FSBW-2015.6.30-10Q
 
 


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 June 30, 2015    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: 333-177125
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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [ ]
 
Accelerated filer [ ]
Non-accelerated filer [ ] (Do not check if a smaller reporting company)
 
Smaller reporting company [ X ]
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 August 5, 2015, there were 3,240,620 outstanding shares of the registrant's common stock.



 
 


FS Bancorp, Inc.
Form 10-Q
Table of Contents
 
 
Page Number
PART I
FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014 (Unaudited)
2

 
 
 
 
Consolidated Statements of Income for the Three and Six Months Ended June 30, 2015 and 2014 (Unaudited)
3

 
 
 
 
Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2015 and 2014 (Unaudited)
4

 
 
 
 
Consolidated Statements of Changes in Stockholders' Equity as of June 30, 2015 and 2014 (Unaudited)
5

 
 
 
 
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2015 and 2014 (Unaudited)
6

 
 
 
 
Notes to Consolidated Financial Statements
7 - 39

 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
40 - 48

 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
48

 
 
 
Item 4.
Controls and Procedures
48 - 49

 
 
 
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
50

 
 
 
Item 5.
Other Information
50

 
 
 
Item 6.
Exhibits
50

 
 
 
SIGNATURES
 
51

As used in this report, the terms "we," "our," and "us," and "Company" refer to FS Bancorp, Inc. and its consolidated subsidiary, 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, Inc.




 
 


Item 1. Financial Statements
FS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS

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

 
June 30,
2015
 
December 31, 2014
ASSETS
 
 
 
Cash and due from banks
$
2,114

 
$
10,799

Interest-bearing deposits at other financial institutions
11,688

 
9,299

Securities available-for-sale, at fair value
50,414

 
48,744

Loans held for sale, at fair value
41,039

 
25,983

Loans receivable, net
432,265

 
387,174

Accrued interest receivable
1,772

 
1,558

Premises and equipment, net
13,953

 
13,584

Federal Home Loan Bank ("FHLB") stock, at cost
1,412

 
1,650

Bank owned life insurance ("BOLI")
6,650

 
6,556

Servicing rights, held at the lower of cost or fair value
4,569

 
3,061

Other assets
2,713

 
1,346

TOTAL ASSETS
$
568,589

 
$
509,754

 
 
 
 
LIABILITIES
 
 
 

Deposits
 
 
 

Noninterest-bearing accounts
$
68,558

 
$
56,734

Interest-bearing accounts
401,950

 
363,710

Total deposits
470,508

 
420,444

Borrowings
20,269

 
17,034

Other liabilities
6,957

 
6,440

Total liabilities
497,734

 
443,918

COMMITMENTS AND CONTINGENCIES (NOTE 9)


 


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; 3,240,620 shares issued and outstanding at June 30, 2015, and 3,235,625 at December 31, 2014
                            
32

 
32

Additional paid-in capital
30,011

 
29,450

Retained earnings
42,592

 
38,125

Accumulated other comprehensive (loss) income, net of tax
(24
)
 
117

Unearned shares - Employee Stock Ownership Plan ("ESOP")
(1,756
)
 
(1,888
)
Total stockholders' equity
70,855

 
65,836

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$
568,589

 
$
509,754


See accompanying notes to these consolidated financial statements.


 
 
2









 
 

FS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except share amounts) (Unaudited)
 
 
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2015
 
2014
 
2015
 
2014
 INTEREST INCOME
 
 
 
 
 
 
 
Loans receivable including fees
$
7,494

 
$
5,493

 
$
14,312

 
$
10,674

Interest and dividends on investment securities, cash and cash equivalents, and interest-bearing deposits at other financial institutions
281

 
356

 
545

 
686

Total interest and dividend income
7,775

 
5,849

 
14,857

 
11,360

 INTEREST EXPENSE
 
 
 

 
 
 
 
Deposits
812

 
594

 
1,559

 
1,144

Borrowings
72

 
63

 
139

 
121

Total interest expense
884

 
657

 
1,698

 
1,265

 NET INTEREST INCOME
6,891

 
5,192

 
13,159

 
10,095

 PROVISION FOR LOAN LOSSES
600

 
450

 
1,200

 
900

 NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
6,291

 
4,742

 
11,959

 
9,195

 NONINTEREST INCOME
 
 
 

 
 
 
 
Service charges and fee income
500

 
446

 
924

 
844

Gain on sale of loans
4,606

 
1,794

 
7,933

 
3,302

Gain on sale of investment securities

 
10

 
76

 
10

Earnings on cash surrender value of BOLI
48

 
46

 
95

 
92

Other noninterest income
124

 
160

 
321

 
260

Total noninterest income
5,278

 
2,456

 
9,349

 
4,508

 NONINTEREST EXPENSE
 
 
 

 
 
 
 
Salaries and benefits
4,216

 
3,240

 
8,166

 
6,363

Operations
1,128

 
926

 
2,091

 
1,472

Occupancy
456

 
403

 
891

 
801

Data processing
393

 
300

 
751

 
588

Other real estate owned ("OREO") fair value impairments, net of (gain) loss on sales

 
(1
)
 

 
30

OREO (income) expense

 
(29
)
 

 
3

Loan costs
417

 
391

 
750

 
696

Professional and board fees
423

 
298

 
790

 
602

FDIC insurance
82

 
62

 
160

 
125

Marketing and advertising
145

 
125

 
275

 
232

Impairment (recovery) on servicing rights
1

 
(1
)
 

 
(1
)
Total noninterest expense
7,261

 
5,714

 
13,874

 
10,911

 INCOME BEFORE PROVISION FOR INCOME TAXES
4,308

 
1,484

 
7,434

 
2,792

 PROVISION FOR INCOME TAXES
1,514

 
498

 
2,570

 
931

 NET INCOME
$
2,794

 
$
986

 
$
4,864

 
$
1,861

Basic earnings per share
$
0.94

 
$
0.33

 
$
1.65

 
$
0.62

Diluted earnings per share
$
0.93

 
$
0.33

 
$
1.63

 
$
0.62


See accompanying notes to these consolidated financial statements.

 
 
3









 
 

FS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands) (Unaudited)
 
 
 
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Net Income
$
2,794

 
$
986

 
$
4,864

 
$
1,861

Other comprehensive (loss) income, net of tax:

 

 

 

Unrealized (loss) gain on securities available-for-sale:

 

 

 

Unrealized holding (loss) gain arising during period
(474
)
 
802

 
(138
)
 
1,344

Income tax benefit (provision) related to unrealized (loss) gain
161

 
(272
)
 
47

 
(457
)
Reclassification adjustment for realized gains included in net income

 
(10
)
 
(76
)
 
(10
)
Income tax provision related to reclassification for realized gains

 
3

 
26

 
3

Other comprehensive (loss) income, net of tax
(313
)
 
523

 
(141
)
 
880

COMPREHENSIVE INCOME
$
2,481

 
$
1,509

 
$
4,723

 
$
2,741


See accompanying notes to these consolidated financial statements.


 
 
4









 
 
 
 
 
 


FS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except share amounts) (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
 
 
 
 
 
Accumulated
 
 
 
 
 
Shares
 
Amount
 
Additional Paid-in Capital
 
Retained Earnings
 
Other Comprehensive
(Loss) Income
 
Unearned ESOP Shares
 
Total Stockholders'
Equity
BALANCE, January 1, 2014
3,240,125

 
$
32

 
$
30,097

 
$
35,215

 
$
(898
)
 
$
(2,133
)
 
$
62,313

Net income

 

 

 
1,861

 

 

 
1,861

Dividends paid ($0.11 per share)

 

 

 
(341
)
 

 

 
(341
)
Share-based compensation

 

 
110

 

 

 

 
110

Restricted stock awards
125,105

 

 
(1
)
 

 

 

 
(1
)
Common stock repurchased
(129,605
)
 

 
(1,295
)
 
(927
)
 

 

 
(2,222
)
Other comprehensive
income, net of tax

 

 

 

 
880

 

 
880

ESOP cash distribution

 

 
(35
)
 

 

 

 
(35
)
ESOP shares allocated

 

 
87

 

 

 
132

 
219

BALANCE, June 30, 2014
3,235,625

 
$
32

 
$
28,963

 
$
35,808

 
$
(18
)
 
$
(2,001
)
 
$
62,784

 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, January 1, 2015
3,235.625

 
$
32

 
$
29,450

 
$
38,125

 
$
117

 
$
(1,888
)
 
$
65,836

Net income

 

 

 
4,864

 

 

 
4,864

Dividends paid ($0.12 per share)

 

 

 
(397
)
 

 

 
(397
)
Share-based compensation

 

 
373

 

 

 

 
373

Common stock repurchased
(4,605
)
 

 
(101
)
 

 

 

 
(101
)
Stock options exercised
9,600

 

 
162

 

 

 

 
162

Other comprehensive
loss, net of tax

 

 

 

 
(141
)
 

 
(141
)
ESOP shares allocated

 

 
127

 

 

 
132

 
259

BALANCE, June 30, 2015
3,240,620

 
$
32

 
$
30,011

 
$
42,592

 
$
(24
)
 
$
(1,756
)
 
$
70,855

 
See accompanying notes to these consolidated financial statements.


 
 
5









 
 


FS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) (Unaudited)
 
 
 
 
 
Six Months Ended June 30,
CASH FLOWS FROM OPERATING ACTIVITIES
2015
 
2014
Net income
$
4,864

 
$
1,861

Adjustments to reconcile net income to net cash from operating activities

 

Provision for loan losses
1,200

 
900

Depreciation, amortization and accretion
957

 
1,677

Compensation expense related to stock options and restricted stock awards
373

 
110

ESOP compensation expense for allocated shares
259

 
219

Provision for deferred income taxes

 
816

Increase in cash surrender value of BOLI
(95
)
 
(92
)
Gain on sale of loans held for sale
(7,933
)
 
(2,741
)
Gain on sale of portfolio loans

 
(561
)
Origination of loans held for sale
(296,744
)
 
(103,425
)
Proceeds from sale of loans held for sale
287,763

 
100,887

Gain on sale of investment securities
(76
)
 
(10
)
Gain on sale of OREO

 
(10
)
Recovery of loss on servicing rights

 
(1
)
Impairment loss on other real estate owned

 
40

Changes in operating assets and liabilities

 

Accrued interest receivable
(214
)
 
(105
)
Other assets
(1,365
)
 
(461
)
Other liabilities
589

 
708

Net cash used by operating activities
(10,422
)
 
(188
)
CASH FLOWS FROM INVESTING ACTIVITIES

 

Activity in securities available-for-sale:


 


Proceeds from sale of investment securities
4,178

 
11,720

Maturities, prepayments, sales, and calls
2,727

 
7,964

Purchases
(8,907
)
 
(20,673
)
Maturities of interest-bearing time deposits
248

 

Purchase of interest-bearing time deposits
(3,224
)
 
(250
)
Loan originations and principal collections, net
(46,120
)
 
(58,734
)
Proceeds from sale of portfolio loans

 
12,849

Proceeds from sale of OREO

 
2,454

Purchase of premises and equipment, net
(952
)
 
(447
)
FHLB stock purchased
(1,226
)
 

FHLB stock redeemed
1,464

 
32

Net cash used by investing activities
(51,812
)
 
(45,085
)
CASH FLOWS FROM FINANCING ACTIVITIES

 

Net increase in deposits
50,064

 
14,768

Proceeds from borrowings
199,737

 
30,207

Repayments of borrowings
(196,502
)
 
(29,319
)
Dividends paid
(397
)
 
(341
)
Proceeds from stock options exercised
162

 

Common stock repurchased
(101
)
 
(2,222
)
Net cash from financing activities
52,963

 
13,093

NET DECREASE IN CASH AND CASH EQUIVALENTS
(9,271
)
 
(32,180
)
CASH AND CASH EQUIVALENTS, beginning of period
15,555

 
38,459

CASH AND CASH EQUIVALENTS, end of period
$
6,284

 
$
6,279

SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION

 

Cash paid during the year for:

 

Interest
$
1,700

 
$
1,262

Income taxes
$
2,151

 
$
175

SUPPLEMENTARY DISCLOSURES OF NONCASH OPERATING, INVESTING AND FINANCING ACTIVITIES


 


Change in unrealized (loss) gain on investment securities
$
(214
)
 
$
1,334

Property received in settlement of loans
$

 
$
445

See accompanying notes to these consolidated financial statements.

