FS BANCORP, INC. This discussion and analysis reviews our consolidated financial statements and other relevant statistical data and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the Consolidated Financial Statements and footnotes thereto that appear in Item 8. of this Form 10-K. The information contained in this section should be read in conjunction with these Consolidated Financial Statements and footnotes and the business and financial information provided in this Form 10-K. Overview
FS Bancorp and its subsidiary bank, 1stSecurity Bank have been serving thePuget Sound area since 1936. Originally chartered as a credit union, known asWashington's Credit Union , the credit union served various select employment groups. OnApril 1, 2004 , the credit union converted to aWashington state -chartered mutual savings bank. OnJuly 9, 2012 , the Bank converted from mutual to stock ownership and became the wholly owned subsidiary ofFS Bancorp . The Company is relationship-driven, delivering banking and financial services to local families, local and regional businesses and industry niches within distinctWestern Washington communities, predominately, thePuget Sound area, one loan production office located in the Tri-Cities, and our newest loan production office located inVancouver, Washington . OnFebruary 24, 2023 , the Company completed its previously announcedColumbia Branch Purchase of seven retail bank branches fromColumbia State Bank and acquired approximately$425.5 million in deposits and$65.8 million in loans based onFebruary 24, 2023 financial information (subject to a post-closing confirmation and adjustment review). The seven acquired branches are located in the communities ofWhite Salmon andGoldendale, Washington , andNewport ,Waldport ,Ontario ,Manzanita , andTillamook, Oregon . The Columbia Branch Purchase serves to expand ourPuget Sound -focused retail footprint into southeastWashington and the state ofOregon as well as providing an opportunity to extend our unique brand of community banking into those communities. The Company also maintains its long-standing indirect consumer lending platform which operates primarily throughout theWest Coast , expanding our partnership with companies present in other states as well. The Company emphasizes long-term relationships with families and businesses within the communities served, working with them to meet their financial needs. The Company is also actively involved in community activities and events within these market areas, which further strengthens our relationships within those markets. The Company focuses on diversifying revenues, expanding lending channels, and growing the banking franchise. Management remains focused on building diversified revenue streams based upon credit, interest rate, and concentration risks. Our business plan remains as follows:
? Growing and diversifying our loan portfolio;
? Maintaining strong asset quality;
? Emphasizing lower cost core deposits to reduce the costs of funding our loan
growth;
Capturing our customers' full relationship by offering a wide range of products
? and services by leveraging our well-established involvement in our communities
and by selectively emphasizing products and services designed to meet our
customers' banking needs; and
? Expanding the Company's markets.
The Company is a diversified lender with a focus on the origination of
one-to-four-family loans, commercial real estate mortgage loans, second mortgage
or home equity loan products, consumer loans, including indirect home
improvement ("fixture secured") loans which also include solar-related home
improvement loans, marine lending, and commercial business loans. As part of
our expanding lending products, the Company experienced growth in residential
mortgage and commercial construction warehouse lending consistent with our
business plan to further diversify revenues. Historically, consumer loans, in
particular, fixture secured loans had represented the largest portion of the
Company's loan portfolio
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and had traditionally been the mainstay of the Company's lending strategy. AtDecember 31, 2022 , consumer loans represented 25.6% of the Company's total gross loan portfolio, up from 24.1% atDecember 31, 2021 . In recent years, the Company has placed more of an emphasis on real estate lending products, such as one-to-four-family loans, commercial real estate loans, including speculative residential construction loans, as well as commercial business loans, while growing the current size of the consumer loan portfolio. Fixture secured loans to finance window, gutter, siding replacement, solar panels, spas, and other improvement renovations are a large and regionally expanding segment of the consumer loan portfolio. These fixture secured consumer loans are dependent on the Bank's contractor/dealer network of 119 active dealers located throughoutWashington ,Oregon ,California ,Idaho ,Colorado ,Nevada ,Arizona ,Minnesota , and recentlyTexas ,Utah ,Massachusetts , andMontana with five contractor/dealers responsible for 53.0% of the funded loans dollar volume for the year endedDecember 31, 2022 . The Company funded$315.0 million , or approximately 13,000 loans during the year endedDecember 31, 2022 . The following table details fixture secured loan originations by state for the periods indicated: (Dollars in thousands) For the Year Ended For the Year Ended December 31, 2022 December 31, 2021 State Amount Percent Amount Percent Washington$ 102,981 32.7 %$ 92,125 40.6 % Oregon 73,110 23.2 48,315 21.3 California 59,175 18.8 46,492 20.5 Idaho 22,744 7.2 19,790 8.7 Colorado 14,584 4.6 7,956 3.5 Arizona 5,029 1.6 4,294 1.9 Nevada 4,869 1.5 3,664 1.6 Minnesota 28,503 9.1 4,418 1.9 Texas 572 0.2 - - Utah 2,674 0.9 - - Massachusetts 137 - - - Montana 577 0.2 - -
Total fixture secured loans
The Company originates one-to-four-family residential mortgage loans through referrals from real estate agents, financial planners, builders, and from existing customers. Retail banking customers are also an important source of the Company's loan originations. The Company originated$828.8 million of one-to-four-family loans which includes loans held for sale, loans held for investment, and fixed seconds in addition to loans brokered to other institutions of$13.5 million through the home lending segment during the year endedDecember 31, 2022 , of which$715.6 million were sold to investors. Of the loans sold to investors,$477.5 million were sold to theFNMA , FHLMC, FHLB, and/or GNMA with servicing rights retained for the purpose of further developing these customer relationships. AtDecember 31, 2022 , one-to-four-family residential mortgage loans held for investment, which excludes loans held for sale of$20.1 million , totaled$469.5 million , or 21.2%, of the total gross loan portfolio. For the year endedDecember 31, 2022 , one-to-four-family loan originations and refinancing activity decreased as a result of increased market interest rates, compared to the same period in the prior year when home refinancing surged due to the lowering of market interest rates in response to COVID-19. Residential construction and development lending, while not as common as other loan origination options like one-to-four-family loans, will continue to be an important element in our total loan portfolio, and we will continue to take a disciplined approach by concentrating our efforts on loans to builders and developers in our market areas known to us. These short-term loans typically mature in six to 18 months. In addition, the funding is usually not fully disbursed at origination, thereby reducing our net loans receivable in the short-term. The Company is significantly affected by prevailing economic conditions, as well as government policies and regulations concerning, among other things, monetary and fiscal affairs. Deposit flows are influenced by a number of factors, including interest rates paid on time deposits, other investments, account maturities, and the overall level of personal income and savings. Lending activities are influenced by the demand for funds, the number and quality of lenders, and regional 58 Table of Contents
economic cycles. Sources of funds for lending activities include primarily deposits, including brokered deposits, borrowings, payments on loans, and income provided from operations.
The Company's earnings are primarily dependent upon net interest income, the difference between interest income and interest expense. Interest income is a function of the balances of loans and investments outstanding during a given period and the yield earned on these loans and investments. Interest expense is a function of the amount of deposits and borrowings outstanding during the same period, and the interest rates paid on these deposits and borrowings. The Company's earnings are also significantly affected by fee income from mortgage banking activities, the provision for credit losses on loans, service charges and fees, gains from sales of assets, operating expenses and income taxes. The Company recorded a provision for credit losses on loans of$6.6 million for the year endedDecember 31, 2022 , compared to$500,000 for the same period one year ago, primarily due to loan growth.
