FS BANCORP, INC. Forward-Looking Statements
This report contains forward-looking statements, which can be identified by the use of words such as "believes," "expects," "anticipates," "estimates," or similar expressions. Forward-looking statements include, but are not limited to:
? statements of our goals, intentions, and expectations;
? statements regarding our business plans, prospects, growth, and operating
strategies;
? statements regarding the quality of our loan and investment portfolios; and
? estimates of our risks and future costs and benefits.
These forward-looking statements are subject to significant risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:
the effect of the COVID-19 pandemic, including on the Company' credit quality
and business operations, as well as its impact on general economic and ? financial market conditions and other uncertainties resulting from the COVID-19
pandemic, such as the extent and duration of the impact on public health, the
economic activity, employment levels and market liquidity;
? general economic conditions either nationally or in our market area, that are
worse than expected;
the credit risks of lending activities, including changes in the level and ? trend of loan delinquencies, write offs, changes in our allowance for loan
losses, and provision for loan losses that may be impacted by deterioration in
the housing and commercial real estate markets;
? secondary market conditions and our ability to originate loans for sale and
sell loans in the secondary market;
? fluctuations in the demand for loans, the number of unsold homes, land and
other properties, and fluctuations in real estate values in our market area;
staffing fluctuations in response to product demand or the implementation of ? corporate strategies that affect our workforce and potential associated
charges;
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;
uncertainty regarding the future of the London Interbank Offered Rate ? ("LIBOR"), and the potential transition away from LIBOR toward new interest
rate benchmarks;
? increased competitive pressures among financial services companies;
our ability to execute our plans to grow our residential construction lending, ? our home lending operations, our warehouse lending, and the geographic
expansion of our indirect home improvement lending;
? our ability to attract and retain deposits;
our ability to successfully integrate any assets, liabilities, customers, ? systems, and management personnel we may in the future acquire into our
operations and our ability to realize related revenue synergies and cost
savings within expected time frames and any goodwill charges related thereto;
? our ability to control operating costs and expenses;
? our ability to retain key members of our senior management team;
? changes in consumer spending, borrowing, and savings habits;
? our ability to successfully manage our growth;
legislative or regulatory changes that adversely affect our business, including
the effect of the Dodd-Frank Wall Street Reform and Consumer Protection Act of ? 2010, changes in regulation policies and principles, an increase in regulatory
capital requirements or change in the interpretation of regulatory capital or
other rules, including as a result of Basel III;
? adverse changes in the securities markets;
changes in accounting policies and practices, as may be adopted by the bank
? regulatory agencies, the
? costs and effects of litigation, including settlements and judgments;
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disruptions, security breaches, or other adverse events, failures, or ? interruptions in, or attacks on, our information technology systems or on the
third-party vendors who perform several of our critical processing functions;
? inability of key third-party vendors to perform their obligations to us; and
other economic, competitive, governmental, regulatory, and technical factors
affecting our operations, pricing, products, and services, including the ? potential effects of the CARES Act, and other risks described elsewhere in this
Form 10-Q and our other reports filed with the
Commission ("SEC"), including our Annual Report on Form 10-K for the year ended
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.
Highlights in Response to the COVID-19 Pandemic
Due to the current global situation surrounding the COVID-19 pandemic, the Company is offering a variety of relief options designed to support our customers and the communities we serve.
Paycheck Protection Program ("PPP") Participation. The Coronavirus Aid, Relief
and Economic Security Act, or CARES Act, was signed into law on March 27, 2020 ,
and authorized the Small Business Administration ("SBA") to temporarily
guarantee loans under a loan program called the Paycheck Protection Program, or
PPP. The goal of the PPP was to avoid as many layoffs as possible, and to
encourage small businesses to maintain payrolls. As a qualified SBA lender, the
Company was automatically authorized to originate PPP loans upon commencement of
the program in April 2020 . PPP loans have: (a) an interest rate of 1.0%, (b) a
two or five-year loan term to maturity, and (c) principal and interest payments
deferred for six months or less from the date of disbursement. The SBA
guarantees 100% of the PPP loans made to eligible borrowers. The entire
principal amount of the borrower's PPP loan, including any accrued interest, is
eligible to be forgiven and repaid by the SBA provided that certain criteria is
met by the borrower. The PPP program concluded on August 8, 2020 . The Company
has 471 PPP loans totaling $74.1 million as of September 30, 2020 for customers
who are small- to mid-size businesses as well as independent contractors, sole
proprietors and partnerships as allowed under the PPP guidance issued in April
2020 . We have utilized the FRB's Paycheck Protection Program Liquidity Facility
("PPPLF"), pursuant to which the Company has pledged its PPP loans as collateral
at face value to obtain FRB non-recourse loans. For additional information
regarding the PPPLF, see the discussion included in "Note 18 - COVID-19
Pandemic" to the Notes to Consolidated Financial Statements included in Part I.
Item 1 of this report.
Allowance for Loan Losses and Loan Modifications
The Company recorded a provision of$3.1 million and$11.4 million for the quarter and nine months endedSeptember 30, 2020 , respectively, compared to$573,000 and$2.2 million for the quarter and nine months endedSeptember 30, 2019 , respectively, due primarily to probable loan losses reflecting the adverse impact of the COVID-19 pandemic on the economy. According to the CARES Act and related banking agency guidance, banks are not required to designate as TDRs the modification of loans as a result of the COVID-19 pandemic, made on a good faith basis to borrowers who were current, as defined under the CARES Act prior to any relief. This includes short-term (e.g. less than six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current under the CARES Act and related banking agency guidance if they are not more than 30 days past due on their contractual payments as ofDecember 31, 2019 , or prior to any relief, respectively, and have experienced financial difficulty as a result of COVID-19. As ofSeptember 30, 2020 , the amount of portfolio loans remaining under payment/relief agreements includes commercial real estate loans of$23.8 million , commercial business loans of$7.6 million , portfolio one-to-four-family loans of$3.3 million , and consumer loans of$280,000 . The primary method of relief is to allow the borrower up to 90-days of interest only payments and/or loan payment deferments, and, on a more limited basis, waived interest, late fees, or interest only loan payments and suspended foreclosure 48 Table of Contents proceedings. These modifications were not classified as TDRs atSeptember 30, 2020 in accordance with the guidance of the CARES Act and related banking agency guidance. Loan modifications in accordance with the CARES Act and related banking agency guidance are still subject to an evaluation in regard to determining whether or not a loan is deemed to be impaired.
