Welcome to 1st Security Bank where we have a very simple Vision Statement:
Smart, Driven, Nice people building ‘a truly great place to work and bank.’
We sincerely appreciate your support and will do everything we can to provide our clients
with an exceptional banking experience. Thank you again for your trust in our team.”
All the best,
JOE ADAMS, CEO
DIRECTORS AND OFFICERS
Directors
FS Bancorp, Inc. and 1st Security Bank of Washington
Ted A. Leech, Chairman
Joseph C. Adams, Chief Executive Officer
Joseph P. Zavaglia
Marina Cofer-Wildsmith
Michael J. Mansfield
Margaret R. Piesik
Mark H. Tueffers
Executive Management
1st Security Bank of Washington
Joseph C. Adams, Chief Executive Officer
Erin Burr, Executive Vice President
Donn C. Costa, Executive Vice President
Robert B. Fuller, Chief Credit Officer
Vickie Jarman, Executive Vice President
Matthew D. Mullet, Chief Financial Officer
Kelli B. Nielsen, Executive Vice President
Dennis V. O’Leary, Chief Lending Officer
ANNUAL MEETING
Annual Meeting of Shareholders:
2:00 p.m., Thursday, May 28, 2020
Administrative Center
6920 220th Street SW
Mountlake Terrace, WA 98043
CORPORATE WEBSITE
fsbwa.com
CORPORATE AND SHAREHOLDER
INFORMATION
Transfer Agent
American Stock Transfer & Trust, LLC (AST)
6201 15th Avenue
Brooklyn, NY 11219
1-800-937-5449
astfinancial.com
Independent Auditors
Moss Adams, LLP
Rimland Drive, Suite 300
Bellingham, WA 98226
SEC Counsel
Breyer & Associates PC
8180 Greensboro Drive, Suite 785
McLean, VA 22102
Common Stock
The Company’s common stock is traded
on the NASDAQ Stock Market LLC’s
Capital Market under the symbol “FSBW”
Investor Relations
6920 220th Street SW
Mountlake Terrace, WA 98043
investorrelations.fsbwa.com
FS BANCORP, INC.
CONTACT INFORMATION
Joseph C. Adams
joea@fsbwa.com
Chief Executive Officer
425-697-8048
Matthew D. Mullet
mattm@fsbwa.com
Chief Financial Officer
425-697-8026
To our Shareholders:
Normally I would be focused on 2019’s performance in this Shareholder letter. However, given these
unprecedented times, and the fact that the only thing being talked about is COVID-19, this letter will be
different. As I write this letter the date is Sunday, April 5, 2020. Last week we learned that 6.65 million
Americans filed for unemployment for the week ended March 28. This brought the total unemployment claims
in March to 10 million. These truly are unprecedented times. And of course, the impact from COVID-19 does
not appear to be going away any time soon. Retail stores across the country have closed. The airlines have cut
back flights on a massive scale. Hotels are empty. It’s like we are all living in a bad science fiction movie.
But amidst the current doom and gloom, there is at least one bright spot. This is not 2008. Unlike in 2008, the
banking industry entered this pandemic with stronger fundamentals. During this crisis, the banks will be part of
the solution, not part of the problem as they were during the Great Recession. 1st Security Bank is in excellent
fiscal shape. Below are some of the highlights from 2019’s financial performance:
$22.7 million in reported Net Income which included significant costs associated with the Anchor Bank
core conversion and system integrations;
A record level of Tier 1 capital at FS Bancorp, Inc. of $191.7 million, or 11.30% of average assets;
Improved diversification at 1st Security Bank including a lower concentration to total regulatory capital
in construction lending at 86%, down from 131% at the previous year end and total non-owner CRE
concentrations at 245%, well below the 300% regulatory guidance;
Growth in originations of saleable 1-4 family mortgages to $805 million which increases fee income
while maintaining access to balance sheet liquidity by selling $785 million of these loans primarily to
Fannie and Freddie Mac in 2019; and
Continued diversification in our balance sheet as noted below which are reflected as a percentage of
reported total assets at year-end 2019:
o 15% of assets in investment securities, saleable 1-4 family mortgages and cash
o 19% of assets in small balance consumer loans including 15% of assets in home improvement
consumer loans
o 17% of assets in portfolio residential mortgage loans and home equity lending
o 23% of assets in commercial real estate and construction lending
o 8% of assets in multifamily lending
o 8% of assets in traditional C+I lending
o 4% of assets in warehouse lending
o 6% of assets in buildings, accruals, mortgage servicing, and other miscellaneous assets
We remain focused on maintaining diversified, balanced revenue channels. We have also added several new
commercial lenders and the timing could not have been better. As I type this letter our Commercial Lending
Team is working the weekend inputting client data into the Small Business Administration’s (SBA) website to
assist clients with the new Paycheck Protection Program (PPP). This is an important government program that
will help so many businesses that have been devastated by COVID-19.
It has also been very humbling to watch how all our teams have worked so well together during this time of
worldwide crisis. And “together” has taken on a whole new meaning given the social distancing requirements
here in Washington State. Of our 400+ employees, over 300 are now set up to work remotely. On any given
day we have 230 employees routinely working from home and even though most teammates are working
remotely, great teamwork has not been sacrificed. Everyone is going the extra mile to support each other
during this demanding time. I could not be more proud of my 1SB teammates!
Although no one knows what the future holds, we at FS Bancorp, Inc. will continue to approach any challenge as
an opportunity. We have a long history of being dynamic and improving during challenging times. In the 2008-
2011 time frame many banks in our area either failed or were taken over. Outstanding banking talent became
available and we took advantage of the opportunity. In fact, six of our eight Executive Officers joined the Bank
as a result of the Great Recession. We also benefited when Bank of America decided to downsize its branch
network. The four branches we purchased from Bank of America have grown deposits from $186 million to
$290 million since that time. In addition, another surprising scenario presented itself in 2018 when Anchor
Bank’s sale to Washington Federal fell through. Challenging times tend to create extraordinary opportunities
and we remain poised to act.
I want to again thank all our teammates for their hard work and positive attitudes during this unprecedented
time. I also want to thank our customers. They have shown tremendous patience and grace as we have had to
re-invent how to best serve them while keeping everyone safe from COVID-19. Social distancing creates its own
set of demands when trying to provide outstanding customer service. And to our Shareholders, thank you for
your investment and words of encouragement during this pandemic. We have a very talented team and we are
excited about the future. We know that the current stock price is hard to comprehend and has changed quickly.
We believe we have taken the appropriate measures of diversification, prudent underwriting, and constant
customer outreach to remain safe and sound.
We also believe we have only modest exposure to the industries directly hit hardest by COVID-19 (Retail,
Restaurants, Hotels, Airlines, etc.). And as mentioned before, we believe there will be unforeseen opportunities
that will present themselves during this crisis. We remain very optimistic at 1st Security Bank and FSBW. To
quote Warren Buffett “Be fearful when others are greedy, and greedy when others are fearful.” Let’s face it,
there is a lot of fear out there right now. That fear should create some very interesting opportunities.
Thank you again for your continued support. From everyone at 1st Security Bank and FSBW, please stay safe
and healthy. Take care and all the best in 2020.
Joe Adams
Joe Adams, CEO
FS Bancorp, Inc.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2019 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-35589
FS BANCORP, INC.
(Exact name of registrant as specified in its charter)
Washington
(State or other jurisdiction of incorporation or organization)
6920 220th Street SW, Mountlake Terrace, Washington
(Address of principal executive offices)
Registrant’s telephone number, including area code:
Securities registered pursuant to Section 12(b) of the Act:
45-4585178
(I.R.S. Employer Identification Number)
98043
(Zip Code)
(425) 771-5299
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.01 par value per share
FSBW
The NASDAQ Stock Market LLC
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES [ ] NO [X]
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES [ ] NO [X]
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to
Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was
required to submit such files). YES [X] NO [ ]
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting
company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and
“emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ]
Non-accelerated filer [ ]
Emerging growth company [ ]
Accelerated filer [X]
Smaller reporting company [X]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying
with any new or revised financial accounting standards provided pursuant to Section 13 (a) of the Exchange Act. [ ]
Indicate by check mark whether the Registrant is a shell company (as defined in Exchange Act Rule 12b-2). YES [ ] NO [X]
As of March 6, 2020, there were 4,461,041 shares of the Registrant’s common stock outstanding. The aggregate market value of the common
stock held by non-affiliates of the Registrant was $217,316,990, based on the closing sales price of $51.87 per share of the Registrant’s
common stock as quoted on the NASDAQ Stock Market LLC on June 30, 2019. For purposes of this calculation, common stock held by
executive officers and directors of the Registrant is considered to be held by affiliates.
1. Portions of the definitive Proxy Statement for the 2020 Annual Meeting of Shareholders (“Proxy Statement”) are incorporated by
DOCUMENTS INCORPORATED BY REFERENCE
reference into Part III.
FS Bancorp, Inc.
Table of Contents
PART I
Item 1. Business
General
Market Area
Lending Activities
Loan Originations, Servicing, Purchases and Sales
Asset Quality
Allowance for Loan Losses
Investment Activities
Deposit Activities and Other Sources of Funds
Subsidiary and Other Activities
Competition
Employees
How We Are Regulated
Taxation
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Mine Safety Disclosures
PART II
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities
Item 5.
Item 6. Selected Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Critical Accounting Policies and Estimates
Our Business and Operating Strategy and Goals
Comparison of Financial Condition at December 31, 2019 and December 31, 2018
Average Balances, Interest and Average Yields/Costs
Rate/Volume Analysis
Comparison of Results of Operations for the Years Ended December 31, 2019 and December 31,
2018
Asset and Liability Management and Market Risk
Liquidity
Commitments and Off-Balance Sheet Arrangements
Capital Resources
Recent Accounting Pronouncements
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
i
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28
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31
32
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44
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131
131
132
PART III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
PART IV
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accounting Fees and Services
Item 15.
Item 16.
Exhibits and Financial Statement Schedules
Form 10-K Summary
SIGNATURES
Page
133
133
133
134
134
135
136
136
As used in this report, the terms “we,” “our,” “us,” “Company”, and “FS Bancorp” refer to FS Bancorp, Inc. and
its consolidated subsidiary, 1st Security Bank of Washington, unless the context indicates otherwise. When we refer to
“Bank” in this report, we are referring to 1st Security Bank of Washington, the wholly owned subsidiary of FS Bancorp.
ii
Forward-Looking Statements
This Form 10-K contains forward-looking statements, which can be identified by the use of words such as
“believes,” “expects,” “anticipates,” “estimates” or similar expressions. Forward-looking statements include, but are not
limited to:
statements of our goals, intentions and expectations;
statements regarding our business plans, prospects, growth, and operating strategies;
statements regarding the quality of our loan and investment portfolios; and
estimates of our risks and future costs and benefits.