Critical Accounting Estimates
We prepare our consolidated financial statements in accordance with GAAP. In doing so, we have to make estimates and assumptions. Our critical accounting estimates are those estimates that involve a significant level of uncertainty at the time the estimate was made, and changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used in the current period, would have a material impact on our financial condition or results of operations. Accordingly, actual results could differ materially from our estimates. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We have reviewed our critical accounting estimates with the audit committee of our Board of Directors.
See Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for a summary of significant accounting policies and the effect on our financial statements.
Allowance for Credit Losses on Loans ("ACLL"). The ACLL is the amount estimated
by management as necessary to cover expected losses in the loan portfolio at the
balance sheet date. The ACLL is established through the provision for credit
losses on loans, which is charged to income. A high degree of judgment is
necessary when determining the amount of the ACLL. Among the material estimates
required to establish the ACLL are: probability of default; loss exposure at
default; the amount and timing of future cash flows on impacted loans; value of
collateral; and determination of loss factors to be applied to the various
elements of the portfolio. All of these estimates are susceptible to significant
change. Management reviews the level of the ACLL at least quarterly and
establishes the provision for credit losses on loans based upon an evaluation of
the portfolio, past loss experience, current economic conditions, reasonable and
supportable forecasts, and other factors related to the collectability of the
loan portfolio. Although the Company believes that use of the best information
available currently establishes the ACLL, future adjustments to the ACLL may be
necessary if economic conditions differ substantially from the assumptions used
in making the evaluation. As the Company adds new products to the loan portfolio
and expands the Company's market area, management intends to enhance and adapt
the methodology to keep pace with the size and complexity of the loan portfolio.
Changes in any of the above factors could have a significant effect on the
calculation of the ACLL in any given period.
Because current economic conditions and forecasts can change and future events
make it inherently difficult to predict the anticipated amount of estimated
credit losses on loans, management's determination of the appropriateness of the
ACL, could change significantly. It is difficult to estimate how potential
changes in any one economic factor or input might affect the overall allowance
because a wide variety of factors and inputs are considered in estimating the
allowance and changes in those factors and inputs considered may not occur at
the same rate and may not be consistent across all product types. Additionally,
changes in factors and inputs may move independently of one another, such that
improvement in one or certain factors may offset deterioration in others.
Management believes that its systematic methodology continues to be appropriate.
In June 2016 , the Financial Accounting Standards Board issued ASU No.
2016-13, Measurement of Credit Losses on Financial Instruments, referred to as
the CECL model, which was early adopted by the Company and effective January 1,
2022 . For additional information on CECL see "Note 1 - Basis of Presentation and
Summary of Significant Accounting
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Policies - Application of New Accounting Guidance Adopted in 2022" of the Notes to the Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K.
Servicing Rights. Servicing assets are recognized as separate assets when rights
are acquired through the purchase or through the sale of financial assets.
Generally, purchased servicing rights are capitalized at the cost to acquire the
rights. For sales of mortgage loans, the value of servicing is capitalized
during the month of sale. Fair value is based on market prices for comparable
mortgage contracts, when available, or alternatively, is based on a valuation
model that calculates the present value of estimated future net servicing
income. The valuation model incorporates assumptions that market participants
would use in estimating future net servicing income, such as the cost to
service, the discount rate, the custodial earnings rate, an inflation rate,
ancillary income, prepayment speeds, and default rates and losses. The
valuation of servicing rights is based on various assumptions which are set
forth in 'Note 4 - Servicing Rights" of the Notes to the Consolidated Financial
Statements included in "Item 8. Financial Statements and Supplementary Data" of
this Form 10-K. It also provides sensitivity analysis based on the assumptions
used. The sensitivity analyses are hypothetical and have been provided to
indicate the potential impact that changes in assumptions may have on the
estimate of the fair value of the servicing rights.
Servicing assets are evaluated quarterly for impairment based upon the fair
value of the rights as compared to amortized cost. Impairment is determined by
stratifying rights into tranches based on predominant characteristics, such as
interest rate, loan type, and investor type. Impairment is recognized through a
valuation allowance for an individual tranche, to the extent that fair value is
less than the capitalized amount for the tranches. If the Company later
determines that all or a portion of the impairment no longer exists for a
particular tranche, a reduction of the allowance may be recorded as a recovery
and an increase to income. Capitalized servicing rights are stated separately on
the Consolidated Balance Sheets and are amortized into noninterest income in
proportion to, and over the period of, the estimated future net servicing income
of the underlying financial assets.
Derivative and Hedging Activity. Accounting Standards Codification ("ASC") 815,
"Derivatives and Hedging," requires that derivatives of the Company be recorded
in the consolidated financial statements at fair value. Management considers its
accounting policy for derivatives to be a critical accounting policy because
these instruments have certain interest rate risk characteristics that change in
value based upon changes in the capital markets. Fair values for derivative
assets and liabilities are measured on a recurring basis. The Company's primary
use of derivative instruments is related to the mortgage banking activities in
the form of commitments to extend credit, commitments to sell loans,
To-Be-Announced ("TBA") mortgage-backed securities trades and option contracts
to mitigate the risk of the commitments to extend credit. Estimates of the
percentage of commitments to extend credit on loans to be held for sale that may
not fund are based upon historical data and current market trends. The fair
value adjustments of the derivatives are recorded on the Consolidated Statements
of Income with offsets to other assets or other liabilities on the Consolidated
Balance Sheets.
Derivative instruments not related to mortgage banking activities primarily
relate to interest rate swap agreements accounted for as cash flow hedges and
fair value hedges. To qualify for hedge accounting, derivatives must be highly
effective at reducing the risk associated with the exposure being hedged and
must be designated as a hedge at the inception of the derivative contract. If
derivative instruments are designated as fair value hedges, and such hedges are
highly effective, both the change in the fair value of the hedge and the hedged
item are included in current earnings. If derivative instruments are designated
as cash flow hedges, fair value adjustments related to the effective portion are
recorded in other comprehensive income and are reclassified to earnings when the
hedged transaction is reflected in earnings. If derivative instruments are
designated as cash flow hedges, fair value adjustments related to the effective
portion are recorded in other comprehensive income and are reclassified to
earnings when the hedged transaction is reflected in earnings. Ineffective
portions of cash flow hedges are reflected in earnings as they occur. Actual
cash receipts and/or payments and related accruals on derivatives related to
hedges are recorded as adjustments to the interest income or interest expense
associated with the hedged item. During the life of the hedge, the Company
formally assesses whether derivatives designated as hedging instruments continue
to be highly effective in offsetting changes in the fair value or cash flows of
hedged items. If it is determined that a hedge has ceased to be highly
effective, the Company will discontinue hedge accounting prospectively. At such
time, previous adjustments to the carrying value of the hedged item are reversed
into current earnings and the derivative instrument is reclassified to a trading
position recorded at fair value. For derivatives not designated as hedges,
changes in fair value are recognized in earnings, in noninterest income.