Branch Operations and Additional Client Support
We have taken various steps to ensure the safety of our customers and our personnel. The majority of our employees are working remotely or have flexible work schedules, and we have established protective measures within our offices to help ensure the safety of those employees who must work on-site. The Families First Coronavirus Response Act also provides additional flexibility to our employees to help navigate their individual challenges with paid sick leave or expanded family and medical leave for specified reasons related to COVID-19. Since the termination of the stay-at-home order inWashington State and phased re-opening of businesses, the Company has taken steps to resume more normal branch activities with specific guidelines in place to ensure the safety of the Company's customers and personnel. All of our branches are currently open. Overdraft and fee reversals are waived on a case-by-case basis. We are cautious when paying overdrafts beyond the client's total deposit relationship, overdraft protection options or their overdraft coverage limits.
Overview
FS Bancorp, Inc. and its subsidiary bank,1st Security Bank of Washington 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, Inc. 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, and one loan production office located in the Tri-Cities,Washington . The Company also maintains its long-standing indirect consumer lending platform which operates throughout theWest Coast . The Company emphasizes long-term relationships with families and businesses within the communities served, working with them to meet their financial needs. The Company is also actively involved in community activities and events within these market areas, which further strengthens our relationships within those markets. The Company focuses on diversifying revenues, expanding lending channels, and growing the banking franchise. Management remains focused on building diversified revenue streams based upon credit, interest rate, and concentration risks. Our business plan remains as follows:
? Growing and diversifying our loan portfolio;
? Maintaining strong asset quality;
? Emphasizing lower cost core deposits to reduce the costs of funding our loan
growth;
Capturing our customers' full relationship by offering a wide range of products ? and services by leveraging our well-established involvement in our communities
and by selectively emphasizing products and services designed to meet our
customers' banking needs; and
? Expanding the Company's markets.
The Company is a diversified lender with a focus on the origination of
one-to-four-family loans, commercial real estate mortgage loans, 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 and had traditionally been the mainstay of the Company's lending
strategy. At both September 30, 2020 and 2019,
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consumer loans represented 24.0% of the Company's total gross loan portfolio.
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, pools, 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 100 active dealers located throughoutWashington ,Oregon ,California ,Idaho ,Colorado ,Arizona ,Minnesota , andNevada with four contractor/dealers responsible for 47.4% of the funded loans dollar volume for the three months endedSeptember 30, 2020 . The Company funded$42.0 million , or approximately 2,000 loans during the quarter endedSeptember 30, 2020 . The following table details fixture secured loan originations by state for the periods indicated: For the Nine Months Ended For the Twelve Months Ended September 30, 2020 December 31, 2019 State Amount Percent Amount Percent Washington$ 58,589 42.4 %$ 66,834 41.9 % Oregon 36,158 26.1 43,036 27.0 California 29,054 21.0 34,027 21.4 Idaho 7,658 5.5 9,371 5.9 Colorado 3,698 2.7 3,493 2.2 Arizona 2,188 1.6 2,586 1.6 Minnesota 592 0.4 - - Nevada 405 0.3 - - Total consumer loans$ 138,342 100.0 %$ 159,347 100.0 % The Company originates one-to-four-family residential mortgage loans through referrals from real estate agents, financial planners, builders, and from existing customers. Retail banking customers are also an important source of the Company's loan originations. The Company originated$1.35 billion 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$7.0 million through the home lending segment during the nine months endedSeptember 30, 2020 , of which$1.12 billion were sold to investors. Of the loans sold to investors,$993.4 million were sold to theFNMA , FHLMC, FHLB, and/or GNMA with servicing rights retained for the purpose of further developing these customer relationships. AtSeptember 30, 2020 , one-to-four-family residential mortgage loans held for investment, which excludes loans held for sale of$215.1 million , totaled$300.9 million , or 19.8%, of the total gross loan portfolio. For the nine months endedSeptember 30, 2020 , there were higher volumes of refinances and sales of one-to-four-family homes, compared to the prior years' surge in construction loans due to lower housing inventories. Residential construction and development lending, while not as common as other 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 twelve 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 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 50
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borrowings outstanding during the same period and interest rates paid on these deposits and borrowings. Because the length of the COVID-19 pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including the 150 basis point reductions in the targeted federal funds rate inMarch 2020 , until the pandemic subsides the Company expects its net interest income and net interest margin will be adversely affected in 2020 and possibly longer. Another significant influence on the Company's earnings is fee income from mortgage banking activities. The Company's earnings are also affected by the provision for loan losses, service charges and fees, gains from sales of assets, operating expenses and income taxes. The Company recorded a provision of$11.4 million for the nine months endedSeptember 30, 2020 , compared to$2.2 million for the same period one year ago, due primarily to the incurred but not yet experienced probable loan losses reflecting credit deterioration due to the adverse impact of the COVID-19 pandemic, the increase in the loan portfolio due to organic growth, and net loan charge-offs.
Critical Accounting Policies and Estimates
Certain of the Company's accounting policies are important to the portrayal of
the Company's financial condition, since they require management to make
difficult, complex, or subjective judgments, some of which may relate to matters
that are inherently uncertain. Estimates associated with these policies are
susceptible to material changes as a result of changes in facts and
circumstances. Facts and circumstances which could affect these judgments
include, but are not limited to, changes in interest rates, changes in the
performance of the economy, and changes in the financial condition of borrowers.