These forward-looking statements are subject to significant risks and uncertainties. Actual results may differ
materially from those contemplated by the forward-looking statements due to, among others, the following factors:
general economic conditions, either nationally or in our market area, that are worse than expected;
the credit risks of lending activities, including changes in the level and trend of loan delinquencies, write
offs, changes in our allowance for loan losses, and provision for loan losses that may be impacted by
deterioration in the housing and commercial real estate markets;
secondary market conditions and our ability to 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;
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;
iii
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 (the “Dodd Frank Act”), changes in regulation
policies and principles, an increase in regulatory capital requirements or change in the interpretation of
regulatory capital or other rules, including as a result of Basel III;
adverse changes in the securities markets;
changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Public
Company Accounting Oversight Board, or the Financial Accounting Standards Board (“FASB”);
costs and effects of litigation, including settlements and judgments;
disruptions, security breaches, or other adverse events, failures, or interruptions in, or attacks on, our
information technology systems or on the third-party vendors who perform several of our critical processing
functions;
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 coronavirus on international trade (including
supply chains and export levels), and other risks described elsewhere in this Form 10-K and our other reports
filed with the U.S. Securities and Exchange Commission (“SEC”).
Any of the forward-looking statements made in this Form 10-K 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.
Available Information
The Company provides a link on its investor information page at www.fsbwa.com to filings with the SEC for
purposes of providing copies of its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and amendments to these reports, as soon as reasonably practicable after we have electronically filed such
material with, or furnished such material to the SEC. Other than an investor’s own internet access charges, these filings
are free of charge and available through the SEC’s website at www.sec.gov. The information contained on the Company’s
website is not included as part of, or incorporated by reference into, this Annual Report on Form 10-K.
iv
Item 1. Business
General
PART 1
FS Bancorp, Inc. (“FS Bancorp” or the “Company”), a Washington corporation, was organized in
September 2011 for the purpose of becoming the holding company of 1st Security Bank of Washington (“1st Security
Bank of Washington” or the “Bank”) upon the Bank’s conversion from a mutual to a stock savings bank (“Conversion”).
The Conversion was completed on July 9, 2012. At December 31, 2019, the Company had consolidated total assets of
$1.71 billion, total deposits of $1.39 billion, and stockholders’ equity of $200.2 million. The Company has not engaged in
any significant activity other than holding the stock of the Bank. Accordingly, the information set forth in this Annual
Report on Form 10-K (“Form 10-K”), including the consolidated financial statements and related data, relates primarily
to the Bank.
1st Security Bank of Washington is a relationship-driven community bank. The Bank delivers banking and
financial services to local families, local and regional businesses and industry niches within distinct Puget Sound area
communities. The Bank emphasizes long-term relationships with families and businesses within the communities served,
working with them to meet their financial needs. The Bank is also actively involved in community activities and events
within these market areas, which further strengthens relationships within these markets. The Bank has been serving the
Puget Sound area since 1907. Originally chartered as a credit union, and known as Washington’s Credit Union, the Bank
served various select employment groups. On April 1, 2004, the Bank converted from a credit union to a Washington state-
chartered mutual savings bank. Upon completion of the Conversion in July 2012, 1st Security Bank of Washington became
a Washington state-chartered stock savings bank and the wholly owned subsidiary of the Company.
At December 31, 2019, the Bank maintained the headquarter office that accepts deposits located in Mountlake
Terrace, Washington, and an administrative office in Aberdeen, Washington, as well as 21 full-service bank branches and
seven home loan production offices in suburban communities in the greater Puget Sound area. The Bank also has one
home loan production office in the Tri-Cities, Washington. On November 15, 2018, the Company completed the
acquisition of Anchor Bancorp which was merged with and into the Company, and immediately thereafter Anchor’s bank
subsidiary, Anchor Bank was merged with and into 1st Security Bank of Washington (the “Anchor Acquisition”). The
Anchor Acquisition added one administrative office, nine full-service bank branches within Grays Harbor, Thurston,
Lewis, and Pierce counties, and one loan production office located in King County, Washington, that closed on the
acquisition date. The Anchor Acquisition expanded our Puget Sound-focused retail footprint and provided an opportunity
to extend our unique brand of community banking into those communities. For additional information on the Anchor
Acquisition, see “Note 2 - Business Combination” of the Notes to Consolidated Financial Statements included in “Item 8.
Financial Statements and Supplementary Data” of this Form 10-K.
The Company is a diversified lender with a focus on the origination of one-to-four-family, commercial real estate,
consumer, including indirect home improvement (“fixture secured loans”), solar and marine lending, commercial business
and second mortgage or home equity loans. Historically, consumer loans, in particular fixture secured loans represented
the largest portion of the Company’s loan portfolio and the mainstay of the Company’s lending strategy. In recent years,
the Company has placed more of an emphasis on real estate lending products, such as one-to-four-family, commercial real
estate, including speculative residential construction, as well as commercial business loans, while growing the current size
of the consumer loan portfolio. The Company reintroduced in-house originations of residential mortgage loans in 2012,
primarily for sale into the secondary market, through a mortgage banking program. The Company’s lending strategies are
intended to take advantage of: (1) the Company’s historical strength in indirect consumer lending, (2) recent market
consolidation that has created new lending opportunities, and (3) relationship lending. Retail deposits will continue to
serve as an important funding source. For more information regarding the business and operations of 1st Security Bank of
Washington, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of
this Form 10-K.
1st Security Bank of Washington is examined and regulated by the Washington State Department of Financial
Institutions (“DFI”), its primary regulator, and by the Federal Deposit Insurance Corporation (“FDIC”). 1st Security Bank
of Washington is required to have certain reserves set by the Board of Governors of the Federal Reserve System (“Federal
5
Reserve”) and is a member of the Federal Home Loan Bank of Des Moines (“FHLB” or “FHLB of Des Moines”), which
is one of the 11 regional banks in the Federal Home Loan Bank System.
The principal executive offices of the Company are located at 6920 220th Street SW, Mountlake Terrace,
Washington 98043 and its telephone number is (425) 771-5299.
Market Area
The Company conducts operations out of its headquarters, seven home loan production offices (four of which
stand alone), and 21 full-service bank branches in the Puget Sound region of Washington, and one stand-alone loan
production office in Eastern Washington. The headquarters is located in Mountlake Terrace, in Snohomish County,
Washington. The four stand-alone home lending offices in the Puget Sound region are located in Puyallup, in Pierce
County, Bellevue, in King County, Port Orchard, in Kitsap County, Everett, in Snohomish County, and the one in Eastern
Washington located in the Tri-Cities (Kennewick), in Benton County, Washington. The 21 full-service bank branches are
located in the following counties: three in Snohomish, two in King, two in Clallam, two in Jefferson, two in Pierce, five
in Grays Harbor, two in Thurston, one in Lewis, and two in Kitsap County.
The primary market area for business operations is the Seattle-Tacoma-Bellevue, Washington Metropolitan
Statistical Area (the “Seattle MSA”). Kitsap, Clallam, Jefferson, Thurston, Lewis, and Grays Harbor counties, though not
in the Seattle MSA, are also part of the Company’s market area. This overall region is typically known as the Puget Sound
region. The population of the Puget Sound region as estimated by Puget Sound Regional Council was 4.2 million in 2019,
over half of the state’s population, representing a large population base for potential business. The region has a well-
developed urban area in the western portion along Puget Sound, with the north, central and eastern portions containing a
mixture of developed residential and commercial neighborhoods and undeveloped, rural neighborhoods.
The Puget Sound region is the largest business center in both the State of Washington and the Pacific Northwest.
Currently, key elements of the economy are aerospace, military bases, clean technology, biotechnology, education,
information technology, logistics, international trade and tourism. The region is well known for the long presence of The
Boeing Corporation and Microsoft, two major industry leaders, and for its leadership in technology. Amazon.com has
expanded significantly in the Seattle downtown area. The workforce in general is well-educated and strong in technology.
Washington State’s location with regard to the Pacific Rim, along with a deep-water port has made international trade a
significant part of the regional economy. Tourism has also developed into a major industry for the area, due to the scenic
beauty, temperate climate and easy accessibility.
Among the counties the Company operates in, King County, the location of the city of Seattle, has the largest
employment base and overall level of economic activity. Six of the largest employers in the state are headquartered in
King County including Microsoft Corporation, University of Washington, Amazon.com, King County Government,
Starbucks, and Swedish Health Services. Pierce County is the second most populous county in the state and its economy
is also well diversified with the presence of military related government employment (Joint Base Lewis-McChord), along
with health care (the Multicare Health System and the Franciscan Health System). In addition, there is a large employment
base in the economic sectors of shipping (the Port of Tacoma) and aerospace employment (Boeing). Snohomish County
to the north has an economy based on aerospace employment (Boeing), health care (Providence Regional Medical Center),
and military (the Everett Naval Station) along with additional employment concentrations in biotechnology,
electronics/computers, and wood products.
The United States Navy is a key element for Kitsap County’s economy. The United States Navy is the largest
employer in the county, with installations at Puget Sound Naval Shipyard, Naval Undersea Warfare Center Keyport and
Naval Base Kitsap (which comprises former Naval Submarine Base Bangor, and Naval Station Bremerton). The largest
private employers in the county are the Harrison Medical Center and Port Madison Enterprises. Clallam County depends
on agriculture, forestry, fishing, outdoor recreation and tourism. Jefferson County’s largest private employer is Port
Townsend Paper Mill and the largest employer overall (private and public) is Jefferson Healthcare.
From the Anchor Acquisition, we entered three additional counties, Thurston, Lewis, and Grays Harbor. Thurston
County includes Olympia, home of Washington State’s capital and its economic base is largely driven by state government
related employment. Lewis County is supported by manufacturing, retail trade, local government and industrial services.
6
Grays Harbor County has been historically dependent on the timber and fishing industries, but also relies on tourism,
manufacturing, agriculture, shipping, transportation, and technology.
In 2018, the median household income for King County was $95,000, compared to $74,000 for the State of
Washington, and $62,000 for the United States.
Unemployment in Washington was an estimated 4.3% at December 31, 2019, closely paralleling national trends
as disclosed in the U.S. Bureau of Labor Statistics. King County had the lowest unemployment rate in the state at 2.1%, a
decrease from 3.3% in the prior year, and much lower than the state average of 4.3% and national average of 3.5%,
respectively. The estimated unemployment rate in Snohomish County at year end 2019 was 2.4%, decreased from 3.6%
at year end 2018. Kitsap County’s unemployment rate improved slightly to 4.1% at December 31, 2019, compared to
4.9% at December 31, 2018. At December 31, 2019, the estimated unemployment rate in Pierce County was 4.8%, down
from 5.3% at December 31, 2018. Grays Harbor County’s, Thurston County’s, and Lewis County’s unemployment rate
improved to 7.0%, 4.4%, and 6.0%, respectively at December 31, 2019, compared to 7.4%, 5.0%, and 6.9% at year end
2018, respectively. Outside of the Puget Sound area, the Tri-Cities market includes two counties, Benton and Franklin,
and we have two full-service branches in Clallam County and two in Jefferson County. The estimated unemployment rate
in Benton County at year end 2019 was 5.4%, down from 5.8% at year end 2018. At December 31, 2019, the estimated
unemployment rate in Franklin County was down slightly to 7.3%, from 7.7% at December 31, 2018. For Clallam and
Jefferson counties, the estimated unemployment rates at December 31, 2019 decreased to 6.3% and 5.3%, respectively,
compared to 6.9% and 5.9%, respectively at December 31, 2018.