 
 
6









 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 









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”) 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 seven branches and four loan production offices in suburban communities in the greater Puget Sound area, and one loan production office in the most recently entered 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.

Financial Statement Presentation – The accompanying unaudited consolidated interim financial statements do not contain all necessary disclosures required by generally accepted accounting principles in the United States of America (“U.S. GAAP”) for complete financial statements and, therefore, should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2014 filed with the U.S. Securities and Exchange Commission ("SEC") on March 27, 2015.  These unaudited consolidated financial statements include all normal and recurring adjustments that management believes are necessary in order to conform to U.S. GAAP and have been reflected as required by Article 10 of Regulation S-X as promulgated by the SEC.  The results for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015, or any other future period. Amounts presented in the 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 2015 presentation with no change to net income or stockholders' equity previously reported.

Conversion and Change in Corporate Form – On July 9, 2012, in accordance with a Plan of Conversion (the "Plan") adopted by its Board of Directors and as approved by its depositors and borrower members, the Bank (i) converted from a mutual savings bank to a stock savings bank, and (ii) became the wholly-owned subsidiary of FS Bancorp, Inc., a bank holding company registered with the Board of Governors of the Federal Reserve System ("Federal Reserve"). In connection with the conversion, FS Bancorp, Inc. issued an aggregate of 3,240,125 shares of common stock at an offering price of $10.00 per share for gross proceeds of $32.4 million. From the proceeds, the Company made a capital contribution of $15.5 million to the Bank. The Bank is using this additional capital for lending and investment activities and for general and other corporate purposes subject to regulatory limitations. The cost of conversion and the issuance of capital stock was approximately $2.5 million, which was deducted from the proceeds of the offering.

Pursuant to the Plan, the Company's Board of Directors adopted an employee stock ownership plan ("ESOP") plan 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 as of December 31, 2011. The liquidation account will be maintained for the benefit of eligible savings account holders as of 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.

Use of Estimates – 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 change in the near term are allowances for loan losses, fair value of measurements, servicing assets, and the estimated accounting for deferred income taxes.

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.


 
 
7









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
 
 


NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Segment Reporting – The Company’s major line of business is community banking. Management has determined that the Company operates as a single operating segment based on U. S. GAAP.

Subsequent Events – The Company has evaluated events and transactions subsequent to June 30, 2015, for potential recognition or disclosure.

Cash and Cash Equivalents – Cash and cash equivalents include cash and due from banks, and interest-bearing balances due from other banks and the Federal Reserve Bank of San Francisco ("Federal Reserve Bank"). Cash and cash equivalents with a cost basis of $6.3 million and $15.6 million as of June 30, 2015 and December 31, 2014, respectively, have a maturity of 90 days or less at the time of purchase. As of June 30, 2015 the Company had no cash deposits at other financial institutions in excess of Federal Deposit Insurance Corporation ("FDIC") insured limits and as of December 31, 2014, the Company had cash deposits at other financial institutions in excess of FDIC insured limits. However, as the Company places these deposits with major financial institutions and monitors the financial condition of these institutions, management believes the risk of loss to be minimal.

The Company held interest-bearing deposits at other financial institutions with a cost basis of $11.7 million, including $3.9 million at the Federal Reserve Bank, as of June 30, 2015, and $9.3 million, including $4.7 million at the Federal Reserve Bank, as of December 31, 2014. Certificates of deposits in the amount of $7.5 million and $4.5 million with original maturity dates greater than 90 days were excluded from cash and cash equivalents as of June 30, 2015 and December 31, 2014, respectively.

RECENT ACCOUNTING PRONOUNCEMENTS

In January 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2015-01, Income Statement - Extraordinary and Unusual Items (Subtopic 225-20). The objective of this ASU is to simplify the income statement presentation requirements in Subtopic 225-20 by eliminating the concept of extraordinary items. Extraordinary items are events and transactions that are distinguished by their unusual nature and by the infrequency of their occurrence. Eliminating the extraordinary classification simplifies income statement presentation by altogether removing the concept of extraordinary items from consideration. This ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015 with early adoption permitted. The Company does not expect this ASU to have a material impact on the Company's consolidated financial statements.

In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, which is intended to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). The ASU focuses on simplifying the consolidation evaluation for reporting organizations that are required to evaluate whether they should consolidate certain legal entities by reducing the number of consolidation model from four to two, among other changes.  The ASU will be effective for periods beginning after December 31, 2015, while early adoption is permitted.  The Company does not expect this ASU to have a material impact on the Company's consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected. ASU No 2015-03 is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years.  ASU No. 2015-03 should be applied on a retrospective basis.  The Company is currently evaluating the impacts of this ASU on the Company's consolidated financial statements.


 
 
8









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
 
 


NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

In April 2015, the FASB issued ASU No. 2015-05, Customer's Accounting for Fees Paid in a Cloud Computing Arrangement. The amendments in this ASU provide guidance to customers in cloud computing arrangements about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement does include a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The amendments are effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted. This ASU is not expected to have a material effect on the Company's consolidated financial statements.

In June 2015, FASB issued ASU No. 2015-10, Technical Corrections and Improvements. On November 10, 2010 FASB added a standing project that will facilitate the FASB Accounting Standards Codification (‘Codification”) updates for technical corrections, clarifications, and improvements. These amendments are referred to as Technical Corrections and Improvements. Maintenance updates include non-substantive corrections to the Codification, such as editorial corrections, various link-related changes, and changes to source fragment information. This update contains amendments that will affect a wide variety of Topics in the Codification. The amendments in this ASU will apply to all reporting entities within the scope of the affected accounting guidance and generally fall into one of four categories: amendments related to differences between original guidance and the Codification, guidance clarification and reference corrections, simplification, and minor improvements. In summary, the amendments in this ASU represent changes to clarify the Codification, correct unintended application of guidance, or make minor improvements to the Codification that are not expected to have a significant effect on current accounting practice. Transition guidance varies based on the amendments in this ASU. The amendments in this ASU that require transition guidance are effective for fiscal years and interim reporting periods after December 15, 2015. Early adoption is permitted including adoption in an interim period. All other amendments are effective upon the issuance of this ASU. ASU 2015-10 did not have a material impact on the Company's consolidated financial statements.








 
 
9









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
 
 


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 June 30, 2015 and December 31, 2014:

 
June 30, 2015
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair
Values
 
SECURITIES AVAILABLE-FOR-SALE
 
 
 
 
 
 
 
Federal agency securities
$
6,075

 
$

 
$
(153
)
 
$
5,922

Municipal bonds
16,927

 
262

 
(58
)
 
17,131

Corporate securities
4,495

 
6

 
(58
)
 
4,443

Mortgage-backed securities
19,928

 
77

 
(146
)
 
19,859

  Small Business Administration securities
3,026

 
33

 

 
3,059

Total securities available-for-sale
$
50,451

 
$
378

 
$
(415
)
 
$
50,414

 
 
 
 
 
 
 
 
 
December 31, 2014
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair
Values
 
SECURITIES AVAILABLE-FOR-SALE
 
 
 
 
 
 
 
Federal agency securities
$
5,998

 
$
3

 
$
(156
)
 
$
5,845

Municipal bonds
15,886

 
326

 
(51
)
 
16,161

Corporate securities
4,495

 

 
(58
)
 
4,437

Mortgage-backed securities
20,169

 
132

 
(57
)
 
20,244

    Small Business Administration securities
2,019

 
38

 

 
2,057

Total securities available-for-sale
$
48,567

 
$
499

 
$
(322
)
 
$
48,744

 





















 
 
10









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
 
 


NOTE 2 - SECURITIES AVAILABLE-FOR-SALE (Continued)

Investment securities that were in an unrealized loss position as of June 30, 2015 and December 31, 2014 are presented in the following tables, based on the length of time individual securities have been in an unrealized loss position. In the opinion of management, these securities are considered 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. 

 
June 30, 2015
 
Less than 12 Months
 
12 Months or Longer
 
Total
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
SECURITIES AVAILABLE-FOR-SALE
 
 
 
 
 
 
 
 
 
 
 
Federal agency securities
$
2,031

 
$
(48
)
 
$
3,891

 
$
(105
)
 
$
5,922

 
$
(153
)
Municipal bonds
4,202

 
(38
)
 
286

 
(20
)
 
4,488

 
(58
)
Corporate securities
1,989

 
(11
)
 
1,454

 
(47
)
 
3,443

 
(58
)
Mortgage-backed securities
9,994

 
(91
)
 
2,266

 
(55
)
 
12,260

 
(146
)
Total securities available-for-sale
$
18,216

 
$
(188
)
 
$
7,897

 
$
(227
)
 
$
26,113

 
$
(415
)
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2014
 
Less than 12 Months
 
12 Months or Longer
 
Total
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
SECURITIES AVAILABLE-FOR-SALE
 
 
 
 
 
 
 
 
 
 
 
Federal agency securities
$

 
$

 
$
4,840

 
$
(156
)
 
$
4,840

 
$
(156
)
Municipal bonds
950

 
(2
)
 
2,266

 
(49
)
 
3,216

 
(51
)
Corporate securities
2,977

 
(18
)
 
1,460

 
(40
)
 
4,437

 
(58
)
Mortgage-backed securities
3,776

 
(2
)
 
3,648

 
(55
)
 
7,424

 
(57
)
Total securities available-for-sale
$
7,703

 
$
(22
)
 
$
12,214

 
$
(300
)
 
$
19,917

 
$
(322
)
 
 
 
 
 
 
 
 
 
 
 
 

There were 19 investments with unrealized losses of less than one year, and eight investments with unrealized losses of more than one year at June 30, 2015. There were eight investments with unrealized losses of less than one year, and 13 investments with unrealized losses of more than one year as of December 31, 2014. The unrealized losses associated with these investments are believed to be caused by changing market conditions 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. No other-than-temporary impairment was recorded for the three and six months ended June 30, 2015 and 2014.
 












 
 
11









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
 
 


NOTE 2 - SECURITIES AVAILABLE-FOR-SALE (Continued)

The contractual maturities of securities available-for-sale at June 30, 2015 were as follows:
 
June 30, 2015
 
Amortized
Cost
 
Fair
Value
Due in one year or less
$
1,000

 
$
999

Due after one year through five years
6,279

 
6,297

Due after five years through ten years
19,065

 
18,965

Due after ten years
24,107

 
24,153

Total
$
50,451

 
$
50,414

 

The proceeds and resulting gains, computed using specific identification, from sales of securities available-for-sale for the three and six months ended June 30, 2015 and 2014 were as follows:  
 
Three Months Ended
June 30, 2015
 
Six Months Ended
June 30, 2015
 
Proceeds
 
Gross Gains
 
Gross (Losses)
 
Proceeds
 
Gross Gains
 
Gross (Losses)
Securities available-for-sale
$

 
$

 
$

 
$
4,178

 
$
76

 
$

 
 
 
 
 
 
 
 
 
Three Months Ended
June 30, 2014
 
Six Months Ended
June 30, 2014
 
Proceeds
 
Gross Gains
 
Gross (Losses)
 
Proceeds
 
Gross Gains
 
Gross (Losses)
Securities available-for-sale
$
11,720

 
$
64

 
$
(54
)
 
$
11,720

 
$
64

 
$
(54
)
 
 
 
 
 
 
 
 
 
 
 
 


 
 
12









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 


NOTE 3 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

The composition of the loan portfolio at June 30, 2015 and December 31, 2014 was as follows:
 
June 30,
 
December 31,
 
2015
 
2014
REAL ESTATE LOANS
 
 
 
Commercial
$
44,813

 
$
42,970

Construction and development
63,624

 
57,813

Home equity
16,411

 
15,737

One-to-four-family (excludes held for sale loans)
67,143

 
46,801

Multi-family
22,851

 
16,201

Total real estate loans
214,842

 
179,522

CONSUMER LOANS
 
 
 
Indirect home improvement
101,791

 
99,304

Solar
24,713

 
18,162

Marine
20,572

 
16,713

Automobile
643

 
674

Recreational
386

 
441

Home improvement
251

 
329

Other
1,175

 
1,184

Total consumer loans
149,531

 
136,807

COMMERCIAL BUSINESS LOANS
75,595

 
77,881

Total loans receivable, gross
439,968

 
394,210

Allowance for loan losses
(6,927
)
 
(6,090
)
Deferred costs, fees, and discounts, net
(776
)
 
(946
)
Total loans receivable, net
$
432,265

 
$
387,174


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:
 
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.