Management believes that its critical accounting policies include the following:
Allowance for Loan and Lease Losses ("ALLL"). The ALLL is the amount estimated
by management as necessary to cover probable losses inherent in the loan
portfolio at the balance sheet date. The ALLL is established through the
provision for loan losses, which is charged to income. A high degree of judgment
is necessary when determining the amount of the ALLL. Among the material
estimates required to establish the ALLL are: loss exposure at default; the
amount and timing of future cash flows on impacted loans; value of collateral;
and determination of loss factors to be applied to the various elements of the
portfolio. All of these estimates are susceptible to significant change.
Management reviews the level of the ALLL at least quarterly and establishes the
provision for loan losses based upon an evaluation of the portfolio, past loss
experience, current economic conditions, and other factors related to the
collectability of the loan portfolio. Although the Company believes that use of
the best information available currently establishes the ALLL, future
adjustments to the ALLL may be necessary if economic conditions differ
substantially from the assumptions used in making the evaluation. As the Company
adds new products to the loan portfolio and expands the Company's market area,
management intends to enhance and adapt the methodology to keep pace with the
size and complexity of the loan portfolio. Changes in any of the above factors
could have a significant effect on the calculation of the ALLL in any given
period. Management believes that its systematic methodology continues to be
appropriate.
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.
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.
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Derivatives and Hedging Activity. ASC 815, "Derivatives and Hedging," requires that derivatives of the Company be recorded in the consolidated financial statements at fair value. Management considers its accounting policy for derivatives to be a critical accounting policy because these instruments have certain interest rate risk characteristics that change in value based upon changes in the capital markets. Fair values for derivative assets and liabilities are measured on a recurring basis. The Company's primary use of derivative instruments are related to the mortgage banking activities in the form of commitments to extend credit, commitments to sell loans, TBA mortgage-backed securities trades and option contracts to mitigate the risk of the commitments to extend credit. Estimates of the percentage of commitments to extend credit on loans to be held for sale that may not fund are based upon historical data and current market trends. The fair value adjustments of the derivatives are recorded in the Consolidated Statements of Income with offsets to other assets or other liabilities on the Consolidated Balance Sheets. Derivative instruments not related to mortgage banking activities primarily relate to interest rate swap agreements accounted for as cash flow 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 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. 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 10 - Fair Value Measurements" of the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report. 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 provision represents the difference between net deferred tax asset/liability at the beginning and end of the reported period. In formulating the deferred tax asset, the Company is required to estimate income and taxes in the jurisdiction in which the Company operates. This process involves estimating the actual current tax exposure for the reported period together with assessing temporary differences resulting from differing treatment of items, such as depreciation and the provision for loan losses, for tax and financial reporting purposes.
Deferred tax 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
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deductible or payable in future periods. The Company had net deferred tax
liabilities of
Comparison of Financial Condition at
Assets. Total assets increased$341.6 million , or 19.9%, to$2.05 billion atSeptember 30, 2020 , compared to$1.71 billion atDecember 31, 2019 , primarily due to increases in loans receivable, net of$155.2 million , loans held for sale of$145.4 million , securities available-for-sale, of$47.0 million , other assets of$5.8 million , and securities held-to-maturity of$5.5 million , partially offset by decreases in total cash and cash equivalents of$9.7 million , certificates of deposit at other financial institutions of$6.6 million , and FHLB stock of$1.5 million . The increases in total assets were primarily funded by deposit growth and the use of PPPLF funds and FRB borrowings. Loans receivable, net increased$155.2 million to$1.49 billion atSeptember 30, 2020 , from$1.34 billion atDecember 31, 2019 . Total real estate loans increased$66.8 million , including increases in one-to-four-family portfolio loans of$39.3 million , which includes$20.1 million of adjustable rate mortgage loans purchased in the first quarter of 2020, commercial real estate loans of$16.6 million , construction and development loans of$12.3 million , and home equity loans of$2.3 million , partially offset by a decrease in multi-family loans of$3.7 million . Undisbursed construction and development loan commitments increased$48.6 million , or 51.2%, to$143.6 million atSeptember 30, 2020 , as compared to$95.0 million atDecember 31, 2019 . Commercial business loans increased$62.1 million , due to increases in commercial and industrial loans of$83.7 million , reflecting primarily PPP loans of$74.1 million originated in the second and third quarters of 2020 and the$3.7 million purchase of aU.S. Department of Agriculture guaranteed loan in the first quarter of 2020, partially offset by the decrease in warehouse lending of$21.6 million .
Consumer loans increased
Loans held for sale, consisting of one-to-four-family loans, increased by$145.4 million , or 208.6%, to$215.1 million atSeptember 30, 2020 , from$69.7 million atDecember 31, 2019 . The Company continues to build its home lending operations and strategically add production staff in the markets we serve. One-to-four-family loan originations, included$1.26 billion of loans originated for sale,$86.2 million of portfolio loans including first and second liens, and$7.0 million of loans brokered to other institutions. Refinance activity increased significantly over the last year in response to decreases in market interest rates.
Originations of one-to-four-family loans to purchase and to refinance a home for the periods indicated were as follows:
For the Nine Months Ended For the Nine Months Ended Year Year
September 30, 2020 September 30, 2019 over Year over Year
Amount Percent Amount Percent $ Change % Change
Purchase $ 502,067 37.1 % $ 411,167 64.4 % $ 90,900 22.1
Refinance 851,821 62.9 227,547 35.6 624,274 274.3
Total $ 1,353,888 100.0 % $ 638,714 100.0 % $ 715,174 112.0
During the nine months ended September 30, 2020 , the Company sold $1.12 billion
of one-to-four-family loans, compared to sales of $551.6 million for the same
period one year ago. In addition, the cash margin on loans sold, net of deferred
fees and capitalized expenses, increased to 2.24% for the nine months ended
September 30, 2020 , compared to 1.66% for the nine months ended September 30,
2019 . 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, excluding capitalized costs and deferred fees, were 4.02% and 3.31% for
the nine months ended September 30, 2020 and 2019, respectively.