According to the Washington Center for Real Estate Research, home values in the State of Washington continued
to improve in 2019. For the quarter ended December 31, 2019, the average home value was $671,000 in King County,
$495,000 in Snohomish County, $405,000 in Jefferson County, $390,000 in Kitsap County, $375,000 in Pierce County,
$346,000 in Thurston County, $322,000 in Clallam County, $308,000 in both Benton and Franklin counties, $255,000 in
Lewis County, and $216,000 in Grays Harbor County. Compared to the statewide average increase in home values of
11.5% in the fourth quarter of 2019, Kitsap and Lewis counties outperformed the state average with 12.9% and 12.3%,
respectively, with our remaining counties: Benton, Franklin, Pierce, Thurston, Clallam, Grays Harbor, Jefferson,
Snohomish, and King counties below the state average increase, with 10.4%, 10.4%, 9.7%, 9.0%, 8.6%, 8.5%, 4.8%, 4.6%
and 2.1% increases in average home values, respectively.
For a discussion regarding the competition in the Company’s primary market area, see “Competition.”
Lending Activities
General. Historically, the Company’s primary emphasis was the origination of consumer loans (primarily indirect
home improvement loans), one-to-four-family residential first mortgages, and second mortgage/home equity loan
products. As a result of the Company’s initial public offering in 2012, while maintaining the active indirect consumer
lending program, the Company shifted its lending focus to include non-mortgage commercial business loans, as well as
commercial real estate which includes construction and development loans. The Company reintroduced in-house
originations of residential mortgage loans in 2012, primarily for sale in the secondary market. While maintaining the
Company’s historical strength in consumer lending, the Company has added management and personnel in the commercial
and home lending areas to take advantage of the relatively favorable long-term business and economic environments
prevailing in the markets.
7
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1
Lending Authority. The Chief Credit Officer has the authority to approve multiple loans to one borrower up
to $10.0 million in aggregate. All loans that are approved over $5.0 million are reported to the asset quality committee
(“AQC”) at each AQC meeting. Loans in excess of $10.0 million and up to $25.0 million require additional approval
from management’s senior loan committee. The Chief Credit Officer may delegate lending authority to other
individuals at levels consistent with their responsibilities.
The Board of Directors has implemented a lending limit policy that it believes matches the Washington State
legal lending limit. The Bank’s largest lending relationship at December 31, 2019, consisted of a commercial line of
credit to one company having a total available commitment of $45.0 million, with the Bank’s total potential
commitment of $30.0 million, and two other banks participating in the remaining $15.0 million. This line of credit is
secured by notes for 25 properties, primarily located in Seattle, Washington. The outstanding balance of this line of
credit at December 31, 2019 was $30.0 million for the Bank. The second largest lending relationship consisted of
seven residential construction loans and two permanent one-to-four-family loans having combined commitments of
$21.1 million to four related limited liability companies. All of these loans are secured by one-to-four-family
properties located in the Seattle metropolitan area of Washington State. The outstanding balance of these nine loans
at December 31, 2019 was $15.8 million. The third largest lending relationship consisted of a diverse mix of real estate
secured loans having combined commitments of $18.7 million, to 12 related limited liability companies and/or
individuals. All of these loans are secured by real estate located in the Puget Sound region of Washington State. The
outstanding balance of these loans at December 31, 2019 was $18.0 million. At December 31, 2019, all of the
borrowers listed above were in compliance with the original repayment terms of their respective loans.
At December 31, 2019, the Company had $70.0 million in approved commercial construction warehouse
lending lines for six companies. The commitments range from $500,000 to $30.0 million. At December 31, 2019,
there was $48.2 million outstanding, compared to $87.0 million approved in commercial construction warehouse
lending lines for nine companies with $61.4 million outstanding at December 31, 2018. In addition, the Company had
$25.0 million approved in mortgage warehouse lending lines for four companies. The commitments ranged from $4.0
million to $8.0 million. At December 31, 2019, there was $12.9 million in mortgage warehouse lending lines
outstanding, compared to $23.0 million approved in mortgage warehouse lending lines with $4.4 million outstanding
at December 31, 2018. At December 31, 2019, all of these warehouse lines were in compliance with the original
repayment terms of their respective lending lines.
Commercial Real Estate Lending. The Company offers a variety of commercial real estate loans. Most of
these loans are secured by income producing properties, including multi-family residences, retail centers, warehouses
and office buildings located in the market areas. At December 31, 2019, commercial real estate loans (including $133.9
million of multi-family residential loans) totaled $344.7 million, or 25.5%, of the gross loan portfolio.
The Company’s loans secured by commercial real estate are originated with a fixed or variable interest rate
for up to a 15-year maturity and a 30-year amortization. The variable rate loans are indexed to the prime rate of interest
or a short-term LIBOR rate, or five or seven-year FHLB rate, with rates equal to the prevailing index rate to 5.0%
above the prevailing rate. Loan-to-value ratios on the Company’s commercial real estate loans typically do not exceed
80% of the appraised value of the property securing the loan. In addition, personal guarantees are typically obtained
from a principal of the borrower on substantially all credits.
Loans secured by commercial real estate are generally underwritten based on the net operating income of the
property and the financial strength of the borrower. The net operating income, which is the income derived from the
operation of the property less all operating expenses, must be sufficient to cover the payments related to the
outstanding debt plus an additional coverage requirement. The Company generally requires an assignment of rents or
leases in order to be assured that the cash flow from the project will be sufficient to repay the debt. Appraisals on
properties securing commercial real estate loans are performed by independent state certified or licensed fee
appraisers. The Company does not generally maintain insurance or tax escrows for loans secured by commercial real
estate. In order to monitor the adequacy of cash flows on income-producing properties, the borrower is required to
provide financial information on at least an annual basis.
11
Loans secured by commercial real estate properties generally involve a greater degree of credit risk than one-
to-four-family residential mortgage loans. These loans typically involve large balances to single borrowers or groups
of related borrowers. Because payments on loans secured by commercial and multi-family real estate properties are
often dependent on the successful operation or management of the properties, repayment of these loans may be subject
to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced, or if leases
are not obtained or renewed, the borrower’s ability to repay the loan may be impaired. Commercial and multi-family
loans also expose a lender to greater credit risk than loans secured by one-to-four-family because the collateral
securing these loans typically cannot be sold as easily as one-to-four-family. In addition, most of our commercial and
multi-family loans are not fully amortizing and include balloon payments upon maturity. Balloon payments may
require the borrower to either sell or refinance the underlying property in order to make the payment, which may
increase the risk of default or non-payment. The largest single commercial or multi-family real estate loan at
December 31, 2019 was a loan secured by a fully-leased apartment building built in 2019 (which includes a 1,200
square foot retail space, currently leased to a well-established and locally-owned coffee shop) located in Seattle,
Washington. The total outstanding balance of this loan was $9.0 million at December 31, 2019, and performing in
accordance with its repayment terms.
The Company intends to continue to emphasize commercial real estate lending and, as a result, the Company
has assembled a highly experienced Senior Loan Committee, with an average of over 20 years of experience. As
members of the Senior Loan Committee, the Bank’s Chief Credit Officer and Chief Lending Officer have over
30 years of commercial lending experience in the northwestern U.S. region. Management has also hired experienced
commercial loan officers to support the Company’s commercial real estate lending objectives. As the commercial real
estate loan portfolio expands, the Company intends to bring in additional experienced personnel in the areas of loan
analysis and commercial deposit relationship management.
Construction and Development Lending. The Company expanded its residential construction lending team
in 2011 with a focus on vertical, in-city one-to-four-family development in our market area. This team has over
60 years of combined experience and expertise in acquisition, development and construction (“ADC”) lending in the
Puget Sound market area. The Company has implemented this strategy to take advantage of what is believed to be a
strong demand for construction and ADC loans to experienced, successful and relationship driven builders in our
market area after many other banks abandoned this segment because of previous overexposure. At December 31,
2019, outstanding construction and development loans totaled $179.7 million, or 13.3%, of the gross loan portfolio
and consisted of 216 projects, compared to $247.3 million and 279 projects at December 31, 2018. The construction
and development loans at December 31, 2019, consisted of loans for residential and commercial construction projects
primarily for vertical construction and $10.6 million of land acquisition and development loans. Total committed,
including unfunded construction and development loans at December 31, 2019, was $278.4 million. At December 31,
2019, $115.6 million, or 64.3% of our outstanding construction and development loan portfolio was comprised of
speculative one-to-four-family construction loans. Approximately $8.8 million of our residential construction loans at
December 31, 2019 were made to finance the custom construction of owner-occupied homes and are structured to be
converted to permanent loans at the end of the construction phase. In addition, the Company had six commercial
secured lines of credit, secured by notes to residential construction borrowers with guarantees from principals with
experience in the construction re-lending market. These loans had combined commitments of $70.0 million, and an
outstanding balance of $48.2 million at December 31, 2019.
The Company’s residential construction lending program includes loans for the purpose of constructing both
speculative and pre-sold one-to-four-family residences, the acquisition of in-city lots with and without existing
improvements for later development of one-to-four-family residences, the acquisition of land to be developed, and
loans for the acquisition and development of land for future development of single family residences. The Company
generally limits these types of loans to known builders and developers in the market area. Construction loans generally
provide for the payment of interest-only during the construction phase, which is typically up to 12 months. At the end
of the construction phase, the construction loan is generally paid off through the sale of the newly constructed home
and a permanent loan from another lender, although commitments to convert to a permanent loan may be made by us.
Construction loans are generally made with a maximum loan amount of the lower of 95% of cost or 75% of appraised
value at completion. During the term of construction, the accumulated interest on the loan is typically added to the
principal balance of the loan through an interest reserve of 3% to 5.5% of the loan commitment amount.
12
Commitments to fund construction loans generally are made subject to an appraisal of the property by an
independent licensed appraiser. The Company also reviews and has a licensed third-party inspect each property before
disbursement of funds during the term of the construction loan. Loan proceeds are disbursed after inspection by a
third-party inspector based on the percentage of completion method.
The Company may also make land acquisition and development loans to builders or residential lot developers
on a limited basis. These loans involve a higher degree of credit risk, similar to commercial construction loans. At
December 31, 2019, included in the $179.7 million of construction and development loans, were six residential land
acquisition and development loans for finished lots totaling $8.4 million, with total commitments of $8.5 million.
These land loans also involve additional risks because the loan amount is based on the projected value of the lots after
development. Loans are made for up to 75% of the estimated value with a term of up to two years. These loans are
required to be paid on an accelerated basis as the lots are sold, so that the Company is repaid before all the lots are
sold. Construction financing is generally considered to involve a higher degree of credit risk than longer-term
financing on improved, owner-occupied real estate.
Construction and development lending contains the inherent difficulty in estimating both a property’s value
at completion of the project and the estimated cost (including interest) of the project. Changes in the demand, such as
for new housing and higher than anticipated building costs may cause actual results to vary significantly from those
estimated. If the estimate of construction cost proves to be inaccurate, we may be required to advance funds beyond
the amount originally committed to permit completion of the project. This type of lending also typically involves
higher loan principal amounts and is often concentrated with a small number of builders. In addition, during the term
of most of our construction loans, an interest reserve is created at origination and is added to the principal of the loan
through the construction phase. If the estimate of value upon completion proves to be inaccurate, we may be
confronted at, or prior to, the maturity of the loan with a project, the value of which is insufficient to assure full
repayment. Because construction loans require active monitoring of the building process, including cost comparisons
and on-site inspections, these loans are more difficult and costly to monitor.