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Fair Value. ASC 820, "Fair Value Measurements and Disclosures," establishes a hierarchical disclosure framework associated with the level of pricing observability utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no pricing observability and a higher degree of judgment utilized in measuring fair value. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction. The objective of a fair value measurement is to estimate the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants at the measurement date under current market conditions (that is, an exit price at the measurement date from the perspective of a market participant that holds the asset or owes the liability). For additional details, see "Note 15 - Fair Value Measurement" of the Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K. Income Taxes. Income taxes are reflected in the Company's consolidated financial statements to show the tax effects of the operations and transactions reported in the consolidated financial statements and consist of taxes currently payable plus deferred taxes. ASC 740, "Accounting for Income Taxes," requires the asset and liability approach for financial accounting and reporting for deferred income taxes. Deferred tax assets and liabilities result from temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. They are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled and are determined using the assets and liability method of accounting. The deferred income tax provision represents the difference between net deferred tax asset/liability at the beginning and end of the reported period. In formulating the deferred tax asset, the Company is required to estimate income and taxes in the jurisdiction in which the Company operates. This process involves estimating the actual current tax exposure for the reported period together with assessing temporary differences resulting from differing treatment of items, such as depreciation and the provision for credit losses, for tax and financial reporting purposes. Deferred tax assets and liabilities occur when taxable income is larger or smaller than reported income on the income statements due to accounting valuation methods that differ from tax, as well as tax rate estimates and payments made quarterly and adjusted to actual at the end of the year. Deferred tax assets and liabilities are temporary differences deductible or payable in future periods. The Company had net deferred tax assets of$6.7 million and net deferred tax liabilities of$1.2 million atDecember 31, 2022 and 2021, respectively.Goodwill and Other Intangibles. The Company records all assets and liabilities acquired in purchase acquisitions, including goodwill and other intangibles, at fair value.Goodwill and indefinite-lived assets are not amortized but are subject, at a minimum, to annual tests for impairment. In certain situations, interim impairment tests may be required if events occur or circumstances change that would more likely than not reduce the fair value of a reporting segment below its carrying amount. Other intangible assets are amortized over their estimated useful lives using straight-line and accelerated methods and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount. The initial recognition of goodwill and other intangible assets and subsequent impairment analysis require management to make subjective judgments concerning estimates of how the acquired assets will perform in the future using valuation methods including discounted cash flow analysis. Additionally, estimated cash flows may extend beyond 10 years and, by their nature, are difficult to determine over an extended timeframe. Events and factors that may significantly affect the estimates include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures, technology, changes in discount rates and specific industry and market conditions. In determining the reasonableness of cash flow estimates, the Company reviews historical performance of the underlying assets or similar assets in an effort to assess and validate assumptions utilized in its estimates. The Company's annual assessment of potential goodwill impairment was completed during the fourth quarter of 2022. Based on the results of this assessment, no goodwill impairment was recognized. Because of current economic conditions the Company continues to monitor goodwill and other intangible assets for impairment indicators throughout the year. 61
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On an on-going basis, the Company evaluates its estimates. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company's policies related to these estimates can be found in "Note 1 - Basis of Presentation and Summary of Significant Accounting Policies" of the Notes to the Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K. The Company's accounting policies are discussed in detail in "Note 1 - Basis of Presentation and Summary" of the Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K.
Our Business and Operating Strategy and Goals
The Company's primary objective is to operate 1stSecurity Bank as a well-capitalized, profitable, independent, community-oriented financial institution, serving customers in its primary market area defined generally as the greaterPuget Sound market area. The Company's strategy is to provide innovative products and superior customer service to small businesses, industry and geographic niches, and individuals located in its primary market area.
Services are currently provided to communities through the main office, 20 full-service bank branches and seven stand-alone loan production offices, and are supported with 24/7 access to on-line banking and participation in a worldwide ATM network.
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. The Board of Directors seeks to accomplish the Company's objectives through the adoption of a strategy designed to improve profitability and maintain a strong capital position and high asset quality. This strategy primarily involves: Growing and diversifying the loan portfolio and revenue streams. The Company is transitioning lending activities from a predominantly consumer-driven model to a more diversified consumer and business model by emphasizing three key lending initiatives: expansion of commercial business lending programs, increasing in-house originations of residential mortgage loans primarily for sale into the secondary market through the mortgage banking program; and commercial real estate lending. Additionally, the Company seeks to diversify the loan portfolio by increasing lending to small businesses in the market area, as well as residential construction lending. Maintaining strong asset quality. The Company believes that strong asset quality is a key to long-term financial success. The percentage of nonperforming loans to total gross loans were 0.39% and 0.33% atDecember 31, 2022 and 2021, respectively. The percentage of nonperforming assets to total assets were 0.35% and 0.25% atDecember 31, 2022 and 2021, respectively. The Company has actively managed the delinquent loans and nonperforming assets by aggressively pursuing the collection of consumer debts and marketing saleable properties upon which were foreclosed or repossessed, work-outs of classified assets and loan charge-offs. In the past several years, the Company also began emphasizing consumer loan originations to borrowers with higher credit scores, generally, credit scores over 720 (although the policy allows us to go lower). Although the Company plans to place more emphasis on certain lending products, such as commercial and multi-family real estate loans, construction and development loans, including speculative residential construction loans, and commercial business loans, while growing the current size of the one-to-four-family residential mortgage loans and the consumer loan portfolios, the Company continues to manage its credit exposures through the use of experienced bankers and an overall conservative approach to lending. Emphasizing lower cost core deposits to reduce the costs of funding loan growth. The Company offers personal and business checking accounts, NOW accounts and savings and money market accounts, which generally are lower-cost sources of funds than certificates of deposit, and are less sensitive to withdrawal when interest rates fluctuate. In order to build a core deposit base, the Company is pursuing a number of strategies. First, a diligent attempt to recruit all commercial loan customers to maintain a deposit relationship with the Company, generally a business checking account relationship to the extent practicable, for the term of their loan. Second, interest rate promotions are provided on savings and checking accounts from time to time to encourage the growth of these types of deposits. Third, by hiring experienced personnel with relationships in the communities we serve. 62 Table of Contents
Capturing customers' full relationship. The Company offers a wide range of products and services that provide diversification of revenue sources and solidify the relationship with the Bank's customers. The Company focuses on core retail and business deposits, including savings and checking accounts, that lead to long-term customer retention. As part of the commercial lending process, cross-selling the entire business banking relationship, including deposit relationships and business banking products, such as online cash management, treasury management, wires, direct deposit, payment processing and remote deposit capture. The Company's mortgage banking program also provides opportunities to cross-sell products to new customers. Expanding the Company's markets. In addition to deepening relationships with existing customers, the Company intends to expand business to new customers by leveraging the Company's well-established involvement in the community and by selectively emphasizing products and services designed to meet their banking needs. The Company also intends to pursue expansion in other market areas through selective growth of the home lending network.
Comparison of Financial Condition at
Assets. Total assets increased$346.5 million , to$2.63 billion atDecember 31, 2022 , from$2.29 billion atDecember 31, 2021 , primarily due to increases in loans receivable, net of$462.3 million , total cash and cash equivalents of$14.9 million , deferred tax assets, net of$6.7 million ,Federal Home Loan Bank ("FHLB") stock of$5.8 million , other assets of$5.0 million , accrued interest receivable of$3.6 million , operating lease right-of-use of$1.7 million , and servicing rights of$1.0 million , partially offset by decreases in loans held for sale of$105.7 million , securities available-for-sale of$42.1 million , certificates of deposit at other financial institutions of$5.8 million , and premises and equipment, net of$1.5 million . The increase in total assets was primarily funded by deposit growth and borrowings during the year endedDecember 31, 2022 . Loans receivable, net, increased$462.3 million , to$2.19 billion atDecember 31, 2022 , from$1.73 billion atDecember 31, 2021 . Total real estate loans increased$331.0 million , including increases in one-to-four-family portfolio loans of$103.3 million , construction and development loans of$102.0 million , commercial real estate loans of$69.6 million , multi-family loans of$41.6 million , and home equity loans of$14.4 million . Undisbursed construction and development loan commitments increased$19.4 million , or 10.6%, to$201.7 million atDecember 31, 2022 , as compared to$182.3 million atDecember 31, 2021 . Consumer loans increased$147.5 million , primarily due to increases of$159.7 million in indirect home improvement loans, partially offset by a decrease of$12.2 million in marine loans. Commercial business loans decreased$13.8 million due to a decrease in commercial and industrial loans of$11.8 million as a result of the repayment of$23.8 million in PPP loans, and a decrease in warehouse lending of$2.0 million reflecting the recent increase in residential mortgage interest rates and reduced refinance activity. The decrease in commercial and industrial loans resulting from the repayment of PPP loans was partially offset by the focused increase in commercial and industrial loans tied to the Bank's investment in our business lending platform, including employees to service business lending customers and cash management teams to support business deposits. Loans held for sale, consisting of one-to-four-family loans, decreased by$105.7 million , or 84.0%, to$20.1 million atDecember 31, 2022 , compared to$125.8 million atDecember 31, 2021 . Higher market rates in 2022 reduced purchase and refinance activity. The Company continues to invest in its home lending operations and strategically adds production staff in the markets we serve.
