional changes to processes or procedures were identified for the recognition of revenues in scope. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.  However, additional disclosures required by the ASU have been included in “Note 15 - Revenue from Contracts with Customers” to the Company’s consolidated financial statements.

On January 1, 2018, the FASB issued ASU No. 2016‑01, Financial Instruments - Overall (Subtopic 825‑10): Recognition and Measurement of Financial Assets and Financial Liabilities. The new guidance improves the recognition and measurement of financial instruments. This ASU requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes and requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. Exit price is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This ASU also eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The adoption of ASU No. 2016-01 did not have a material impact on the Company’s consolidated financial statements. The disclosures to the Company’s consolidated financial statements have been updated appropriately using the exit price notion in “Note 8 – Fair Value of Financial Instruments”.

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NOTE 2 - SECURITIES AVAILABLE-FOR-SALE

The following tables present the amortized costs, unrealized gains, unrealized losses, and estimated fair values of securities available-for-sale at March 31, 2018 and December 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

    

 

 

    

 

 

    

 

 

    

Estimated

 

 

Amortized 

 

Unrealized 

 

Unrealized 

 

Fair 

 

 

Cost

 

Gains

 

Losses

 

Values

SECURITIES AVAILABLE-FOR-SALE

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency securities

 

$

12,071

 

$

39

 

$

(84)

 

$

12,026

Corporate securities

 

 

7,103

 

 

 4

 

 

(188)

 

 

6,919

Municipal bonds

 

 

10,889

 

 

 —

 

 

(353)

 

 

10,536

Mortgage-backed securities

 

 

46,911

 

 

16

 

 

(1,235)

 

 

45,692

U.S. Small Business Administration securities

 

 

16,583

 

 

 8

 

 

(393)

 

 

16,198

Total securities available-for-sale

 

$

93,557

 

$

67

 

$

(2,253)

 

$

91,371

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

    

 

 

    

 

 

    

 

 

    

Estimated

 

 

Amortized 

 

Unrealized

 

Unrealized

 

Fair

 

 

Cost

 

Gains

 

Losses

 

Values

SECURITIES AVAILABLE-FOR-SALE

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency securities

 

$

9,077

 

$

49

 

$

(11)

 

$

9,115

Corporate securities

 

 

7,113

 

 

 9

 

 

(96)

 

 

7,026

Municipal bonds

 

 

12,720

 

 

148

 

 

(82)

 

 

12,786

Mortgage-backed securities

 

 

40,161

 

 

63

 

 

(490)

 

 

39,734

U.S. Small Business Administration securities

 

 

14,014

 

 

 —

 

 

(195)

 

 

13,819

Total securities available-for-sale

 

$

83,085

 

$

269

 

$

(874)

 

$

82,480

 

At March 31, 2018, the Bank had pledged eight securities held at the FHLB of Des Moines with a carrying value of $12.2 million to secure Washington State public deposits of $9.7 million with a $4.2 million collateral requirement by the Washington Public Deposit Protection Commission.  At December 31, 2017, the Bank pledged nine securities held at the FHLB of Des Moines with a carrying value of $10.7 million to secure Washington State public deposits of $7.6 million with a $3.2 million collateral requirement by the Washington Public Deposit Protection Commission.

Investment securities that were in an unrealized loss position at March 31, 2018 and December 31, 2017 are presented in the following tables, based on the length of time individual securities have been in an unrealized loss position. Management believes that these securities are only temporarily impaired due to changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

 

Less than 12 Months

 

12 Months or Longer

 

Total

 

    

Fair

    

Unrealized

    

Fair

    

Unrealized

    

Fair

    

Unrealized

 

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

SECURITIES AVAILABLE-FOR-SALE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency securities

 

$

7,958

 

$

(84)

 

$

 —

 

$

 —

 

$

7,958

 

$

(84)

Corporate securities

 

 

4,024

 

 

(83)

 

 

1,891

 

 

(105)

 

 

5,915

 

 

(188)

Municipal bonds

 

 

10,537

 

 

(353)

 

 

 —

 

 

 —

 

 

10,537

 

 

(353)

Mortgage-backed securities

 

 

24,592

 

 

(445)

 

 

19,301

 

 

(790)

 

 

43,893

 

 

(1,235)

U.S. Small Business Administration securities

 

 

11,080

 

 

(273)

 

 

3,104

 

 

(120)

 

 

14,184

 

 

(393)

Total

 

$

58,191

 

$

(1,238)

 

$

24,296

 

$

(1,015)

 

$

82,487

 

$

(2,253)

 

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Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

Less than 12 Months

 

12 Months or Longer

 

Total

 

    

Fair

    

Unrealized

    

Fair

    

Unrealized

    

Fair

    

Unrealized

 

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

SECURITIES AVAILABLE-FOR-SALE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency securities

 

$

2,987

 

$

(11)

 

$

 —

 

$

 —

 

$

2,987

 

$

(11)

Corporate securities

 

 

4,102

 

 

(15)

 

 

1,915

 

 

(81)

 

 

6,017

 

 

(96)

Municipal bonds

 

 

5,982

 

 

(82)

 

 

 —

 

 

 —

 

 

5,982

 

 

(82)

Mortgage-backed securities

 

 

7,262

 

 

(61)

 

 

20,635

 

 

(429)

 

 

27,897

 

 

(490)

U.S. Small Business Administration securities

 

 

11,876

 

 

(162)

 

 

1,943

 

 

(33)

 

 

13,819

 

 

(195)

Total

 

$

32,209

 

$

(331)

 

$

24,493

 

$

(543)

 

$

56,702

 

$

(874)

 

There were 40 investments with unrealized losses of less than one year, and 18 investments with unrealized losses of more than one year at March 31, 2018. There were 21 investments with unrealized losses of less than one year, and 17 investments with unrealized losses of more than one year at December 31, 2017. The unrealized losses associated with these investments are believed to be caused by changes in market interest rates that are considered to be temporary and the Company does not intend to sell the securities, and it is not likely to be required to sell these securities prior to maturity. No other-than-temporary impairment was recorded for the three months ended March 31, 2018, or for the year ended December 31, 2017.

The contractual maturities of securities available-for-sale at March 31, 2018 and December 31, 2017 are listed below. Expected maturities of mortgage-backed securities may differ from contractual maturities because borrowers may have the right to call or prepay the obligations; therefore, these securities are classified separately with no specific maturity date.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

December 31, 2017

 

    

Amortized

    

Fair

    

Amortized

    

Fair

 

 

Cost

 

Value

 

Cost

 

Value

U.S. agency securities

 

 

 

 

 

 

 

 

 

 

 

 

Due after five years through ten years

 

$

7,073

 

$

7,047

 

$

4,079

 

$

4,124

Due after ten years

 

 

4,998

 

 

4,979

 

 

4,998

 

 

4,991

Subtotal

 

 

12,071

 

 

12,026

 

 

9,077

 

 

9,115

Corporate securities

 

 

  

 

 

  

 

 

  

 

 

  

Due after one year through five years

 

 

5,107

 

 

5,028

 

 

5,117

 

 

5,111

Due after five years through ten years

 

 

1,996

 

 

1,891

 

 

1,996

 

 

1,915

Subtotal

 

 

7,103

 

 

6,919

 

 

7,113

 

 

7,026

Municipal bonds

 

 

  

 

 

  

 

 

  

 

 

  

Due after one year through five years

 

 

 —

 

 

 —

 

 

2,001

 

 

2,026

Due after five years through ten years

 

 

3,816

 

 

3,743

 

 

4,111

 

 

4,206

Due after ten years

 

 

7,073

 

 

6,793

 

 

6,608

 

 

6,554

Subtotal

 

 

10,889

 

 

10,536

 

 

12,720

 

 

12,786

Mortgage-backed securities

 

 

  

 

 

  

 

 

  

 

 

  

Federal National Mortgage Association (“FNMA”)

 

 

29,407

 

 

28,696

 

 

23,310

 

 

23,091

Federal Home Loan Mortgage Corporation (“FHLMC”)

 

 

11,528

 

 

11,165

 

 

10,818

 

 

10,629

Government National Mortgage Association (“GNMA”)

 

 

5,976

 

 

5,831

 

 

6,033

 

 

6,014

Subtotal

 

 

46,911

 

 

45,692

 

 

40,161

 

 

39,734

U.S. Small Business Administration securities

 

 

  

 

 

  

 

 

  

 

 

  

Due after five years through ten years

 

 

14,677

 

 

14,339

 

 

12,065

 

 

11,896

Due after ten years

 

 

1,906

 

 

1,859

 

 

1,949

 

 

1,923

Subtotal

 

 

16,583

 

 

16,198

 

 

14,014

 

 

13,819

Total

 

$

93,557

 

$

91,371

 

$

83,085

 

$

82,480

 

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The proceeds and resulting gains and losses, computed using specific identification from sales of securities available-for-sale for the three months ended March 31, 2018 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

 

 

 

Gross

 

Gross

 

    

Proceeds

    

Gains

    

(Losses)

Securities available-for-sale

 

$

5,305

 

$

113

 

$

 —

 

There were no proceeds, gains, or losses for March 31, 2017.

 

 

 

NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

The composition of the loan portfolio was as follows at March 31, 2018 and December 31, 2017:

 

 

 

 

 

 

 

 

    

March 31, 

    

December 31, 

 

 

2018

    

2017

REAL ESTATE LOANS

 

 

 

 

 

 

Commercial

 

$

61,956

 

$

63,611

Construction and development

 

 

143,611

 

 

143,068

Home equity

 

 

23,563

 

 

25,289

One-to-four-family (excludes loans held for sale)

 

 

165,030

 

 

163,655

Multi-family

 

 

52,431

 

 

44,451

Total real estate loans

 

 

446,591

 

 

440,074

CONSUMER LOANS

 

 

  

 

 

  

Indirect home improvement

 

 

136,946

 

 

130,176

Solar

 

 

41,581

 

 

41,049

Marine

 

 

38,451

 

 

35,397

Other consumer

 

 

1,951

 

 

2,046

Total consumer loans

 

 

218,929

 

 

208,668

COMMERCIAL BUSINESS LOANS

 

 

  

 

 

  

Commercial and industrial

 

 

104,612

 

 

83,306

Warehouse lending

 

 

47,563

 

 

41,397

Total commercial business loans

 

 

152,175

 

 

124,703

Total loans receivable, gross

 

 

817,695

 

 

773,445

Allowance for loan losses

 

 

(11,140)

 

 

(10,756)

Deferred costs, fees, premiums, and discounts, net

 

 

(923)

 

 

(1,131)

Total loans receivable, net

 

$

805,632

 

$

761,558

 

Most of the Company’s commercial and multi-family real estate, construction, residential, and/or commercial business lending activities are with customers located in the greater Puget Sound area and near our one loan production office located in the Tri-Cities, Washington. The Company originates real estate, consumer, and commercial business loans and has concentrations in these areas, however, indirect home improvement loans are originated through a network of home improvement contractors and dealers located throughout Washington, Oregon, California, Idaho, and Colorado. The Company also originates solar loans through contractors and dealers in the state of California. Loans are generally secured by collateral and rights to collateral vary and are legally documented to the extent practicable. Local economic conditions may affect borrowers’ ability to meet the stated repayment terms.

The Company has defined its loan portfolio into three segments that reflect the structure of the lending function, the Company’s strategic plan and the manner in which management monitors performance and credit quality. The three loan portfolio segments are: (a) Real Estate Loans, (b) Consumer Loans and (c) Commercial Business Loans. Each of these segments is disaggregated into classes based on the risk characteristics of the borrower and/or the collateral type securing the loan. The following is a summary of each of the Company’s loan portfolio segments and classes:

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Real Estate Loans

Commercial Lending. Loans originated by the Company primarily secured by income producing properties, including retail centers, warehouses, and office buildings located in our market areas.

Construction and Development Lending. Loans originated by the Company for the construction of, and secured by, commercial real estate, one-to-four-family, and multi-family residences and tracts of land for development that are not pre-sold. A small portion of the one-to-four-family construction portfolio is custom construction loans to the intended occupant of the residence.

Home Equity Lending. Loans originated by the Company secured by second mortgages on one-to-four-family residences,   including home equity lines of credit in our market areas.

One-to-Four-Family Real Estate Lending. One-to-four-family residential loans include owner occupied properties (including second homes), and non-owner occupied properties. These loans originated by the Company are secured by first mortgages on one-to-four-family residences in our market areas that the Company intends to hold (excludes loans held for sale).

Multi-Family Lending. Apartment term lending (five or more units) to current banking customers and community reinvestment loans for low to moderate income individuals in the Company’s footprint.

Consumer Loans

Indirect Home Improvement. Fixture secured loans for home improvement are originated by the Company through its network of home improvement contractors and dealers and are secured by the personal property installed in, on, or at the borrower’s real property, and may be perfected with a UCC‑2 financing statement filed in the county of the borrower’s residence. These indirect home improvement loans include replacement windows, siding, roofing, and other home fixture installations.

Solar. Fixture secured loans for solar related home improvement projects are originated by the Company through its network of contractors and dealers, and are secured by the personal property installed in, on, or at the borrower’s real property, and which may be perfected with a UCC‑2 financing statement filed in the county of the borrower’s residence.

Marine. Loans originated by the Company secured by boats to borrowers primarily located in its market areas.

Other Consumer. Loans originated by the Company, including automobiles, recreational vehicles, direct home improvement loans, loans on deposits, and other consumer loans, primarily consisting of personal lines of credit.

Commercial Business Loans

Commercial and Industrial Lending (“C&I”). Loans originated by the Company to local small- and mid-sized businesses in our Puget Sound market area are secured primarily by accounts receivable, inventory, or personal property, plant and equipment. Some of the C&I loans purchased by the Company are outside of our standard Puget Sound market area.  C&I loans are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. 