The ALLL was
Substandard loans increased to$18.5 million atSeptember 30, 2020 , compared to$6.7 million atDecember 31, 2019 . This increase in substandard loans was mostly driven by the downgrade of two one-to-four-family loan relationships with principal balances totaling$6.5 million , primarily due to COVID-19 related factors, the downgrade of two commercial business loans totaling$4.3 million , which were also classified as non-performing, and two commercial real estate loans 53 Table of Contents
totaling
At
September 30, 2020 , non-performing loans consisted of$4.3 million in commercial business loans,$1.1 million in commercial real estate loans,$781,000 of indirect home improvement loans,$733,000 in one-to-four-family loans, and$636,000 of home equity loans. The ratio of non-performing loans to total gross loans was 0.50% atSeptember 30, 2020 , compared to 0.22% atDecember 31, 2019 . There was one OREO property in the amount of$90,000 atSeptember 30, 2020 , and two OREO properties totaling$168,000 atDecember 31, 2019 .
In accordance with acquisition accounting, the ALLL does not include the
recorded discount on loans acquired in the Anchor Acquisition of
Loans in their respective industries that were downgraded as a result of the COVID-19 pandemic and remain downgraded at the dates indicated are as follows: (Dollars in thousands) Loan types: September 30, 2020 June 30, 2020 March 31, 2020 Construction $ 4,335 $ 4,704 $ 4,565 Education/worship 4,796 5,558 5,525 Food and beverage 14,346 16,199 12,988 Hospitality 43,903 44,136 15,578 Manufacturing 18,765 19,777 18,122 Retail 2,663 11,865 4,058 Transportation 4,992 4,532 5,111 Other 23,241 20,040 18,452 Total $ 117,041$ 126,811 $ 84,399 Additionally, management increased the economic factors of the ALLL associated with the loan portfolio based on current economic conditions and the potential effects from higher forecasted unemployment rates and lower gross domestic product, as well as the impact on other economic conditions on theU.S. and global economies from COVID-19. Management recognizes the potential impact on all of our customers and will continue to assess and evaluate our level of reserves against our homogenous residential and consumer portfolios during the COVID-19 pandemic.
Liabilities. Total liabilities increased
Total deposits increased$220.8 million to$1.61 billion atSeptember 30, 2020 , from$1.39 billion atDecember 31, 2019 . The increase in deposits was primarily driven by organic growth in customer relationships, proceeds from PPP loans and government stimulus checks deposited directly into customer accounts, and reduced withdrawals from deposit accounts due to a change in spending habits as a result of COVID-19. Relationship-based transactional accounts (noninterest-bearing checking, interest-bearing checking, and escrow accounts) increased$134.8 million to$586.4 million atSeptember 30, 2020 , from$451.6 million atDecember 31, 2019 , primarily due to a$78.7 million increase in noninterest-bearing checking, and a$51.6 million increase in interest-bearing checking. Money market and savings accounts increased$133.1 million to$522.5 million atSeptember 30, 2020 , from$389.3 million atDecember 31, 2019 . Time deposits decreased$47.2 million to$504.3 million atSeptember 30, 2020 , from$551.5 million atDecember 31, 2019 due to a managed run-off of higher costing CDs. Non-retail certificates of deposit ("CDs") which includes brokered CDs, online CDs, and public funds increased$27.1 million to$173.3 million atSeptember 30, 2020 , compared to$146.2 million atDecember 31, 2019 , primarily due to a$24.7 million increase in brokered CDs. Management remains focused on increasing its lower cost relationship-based deposits to fund long-term asset growth. 54 Table of Contents
Deposits are summarized as follows at the periods indicated:
September 30, December 31,
2020 (1)(2) 2019(1)(2)
Noninterest-bearing checking $ 338,781 $ 260,131
Interest-bearing checking 229,576 177,972
Savings 144,886 118,845
Money market (3) 377,585 270,489
Certificates of deposit less than $100,000 (4) 285,650 277,988
Certificates of deposit of $100,000 through $250,000 150,437 181,402
Certificates of deposit of $250,000 and over(5) 68,242 92,110
Escrow accounts related to mortgages serviced 18,062 13,471
Total $ 1,613,219 $ 1,392,408
__________________________
(1) Includes
Purchase and
(2) Includes
and
(3) Includes
2020 and
(4) Includes
and
(5) Time deposits that meet or exceed the
Borrowings increased
Management entered into two liability interest rate swap arrangements designated as cash flow hedges in the first quarter of 2020 and one liability interest rate swap arrangement in the third quarter of 2020 to lock the expense costs associated with$90.0 million in brokered deposits and borrowings. The average cost of these$90 million in notional pay fixed interest rate swap agreements was 73 basis points for which the Bank will pay 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 will continue to implement processes to match balance sheet funding duration and minimize interest rate risk and costs. Stockholders' Equity. Total stockholders' equity increased$20.3 million to$220.6 million atSeptember 30, 2020 , from$200.2 million atDecember 31, 2019 . The increase in stockholders' equity during the nine months endedSeptember 30, 2020 , was primarily due to net income of$27.9 million and$2.5 million of other comprehensive income, net of tax, partially offset by common stock repurchases of$8.7 million under our 2020 stock repurchase plans. The Company repurchased 227,010 shares of its common stock in accordance with the stock repurchase plans during the nine months endedSeptember 30, 2020 , at an average price of$38.22 per share. Book value per common share was$52.82 atSeptember 30, 2020 , compared to$45.85 atDecember 31, 2019 . We calculated book value based on common shares outstanding of 4,263,091 atSeptember 30, 2020 , less 55,092 unvested restricted stock shares, and 32,401 of unallocated ESOP shares for the reported common shares outstanding of 4,175,598. Common shares outstanding was calculated using 4,459,041 shares atDecember 31, 2019 , less 40,215 unvested restricted stock shares, and 51,842 of unallocated ESOP shares for the reported common shares outstanding of 4,366,984.