One-to-four-family loan originations for the year ended
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Originations of one-to-four-family loans to purchase and to refinance a home for the periods indicated were as follows:
(Dollars in thousands) For the Year Ended December 31,
2022 2021
Amount Percent Amount Percent $ Change % Change
Purchase $ 664,361 80.2 % $ 869,108 55.9 % $ (204,747) (23.6) %
Refinance 164,380 19.8 685,727 44.1 (521,347) (76.0)
Total $ 828,741 100.0 % $ 1,554,835 100.0 % $ (726,094) (46.7) %
During the year endedDecember 31, 2022 , the Company sold$715.6 million of one-to-four-family loans, compared to sales of$1.42 billion one year ago. The decrease in loan purchase and refinance activity, as well as sales activity, compared to the prior year reflects the impact of rising interest rates. The cash margin on loans sold, net of deferred fees and capitalized expenses, decreased to 1.39% for the year endedDecember 31, 2022 , compared to 2.69% for the year endedDecember 31, 2021 . Margin reported is based on actual loans sold into the secondary market and the related value of capitalized servicing, partially offset by recognized deferred loans fees and capitalized expenses. The gross cash margins on loans sold, were 2.78% and 3.97% for the year endedDecember 31, 2022 and 2021, respectively. Gross cash margins on loans sold is defined as the margin on loans sold without the impact of deferred loan costs. The ACLL was$28.0 million , or 1.26% of gross loans receivable, excluding loans held for sale atDecember 31, 2022 , compared to$25.6 million , or 1.46% of gross loans receivable, excluding loans held for sale, atDecember 31, 2021 . The increase was primarily due to an increase in the provision for credit losses on loans of$6.1 million during the period due to loan growth, partially offset with the one-time cumulative-effect adjustment of$2.9 million as of the CECL adoption date. The allowance for credit losses - unfunded loan commitments increased$2.0 million to$2.5 million atDecember 31, 2022 , from$499,000 atDecember 31, 2021 , primarily due to the one-time cumulative-effect adjustment of$2.4 million as of the CECL adoption date and increases in unfunded commitments. Loans classified as substandard increased to$20.2 million atDecember 31, 2022 , compared to$18.1 million atDecember 31, 2021 . This increase in substandard loans was primarily due to increases of$4.5 million in commercial real estate loans,$522,000 in indirect home improvement loans, and$450,000 in one-to-four-family loans, partially offset by a decrease of$3.3 million in commercial and industrial loans. Nonperforming loans, consisting solely of nonaccrual loans, increased$2.9 million to$8.7 million atDecember 31, 2022 , from$5.8 million atDecember 31, 2021 . AtDecember 31, 2022 , nonperforming loans consisted of$6.3 million in commercial business loans,$1.1 million of indirect home improvement loans,$920,000 in one-to-four-family loans,$267,000 in marine loans,$46,000 of home equity loans and$9,000 of other consumer loans. The ratio of nonperforming loans to total gross loans was 0.39% atDecember 31, 2022 , compared to 0.33% atDecember 31, 2021 . There was one OREO property totaling$570,000 atDecember 31, 2022 , compared to none atDecember 31, 2021 . AtDecember 31, 2022 , the Company had two commercial business loans that were classified as TDRs totaling$3.7 million on nonaccrual status. See "Item 1. Business - Lending Activities - Asset Quality" of this Form 10-K for additional information regarding the Company's nonperforming loans. Liabilities. Total liabilities increased$362.3 million to$2.40 billion atDecember 31, 2021 , from$2.04 billion atDecember 31, 2021 , primarily due to increases of$212.0 million in deposits,$144.0 million in borrowings, and$5.8 million in other liabilities. Total deposits increased$212.0 million to$2.13 billion atDecember 31, 2022 , from$1.92 billion atDecember 31, 2021 . Certificates of deposits increased$369.1 million to$729.8 million atDecember 31, 2022 , from$360.7 million atDecember 31, 2021 . Transactional accounts (noninterest-bearing checking, interest-bearing checking, and escrow accounts) decreased$119.5 million to$689.3 million atDecember 31, 2022 , from$808.8 million atDecember 31, 2021 , primarily due to a$92.9 million decrease in interest-bearing checking and a$26.4 million decrease in noninterest-bearing checking. Money market and savings accounts decreased$37.6 million , to$708.6 million atDecember 31, 2022 , from$746.3 million atDecember 31, 2021 . A portion of our wholesale funding activity has been tied to liability interest rate swap arrangements of$90.0 million that are funded with 90-day liabilities, as discussed below. 64
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Deposits are summarized as follows at the years indicated:
(Dollars in thousands)December 31, 2022
2021
Noninterest-bearing checking (1)$ 537,938 $
564,360
Interest-bearing checking (1)(2) 135,127
228,024 Savings 134,358 193,922 Money market (3) 574,290 552,357
Certificates of deposit less than$100,000 (4) 440,785
186,974
Certificates of deposit of
93,560 57,512
Escrow accounts related to mortgages serviced (6) 16,236
16,389 Total$ 2,127,741 $ 1,915,744
_______________________________
Interest-bearing checking balances as of
to misclassification of certain checking products in previous periods. As a
result of the misclassification, interest-bearing checking balance as of
(1)
noninterest-bearing checking for comparative purposes. Balances as of the
dates and average values included herein have been revised to reflect the
reclassification.
(2) Includes
2022 and
(3) Includes
at
(4) Includes
31, 2022 and
(5) Time deposits that meet or exceed the
(6) Noninterest-bearing checking.
Borrowings comprised of FHLB advances, increased
Management entered into two liability interest rate swap arrangements designated as cash flow hedges during 2020 and one liability interest rate swap arrangement in 2020 to lock the expense costs associated with$90.0 million in brokered deposits and borrowings. The average cost of these$90.0 million in notional pay fixed interest rate swap agreements was 73 basis points for which the Bank pays a fixed rate of 73 basis points to the interest rate swap counterparty, compared to the quarterly reset of three-month LIBOR that will adjust quarterly. Management entered into two asset interest rate swap arrangements designated as fair value hedges in 2022 to offset changes in the fair value of$60.0 million in available for sale securities due to rising interest rates. The average cost of these$60.0 million in notional pay fixed interest rate swap agreements was 256 basis points for which the Bank will pay a fixed rate of 256 basis points to the interest rate swap counterparty, compared to receiving the monthly reset of SOFR. Management will continue to implement processes to match balance sheet funding duration and minimize interest rate risk and costs.