Home Equity Lending. Loans originated by the Company secured by second mortgages on one-to-four-family residences in our market areas.


 
 
13









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 


NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

One-to-Four-Family Real Estate Lending. Loans originated by the Company secured by first mortgages on one-to-four-family residences in our market areas that the Company intends to hold (excludes held for sale loans). 

Multi-Family Lending. Apartment term lending (more than four 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 are originated by the Company for home improvement 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 are originated by the Company for home improvement 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.

Marine, Automobile and Recreational. Loans originated by the Company secured by boats, automobiles, and RVs to borrowers primarily located in its market areas.
 
Other Consumer and Home Improvement. Loans originated by the Company, including direct home improvement loans, loans on deposits, and other consumer loans, primarily consisting of personal lines of credit.
 
Commercial Business Loans
 
Commercial Business Lending. Commercial business 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. Commercial business loans are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.






















 
 
14









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 


NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

The following tables detail activity in the allowance for loan losses by loan categories at or for the three and six months ended June 30, 2015 and 2014:
 
At or For the Three Months Ended June 30, 2015
ALLOWANCE FOR LOAN LOSSES
Real Estate
 
Consumer
 
Commercial
Business
 
Unallocated
 
Total
Beginning balance
$
2,125

 
$
1,438

 
$
2,134

 
$
708

 
$
6,405

   Provision for loan losses
119

 
187

 
45

 
249

 
600

   Charge-offs
(57
)
 
(328
)
 
(34
)
 

 
(419
)
   Recoveries
191

 
147

 
3

 

 
341

Net recoveries (charge-offs)
134

 
(181
)
 
(31
)
 

 
(78
)
Ending balance
$
2,378

 
$
1,444

 
$
2,148

 
$
957

 
$
6,927

Period end amount allocated to:
 

 
 

 
 

 
 

 
 

Loans individually evaluated for impairment
$

 
$

 
$

 
$

 
$

Loans collectively evaluated for impairment
2,378

 
1,444

 
2,148

 
957

 
6,927

Ending balance
$
2,378

 
$
1,444

 
$
2,148

 
$
957

 
$
6,927

LOANS RECEIVABLE
 

 
 

 
 

 
 

 
 

Loans individually evaluated for impairment
$
1,468

 
$

 
$

 
$

 
$
1,468

Loans collectively evaluated for impairment
213,374

 
149,531

 
75,595

 

 
438,500

Ending balance
$
214,842

 
$
149,531

 
$
75,595

 
$

 
$
439,968

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
At or For the Six Months Ended June 30, 2015
ALLOWANCE FOR LOAN LOSSES
Real Estate
 
Consumer
 
Commercial
Business
 
Unallocated
 
Total
Beginning balance
$
1,872

 
$
1,431

 
$
1,184

 
$
1,603

 
$
6,090

   Provision for loan losses
563

 
290

 
993

 
(646
)
 
1,200

   Charge-offs
(248
)
 
(745
)
 
(34
)
 

 
(1,027
)
   Recoveries
191

 
468

 
5

 

 
664

Net charge-offs
(57
)
 
(277
)
 
(29
)
 

 
(363
)
Ending balance
$
2,378

 
$
1,444

 
$
2,148

 
$
957

 
$
6,927

Period end amount allocated to:
 

 
 

 
 

 
 

 
 

Loans individually evaluated for impairment
$

 
$

 
$

 
$

 
$

Loans collectively evaluated for impairment
2,378

 
1,444

 
2,148

 
957

 
6,927

Ending balance
$
2,378

 
$
1,444

 
$
2,148

 
$
957

 
$
6,927

LOANS RECEIVABLE
 

 
 

 
 

 
 

 
 

Loans individually evaluated for impairment
$
1,468

 
$

 
$

 
$

 
$
1,468

Loans collectively evaluated for impairment
213,374

 
149,531

 
75,595

 

 
438,500

Ending balance
$
214,842

 
$
149,531

 
$
75,595

 
$

 
$
439,968





 
 
15









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 


NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

 
At or For the Three Months Ended June 30, 2014
ALLOWANCE FOR LOAN LOSSES
Real Estate
 
Consumer
 
Commercial
Business
 
Unallocated
 
Total
Beginning balance
$
1,465

 
$
1,462

 
$
1,036

 
$
1,280

 
$
5,243

   Provision for loan losses
(76
)
 
503

 
662

 
(639
)
 
450

   Charge-offs
(3
)
 
(386
)
 

 

 
(389
)
   Recoveries
61

 
183

 

 

 
244

Net recoveries (charge-offs)
58

 
(203
)
 

 

 
(145
)
Ending balance
$
1,447

 
$
1,762

 
$
1,698

 
$
641

 
$
5,548

Period end amount allocated to:
 
 
 
 
 
 
 
 
 
Loans individually evaluated for impairment
$

 
$

 
$
4

 
$

 
$
4

Loans collectively evaluated for impairment
1,447

 
1,762

 
1,694

 
641

 
5,544

Ending balance
$
1,447

 
$
1,762

 
$
1,698

 
$
641

 
$
5,548

LOANS RECEIVABLE
 
 
 
 
 
 
 
 
 
Loans individually evaluated for impairment
$
627

 
$

 
$
45

 
$

 
$
672

Loans collectively evaluated for impairment
138,541

 
128,492

 
64,539

 

 
331,572

Ending balance
$
139,168

 
$
128,492

 
$
64,584

 
$

 
$
332,244

 
 
 
 
 
 
 
 
 
 
 
At or For the Six Months Ended June 30, 2014
ALLOWANCE FOR LOAN LOSSES
Real Estate
 
Consumer
 
Commercial
Business
 
Unallocated
 
Total
Beginning balance
$
1,963

 
$
1,512

 
$
800

 
$
817

 
$
5,092

   Provision for loan losses
(449
)
 
552

 
973

 
(176
)
 
900

   Charge-offs
(147
)
 
(637
)
 
(75
)
 

 
(859
)
   Recoveries
80

 
335

 

 

 
415

Net charge-offs
(67
)
 
(302
)
 
(75
)
 

 
(444
)
Ending balance
$
1,447

 
$
1,762

 
$
1,698

 
$
641

 
$
5,548

Period end amount allocated to:
 
 
 
 
 
 
 
 
 
Loans individually evaluated for impairment
$

 
$

 
$
4

 
$

 
$
4

Loans collectively evaluated for impairment
1,447

 
1,762

 
1,694

 
641

 
5,544

Ending balance
$
1,447

 
$
1,762

 
$
1,698

 
$
641

 
$
5,548

LOANS RECEIVABLE
 
 
 
 
 
 
 
 
 
Loans individually evaluated for impairment
$
627

 
$

 
$
45

 
$

 
$
672

Loans collectively evaluated for impairment
138,541

 
128,492

 
64,539

 

 
331,572

Ending balance
$
139,168

 
$
128,492

 
$
64,584

 
$

 
$
332,244








 
 
16









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 


NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

Information pertaining to the aging analysis of past due loans at June 30, 2015 and December 31, 2014 is summarized as follows:
 
 
June 30, 2015
 
30-59 Days Past Due
 
60-89 Days Past Due
 
90 Days or More Past Due and Non-Accrual
 
Total
Past Due
 
Current
 
Total Loans
Receivable
REAL ESTATE LOANS
 
 
 
 
 
 
 
 
 
 
 
Commercial
$

 
$

 
$
544

 
$
544

 
$
44,269

 
$
44,813

 Construction and development

 

 

 

 
63,624

 
63,624

Home equity
43

 
100

 
197

 
340

 
16,071

 
16,411

One-to-four-family

 

 
55

 
55

 
67,088

 
67,143

Multi-family

 

 

 

 
22,851

 
22,851

Total real estate loans
43

 
100

 
796

 
939

 
213,903

 
214,842

CONSUMER LOANS
 

 
 

 
 

 
 

 
 

 
 

Indirect home improvement
430

 
223

 
194

 
847

 
100,944

 
101,791

Solar

 

 
38

 
38

 
24,675

 
24,713

Marine
31

 

 

 
31

 
20,541

 
20,572

Automobile
26

 

 

 
26

 
617

 
643

Recreational

 

 

 

 
386

 
386

Home improvement

 

 

 

 
251

 
251

Other
2

 
11

 

 
13

 
1,162

 
1,175

Total consumer loans
489

 
234

 
232

 
955

 
148,576

 
149,531

COMMERCIAL BUSINESS LOANS

 

 

 

 
75,595

 
75,595

Total loans
$
532

 
$
334

 
$
1,028

 
$
1,894

 
$
438,074

 
$
439,968

 
 
 
 
 
 
 
 
 
 
 
 






 
 
17









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 


NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

 
December 31, 2014
 
30-59 Days Past Due
 
60-89 Days Past Due
 
90 Days or More Past Due and Non-Accrual
 
Total
Past Due
 
Current
 
Total Loans
Receivable
REAL ESTATE LOANS
 
 
 
 
 
 
 
 
 
 
 
   Commercial
$

 
$

 
$

 
$

 
$
42,970

 
$
42,970

   Construction and development

 

 

 

 
57,813

 
57,813

   Home equity
159

 
196

 
61

 
416

 
15,321

 
15,737

   One-to-four-family

 

 
73

 
73

 
46,728

 
46,801

   Multi-family

 

 

 

 
16,201

 
16,201

      Total real estate loans
159

 
196

 
134

 
489

 
179,033

 
179,522

CONSUMER LOANS
 
 
 
 
 
 
 
 
 
 
 
   Indirect home improvement
501

 
277

 
250

 
1,028

 
98,276

 
99,304

   Solar

 

 
29

 
29

 
18,133

 
18,162

   Marine
81

 

 
19

 
100

 
16,613

 
16,713

   Automobile
13

 

 

 
13

 
661

 
674

   Recreational

 

 

 

 
441

 
441

   Home improvement

 
6

 

 
6

 
323

 
329

   Other
15

 
14

 
1

 
30

 
1,154

 
1,184

      Total consumer loans
610

 
297

 
299

 
1,206

 
135,601

 
136,807

COMMERCIAL BUSINESS LOANS

 

 

 

 
77,881

 
77,881

      Total loans
$
769

 
$
493

 
$
433

 
$
1,695

 
$
392,515

 
$
394,210


There were no loans 90 days or more past due and still accruing at June 30, 2015 and December 31, 2014.