Comparison of Results of Operations for the Three Months Ended
General. Net income was$12.7 million for the three months endedSeptember 30, 2020 , and$7.1 million for the three months endedSeptember 30, 2019 . Net income for the three months endedSeptember 30, 2020 was primarily impacted by a$10.8 million , or 160.2% increase in noninterest income, partially offset by a$2.5 million increase in the provision for loan losses and a$2.5 million , or 16.7% increase in noninterest expense. Earnings for the quarter also reflect the impact of the COVID-19 pandemic which resulted in a substantial reduction in business activity or the closing of businesses in the market areas we operate. 55 Table of Contents
The following table sets forth the average balances of all major categories of interest-earning assets and interest-bearing liabilities to calculate the comparison of results of operations for the three months endedSeptember 30, 2020 and 2019: For the Three Months Ended For the Three Months Ended September 30, 2020 September 30, 2019 Average Interest Average Interest Balance Earned/ Balance Earned/
Average Balances Outstanding Paid Yield/ Rate Outstanding Paid Yield/ Rate ASSETS Loans receivable, net deferred loan fees (1)$ 1,648,070 $ 21,066 5.09%$ 1,368,962 $ 21,466 6.22% Mortgage-backed securities 70,502 408 2.30% 48,152 389 3.21% Investment securities 97,055 533 2.18% 51,661 353 2.71% Federal Home Loan Bank stock 7,219 83 4.57% 8,334 107 5.09% Interest-bearing deposits at other financial institutions 97,473 138 0.56% 74,234 396 2.12% Total interest-earning assets 1,920,319 22,228 4.60%
1,551,343 22,711 5.81%
Noninterest-earning assets 94,190 101,873
Total assets $ 2,014,509 $ 1,653,216
LIABILITIES AND STOCKHOLDERS'
EQUITY
Savings and money market $ 499,138 $ 464 0.37% $ 366,282 $ 777 0.84%
Interest-bearing checking 223,578 87 0.15% 188,883 474 1.00%
Certificates of deposit 546,079 2,086 1.52% 513,024 2,972 2.30%
Borrowings 152,045 503 1.32% 83,208 582 2.77%
Subordinated note 9,897 170 6.83% 9,877 171 6.87%
Total interest-bearing
liabilities 1,430,737 3,310 0.92% 1,161,274 4,976 1.70%
Noninterest-bearing accounts 344,731
276,689
Other noninterest-bearing
liabilities 28,698 23,075
Stockholders' equity 210,343 192,178
Total liabilities and
stockholders' equity $ 2,014,509 $ 1,653,216
Net interest income $ 18,918 $ 17,735
Net interest rate spread 3.68% 4.11%
Net earning assets $ 489,582 $ 390,069
Net interest margin 3.92% 4.54%
Average interest-earning
assets to averageinterest-bearing liabilities 134.22%
133.59%
_______________________
(1) Includes loans held for sale.
Net Interest Income. Net interest income increased$1.2 million to$18.9 million for the three months endedSeptember 30, 2020 , from$17.7 million for the three months endedSeptember 30, 2019 . This increase was primarily the result of increased loans and deposits partially offset by lower interest-earning asset yields and cost of funds. Interest income decreased$483,000 , including decreases of$400,000 in interest income on loans receivable, including fees, impacted primarily by the recent significant reduction in market interest rates decreasing yields on new loan originations and adjustable rate instruments, including PPP loans, and the impact of refinances of higher yielding one-to-four-family portfolio loans, along with an$83,000 decrease in interest and dividends on investment securities, and cash and cash 56
Table of Contents
equivalents. Interest expense decreased
The net interest margin ("NIM") decreased 62 basis points to 3.92% for the
three months ended September 30, 2020 , from 4.54% for the same period in the
prior year. The decrease in NIM was impacted by higher balances of low yielding
cash balances and reduced interest rates on new fixed-rate real estate loan
originations and adjustable-rate commercial loans, as well as repricing loans
from the March 2020 interest rate cuts due to COVID-19. Management remains
focused on matching deposit/liability duration with the duration of loans/assets
where appropriate.
Interest Income. Interest income for the three months ended September 30, 2020 ,
decreased $483,000 , to $22.2 million , from $22.7 million for the three months
ended September 30, 2019 . The decrease during the period was primarily
attributable to a 121 basis point decrease in the average yield on
interest-earning assets to 4.60% for the three months ended September 30, 2020 ,
compared to 5.81% for the three months ended September 30, 2019 . The decrease in
average yield on interest-earning assets compared to the same period a year
earlier primarily reflects the reduction of higher interest rate and fee income
loans, particularly construction and development loans, the impact of refinances
of one-to-four-family loans and the origination of PPP loans. The impact of PPP
loans on loan yields will change during any period based on the volume of
prepayments or amounts forgiven by the SBA as certain criteria are met, but is
expected to cease completely after the maturity of the loans.