Warehouse Lending. Loans originated to non-depository financial institutions and secured by notes originated at the non-depository financial institution.  The Company has two distinct warehouse lending divisions: commercial warehouse re-lending secured by notes on construction loans and mortgage warehouse re-lending secured by notes on one-to-four-family loans.  The Company’s commercial construction warehouse lines are secured by notes on construction loans and typically guaranteed by principles with experience in construction lending.  Mortgage warehouse lending loans are funded through third-party residential mortgage bankers.  Under this program the Company provides short-term funding to the mortgage banking companies for the purpose of originating residential mortgage loans for sale into the secondary market.

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The following tables detail activity in the allowance for loan losses by loan categories at or for the three months ended March 31, 2018 and 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At or For the Three Months Ended March 31, 2018

 

    

 

 

    

 

 

    

Commercial

    

 

 

    

 

 

 

 

Real Estate

 

Consumer

 

Business

 

Unallocated

 

Total

ALLOWANCE FOR LOAN LOSSES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

4,770

 

$

2,814

 

$

2,014

 

$

1,158

 

$

10,756

Provision for loan losses

 

 

14

 

 

84

 

 

295

 

 

(43)

 

 

350

Charge-offs

 

 

(4)

 

 

(228)

 

 

 —

 

 

 —

 

 

(232)

Recoveries

 

 

 —

 

 

264

 

 

 2

 

 

 —

 

 

266

Net (charge-offs) recoveries

 

 

(4)

 

 

36

 

 

 2

 

 

 —

 

 

34

Ending balance

 

$

4,780

 

$

2,934

 

$

2,311

 

$

1,115

 

$

11,140

Period end amount allocated to:

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Loans individually evaluated for impairment

 

$

41

 

$

87

 

$

 —

 

$

 —

 

$

128

Loans collectively evaluated for impairment

 

 

4,739

 

 

2,847

 

 

2,311

 

 

1,115

 

 

11,012

Ending balance

 

$

4,780

 

$

2,934

 

$

2,311

 

$

1,115

 

$

11,140

LOANS RECEIVABLE

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Loans individually evaluated for impairment

 

$

472

 

$

248

 

$

 —

 

$

 —

 

$

720

Loans collectively evaluated for impairment

 

 

446,119

 

 

218,681

 

 

152,175

 

 

 —

 

 

816,975

Ending balance

 

$

446,591

 

$

218,929

 

$

152,175

 

$

 —

 

$

817,695

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At or For the Three Months Ended March 31, 2017

 

    

 

 

    

 

 

    

Commercial

    

 

 

    

 

 

 

 

Real Estate

 

Consumer

 

Business

 

Unallocated

 

Total

ALLOWANCE FOR LOAN LOSSES

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

3,547

 

$

2,082

 

$

2,675

 

$

1,907

 

$

10,211

Provision for loan losses

 

 

266

 

 

572

 

 

(508)

 

 

(330)

 

 

 —

Charge-offs

 

 

 —

 

 

(204)

 

 

 —

 

 

 —

 

 

(204)

Recoveries

 

 

 —

 

 

138

 

 

 2

 

 

 —

 

 

140

Net (charge-offs) recoveries

 

 

 —

 

 

(66)

 

 

 2

 

 

 —

 

 

(64)

Ending balance

 

$

3,813

 

$

2,588

 

$

2,169

 

$

1,577

 

$

10,147

Period end amount allocated to:

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Loans individually evaluated for impairment

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Loans collectively evaluated for impairment

 

 

3,813

 

 

2,588

 

 

2,169

 

 

1,577

 

 

10,147

Ending balance

 

$

3,813

 

$

2,588

 

$

2,169

 

$

1,577

 

$

10,147

LOANS RECEIVABLE

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Loans individually evaluated for impairment

 

$

444

 

$

 —

 

$

 —

 

$

 —

 

$

444

Loans collectively evaluated for impairment

 

 

357,525

 

 

178,311

 

 

93,635

 

 

 —

 

 

629,471

Ending balance

 

$

357,969

 

$

178,311

 

$

93,635

 

$

 —

 

$

629,915

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are automatically placed on non-accrual once the loan is 90 days past due or sooner if, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, or as required by regulatory authorities.

16


 

Table of Contents

The following tables provide information pertaining to the aging analysis of contractually past due loans and non-accrual loans at March 31, 2018 and December 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

    

30-59

    

60-89

    

 

    

 

    

 

    

 

    

 

 

 

 Days

 

 Days

 

90 Days

 

Total

 

 

 

Total

 

 

 

 

 Past

 

 Past

 

 or More

 

Past

 

 

 

 Loans

 

Non-

 

 

 Due

 

 Due

 

 Past Due

 

Due

 

Current

 

Receivable

 

Accrual

REAL ESTATE LOANS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

61,956

 

$

61,956

 

$

 —

Construction and development

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

143,611

 

 

143,611

 

 

 —

Home equity

 

 

11

 

 

16

 

 

186

 

 

213

 

 

23,350

 

 

23,563

 

 

201

One-to-four-family

 

 

 —

 

 

 —

 

 

130

 

 

130

 

 

164,900

 

 

165,030

 

 

271

Multi-family

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

52,431

 

 

52,431

 

 

 —

Total real estate loans

 

 

11

 

 

16

 

 

316

 

 

343

 

 

446,248

 

 

446,591

 

 

472

CONSUMER LOANS

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Indirect home improvement

 

 

344

 

 

140

 

 

72

 

 

556

 

 

136,390

 

 

136,946

 

 

215

Solar

 

 

79

 

 

18

 

 

33

 

 

130

 

 

41,451

 

 

41,581

 

 

33

Marine

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

38,451

 

 

38,451

 

 

 —

Other consumer

 

 

 2

 

 

 2

 

 

 —

 

 

 4

 

 

1,947

 

 

1,951

 

 

 —

Total consumer loans

 

 

425

 

 

160

 

 

105

 

 

690

 

 

218,239

 

 

218,929

 

 

248

COMMERCIAL BUSINESS LOANS

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

104,612

 

 

104,612

 

 

 —

Warehouse lending

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

47,563

 

 

47,563

 

 

 —

Total commercial business loans

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

152,175

 

 

152,175

 

 

 —

Total loans

 

$

436

 

$

176

 

$

421

 

$

1,033

 

$

816,662

 

$

817,695

 

$

720

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

    

30-59

    

60-89

    

 

    

 

    

 

    

 

    

 

 

 

 Days

 

 Days

 

90 Days

 

Total

 

 

 

Total

 

 

 

 

 Past

 

 Past

 

 or More

 

Past

 

 

 

Loans

 

Non-

 

 

 Due

 

 Due

 

 Past Due

 

Due

 

Current

 

Receivable

 

Accrual

REAL ESTATE LOANS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

63,611

 

$

63,611

 

$

 —

Construction and development

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

143,068

 

 

143,068

 

 

 —

Home equity

 

 

122

 

 

 —

 

 

136

 

 

258

 

 

25,031

 

 

25,289

 

 

151

One-to-four-family

 

 

142

 

 

 —

 

 

 —

 

 

142

 

 

163,513

 

 

163,655

 

 

142

Multi-family

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

44,451

 

 

44,451

 

 

 —

Total real estate loans

 

 

264

 

 

 —

 

 

136

 

 

400

 

 

439,674

 

 

440,074

 

 

293

CONSUMER LOANS

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Indirect home improvement

 

 

255

 

 

215

 

 

99

 

 

569

 

 

129,607

 

 

130,176

 

 

195

Solar

 

 

49

 

 

19

 

 

 —

 

 

68

 

 

40,981

 

 

41,049

 

 

 —

Marine

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

35,397

 

 

35,397

 

 

 —

Other consumer

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

2,046

 

 

2,046

 

 

 —

Total consumer loans

 

 

304

 

 

234

 

 

99

 

 

637

 

 

208,031

 

 

208,668

 

 

195

COMMERCIAL BUSINESS LOANS

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

 

 —

 

 

551

 

 

 —

 

 

551

 

 

82,755

 

 

83,306

 

 

551

Warehouse lending

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

41,397

 

 

41,397

 

 

 —

Total commercial business loans

 

 

 —

 

 

551

 

 

 —

 

 

551

 

 

124,152

 

 

124,703

 

 

551

Total loans

 

$

568

 

$

785

 

$

235

 

$

1,588

 

$

771,857

 

$

773,445

 

$

1,039

 

There were no loans 90 days or more past due and still accruing interest at March 31, 2018 and December 31, 2017.

17


 

Table of Contents

The following tables provide additional information about our impaired loans that have been segregated to reflect loans for which an allowance for credit losses has been provided and loans for which no allowance was provided at March 31, 2018 and December 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

    

Unpaid

    

 

 

    

 

 

    

 

 

 

 

Principal

 

 

 

Recorded

 

Related

 

 

Balance

 

Impairment

 

Investment

 

Allowance

WITH NO RELATED ALLOWANCE RECORDED

 

 

 

 

 

 

 

 

 

 

 

 

Home equity

 

$

201

 

$

 —

 

$

201

 

$

 —

WITH RELATED ALLOWANCE RECORDED

 

 

 

 

 

 

 

 

 

 

 

 

One-to-four-family

 

 

271

 

 

 —

 

 

271

 

 

41

Consumer loans

 

 

248

 

 

 —

 

 

248

 

 

87

 

 

 

519

 

 

 —

 

 

519

 

 

128

Total

 

$

720

 

$

 —

 

$

720

 

$

128

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

    

Unpaid

    

 

 

    

 

 

    

 

 

 

 

Principal

 

 

 

Recorded

 

Related

 

 

Balance

 

Impairment

 

Investment

 

Allowance

WITH NO RELATED ALLOWANCE RECORDED

 

 

 

 

 

 

 

 

 

 

 

 

Home equity

 

$

151

 

$

 —

 

$

151

 

$

 —

One-to-four-family

 

 

67

 

 

(12)

 

 

55

 

 

 —

Total real estate loans

 

 

218

 

 

(12)

 

 

206

 

 

 —

Commercial business loans

 

 

551

 

 

 —

 

 

551

 

 

 —

 

 

 

769

 

 

(12)

 

 

757

 

 

 —

WITH RELATED ALLOWANCE RECORDED

 

 

 

 

 

 

 

 

 

 

 

 

One-to-four-family

 

 

142

 

 

 —

 

 

142

 

 

21

Consumer loans

 

 

195

 

 

 —

 

 

195

 

 

68

 

 

 

337

 

 

 —

 

 

337

 

 

89

Total

 

$

1,106

 

$

(12)

 

$

1,094

 

$

89

 

The following table presents the average recorded investment in loans individually evaluated for impairment and the interest income recognized and received for the three months ended March 31, 2018 and 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At or For the Three Months Ended

 

 

March 31, 2018

 

March 31, 2017

 

    

Average Recorded

    

Interest Income

    

Average Recorded

    

Interest Income

 

 

 Investment

 

 Recognized

 

 Investment

 

 Recognized

WITH NO RELATED ALLOWANCE RECORDED

 

 

 

 

 

 

 

 

 

 

 

 

Home equity

 

$

203

 

$

 2

 

$

220

 

$

 —

One-to-four-family

 

 

 —

 

 

 —

 

 

154

 

 

 1

Total real estate loans

 

 

203

 

 

 2

 

 

374

 

 

 1

WITH RELATED ALLOWANCE RECORDED

 

 

 

 

 

 

 

 

 

 

 

 

One-to-four-family

 

 

271

 

 

 2

 

 

 —

 

 

 —

Consumer loans

 

 

259

 

 

 6

 

 

 —

 

 

 —

 

 

 

530

 

 

 8

 

 

 —

 

 

 —

Total

 

$

733

 

$

10

 

$

374

 

$

 1

 

 

 

 

 

 

 

 

 

 

 

 

 

 


18


 

Table of Contents

Credit Quality Indicators

As part of the Company’s on-going monitoring of credit quality of the loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grading of loans, (ii) the level of classified loans, (iii) net charge-offs, (iv) non-performing loans and (v) the general economic conditions in the Company’s markets.

The Company utilizes a risk grading matrix to assign a risk grade to its real estate and commercial business loans. Loans are graded on a scale of 1 to 10, with loans in risk grades 1 to 6 considered “Pass” and loans in risk grades 7 to 10 are reported as classified loans in the Company’s allowance for loan loss analysis.

A description of the 10 risk grades is as follows:

Grades 1 and 2 - These grades include loans to very high quality borrowers with excellent or desirable business credit.

Grade 3 - This grade includes loans to borrowers of good business credit with moderate risk.

Grades 4 and 5 - These grades include “Pass” grade loans to borrowers of average credit quality and risk.

Grade 6 - This grade includes loans on management’s “Watch” list and is intended to be utilized on a temporary basis for “Pass” grade borrowers where frequent and thorough monitoring is required due to credit weaknesses and where significant risk-modifying action is anticipated in the near term.

Grade 7 - This grade is for “Other Assets Especially Mentioned” (“OAEM”) in accordance with regulatory guidelines and includes borrowers where performance is poor or significantly less than expected.

Grade 8 - This grade includes “Substandard” loans in accordance with regulatory guidelines which represent an unacceptable business credit where a loss is possible if loan weakness is not corrected.

Grade 9 - This grade includes “Doubtful” loans in accordance with regulatory guidelines where a loss is highly probable.

Grade 10 - This grade includes “Loss” loans in accordance with regulatory guidelines for which total loss is expected and when identified are charged off.

