In my quest to find good regional or local banks to invest in, I came across FS Bancorp (NASDAQ: FSBW), the holding of 1st Security Bank of Washington which served the Puget Healthy communities for over 100 years. The bank started out as a credit union, but ‘morphed’ into a state-chartered mutual savings bank in 2004, then became an equity savings bank in 2012. The bank currently operates 21 branches in the region and with a balance sheet total of more than 2.2 billion dollars, it is a major operator in the region.
A growing balance sheet translates into stronger financial performance
Thanks to the increase in the size of the balance sheet, FS Bancorp saw its interest and dividend income increase by approximately 10% to reach $96.4 million. And despite accepting more deposits as a source of funding, total interest expense actually decreased from $14.7M to $9.7M. And the combination of lower interest expense as interest income increased obviously led to a very impressive increase in net interest income from $74.1 million to $86.6 million.
FS Bancorp also earns money from the sale of loans it has issued. This helped the bank through the pandemic year 2020 as they were able to record nearly $50 million in gains on the sale of these loans and the only reason EPS declined in 2021 is that the bank recorded a lower income on the sale of these loans.
Pre-tax and pre-loan loss provision income for fiscal year 2021 was approximately $48 million (compared to nearly $63 million for fiscal year 2020), but as you can see in the image above Above, the difference can be entirely explained by the much higher recorded gains on the sale of loans in 2020.
It’s also interesting to see how the amount of loan loss provisions decreased to just $0.5 million in fiscal 2021, as the provisions recorded in 2020 appear to have been sufficient. EPS for fiscal 2021 was around $4.42, but that’s based on the average share count of nearly 8.5 million shares. As the bank ended the year with less than 8.2 million shares outstanding, EPS will likely be increased in 2022, keeping all other items unchanged.
A significant portion of the loan portfolio consists of “home improvement loans
As you notice, a substantial part of the profit is determined by FS Bancorp’s ability to sell the loans it originated. It is therefore more difficult to “guess” the financial performance of the bank because it is unclear how much money the bank could also save on staff costs and other overheads if it refrained from continuing to sell the loans it she issued. And just to give you an idea, the bank sold about $1.44 billion in loans in fiscal 2021 and issued $1.35 billion in new loans. Meanwhile, in 2020, around $1.67 billion in loans were sold while the bank issued around $1.73 billion in new loans. It is very difficult to try to calculate the contribution from the sale of loans because there is no specific time frame as to how long an original loan remains on FS Bancorp’s books.
This is the “swing factor” and I prefer to focus on the balance sheet items that FS Bancorp controls. And specifically, I’m interested in the $1.73 billion loan book.
Around 60% of these loans are related to real estate, with CRE and construction and development loans accounting for around half of the real estate loan portfolio. The other half is related to residential real estate.
I was very interested to see indirect home improvement loans on the balance sheet, as they make up about 20% of the entire loan portfolio. These loans are linked to the purchase of, for example, new windows or an HVAC system for a house, are offered by the sellers of said items and are guaranteed by FS Bancorp. It is a very interesting niche and FS Bancorp clearly develops in this area. division as the total amount of home improvement loans increased by almost 20% while the amount of commercial loans decreased. That said, the amount of commercial loans excluding PPP loans went from $162 million to $184 million.
The image above also shows that the total loan loss provision exceeds $25 million, which is relatively high given that the total amount of loans in non-recognition status is relatively small at less than $6 million. dollars by the end of 20221.
Of course, we will also have to keep an eye on the total amount of delinquent loans, but it seems that FS Bancorp’s provisions are sufficient. That being said, more than $34 million in loans were rated as “ones to watch,” “special mention,” and “lower quality,” as you can see below. Fortunately, a substantial part of these loans is linked to real estate and thanks to the presence of collateral, real losses should remain limited. I’m more “worried” about the nearly $20 million in commercial and industrial loans that haven’t been categorized as “successful.”
That being said, FS Bancorp has come a long way since late 2020 (see below), when total lending in these three riskiest categories was over $112 million, nearly $30 million. % of commercial real estate loans not making the “successful” category. But throughout 2020 and 2021, just about every home improvement loan was rated very high when it came to determining credit quality, so I completely understand why FS Bancorp has grown in this niche .
Gains on the sale of loans are both the main driver and the main uncertainty when it comes to valuing FS Bancorp. It is virtually impossible to estimate how much money the bank will earn in a year given by selling some of the loans it issued. and that explains why the bank is trading at less than 8 times earnings. And since the dividend yield is relatively low ($0.20 per quarter, for a dividend yield of 2.6%), FS Bancorp does not appeal to income-oriented investors either.
There is value, however, as the bank ended 2021 with a book value of over $30/share and a tangible book value of $29.50. Given that FS Bancorp has aggressively repurchased its shares and the majority of its earnings are retained on the balance sheet, I expect the bank’s tangible book value per share to exceed $32/share by the end of this year (barring any sudden surprises in the loan sales division) which makes the bank rather cheap at current levels. Maybe a small position is warranted, but I have to keep in mind that making and selling loans is an important part of the business model here.