The following table compares average earning asset balances, associated yields,
and resulting changes in interest income for the three months ended September
30, 2020 and 2019:
Three Months Ended September 30,
2020 2019 (Decrease)/
Average Average Increase
Balance Yield/ Balance Yield/ in Interest
(Dollars in thousands) Outstanding Rate Outstanding Rate Income
Loans receivable, net and loans held
for sale $ 1,648,070 5.09 % $ 1,368,962 6.22 % $ (400)
Mortgage-backed securities 70,502 2.30 48,152 3.21 19
Investment securities 97,055 2.18 51,661 2.71 180
FHLB stock 7,219 4.57 8,334 5.09 (24)
Interest-bearing deposits at other
financial institutions 97,473 0.56 74,234 2.12 (258)
Total interest-earning assets $ 1,920,319 4.60 % $ 1,551,343 5.81 % $ (483) Interest Expense. Interest expense decreased$1.7 million , to$3.3 million for the three months endedSeptember 30, 2020 , from$5.0 million for the same prior year period, due to decreases of interest expense on deposits of$1.6 million and on borrowings of$79,000 . The average cost of funds for total interest-bearing liabilities decreased 78 basis points to 0.92% for the three months endedSeptember 30, 2020 , from 1.70% for the three months endedSeptember 30, 2019 . The decrease was predominantly due to the decrease in cost for market rate deposits and decreased borrowing costs reflecting the lower market interest rates. The average cost of total interest-bearing deposits decreased 74 basis points to 0.83%, for the three months endedSeptember 30, 2020 , compared to 1.57%, for the three months endedSeptember 30, 2019 , reflecting lower market interest rates primarily in interest-bearing checking, brokered CDs, and CDs. 57 Table of Contents
The following table details average balances for cost of funds on
interest-bearing liabilities and the change in interest expense for the three
months ended
Three Months Ended September 30,
2020 2019
Average Average (Decrease)
Balance Yield/ Balance Yield/ in Interest
(Dollars in thousands) Outstanding Rate Outstanding Rate Expense
Savings and money market $ 499,138 0.37 % $ 366,282 0.84 % $ (313)
Interest-bearing checking 223,578 0.15 188,883 1.00 (387)
Certificates of deposit 546,079 1.52 513,024 2.30 (886)
Borrowings 152,045 1.32 83,208 2.77 (79)
Subordinated note 9,897 6.83 9,877 6.87 (1)
Total interest-bearing liabilities
Provision for Loan Losses. For the three months endedSeptember 30, 2020 , the provision for loan losses was$3.1 million , compared to$573,000 for the three months endedSeptember 30, 2019 , due primarily to the incurred but not yet reported probable loan losses reflecting credit deterioration due to the adverse impact of the COVID-19 pandemic and the increase in the loan portfolio due to organic growth. The$74.1 million balance of PPP loans was omitted from the calculation for the allowance for loan and lease losses atSeptember 30, 2020 as these loans are fully guaranteed by the SBA and management expects that the great majority of PPP borrowers will seek full or partial forgiveness of their loan obligations from the SBA within a short time frame, which in turn will reduce the Bank's loan balance for the amount forgiven. In addition, the current quarter provision for loan losses also reflects risk rating downgrades on loans that are considered at risk due to the COVID-19 pandemic. During the three months endedSeptember 30, 2020 , net loan recoveries totaled$175,000 , compared to net loan charge-offs of$147,000 during the three months endedSeptember 30, 2019 . A further decline in national and local economic conditions, as a result of the COVID-19 pandemic or other factors, could result in a material increase in the ALLL and may adversely affect the Company's financial condition and results of operations. Noninterest Income. Noninterest income increased$10.8 million , or 160.2%, to$17.5 million for the three months endedSeptember 30, 2020 , from$6.7 million for the three months endedSeptember 30, 2019 . The increase between periods was driven by a$11.6 million , or 254.1% increase in gain on sale of loans, primarily due to higher sales volume, partially offset by a$1.1 million , or 66.3% decrease in net service charges and fee income, primarily due to an increase in mortgage servicing rights amortization of$711,000 reflecting higher volumes of loan payoffs in the underlying servicing portfolio from declining interest rates and increased refinancing activity. Noninterest Expense. Noninterest expense increased$2.5 million , or 16.7%, to$17.2 million for the three months endedSeptember 30, 2020 , from$14.7 million for the three months endedSeptember 30, 2019 . The increase in noninterest expense primarily reflects a$2.4 million increase in salaries and benefits, primarily attributable to increases in incentives and commissions of$5.9 million driven by increased production of loans held for sale, and compensation of$792,000 , partially offset by increases in recognized deferred costs on direct loan origination activities of$4.7 million . In addition,FDIC insurance premiums increased$319,000 to$290,000 as a portion of the Bank's small bank assessment credit offset the assessment in the quarter endedSeptember 30, 2019 , with no such credit available in the quarter endedSeptember 30, 2020 .
The efficiency ratio, which is noninterest expense as a percentage of net
interest income and noninterest income, improved to 47.11% for the three months
ended
Provision for Income Tax. For the three months endedSeptember 30, 2020 , the Company recorded a provision for income tax expense of$3.5 million on pre-tax income as compared to$2.0 million for the three months endedSeptember 30, 2019 . The effective corporate income tax rates for the three months endedSeptember 30, 2020 and 2019 were 21.5% and 22.2%, respectively. The increase in the tax provision is primarily due to a$7.0 million increase in pre-tax income during the three months endedSeptember 30, 2020 , as compared to the same period last year. 58 Table of Contents
Comparison of Results of Operations for the Nine Months Ended
General. Net income was$27.9 million for the nine months endedSeptember 30, 2020 , and$16.8 million for the nine months endedSeptember 30, 2019 . Net income for the nine months endedSeptember 30, 2020 was primarily impacted by a$23.2 million , or 133.4% increase in noninterest income, partially offset by a$9.2 million increase in provision for loans losses. Earnings for the period also reflect the impact of the COVID-19 pandemic which, until recently, resulted in a substantial reduction in business activity or the closing of businesses in the market areas we operate. 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 nine months endedSeptember 30 ,
2020
and 2019:
For the Nine Months Ended For the Nine Months Ended
September 30, 2020 September 30, 2019
Average Balance Interest Earned/ Interest Earned/
Average Balances Outstanding Paid Yield/ Rate Average Balance Outstanding Paid Yield/ Rate
ASSETS
Loans receivable, net deferred
loan fees (1) $ 1,537,365 $ 62,370 5.42% $ 1,352,007 $ 63,677 6.30%
Mortgage-backed securities 68,996 1,231 2.38% 47,545 1,027 2.89%
Investment securities 83,006 1,401 2.25% 52,000 1,101 2.83%Federal Home Loan Bank stock 8,240 301 4.88% 8,482 342
5.39%
Interest-bearing deposits at other financial institutions 100,836 587 0.78% 75,425 1,240
2.20%