 
 
18









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 


NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

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 has been provided as of June 30, 2015 and December 31, 2014:
 
June 30, 2015
 
Unpaid
Principal
Balance
 
Write-
downs
 
Recorded
Investment
 
Related
Allowance
 
Adjusted
Recorded
Investment
WITH NO RELATED ALLOWANCE RECORDED
 
 
 
 
 
 
 
 
 
Commercial
$
544

 
$

 
$
544

 
$

 
$
544

Home equity
132

 

 
132

 

 
132

One-to-four-family
859

 
(67
)
 
792

 

 
792

Total real estate loans
$
1,535

 
$
(67
)

$
1,468


$

 
$
1,468

 
 
December 31, 2014
 
Unpaid
Principal
Balance
 
Write-
downs
 
Recorded
Investment
 
Related
Allowance
 
Adjusted
Recorded
Investment
WITH NO RELATED ALLOWANCE RECORDED
 
 
 
 
 
 
 
 
 
One-to-four-family
$
885

 
$
(67
)
 
$
818

 
$

 
$
818

WITH AN ALLOWANCE RECORDED
 

 
 

 
 

 
 

 
 

Commercial business loans
40

 
(2
)
 
38

 
(6
)
 
32

Total
$
925

 
$
(69
)
 
$
856

 
$
(6
)
 
$
850























 
 
19









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 


NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

The following tables present the average recorded investment in loans individually evaluated for impairment and the interest income recognized and received for the three and six months ended June 30, 2015 and 2014:
 
Three Months Ended
 
June 30, 2015
 
June 30, 2014
 
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
WITH NO RELATED ALLOWANCE RECORDED
 
 
 
 
 
 
 
Commercial
$
767

 
$
22

 
$

 
$

Home equity
153

 
1

 

 

One-to-four-family
796

 
11

 
631

 
8

Subtotal real estate loans
1,716

 
34

 
631

 
8

 
 
 
 
 
 
 
 
WITH AN ALLOWANCE RECORDED
 
 
 
 
 
 
 
Commercial business loans
12

 

 
46

 
1

Total
$
1,728

 
$
34

 
$
677

 
$
9


 
Six Months Ended
 
June 30, 2015
 
June 30, 2014
 
Average Recorded Investment
 
Interest Income Recognized
 
Average Recorded Investment
 
Interest Income Recognized
WITH NO RELATED ALLOWANCE RECORDED
 
 
 
 
 
 
 
Commercial
$
992

 
$
38

 
$

 
$

Home equity
131

 
4

 

 

One-to-four-family
798

 
26

 
634

 
17

Subtotal real estate loans
1,921

 
68

 
634

 
17

 
 
 
 
 
 
 
 
WITH AN ALLOWANCE RECORDED
 
 
 
 
 
 
 
Commercial business loans
25

 

 
48

 
2

Total
$
1,946

 
$
68

 
$
682

 
$
19


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.
 


 
 
20









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 


NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

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 FDIC'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, recreational, automobile, direct home improvement and other, 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" internally. Loans that are past due more than 90 days are classified “Substandard” and risk rated "8" internally. 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.

 






















 
 
21









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 


NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

The following tables summarize risk rated loan balances by category at June 30, 2015 and December 31, 2014:
 
June 30, 2015
 
Pass (1 - 5)
 
Watch (6)
 
Special
Mention (7)
 
Substandard (8)
 
Doubtful(9)
 
Loss (10)
 
Total
REAL ESTATE LOANS
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
44,269

 
$

 
$

 
$
544

 
$

 
$

 
$
44,813

 Construction and development
62,311

 
1,313

 

 

 

 

 
63,624

Home equity
16,214

 

 

 
197

 

 

 
16,411

One-to-four-family
66,563

 

 

 
580

 

 

 
67,143

Multi-family
22,851

 

 

 

 

 

 
22,851

Total real estate loans
212,208

 
1,313

 

 
1,321

 

 

 
214,842

CONSUMER LOANS
 

 
 

 
 

 
 

 
 

 
 

 
 

Indirect home improvement
101,559

 

 

 
232

 

 

 
101,791

Solar
24,713

 

 

 

 

 

 
24,713

Marine
20,572

 

 

 

 

 

 
20,572

Automobile
643

 

 

 

 

 

 
643

Recreational
386

 

 

 

 

 

 
386

Home improvement
251

 

 

 

 

 

 
251

Other
1,175

 

 

 

 

 

 
1,175

Total consumer loans
149,299

 

 

 
232

 

 

 
149,531

COMMERCIAL BUSINESS LOANS
61,212

 
2,929

 
9,157

 
2,297

 

 

 
75,595

Total loans
$
422,719

 
$
4,242

 
$
9,157

 
$
3,850

 
$

 
$

 
$
439,968

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2014
 
Pass (1 - 5)
 
Watch (6)
 
Special
Mention (7)
 
Substandard (8)
 
Doubtful(9)
 
Loss (10)
 
Total
REAL ESTATE LOANS
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
$
41,559

 
$
545

 
$

 
$
866

 
$

 
$

 
$
42,970

 Construction and development
57,813

 

 

 

 

 

 
57,813

Home equity
15,676

 

 

 
61

 

 

 
15,737

One-to-four-family
46,200

 

 

 
601

 

 

 
46,801

Multi-family
16,201

 

 

 

 

 

 
16,201

Total real estate loans
177,449

 
545

 

 
1,528

 

 

 
179,522

CONSUMER LOANS
 

 
 

 
 

 
 

 
 

 
 

 
 

Indirect home improvement
99,054

 

 

 
250

 

 

 
99,304

Solar
18,133

 

 

 
29

 

 

 
18,162

Marine
16,694

 

 

 
19

 

 

 
16,713

Automobile
674

 

 

 

 

 

 
674

Recreational
441

 

 

 

 

 

 
441

Home improvement
329

 

 

 

 

 

 
329

Other
1,183

 

 

 
1

 

 

 
1,184

Total consumer loans
136,508

 

 

 
299

 

 

 
136,807

COMMERCIAL BUSINESS LOANS
68,687

 
2,020

 
6,795

 
379

 

 

 
77,881

Total loans
$
382,644

 
$
2,565

 
$
6,795

 
$
2,206

 
$

 
$

 
$
394,210


 
 
22









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
 


NOTE 3 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)

Troubled Debt Restructured Loans
 
Troubled debt restructured (“TDR”) loans are loans for which the Company, for economic or legal reasons related to the borrower’s financial condition, has granted a significant concession to the borrower that it would otherwise not consider. The loan terms which have been modified or restructured due to a borrower’s financial difficulty include but are not limited to: a reduction in the stated interest rate; an extension of the maturity at an interest rate below current market; a reduction in the face amount of the debt; a reduction in the accrued interest; or re-aging, extensions, deferrals and renewals. TDR loans are considered impaired loans and are individually evaluated for impairment. TDR loans can be classified as either accrual or non-accrual. TDR loans are classified as non-performing loans unless they have been performing in accordance with their modified terms for a period of at least six months in which case they are placed on accrual status. The Company had three TDR loans on accrual and included in impaired loans at June 30, 2015, and four TDR loans at December 31, 2014. In addition, the Company had no TDR loans on non-accrual, and had no commitments to lend additional funds on these restructured loans at June 30, 2015, and December 31, 2014.
 
A summary of TDR loan balances at the dates indicated is as follows:
 
June 30,
 
December 31,
 
2015
 
2014
TDR loans still on accrual
$
737

 
$
783

TDR loans on non-accrual

 

 Total TDR loan balances
$
737

 
$
783

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
There were no TDRs recorded in the twelve months prior to June 30, 2015 and 2014, that subsequently defaulted in the three or six months ended June 30, 2015 and 2014.


NOTE 4 – SERVICING RIGHTS
 
Loans serviced for others are not included on the consolidated balance sheets. The unpaid principal balances of mortgage, commercial, and consumer loans serviced for others were $495.2 million and $345.9 million at June 30, 2015 and December 31, 2014, respectively. The fair market value of the servicing rights’ asset was $5.7 million and $3.5 million at June 30, 2015 and December 31, 2014, respectively.
 
The following tables summarize servicing rights activity for the three and six months ended June 30, 2015 and 2014:
 
 
At or For the Three Months Ended
June 30,
 
2015
 
2014
 Beginning balance
$
3,670

 
$
2,134

Additions
1,117

 
313

Mortgage, commercial, and consumer servicing rights amortized
(217
)
 
(112
)
(Impairment) recovery on servicing rights
(1
)
 
1

Ending balance
$
4,569

 
$
2,336

 
 
 
 




 
 
23









 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 









NOTE 4 – SERVICING RIGHTS (Continued)

 
At or For the Six Months Ended
June 30,
 
2015
 
2014
 Beginning balance
$
3,061

 
$
2,093

Additions
1,902

 
489

Mortgage, commercial, and consumer servicing rights amortized
(394
)
 
(247
)
Recovery of loss on servicing rights

 
1

Ending balance
$
4,569

 
$
2,336


Fair value adjustments to mortgage, commercial, and consumer servicing rights were mainly due to market based assumptions associated with discounted cash flows, loan prepayment speeds, and changes in interest rates. Valuation assumptions used in determining the fair value of servicing rights at the dates indicated are as follows:

 
 
At June 30,
 
 
2015
 
2014
Key assumptions:
 
 
 
 
Weighted average discount rate
 
8.5
%
 
8.5
%
Conditional prepayment rate ("CPR")
 
10.4
%
 
9.8
%
Weighted average life in years
 
7.2

 
7.3


The Company recorded $281,000 and $172,000 of contractually specified servicing fees, late fees, and other ancillary fees resulting from servicing of mortgage, commercial and consumer loans for the three months ended June 30, 2015 and 2014, respectively, and $514,000 and $334,000 for the six months ended June 30, 2015 and 2014, respectively, which is reported in noninterest 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. 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.












 
 
24









 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 








NOTE 5 - DERIVATIVES (Continued)

The following tables summarize the Company's derivative instruments as of the dates indicated:
 
 
June 30, 2015
 
 
 
 
Fair Value
 
 
Notional
 
Asset
 
Liability
Fallout adjusted interest rate lock commitments with customers
 
$
43,573

 
$
934

 
$

Mandatory and best effort forward commitments with investors
 
23,305

 
110

 

Forward TBA mortgage-backed securities
 
58,000

 
292

 

TBA mortgage-backed securities forward sales paired off with investors
 
26,000

 
331

 



 
 
December 31, 2014
 
 
 
 
Fair Value
 
 
Notional
 
Asset
 
Liability
Fallout adjusted interest rate lock commitments with customers
 
$
16,516

 
$
396

 
$

Mandatory and best effort forward commitments with investors
 
10,763

 
12

 

Forward TBA mortgage-backed securities
 
30,000

 

 
194

TBA mortgage-backed securities forward sales paired off with investors
 
29,000

 

 
207


The income on derivatives from fair value changes recognized in other noninterest income on the consolidated statements of income, included in gain on sale of loans was $417,000 and $110,000 for the three months ended June 30, 2015 and 2014, respectively, and $1.5 million and $322,000 for the six months ended June 30, 2015 and 2014, respectively.


NOTE 6 – OTHER REAL ESTATE OWNED
 
The following table presents the activity related to OREO for the three and six months ended June 30, 2015 and 2014:
 
 
At or For the Three Months Ended June 30,
 
At or For the Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Beginning balance
$

 
$
535

 
$

 
$
2,075

Additions

 

 

 
445

Fair value impairments

 

 

 
(40
)
Disposition of assets

 
(499
)
 

 
(2,444
)
Ending balance
$

 
$
36

 
$

 
$
36

 

There were no OREO properties at June 30, 2015, and one property located in the State of Washington with a balance of $36,000 at June 30, 2014. For the three months ended June 30, 2015 and 2014, the Company recorded no net gain or loss, and a $1,000 net gain on disposals of OREO, respectively. For the six months ended June 30, 2015 and 2014, the Company recorded no net gain or loss, and a $10,000 net gain, respectively, on disposals of OREO. Holding costs or (recovery) associated with OREO were none and $(29,000) for the three months ended June 30, 2015 and 2014, respectively, and none and $3,000 for the six months ended June 30, 2015 and 2014, respectively.