Consumer, Home Equity and One-to-Four-Family Real Estate Loans

Homogeneous loans are risk rated based upon the Federal Financial Institutions Examination Council’s Uniform Retail Credit Classification and Account Management Policy. Loans classified under this policy at the Company are consumer loans which include indirect home improvement, solar, marine, other consumer, and one-to-four-family first and second liens. Under the Uniform Retail Credit Classification Policy, loans that are current or less than 90 days past due are graded “Pass” and risk rated “4” or “5” internally. Loans that are past due more than 90 days are classified “Substandard” and risk rated “8” internally until the loan has demonstrated consistent performance, typically six months of contractual payments. Closed-end loans that are 120 days past due and open-end loans that are 180 days past due are charged off based on the value of the collateral less cost to sell.

 

 

 

 

19


 

Table of Contents

The following tables summarize risk rated loan balances by category at the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

    

 

    

 

    

Special

    

 

    

 

    

 

    

 

 

 

Pass

 

Watch

 

Mention

 

Substandard

 

Doubtful

 

Loss

 

 

 

 

(1 - 5)

 

 (6)

 

 (7)

 

 (8)

 

(9)

 

 (10)

 

Total

REAL ESTATE LOANS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

$

61,956

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

61,956

Construction and development

 

 

143,611

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

143,611

Home equity

 

 

23,362

 

 

 —

 

 

 —

 

 

201

 

 

 —

 

 

 —

 

 

23,563

One-to-four-family

 

 

164,759

 

 

 —

 

 

 —

 

 

271

 

 

 —

 

 

 —

 

 

165,030

Multi-family

 

 

52,431

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

52,431

Total real estate loans

 

 

446,119

 

 

 —

 

 

 —

 

 

472

 

 

 —

 

 

 —

 

 

446,591

CONSUMER LOANS

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Indirect home improvement

 

 

136,731

 

 

 —

 

 

 —

 

 

215

 

 

 —

 

 

 —

 

 

136,946

Solar

 

 

41,548

 

 

 —

 

 

 —

 

 

33

 

 

 —

 

 

 —

 

 

41,581

Marine

 

 

38,451

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

38,451

Other consumer

 

 

1,915

 

 

 —

 

 

 —

 

 

36

 

 

 —

 

 

 —

 

 

1,951

Total consumer loans

 

 

218,645

 

 

 —

 

 

 —

 

 

284

 

 

 —

 

 

 —

 

 

218,929

COMMERCIAL BUSINESS LOANS

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

 

98,686

 

 

400

 

 

325

 

 

5,201

 

 

 —

 

 

 —

 

 

104,612

Warehouse lending

 

 

43,942

 

 

3,621

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

47,563

Total commercial business loans

 

 

142,628

 

 

4,021

 

 

325

 

 

5,201

 

 

 —

 

 

 —

 

 

152,175

Total loans

 

$

807,392

 

$

4,021

 

$

325

 

$

5,957

 

$

 —

 

$

 —

 

$

817,695

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

Special

 

 

 

 

 

 

 

 

 

 

Pass

 

Watch

 

Mention 

 

Substandard

 

Doubtful

 

Loss

 

 

 

    

(1 - 5)

    

 (6)

    

 (7)

    

 (8)

    

(9)

    

 (10)

    

Total

REAL ESTATE LOANS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

$

62,057

 

$

 —

 

$

1,554

 

$

 —

 

$

 —

 

$

 —

 

$

63,611

Construction and development

 

 

143,068

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

143,068

Home equity

 

 

25,138

 

 

 —

 

 

 —

 

 

151

 

 

 —

 

 

 —

 

 

25,289

One-to-four-family

 

 

163,513

 

 

 —

 

 

 —

 

 

142

 

 

 —

 

 

 —

 

 

163,655

Multi-family

 

 

44,451

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

44,451

Total real estate loans

 

 

438,227

 

 

 —

 

 

1,554

 

 

293

 

 

 —

 

 

 —

 

 

440,074

CONSUMER LOANS

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Indirect home improvement

 

 

129,981

 

 

 —

 

 

 —

 

 

195

 

 

 —

 

 

 —

 

 

130,176

Solar

 

 

41,049

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

41,049

Marine

 

 

35,397

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

35,397

Other consumer

 

 

1,998

 

 

 —

 

 

 —

 

 

48

 

 

 —

 

 

 —

 

 

2,046

Total consumer loans

 

 

208,425

 

 

 —

 

 

 —

 

 

243

 

 

 —

 

 

 —

 

 

208,668

COMMERCIAL BUSINESS LOANS

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

Commercial and industrial

 

 

76,942

 

 

 —

 

 

425

 

 

5,939

 

 

 —

 

 

 —

 

 

83,306

Warehouse lending

 

 

40,724

 

 

673

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

41,397

Total commercial business loans

 

 

117,666

 

 

673

 

 

425

 

 

5,939

 

 

 —

 

 

 —

 

 

124,703

Total loans

 

$

764,318

 

$

673

 

$

1,979

 

$

6,475

 

$

 —

 

$

 —

 

$

773,445

 

 

 

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NOTE 4 - SERVICING RIGHTS

Loans serviced for others are not included on the Consolidated Balance Sheets. The unpaid principal balances of permanent loans serviced for others were $869.9 million and $778.9 million at March 31, 2018 and December 31, 2017, respectively, and are carried at the lower of cost or market.

The following table summarizes servicing rights activity for the three months ended March 31, 2018 and 2017:

 

 

 

 

 

 

 

 

 

At or For the Three Months Ended

 

 

March 31, 

 

    

2018

    

2017

Beginning balance

 

$

6,795

 

$

8,459

Additions

 

 

1,138

 

 

990

Servicing rights amortized

 

 

(418)

 

 

(509)

Impairment on servicing rights

 

 

 —

 

 

(1)

Ending balance

 

$

7,515

 

$

8,939

 

 

 

 

 

 

 

 

 

The fair market value of the permanent servicing rights’ assets was $10.8 million and $8.6 million at March 31, 2018 and December 31, 2017, respectively. Fair value adjustments to servicing rights are mainly due to market based assumptions associated with discounted cash flows, loan prepayment speeds, and changes in interest rates. A significant change in prepayments of the loans in the servicing portfolio could result in significant changes in the valuation adjustments, thus creating potential volatility in the carrying amount of servicing rights.

The following provides valuation assumptions used in determining the fair value of mortgage servicing rights (“MSR”) at the dates indicated:

 

 

 

 

 

 

 

 

At March 31, 

 

 

    

2018

    

2017

 

Key assumptions:

 

 

 

 

 

Weighted average discount rate

 

9.5

%  

9.5

%

Conditional prepayment rate (“CPR”)

 

9.1

%  

8.7

%

Weighted average life in years

 

8.0

 

7.9

 

 

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Key economic assumptions and the sensitivity of the current fair value for single family MSR to immediate adverse changes in those assumptions at March 31, 2018 and December 31, 2017 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

    

March 31, 2018

    

December 31, 2017

 

Aggregate portfolio principal balance

 

 

  

 

$

860,038

 

$

775,093

 

Weighted average rate of note

 

 

  

 

 

4.1

%  

 

4.1

%

 

 

 

 

 

 

 

 

 

 

 

At March 31, 2018

 

Base

 

0.5%Adverse Rate Change

 

1.0%Adverse Rate Change

 

Conditional prepayment rate

 

 

9.1

%  

 

11.3

%  

 

16.3

%

Fair value MSR

 

$

10,792

 

$

9,482

 

$

7,941

 

Percentage of MSR

 

 

1.3

%  

 

1.1

%  

 

0.9

%

 

 

 

 

 

 

 

 

 

 

 

Discount rate

 

 

9.7

%  

 

10.2

%  

 

10.7

%

Fair value MSR

 

$

10,792

 

$

10,557

 

$

10,331

 

Percentage of MSR

 

 

1.3

%  

 

1.2

%  

 

1.2

%

 

 

 

 

 

 

 

 

 

 

 

At December 31, 2017

 

Base

 

0.5%Adverse Rate Change

 

1.0%Adverse Rate Change

 

Conditional prepayment rate

 

 

10.9

%  

 

17.7

%  

 

24.5

%

Fair value MSR

 

$

8,602

 

$

6,811

 

$

5,614

 

Percentage of MSR

 

 

1.1

%  

 

0.9

%  

 

0.7

%

 

 

 

 

 

 

 

 

 

 

 

Discount rate

 

 

9.6

%  

 

10.1

%  

 

10.6

%

Fair value MSR

 

$

8,602

 

$

8,433

 

$

8,271

 

Percentage of MSR

 

 

1.1

%  

 

1.1

%  

 

1.1

%

 

The above table shows the sensitivity to market rate changes for the par rate coupon for a conventional one-to-four-family FNMA, FHLMC, GNMA, or FHLB serviced home loan. The above tables reference a 50 basis point and 100 basis point decrease in note rates.

These sensitivities are hypothetical and should be used with caution as the tables above demonstrate the Company’s methodology for estimating the fair value of MSR is highly sensitive to changes in key assumptions. For example, actual prepayment experience may differ and any difference may have a material effect on MSR fair value. Changes in fair value resulting from changes in assumptions generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear. Also, in these tables, the effects of a variation in a particular assumption on the fair value of the MSR is calculated without changing any other assumption; in reality, changes in one factor may be associated with changes in another (for example, decreases in market interest rates may provide an incentive to refinance, however, this may also indicate a slowing economy and an increase in the unemployment rate, which reduces the number of borrowers who qualify for refinancing), which may magnify or counteract the sensitivities. Thus, any measurement of MSR fair value is limited by the conditions existing and assumptions made at a particular point in time. Those assumptions may not be appropriate if they are applied to a different point in time.

The Company recorded $536,000 and $654,000 of gross contractually specified servicing fees, late fees, and other ancillary fees resulting from servicing of mortgage and commercial loans for the three months ended March 31, 2018 and 2017, respectively. The income, net of amortization, is reported in noninterest income on the Consolidated Statements of Income.

NOTE 5 - DERIVATIVES

The Company regularly enters into commitments to originate and sell loans held for sale. The Company has established a hedging strategy to protect itself against the risk of loss associated with interest rate movements on loan commitments. The Company enters into contracts to sell forward To-Be-Announced (“TBA”) mortgage-backed securities. These commitments and contracts are considered derivatives but have not been designated as hedging instruments for reporting purposes under U.S. GAAP. Rather, they are accounted for as free-standing derivatives, or economic hedges, with changes in the fair value of the derivatives reported in noninterest income. The Company recognizes all derivative instruments as either other assets or other liabilities on the Consolidated Balance Sheets and measures those instruments at fair value.

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The following tables summarize the Company’s derivative instruments at the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2018

 

 

 

 

 

Fair Value

 

    

Notional

    

Asset

    

Liability

Fallout adjusted interest rate lock commitments with customers

 

$

34,764

 

$

814

 

$

 —

Mandatory and best effort forward commitments with investors

 

 

11,511

 

 

 4

 

 

 —

Forward TBA mortgage-backed securities

 

 

65,500

 

 

 —

 

 

178

TBA mortgage-backed securities forward sales paired off with investors

 

 

19,500

 

 

186

 

 

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

Fair Value

 

    

Notional

     

Asset

     

Liability

Fallout adjusted interest rate lock commitments with customers

 

$

31,951

 

$

726

 

$

 —

Mandatory and best effort forward commitments with investors

 

 

12,505

 

 

51

 

 

 —

Forward TBA mortgage-backed securities

 

 

66,500

 

 

 —

 

 

65

TBA mortgage-backed securities forward sales paired off with investors

 

 

36,500

 

 

53

 

 

 —

 

At March 31, 2018 and December 31, 2017, the Company had $65.5 million and $66.5 million of unsettled TBA trades with counterparties that required margin collateral of $75,000 for both periods, respectively.  This collateral is included in interest-bearing deposits at other financial institutions on the Consolidated Balance Sheets.

Changes in the fair value of the derivatives recognized in other noninterest income on the Consolidated Statements of Income and included in gain on sale of loans resulted in net gain (loss) of $81,000 and ($495,000) for the three months ended March 31, 2018 and 2017, respectively.

NOTE 6 - DEPOSITS

Deposits are summarized as follows at March 31, 2018 and December 31, 2017:

 

 

 

 

 

 

 

 

    

March 31, 

    

December 31, 

 

 

2018(1)

    

2017(1)

Noninterest-bearing checking

 

$

177,251

 

$

177,739

Interest-bearing checking

 

 

130,002

 

 

119,872

Savings

 

 

76,843

 

 

72,082

Money market(2)

 

 

214,676

 

 

228,742

Certificates of deposit less than $100,000(3)

 

 

129,778

 

 

111,489

Certificates of deposit of $100,000 through $250,000

 

 

73,934

 

 

77,934

Certificates of deposit of $250,000 and over(4)

 

 

41,944

 

 

32,833

Escrow accounts related to mortgages serviced

 

 

13,050

 

 

9,151

Total

 

$

857,478

 

$

829,842


(1)

Includes $134.1 million of deposits at March 31, 2018 (that which is remaining from the purchase of four retail bank branches from Bank of America, National Association on January 22, 2016) and $134.6 million at December 31, 2017.

(2)

Includes $1.5 million of brokered deposits at March 31, 2018 and $6.5 million at December 31, 2017.

(3)

Includes $77.5 million and $59.3 million of brokered deposits at March 31, 2018 and December 31, 2017, respectively.

(4)

Time deposits that meet or exceed the FDIC insurance limit.

 

Federal Reserve regulations require that the Bank maintain reserves in the form of cash on hand and deposit balances with the Federal Reserve Bank, based on a percentage of deposits. The amounts of such balances at March 31, 2018 and December 31, 2017 were $19.3 million and $18.2 million, respectively.