Increases in market rates of interest may have a more pronounced effect on construction loans by rapidly
increasing the end-purchasers’ borrowing costs, thereby reducing the overall demand for the project. Properties under
construction are often difficult to sell and typically must be completed in order to be successfully sold which also
complicates the process of working out problem construction loans. This may require us to advance additional funds
and/or contract with another builder to complete construction. Furthermore, speculative construction loans to a builder
are often associated with homes that are not pre-sold, and thus pose a greater potential risk than construction loans to
individuals on their personal residences as there is the added risk associated with identifying an end-purchaser for the
finished project. Loans on land under development or held for future construction pose additional risk because of the
lack of income being produced by the property and the potential illiquid nature of the collateral. These risks can be
significantly impacted by supply and demand. As a result, this type of lending often involves the disbursement of
substantial funds with repayment dependent on the success of the ultimate project and the ability of the borrower to
sell or lease the property, rather than the ability of the borrower or guarantor themselves to repay principal and interest.
The Company seeks to address the forgoing risks associated with construction development lending by
developing and adhering to underwriting policies, disbursement procedures, and monitoring practices. Specifically,
the Company (i) seeks to diversify the number of loans and projects in the market area, (ii) evaluate and document the
creditworthiness of the borrower and the viability of the proposed project, (iii) limit loan-to-value ratios to specified
levels, (iv) control disbursements on construction loans on the basis of on-site inspections by a licensed third-party,
(v) monitor economic conditions and the housing inventory in each market, and (iv) typically obtains personal
guarantees from a principal of the borrower on substantially all credits. No assurances, however, can be given that
these practices will be successful in mitigating the risks of construction development lending.
Home Equity Lending. The Company has been active in second lien mortgage and home equity lending,
with the focus of this lending being conducted in the Company’s primary market area. The home equity lines of credit
generally have adjustable rates tied to the prime rate of interest with a draw term of 10 years plus and a term to maturity
of 15 years. Monthly payments are based on 1.0% of the outstanding balance with a maximum combined loan-to-
value ratio of up to 90%, including any underlying first mortgage. Fixed second lien mortgage home equity loans are
13
typically amortizing loans with terms of up to 20 years. Total second lien mortgage/home equity loans totaled $38.2
million, or 2.8% of the gross loan portfolio, at December 31, 2019, $26.9 million of which were adjustable rate home
equity lines of credit. Unfunded commitments on home equity lines of credit at December 31, 2019, was $47.9 million.
Residential. The Company originates loans secured by first mortgages on one-to-four-family residences
primarily in the market area. 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
important referral sources of the Company’s loan originations. The Company originated $891.4 million of one-to-
four-family mortgages (including $10.5 million loans brokered to other institutions) and sold $785.4 million to
investors in 2019. Of the loans sold to investors, $550.1 million were sold to the Federal National Mortgage
Association (“Fannie Mae”), the Government National Mortgage Association (“Ginnie Mae”), the FHLB, and/or the
Federal Home Loan Mortgage Corporation (“Freddie Mac”) with servicing rights retained in order to further build the
relationship with the customer. At December 31, 2019, one-to-four-family residential mortgage loans totaled $261.5
million, or 19.3%, of the gross loan portfolio, excluding loans held for sale of $69.7 million. In addition, the Company
originates residential loans through its commercial lending channel, secured by single family rental homes in
Washington, with an outstanding balance of $56.8 million at December 31, 2019, classified as commercial business
loans that are not included in our one-to-four-family residential mortgage loan portfolio. See below “Commercial
Business Lending.”
The Company generally underwrites the one-to-four-family loans based on the applicant’s ability to repay.
This includes employment and credit history and the appraised value of the subject property. The Company will lend
up to 100% of the lesser of the appraised value or purchase price for one-to-four-family first mortgage loans. For first
mortgage loans with a loan-to-value ratio in excess of 80%, the Company generally requires either private mortgage
insurance or government sponsored insurance in order to mitigate the higher risk level associated with higher loan-to-
value loans. Fixed-rate loans secured by one-to-four-family residences have contractual maturities of up to 30 years
and are generally fully amortizing, with payments due monthly. Adjustable-rate mortgage loans generally pose
different credit risks than fixed-rate loans, primarily because as interest rates rise the borrower’s payments rise,
increasing the potential for default. Properties securing the one-to-four-family loans are appraised by independent fee
appraisers who are selected in accordance with industry and regulatory standards. The Company requires borrowers
to obtain title and hazard insurance, and flood insurance, if necessary. Loans are generally underwritten to the
secondary market guidelines with overlays as determined by the internal underwriting department.
Consumer Lending. Consumer lending represents a significant and important historical activity for the
Company, primarily reflecting the indirect lending through home improvement contractors and dealers, which include
brokers. At December 31, 2019, consumer loans totaled $326.2 million, or 24.1% of the gross loan portfolio.
The Company’s indirect home improvement loans, also referred to as fixture secured loans, represent the
largest portion of the consumer loan portfolio and have traditionally been the mainstay of the Company’s consumer
lending strategy. These loans totaled $210.7 million, or 15.6% of the gross loan portfolio, and 64.6% of total consumer
loans, at December 31, 2019. Indirect home improvement loans are originated through a network of 155 home
improvement contractors and dealers located in Washington, Oregon, California, Idaho, Colorado, and Arizona. Ten
dealers are responsible for a majority, or 62.3% of the loan volume. These fixture secured loans consist of loans for a
wide variety of products, such as replacement windows, siding, roofs, HVAC systems, and pools.
In connection with fixture secured and solar loans, the Company receives loan applications from the dealers,
and originates the loans based on pre-defined lending criteria. These loans are processed through the loan origination
software, with approximately 20% of the loan applications receiving an automated approval based on the information
provided, and the remaining loans are processed by the Company’s credit analysts. The Company follows the internal
underwriting guidelines in evaluating loans obtained through the indirect dealer program, including using a Fair Isaac
and Company, Incorporated (“FICO”) credit score to approve loans. A FICO score is a principal measure of credit
quality and is one of the significant criteria we rely upon in our underwriting in addition to the borrower’s debt to
income.
14
The Company’s fixture secured loans generally range in amounts from $2,500 to $100,000, and generally
carry terms of 12 to 20 years with fixed rates of interest. In some instances, the participating dealer may pay a fee to
buy down the borrower’s interest rate to a rate below the Company’s published rate. Fixture secured loans are secured
by the personal property installed in, on or at the borrower’s real property, and may be perfected with a financing
statement under the Uniform Commercial Code (“UCC-2”) filed in the county of the borrower’s residence. The
Company generally files a UCC-2 financing statement to perfect the security interest in the personal property in
situations where the borrower’s credit score is below 720 or the home improvement loan is for an amount in excess
of $5,000. Perfection gives the Company a claim to the collateral that is superior to someone that obtains a lien through
the judicial process subsequent to the perfection of a security interest. The failure to perfect a security interest does
not render the security interest unenforceable against the borrower. However, failure to perfect a security interest risks
avoidance of the security interest in bankruptcy or subordination to the claims of third parties.
The Company also offers consumer marine loans secured by boats. At December 31, 2019, the marine loan
portfolio totaled $67.2 million, or 20.6% of total consumer loans. Marine loans are originated with borrowers on both
a direct and indirect basis, and generally carry terms of up to 20 years with fixed rates of interest. The Company
generally requires a 10% down payment, and the loan amount may be up to the lesser of 120% of factory invoice or
90% of the purchase price.
Solar loans, which are fixture secured loans, represent the third largest segment of the consumer loan portfolio
following marine loans. At December 31, 2019, the solar loan portfolio totaled $44.0 million, or 13.5% of total
consumer loans.
The Company originates other consumer loans which totaled $4.3 million at December 31, 2019. These
loans primarily include personal lines of credit, credit cards, automobile, direct home improvement, loans on deposit,
and recreational loans.
In evaluating any consumer loan application, a borrower’s FICO score is utilized as an important indicator
of credit risk. The FICO score represents the creditworthiness of a borrower based on the borrower’s credit history, as
reported by an independent third party. A higher FICO score typically indicates a greater degree of creditworthiness.
Over the last several years the Company has emphasized originations of loans to consumers with higher credit scores.
This has resulted in a lower level of loan charge-offs in recent periods. At December 31, 2019, 73.7% of the consumer
loan portfolio was originated with borrowers having a FICO score over 720 at the time of origination, and 23.1% was
originated with borrowers having a FICO score between 660 and 720 at the time of origination. Generally, a FICO
score of 660 or higher indicates the borrower has an acceptable credit reputation. A credit score at the time of loan
origination of less than 660 is considered “subprime” by federal banking regulators and these loans comprised just
3.2% of our consumer loan portfolio at December 31, 2019. Consideration for loans with FICO scores below 660
require additional management oversight and approval.
Consumer loans generally have shorter average lives with faster prepayment, which reduces the Company’s
exposure to changes in interest rates. In addition, management believes that offering consumer loan products helps to
expand and create stronger ties to existing customer base by increasing the number of customer relationships and
providing cross-marketing opportunities.
Consumer and other loans generally entail greater risk than do one-to-four-family residential mortgage loans,
particularly in the case of consumer loans that are secured by rapidly depreciable assets, such as boats, automobiles
and other recreational vehicles. In these cases, any repossessed collateral for a defaulted loan may not provide an
adequate source of repayment of the outstanding loan balance. As a result, consumer loan collections are dependent
on the borrower’s continuing financial stability and, thus, are more likely to be adversely affected by job loss, divorce,
illness, or personal bankruptcy. In the case of fixture secured loans, it is very difficult to repossess the personal property
securing these loans as they are typically attached to the borrower’s personal residence. Accordingly, if a borrower
defaults on a fixture secured loan the only practical recourse is to wait until the borrower wants to sell or refinance the
home, at which time if there is a perfected security interest the Company generally will be able to collect a portion of
the loan previously charged off.
15
Commercial Business Lending. The Company originates commercial business loans and lines of credit to
local small- and mid-sized businesses in the Puget Sound market area that are secured by accounts receivable,
inventory, or personal/business property, plant and equipment. Consistent with management’s objectives to expand
commercial business lending, in 2009, the Company commenced a mortgage warehouse lending program through
which the Company funds third-party residential mortgage bankers. Under this program the Company provides short-
term funding to the mortgage banking companies for the purpose of originating residential mortgage loans for sale
into the secondary market. The Company’s warehouse lending lines are secured by the underlying notes associated
with one-to-four-family mortgage loans made to borrowers by the mortgage banking company and generally require
guarantees from the principal shareholder(s) of the mortgage banking company. These loans are repaid when the note
is sold by the mortgage bank into the secondary market, with the proceeds from the sale used to pay down the
outstanding loan before being dispersed to the mortgage bank. The Company had $25.0 million approved in residential
mortgage warehouse lending lines for four companies at December 31, 2019. The commitments ranged from $4.0
million to $8.0 million. At December 31, 2019, there was $12.9 million in residential warehouse lines outstanding,
compared to $23.0 million in approved residential warehouse lending lines with $4.4 million outstanding at
December 31, 2018. During the year ended December 31, 2019, we processed approximately 790 loans and funded
approximately $323.8 million in total under our mortgage warehouse lending program.