 
 
25









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
 
 



NOTE 7 – DEPOSITS

Deposits are summarized as follows as of June 30, 2015 and December 31, 2014: 
 
June 30,
 
December 31,
 
2015
 
2014
Noninterest-bearing checking
$
64,866

 
$
53,743

Interest-bearing checking
31,901

 
29,585

Savings
25,227

 
21,560

Money market
162,877

 
152,611

Certificates of deposits of less than $100,000(1)
63,229

 
52,323

Certificates of deposits of $100,000 through $250,000
84,534

 
74,008

Certificates of deposits of more than $250,000(2) 
34,182

 
33,623

Escrow accounts related to mortgages serviced
3,692

 
2,991

Total
$
470,508

 
$
420,444

(1) Includes $30.5 million and $19.1 million of brokered deposits at June 30, 2015 and December 31, 2014, respectively.
(2) Time deposits that meet or exceed the FDIC insurance limit.

Scheduled maturities of time deposits as of June 30, 2015 for future periods ending is as follows:
 
 
 As of June 30, 2015
2015
 
$
27,329

2016
 
78,313

2017
 
59,104

2018
 
11,378

2019
 
4,038

Thereafter
 
1,783

Total
 
$
181,945


The Bank pledged two securities held at the FHLB of Des Moines with a fair value of $1.2 million to secure Washington State public deposits of $1.7 million with a $117,000 collateral requirement by the Washington Public Deposit Protection Commission as of June 30, 2015.

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 June 30, 2015 and December 31, 2014 were $2.2 million and $1.9 million, respectively, and were in compliance with Federal Reserve regulations.

Interest expense by deposit category for the three and six months ended June 30, 2015 and 2014 is as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Interest-bearing checking
$
7

 
$
7

 
$
13

 
$
16

Savings and money market
259

 
130

 
498

 
248

Certificates of deposit
546

 
457

 
1,048

 
880

Total
$
812

 
$
594

 
$
1,559

 
$
1,144

 



 
 
26









 
 
 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
 
 


NOTE 8 – INCOME TAXES
 
The Company recorded a provision for income taxes of $2.6 million and $931,000 during the six months ended June 30, 2015 and 2014, respectively.
The Company files a consolidated U.S. Federal income tax return, which is subject to examinations by tax authorities for years 2011 and later. At June 30, 2015, the Company had no uncertain tax positions. The Company recognizes interest and penalties in tax expense and at June 30, 2015, the Company had recognized no interest and penalties.


NOTE 9 – 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 balance sheet.

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.

A summary of the Company’s commitments at June 30, 2015 and December 31, 2014 is as follows:
 
 
June 30,
 
December 31,
 
2015
 
2014
COMMITMENTS TO EXTEND CREDIT
 
 
 
REAL ESTATE LOANS
 
 
 
Construction and development
$
47,126

 
$
42,290

One-to-four-family (includes held for sale)
85,697

 
45,331

Home equity
15,440

 
13,735

Multi-family
1,379

 
474

Total real estate loans
149,642

 
101,830

CONSUMER LOANS
 

 
 

Other
5,821

 
5,832

Total consumer loans
5,821

 
5,832

COMMERCIAL BUSINESS LOANS
56,414

 
54,664

Total commitments to extend credit
$
211,877

 
$
162,326

 
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 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

 
 
27









 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 9 – COMMITMENTS AND CONTINGENCIES (Continued)

of $135,000 and $124,000 as of June 30, 2015 and December 31, 2014, respectively. 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 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 and the Chief Operating Officer. 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.

Because 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 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.
Contingent liabilities for loans held for sale - In the ordinary course of business, the Company sells loans without recourse that 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 payment defaults, breach of representation or warranty, servicing errors, and 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 $481,000 and $340,000 to cover loss exposure related to these guarantees for one-to-four-family loans sold into the secondary market at June 30, 2015 and December 31, 2014, respectively.

NOTE 10 – SIGNIFICANT CONCENTRATION OF CREDIT RISK
 
Most of the Company’s business activity is with customers located in the greater Puget Sound area, and since the fourth quarter of 2014, one loan production office located in the Tri-Cities, Washington. The Company originates real estate and consumer loans and has concentrations in these areas. Generally, loans are secured by deposit accounts, personal property, or real estate. 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.


NOTE 11 – 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 Company must meet specific capital adequacy guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's



 
 
28










 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 11 – REGULATORY CAPITAL (Continued)

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 and total capital (as defined) to risk-weighted assets (as defined).

As of June 30, 2015 and December 31, 2014, the Bank was categorized as "well capitalized" under the newly implemented Basel III revised capital adequacy standards and relevant provisions of the Wall Street Reform and Consumer Protection Act ("Dodd Frank Act"). 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. There are no conditions or events since that notification that management believes have changed the Bank’s category.

The Bank’s capital amounts and ratios at June 30, 2015 and December 31, 2014 are also presented in the table.
 
 
 
 
 
 
 
 
 
 
To be Well Capitalized
Under Prompt Corrective
Action Provisions
 
 
 
 
 
For Capital
Adequacy Purposes
 
 
Actual
 
 
Bank Only
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
As of June 30, 2015
 
 
 
 
 
 
 
 
 
 
 
Total risk-based capital
 
 
 
 
 
 
 
 
 
 
 
(to risk-weighted assets)
$
66,827

 
13.57
%
 
$
39,401

 
8.00
%
 
$
49,251

 
10.00
%
Tier 1 risk-based capital
 
 
 
 
 
 
 

 
 
 
 

(to risk-weighted assets)
$
60,655

 
12.32
%
 
$
29,551

 
6.00
%
 
$
39,401

 
8.00
%
Tier 1 leverage capital
 
 
 
 
 
 
 

 
 
 
 

(to average assets)
$
60,655

 
10.92
%
 
$
22,223

 
4.00
%
 
$
27,779

 
5.00
%
 Common equity tier 1 capital (1)
$
60,655

 
12.32
%
 
$
22,163

 
4.50
%
 
$
32,013

 
6.50
%
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
Total risk-based capital
 
 
 
 
 
 
 
 
 
 
 
(to risk-weighted assets)
$
60,978

 
14.68
%
 
$
33,223

 
8.00
%
 
$
41,529

 
10.00
%
Tier 1 risk-based capital
 

 
 

 
 

 
 

 
 

 
 

(to risk-weighted assets)
$
55,770

 
13.43
%
 
$
16,611

 
4.00
%
 
$
24,917

 
6.00
%
Tier 1 leverage capital
 

 
 

 
 

 
 

 
 

 
 

(to average assets)
$
55,770

 
11.17
%
 
$
19,965

 
4.00
%
 
$
24,956

 
5.00
%
 (1) The CET1 ratio is a new regulatory capital ratio which became effective in the quarter ended March 31, 2015.

Regulatory capital levels reported above at the Bank differ from the Company's total equity, computed in accordance with U.S. GAAP with $10.2 million of additional capital held at the holding company.






 
 
29










 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 11 – REGULATORY CAPITAL (Continued)
 
 
Company
 
Bank
 
June 30,
 
December 31,
 
June 30,
 
December 31,
 
2015
 
2014
 
2015
 
2014
Equity
$
70,855

 
$
65,836

 
$
60,631

 
$
55,887

Unrealized loss on securities available-for-sale
24

 
(117
)
 
24

 
(117
)
Total Tier 1 capital
70,879

 
65,719

 
60,655

 
55,770

Allowance for loan and lease losses for
 regulatory capital purposes
6,172

 
5,208

 
6,172

 
5,208

Total risk-based capital
$
77,051

 
$
70,927

 
$
66,827

 
$
60,978


The regulatory capital ratios calculated for the Company as of June 30, 2015 were 12.6% for Tier 1 leverage-based capital, 14.3% for Tier 1 risk-based capital, 15.6% for total risk-based capital, and 14.3% for CET1 capital ratio.


NOTE 12 – 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.
 
Accounting guidance regarding fair value measurements defines fair value and establishes a framework for measuring fair value in accordance with U.S. GAAP. Fair value is the exchange price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. 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.









 
 
30









 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 12 – FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

Determination of Fair Market Values:

Securities - Securities available-for-sale are recorded at fair value 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 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 valued using similar contracts in the market and changes in the market interest rates (Levels 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 (Level 3).
 
The following tables present securities available-for-sale measured at fair value on a recurring basis at June 30, 2015 and December 31, 2014:
 
Securities Available-for-Sale
 
Level 1
 
Level 2
 
Level 3
 
Total
 
As of June 30, 2015
 
 
 
 
 
 
 
Federal agency securities
$

 
$
5,922

 
$

 
$
5,922

Municipal bonds

 
17,131

 

 
17,131

Corporate securities

 
4,443

 

 
4,443

Mortgage-backed securities

 
19,859

 

 
19,859

Small Business Administration securities

 
3,059

 

 
3,059

Total
$

 
$
50,414

 
$

 
$
50,414













 
 
31









 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 12 – FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 
Securities Available-for-Sale
 
Level 1
 
Level 2
 
Level 3
 
Total
 
As of December 31, 2014
 
 
 
 
 
 
 
Federal agency securities
$

 
$
5,845

 
$

 
$
5,845

Municipal bonds

 
16,161

 

 
16,161

Corporate securities

 
4,437

 

 
4,437

Mortgage-backed securities

 
20,244

 

 
20,244

Small Business Administration securities

 
2,057

 

 
2,057

Total
$

 
$
48,744

 
$

 
$
48,744


The following table presents mortgage loans held for sale measured at fair value on a recurring basis at June 30, 2015 and December 31, 2014:
 
Mortgage Loans Held for Sale
 
Level 1
 
Level 2
 
Level 3
 
Total
June 30, 2015
$

 
$
41,039

 
$

 
$
41,039

December 31, 2014
$

 
$
25,983

 
$

 
$
25,983


The following tables present the fair value of interest rate lock commitments with customers, forward sale commitments with investors, and paired off commitments with investors measured at their fair value on a recurring basis at June 30, 2015 and December 31, 2014.
 