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Scheduled maturities of time deposits at March 31, 2018 for future periods ending are as follows:

 

 

 

 

 

    

At March 31, 2018

Maturing in 2018

 

$

104,292

Maturing in 2019

 

 

68,550

Maturing in 2020

 

 

36,654

Maturing in 2021

 

 

16,497

Maturing in 2022

 

 

17,990

Thereafter

 

 

1,673

Total

 

$

245,656

 

Interest expense by deposit category for the three months ended March 31, 2018 and 2017 is as follows:

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

March 31, 

 

 

2018

    

2017

Interest-bearing checking

 

$

67

 

$

 8

Savings and money market

 

 

319

 

 

269

Certificates of deposit

 

 

858

 

 

575

Total

 

$

1,244

 

$

852

 

 

 

NOTE 7 - COMMITMENTS AND CONTINGENCIES

Commitments - The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized on the Consolidated Balance Sheets.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

The following table provides a summary of the Company’s commitments at March 31, 2018 and December 31, 2017:

 

 

 

 

 

 

 

 

    

March 31, 

    

December 31, 

 

 

2018

    

2017

COMMITMENTS TO EXTEND CREDIT

 

 

 

 

 

 

REAL ESTATE LOANS

 

 

  

 

 

  

Commercial

 

$

108

 

$

107

Construction and development

 

 

82,729

 

 

73,321

One-to-four-family (includes locks for salable loans)

 

 

42,020

 

 

37,336

Home equity

 

 

34,289

 

 

32,889

Multi-family

 

 

436

 

 

438

Total real estate loans

 

 

159,582

 

 

144,091

CONSUMER LOANS

 

 

10,164

 

 

10,041

COMMERCIAL BUSINESS LOANS

 

 

  

 

 

  

Commercial and industrial

 

 

54,812

 

 

52,452

Warehouse lending

 

 

69,137

 

 

78,303

Total commercial business loans

 

 

123,949

 

 

130,755

Total commitments to extend credit

 

$

293,695

 

$

284,887

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the amount of the total commitments do not necessarily represent future cash requirements. The Company evaluates each customer’s

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creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon an extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate, and income-producing commercial properties.

Unfunded commitments under commercial lines of credit, revolving credit lines, and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are uncollateralized and usually do not contain a specified maturity date and ultimately may not be drawn upon to the total extent to which the Company is committed. The Company has established reserves for estimated losses from unfunded commitments of $259,000 at March 31, 2018 and $253,000 at December 31, 2017. One-to-four-family commitments included in the table above are accounted for as fair value derivatives and do not carry an associated loss reserve.

The Company also sells one-to-four-family loans to the FHLB of Des Moines that require a limited level of recourse if the loans default and exceed a certain loss exposure. Specific to that recourse, the FHLB of Des Moines established a first loss account (“FLA”) related to the loans and required a credit enhancement (“CE”) obligation by the Bank to be utilized after the FLA is used. Based on loans sold through March 31, 2018, the total loans sold to the FHLB of Des Moines were $38.1 million with the FLA being $433,000 and the CE obligation at $99,000 or 0.25% of the loans outstanding. The holdback for CE obligations is included in the contingent liabilities detailed below. There were no outstanding delinquencies on the loans sold to the FHLB of Des Moines at March 31, 2018 and December 31, 2017.

Contingent liabilities for loans held for sale - In the ordinary course of business, loans are sold with limited recourse against the Company and may have to subsequently be repurchased due to defects that occurred during the origination of the loan. The defects are categorized as documentation errors, underwriting errors, early payoff, early payment defaults, breach of representation or warranty, servicing errors, and/or fraud. When a loan sold to an investor without recourse fails to perform according to its contractual terms, the investor will typically review the loan file to determine whether defects in the origination process occurred. If a defect is identified, the Company may be required to either repurchase the loan or indemnify the investor for losses sustained. If there are no such defects, the Company has no commitment to repurchase the loan. The Company has recorded reserves of $972,000 and $1.0 million to cover loss exposure related to these guarantees for one-to-four-family loans sold into the secondary market at March 31, 2018 and December 31, 2017, respectively, which is included in other liabilities on the Consolidated Balance Sheets.

The Company has entered into a severance agreement with its Chief Executive Officer. The severance agreement, subject to certain requirements, generally includes a lump sum payment to the Chief Executive Officer equal to 24 months of base compensation in the event his employment is involuntarily terminated, other than for cause or the executive terminates his employment with good reason, as defined in the severance agreement.

The Company has entered into change of control agreements with its Chief Financial Officer, Chief Operating Officer, Chief Lending Officer, and two Executive Vice Presidents of Home Lending. The change of control agreements, subject to certain requirements, generally remain in effect until canceled by either party upon at least 24 months prior written notice. Under the change of control agreements, the executive generally will be entitled to a change of control payment from the Company if the executive is involuntarily terminated within six months preceding or 12 months after a change in control (as defined in the change of control agreements). In such an event, the executives would each be entitled to receive a cash payment in an amount equal to 12 months of their then current salary, subject to certain requirements in the change of control agreements.

The Bank received 7,158 shares of Class B common stock in Visa, Inc. as a result of the Visa initial public offering (“IPO”) in March 2008. These Class B shares of stock held by the Bank could be converted to Class A shares at a conversion rate of 1.6483 when all litigation pending as of the date of the IPO is concluded. However, at March 31, 2018, the date that litigation will be concluded cannot be determined. Until such time, the stock cannot be redeemed or sold by the Bank; therefore, it is not readily marketable and has a current carrying value of $0. Visa, Inc. Class A stock’s market value at March 31, 2018 and December 31, 2017 was $119.62 per share and $114.02 per share, respectively.

As a result of the nature of our activities, the Company is subject to various pending and threatened legal actions, which arise in the ordinary course of business. From time to time, subordination liens may create litigation which requires us to

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defend our lien rights. In the opinion of management, liabilities arising from these claims, if any, will not have a material effect on our financial position. The Company had no material pending legal actions at March 31, 2018.

NOTE 8 - FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. Consequently, the fair value of the Company’s consolidated financial instruments will change when interest rate levels change and that change may either be favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed interest rate obligations are less likely to prepay in a rising interest rate environment and more likely to prepay in a falling interest rate environment. Conversely, depositors who are receiving fixed interest rates are more likely to withdraw funds before maturity in a rising interest rate environment and less likely to do so in a falling interest rate environment. Management monitors interest rates and maturities of assets and liabilities, and attempts to minimize interest rate risk by adjusting terms of new loans and deposits, and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

On January 1, 2018, the Company adopted ASU 2016-01,  Financial Instruments - Overall (Subtopic 825‑10), Recognition and Measurement of Financial Assets and Financial Liabilities, which requires us to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes.

The Company determines the fair values of its financial instruments based on the requirements established in Accounting Standards (“ASC”) 820, Fair Value Measurements, which provides a framework for measuring fair value in accordance with U.S. GAAP and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  ASC 820 defines fair values as the exit price, the price that would be received for an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date under current market conditions.  The Company’s fair values for financial instruments at March 31, 2018 were determined based on these requirements. 

The following definitions describe the levels of inputs that may be used to measure fair value:

Level 1 - Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 - Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 - Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Determination of Fair Market Values at December 31, 2017:

Securities Available-for-Sale - The fair value of securities available-for-sale are recorded on a recurring basis. The fair value of investments and mortgage-backed securities are provided by a third-party pricing service. These valuations are based on market data using pricing models that vary by asset class and incorporate available current trade, bid, and other market information, and for structured securities, cash flow, and loan performance data. The pricing processes utilize benchmark curves, benchmarking of similar securities, sector groupings, and matrix pricing. Option adjusted spread models are also used to assess the impact of changes in interest rates and to develop prepayment scenarios. Transfers between the fair value hierarchy are determined through the third-party service provider which, from time to time will transfer between levels based on market conditions per the related security. All models and processes used take into account market convention (Level 2).

Mortgage Loans Held for Sale - The fair value of loans held for sale reflects the value of commitments with investors and/or the relative price as delivered into a TBA mortgage-backed security (Level 2).

Derivative Instruments - The fair value of the interest rate lock commitments and forward sales commitments are estimated using quoted or published market prices for similar instruments, adjusted for factors such as pull-through rate

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assumptions based on historical information, where appropriate. TBA mortgage-backed securities are fair valued on similar contracts in active markets (Level 2) while locks and forwards with customers and investors are fair valued using similar contracts in the market and changes in the market interest rates (Level 2 and 3).

Impaired Loans - Fair value adjustments to impaired collateral dependent loans are recorded to reflect partial write-downs based on the current appraised value of the collateral or internally developed models, which contain management’s assumptions. Management will utilize discounted cashflow impairment for TDRs when the change in terms results in a discount to the overall cashflows to be received (Level 3).

The following tables present securities available-for-sale measured at fair value on a recurring basis at the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities Available-for-Sale

 

    

Level 1

    

Level 2

    

Level 3

    

Total

At March 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency securities

 

$

 —

 

$

12,026

 

$

 —

 

$

12,026

Corporate securities

 

 

 —

 

 

6,919

 

 

 —

 

 

6,919

Municipal bonds

 

 

 —

 

 

10,536

 

 

 —

 

 

10,536

Mortgage-backed securities

 

 

 —

 

 

45,692

 

 

 —

 

 

45,692

U.S. Small Business Administration securities

 

 

 —

 

 

16,198

 

 

 —

 

 

16,198

Total

 

$

 —

 

$

91,371

 

$

 —

 

$

91,371

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities Available-for-Sale

 

    

Level 1

    

Level 2

    

Level 3

    

Total

At December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agency securities

 

$

 —

 

$

9,115

 

$

 —

 

$

9,115

Corporate securities

 

 

 —

 

 

7,026

 

 

 —

 

 

7,026

Municipal bonds

 

 

 —

 

 

12,786

 

 

 —

 

 

12,786

Mortgage-backed securities

 

 

 —

 

 

39,734

 

 

 —

 

 

39,734

U.S. Small Business Administration securities

 

 

 —

 

 

13,819

 

 

 —

 

 

13,819

Total

 

$

 —

 

$

82,480

 

$

 —

 

$

82,480

 

The following table presents mortgage loans held for sale measured at fair value on a recurring basis at the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage Loans Held for Sale

 

    

Level 1

    

Level 2

    

Level 3

    

Total

March 31, 2018

 

$

 —

 

$

51,315

 

$

 —

 

$

51,315

December 31, 2017

 

$

 —

 

$

53,463

 

$

 —

 

$

53,463

 

The following tables present the fair value of interest rate lock commitments with customers, individual forward sale commitments with investors, and paired off commitments with investors measured at their fair value on a recurring basis at the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Rate Lock Commitments with Customers

 

    

Level 1

    

Level 2

    

Level 3

    

Total

March 31, 2018

 

$

 —

 

$

 —

 

$

814

 

$

814

December 31, 2017

 

$

 —

 

$

 —

 

$

726

 

$

726

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individual Forward Sale Commitments with Investors

 

    

Level 1

    

Level 2

    

Level 3

    

Total

March 31, 2018

 

$

  

$

(178)

  

$

 4

  

$

(174)

December 31, 2017

 

$

  

$

(65)

  

$

51

  

$

(14)

 

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Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Paired Off Commitments with Investors

 

    

Level 1

    

Level 2

    

Level 3

    

Total

March 31, 2018

 

$

 —

 

$

186

 

$

 —

 

$

186

December 31, 2017

 

$

 —

 

$

53

 

$

 —

 

$

53

 

The following table presents impaired loans measured at fair value on a nonrecurring basis for which a nonrecurring change in fair value has been recorded during the reporting periods indicated. The amounts disclosed below represent the fair values at the time the nonrecurring fair value measurements were evaluated.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impaired Loans

 

    

Level 1

    

Level 2

    

Level 3

    

Total

March 31, 2018

 

$

  

$

  

$

720

  

$

720

December 31, 2017

 

$

  

$

  

$

1,094

  

$

1,094

 

Quantitative Information about Level 3 Fair Value Measurements - Shown in the table below is the fair value of financial instruments measured under a Level 3 unobservable input on a recurring and nonrecurring basis at March 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

Significant

    

Range

    

Weighted

 

Level 3 Fair Value Instrument

 

Valuation Technique

 

Unobservable Inputs

 

(Weighted Average)

 

Average

 

RECURRING

 

  

 

  

 

  

 

  

 

Interest rate lock commitments with customers

 

Quoted market prices

 

Pull-through expectations

 

80% - 99%

 

94.3

%

Individual forward sale commitments with investors

 

Quoted market prices

 

Pull-through expectations

 

80% - 99%

 

94.3

%

NONRECURRING

 

  

 

  

 

  

 

  

 

Impaired loans

 

Fair value of underlying collateral

 

Discount applied to the obtained appraisal

 

0% - 18.0%

 

17.7

%

 

An increase in the pull-through rate utilized in the fair value measurement of the interest rate lock commitments with customers and forward sale commitments with investors will result in positive fair value adjustments (and an increase in the fair value measurement). Conversely, a decrease in the pull-through rate will result in a negative fair value adjustment (and a decrease in the fair value measurement).