Stockholders' Equity. Total stockholders' equity decreased
The decrease in stockholders' equity during the year endedDecember 31, 2022 , was primarily due to net unrealized losses in securities available-for-sale of$32.9 million , common stock repurchases of$16.4 million and cash dividends paid of$7.1 million , partially offset by net income of$29.6 million . In addition, the adoption of CECL onJanuary 1, 2022 , resulted in a$297,000 increase to retained earnings reflecting the combined impact of the$2.9 million decrease to our ACLL and a$2.4 million increase to the allowance for credit losses - unfunded commitments as of the adoption date. The Company repurchased 550,680 shares of its common stock during the year endedDecember 31, 2022 , at an average price of$29.85 per share. Book value per common share was$30.42 atDecember 31, 2022 , compared to$30.75 atDecember 31, 2021 . We calculated book value based on common shares outstanding of 7,736,185 atDecember 31, 2022 , less 118,530 unvested restricted stock shares for the reported common shares outstanding of 7,617,655. Common shares outstanding was calculated using 8,169,887 shares atDecember 31, 2021 , less 121,672 unvested restricted stock shares for the reported common shares outstanding of 8,048,215. 65 Table of Contents
Average Balances, Interest and Average Yields/Cost
The following table sets forth for the periods indicated, information regarding average balances of assets and liabilities, as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spread, net interest margin (otherwise known as net yield on interest-earning assets), and the ratio of average interest-earning assets to average interest-bearing liabilities. Also presented is the weighted average yield on interest-earning assets, rates paid on interest-bearing liabilities and the resultant spread atDecember 31, 2022 . Income and all average balances are monthly average balances. Nonaccrual loans have been included in the table as loans carrying a zero yield.
The yields on tax-exempt municipal bonds have not been computed on a tax equivalent basis.
Year Ended December 31,
2022 2021 2020
Average Interest Average Interest Average Interest
Balance Earned Yield/ Balance Earned Yield/ Balance Earned Yield/
(Dollars in thousands) Outstanding Paid Rate Outstanding Paid Rate Outstanding Paid Rate
Interest-earning assets:
Loans receivable, net and loans held for
sale (1) (2) $ 2,014,017 $ 111,648 5.54 % $ 1,762,832 $ 90,737 5.15 % $ 1,576,975 $ 84,128 5.33 %
Taxable mortgage-backed securities 86,626 1,842 2.13 75,493 1,690 2.24 68,739 1,593
2.32
Taxable AFS investment securities 60,729 1,431
2.36 56,063 1,152 2.05 47,344 1,105
2.33
Tax-exempt AFS investment securities 130,744 2,488
1.90 97,471 1,733 1.78 39,721 795
2.00
Taxable HTM Investment securities 8,084 409
5.06 7,500 380 5.07 2,441 123 5.04 FHLB stock 7,231 401 5.55 5,494 256 4.66 8,079 394 4.88 Interest-bearing deposits at other financial institutions 32,689 475
1.45 93,435 426 0.46 100,783 699
0.69
Total interest-earning assets 2,340,120 118,694
5.07 2,098,288 96,374 4.59 1,844,082 88,837
4.82
Interest-bearing liabilities: Savings and money market 781,763 3,775 0.48 661,199 1,604 0.24 476,589 2,457 0.52 Interest-bearing checking 176,204 495 0.28 203,230 282 0.14 210,759 388 0.18 Certificates of deposit 459,594 5,150 1.12 464,921 5,043 1.08 535,047 9,135 1.71 Borrowings 102,571 3,052 2.98 63,128 1,074 1.70 147,836 1,961 1.33 Subordinated note 49,425 1,942 3.93 44,160 1,722 3.90 9,899 776 7.84
Total interest-bearing liabilities 1,569,557 14,414
0.92 % 1,436,638 9,725 0.68 % 1,380,130 14,717 1.07 % Net interest income$ 104,280 $ 86,649 $ 74,120 Net interest rate spread 4.15 % 3.91 % 3.75 % Net earning assets$ 770,563 $ 661,650 $ 463,952 Net interest margin 4.46 % 4.13 % 4.02 % Average interest-earning assets to average interest-bearing liabilities 149.09 % 146.06 % 133.62 % ____________________________
(1) The average loans receivable, net balances include nonaccrual loans.
(2) Includes net deferred fee recognition of
million for the years ended December 31, 2022 , 2021, 2020, respectively.
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Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income and
interest expense for major components of interest-earning assets and
interest-bearing liabilities for the periods indicated. It distinguishes between
the changes related to outstanding balances and that due to the changes in
interest rates. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (i.e., changes in volume multiplied by old rate) and
(ii) changes in rate (i.e., changes in rate multiplied by old volume). For
purposes of this table, changes attributable to both rate and volume, which
cannot be segregated, have been allocated proportionately to the change due to
volume and the change due to rate.
Year Ended December 31, 2022 vs. 2021 Year Ended December 31, 2021 vs. 2020
Increase (Decrease) Due to Total Increase Increase (Decrease) Due to Total Increase (Dollars in thousands) Volume
Rate (Decrease) Volume Rate (Decrease)
Interest-earning assets:
Loans receivable, net and
loans held for sale(1) $ 12,929 $ 7,982 $ 20,911 $ 9,915 $ (3,306) $ 6,609
Taxable mortgage-backed
securities 249 (97) 152 157 (60) 97
Taxable AFS Investment
securities 96 183 279 204 (157) 47
Tax-exempt AFS investment
securities 592 163 755 1,155 (217) 938
Taxable HTM Investment
securities 30 (1) 29 255 2 257
FHLB stock 81 64 145 (126) (12) (138)
Interest-bearing deposits
at other financial
institutions (277) 326 49 (51) (222) (273)
Total interest-earning
assets $ 13,700 $ 8,620 $
22,320
Interest-bearing
liabilities:
Savings and money market $ 292
(38) 251 213 (13) (93) (106)
Certificates of deposit (58) 165 107 (1,197) (2,895) (4,092)
Borrowings 671 1,307 1,978 (1,124) 237 (887)
Subordinated note 205 15 220 2,686 (1,740) 946
Total interest-bearing
liabilities $ 1,072 $ 3,617 $ 4,689 $ 1,304 $ (6,296) $ (4,992)
Net change in net
interest income $ 17,631 $ 12,529
__________________________
(1) The average loans receivable, net balances include nonaccrual loans.
Comparison of Results of Operations for the Years Ended
General. Net income was
$37.4 million for the year endedDecember 31, 2021 . The decrease in net income was primarily the result of a$19.4 million , or 51.7% reduction in noninterest income, primarily due to a decrease in gain on sale of loans, a$5.7 million , or 1,143.4% increase in the provision for credit losses on loans, and a$2.9 million , or 3.9% increase in noninterest expense, partially offset by a$17.6 million , or 20.3% increase in net interest income and a$2.7 million , or 26.7% decrease in the provision for income tax expense. 67
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Net Interest Income. Net interest income increased$17.6 million , to$104.3 million for the year endedDecember 31, 2022 , from$86.6 million for the year endedDecember 31, 2021 . This increase was primarily the result of increased balances in higher yielding loans and an improved mix of loans versus other interest-earning assets. Interest income increased$22.3 million , primarily due to an increase of$20.9 million in interest income on loans receivable, including fees, impacted primarily by organic loan growth. Interest expense increased$4.7 million , primarily as a result of repricing deposit rates and an increase in higher cost borrowings and brokered deposits. The net interest margin ("NIM") increased 33 basis points to 4.46% for the year endedDecember 31, 2022 , from 4.13% for the same period in the prior year. The increase in NIM reflects new loan originations at higher market interest rates, variable rate interest-earning assets repricing higher following recent increases in market interest rates, and an improved asset mix of higher yielding assets as lower yielding excess cash funded higher yielding loans. The benefit from higher yields and increased interest-earning assets was partially offset by rising deposit and borrowing costs. Increases in average balances of higher costing CDs and borrowings placed additional pressure on the NIM. Management remains focused on matching deposit/liability duration with the duration of loans/assets where appropriate. Interest Income. Interest income for the year endedDecember 31, 2022 , increased$22.3 million , to$118.7 million , from$96.4 million for the year endedDecember 31, 2021 . The increase during the year was attributable to an increase in the average balance of total interest-earning assets and to a lesser extent, a 48 basis point increase in the average yield earned on interest-earning assets, primarily loans receivable, net and loans held for sale as indicated in the table below. The following table compares average earning asset balances, associated yields, and resulting changes in interest income for the years endedDecember 31, 2022 and 2021: (Dollars in thousands) Year Ended December 31, 2022 2021 Average Average $ Change Balance Yield/ Balance Yield/ in Interest Outstanding Rate Outstanding Rate Income Loans receivable, net and loans held for sale$ 2,014,017 5.54 %$ 1,762,832 5.15 %$ 20,911 Taxable mortgage-backed securities 86,626 2.13 75,493 2.35 152 Taxable AFS investment securities 60,729 2.36 56,063 1.79 279 Tax-exempt AFS investment securities 130,744 1.90 97,471 1.85 755 Taxable HTM investment securities 8,084 5.06 7,500 5.07 29 FHLB stock 7,231 5.55 5,494 4.66 145 Interest-bearing deposits at other financial institutions 32,689 1.45 93,435 0.46 49 Total interest-earning assets$ 2,340,120 5.07 %$ 2,098,288 4.59 %$ 22,320 ___________________________
(1) The average loans receivable, net balances include nonaccrual loans.