The Company also has commercial construction warehouse lending lines secured by notes on construction
loans and typically guaranteed by principals with experience in construction lending. In April 2013, we commenced
an expansion of our mortgage warehouse lending program to include construction re-lending warehouse lines. These
lines are secured by notes provided to construction lenders and are typically guaranteed by a principal of the borrower
with experience in construction lending. Terms for the underlying notes can be up to 18 months and the Bank will
lend a percentage (typically 75%) of the underlying note which may have a loan-to-value ratio up to 75%. Combined,
the loan-to-value ratio on the underlying note would be up to 52.5% with additional credit support provided by the
guarantor. At December 31, 2019, the Company had $70.0 million in approved commercial construction warehouse
lending lines for six companies. The commitments range from $500,000 to $30.0 million. At December 31, 2019,
there was $48.2 million outstanding, compared to $87.0 million approved in commercial warehouse lending lines for
nine companies with $61.4 million outstanding at December 31, 2018.
Commercial business loans may be fixed-rate, but are usually adjustable-rate loans indexed to the prime rate
of interest, plus a margin. Some of the commercial business loans, such as those made pursuant to the warehouse
lending program, are structured as lines of credit with terms of 12 months and interest-only payments required during
the term, while other loans may reprice on an annual basis and amortize over a two to five year period. Due to the
current interest rate environment, these loans and lines of credit are generally originated with a floor, which is set
between 2.0% and 7.0%. Loan fees are generally charged at origination depending on the credit quality and account
relationships of the borrower. Advance rates on these types of lines are generally limited to 80% of accounts receivable
and 50% of inventory. The Company also generally requires the borrower to establish a deposit relationship as part of
the loan approval process. At December 31, 2019, the commercial business loan portfolio totaled $201.6 million, or
14.9%, of the gross loan portfolio including warehouse lending loans.
At December 31, 2019, most of the commercial business loans were secured. The Company’s commercial
business lending policy includes credit file documentation and analysis of the borrower’s background, capacity to
repay the loan, the adequacy of the borrower’s capital and collateral, as well as an evaluation of other conditions
affecting the borrower. Analysis of the borrower’s past, present, and future cash flows is also an important aspect of
credit analysis. The Company generally requires personal guarantees on commercial business loans. Nonetheless,
commercial business loans are believed to carry higher credit risk than residential mortgage loans. The two largest
commercial business lending relationships consisted of a line of credit provided to two unaffiliated companies. The
first of the two largest lending relationships at December 31, 2019, consisted of a participating commercial line of
credit having a commitment of $30.0 million with the Bank. This line of credit is secured by residential construction
projects located primarily in Seattle, Washington. The outstanding balance of this line of credit at December 31, 2019
was $30.0 million. The second of the two largest commercial business lending relationships consisted of one
commercial line of credit having a commitment of $15.0 million. This line of credit is secured by notes to finance
residential construction projects located primarily in Seattle, Washington. The outstanding balance of this line of
credit at December 31, 2019 was $10.3 million.
16
Unlike residential mortgage loans, commercial business loans, particularly unsecured loans, are made on the
basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business and, therefore, are of
higher risk. The Company makes commercial loans secured by business assets, such as accounts receivable, inventory,
equipment, real estate and cash as collateral with loan-to-value ratios in most cases up to 80%, based on the type of
collateral. This collateral depreciates over time, may be difficult to appraise and may fluctuate in value based on the
specific type of business and equipment used. As a result, the availability of funds for the repayment of commercial
business loans may be substantially dependent on the success of the business itself (which, in turn, is often dependent
in part upon general economic conditions).
Loan Originations, Servicing, Purchases and Sales
The Company originates both fixed-rate and adjustable-rate loans. The ability to originate loans, however, is
dependent upon customer demand for loans in the market areas. From time to time to supplement our loan originations
and based on our asset/liability objectives we will also purchase bulk loans or pools of loans from other financial
institutions.
Over the past few years, the Company has continued to originate consumer loans, and increased emphasis on
commercial real estate loans, including construction and development lending, as well as commercial business loans.
Demand is affected by competition and the interest rate environment. In periods of economic uncertainty, the ability
of financial institutions, including us, to originate large dollar volumes of commercial business and real estate loans
may be substantially reduced or restricted, with a resultant decrease in interest income. In addition to interest earned
on loans and loan origination fees, the Company receives fees for loan commitments, late payments, and other
miscellaneous services. The fees vary from time to time, generally depending on the supply of funds and other
competitive conditions in the market.
The Company will sell long-term, fixed-rate residential real estate loans in the secondary market to mitigate
interest rate risk. Gains and losses from the sale of these loans are recognized based on the difference between the
sales proceeds and carrying value of the loans at the time of the sale. Some residential real estate loans originated as
Federal Housing Administration or FHA, U.S. Department of Veterans Affairs or VA, or United States Department
of Agriculture or USDA Rural Housing loans were sold by the Company as servicing released loans to other
companies. A majority of residential real estate loans sold by the Company were sold with servicing retained at a
specified servicing fee. The Company earned gross mortgage servicing fees of $3.5 million for the year ended
December 31, 2019. The Company was servicing $1.46 billion of one-to-four-family loans at December 31, 2019,
for Fannie Mae, Freddie Mac, Ginnie Mae, the FHLB, and another financial institution. These mortgage servicing
rights (“MSRs”) constituted an $11.6 million asset on our books on that date, which is amortized in proportion to and
over the period of the net servicing income. These MSRs are periodically evaluated for impairment based on their fair
value, which takes into account the rates and potential prepayments of those sold loans being serviced. The fair value
of our MSRs at December 31, 2019 was $13.3 million. See “Note 5 - Servicing Rights” and “Note 16 - Fair Value
Measurements” of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and
Supplementary Data” of this Form 10-K.
17
The following table presents the activity during the year ended December 31, 2019, related to loans serviced
for others.
Beginning balance at January 1, 2019
One-to-four-family
Consumer
Subtotal
Additions
One-to-four-family
Repayments
One-to-four-family
Consumer
Subtotal
Ending balance at December 31, 2019
One-to-four-family
Consumer
Total
(In thousands)
$ 1,186,858
777
1,187,635
550,685
(273,811)
(186)
(273,997)
1,463,732
591
$ 1,464,323
18
The following table shows total loans originated, purchased, sold and repaid during the years indicated.
(In thousands)
Originations by type:
Fixed-rate:
Commercial
Construction and development
Home equity
One-to-four-family (1)
Loans held for sale (one-to-four-family)
Multi-family
Consumer
Commercial business (2)
Total fixed-rate
Adjustable- rate:
Commercial
Construction and development
Home equity
One-to-four-family (1)
Loans held for sale (one-to-four-family)
Multi-family
Consumer
Commercial business (2)
Warehouse lines, net
Total adjustable-rate
Total loans originated
Purchases by type (4):
Fixed-rate:
Commercial
Home equity
One-to-four-family (1)
Multi-family
Consumer
Construction and development
Commercial business (2) (3)
Adjustable-rate:
Commercial
Home equity
One-to-four-family (1)
Multi-family
Consumer
Construction and development
Commercial business (2) (3)
Total loans purchased
Sales and repayments:
One-to-four-family (1)
Loans held for sale (one-to-four-family)
Commercial business (2) (3)
Total loans sold
Total principal repayments
Total reductions
Net increase
Year Ended December 31,
2019
2018 (4)
$
23,110 $
3,641
6,163
23,426
778,866
2,886
161,269
5,903
1,005,264
6,943
—
5,895
4,753
608,065
132
149,726
16,811
792,325
30,679
243,000
20,199
81,457
25,753
44,803
2,216
338,859
(4,644)
782,322
1,787,586
14,552
205,649
15,988
81,256
11,567
10,793
2,489
282,868
(2,988)
622,174
1,414,499
—
—
321 (5)
—
—
—
1,798
—
—
—
—
—
—
—
2,119
32,567
8,795
38,322
28,958
1,332
29,064
9,267
114,700
3,424
25,261
31,974
2,180
35,750
24,029
385,623
—
(785,438)
(8,365)
(793,803)
(951,743)
(1,745,546)
44,159 $
(16,034)
(621,636)
(1,918)
(639,588)
(610,009)
(1,249,597)
550,525
$
19
_____________________________
(1) One-to-four-family portfolio loans.
(2) Excludes warehouse lines.
(3) Includes USDA/U.S. Small Business Administration or SBA guaranteed loans purchased at a premium.
(4) Purchases include loans acquired in the Anchor Acquisition.
(5) Loan repurchased, previously sold.
Sales of whole real estate loans and participations in real estate loans can be beneficial to us since these sales
systematically generate income at the time of sale, produce future servicing income on loans where servicing is
retained, provide funds for additional lending and other investments, and increase liquidity.
From time to time we also sell whole consumer loans, specifically long term consumer loans, which can be
beneficial to us since these sales generate income at the time of sale, can potentially create future servicing income
where servicing is retained, and provide a mitigation of interest rate risk associated with holding 15-20 year maturity
consumer loans.
Asset Quality
When a borrower fails to make a required payment on a residential real estate loan, the Company attempts to
cure the delinquency by contacting the borrower. In the case of loans secured by residential real estate, a late notice
typically is sent 16 days after the due date, and the borrower is contacted by phone within 16 to 25 days after the due
date. When the loan is 30 days past due, an action plan is formulated for the credit under the direction of the Loan
Control department manager. Generally, a delinquency letter is mailed to the borrower. All delinquent accounts are
reviewed by a loan control representative who attempts to cure the delinquency by contacting the borrower once the
loan is 30 days past due. If the account becomes 60 days delinquent and an acceptable repayment plan has not been
agreed upon, a Loan Control representative will generally refer the account to legal counsel with instructions to prepare
a notice of intent to foreclose. The notice of intent to foreclose allows the borrower up to 30 days to bring the account
current. Between 90 - 120 days past due, a value is obtained for the loan collateral. At that time, a mortgage analysis
is completed to determine the loan-to-value ratio and any collateral deficiency. If foreclosed, the Company customarily
takes title to the property and sells it directly through a real estate broker.
Delinquent consumer loans are handled in a similar manner. Appropriate action is taken in the form of phone
calls and notices to collect any loan payment that is delinquent more than 16 days. Once the loan is 90 days past due,
it is classified as non-accrual. Generally, credits are charged off if past due 120 days, unless the collections department
provides support for a customer repayment plan. Bank procedures for repossession and sale of consumer collateral are
subject to various requirements under the applicable consumer protection laws as well as other applicable laws and
the determination by us that it would be beneficial from a cost basis.
Delinquent commercial business loans and loans secured by commercial real estate are handled by the loan
officer in charge of the loan, who is responsible for contacting the borrower. The loan officer works with outside
counsel and, in the case of real estate loans, a third party consultant to resolve problem loans. In addition, management
meets as needed and reviews past due and classified loans, as well as other loans that management feels may present
possible collection problems, which are reported to the AQC and the board on a monthly basis. If an acceptable
workout of a delinquent commercial loan cannot be agreed upon, the Company customarily will initiate foreclosure
or repossession proceedings on any collateral securing the loan.