The following table provides a reconciliation of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three months ended March 31, 2018 and 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Net change in fair

 

 

 

 

 

 

 

 

 

 

 

 

 

value for gains/

 

 

 

 

 

Purchases

 

 

 

 

 

 

 

(losses) relating to

 

 

Beginning

 

and

 

Sales and

 

Ending

 

items held at end of

Three Months Ended March 31,

 

Balance

 

Issuances

 

Settlements

 

Balance

 

period

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate lock commitments with customers

 

$

726

 

$

2,435

 

$

(2,346)

 

$

815

 

$

89

Individual forward sale commitments with investors

 

 

51

  

 

573

 

 

(620)

  

 

 4

 

 

(47)

2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

Interest rate lock commitments with customers

 

$

818

  

$

3,482

 

$

(2,863)

  

$

1,437

 

$

619

Individual forward sale commitments with investors

 

 

177

  

 

19

 

 

(215)

  

 

(19)

 

 

(196)

 

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Gains (losses) on interest rate lock commitments carried at fair value are recorded in other noninterest income. Gains (losses) on forward sale commitments with investors carried at fair value are recorded within other noninterest income.

Fair Values of Financial Instruments - The following methods and assumptions were used by the Company in estimating the fair values of financial instruments disclosed in the financial statements at December 31, 2017:

Cash, and Cash Equivalents and Certificates of Deposit at Other Financial Institutions - The carrying amounts of cash and short-term instruments approximate their fair value (Level 1).

Federal Home Loan Bank stock - The par value of FHLB stock approximates its fair value (Level 2).

Bank-owned Life Insurance - The estimated fair value is equal to the cash surrender value of policies, net of surrender charges (Level 1).

Accrued Interest - The carrying amounts of accrued interest approximate its fair value (Level 2).

Loans Receivable, Net - For variable rate loans that re-price frequently and have no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cashflow analyses, using interest rates currently being offered for loans with similar terms to borrowers or similar credit quality (Level 3).

Servicing Rights - The fair value of mortgage, commercial, and consumer servicing rights are estimated using net present value of expected cash flows using a third party model that incorporates assumptions used in the industry to value such rights, adjusted for factors such as weighted average prepayments speeds based on historical information where appropriate (Level 3).

Deposits - The fair value of deposits with no stated maturity date is included at the amount payable on demand. Fair values for fixed rate certificates of deposit are estimated using a discounted cashflow calculation on interest rates currently offered on similar certificates (Level 2).

Borrowings - The carrying amounts of advances maturing within 90 days approximate their fair values. The fair values of long-term advances are estimated using discounted cashflow analyses based on the Bank’s current incremental borrowing rates for similar types of borrowing arrangements (Level 2).

Subordinated Note - The fair value of the Subordinated Note is based upon the average yield of debt issuances for similarly sized issuances (Level 2).

Off-Balance Sheet Instruments - The fair value of commitments to extend credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreement and the present creditworthiness of the customers. The majority of the Company’s off-balance sheet instruments consist of non-fee producing, variable-rate commitments, the Company has determined they do not have a distinguishable fair value. The fair value of loan lock commitments with customers and investors reflect an estimate of value based upon the interest rate lock date, the expected pull-through percentage for the commitment, and the interest rate at year end (Level 2 and 3).

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The following table provides estimated fair values of the Company’s financial instruments at March 31, 2018 and December 31, 2017, whether or not recognized at fair value in the Consolidated Balance Sheets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

 

2018

 

2017

 

    

Carrying

    

Fair

    

Carrying

    

Fair

 

 

Amount

 

Value

 

Amount

 

Value

Financial Assets

 

 

 

 

 

 

 

 

 

 

 

 

Level 1 inputs:

 

 

  

 

 

  

 

 

  

 

 

  

Cash and cash equivalents

 

$

25,640

 

$

25,640

 

$

18,915

 

$

18,915

Certificates of deposit at other financial institutions

 

 

17,611

 

 

17,611

 

 

18,108

 

 

18,108

Level 2 inputs:

 

 

 

 

 

 

 

 

 

 

 

 

Securities available-for-sale, at fair value

 

 

91,371

 

 

91,371

 

 

82,480

 

 

82,480

Loans held for sale, at fair value

 

 

51,315

 

 

51,315

 

 

53,463

 

 

53,463

FHLB stock, at cost

 

 

4,308

 

 

4,308

 

 

2,871

 

 

2,871

Accrued interest receivable

 

 

3,693

 

 

3,693

 

 

3,566

 

 

3,566

Paired off commitments with investors

 

 

186

 

 

186

 

 

53

 

 

53

Level 3 inputs:

 

 

 

 

 

 

 

 

 

 

 

 

Loans receivable, gross

 

 

817,695

 

 

812,459

 

 

773,445

 

 

780,551

Servicing rights, held at lower of cost or fair value

 

 

7,515

 

 

10,797

 

 

6,795

 

 

8,608

Fair value interest rate locks with customers

 

 

814

 

 

814

 

 

726

 

 

726

Individual forward sale commitments with investors

 

 

 4

 

 

 4

 

 

51

 

 

51

Financial Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

Level 2 inputs:

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

857,478

 

 

847,489

 

 

829,842

 

 

838,087

Borrowings

 

 

39,529

 

 

39,480

 

 

7,529

 

 

7,498

Subordinated note

 

 

9,850

 

 

10,741

 

 

9,845

 

 

10,741

Accrued interest payable

 

 

289

 

 

289

 

 

214

 

 

214

Individual forward sale commitments with investors

 

 

178

 

 

178

 

 

65

 

 

65

 

 

 

NOTE 9 - EMPLOYEE BENEFITS

Employee Stock Ownership Plan

On January 1, 2012, the Company established an ESOP for eligible employees of the Company and the Bank.  Employees of the Company and the Bank are eligible to participate in the ESOP if they have been credited with at least 1,000 hours of service during the employees’ first 12‑month period and based on the employee’s anniversary date will be vested in the ESOP. The employee will be 100% vested in the ESOP after two years of working at least 1,000 hours in each of those two years.

The ESOP borrowed $2.6 million from FS Bancorp, Inc. and used those funds to acquire 259,210 shares of FS Bancorp, Inc. common stock in the open market at an average price of $10.17 per share during the second half of 2012. It is anticipated that the Bank will make contributions to the ESOP in amounts necessary to amortize the ESOP loan payable to FS Bancorp, Inc. over a period of 10 years, bearing interest at 2.30%. Intercompany expenses associated with the ESOP are eliminated in consolidation. Shares purchased by the ESOP with the loan proceeds are held in a suspense account and allocated to ESOP participants on a pro rata basis as principal and interest payments are made by the ESOP to FS Bancorp, Inc. The loan is secured by shares purchased with the loan proceeds and will be repaid by the ESOP with funds from the Bank’s discretionary contributions to the ESOP and earnings on the ESOP assets. Payments of principal and interest are due annually on December 31, the Company’s fiscal year end. On December 31, 2017, the ESOP paid the sixth annual installment of principal in the amount of $263,000, plus accrued interest of $32,000 pursuant to the ESOP loan agreement.

As shares are committed to be released from collateral, the Company reports compensation expense equal to the average daily market prices of the shares at March 31, 2018 for the prior 90 days. These shares become outstanding for earnings per share computations. The compensation expense is accrued monthly throughout the year. Dividends on allocated ESOP

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shares are recorded as a reduction of retained earnings; dividends on unallocated ESOP shares are recorded as a reduction of debt and accrued interest.

Compensation expense related to the ESOP for the three months ended March 31, 2018 and 2017 was $359,000 and $237,000, respectively.

Shares held by the ESOP at March 31, 2018 and 2017 were as follows (shown as actual):

 

 

 

 

 

 

 

 

 

Balances

 

Balances

 

    

at March 31, 2018

    

at March 31, 2017

Allocated shares

 

 

153,049

 

 

126,589

Committed to be released shares

 

 

6,480

 

 

6,480

Unallocated shares

 

 

97,204

 

 

123,125

Total ESOP shares

 

 

256,733

 

 

256,194

 

 

 

 

 

 

 

Fair value of unallocated shares (in thousands)

 

$

5,382

 

$

4,497

 

 

 

NOTE 10 - EARNINGS PER SHARE

Basic earnings per share are computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. For earnings per share calculations, the ESOP shares committed to be released are included as outstanding shares for both basic and diluted earnings per share.

The following table presents a reconciliation of the components used to compute basic and diluted earnings per share for the three months ended March 31, 2018 and 2017:

 

 

 

 

 

 

 

 

 

At or For the Three Months Ended March 31, 

Numerator:

    

2018

    

2017

Net income (in thousands)

 

$

4,322

 

$

2,593

Denominator:

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

 

3,556,581

 

 

2,872,317

Dilutive shares

 

 

194,956

 

 

189,680

Diluted weighted average common shares outstanding

 

 

3,751,537

 

 

3,061,997

Basic earnings per share

 

$

1.22

 

$

0.90

Diluted earnings per share

 

$

1.15

 

$

0.85

 

 

NOTE 11 - STOCK-BASED COMPENSATION

Stock Options and Restricted Stock

In September 2013, the shareholders of FS Bancorp, Inc. approved the FS Bancorp, Inc. 2013 Equity Incentive Plan (“Plan”). The Plan provides for the grant of stock options and restricted stock awards.

Total share-based compensation expense for the Plan was $135,000 and $191,000 for the three months ended March 31, 2018 and March 31, 2017, respectively.

Stock Options

The Plan authorizes the grant of stock options totaling 324,013 shares of common stock to Company directors and employees of which 322,000 option share awards under the Plan were granted with an exercise price equal to the market price of FS Bancorp’s common stock at the grant date of May 8, 2014, of $16.89 per share. These option awards were

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granted as non-qualified stock options, having a vesting period of five years, with 20% vesting on the anniversary date of each grant date, and a contractual life of 10 years. Any unexercised stock options will expire 10 years after the grant date or sooner in the event of the award recipient’s termination of service with the Company or the Bank.  At March 31, 2018, 6,013 option share awards are available to be granted.

The fair value of each option award is estimated on the grant date using a Black-Scholes Option pricing model that uses the following assumptions. The dividend yield is based on the current quarterly dividend in effect at the time of the grant. Historical employment data is used to estimate the forfeiture rate. The Company became a publicly held company in July 2012, therefore historical data was not available to calculate the volatility for FS Bancorp stock. Instead, management utilized the NASDAQ Bank Index, or NASDAQ Bank (NASDAQ symbol: BANK) to determine the expected volatility of FS Bancorp’s stock at grant date for the majority of stock options granted in 2014. This index provides the volatility of the banking sector for NASDAQ traded banks. The majority of smaller banks are traded on the NASDAQ given the costs and daily interaction required with trading on the New York Stock Exchange. The Company utilized the comparable Treasury rate for the discount rate associated with the stock options granted. The Company elected to use Staff Accounting Bulletin 107, simplified expected term calculation for the “Share-Based Payments” method permitted by the SEC to calculate the expected term. This method uses the vesting term of an option along with the contractual term, setting the expected life at 6.5 years.

The following table presents a summary of the Company’s stock option plan awards during the three months ended March 31, 2018 (shown as actual):

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

 

    

Weighted-Average

    

 

 

 

 

 

 

Weighted-

 

Remaining

 

 

 

 

 

 

 

Average

 

Contractual Term In

 

Aggregate

 

 

Shares

 

Exercise Price

 

Years

 

Intrinsic Value

Outstanding at January 1, 2018

 

256,237

 

$

16.89

 

6.36

 

$

9,655,010

Granted

 

 —

 

 

 —

 

 —

 

 

 —

Less exercised

 

15,400

 

$

16.89

 

 —

 

$

596,297

Forfeited or expired

 

 —

 

 

 —

 

 —

 

 

 —

Outstanding at March 31, 2018

 

240,837

 

$

16.89

 

6.11

 

$

8,817,043

 

 

 

 

 

 

 

 

 

 

 

Expected to vest, assuming a 0.31% annual forfeiture rate (1)

 

240,598

 

$

16.89

 

6.11

 

$

8,808,311

 

 

 

 

 

 

 

 

 

 

 

Exercisable at March 31, 2018

 

114,037

 

$

16.89

 

6.11

 

$

4,174,895

 

(1) Forfeiture rate has been calculated and estimated to assume a forfeiture of 1/32 over the 10-year contractual life, or 3.1% of the options forfeited over 10 years.

At March 31, 2018, there was $255,000 of total unrecognized compensation cost related to nonvested stock options granted under the Plan. The cost is expected to be recognized over the remaining weighted-average vesting period of 1.1 years. 

Restricted Stock Awards

The Plan authorizes the grant of restricted stock awards totaling 129,605 shares to Company directors and employees, and 125,105 shares were granted on May 8, 2014 at a grant date fair value of $16.89 per share. The remaining 4,500 restricted stock awards were granted January 1, 2016 at a grant date fair value of $26.00 per share. Compensation expense is recognized over the vesting period of the awards based on the fair value of the restricted stock. The restricted stock awards’ fair value is equal to the value on the grant date. Shares awarded as restricted stock vest ratably over a three-year period for directors and a five-year period for employees, beginning at the grant date. Any unvested restricted stock awards will expire after vesting or sooner in the event of the award recipient’s termination of service with the Company or the Bank.

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The following table presents a summary of the Company’s nonvested awards during the three months ended March 31, 2018 (shown as actual):

 

 

 

 

 

 

 

    

 

    

Weighted-Average

 

 

 

 

Grant-Date Fair Value

Nonvested Shares

 

Shares

 

Per Share

Nonvested at January 1, 2018

 

36,842

 

$

17.63

Granted

 

 —

 

 

 —

Less vested

 

1,500

 

$

26.00

Forfeited or expired

 

 —

 

 

 —

Nonvested at March 31, 2018

 

35,342

 

$

17.28

 

At March 31, 2018, there was $347,000 of total unrecognized compensation costs related to nonvested shares granted as restricted stock awards. The cost is expected to be recognized over the remaining weighted-average vesting period of 1.1 years.