Interest Expense. Interest expense increased$4.7 million , to$14.4 million for the year endedDecember 31, 2022 , from$9.7 million for the prior year, primarily due to an increase in interest expense on deposits of$2.5 million and an increase in higher cost borrowings of$2.0 million . The average cost of funds for total interest-bearing liabilities increased 24 basis points to 0.92% for the year endedDecember 31, 2022 , compared to 0.68% for the year endedDecember 31, 2021 . This increase was predominantly due to the increase in the average rates paid on deposits and borrowings reflecting the increase in market rates during 2022. The average cost of interest-bearing deposits increased 14 basis points to 0.66% for the year endedDecember 31, 2022 , compared to 0.52% for the year endedDecember 31, 2021 , reflecting higher market interest rates.
Total funding costs factoring in average outstanding noninterest-bearing
deposits of
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The following table details average balances for cost of funds on
interest-bearing liabilities and the change in interest expense for the years
ended
(Dollars in thousands) Year Ended December 31,
2022 2021
Average Average $ Change
Balance Yield/ Balance Yield/ in Interest
Outstanding Rate Outstanding Rate Expense
Savings and money market $ 781,763 0.48 % $ 661,199 0.24 % $ 2,171
Interest-bearing checking 176,204 0.28 203,230 0.14 213
Certificates of deposit 459,594 1.12 464,921 1.08 107
Borrowings 102,571 2.98 63,128 1.70 1,978
Subordinated note 49,425 3.93 44,160 3.90 220
Total interest-bearing liabilities
Provision for Credit Losses. For the year endedDecember 31, 2022 , the provision for credit losses on loans was$6.6 million as calculated under CECL, compared to$500,000 for the year endedDecember 31, 2021 as calculated under the prior incurred loss methodology. The provision for credit losses on loans reflects the increase in total loans receivable, partially offset with the one-time cumulative-effect adjustment of$2.9 million as of the CECL adoption date. For the year endedDecember 31, 2022 , the Company recorded a negative provision for credit losses on unfunded commitments of$365,000 , compared to a provision of$92,000 for the year endedDecember 31, 2021 . The decrease was attributable to a change in methodology as a result of the adoption of CECL, as well as decreases in total unfunded commitments during the year. During the year endedDecember 31, 2022 , net charge-offs totaled$1.4 million , compared to$1.0 million during the year endedDecember 31, 2021 . The increase in net charge-offs was primarily due to increases in the following loan categories:$326,000 in other consumer loans (which includes deposit overdraft net charge-offs of$301,000 ), and$94,000 in marine loans, partially offset by decreases of$38,000 in commercial business loans and$12,000 in indirect home improvement loans. A further decline in national and local economic conditions, as a result of current economic factors, could result in a material increase in the allowance for credit losses and may adversely affect the Company's financial condition and result of operations.
The following table details activity and information related to the allowance
for credit losses on loans for the years ended
At or For the Year Ended
December 31,
(Dollars in thousands) 2022 2021Provision for credit losses on loans$ 6,623 $ 500 Net charge-offs$ 1,407 $ 1,037 Allowance for credit losses on loans$ 27,992
1.26 % 1.46 %
Nonperforming loans $ 8,652
323.49 % 440.24 %
Nonperforming loans as a percentage of gross loans
receivable at year end 0.39 % 0.33 %
Total gross loans $ 2,218,852 $ 1,754,175 Management considers the ACLL atDecember 31, 2022 , to be adequate to cover forecasted losses in the loan portfolio based on the assessment of the above-mentioned factors affecting the loan portfolio. While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not 69
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adversely impact the Company's financial condition and results of operations. In addition, the determination of the amount of allowance for credit losses on loans is subject to review by bank regulators, as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination.
Noninterest Income. Noninterest income decreased
Year Ended December 31 , Increase/(Decrease)
(Dollars in thousands) 2022 2021 Amount Percent Service charges and fee income$ 8,525 $ 4,349 $ 4,176 96.0 % Gain on sale of loans 7,917 31,083 (23,166) (74.5) Earnings on cash surrender value of BOLI 876 866 10 1.2 Other noninterest income 790 1,215 (425) (35.0) Total noninterest income$ 18,108 $
37,513
The year over year decreases include a$23.2 million , or 74.5% decrease in gain on sale of loans, primarily due to a reduction in origination and sales volume of loans held for sale and a reduction in gross margins of sold loans, partially offset by a$4.2 million increase in service charges and fee income as a result of less MSR amortization reflecting increased market interest rates and increased servicing fees from non-portfolio service loans. Gross margins on home loan sales decreased to 2.78% for the year endedDecember 31, 2022 , from 3.97% for the year endedDecember 31, 2021 . Noninterest Expense. Noninterest expense increased$2.9 million , to$79.2 million for the year endedDecember 31, 2022 , from$76.2 million for the year endedDecember 31, 2021 . The following table provides an analysis of the changes in the components of noninterest expense: Year Ended December 31, (Decrease)/Increase (Dollars in thousands) 2022 2021 Amount Percent Salaries and benefits$ 47,632 $ 49,721 $ (2,089) (4.2) % Operations 10,743 10,791 (48) (0.4) Occupancy 5,165 4,892 273 5.6 Data processing 6,062 4,951 1,111 22.4 Loss on sale of OREO - 9 (9) (100.0) Loan costs 2,718 2,795 (77) (2.8) Professional and board fees 3,154 3,181 (27) (0.8) FDIC insurance 1,224 636 588 92.5 Marketing and advertising 897 634 263 41.5 Acquisition cost 898 - 898 100.0
Amortization of core deposit intangible 691 691 - - (Recovery) impairment of servicing rights (1) (2,059) 2,058 (100.0) Total noninterest expense$ 79,183 $
76,242
The increase in noninterest expense was primarily due to a reduction in the recovery of servicing rights to$1,000 from$2.1 million , along with increases of$1.1 million in data processing,$898,000 in acquisition costs related to the pending Columbia Branch Acquisition,$588,000 inFDIC insurance,$273,000 in occupancy, and$263,000 in marketing and advertising expenses, partially offset by a decrease of$2.1 million in salaries and benefits, primarily due to a reduction in incentive compensation and commissions.