20
The following table shows delinquent loans by the type of loan and number of days delinquent at
December 31, 2019. Categories not included in the table below did not have any delinquent loans at December 31,
2019.
Loans Delinquent For:
60-89 Days
90 Days or More
Total Loans Delinquent
60 Days or More
Percent of
Loan
Percent of
Loan
Percent of
Loan
Number Amount Category Number Amount Category Number Amount Category
— $ —
114
114
1
1
— %
0.04
0.01
3 $
5
8
185
1,150
1,335
0.48 %
0.44
0.16
3 $
6
9
185
1,264
1,449
0.48 %
0.48
0.18
15 187
40
2
2
3
20 229
21 $ 343
0.09
0.09
0.05
0.07
0.03 %
131
14
16
1
20
3
18
167
26 $ 1,502
0.06
0.04
0.46
0.05
0.11 %
318
29
56
3
22
6
38
396
47 $ 1,845
0.15
0.13
0.51
0.12
0.14 %
(Dollars in thousands)
Real estate loans
Home equity
One-to-four-family
Total real estate loans
Consumer loans
Indirect home
improvement
Solar
Other consumer
Total consumer loans
Total
Non-performing Assets. The following table sets forth information with respect to the Company’s non-
performing assets.
(Dollars in thousands)
Non-accruing loans:
Real estate loans
Commercial
Home equity
One-to-four-family
Total real estate loans
Consumer loans
Indirect home improvement
Solar
Marine
Other consumer
Total consumer loans
Commercial business loans
Commercial and industrial
Total commercial business loans
Total non-accruing loans
Accruing loans contractually past due 90 days or more
Other real estate owned
Repossessed assets
Total non-performing assets
Restructured loans
Total non-performing assets as a percentage of total assets
December 31,
2019 2018 2017 2016 2015
$ 1,086
190
1,264
2,540
$
$
—
229
1,552
1,781
451
17
—
25
493
367
41
18
2
428
—
151
142
293
195
—
—
—
195
$ —
210
—
210
435
69
—
7
511
$
—
47
525
572
408
37
—
—
445
—
—
3,033
—
168
10
$ 3,211
—
$
—
—
1,017
—
—
—
$ 1,017
$ 734
0.19 % 0.28 % 0.11 % 0.09 % 0.15 %
551
551
1,039
—
—
—
$ 1,039
55
$
1,685
1,685
3,894
11
689
—
$ 4,594
—
$
—
—
721
—
—
15
$ 736
$ 57
21
For the year ended December 31, 2019, gross interest income, which would have been recorded had the non-
accruing loans been current in accordance with their original terms was $59,000. Prior to non-accrual status, the
amount of interest income included in net income for the year ended December 31, 2019 was $136,000 for these loans.
Other Real Estate Owned. Real estate acquired by the Company as a result of foreclosure or by deed-in-lieu
of foreclosure is classified as real estate owned until it is sold. When the property is acquired, it is recorded at the
lower of its cost, which is the unpaid principal balance of the related loan plus foreclosure costs, or the fair market
value of the property less selling costs. The Company had two real estate owned properties as of December 31, 2019.
Restructured Loans. According to generally accepted accounting principles in the United States of America
(“U.S. GAAP”), the Company is required to account for certain loan modifications or restructuring as a “troubled debt
restructuring” or “TDR”. In general, the modification or restructuring of a debt is considered a TDR if the Company,
for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrowers that
would not otherwise be considered. The Company had no TDRs at December 31, 2019.
Other Assets Especially Mentioned. At December 31, 2019, there was $5.2 million of loans with respect to
which known information about the possible credit problems of the borrowers caused management to have doubts as
to the ability of the borrowers to comply with present loan repayment terms and which may result in the future
inclusion of such items in the non-performing asset categories.
Classified Assets. Federal regulations provide for the classification of lower quality loans and other assets
(such as other real estate owned and repossessed property), debt and equity securities, as substandard, doubtful or loss.
An asset is considered substandard if it is inadequately protected by the current net worth and pay capacity of the
borrower or of any collateral pledged. Substandard assets include those characterized by the distinct possibility that
the Company will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all the
weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make
collection or liquidation in full highly questionable and improbable, on the basis of currently existing facts, conditions,
and values. Assets classified as loss are those considered uncollectible and of such little value that their continuance
as assets without the establishment of a specific loss reserve is not warranted.
When the Company classifies problem assets as either substandard or doubtful, a specific allowance may be
established in an amount deemed prudent to address specific impairments. General allowances represent loss
allowances which have been established to recognize the inherent risk associated with lending activities, but which,
unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies
problem assets as a loss, it is required to charge off those assets in the period in which they are deemed uncollectible.
The Company’s determination as to the classification of assets and the amount of valuation allowances is subject to
review by the FDIC and the DFI, which can order the establishment of additional loss allowances. Assets which do
not currently expose the Company to sufficient risk to warrant classification in one of the aforementioned categories
but possess weaknesses are required to be designated as special mention.
In connection with the filing of periodic reports with the FDIC and in accordance with the Company’s
classification of assets policy, the Company regularly reviews the problem assets in the portfolio to determine whether
any assets require classification in accordance with applicable regulations. On the basis of the review of the
Company’s assets, at December 31, 2019, the Company had classified $6.7 million of assets as substandard. The $6.7
million of classified assets represented 3.3% of equity and 0.4% of total assets at December 31, 2019. The Company
had $5.2 million of assets classified as special mention at December 31, 2019, not included in classified assets reported
above.
Allowance for Loan Losses
The Company maintains an allowance for loan losses to absorb probable incurred credit losses in the loan
portfolio. The allowance is based on ongoing monthly assessments of the estimated probable incurred losses in the
loan portfolio. Ultimate losses may vary from these estimates. In evaluating the level of the allowance for loan losses,
management considers the types of loans and the amount of loans in the loan portfolio, peer group information,
historical loss experience, adverse situations that may affect the borrower’s ability to repay, estimated value of any
22
underlying collateral, and prevailing economic conditions. Large groups of smaller balance homogeneous loans, such
as residential real estate, small commercial real estate, home equity and consumer loans, are evaluated in the aggregate
using historical loss factors and peer group data adjusted for current economic conditions. More complex loans, such
as commercial real estate loans and commercial business loans, are evaluated individually for impairment, primarily
through the evaluation of net operating income and available cash flow and their possible impact on collateral values.
The allowance is increased by the provision for loan losses, which is charged against current period earnings
and decreased by the amount of actual loan charge-offs, net of recoveries.
The provision for loan losses was $2.9 million for the year ended December 31, 2019. The allowance for
loan losses was $13.2 million, or 0.98% of gross loans receivable at December 31, 2019, as compared to $12.3 million,
or 0.93% of gross loans receivable outstanding at December 31, 2018. In accordance with acquisition accounting,
loans acquired in the Anchor Acquisition were recorded at their estimated fair value, which resulted in a net discount
to the contractual amounts of the loans, of which a portion reflects a discount for possible credit losses. Credit
discounts are included in the determination of fair value and as a result, no allowance for loan losses is recorded for
acquired loans at the acquisition date. Although the discount recorded on the acquired loans is not reflected in the
allowance for loan losses, or related allowance coverage ratios, we believe it should be considered when comparing
the current ratios to similar ratios in periods prior to the acquisition. The recorded value of loans acquired in the
Anchor Acquisition as of the November 15, 2018 acquisition date was $361.6 million, including $1.3 million of
purchased credit impaired loans, and the fair value discount was $5.3 million, or 1.5% of the loans acquired. The
remaining fair value discount on loans acquired in the Anchor Acquisition was $2.7 million, on $198.5 million of
gross loans at December 31, 2019. Management will continue to review the adequacy of the allowance for loan losses
and make adjustments to the provision for loan losses based on loan growth, economic conditions, charge-offs and
portfolio composition.
Assessing the allowance for loan losses is inherently subjective as it requires making material estimates,
including the amount and timing of future cash flows expected to be received on impaired loans that may be susceptible
to significant change. In the opinion of management, the allowance, when taken as a whole, reflects probable incurred
loan losses in the loan portfolio. See “Item 7. Management’s Discussion and Analysis of Financial Condition and
Results of Operations - Comparison of Results of Operations for the Years Ended December 31, 2019 and 2018 -
Provision for Loan Losses” and “Notes 1- Basis of Presentation and Summary of Significant Accounting Policies”
and “Note 4 - Loans Receivable and Allowance for Loan Losses” of the Notes to Consolidated Financial Statements
included in “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
23
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The following table sets forth an analysis of the allowance for loan losses at the dates and or the years indicated.
(Dollars in thousands)
Balance at beginning of year
Charge-offs:
Real estate loans
Commercial
One-to-four-family
Home equity
Total real estate loans
Consumer loans
Indirect home improvement
Solar
Marine
Other consumer
Total consumer loans
Commercial business loans
Commercial and industrial
Total commercial business loans
Total charge-offs
Recoveries:
Real estate loans
Commercial
Home equity
One-to-four-family
Total real estate loans
Consumer loans
Indirect home improvement
Solar
Marine
Other consumer
Total consumer loans
Commercial business loans
Commercial and industrial
Total commercial business loans
Total recoveries
2019
$ 12,349 $ 10,756 $ 10,211 $
2018
2016
7,785 $ 6,090
2015
Year Ended December 31,
2017
—
2
3
5
787
63
122
68
1,040
1,583
1,583
2,628
—
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1
11
489
34
56
38
617
—
—
628
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4
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198
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42
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104
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22
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4
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65
652
129
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28
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33
33
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10
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191
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50
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46
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40
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116
780
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81
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191
33
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87
87
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555
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$ 13,229 $ 12,349 $ 10,756 $ 10,211 $ 7,785
Net charge-offs (recoveries)
Additions charged to operations
Balance at end of year
Net charge-offs to average loans outstanding
Net charge-offs (recoveries) to average non-
performing assets
(3.00)% 76.55 %
51.24 %
Allowance as a percentage of non-performing loans 436.17 % 317.13 % 1,035.23 % 1,416.23 % 765.49 %
Allowance as a percentage of gross loans receivable
(end of year)
(53)
1,540
(26)
2,400
205
750
23.10 %
(1.90)%
0.03 %
1.39 %
1.69 %
0.15 %
0.98 %
0.93 %
— %
— %
1.52 %
0.11 %
While management believes that the estimates and assumptions used in its determination of the adequacy of the
allowance for loan losses 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
25
any increased provisions that may be required will not adversely impact the Company’s financial condition and results of
operations. In addition, the determination of the amount of the Bank’s allowance for loan losses is subject to review by
bank regulators as part of the routine examination process, which may result in the adjustment of reserves based upon their
judgment of information available to them at the time of their examination.
Investment Activities
General. Under Washington law, savings banks are permitted to invest in various types of liquid assets, including
U.S. Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings
institutions, banker’s acceptances, repurchase agreements, federal funds (“Fed Funds”), commercial paper, investment
grade corporate debt securities, and obligations of states and their political subdivisions.