Interest Rate Lock Commitments with Customers
 
Level 1
 
Level 2
 
Level 3
 
Total
June 30, 2015
$

 
$

 
$
934

 
$
934

December 31, 2014
$

 
$

 
$
396

 
$
396


 
Forward Sale Commitments with Investors
 
Level 1
 
Level 2
 
Level 3
 
Total
June 30, 2015
$

 
$
292

 
$
110

 
$
402

December 31, 2014
$

 
$
(194
)
 
$
12

 
$
(182
)


 
Paired Off Commitments with Investors
 
Level 1
 
Level 2
 
Level 3
 
Total
June 30, 2015
$

 
$
331

 
$

 
$
331

December 31, 2014
$

 
$
(207
)
 
$

 
$
(207
)




 
 
32









 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 12 – FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

The following table presents the impaired loans measured at fair value on a nonrecurring basis at June 30, 2015 and December 31, 2014:
    
 
Impaired Loans
 
Level 1
 
Level 2
 
Level 3
 
Total
June 30, 2015
$

 
$

 
$
1,468

 
$
1,468

December 31, 2014
$

 
$

 
$
856

 
$
856

 
 
 
 
 
 
 
 
 
Quantitative Information about Level 3 Fair Value Measurements – The fair value of financial instruments measured under a Level 3 unobservable input on a recurring and nonrecurring basis at June 30, 2015 is shown in the following table:
Level 3 Fair Value Instrument
Valuation Technique
Significant Unobservable Inputs
Range
(Weighted Average)
Weighted Average Rate
 
 
 
 
 
RECURRING
 
 
 
 
Interest rate lock commitments with customers
Quoted market prices
Pull-through expectations
80% - 99.99%
87.76%
Forward sale commitments with investors
Quoted market prices
Pull-through expectations
80% - 99.99%
87.76%


The following tables provide a reconciliation of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three and six months ended June 30, 2015 and 2014:
Three Months Ended June 30,
 
Beginning Balance
 
Purchases and issuances
 
Sales and settlements
 
Ending Balance
 
Net change in fair value for gains/(losses) relating to items held at end of period
2015
 
 
 
 
 
 
 
 
 
 
Interest rate lock commitments with customers
 
$
1,026

 
$
2,816

 
$
(2,908
)
 
$
934

 
$
(92
)
Forward sale commitments with investors
 
(55
)
 
147

 
18

 
110

 
165

 
 
 
 
 
 
 
 
 
 
 
2014
 
 
 
 
 
 
 
 
 
 
Interest rate lock commitments with customers
 
$
360

 
$
1,885

 
$
(1,594
)
 
$
651

 
$
291

Forward sale commitments with investors
 
24

 
(155
)
 
70

 
(61
)
 
(85
)









 
 
33









 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 12 – FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

Six Months Ended June 30,
 
Beginning Balance
 
Purchases and issuances
 
Sales and settlements
 
Ending Balance
 
Net change in fair value for gains/(losses) relating to items held at end of period
2015
 
 
 
 
 
 
 
 
 
 
Interest rate lock commitments with customers
 
396

 
5,963

 
(5,425
)
 
934

 
538

Forward sale commitments with investors
 
12

 
87

 
11

 
110

 
98

 
 
 
 
 
 
 
 
 
 
 
2014
 
 
 
 
 
 
 
 
 
 
Interest rate lock commitments with customers
 
166

 
2,928

 
(2,443
)
 
651

 
485

Forward sale commitments with investors
 
45

 
(143
)
 
37

 
(61
)
 
(106
)

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 these financial statements: 

Cash, and Due from Banks and Interest-Bearing Deposits at Other Financial Institutions – The carrying amounts of cash and short-term instruments approximates their fair value (Level 1).

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

Accrued Interest – The carrying amounts of accrued interest approximates 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 cash flow 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 cash flow calculation on interest rates currently offered on similar certificates (Level 2).
 






 
 
34









 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 12 – FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

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 cash flow analyses based on the Bank’s current incremental borrowing rates for similar types of borrowing arrangements (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 (Levels 2 and 3).

The estimated fair values of the Company’s financial instruments at June 30, 2015 and December 31, 2014 were as follows:
 
June 30,
 
December 31,
 
2015
 
2014
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
Financial Assets
 
 
 
 
 
 
 
Level 1 inputs:
 
 
 
 
 
 
 
Cash, due from banks, and interest-bearing deposits at other
   financial institutions
$
13,802

 
$
13,802

 
$
20,098

 
$
20,098

Level 2 inputs:
 
 
 
 
 
 
 
Securities available-for-sale, at fair value
50,414

 
50,414

 
48,744

 
48,744

Loans held for sale, at fair value
41,039

 
41,039

 
25,983

 
25,983

FHLB stock, at cost
1,412

 
1,412

 
1,650

 
1,650

Accrued interest receivable
1,772

 
1,772

 
1,558

 
1,558

  Forward sale commitments with investors
292

 
292

 

 

  Paired off commitments with investors
331

 
331

 

 

Level 3 inputs:
 
 
 
 
 
 
 
Loans receivable, net
432,265

 
496,205

 
387,174

 
433,885

Servicing rights, held at lower of cost or fair value
4,569

 
5,733

 
3,061

 
3,549

  Fair value interest rate locks with customers
934

 
934

 
396

 
396

  Forward sale commitments with investors
110

 
110

 
12

 
12

Financial Liabilities
 
 
 
 
 

 
 

Level 2 inputs:
 
 
 
 
 
 
 
Deposits
470,508

 
481,806

 
420,444

 
424,672

Borrowings
20,269

 
20,279

 
17,034

 
17,031

  Accrued interest payable
22

 
22

 
24

 
24

  Forward sale commitments with investors

 

 
194

 
194

  Paired off commitments with investors

 

 
207

 
207

 







 
 
35









 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 13 - 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 who have been credited with at least 1,000 hours of service during a 12-month period are eligible to participate in the ESOP.  

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, 2014, the ESOP paid the third annual installment of principal in the amount of $245,000, plus accrued interest of $50,000 pursuant to the ESOP loan agreement. No payment of principal or interest was made during the six months ended June 30, 2015.

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 June 30, 2015 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 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 was $137,000 and $109,000 for the three months ended June 30, 2015 and 2014, respectively, and $259,000 and $219,000 for the six months ended June 30, 2015 and 2014, respectively.

Shares held by the ESOP as of June 30, 2015 were as follows:
 
Balances
Allocated shares
77,141

Committed to be released shares
12,960

Unallocated shares
168,487

Total ESOP shares
258,588

 
 
Fair value of unallocated shares (in thousands)
$
3,555


NOTE 14 - EARNINGS PER SHARE
Basic earnings per share are computed by dividing income available to common stockholders 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.



 
 
36









 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 


NOTE 14 - EARNINGS PER SHARE (Continued)
The following table presents a reconciliation of the components used to compute basic and diluted earnings per share for the three and six months ended June 30, 2015 and 2014:
 
At or For the Three Months Ended
 
At or For the Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Net income (in thousands)
$
2,794

 
$
986

 
$
4,864

 
$
1,861

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
2,962,302

 
3,002,515

 
2,952,223

 
3,024,116

 
 
 
 
 
 
 
 
Dilutive shares
41,677

 
2,233

 
33,104

 
1,123

Diluted weighted average common shares outstanding
3,003,979

 
3,004,748

 
2,985,327

 
3,025,239

Basic earnings per share
$
0.94

 
$
0.33

 
$
1.65

 
$
0.62

 
 
 
 
 
 
 
 
Diluted earnings per share
$
0.93

 
$
0.33

 
$
1.63

 
$
0.62

Potentially dilutive weighted average share options that were not included in the computation of diluted earnings per share because to do so would be anti-dilutive

 
23,572

 

 
11,852


The Company purchased 259,210 shares in the open market during the year ended December 31, 2012, for the ESOP. 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. There were 168,487 shares in the ESOP that were not committed to be released as of June 30, 2015.
NOTE 15 - 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 $191,000 and $373,000 for the three and six months ended June 30, 2015, respectively, and $110,000 for both the three and six months ended June 30, 2014.

Stock Options

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



 
 
37









 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 


NOTE 15 - STOCK-BASED COMPENSATION (Continued)

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. Given this limitation, management utilized a proxy to determine the expected volatility of FS Bancorp’s stock. The proxy chosen was the NASDAQ Bank Index, or NASDAQ Bank (NASDAQ symbol: BANK). 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.

A summary of the Company's stock option plan awards during the six months ended June 30, 2015 is as follows:
 
Shares
 
Weighted-Average Exercise Price
 
Weighted-Average Remaining Contractual Term In Years
 
Aggregate Intrinsic Value
Outstanding at January 1, 2015
322,000

 
$
16.89

 
9.36

 
$

Granted

 

 

 

Exercised
9,600

 
16.89

 

 
45,679

Forfeited or expired

 

 

 

Outstanding at June 30, 2015
312,400

 
$
16.89

 
8.86

 
$
1,736,944

 
 
 
 
 
 
 
 
Expected to vest, assuming a 0.31% annual forfeiture rate
310,521

 
$
16.89

 
8.86

 
$
1,726,496

 
 
 
 
 
 
 
 
Exercisable at June 30, 2015
54,800

 
$
16.89

 
8.86

 
$
304,688

As of June 30, 2015, there was $897,000 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 3.9 years.

Restricted Stock Awards

The Plan authorizes the grant of restricted stock awards totaling 129,605 shares to Company directors and employees, and all but 4,500 shares were granted on May 8, 2014. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at the grant date of $16.89 per share. 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 unexercised 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.




 
 
38









 
 
 
FS BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 


NOTE 15 - STOCK-BASED COMPENSATION (Continued)

A summary of the Company's nonvested awards during the six months ended June 30, 2015 is as follows:
Nonvested Shares
 
Shares
 
Weighted-Average Grant-Date Fair Value Per Share
 
Weighted-Average Grant-Date Fair Value
 
Nonvested at January 1, 2015
 
125,105

 
$
16.89

 
$
2,113,023

 
Granted
 

 

 

 
Vested
 
30,421

 
16.89

 
513,811

 
Forfeited or expired
 

 

 

 
Nonvested at June 30, 2015
 
94,684

 
$
16.89

 
$
1,599,212

 

As of June 30, 2015, there was $1.5 million 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 3.3 years.

 
 
39









 
 


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

Forward-Looking Statements

This report may contain forward-looking statements, which can be identified by the use of words such as “believes,” “expects,” “anticipates,” “estimates,” or similar expressions. Forward-looking statements include, but are not limited to:

statements of our goals, intentions, and expectations;
statements regarding our business plans, prospects, growth, and operating strategies;
statements regarding the quality of our loan and investment portfolios; and
estimates of our risks and future costs and benefits.
These forward-looking statements are 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 and write offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;
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;
increases in premiums for deposit insurance;
the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;
changes in the interest rate environment that reduce our interest margins or reduce the fair value of financial instruments;
increased competitive pressures among financial services companies;
our ability to execute our plans to grow our residential construction lending, our mortgage banking operations, our warehouse lending, and the geographic expansion of our indirect home improvement lending;
our ability to attract and retain deposits;
our ability to control operating costs and expenses;
changes in consumer spending, borrowing, and savings habits;
our ability to successfully manage our growth;
legislative or regulatory changes that adversely affect our business, or increase capital requirements, including the effect of the Dodd-Frank Wall Street Reform and Consumer Protection Act, changes in regulation policies and principles, or 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;
our ability to implement our branch expansion strategy;
inability of key third-party vendors to perform their obligations to us; and

40

 
 


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, 2014.
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, previously 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 opened one loan production office located in the Tri-Cities, Washington during the fourth quarter of 2014. The Company also maintains its long-standing indirect consumer lending platform which operates up and down 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 these 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 and improving 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; and
Expanding our reach by leveraging our well-established involvement in our communities and by selectively emphasizing products and services designed to meet our customers’ banking needs.

The Company is a diversified lender with a focus on the origination of indirect home improvement loans, also referred to as fixture secured loans, commercial real estate mortgage loans, home loans, commercial business loans, and second mortgage/home equity loan products. Consumer loans, in particular indirect home improvement loans to finance window replacement, gutter replacement, siding replacement, solar panels, and other improvement renovations, represent the largest portion of the loan portfolio and have traditionally been the mainstay of our lending strategy. As of June 30, 2015, consumer loans represented 34.0% of the Company's total portfolio, down from 34.7% at December 31, 2014, as real estate loan originations have increased at a faster pace than consumer loan originations during the six months ended June 30, 2015.

Indirect home improvement lending is dependent on the Bank’s relationships with home improvement contractors and dealers. The Company funded $19.8 million, or 1,199 loans during the quarter ended June 30, 2015, using its indirect home improvement contractor/dealer network located throughout Washington, Oregon, and California with four contractors/dealers responsible for 49.1% of the funded loans dollar volume. The Company began originating consumer indirect loans during the fourth quarter of 2012 in the State of California and since the program's inception has originated

41

 
 


$64.2 million. During the six months ended June 30, 2015, the Company originated $12.4 million of consumer loans in California, and as of June 30, 2015, the Company had $24.4 million of consumer indirect solar loans outstanding that were originated in California. Management has established a limit of no more than 20% of the total consumer loan portfolio for loans originated in California. As of June 30, 2015, the limit was $29.9 million.