The efficiency ratio, which is noninterest expense as a percentage of net
interest income and noninterest income, rose to, 64.70% for the year ended
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Provision for Income Tax. For the year endedDecember 31, 2022 , the Company recorded a provision for income tax expense of$7.3 million on pre-tax income of$37.0 million , as compared to a provision of income tax expense of$10.0 million on pre-tax income of$47.4 million for the year endedDecember 31, 2021 . There was a net deferred tax asset of$6.7 million and a net deferred tax liability of$1.2 million atDecember 31, 2022 and 2021, respectively. The effective corporate income tax rates for the years endedDecember 31, 2022 and 2021 were 19.8% and 21.1%, respectively. For additional information regarding income taxes, see "Note 11 - Income Taxes" of the Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K.
Comparison of Results of Operations for the Years Ended
See Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year endedDecember 31, 2021 filed with theSEC .
Asset and Liability Management and Market Risk
Risk When Interest Rates Change. The rates of interest the Company earns on
assets and pays on liabilities generally is established contractually for a
period of time. Market rates change over time. Like other financial
institutions, the Company's results of operations are impacted by changes in
interest rates and the interest rate sensitivity of the Company's assets and
liabilities. The risk associated with changes in interest rates and the
Company's ability to adapt to these changes is known as interest rate risk and
is the most significant market risk.
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.
How The Company Measures Risk of Interest Rate Changes. As part of an attempt to
manage exposure to changes in interest rates and comply with applicable
regulations, the Company monitors interest rate risk. In doing so, the Company
analyzes and manages assets and liabilities based on their interest rates and
payment streams, timing of maturities, repricing opportunities, and sensitivity
to actual or potential changes in market interest rates.
The Company is subject to interest rate risk to the extent that its
interest-bearing liabilities, primarily deposits, subordinated notes, and FHLB
advances, reprice more rapidly or at different rates than the interest-earning
assets. In order to minimize the potential for adverse effects of material
prolonged increases or decreases in interest rates on the Company's results of
operations, the Company has adopted an Asset and Liability Management Policy.
The Board of Directors sets the Asset and Liability Management Policy for the
Bank, which is implemented by the Asset/Liability Committee ("ALCO"), an
internal management committee. The board-level oversight for ALCO is performed
by the Audit Committee of the Board of Directors.
The purpose of the ALCO is to communicate, coordinate, and control
asset/liability management consistent with the business plan and board-approved
policies. The committee establishes and monitors the volume and mix of assets
and funding sources, taking into account relative costs and spreads, interest
rate sensitivity and liquidity needs. The objectives are to manage assets and
funding sources to produce results that are consistent with liquidity, capital
adequacy, growth, risk, and profitability goals.
The committee generally meets monthly to, among other things, protect capital
through earnings stability over the interest rate cycle; maintain the Bank's
well capitalized status; and provide a reasonable return on investment. The
committee recommends appropriate strategy changes based on this review. The
committee is responsible for reviewing and reporting
71
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the effects of the policy implementations and strategies to the Board of Directors at least quarterly. The Chief Financial Officer oversees the process on a daily basis.
A key element of the Bank's asset/liability management plan is to protect net earnings by managing the maturity or repricing mismatch between interest-earning assets and rate-sensitive liabilities. The Company seeks to accomplish this by extending funding maturities through wholesale funding sources, including the use of FHLB advances and brokered certificates of deposit, and through asset management, including the use of adjustable-rate loans and selling certain fixed-rate loans in the secondary market. Management is also focused on matching deposit duration with the duration of earning assets as appropriate.
As part of the efforts to monitor and manage interest rate risk, a number of indicators are used to monitor overall risk. Among the measurements are:
Market Risk. Market risk is the potential change in the value of investment securities if interest rates change. This change in value impacts the value of the Company and the liquidity of the securities. Market risk is controlled by setting a maximum average maturity/average life of the securities portfolio to 10 years. Economic Risk. Economic risk is the risk that the underlying value of a bank will change when rates change. This can be caused by a change in value of the existing assets and liabilities (this is called Economic Value of Equity or EVE), or a change in the earnings stream (this is caused by interest rate risk). The Company takes economic risk primarily when fixed rate loans are made, or purchase fixed-rate investments, or issue long term certificates of deposit or take fixed-rate FHLB advances. It is the risk that interest rates will change and these fixed-rate assets and liabilities will change in value. This change in value usually is not recognized in the earnings, or equity (other than marking to market securities available-for-sale or fair value adjustments on loans held for sale). The change is recognized only when the assets and liabilities are liquidated. Although the change in market value is usually not recognized in earnings or in capital, the impact is real to the long-term value of the Company. Therefore, the Company will control the level of economic risk by limiting the amount of long-term, fixed-rate assets it will have and by setting a limit on concentrations and maturities of securities.
Interest Rate Risk. If the
The table presented below, as ofDecember 31, 2022 , is an analysis prepared for the Company by a third-party consultant utilizing various market and actual experience-based assumptions. The table represents a static shock to the net interest income using instantaneous and sustained shifts in the yield curve, in 100 basis point increments, up and down 100 basis points. The results reflect a projected income statement with minimal exposure to instantaneous changes in interest rates. These results are primarily based upon historical prepayment speeds within the consumer lending portfolio in combination with the above average yields associated with the consumer portfolio if those prepayments do not occur. The table illustrates the estimated change in our net interest income over the next 12 months fromDecember 31, 2022 . Change in Interest Net Interest Income Rates in Basis Points Amount Change Change (Dollars in thousands) +300bp$ 114,787 $ 1,146 1.01 % +200bp 114,777 1,136 1.00 +100bp 114,370 729 0.64 0bp 113,641 - - -100bp 111,875 (1,465) (1.55) -200bp 109,031 (4,610) (4.06) -300bp 104,140 (9,502) (8.36)
In managing the assets/liability mix the Company typically places an equal
emphasis on maximizing net interest margin and matching the interest rate
sensitivity of the assets and liabilities. From time to time, however, depending
on the relationship between long- and short-term interest rates, market
conditions and consumer preference, the Company may place somewhat greater
emphasis on maximizing net interest margin than on strict dollar for dollar
categories matching the interest rate sensitivity of the assets and liabilities.
Management also believes that the increased net income which may result from a
prepayment assumption mismatch in the actual maturity or repricing of the asset
and liability portfolios can,
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during periods of changing interest rates, provide sufficient returns to justify the increased exposure to sudden and unexpected increases in interest rates which may result from such a mismatch. Management believes that 1stSecurity Bank's level of interest rate risk is acceptable under this approach. In evaluating the Company's exposure to interest rate movements, certain shortcomings inherent in the method of analysis presented in the foregoing table must be considered. For example, although certain assets and liabilities may have similar maturities or repricing periods, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in interest rates. Additionally, certain assets, such as adjustable-rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a significant change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed above. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. The Company considers all of these factors in monitoring its exposure to interest rate risk.