NOTE 12 - REGULATORY CAPITAL

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines of the regulatory framework for prompt corrective action, the Bank must meet specific capital adequacy guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital classification is also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of Tier 1 capital (as defined in the regulations) to total average assets (as defined), and minimum ratios of Tier 1 total capital (as defined) and common equity Tier 1 (“CET 1”) capital to risk-weighted assets (as defined).

The Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below to be categorized as well capitalized. At March 31, 2018 and December 31, 2017, the Bank was categorized as well capitalized under applicable regulatory requirements. There are no conditions or events since that notification that management believes have changed the Bank’s category. Management believes, at March 31 2018, that the Company and the Bank met all capital adequacy requirements.

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The following table compares the Bank’s actual capital amounts and ratios at March 31, 2018 and December 31, 2017 to their minimum regulatory capital requirements and well capitalized regulatory capital at those dates (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

To be Well Capitalized

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Under Prompt

 

 

 

 

 

 

 

 

For Capital

 

For Capital Adequacy

 

Corrective

 

 

 

Actual

 

Adequacy Purposes

 

with Capital Buffer

 

Action Provisions

 

Bank Only

    

Amount

    

Ratio

    

Amount

    

Ratio

    

Amount

    

Ratio

    

Amount

    

Ratio

 

At March 31, 2018

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

Total risk-based capital

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

(to risk-weighted assets)

 

$

138,125

 

16.21

%  

$

68,160

 

8.00

%  

$

84,178

 

9.88

%  

$

85,200

 

10.00

%

Tier 1 risk-based capital

 

 

 

 

 

 

 

 

 

  

 

 

 

 

  

 

 

 

 

  

 

(to risk-weighted assets)

 

$

127,466

 

14.96

%  

$

51,120

 

6.00

%  

$

67,138

 

7.88

%  

$

68,160

 

8.00

%

Tier 1 leverage capital

 

 

 

 

 

 

 

 

 

  

 

 

 

 

  

 

 

 

 

  

 

(to average assets)

 

$

127,466

 

12.58

%  

$

40,522

 

4.00

%  

 

N/A

 

N/A

 

$

50,652

 

5.00

%

CET 1 capital

 

 

 

 

 

 

 

 

 

  

 

 

 

 

  

 

 

 

 

  

 

(to risk-weighted assets)

 

$

127,466

 

14.96

%  

$

38,340

 

4.50

%  

$

54,358

 

6.38

%  

$

55,380

 

6.50

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At December 31, 2017

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

Total risk-based capital

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

(to risk-weighted assets)

 

$

133,967

 

16.25

%  

$

65,965

 

8.00

%  

$

76,272

 

9.25

%  

$

82,456

 

10.00

%

Tier 1 risk-based capital

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

(to risk-weighted assets)

 

$

123,651

 

15.00

%  

$

49,474

 

6.00

%  

$

59,781

 

7.25

%  

$

65,965

 

8.00

%

Tier 1 leverage capital

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

 

  

 

  

 

(to average assets)

 

$

123,651

 

12.61

%  

$

39,233

 

4.00

%  

 

N/A

 

N/A

 

$

49,041

 

5.00

%

CET 1 capital

 

 

  

 

  

 

 

  

 

  

 

 

 

 

  

 

 

  

 

  

 

(to risk-weighted assets)

 

$

123,651

 

15.00

%  

$

37,105

 

4.50

%  

$

47,412

 

5.75

%  

$

53,597

 

6.50

%

 

In addition to the minimum CET 1, Tier 1, total capital, and leverage ratios, the Bank now has to maintain a capital conservation buffer consisting of additional CET 1 capital above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of eligible retained income that could be utilized for such actions. The capital conservation buffer requirement was phased-in on January 1, 2016 when more than 0.625% of risk-weighted assets was required and increases by 0.625% on each subsequent January 1, until fully implemented to an amount more than 2.5% of risk-weighted assets in January 2019. At March 31, 2018, the Bank’s CET1 capital exceeded the required capital conservation buffer of an amount more than 1.875%.

FS Bancorp, Inc. is a bank holding company subject to the capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve.  For a bank holding company with less than $1.0 billion in assets (as of June 30th of the preceding year), the capital guidelines apply on a bank only basis and the Federal Reserve expects the holding company’s subsidiary bank to be well capitalized under the prompt corrective action regulations. At March 31, 2018, if FS Bancorp, Inc. was subject to regulatory guidelines for bank holding companies with $1.0 billion or more in assets, FS Bancorp, Inc. would have exceeded all regulatory capital requirements. The regulatory capital ratios calculated for FS Bancorp, Inc. at March 31, 2018 were 12.2% for Tier 1 leverage-based capital, 14.5% for Tier 1 risk-based capital, 15.8% for total risk-based capital, and 14.5% for CET 1 capital ratio.

NOTE 13 - BUSINESS SEGMENTS

The Company’s business segments are determined based on the products and services provided, as well as the nature of the related business activities, and they reflect the manner in which financial information is currently evaluated by management. This process is dynamic and is based on management’s current view of the Company’s operations and is not necessarily comparable with similar information for other financial institutions. We define our business segments by

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product type and customer segment which we have organized into two lines of business: commercial and consumer banking and home lending.

We use various management accounting methodologies to assign certain income statement items to the responsible operating segment, including:

a funds transfer pricing (“FTP”) system, which allocates interest income credits and funding charges between the segments, assigning to each segment a funding credit for its liabilities, such as deposits, and a charge to fund its assets;

a cost per loan serviced allocation based on the number of loans being serviced on the balance sheet and the number of loans serviced for third parties;

an allocation based upon the approximate square footage utilized by the home lending segment in Company owned locations;

an allocation of charges for services rendered to the segments by centralized functions, such as corporate overhead, which are generally based on the number of full time employees (“FTEs”) in each segment; and

an allocation of the Company’s consolidated income taxes which are based on the effective tax rate applied to the segment’s pretax income or loss.

The FTP methodology is based on management’s estimated cost of originating funds including the cost of overhead for deposit generation.

A description of the Company’s business segments and the products and services that they provide is as follows:

Commercial and Consumer Banking Segment

The commercial and consumer banking segment provides diversified financial products and services to our commercial and consumer customers through Bank branches, automated teller machines (“ATM”), online banking platforms, mobile banking apps, and telephone banking. These products and services include deposit products; residential, consumer, business and commercial real estate lending portfolios and cash management services. We originate consumer loans, commercial and multi-family real estate loans, construction loans on residential and multi-family construction, and commercial business loans. At March 31, 2018, our retail deposit branch network consisted of 11 branches in the Pacific Northwest. At March 31, 2018 and December 31, 2017, our deposits totaled $857.5 million and $829.8 million, respectively. This segment is also responsible for the management of our investment portfolio and other assets of the Bank.

Home Lending Segment

The home lending segment originates one-to-four-family residential mortgage loans primarily for sale in the secondary markets as well as originating adjustable rate mortgage (“ARM”) loans held for investment. The majority of our mortgage loans are sold to or securitized by FNMA, FHLMC, GNMA, or FHLB, while we retain the right to service these loans. Loans originated under the guidelines of the Federal Housing Administration or FHA, US Department of Veterans Affairs or VA, and United States Department of Agriculture or USDA are generally sold servicing released to a correspondent bank or mortgage company. We have the option to sell loans on a servicing-released or servicing-retained basis to securitizers and correspondent lenders. A small percentage of our loans are brokered to other lenders. On occasion, we may sell a portion of our MSR portfolio and we may sell small pools of loans originated for the portfolio. We manage the loan funding and the interest rate risk associated with the secondary market loan sales and the retained one-to-four-family mortgage servicing rights within this business segment. One-to-four-family loans originated for investment are allocated to the home lending segment with a corresponding provision expense and FTP for cost of funds.

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Segment Financial Results

The tables below summarize the financial results for each segment based primarily on the number of FTEs and assets within each segment for the three months ended March 31, 2018 and 2017:

 

 

 

 

 

 

 

 

 

 

 

 

At or For the Three Months Ended March 31, 2018

 

    

Home Lending

    

Commercial and Consumer Banking

    

Total

Condensed income statement:

 

 

 

 

 

 

 

 

 

Net interest income (1)

 

$

715

 

$

10,782

 

$

11,497

Provision for loan losses

 

 

 4

 

 

(354)

 

 

(350)

Noninterest income

 

 

3,766

 

 

1,258

 

 

5,024

Noninterest expense

 

 

(4,056)

 

 

(6,980)

 

 

(11,036)

Income before provision for income taxes

 

 

429

 

 

4,706

 

 

5,135

Provision for income taxes

 

 

(68)

 

 

(745)

 

 

(813)

Net income

 

$

361

 

$

3,961

 

$

4,322

Total average assets at period end

 

$

216,384

 

$

800,334

 

$

1,016,718

FTEs

 

 

116

 

 

213

 

 

329

 

 

 

 

 

 

 

 

 

 

 

 

 

At or For the Three Months Ended March 31, 2017

 

    

Home Lending

    

Commercial and Consumer Banking

    

Total

Condensed income statement:

 

 

 

 

 

 

 

 

 

Net interest income (1)

 

$

630

 

$

8,345

 

$

8,975

Provision for loan losses

 

 

(80)

 

 

80

 

 

 —

Noninterest income

 

 

4,387

 

 

1,033

 

 

5,420

Noninterest expense

 

 

(4,017)

 

 

(6,360)

 

 

(10,377)

Income before provision for income taxes

 

 

920

 

 

3,098

 

 

4,018

Provision for income taxes

 

 

(326)

 

 

(1,099)

 

 

(1,425)

Net income

 

$

594

 

$

1,999

 

$

2,593

Total average assets at period end

 

$

171,424

 

$

667,327

 

$

838,751

FTEs

 

 

113

 

 

198

 

 

311


(1)

Net interest income is the difference between interest earned on assets and the cost of liabilities to fund those assets. Interest earned includes actual interest earned on segment assets and, if the segment has excess liabilities, interest credits for providing funding to the other segment. The cost of liabilities includes interest expense on segment liabilities and, if the segment does not have enough liabilities to fund its assets, a funding charge based on the cost of assigned liabilities to fund segment assets.

NOTE 14 – GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill and certain other intangibles generally arise from business combinations accounted for under the purchase method of accounting.  Goodwill totaled $2.3 million at March 31, 2018 and December 31, 2017, and represents the excess of the total acquisition price paid over the fair value of the assets acquired, net of the fair values of liabilities assumed.  Goodwill is not amortized but is evaluated for impairment on an annual basis at December 31 of each year or whenever events or changes in circumstances indicate the carrying value may not be recoverable. The Company performed an impairment analysis at December 31, 2017, and determined that no impairment of goodwill existed. No events or circumstances since the December 31, 2017 annual impairment test were noted that would indicate it was more likely than not a goodwill impairment existed at March 31, 2018.

 

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The following table summarizes the changes in the Company’s other intangible assets for the year ended December 31, 2017, and the three months ended March 31, 2018.

 

 

 

 

 

 

 

 

 

 

(in thousands)

 

Other Intangible Assets

 

 

 

 

 

Accumulated

 

 

 

 

    

Gross

    

Amortization

    

Net

Balance, December 31, 2016

 

$

2,239

 

$

(522)

 

$

1,717

Amortization

 

 

 —

 

 

(400)

 

 

(400)

Balance, December 31, 2017

 

 

2,239

 

 

(922)

 

 

1,317

Amortization

 

 

 —

 

 

(77)

 

 

(77)

Balance, March 31, 2018

 

$

2,239

 

$

(999)

 

$

1,240

 

The core deposit intangible represents the fair value of the acquired core deposit base. The core deposit intangible will be amortized on an accelerated basis over approximately nine years. Total amortization expense was $77,000 for the three months ended March 31, 2018, and $100,000 for the same period in 2017. Amortization expense for core deposit intangible is expected to be as follows at March 31, 2018:

 

 

 

 

Remainder of 2018

 

$

230

2019

 

 

235

2020

 

 

181

2021

 

 

166

2022

 

 

166

Thereafter

 

 

262

Total

 

$

1,240

 

 

 

 

 

 

NOTE 15 – REVENUE FROM CONTRACTS WITH CUSTOMERS

As noted in Note 1, the Company adopted the provisions of ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), on January 1, 2018 and all subsequent ASUs that modified Topic 606.  Results for reporting periods beginning after December 31, 2017 are presented under Topic 606, while prior period amounts have not been adjusted and continue to be reported in accordance with Topic 605.

Revenue Recognition

In accordance with Topic 606, revenues are recognized when control of promised goods or services is transferred to customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of Topic 606, the Company performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the Company satisfies a performance obligation. The Company only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of Topic 606, the Company assesses the goods or services that are promised within each contract and identifies those that contain performance obligations, and assesses whether each promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

All of the Company’s revenue from contracts with customers in scope of ASC 606 is recognized in noninterest income and included in our commercial and consumer banking segment. For the three months ended March 31, 2018, the Company recognized $551,000 in total deposit fees, which included $260,000 of debit card interchange fees and $120,000 of fees from non-sufficient funds, both considered in scope of ASC 606, and $4.6 million of noninterest income considered not in scope of ASC 606.

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Deposit Fees

The Bank earns fees from its deposit customers for account maintenance, transaction-based and overdraft services.  Account maintenance fees consist primarily of account fees and analyzed account fees charged on deposit accounts on a monthly basis.  The performance obligation is satisfied and the fees are recognized on a monthly basis as the service period is completed. Transaction-based fees on deposits accounts are charged to deposit customers for specific services provided to the customer, such as non-sufficient funds fees, overdraft fees, and wire fees. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer. 

Debit Interchange Income

Debit and ATM interchange income represent fees earned when a debit card issued by the Bank is used.  The Bank earns interchange fees from debit cardholder transactions through the Visa payment network.  Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholders’ debit card.  Certain expenses directly associated with the debit card are recorded on a net basis with the interchange income.