Total interest-earning assets 1,798,443 65,890 4.89% 1,535,459 67,387 5.87% Noninterest-earning assets 97,435 96,602 Total assets $ 1,895,878 $ 1,632,061 LIABILITIES AND STOCKHOLDERS' EQUITY Savings and money market $ 450,731 $ 1,932 0.57% $ 379,995 $ 2,282 0.80% Interest-bearing checking 204,592 299 0.20% 179,819 1,056 0.79% Certificates of deposit 545,473 7,439 1.82% 506,782 8,651 2.28% Borrowings 138,749 1,458 1.40% 93,356 1,932 2.77% Subordinated note 9,892 511 6.90% 9,872 508 6.88% Total interest-bearing liabilities 1,349,437 11,639 1.15% 1,169,824 14,429 1.65%
Noninterest-bearing accounts 314,789
253,529
Other noninterest-bearing
liabilities 25,837 20,456
Stockholders' equity 205,815 188,252
Total liabilities and
stockholders' equity $ 1,895,878 $ 1,632,061
Net interest income $ 54,251 $ 52,958
Net interest rate spread 3.74% 4.22%
Net earning assets $ 449,006 $ 365,635
Net interest margin 4.03% 4.61%
Average interest-earning assets
to average interest-bearing
liabilities 133.27% 131.26%
________________________
(1) Includes loans held for sale
59
Table of Contents
Net Interest Income. Net interest income increased
The NIM decreased 58 basis points to 4.03% for the nine months endedSeptember 30, 2020 , from 4.61% for the same period in the prior year. The decrease in NIM was primarily impacted by increased cash balances and lower interest rates on recent fixed-rate real estate loan originations and adjustable-rate commercial loans, as well as the PPP loans and repricing loans since the 150 basis point reduction in the targeted federal funds rate inMarch 2020 due to COVID-19. Management remains focused on matching deposit/liability duration with the duration of loans/assets where appropriate. Interest Income. Interest income for the nine months endedSeptember 30, 2020 , decreased$1.5 million , to$65.9 million , from$67.4 million for the nine months endedSeptember 30, 2019 . The decrease during the period was primarily attributable to a 98 basis point decrease in the average yield on interest-earning assets to 4.89% for the nine months endedSeptember 30, 2020 , compared to 5.87% for the nine months endedSeptember 30, 2019 . The decrease in average yield on interest-earning assets compared to the same period a year earlier primarily reflects the reduction of higher interest rate and fee income loans, particularly construction and development loans, the impact of refinances of one-to-four-family loans and the origination of PPP loans. The impact of PPP loans on loan yields will change during any period based on the volume of prepayments or amounts forgiven by the SBA as certain criteria are met, but is expected to cease completely after the maturity of the loans. The following table compares average earning asset balances, associated yields, and resulting changes in interest income for the nine months endedSeptember 30, 2020 and 2019:
Nine Months Ended
2020 2019 (Decrease)/
Average Average Increase
Balance Yield/ Balance Yield/ in Interest
(Dollars in thousands) Outstanding Rate Outstanding Rate Income
Loans receivable, net and loans held for sale (1) $ 1,537,365 5.42 %
68,996 2.38 47,545 2.89 204
Investment securities available-for-sale 83,006 2.25 52,000 2.83 300
FHLB stock 8,240 4.88 8,482 5.39 (41)
Interest-bearing deposits at other financial institutions 100,836 0.78 75,425 2.20 (653)
Total interest-earning assets $ 1,798,443 4.89 %$ 1,535,459 5.87 %$ (1,497)
Interest Expense. Interest expense decreased$2.8 million , to$11.6 million for the nine months endedSeptember 30, 2020 , from$14.4 million for the same prior year period, primarily due to decreased interest expense on deposits of$2.3 million and of interest expense on borrowings of$474,000 . The average cost of funds for total interest-bearing liabilities decreased 50 basis points to 1.15% for the nine months endedSeptember 30, 2020 , from 1.65% for the nine months endedSeptember 30, 2019 . The decrease was predominantly due to lowered borrowing interest expense, primarily due to the reduction of interest rates for the use of FHLB borrowings and the repricing of CD deposits. The average cost of total interest-bearing deposits decreased 42 basis points to 1.08%, for the nine months endedSeptember 30, 2020 , compared to 1.50%, for the nine months endedSeptember 30, 2019 , reflecting lower market interest rates primarily in interest-bearing checking, brokered CDs, and CDs. 60 Table of Contents
The following table details average balances for cost of funds on
interest-bearing liabilities and the change in interest expense for the nine
months ended
Nine Months Ended September 30,
2020 2019 (Decrease)/
Average Average Increase
Balance Yield/ Balance Yield/ in Interest
(Dollars in thousands) Outstanding Rate Outstanding Rate Expense
Savings and money market $ 450,731 0.57 % $ 379,995 0.80 % $ (350)
Interest-bearing checking 204,592 0.20 179,819 0.79 (757)
Certificates of deposit 545,473 1.82 506,782 2.28 (1,212) Borrowings 138,749 1.40 93,356 2.77 (474) Subordinated note 9,892 6.90 9,872 6.88 3
Total interest-bearing liabilities
Provision for Loan Losses. For the nine months endedSeptember 30, 2020 , the provision for loan losses was$11.4 million , compared to$2.2 million for the nine months endedSeptember 30, 2019 , due primarily to the incurred but not yet reported probable loan losses reflecting credit deterioration due to the adverse impact of the COVID-19 pandemic, the increase in the loan portfolio due to organic growth. In addition, the provision for credit losses also reflects risk rating downgrades on loans that are considered at risk due to the COVID-19 pandemic. During the nine months endedSeptember 30, 2020 , net loan recoveries totaled$135,000 , compared to net loan charge-offs of$1.8 million during the nine months endedSeptember 30, 2019 . A further decline in national and local economic conditions, as a result of the COVID-19 pandemic or other factors, could result in a material increase in the ALLL and may adversely affect the Company's financial condition and results of operations. Noninterest Income. Noninterest income increased$23.2 million , or 133.4%, to$40.6 million for the nine months endedSeptember 30, 2020 , from$17.4 million for the nine months endedSeptember 30, 2019 . This increase was impacted by a$24.9 million increase in gain on sale of loans and a$1.5 million , or 153.0% increase in other noninterest income, mostly due to the one-time sale of ClassB Visa stock shares of$1.5 million in the first quarter of 2020. These increases were partially offset by a$3.6 million , or 69.5% decrease in net service charges and fee income, primarily due to an increase in mortgage servicing rights amortization of$3.2 million , primarily a result of higher volumes of loan payoffs in the underlying servicing portfolio. Noninterest Expense. Noninterest expense increased$1.4 million , or 3.0%, to$48.0 million for the nine months endedSeptember 30, 2020 , from$46.6 million for the nine months endedSeptember 30, 2019 . This increase was primarily due to was primarily due to a$2.4 million increase in salaries and benefits, primarily attributable to increases in incentives and commissions of$11.2 million , again driven by increased production of HFS loans, and compensation of$2.0 million , partially offset by increases in recognized deferred costs on direct loan origination activities of$11.9 million . In addition, there were no acquisition costs for the nine months endedSeptember 30, 2020 , compared to$1.9 million for the nine months endedSeptember 30, 2019 . Other increases between the periods included$1.1 million in the impairment of servicing rights, and$723,000 in operations expense, partially offset by decreases of$738,000 in loan costs and$612,000 in data processing.