The Company originates loans secured by first mortgages on one-to-four-family residences primarily in the market area served by the Company. The Company originates one-to-four-family residential mortgage loans through referrals from real estate agents, financial planners, builders, and from existing customers. Walk-in customers are also an important source of the Company’s loan originations. The Company originated $299.3 million of one-to-four-family mortgages during the first half of 2015, of which $257.7 million were sold to investors. Of the loans sold to investors, $170.7 million were sold to Fannie Mae, Freddie Mac, and/or Ginnie Mae with servicing rights retained for the purpose of developing these customer relationships. At June 30, 2015, one-to-four-family residential mortgage loans, excluding loans held for sale of $41.0 million, totaled $67.1 million, or 15.3%, of the gross loan portfolio.
The Company generally underwrites the one-to-four-family loans based on the applicant’s ability to repay. This includes employment and credit history and the appraised value of the subject property. The Company lends up to 100% of the lesser of the appraised value or purchase price for one-to-four-family first mortgage loans. For first mortgage loans with a loan-to-value ratio in excess of 80%, the Company generally requires either private mortgage insurance or government sponsored insurance in order to mitigate the higher risk level associated with higher loan-to-value loans. Fixed-rate loans secured by one-to-four-family residences have contractual maturities of up to 30 years and are generally fully amortizing, with payments due monthly. Adjustable-rate mortgage loans may pose different credit risks than fixed-rate loans, primarily because as interest rates rise the borrower’s payments rise, increasing the potential for default. Properties securing the one-to-four-family loans are appraised by independent fee appraisers who are selected in accordance with industry and regulatory standards. The Company requires borrowers to obtain title and hazard insurance, and flood insurance, if necessary. Loans are generally underwritten to the secondary market guidelines with additional requirements as determined by the internal underwriting department.
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, outside of mortgage banking activities, 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. 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 Loss. The allowance for loan losses is the amount estimated by management as necessary to cover probable losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on impacted loans; value of collateral; and determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible

42

 
 


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 it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. As the Company adds new products to the loan portfolio and expands the Company's market area, management intends to enhance and adapt our methodology to keep pace with the size and complexity of the loan portfolio. Changes in any of the above factors could have a significant effect on the calculation of the allowance for loan losses in any given period. Management believes that its systematic methodology continues to be appropriate given our size and level of complexity.

Derivative 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 MBS 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 in 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 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 the income and taxes in the jurisdiction in which it operates. This process involves estimating actual current tax exposure for the reported period together with assessing temporary differences resulting from differing treatment of items, such as depreciation and the provision for loan losses, for tax and financial reporting purposes.

Deferred tax assets are attributable to deductible temporary differences and carryforwards. After the deferred tax asset has been measured using the applicable enacted tax rate and provisions of the enacted tax law, it is then necessary to assess the need for a valuation allowance. A valuation allowance is needed when, based on the weight of the available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. Management determined there was no valuation allowance necessary at June 30, 2015 and December 31, 2014.

Comparison of Financial Condition at June 30, 2015 and December 31, 2014

Assets. Total assets increased $58.8 million, or 11.5%, to $568.6 million at June 30, 2015, from $509.8 million at December 31, 2014, primarily as a result of a $45.1 million, or 11.6% increase in net loans receivable, a $15.0 million, or 57.9% increase in loans held for sale, a $1.7 million, or 3.4% increase in securities available-for-sale, and a $1.5 million, or 49.3% increase in capitalized servicing rights, partially offset by a $6.3 million, or 31.3% decrease in cash and cash equivalents. The increase in assets was funded by increases in deposits and borrowings.
 
Loans receivable, net increased $45.1 million, or 11.6%, to $432.3 million at June 30, 2015, from $387.2 million at December 31, 2014. The increase in loans receivable, net was primarily a result of increases in total real estate loans of $35.3 million including increases in construction and development, one-to-four-family, and multi-family real estate loans, and consumer loans of $12.7 million, offset slightly by a reduction in commercial business loans of $2.3 million.

Loans held for sale, consisting of one-to-four-family loans, increased by $15.0 million, or 57.9%, to $41.0 million at June 30, 2015, from $26.0 million at December 31, 2014. The Company continues to expand its home lending operations by hiring additional lending staff and will continue selling one-to-four-family mortgage loans into the secondary market for asset/liability management purposes. During the quarter ended June 30, 2015, the Company sold $185.5 million

43

 
 


of one-to-four-family mortgage loans to investors, compared to sales of $65.2 million for the quarter ended June 30, 2014.

One-to-four-family originations of loans held for sale, including loans brokered to other institutions, increased 100.7% to $195.5 million during the three months ended June 30, 2015, compared to $72.2 million for the three months ended June 30, 2014. The increase in originations was as a result of key production staff hired in the third and fourth quarters of 2014 and continued favorable market interest rates.

The allowance for loan losses at June 30, 2015 was $6.9 million, or 1.6% of gross loans receivable, compared to $6.1 million, or 1.5% of gross loans receivable, at December 31, 2014. Substandard loans increased $1.7 million, or 74.5%, to $3.9 million at June 30, 2015, compared to $2.2 million at December 31, 2014, primarily due to one commercial real estate loan and two commercial business loans downgraded as a result of the financial performance of the borrowers. Non-performing loans, consisting of non-accruing loans, increased $595,000, or 137.4%, to $1.0 million at June 30, 2015, from $433,000 at December 31, 2014. At June 30, 2015, non-performing loans consisted of $544,000 of commercial loans, $197,000 of home equity loans, $194,000 of indirect home improvement loans, $55,000 of one-to-four-family loans, and $38,000 in solar loans. Non-performing loans to total gross loans increased to 0.2% at June 30, 2015, compared to 0.1% at December 31, 2014. The Company had no OREO at June 30, 2015 or at December 31, 2014. The Company had $737,000 and $783,000 in TDRs at June 30, 2015 and December 31, 2014, respectively, all of which were performing in accordance with their modified payment terms.
 
 
 
 
Liabilities. Total liabilities increased $53.8 million, or 12.1%, to $497.7 million at June 30, 2015, from $443.9 million at December 31, 2014. Deposits increased $50.1 million, or 11.9%, to $470.5 million at June 30, 2015, from $420.4 million at December 31, 2014. Relationship-based transactional accounts (noninterest-bearing checking, interest-bearing checking, and escrow accounts) increased $14.1 million, or 16.4%, to $100.4 million as of June 30, 2015, from $86.3 million at December 31, 2014. Money market and savings accounts increased $13.9 million, or 8.0%, to $188.1 million at June 30, 2015, from $174.2 million at December 31, 2014. Time deposits increased $21.9 million, or 13.7%, to $181.9 million at June 30, 2015, from $160.0 million at December 31, 2014. Non-retail deposits which include $30.5 million of brokered certificates of deposit, $21.0 million of online certificates of deposit, and $1.7 million of public funds, increased to $53.2 million as of June 30, 2015, compared to $36.4 million at December 31, 2014. The Company continues its focus on relationship deposit growth with new and existing customers as the primary source of funds for loan growth.

Total borrowings, which consisted of FHLB advances and funds in a FHLB cash management account ("CMA"), increased $3.3 million, or 19.0%, to $20.3 million at June 30, 2015, from $17.0 million at December 31, 2014. The increase in borrowings was primarily due to funding loan growth through similar duration borrowings to manage interest rate risk.

Stockholders' Equity. Total stockholders' equity increased $5.1 million, or 7.6%, to $70.9 million at June 30, 2015, from $65.8 million at December 31, 2014. The increase in stockholders' equity was primarily a result of net income of $4.9 million for the six months ended June 30, 2015. Book value per common diluted shares outstanding was $23.80 at June 30, 2015, compared to $22.48 at December 31, 2014.

Comparison of Results of Operations for the Three and Six Months Ended June 30, 2015 and 2014

General. Net income for the three months ended June 30, 2015, increased $1.8 million, or 183.4%, to $2.8 million, from $986,000 for the three months ended June 30, 2014. The increase in net income was primarily a result of a $2.8 million, or 114.9% increase in noninterest income, and a $1.9 million, or 32.9% increase in interest income, partially offset by a $1.5 million, or 27.1% increase in noninterest expense, a $1.0 million, or 204.0% increase in income tax expense and a $227,000, or 34.6% increase in interest expense.

Net income for the six months ended June 30, 2015, increased $3.0 million, or 161.4%, to $4.9 million, from $1.9 million for the six months ended June 30, 2014. The $3.0 million increase in net income was primarily attributable to a $4.8 million, or 107.4% increase in noninterest income, and a $3.5 million, or 30.8% increase in interest income, partially offset by a $3.0 million, or 27.2% increase in noninterest expense, a $1.6 million, or 176.0% increase in the provision for income tax, and a $433,000, or 34.2% increase in interest expense.

44

 
 



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 and six months ended June 30, 2015 and 2014:
Average Balances
For the Three Months Ended June 30,
 
 For the Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Assets
 
 
 
 
 
 
 
Loans receivable (1)
$
473,224

 
$
325,777

 
$
455,820

 
$
312,850

Securities available-for-sale, at fair value
46,668

 
68,359

 
45,839

 
66,771

Interest-bearing deposits at other financial institutions
17,371

 
15,810

 
16,970

 
25,903

Total interest-earning assets
537,263

 
409,946

 
518,629

 
405,524

Noninterest-earning assets
25,140

 
21,546

 
25,666

 
21,814

Total assets
$
562,403

 
$
431,492

 
$
544,295

 
$
427,338

 
 
 
 
 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
 
 
 
 
Interest-bearing deposits
$
388,377

 
$
296,856

 
$
379,100

 
$
295,162

Borrowings
33,886

 
21,021

 
29,548

 
18,796

Total interest-bearing liabilities
422,263

 
317,877

 
408,648

 
313,958

Noninterest-bearing deposits
63,972

 
47,380

 
61,580

 
47,067

Other noninterest-bearing liabilities
7,623

 
3,307

 
6,702

 
3,556

Stockholders' equity
68,545

 
62,928

 
67,365

 
62,757

Total liabilities and stockholders' equity
$
562,403

 
$
431,492

 
$
544,295

 
$
427,338

 (1) Includes loans held for sale
 
 
 
 
 
 
 

Net Interest Income. Net interest income increased $1.7 million, or 32.7%, to $6.9 million for the three months ended June 30, 2015, from $5.2 million for the three months ended June 30, 2014. The increase in net interest income was attributable to a $2.0 million, or 36.4% increase in loans receivable interest income primarily due to an increase in the average loans receivable balance, partially offset by a $227,000 or 34.6% increase in interest expense, primarily due to increases in the average balances of interest-bearing deposits and borrowings as compared to the same period last year, and a $75,000, or 21.1% decrease in interest and dividends on investment securities, and cash and cash equivalents.

Net interest income increased $3.1 million, or 30.4%, to $13.2 million for the six months ended June 30, 2015, from $10.1 million for the six months ended June 30, 2014. The increase in net interest income was primarily attributable to a $3.6 million, or 34.1% increase in loan receivable interest income, partially offset by a $433,000, or 34.2% increase in interest expense as a result of increases in the average balances of interest-bearing deposits and borrowings, and a $141,000, or 20.6% decrease in interest and dividends on investment securities, and cash and cash equivalents compared to the same period last year.

The net interest margin ("NIM") increased six basis points to 5.14% for the three months ended June 30, 2015, from 5.08% for the three months ended June 30, 2014, and increased 10 basis points to 5.12% for the six months ended June 30, 2015, from 5.02% for the same period of the prior year. The increase reflects the change in our asset mix, including increased consumer and construction loans held in our loan portfolio which historically carry higher note rates than investment securities and cash. Our strategy to increase lending through diversified lending channels may, however, pressure the NIM in future periods as real estate and business loans have a lower yield than consumer and construction loan products. As a percentage, consumer loans to total loans were 34.0% at June 30, 2015, compared to 38.7% at June 30, 2014. The average cost of funds increased one basis point to 0.73% for the three months ended June 30, 2015, from 0.72% for the three months ended June 30, 2014, and a two basis points increase in the cost of funds to 0.73% for the six months ended June 30, 2015, from 0.71% for the same period in the prior year as a result of growth in interest-bearing deposits. 