The Chief Financial Officer has the responsibility for the management of the Company’s investment portfolio,
subject to consultation with the Chief Executive Officer, and the direction and guidance of the Board of Directors. Various
factors are considered when making investment decisions, including the marketability, maturity and tax consequences of
the proposed investment. The maturity structure of investments will be affected by various market conditions, including
the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows, and the
anticipated demand for funds via deposit withdrawals and loan originations and purchases.
The general objectives of the Company’s investment portfolio will be to provide liquidity when loan demand is
high, to assist in maintaining earnings when loan demand is low and to maximize earnings while satisfactorily managing
risk, including credit risk, reinvestment risk, liquidity risk, and interest rate risk. See “Item 7. Management’s Discussion
and Analysis of Financial Condition and Results of Operations - Asset and Liability Management and Market Risk” of
this Form 10-K.
As a member of the FHLB of Des Moines, the Bank had $8.0 million in stock at December 31, 2019. For the year
ended December 31, 2019, the Bank received $454,000 in dividends.
The table below sets forth information regarding the composition of the securities portfolio and other investments
at the dates indicated. At December 31, 2019, the securities portfolio did not contain securities of any issuer with an
aggregate book value in excess of 10% of equity capital, excluding those issued by the United States Government or its
agencies.
(In thousands)
Securities available-for-sale
U.S. agency securities
Corporate securities
Municipal bonds
Mortgage-backed securities
U.S. Small Business Administration securities
Total securities available-for-sale
2019
December 31,
2018
2017
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
$ 8,986 $ 9,066 $ 16,052 $ 15,887 $ 9,077 $ 9,115
7,026
12,786
39,734
13,819
$ 125,053 $ 126,057 $ 99,089 $ 97,205 $ 83,085 $ 82,480
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62,745
22,281
10,570
21,120
62,850
22,451
7,113
12,720
40,161
14,014
7,074
14,446
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15,690
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Deposit Activities and Other Sources of Funds
General. Deposits, borrowings, and loan repayments are the major sources of funds for lending and other
investment purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows
and loan prepayments are influenced significantly by general interest rates and market conditions. Borrowings from the
FHLB of Des Moines are used to supplement the availability of funds from other sources and also as a source of term
funds to assist in the management of interest rate risk.
The Company’s deposit composition reflects a mixture with certificates of deposit (including brokered)
accounting for 39.6% of the total deposits at December 31, 2019, and interest and noninterest-bearing checking, savings
and money market accounts comprising the balance of total deposits. The Company relies on marketing activities,
convenience, customer service and the availability of a broad range of deposit products and services to attract and retain
customer deposits. The Company had $147.6 million of brokered deposits, or 10.6% of total deposits at December 31,
2019. As a wholesale funding alternative, brokered deposits have competitive rates that are comparable to FHLB
borrowings and local certificates of deposit.
Deposits. Deposits are attracted from within the market area through the offering of a broad selection of deposit
instruments, including checking accounts, money market deposit accounts, savings accounts, and certificates of deposit
with a variety of rates. Deposit account terms vary according to the minimum balance required, the time periods the funds
must remain on deposit, and the interest rate, among other factors. In determining the terms of the Company’s deposit
accounts, the Company considers the development of long term profitable customer relationships, current market interest
rates, current maturity structure and deposit mix, customer preferences, and the profitability of acquiring customer deposits
compared to alternative sources.
The following table sets forth total deposit activities for the years indicated.
(Dollars in thousands)
Beginning balance
Net deposits before interest credited
Interest credited
Ending balance
2019
$ 1,274,219
Year Ended December 31,
2018
$ 829,842
2017
$ 712,593
102,027 (1)(2)
16,162
$ 1,392,408
437,056 (1)(2) 113,329 (1)
7,321
$ 1,274,219
3,920
$ 829,842
Net increase in deposits
Percent increase
_______________________
(1) On January 22, 2016, the Company purchased four retail bank branches from Bank of America, N.A (the “Branch
Purchase”) and acquired approximately $186.4 million in deposits. At December 31, 2019, 2018, and 2017,
approximately $117.1 million, $120.0 million, and $134.6 million of the acquired deposits, respectively, remained
with the Bank. These branches also attracted new deposits. At December 31, 2019, they had an aggregated total of
$290.2 million in deposits, including public funds.
$ 118,189
$ 444,377
53.55 %
9.28 %
$ 117,249
16.45 %
(2) On November 15, 2018, the Company completed the Anchor Acquisition and acquired approximately $357.9 million
in deposits. At December 31, 2019, approximately $299.0 million of the acquired deposits remained with the Bank.
28
The following table sets forth the dollar amount of savings deposits in the various types of deposit programs the
Company offered at the dates indicated.
(Dollars in thousands)
Transactions and Savings Deposits
Noninterest-bearing checking
Interest-bearing checking
Savings
Money market
Escrow accounts related to mortgages serviced
Total transaction and savings deposits
Certificates
0.00 - 1.99%
2.00 - 3.99%
Total certificates
Total deposits
December 31,
Amount
2019
Percent of Total
Amount
2018
Percent of Total
$
260,131
177,972
118,845
270,489
13,471
840,908
18.68 % $ 221,107
151,103
12.78
122,344
8.53
282,595
19.43
13,425
0.97
790,574
60.39
297,118
254,382
551,500
$ 1,392,408
188,049
21.34
295,596
18.27
39.61
483,645
100.00 % $ 1,274,219
17.35 %
11.86
9.60
22.18
1.05
62.04
14.76
23.20
37.96
100.00 %
The following table sets forth the rate and maturity information of time deposit certificates at December 31, 2019.
(Dollars in thousands)
Certificate accounts maturing in quarter ending:
March 31, 2020
June 30, 2020
September 30, 2020
December 31, 2020
March 31, 2021
June 30, 2021
September 30, 2021
December 31, 2021
March 31, 2022
June 30, 2022
September 30, 2022
December 31, 2022
Thereafter
Total
Percent of total
Rate
0.00 -
1.99%
2.00 -
3.99%
Total
Percent
of Total
$ 66,309
33,185
64,584
34,684
19,285
11,388
18,641
10,858
3,176
1,419
9,450
10,202
13,937
$ 297,118
$ 57,357
35,241
54,634
11,792
184
13,397
15,873
13,934
8,157
16,138
4,278
5,152
18,245
$ 254,382
$ 123,666
68,426
119,218
46,476
19,469
24,785
34,514
24,792
11,333
17,557
13,728
15,354
32,182
$ 551,500
22.42 %
12.41
21.62
8.43
3.53
4.49
6.26
4.50
2.05
3.18
2.49
2.78
5.84
100.00 %
53.87 %
46.13 % 100.00 %
The following table indicates the amount of jumbo certificates of deposit by time remaining until maturity at
December 31, 2019. Jumbo certificates of deposit are certificates in amounts of $100,000 or more.
Maturity
(In thousands)
Certificates of deposit of less than $100,000(1)
Certificates of deposit of $100,000 to less than $250,000
Certificates of deposit of $250,000 and over
Total certificates of deposit
__________________________
(1) Includes $141.4 million of brokered deposits at December 31, 2019.
32,278
22,823
3 Months
or Less
Over
3 to 6
Months
Over
6 to 12
Months
$ 68,565 $ 35,626 $ 70,962 $ 102,835 $ 277,988
181,402
62,421
92,110
32,311
$ 123,666 $ 68,426 $ 165,694 $ 193,714 $ 551,500
62,583
28,296
24,120
8,680
Over
12 Months
Total
29
The Federal Reserve requires the Bank to maintain reserves on transaction accounts or non-personal time
deposits. These reserves may be in the form of cash or noninterest-bearing deposits with the Federal Reserve Bank of San
Francisco (“Federal Reserve Bank”). Negotiable order of withdrawal (“NOW”) accounts and other types of accounts that
permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to the reserve
requirements, as are any non-personal time deposits at a savings bank. In efforts to minimize required reserves, 1st Security
Bank of Washington utilizes deposit reclassification software that sweeps transaction account balances into non-
transaction accounts for regulatory reporting purposes. As of December 31, 2019, $383.6 million of transactional account
balances were swept to non-transaction accounts for regulatory reporting. At December 31, 2019, the Bank’s deposit with
the Federal Reserve Bank and vault cash exceeded the reserve requirements.
Debt. Although customer deposits are the primary source of funds for lending and investment activities, the
Company uses various borrowings such as advances and warehouse lines of credit from the FHLB of Des Moines, and to
a lesser extent Fed Funds purchased to supplement the supply of lendable funds, to meet short-term deposit withdrawal
requirements and also to provide longer term funding to better match the duration of selected loan and investment
maturities.
As one of the Company’s capital management strategies, the Company has used advances from the FHLB of Des
Moines to fund loan originations in order to increase net interest income. Depending upon the retail banking activity, the
Company will consider and may undertake additional leverage strategies within applicable regulatory requirements or
restrictions. These borrowings would be expected to primarily consist of FHLB of Des Moines advances.
As a member of the FHLB of Des Moines, the Bank is required to own capital stock in the FHLB of Des Moines
and authorized to apply for advances on the security of that stock and certain mortgage loans and other assets (principally
securities which are obligations of, or guaranteed by, the U.S. Government) provided certain creditworthiness standards
have been met. Advances are individually made under various terms pursuant to several different credit programs, each
with its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are
based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit. The
Bank maintains a committed credit facility with the FHLB of Des Moines that provides for immediately available advances
up to an aggregate of $477.2 million at December 31, 2019. Outstanding advances from the FHLB of Des Moines totaled
$84.9 million at December 31, 2019.
At December 31, 2019, the Bank had no other outstanding borrowings and $156.1 million additional short-term
borrowing capacity with the Federal Reserve Bank. The Bank also had an aggregate of $71.0 million in unsecured Fed
Funds lines of credit with other financial institutions of which none was outstanding at December 31, 2019.
On October 15, 2015 (the “Closing Date”), FS Bancorp, Inc. closed on a third-party loan commitment by the
issuance of an unsecured subordinated term note in the aggregate principal amount of $10.0 million due October 1, 2025
(the “Subordinated Note”). The Subordinated Note bears interest at an annual interest rate of 6.50%, payable by the
Company quarterly in arrears on January 1, April 1, July 1 and October 1 of each year, commencing on the first such date
following the Closing Date and on the maturity date. The Subordinated Note will mature on October 1, 2025 but may be
prepaid at the Company’s option and with regulatory approval at any time on or after five years after the Closing Date or
at any time upon certain events, such as a change in the regulatory capital treatment of the Subordinated Note or the interest
on the Subordinated Note no longer being deductible by the Company for United States federal income tax purposes. The
Company contributed $9.0 million of the proceeds from the Subordinated Note as additional capital to the Bank in the
fourth quarter of 2015. See “Note 10 - Debt” of the Notes to Consolidated Financial Statements included in “Item 8.
Financial Statements and Supplementary Data” of this Form 10-K.
30
The following tables set forth information regarding both long- and short-term borrowings.