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

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 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 subject to significant risks and uncertainties. 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, write offs, 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;

·

secondary market conditions and our ability to sell loans in the secondary market;

·

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;

·

staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

·

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 home lending operations, our warehouse lending, and the geographic expansion of our indirect home improvement lending;

·

our ability to attract and retain deposits;

·

our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto;

·

our ability to control operating costs and expenses;

·

our ability to retain key members of our senior management team;

·

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 Wall Street Reform and Consumer Protection Act of 2010, changes in regulation policies and principles, an increase in regulatory capital requirements or change in the interpretation of regulatory capital or other rules, including as a result of 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;

·

disruptions, security breaches, or other adverse events, failures, or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions;

·

our ability to implement our branch expansion strategy;

·

inability of key 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, pricing, products, and services and other risks described elsewhere in this Form 10‑Q and our other reports filed with the U.S. Securities and Exchange Commission, including our Annual Report on Form 10‑K for the year ended December 31, 2017.

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.

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, known as Washington’s Credit Union, the credit union 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 ownership and became the wholly owned subsidiary of FS Bancorp, Inc.

The Company is relationship-driven, delivering banking and financial services to local families, local and regional businesses and industry niches within distinct Puget Sound area communities, and one loan production office located in the Tri-Cities, Washington. The Company also maintains its long-standing indirect consumer lending platform which operates throughout the West 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:

·

Growing and diversifying our loan portfolio;

·

Maintaining strong asset quality;

·

Emphasizing lower cost core deposits to reduce the costs of funding our loan growth;

·

Capturing our customers’ full relationship by offering a wide range of products and services by leveraging our well-established involvement in our communities and by selectively emphasizing products and services designed to meet our customers’ banking needs; and

·

Expanding 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, consumer loans including home improvement (“fixture secured”) loans and marine lending, commercial business loans, and second mortgage or home equity loan products.  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.  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.

Consumer loans, in particular indirect home improvement loans to finance window replacement, gutter replacement, siding replacement, solar panels, and other improvement renovations is a large portion of the loan portfolio.  Indirect home improvement lending is dependent on the Bank’s relationships with home improvement contractors and dealers. The Company funded $25.5 million, or approximately 1,500 loans during the quarter ended March 31, 2018, using its indirect

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home improvement contractor/dealer network located throughout Washington, Oregon, California, Idaho, and Colorado with four contractor/dealers responsible for 47.9% of the funded loans dollar volume.

The following table details total consumer loans funded by state for the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At March 31, 2018

 

 

At December 31, 2017

 

State

 

Amount

 

Percent

 

 

Amount

 

Percent

 

Washington

 

$

12,597

 

41.9

%

 

$

9,424

 

37.0

%

Oregon

 

 

10,009

 

33.3

 

 

 

9,839

 

38.7

 

California

 

 

5,628

 

18.7

 

 

 

4,785

 

18.8

 

Idaho

 

 

1,503

 

5.0

 

 

 

1,294

 

5.1

 

Colorado

 

 

350

 

1.1

 

 

 

108

 

0.4

 

Total consumer loans

 

$

30,087

 

100.0

%

 

$

25,450

 

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 $170.2 million of one-to-four-family loans which includes loans held for sale, loans held for investment, fixed seconds, and loans brokered to other institutions through the home lending segment, totaling $1.4 million during the three months ended March 31, 2018, of which $155.0 million were sold to investors. Of the loans sold to investors, $99.5 million were sold to the FNMA, FHLMC, FHLB, and/or GNMA with servicing rights retained for the purpose of further developing these customer relationships. At March 31, 2018, one-to-four-family residential mortgage loans held for investment, which excludes loans held for sale of $51.3 million, totaled $165.0 million, or 20.2%, of the total gross loan portfolio. 

The Company expanded its residential construction and commercial real estate lending team in 2011 with a focus on vertical, in-city one-to-four-family development in our market area. This team has over 60 years of combined experience and expertise in commercial real estate and multi-family acquisition, development and construction (“ADC”) lending in the Puget Sound market area and the related take-out financing as applicable. The Company has implemented this strategy to take advantage of what is believed to be a strong demand for construction and ADC loans to experienced, successful and relationship driven builders in our market area after many other banks abandoned this segment because of previous overexposure.

The Company originates commercial business loans and lines of credit to local small- and mid-sized businesses in the Puget Sound market area that are secured by accounts receivable, inventory or property, plant and equipment. Consistent with management’s objectives to expand commercial business lending, in 2009, the Company commenced a mortgage warehouse lending program through which the Company funds third-party residential mortgage bankers. Under this program the Company provides short-term funding to the mortgage banking companies for the purpose of originating residential mortgage loans for sale into the secondary market.

Since 2012, the Company has had an emphasis on diversifying lending products by expanding commercial real estate, commercial business and residential lending, while maintaining the current volume of production and historical growth of the consumer loan portfolio. The Company’s lending strategies are intended to take advantage of: (1) historical strength in indirect consumer lending, (2) recent market consolidation 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 an important funding source.

Recently, improvements in the economy, employment rates, stronger real estate prices, and a general lack of new housing inventory has resulted in our significantly increasing originations of construction loans for properties located in our market areas. We anticipate that construction and development lending will continue to be a strong element of our total loan portfolio in future periods. We will continue to take a disciplined approach in our construction and development lending 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.

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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. 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.

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 the following:

Allowance for Loan and Lease Losses. The allowance for loan losses (“ALLL”) 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. A high degree of judgment is necessary when determining the amount of the ALLL. 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 Company believes that use of the best information available currently establishes the ALLL, future adjustments to the allowance 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 ALLL in any given period. Management believes that its systematic methodology continues to be appropriate given the Company’s increased size and level of complexity.

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, commercial and consumer loans, a portion of the cost of originating the loan is allocated to the servicing right based on relative fair value. Fair value is based on market prices for comparable mortgage, commercial, or consumer servicing 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

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income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.

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. The Company’s derivatives are primarily the result of its 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.

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. 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 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 liabilities occur when taxable income is smaller than reported income on the income statements due to accounting valuation methods that differ from tax, as well as tax rate estimates and payments made quarterly and adjusted to actual at the end of the year. Deferred tax liabilities are temporary differences payable in future periods. The Company had a net deferred tax liability of $137,000 and $607,000, at March 31, 2018 and December 31, 2017, respectively.

Comparison of Financial Condition at March 31, 2018 and December 31, 2017

Assets. Total assets increased $61.8 million, or 6.3%, to $1.0 billion at March 31, 2018, from $981.8 million at December 31, 2017, primarily as a result of a $44.1 million, or 5.8% increase in loans receivable, net, a $8.9 million, or 10.8% increase in securities available-for-sale, a $6.7 million, or 35.6% increase in total cash and cash equivalents, and a $3.1 million, or 29.8% increase in bank owned life insurance mainly funded by growth in deposits and FHLB borrowings, partially offset by a $2.1 million, or 4.0% decrease in loans held for sale. 

Loans receivable, net increased $44.1 million, or 5.8% to $805.6 million at March 31, 2018, from $761.6 million at December 31, 2017. The increase in loans receivable was primarily a result of increases in commercial business loans and consumer loans. Total commercial business loans increased $27.5 million, mostly due to an increase in commercial and industrial lending of $21.3 million, including purchases of $12.0 million in shared national credits, and $4.5 million in U.S. Department of Agriculture loans.  Total consumer loans increased $10.3 million, reflecting growth of $6.8 million in indirect home improvement loans and $3.1 million in marine loans.  Total real estate loans increased $6.5 million including increases in multi-family loans of $8.0 million, one-to-four-family portfolio loans of $1.4 million, which is net of a $5.5 million portfolio loan sale, and construction and development loans of $543,000, partially offset by decreases of $1.7 million in both commercial real estate loans and home equity loans. The growth in multi-family loans and corresponding modest growth in construction loans reflects $8.9 million in construction multi-family loans that were converted to permanent multi-family loans during the quarter. Undisbursed construction and development loan commitments increased $9.4 million, or 12.8%, to $82.7 million at March 31, 2018, as compared to $73.3 million at December 31, 2017.

 

Loans held for sale, consisting of one-to-four-family loans, decreased by $2.1 million, or 4.0% to $51.3 million at March 31, 2018, from $53.5 million at December 31, 2017. The Company continues to expand its home lending operations

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by hiring additional lending staff and will continue selling one-to-four-family loans into the secondary market for asset/liability management purposes.

One-to-four-family loan originations, including $147.6 million loans held for sale, $21.2 million portfolio loans including first and second liens, and $1.4 million loans brokered to other institutions, decreased $38.4 million, or 18.4% to $170.2 million during the quarter ended March 31, 2018, compared to $208.6 million for the preceding quarter. The reduction in originations was primarily due to seasonal purchase activity in the Pacific Northwest. Originations of one-to-four-family loans to purchase a home (purchase production) increased by $13.0 million, or 12.4% with $118.0 million in loan purchase production closing during the three months ended March 31, 2018, up from $105.0 million for the three months ended March 31, 2017. One-to-four-family loan originations for refinance (refinance production) increased $13.6 million, or 36.2% with $51.2 million in refinance production closing during the three months ended March 31, 2018, up from $37.6 million for the three months ended March 31, 2017.  During the quarter ended March 31, 2018, the Company sold $155.0 million of one-to-four-family loans, compared to sales of $136.4 million for the same quarter one year ago. In addition, the margin on loans sold decreased to 2.60% for the three months ended March 31, 2018, from 2.98% for the three months ended March 31, 2017.

The ALLL at March 31, 2018 increased to $11.1 million, or 1.4% of gross loans receivable, excluding loans held for sale, compared to $10.8 million, or 1.4% of gross loans receivable, excluding loans held for sale, at December 31, 2017. Substandard loans decreased to $6.0 million at March 31, 2018, compared to $6.5 million at December 31, 2017. Non-performing loans, consisting solely of non-accruing loans, decreased to $720,000 at March 31, 2018, from $1.0 million at December 31, 2017. At March 31, 2018, non-performing loans consisted of $271,000 of one-to-four-family loans, $215,000 of indirect home improvement loans, $201,000 of home equity loans, and $33,000 of solar loans. Non-performing loans to total gross loans were 0.1% at both March 31, 2018 and December 31, 2017. The Company had no OREO at March 31, 2018, or at December 31, 2017.

Liabilities. Total liabilities increased $58.4 million to $918.2 million at March 31, 2018, from $859.8 million at December 31, 2017, due to growth in deposits and borrowings. Total deposits increased $27.6 million to $857.5 million at March 31, 2018, from $829.8 million at December 31, 2017. Relationship-based transactional accounts (noninterest-bearing checking, interest-bearing checking, and escrow accounts) increased $13.5 million to $320.3 million at March 31, 2018, from $306.8 million at December 31, 2017.  Money market and savings accounts decreased $9.3 million to $291.5 million at March 31, 2018, from $300.8 million at December 31, 2017. Time deposits increased $23.4 million to $245.7 million at March 31, 2018, from $222.3 million at December 31, 2017. Non-retail certificates of deposit which includes brokered certificates of deposit, online certificates of deposit, and public funds increased $17.7 million to $84.2 million at March 31, 2018, compared to $66.5 million at December 31, 2017. Management remains focused on growth in lower cost relationship-based deposits to fund long-term asset growth.

Borrowings increased $32.0 million, or 425.0%, to $39.5 million at March 31, 2018, from $7.5 million at December 31, 2017, primarily due to continued growth in shorter term business loans funded with similar duration overnight FHLB borrowings.

Stockholders’ Equity. Total stockholders’ equity increased $3.4 million to $125.4 million at March 31, 2018, from $122.0 million at December 31, 2017. The increase in stockholders’ equity during the three months ended March 31, 2018, was primarily due to net income of $4.3 million, partially offset by an increase in accumulated other comprehensive loss, net of tax of $1.2 million.  Book value per common share was $35.21 at March 31, 2018, compared to $34.47 at December 31, 2017.

 

We have common shares outstanding of 3,563,006 that were calculated using shares outstanding of 3,695,552 at March 31, 2018, less 35,342 unvested restricted stock shares, and 97,204 unallocated ESOP shares. Common shares of 3,539,626 were calculated using shares outstanding at December 31, 2017 of 3,680,152, less 36,842 unvested restricted stock shares, and 103,684 unallocated ESOP shares.

Comparison of Results of Operations for the Three Months Ended March 31, 2018 and 2017

General. Net income for the three months ended March 31, 2018, increased $1.7 million, or 66.7%, to $4.3 million, from $2.6 million for the three months ended March 31, 2017. The increase in net income was primarily a result of a $2.2

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million, or 24.2% increase in net interest income, after provision for loan losses, partially offset by a $659,000, or 6.4% increase in noninterest expense.