Liquidity and Capital Resources
Management maintains a liquidity position that it believes will adequately provide funding for loan demand and deposit runoff that may occur in the normal course of business. The Company relies on a number of different sources in order to meet potential liquidity demands. The primary sources are increases in deposit accounts, FHLB advances, purchases of federal funds, sale of securities available-for-sale, cash flows from loan payments, sales of one-to-four-family loans held for sale, and maturing securities. While the maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The Bank must maintain an adequate level of liquidity to ensure the availability of sufficient funds to fund its operations. The Bank generally maintains sufficient cash and short-term investments to meet short-term liquidity needs. AtDecember 31, 2022 , the Bank's total borrowing capacity was$601.7 million with the FHLB ofDes Moines , with unused borrowing capacity of$414.8 million . The FHLB borrowing limit is based on certain categories of loans, primarily real estate loans, that qualify as collateral for FHLB advances. AtDecember 31, 2022 , the Bank held approximately$840.2 million in loans that qualify as collateral for FHLB advances. In addition to the availability of liquidity from the FHLB ofDes Moines , the Bank maintained a short-term borrowing line of credit with the FRB, with a current limit of$205.8 million , and a combined credit limit of$101.0 million in written federal funds lines of credit through correspondent banking relationships atDecember 31, 2022 . The FRB borrowing limit is based on certain categories of loans, primarily consumer loans, that qualify as collateral for FRB line of credit. AtDecember 31, 2022 , the Bank held approximately$579.8 million in loans that qualify as collateral for the FRB line of credit. Subject to market conditions, we expect to utilize these borrowing facilities from time to time in the future to fund loan originations and deposit withdrawals, to satisfy other financial commitments, repay maturing debt and to take advantage of investment opportunities to the extent feasible. The Bank's Asset and Liability Management Policy permits management to utilize brokered deposits up to 20% of deposits or$427.0 million atDecember 31, 2022 . Total brokered deposits atDecember 31, 2022 were$393.9 million . Management utilizes brokered deposits to mitigate interest rate risk and to enhance liquidity when appropriate. Liquidity management is both a daily and long-term function of the Company's management. Excess liquidity is generally invested in short-term investments, such as overnight deposits and federal funds. On a longer-term basis, a strategy is maintained of investing in various lending products and investment securities, includingU.S. Government obligations andU.S. agency securities. The Company uses sources of funds primarily to meet ongoing commitments, pay maturing deposits and fund withdrawals, and to fund loan commitments. AtDecember 31, 2022 , the outstanding loan commitments totaled$549.3 million , which included$201.7 million of undisbursed construction and development loan commitments. For information regarding our commitments and off-balance sheet arrangements, see "Note 12 - Commitments and Contingencies" of the Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K. Securities purchased during the years endedDecember 31, 2022 and 2021 totaled 73
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The Bank's liquidity is also affected by the volume of loans sold and loan principal payments. During the years endedDecember 31, 2022 and 2021, the Bank sold$740.4 million and$1.40 billion in loans, respectively. During the years endedDecember 31, 2022 and 2021, the Bank received$737.3 million and$899.3 million in principal repayments on loans, respectively. The Bank's liquidity has been positively impacted by increases in deposit levels. During the years endedDecember 31, 2022 and 2021, deposits increased by$212.0 million and$241.5 million , respectively. Our liquid assets in the form of cash and cash equivalents, CDs at other financial institutions and investment securities decreased to$283.9 million atDecember 31, 2022 from$315.9 million atDecember 31, 2021 . CDs scheduled to mature in one year or less atDecember 31, 2022 , totaled$472.2 million . It is management's policy to offer deposit rates that are competitive with other local financial institutions. Based on this management strategy, the Bank believes that a majority of maturing
relationship deposits will remain with the Bank.
We incur capital expenditures on an ongoing basis to expand and improve our product offerings, enhance and modernize our technology infrastructure, and to introduce new technology-based products to compete effectively in our markets. We evaluate capital expenditure projects based on a variety of factors, including expected strategic impacts (such as forecasted impact on revenue growth, productivity, expenses, service levels and customer retention) and our expected return on investment. The amount of capital investment is influenced by, among other things, current and projected demand for our services and products, cash flow generated by operating activities, cash required for other purposes and regulatory considerations. Based on current capital allocation objectives, there are no projects scheduled for capital investments in premises and equipment during the year endingDecember 31, 2023 that would materially impact liquidity. We also have purchase obligations, generally with remaining terms of less than three years and contracts with various vendors to provide services, including information processing, for periods generally ranging from one to five years, for which our financial obligations are dependent upon acceptable performance by the vendor. For the year endingDecember 31, 2023 , we project that fixed commitments will include$1.5 million of operating lease payments and$182.6 million of scheduled payments and maturities of FHLB advances during the year endingDecember 31, 2023 . For information regarding our operating leases and FHLB advances, see "Note 6 - Leases" and "Note 9 - Debt", respectively, of the Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K.
The Bank's management believes that the liquid assets combined with the available lines of credit provide adequate liquidity to meet current financial obligations for at least the next 12 months.
As a separate legal entity from the Bank,FS Bancorp must provide for its own liquidity. Sources of capital and liquidity forFS Bancorp include distributions from the Bank and the issuance of debt or equity securities. Dividends and other capital distributions from the Bank are subject to regulatory notice. AtDecember 31, 2022 ,FS Bancorp, Inc. had$7.2 million in unrestricted cash to meet liquidity needs. The Company currently expects to continue the current practice of paying quarterly cash dividends on common stock subject to the Board of Directors' discretion to modify or terminate this practice at any time and for any reason without prior notice. Our current quarterly common stock dividend rate is$0.25 per share, which we believe is a dividend rate per share which enables us to balance our multiple objectives of managing and investing in the Bank, and returning a substantial portion of our cash to our shareholders. Assuming continued cash dividend payment during 2023 at this rate of$0.25 per share, our average total dividend paid each quarter would be approximately$1.9 million based on the number of our current outstanding shares as ofDecember 31, 2022 . The Bank is subject to minimum capital requirements imposed by theFDIC . Based on its capital levels atDecember 31, 2022 , the Bank exceeded these requirements as of that date. Consistent with our goals to operate a sound and profitable organization, our policy is for the Bank to maintain a well capitalized status under the capital categories of theFDIC . Based on capital levels atDecember 31, 2022 , the Bank was considered to be well capitalized. AtDecember 31, 2022 , 74 Table of Contents the Bank exceeded all regulatory capital requirements with Tier 1 leverage-based capital, Tier 1 risk-based capital, total risk-based capital, and common equity Tier 1 capital ratios of 11.3%, 12.5%, 13.7%, and 12.5%, respectively. As a bank holding company registered with theFederal Reserve , the Company is subject to the capital adequacy requirements of theFederal Reserve. Bank holding companies with less than$3.0 billion in assets are generally not subject to compliance with theFederal Reserve's capital regulations, which are generally the same as the capital regulations applicable to the Bank. TheFederal Reserve has a policy that a bank holding company is required to serve as a source of financial and managerial strength to the holding company's subsidiary bank and theFederal Reserve expects the holding company's subsidiary bank to be well capitalized under the prompt corrective action regulations.
If
FS Bancorp were subject to regulatory capital guidelines for bank holding companies with$3.0 billion or more in assets atDecember 31, 2022 ,FS Bancorp would have exceeded all regulatory capital requirements. For informational purposes, the regulatory capital ratios calculated forFS Bancorp atDecember 31, 2022 were 9.7% for Tier 1 leverage-based capital, 10.7% for Tier 1 risk-based capital, 14.0% for total risk-based capital, and 10.7% for CET 1 capital ratio. For additional information regarding regulatory capital compliance, see the discussion included in "Note 14 -Regulatory Capital " of the Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K.
Recent Accounting Pronouncements
For a discussion of recent accounting standards, please see "Note 1- Basis of Presentation and Summary of Significant Accounting Policies" of the Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises principally from interest rate risk inherent in lending, investing, deposit and borrowings activities. Management actively monitors and manages its interest rate risk exposure. In addition to other risks that are managed in the normal course of business, such as credit quality and liquidity, management considers interest rate risk to be a significant market risk that could potentially have a material effect on the Company's financial condition and result of operations. The information contained in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management" of this Form 10-K is incorporated herein by reference.
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