45

 
 



Interest Income. Interest income for the three months ended June 30, 2015, increased $2.0 million, or 32.9%, to $7.8 million from $5.8 million for the three months ended June 30, 2014. The increase during the period was primarily attributable to the increase in the average balance of the loan portfolio to $473.2 million for the three months ended June 30, 2015, compared to $325.8 million for the three months ended June 30, 2014. The average yield on interest-earning assets increased eight basis points to 5.80% for the three months ended June 30, 2015, compared to 5.72% for the three months ended June 30, 2014.

Interest income for the six months ended June 30, 2015, increased $3.5 million, or 30.8%, to $14.9 million, from $11.4
million for the six months ended June 30, 2014. The increase during the period was primarily attributable to the increase in the average balance of the loan portfolio to $455.8 million for the six months ended June 30, 2015, compared to $312.9 million for the six months ended June 30, 2014. The average yield on interest-earning assets increased 13 basis points to 5.78% for the six months ended June 30, 2015, compared to 5.65% for the six months ended June 30, 2014.

Interest Expense. Interest expense increased $227,000, or 34.6%, to $884,000 for the three months ended June 30, 2015, from $657,000 for the same period of the prior year. The increase during the period was primarily attributable to the $104.4 million, or 32.8% increase in the average balance of total interest-bearing liabilities to $422.3 million for the quarter ended June 30, 2015, from $317.9 million for the quarter ended June 30, 2014. The average cost of funds increased one basis point to 0.73% for the three months ended June 30, 2015, compared to 0.72% for the three months ended June 30, 2014. The increase was primarily due to growth in interest-bearing deposits.

Interest expense increased $433,000, or 34.2%, to $1.7 million for the six months ended June 30, 2015, from $1.3 million for the same period of the prior year. As a result of the increase in interest-bearing deposits, the average cost of funds for total interest-bearing liabilities increased two basis points to 0.73% for the six months ended June 30, 2015, compared to 0.71% for the six months ended June 30, 2014.

Provision for Loan Losses.  The provision for loan losses was $600,000 for the three months ended June 30, 2015, compared to $450,000 for the three months ended June 30, 2014. The $150,000 increase in the provision during the current quarter over the comparable quarter last year is due to the significant increases in real estate loans, specifically, one-to-four-family, construction and development, and multi-family loans, as well as an increase in consumer loans compared to the same quarter one year ago. During the three months ended June 30, 2015, net charge-offs totaled $78,000, compared to $145,000 during the same period last year.

The provision for loan losses was $1.2 million for the six months ended June 30, 2015, compared to $900,000 for the six months ended June 30, 2014. The $300,000 increase in the provision during the current six months over the comparable period last year is due to the significant increases in real estate loans, primarily in one-to-four-family, construction and development, and multi-family, as well as in consumer loans. Substandard loans increased $2.9 million, or 317.1%, to $3.9 million at June 30, 2015, compared to $923,000 at June 30, 2014. The increase from one year ago was primarily associated with the downgrade of one commercial real estate loan and two commercial business loans as a result of the financial performance by the borrowers. During the six months ended June 30, 2015, net charge-offs totaled $363,000, compared to $444,000 during the same period last year.

Noninterest Income. Noninterest income increased $2.8 million, or 114.9%, to $5.3 million for the three months ended June 30, 2015, from $2.5 million for the three months ended June 30, 2014. The increase during the period was primarily due to an increase of $2.8 million in gain on sale of loans to investors. One-to-four-family originations of loans held for sale, including loans brokered to other institutions, increased 170.8% to $195.5 million during the quarter ended June 30, 2015, compared to $72.2 million for the same quarter one year ago. The increase in originations was attributed to continued low rates during the first half of 2015 and new loan production employees hired in the second half of 2014. Purchase production increased by $88.3 million, or 134.6% with $153.9 million in closed purchase loans for the three months ended June 30, 2015, up from $65.6 million for the three months ended June 30, 2014. Refinances increased by $25.5 million, or 160.4%, to $41.4 million for the three months ended June 30, 2015, from $15.9 million for the same period last year. The percentage of one-to-four-family mortgage loan originations for home purchases was 78.8% of second quarter volume versus 21.2% of second quarter volume for refinance activity. This compares to 52.7% of first quarter volume to purchase a home versus 47.3% to refinance their home in the first quarter of 2015.


46

 
 


Noninterest income increased $4.8 million, or 107.4%, to $9.3 million for the six months ended June 30, 2015, from $4.5 million for the six months ended June 30, 2014. The increase during the period was primarily due to an increase of $4.6 million in gain on sale of loans to investors, as well as an $80,000 increase in service charges and fee income, and a $66,000 increase in gain on sale of investment securities.
 
Noninterest Expense. Noninterest expense increased $1.6 million, or 27.1% to $7.3 million for the three months ended June 30, 2015, from $5.7 million for the three months ended June 30, 2014. Changes in noninterest expense included a $976,000, or 30.1% increase in salaries and benefits, including commissions and incentives for loan production staff, as well as compensation associated with the equity incentive plan, a $202,000, or 21.8% increase in operations associated with the continued growth in the lending and deposit franchise, a $125,000, or 41.9% increase in professional and board fees due to costs associated with the equity incentive plan for the Board of Directors, and a $93,000, or 31.0% increase in data processing, and a $53,000, or 13.2% increase in occupancy expense as compared to the same quarter last year.

Noninterest expense increased $3.0 million, or 27.2% to $13.9 million for the six months ended June 30, 2015, from $10.9 million for the six months ended June 30, 2014. Changes in noninterest expense included a $1.8 million, or 28.3% increase in salaries and benefits, including commissions and incentives for loan production staff, as well as compensation associated with the equity incentive plan, a $619,000, or 42.1% increase in operations associated with the continued growth in the lending and deposit franchise, a $188,000, or 31.2% increase in professional and board fees due to costs associated with the equity incentive plan for the Board of Directors, a $163,000, or 27.7% increase in data processing expense, and a $90,000, or 11.2% increase in occupancy expense as compared to the same period last year.

The efficiency ratio, which is noninterest expense as a percentage of net interest income and noninterest income, improved to 59.7% for the three months ended June 30, 2015, compared to 74.7% for the three months ended June 30, 2014, and improved to 61.6% for the six months ended June 30, 2015, compared to 74.7% for the six months ended June 30, 2014, primarily as a result of a greater increase in noninterest income, compared to smaller increases in noninterest expense and net interest income for both periods.

Provision for Income Tax. For the six months ended June 30, 2015, the Company recorded a provision for income tax expense of $2.6 million on pre-tax income as compared to $931,000 for the six months ended June 30, 2014. The effective tax rate for the six month period ended June 30, 2015 and 2014 was 33.5% and 33.2%, respectively. 

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 its 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.

As of June 30, 2015, the Bank's total borrowing capacity was $108.9 million with the FHLB of Des Moines, with unused borrowing capacity of $88.7 million. The FHLB borrowing limit is based on certain categories of loans, primarily real estate loans that qualify as collateral for FHLB advances. As of June 30, 2015, the Bank held approximately $162.3 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 $74.9 million, and a combined credit limit of $40.0 million in written Fed Funds lines of credit through correspondent banking relationships as of June 30, 2015. 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. As of June 30, 2015, the Bank held approximately $142.7 million in loans that qualify as collateral for the Federal Reserve Bank line of credit.

As of June 30, 2015, $20.3 million in FHLB advances and CMA's were outstanding, and no advances were outstanding against the Federal Reserve Bank line of credit, and Fed Funds lines of credit. The Bank's Asset Liability Management Policy permits management to utilize brokered deposits up to 20% of deposits or $95.6 million as of June 30, 2015. Total brokered deposits as of June 30, 2015 were $30.5 million.


47

 
 


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 and Fed Funds. On a longer-term basis, a strategy is maintained of investing in various lending products and investment securities, including U.S. Government obligations and federal agency securities. The Company uses sources of funds primarily to meet ongoing commitments, pay maturing deposits and fund withdrawals, and to fund loan commitments. At June 30, 2015, the approved outstanding loan commitments, including unused lines of credit amounted to $211.9 million. Certificates of deposit scheduled to mature in three months or less at June 30, 2015, totaled $11.3 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 deposits will remain with the Bank. For additional information see the Consolidated Statements of Cash Flows in Part I. Item 1 of this report.

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 9 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 June 30, 2015, 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 June 30, 2015, the Bank was considered to be "well capitalized". At June 30, 2015, the Bank exceeded all regulatory capital requirements with Tier 1 leverage-based capital, Tier 1 risk-based capital, total risk-based capital, and CET1 capital ratios of 10.9%, 12.3%, 13.6%, and 12.3%, respectively. For additional information regarding the Bank's regulatory capital compliance, see the discussion included in Note 11 to the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report.

For a bank holding company with less than $1 billion in consolidated assets, such as FS Bancorp, Inc., the capital guidelines apply on a bank only basis and the Federal Reserve requires the holding company's subsidiary banks to be well capitalized under the prompt corrective action regulations. If FS Bancorp, Inc. was subject to regulatory guidelines for bank holding companies with $1 billion or more in assets, at June 30, 2015, FS Bancorp, Inc. would have exceeded all regulatory capital requirements.

Item 3. Quantitative and Qualitative Disclosure About Market Risk

Not required for smaller reporting companies.

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 (the "Act")) as of June 30, 2015 was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management. The Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures in effect as of June 30, 2015 were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is: (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.

(b)    Changes in Internal Controls.

There have been no changes in the Company's internal control over financial reporting (as defined in Rule 13a-15(f) of the Act) that occurred during the three months ended June 30, 2015, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

48

 
 



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 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; 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.


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, 2014.


Item 2.        Unregistered Sales of Equity Securities and Use of Proceeds
(a)     Not applicable

(b)     Not applicable

The following table summarizes common stock repurchases during the three months ended June 30, 2015:
Period
 
Total Number of Shares Purchased
 
Average Price Paid per Share
 
Total Number of Shares Repurchased as Part of Publicly Announced Plan
 
Maximum Number of Shares that May Yet Be Repurchased Under the Plan
April 1, 2015 - April 30, 2015
 

 
$

 

 

May 1, 2015 - May 31, 2015(1)
 
4,605

 
21.98

 

 

June 1, 2015 - June 30, 2015
 

 

 

 

Total
 
4,605

 
$
21.98

 

 

(1) Represents stock retained for Federal tax withheld on vested restricted stock.
 
Item 3.         Defaults Upon Senior Securities

Not applicable.


49

 
 


Item 4.        Mine Safety Disclosures

Not applicable.

Item 5.        Other Information

Not applicable.

Item 6.        Exhibits

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

3.2    Bylaws of FS Bancorp, Inc. (1)

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") (2)

10.4    Form of Incentive Stock Option Agreement under the 2013 Plan (2)

10.5    Form of Non-Qualified Stock Option Agreement under the 2013 Plan (2)

10.6    Form of Restricted Stock Agreement under the 2013 Plan (2)

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 June 30, 2015, 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 Registration Statement on Form S-8 (333-192990) filed on December 20, 2013, and incorporated by reference.

(*)
Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.




50

 
 


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: August 7, 2015
By:
/s/Joseph C. Adams
 
 
Joseph C. Adams,
 
 
Chief Executive Officer
 
 
(Duly Authorized Officer)
 
 
 
Date: August 7, 2015
By:
/s/Matthew D. Mullet
 
 
Matthew D. Mullet
 
 
Secretary, Treasurer and
 
 
Chief Financial Officer
 
 
(Principal Financial and Accounting Officer)




51



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 June 30, 2015, 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. *


*Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.