The following table sets forth the average balances of all major categories of interest-earning assets and interest-bearing liabilities to calculate the comparison of results of operations for the three months ended March 31, 2018 and 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended March 31, 

 

 

Year Over Year

Average Balances

    

2018

    

2017

    

 

$ Change

Assets

 

 

 

 

 

 

 

 

 

 

Loans receivable, net deferred loan fees (1)

 

$

844,794

 

$

650,090

 

 

$

194,704

Securities available-for-sale, at fair value

 

 

90,532

 

 

94,115

 

 

 

(3,583)

Interest-bearing deposits and certificates of deposit at other financial institutions

 

 

40,734

 

 

54,666

 

 

 

(13,932)

FHLB stock, at cost

 

 

3,404

 

 

2,909

 

 

 

495

Total interest-earning assets

 

 

979,464

 

 

801,780

 

 

 

177,684

Noninterest-earning assets (2)

 

 

37,254

 

 

36,971

 

 

 

283

Total assets

 

$

1,016,718

 

$

838,751

 

 

$

177,967

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

 

 

Interest-bearing accounts

 

$

670,058

 

$

568,722

 

 

$

101,336

Borrowings

 

 

21,604

 

 

12,616

 

 

 

8,988

Subordinated note

 

 

9,847

 

 

9,827

 

 

 

20

Total interest-bearing liabilities

 

 

701,509

 

 

591,165

 

 

 

110,344

Noninterest-bearing accounts

 

 

180,507

 

 

154,587

 

 

 

25,920

Other noninterest-bearing liabilities

 

 

11,921

 

 

11,986

 

 

 

(65)

Stockholders’ equity

 

 

122,781

 

 

81,013

 

 

 

41,768

Total liabilities and stockholders’ equity

 

$

1,016,718

 

$

838,751

 

 

$

177,967


(1)

Includes loans held for sale

(2)

Includes fixed assets, BOLI, goodwill, and CDI

Net Interest Income. Net interest income increased $2.5 million, or 28.1%, to $11.5 million for the three months ended March 31, 2018, from $9.0 million for the three months ended March 31, 2017. The increase in net interest income was primarily due to a $2.9 million, or 30.8% increase in loans receivable interest income, due to a $194.7 million, or 30.0% increase in the average loans receivable, net balance, partially offset by a $392,000, or 46.0% increase in deposit interest expense mainly driven by an increase of $101.3 million in interest-bearing accounts with higher market rates paid on these deposits.

The net interest margin (“NIM”) increased 22 basis points to 4.76% for the three months ended March 31, 2018, from 4.54% for the three months ended March 31, 2017. The increased NIM reflects growth in higher yielding loans, and reductions in lower yielding securities available-for-sale and cash and cash equivalents. Management remains focused on matching deposit/liability duration with the duration of loans/assets where appropriate.

Interest Income. Interest income for the three months ended March 31, 2018, increased $3.0 million, or 29.5%, to $13.0 million, from $10.0 million for the three months ended March 31, 2017. The increase during the period was primarily attributable to the increase in the average balance of loans receivable to $844.8 million for the three months ended March 31, 2018, compared to $650.1 million for the three months ended March 31, 2017, and a 31 basis point increase in the average yield on interest-earning assets to 5.38% for the three months ended March 31, 2018, compared to 5.07% for the three months ended March 31, 2017. The increase in average yield on interest-earning assets compared to the same period a year earlier primarily reflects the growth in the loan portfolio and the proportionally larger level of loans in the average interest-earning asset mix.

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Interest Expense. Interest expense increased $433,000, or 40.9%, to $1.5 million for the three months ended March 31, 2018, from $1.1 million for the same period of the prior year. The increase was attributable to an increase in interest expense on deposits of $392,000, and borrowings of $41,000. The average cost of funds increased 11 basis points to 0.69% from 0.58% for the three months ended March 31, 2018 and 2017, respectively, driven by growth in time deposits and an increase in borrowings which are closely tied to wholesale overnight borrowing rates. The average cost of deposits increased 11 basis points to 0.59% compared to 0.48%, for the three months ended March 31, 2018 and 2017, respectively, reflecting rising interest rates over the last year and an increase in non-retail certificates of deposit.

Provision for Loan Losses. For the three months ended March 31, 2018, the provision for loan losses was $350,000, compared to no provision for the three months ended March 31, 2017. The increased provision for loan losses for the three months ended March 31, 2018 was due to continued loan growth. During the three months ended March 31, 2018, net recoveries totaled $34,000, compared to net charge-offs of $64,000 during the three months ended March 31, 2017.

Noninterest Income. Noninterest income decreased $396,000 to $5.0 million for the three months ended March 31, 2018, from $5.4 million for the three months ended March 31, 2017. The decrease during the period reflects a $377,000 reduction in gain on sale of loans associated with lower volume of higher margin loans sold and lower lock volume due to the low supply of housing, and a $202,000 reduction in service charges and fee income primarily associated with the sale of servicing assets in 2017, partially offset by a $113,000 increase in gain on sale of investment securities. 

Noninterest Expense. Noninterest expense increased $659,000 to $11.0 million for the three months ended March 31, 2018, from $10.4 million for the three months ended March 31, 2017. The increase in noninterest expense was primarily a result of a $930,000 increase in salaries and benefits, which included $782,000 in incentives and commissions associated with continued strong loan production growth, partially offset by decreases of $127,000 in operations expense and $93,000 in FDIC insurance.

The efficiency ratio, which is noninterest expense as a percentage of net interest income and noninterest income, improved to 66.8% for the three months ended March 31, 2018, compared to 72.1% for the three months ended March 31, 2017, representing a greater increase in interest and noninterest income as compared to a smaller increase in noninterest expense.

Provision for Income Tax. For the three months ended March 31, 2018, the Company recorded a provision for income tax expense of $813,000 on pre-tax income as compared to $1.4 million for the three months ended March 31, 2017.  The effective tax rates for the three months ended March 31, 2018 and 2017 were 15.8% and 35.5%, respectively, reflecting the reduction of tax rates effective January 1, 2018 from the Tax Act enacted on December 22, 2017.

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 Fed 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.

At March 31, 2018, the Bank’s total borrowing capacity was $234.7 million with the FHLB of Des Moines, with unused borrowing capacity of $195.1 million. The FHLB borrowing limit is based on certain categories of loans, primarily real estate loans that qualify as collateral for FHLB advances. At March 31, 2018, the Bank held approximately $314.0 million in loans that qualify as collateral for FHLB advances.

In addition to the availability of liquidity from the FHLB of Des Moines, the Bank maintained a short-term borrowing line with the Federal Reserve Bank, with a current limit of $101.9 million, and a combined credit limit of $43.0 million in written Fed Funds lines of credit through correspondent banking relationships at March 31, 2018. The Federal Reserve Bank borrowing limit is based on certain categories of loans, primarily consumer loans that qualify as collateral for Federal Reserve Bank line of credit. At March 31, 2018, the Bank held approximately $211.3 million in loans that qualify as collateral for the Federal Reserve Bank line of credit.

At March 31, 2018, $39.5 million in FHLB advances and FHLB borrowings were outstanding, and no advances were outstanding against the Federal Reserve Bank line of credit, or the Fed Funds lines of credit. The Bank’s Asset and Liability

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Management Policy permits management to utilize brokered deposits up to 20% of Bank deposits or $172.6 million at March 31, 2018. Total brokered deposits at March 31, 2018 were $79.0 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 Company management. Excess liquidity is generally invested in short-term investments, such as overnight deposits or the repayment of FHLB borrowings. On a longer term basis, a strategy is maintained of investing in various lending products and investment securities, including U.S. Government obligations and U.S. agency securities. The Company uses sources of funds primarily to meet ongoing commitments, pay maturing deposits, fund withdrawals, and to fund loan commitments. At March 31, 2018, the approved outstanding loan commitments, including unused lines of credit amounted to $293.7 million. Certificates of deposit scheduled to mature in three months or less at March 31, 2018, totaled $48.4 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 for FS 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. At March 31, 2018, FS Bancorp, Inc. had $5.8 million in unrestricted cash to meet liquidity needs.

Commitments and Off-Balance Sheet Arrangements

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the financing needs of its customers. For information regarding our commitments and off-balance sheet arrangements, see Note 7 of the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report.

Capital Resources

The Bank is subject to minimum capital requirements imposed by the FDIC. Based on its capital levels at March 31, 2018, 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 the FDIC. Based on capital levels at March 31, 2018, the Bank was considered to be well capitalized. At March 31, 2018, the Bank exceeded all regulatory capital requirements with Tier 1 leverage-based capital, Tier 1 risk-based capital, total risk-based capital, and common equity Tier 1 capital ratios of 12.6%, 15.0%, 16.2%, and 15.0%, respectively. For additional information regarding the Bank’s regulatory capital compliance, see the discussion included in Note 12 to the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report.

FS Bancorp, Inc. is subject to regulatory guidelines for bank holding companies with $1 billion or more in assets, and at March 31, 2018, FS Bancorp, Inc. exceeded all regulatory capital requirements.

Item 3.             Quantitative and Qualitative Disclosures About Market Risk

There has not been any material change in the market risk disclosures contained in FS Bancorp’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

 

Item 4.             Controls and Procedures

(a)Evaluation of Disclosure Controls and Procedures

An evaluation of the disclosure controls and procedures as defined in Rule 13a‑15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) was carried out as of March 31, 2018 under the supervision and with the participation of the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) and several other members of the Company’s senior management. In designing and evaluating the Company’s disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure

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controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

The Company’s CEO and CFO concluded that based on their evaluation at March 31, 2018, the Company’s disclosure controls and procedures were effective in ensuring that information we are required to disclose in the reports we file or submit under the Exchange Act is (1) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and (2) accumulated and communicated to FS Bancorp management, including its CEO and CFO, as appropriate to allow timely decisions regarding required disclosure, specified in the SEC’s rules and forms.

(b)Changes in Internal Controls

There were no significant changes in the Company’s internal control over financial reporting that occurred during the three months ended March 31, 2018, that have materially affected or are reasonably likely to materially affect our internal control over financial reporting. The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls may be circumvented by the individual acts of some persons, by collusion of two or more people, or by override of the control. The design of any control procedure is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

 

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PART II. OTHER INFORMATION

Item 1.             Legal Proceedings

In the normal course of business, the Company occasionally becomes involved in various legal proceedings. In the opinion of management, any liability from such proceedings would not have a material adverse effect on the business or financial condition of the Company.

Item 1A.          Risk Factors

There have been no material changes to the risk factors set forth in Part I. Item 1A of the Company’s Annual Report on Form 10‑K for the year ended December 31, 2017.

Item 2.             Unregistered Sales of Equity Securities and Use of Proceeds

(a)

Not applicable

(b)

Not applicable

(c)

Not applicable

 

 

Item 3.               Defaults Upon Senior Securities

Not applicable.

Item 4.                Mine Safety Disclosures

Not applicable.

Item 5.                Other Information

Not applicable.

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Item 6.                  Exhibits

 

 

 

3.1

    

Articles of Incorporation of FS Bancorp, Inc. (1)

3.2

 

Bylaws of FS Bancorp, Inc. (2)

4.1

 

Form of Common Stock Certificate of FS Bancorp, Inc. (1)

10.1

 

Severance Agreement between 1st Security Bank of Washington and Joseph C. Adams (1)

10.2

 

Form of Change of Control Agreement between 1st Security Bank of Washington and each of  Matthew D. Mullet and Drew B. Ness (1)

10.3

 

FS Bancorp, Inc. 2013 Equity Incentive Plan (the “2013 Plan”) (3)

10.4

 

Form of Incentive Stock Option Agreement under the 2013 Plan (3)

10.5

 

Form of Non-Qualified Stock Option Agreement under the 2013 Plan (3)

10.6

 

Form of Restricted Stock Agreement under the 2013 Plan (3)

10.7

 

Purchase and Assumption Agreement between Bank of America, National Association and 1st Security Bank dated September 1, 2015 (4)

10.8

 

Subordinated Loan Agreement dated September 30, 2015 by and among Community Funding CLO, Ltd. and the Company (5)

10.9

 

Form of change of control agreement with Donn C. Costa, Debbie L. Steck, and Dennis O’Leary (6)

31.1

 

Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

 

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

 

Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

 

Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101

 

The following materials from the Company’s Quarterly Report on Form 10‑Q for the quarter ended March 31, 2018 formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Statements of Income; (3) Consolidated Statements of Comprehensive Income; (4) Consolidated Statements of Changes in Stockholders’ Equity; (5) Consolidated Statements of Cash Flows; and (6) Notes to Consolidated Financial Statements.

(1)

 

Filed as an exhibit to the Registrant’s Registration Statement on Form S‑1 (333‑177125) filed on October 3, 2011, and incorporated by reference.

(2)

 

Filed as an exhibit to the Registrant’s Current Report on Form 8‑K filed on July 10, 2013 (File No. 001‑35589).

(3)

 

Filed as an exhibit to the Registrant’s Registration Statement on Form S‑8 (333‑192990) filed on December 20, 2013, and incorporated by reference.

(4)

 

Filed as an exhibit to the Registrant’s Current Report on Form 8‑K filed on September 2, 2015 (File No. 001‑35589).

(5)

 

Filed as an exhibit to the Registrant’s Current Report on Form 8‑K filed on October 19, 2015 (File No. 001‑35589).

(6)

 

Filed as an exhibit to the Registrant’s Current Report on Form 8‑K filed on February 1, 2016 (File No. 001‑35589).

 

 

 

 

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Exhibit Index

 

 

 

Exhibit No.

 

Description

31.1

 

Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

 

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

 

Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

 

Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101

 

The following materials from the Company’s Quarterly Report on Form 10‑Q for the quarter ended March 31, 2018 formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Statements of Income; (3) Consolidated Statements of Comprehensive Income; (4) Consolidated Statements of Changes in Stockholders’ Equity; (5) Consolidated Statements of Cash Flows; and (6) Notes to Consolidated Financial Statements.

 

 

 

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

FS BANCORP, INC.

 

 

 

 

Date: May 10, 2018

By:

/s/Joseph C. Adams

 

 

Joseph C. Adams,

 

 

Chief Executive Officer

 

 

(Duly Authorized Officer)

 

 

 

Date: May 10, 2018

By:

/s/Matthew D. Mullet

 

 

Matthew D. Mullet

 

 

Secretary, Treasurer and

 

 

Chief Financial Officer

 

 

(Principal Financial and Accounting Officer)

 

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