The efficiency ratio, which is noninterest expense as a percentage of net
interest income and noninterest income, improved to 50.61% for the nine months
ended
Provision for Income Tax. For the nine months endedSeptember 30, 2020 , the Company recorded a provision for income tax expense of$7.5 million on pre-tax income of$35.4 million , as compared to a provision of income tax expense of$4.7 million on pre-tax income of$21.5 million for the nine months endedSeptember 30, 2019 . The effective corporate income tax rates for the nine months endedSeptember 30, 2020 and 2019 were 21.2% and 21.9%, respectively. 61 Table of Contents Liquidity
Management maintains a liquidity position that it believes will adequately provide funding for loan demand and deposit runoff that may occur in the normal course of business. The Company relies on a number of different sources in order to meet potential liquidity demands. The primary sources are increases in deposit accounts, FHLB advances, purchases of 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. AtSeptember 30, 2020 , the Bank's total borrowing capacity was$573.8 million with the FHLB ofDes Moines , with unused borrowing capacity of$495.5 million . The FHLB borrowing limit is based on certain categories of loans, primarily real estate loans that qualify as collateral for FHLB advances. AtSeptember 30, 2020 , the Bank held approximately$780.6 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 with the FRB, with a current limit of$173.4 million , and a combined credit limit of$101.0 million in written federal funds lines of credit through correspondent banking relationships atSeptember 30, 2020 . The FRB borrowing limit is based on certain categories of loans, primarily consumer loans that qualify as collateral for FRB line of credit. AtSeptember 30, 2020 , the Bank held approximately$355.8 million in loans that qualify as collateral for the FRB line of credit. The Bank also had available liquidity from the PPPLF, pursuant to which the Company can pledge its PPP loans as collateral at face value to obtain FRB non-recourse loans. As ofSeptember 30, 2020 , the Company had pledged$74.1 million in PPP loans under the PPPLF. AtSeptember 30, 2020 , the Bank had pledged all qualifying PPP loans as collateral, with no additional borrowing capacity under the PPPLF. AtSeptember 30, 2020 , the outstanding balances of FHLB advances, the FRB line of credit, and federal funds lines of credit were$72.5 million ,$27.0 million , and$0 , respectively. The Bank's Asset and Liability Management Policy permits management to utilize brokered deposits up to 20% of deposits or$325.1 million atSeptember 30, 2020 . Total brokered deposits atSeptember 30, 2020 were$166.2 million . Management utilizes brokered deposits to mitigate interest rate risk and liquidity risk exposure when appropriate. Liquidity management is both a daily and long-term function of 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, fund withdrawals, and to fund loan commitments. AtSeptember 30, 2020 , the approved outstanding loan commitments, including unused lines of credit amounted to$611.4 million . Certificates of deposit scheduled to mature in three months or less atSeptember 30, 2020 , totaled$155.7 million . It is management's policy to offer deposit rates that are competitive with other local financial institutions. Based on this management strategy, the Company believes that a majority of maturing relationship deposits will remain with the Bank. As a separate legal entity from the Bank,FS Bancorp, Inc. must provide for its own liquidity. Sources of capital and liquidity forFS Bancorp, Inc. include distributions from the Bank and the issuance of debt or equity securities. Dividends and other capital distributions from the Bank are subject to regulatory notice. AtSeptember 30, 2020 ,FS Bancorp, Inc. had$12.6 million in unrestricted cash to meet liquidity needs.
Commitments and Off-Balance Sheet Arrangements
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the financing needs of its customers. For information regarding our commitments and off-balance sheet arrangements, see "Note 9 - Commitments and Contingencies" 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 theFDIC . Based on its capital levels atSeptember 30, 2020 , 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 . 62
Table of Contents
Based on capital levels atSeptember 30, 2020 , the Bank was considered to be well capitalized. EffectiveJanuary 1, 2020 , a bank that elects to use the Community Bank Leverage Ratio ("CBLR") will generally be considered well-capitalized and to have met the risk-based and leverage capital requirements of the capital regulations if it has a leverage ratio greater than 9.0%. AtSeptember 30, 2020 , the Bank qualified and elected to use the CBLR to measure capital adequacy. The Tier 1 leverage-based capital ratio calculated for the Bank atSeptember 30, 2020 was 10.7%, compared to 11.6% atDecember 31, 2019 . As required by the CARES Act, theFDIC has temporarily lowered the CBLR to 8% beginning in the second quarter of 2020 through the end of the year. Beginning in 2021, the CBLR will increase to 8.5% for that calendar year. The CBLR will return to 9% onJan. 1, 2022 . 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, Inc. were subject to regulatory capital guidelines for bank holding companies with$3.0 billion or more in assets atSeptember 30, 2020 ,FS Bancorp, Inc. would have exceeded all regulatory capital requirements. The Tier 1 leverage-based capital ratio calculated forFS Bancorp, Inc. atSeptember 30, 2020 was 10.8%. For additional information regarding regulatory capital compliance, see the discussion included in "Note 14 -Regulatory Capital " to the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report.
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