(Dollars in thousands)
Maximum balance:
Federal Home Loan Bank advances and Fed Funds
Federal Reserve Bank
Fed Funds lines of credit
Subordinated note
Average balances:
Federal Home Loan Bank advances and Fed Funds
Federal Reserve Bank
Fed Funds lines of credit
Subordinated note (excluding unamortized debt issuance cost)
Weighted average interest rate:
Federal Home Loan Bank advances and Fed Funds
Federal Reserve Bank
Fed Funds lines of credit
Subordinated note (excluding unamortized debt issuance cost)
(Dollars in thousands)
Balance outstanding at end of year:
Federal Home Loan Bank advances
Weighted average interest rate of:
Federal Home Loan Bank advances, at end of year
Subsidiary and Other Activities
Year Ended December 31,
2018
2019
2017
$ 186,401 $ 180,025 $ 70,419
1,000
17,501
10,000
—
21,016
10,000
5,000
5,000
10,000
$ 93,653
167
318
10,000
$ 96,044
—
5,286
10,000
$ 25,635
3
876
10,000
2.61 %
2.96
2.09
6.50
2.02 %
—
1.93
6.50
1.26 %
1.75
1.30
6.50
2019
At December 31,
2018
2017
$ 84,864
$ 137,149
$ 7,529
2.29 %
2.38 %
1.34 %
The Company has one active subsidiary, the Bank, and the Bank has one inactive subsidiary. The Bank had no
capital investment in its inactive subsidiary at December 31, 2019.
Competition
The Company faces strong competition in attracting deposits. Competition in originating real estate loans comes
primarily from other savings institutions, commercial banks, credit unions, life insurance companies, mortgage bankers,
and more recently, financial technology (or “FinTech”) companies. Other savings institutions, commercial banks, credit
unions, finance, and FinTech companies provide vigorous competition in consumer lending, including indirect lending.
Commercial business competition is primarily from local commercial banks. The Company competes by delivering high-
quality, personal service to customers that result in a high level of customer satisfaction.
The Company’s market areas have a high concentration of financial institutions, many of which are branches of
large money centers and regional banks that have resulted from the consolidation of the banking industry in Washington
and other western states. These include such large national lenders as Wells Fargo, Bank of America, Chase, and others in
the Company’s market area that have greater resources and offer services that the Bank does not provide. For example,
the Bank does not offer trust services. Customers who seek “one-stop shopping” may be drawn to institutions that offer
services that the Bank does not.
The Company attracts deposits through the branch office system. Competition for those deposits is principally
from other savings institutions, commercial banks and credit unions located in the same community, as well as mutual
funds, FinTech companies, and other alternative investments. The Bank competes for these deposits by offering superior
service and a variety of deposit accounts at competitive rates. Based on the most recent branch deposit data provided by
the FDIC, at June 30, 2019, 1st Security Bank of Washington’s share of aggregate deposits in the market area consisting
of the eleven counties where the Company has branches was less than one percent.
31
Employees
At December 31, 2019, the Company had 452 full-time equivalent employees. Company employees are not
represented by any collective bargaining group. The Company considers employee relations to be good.
Set forth below is certain information regarding the executive officers of the Company and the Bank. There are
no family relationships among or between the executive officers.
Executive Officers. The following table sets forth information with respect to the executive officers of the
Company and the Bank.
Name
Age (1) Position with FS Bancorp, Inc.
Position with 1st Security Bank of Washington
Joseph C. Adams
60 Director and
Chief Executive Officer
Director and
Chief Executive Officer
Matthew D. Mullet
41 Chief Financial Officer,
Treasurer and Secretary
Chief Financial Officer and Chief Operating Officer
Robert B. Fuller
60 Chief Credit Officer
Chief Credit Officer
Dennis V. O’Leary
Erin Burr
Vickie Jarman
Donn C. Costa
52
42
42
58
Kelli B. Nielsen
___________________________
(1) At December 31, 2019.
48
Chief Lending Officer
Executive Vice President, Chief Risk Officer and CRA
Officer
Executive Vice President, Chief Human Resources
Officer/WOW! Officer
Executive Vice President, Home Lending Production
Executive Vice President, Retail Banking and Marketing
Joseph C. Adams, age 60, is a director and has been the Chief Executive Officer of 1st Security Bank of
Washington since July 2004. He joined 1st Security Bank of Washington in April 2003 as its Chief Financial Officer,
when the Bank was Washington’s Credit Union. Mr. Adams also served as Supervisory Committee Chairperson from
1993 to 1999. Mr. Adams is a lawyer having worked for Deloitte as a tax consultant, K&L Gates as a lawyer and then at
Univar USA as a lawyer and Director, Regulatory Affairs. Mr. Adams received a Master’s Degree equivalent from the
Pacific Coast Banking School. Mr. Adams’ legal and accounting backgrounds, as well as his duties as Chief Executive
Officer of 1st Security Bank of Washington, bring a special knowledge of the financial, economic, and regulatory
challenges faced by the Bank which makes him well suited to educate the Board on these matters.
Matthew D. Mullet, age 41, joined 1st Security Bank of Washington in July 2011 and was appointed Chief
Financial Officer in September 2011 and Chief Operating Officer in January 2018. Mr. Mullet started his banking career
in June 2000 as a financial examiner with the Washington State Department of Financial Institutions, Division of Banks,
where he worked until October 2004. From October 2004 until August 2010, Mr. Mullet was employed at Golf Savings
Bank, Mountlake Terrace, WA, where he served in several financial capacities, including as Chief Financial Officer from
May 2007 until August 2010. In August 2010, Golf Savings Bank was merged with Sterling Savings Bank, where
Mr. Mullet held the position as Senior Vice President of the Home Loan Division until resigning and commencing work
at 1st Security Bank of Washington.
Robert B. Fuller, age 60, joined 1st Security Bank of Washington as Chief Credit Officer in September of 2013.
Prior to his employment with the Bank, Mr. Fuller served as Chief Financial Officer/Chief Credit Officer for Blueprint
32
Capital, REIT in 2013, Chief Credit Officer for Core Business Bank during 2012, and Plaza Bank during 2011, and in
credit administration at Golf Savings Bank/Sterling Bank during 2009 and 2010. Mr. Fuller also served as Executive Vice
President, Chief Operating Officer, and Chief Financial Officer for Golf Savings Bank from March 2001 to
September 2006 and was a member of the integration team for the Golf sale to Sterling Savings Bank. Mr. Fuller started
his banking career at US Bank of Washington’s mid-market production team and has over 30 years of banking experience.
Dennis V. O’Leary, age 52, joined 1st Security Bank of Washington as Senior Vice President - Consumer, Small
Business and Construction Lending in August 2011 and currently holds the position of Chief Lending Officer. Prior to his
employment with the Bank, Mr. O’Leary previously was employed by Sterling Savings Bank from July 2006 until
August 2011 as Senior Vice President and Puget Sound Regional Director of the residential construction lending division.
Sterling Savings Bank acquired Golf Savings Bank in 2006 where Mr. O’Leary had served as Executive Vice President,
Commercial Real Estate Lending, having previously served in various senior lending positions at Golf Savings Bank since
June 1985.
Erin Burr, age 42, joined 1st Security Bank of Washington in January 2009 and became the Enterprise Risk
Manager in 2012. She was appointed Chief Risk Officer in April 2018. Ms. Burr started her banking career in July 1999
as a financial examiner with the Washington State Department of Financial Institutions, Division of Banks where she
worked until May 2006. From May 2006 until December 2008, Ms. Burr served as senior underwriter for Builders Capital
Mortgage. Ms. Burr became the CRA Officer in January 2010. As the Bank’s CRA Officer, she enjoys building
relationships with non-profit groups that benefit the communities in which we serve. As the Chief Risk Officer, she uses
her regulatory background to help promote and build risk awareness culture throughout the Bank.
Vickie Jarman, age 42, has been a 1st Security Bank of Washington teammate since 2002. Prior to becoming
the Chief Human Resources Officer/WOW! Officer in April 2018, she worked in our indirect lending department. In
2011, Ms. Jarman became the Director of WOW! and focused on corporate culture. Since 2012, she has overseen Human
Resources, Payroll, Benefits, and Recruiting, as well as continuing her work on corporate culture and core values. Ms.
Jarman ensures that as the organization evolves, core values continue to reflect the personal principles that all employees
stand behind and are held accountable.
Donn C. Costa, age 58, Executive Vice President, Home Lending, joined 1st Security Bank of Washington in
October 2011 as Senior Vice President, Home Lending. He previously held the position of Executive Vice President at
Sterling Savings Bank, Mountlake Terrace, Washington after the merger with Golf Savings Bank in August 2009, and
held the position of Executive Vice President at Golf Savings Bank, Mountlake Terrace, Washington since 2006. With
more than 30 years of home lending experience, Mr. Costa began as a loan officer at Lomas and Nettleton Mortgage
Company in Mountlake Terrace in 1986.
Kelli B. Nielsen, age 48, Executive Vice President, Retail Banking and Marketing, joined 1st Security Bank of
Washington in June 2016. Prior to her employment at the Bank, she served as Senior Vice President of Retail Banking and
Marketing at Sound Community Bank and prior to that, she was Vice President, Sales and Service Manager of Retail
Banking at Cascade Bank and its acquirer Opus Bank. Ms. Nielsen has 28 years of experience in the banking industry and
started her banking career at Seafirst Bank and Bank of America. She is a 2016 graduate of the American Bankers
Association (“ABA”) Stonier Graduate School of Banking, a master’s equivalent program where she also received a
leadership certificate from the Wharton Business School. Additionally, Ms. Nielsen is a 2016-2020 Capstone Advisor to
other third year students at Stonier. She was named to the Advisory Board of the ABA Stonier Graduate School of Banking
for the 2018-2020 term.
HOW WE ARE REGULATED
The following is a brief description of certain laws and regulations applicable to FS Bancorp and 1st Security
Bank of Washington. Descriptions of laws and regulations here and elsewhere in this Form 10-K do not purport to be
complete and are qualified in their entirety by reference to the actual laws and regulations. Legislation is introduced from
time to time in the United States Congress or in the Washington State Legislature that may affect the operations of FS
Bancorp and 1st Security Bank of Washington. In addition, the regulations governing the Company and the Bank may be
amended from time to time by the FDIC, DFI, Federal Reserve and the Consumer Financial Protection Bureau (“CFPB”).
33
Any such legislation or regulatory changes in the future could adversely affect our operations and financial condition. We
cannot predict whether any such changes may occur.
The laws and regulations affecting banks and bank holding companies have changed significantly, particularly in
connection with the enactment of the Dodd-Frank Act. Among other changes, the Dodd-Frank Act established the CFPB
as an independent bureau of the Federal Reserve. The CFPB assumed responsibility for the implementation of the federal
financial consumer protection and fair lending laws and regulations and has authority to impose new requirements.
However, as an institution with less than $10 billion in assets, 1st Security Bank of Washington is subject to federal
consumer protection regulations issued by the CFPB while supervision and enforcement of its compliance with federal
and state consumer financial protection laws and regulations is conducted by the FDIC and the DFI.
Many aspects of the Dodd-Frank Act are to be implemented under regulations promulgated by the federal banking
agencies, some of which have not been completed and which in some instances will not take effect for some time, making
it difficult to anticipate the overall financial impact of the Dodd-Frank Act on 1st Security Bank of Washington, FS
Bancorp, and the financial services industry more generally.
In May 2018 the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Act”), was enacted to
modify or remove certain financial reform rules and regulations, including some of those implemented under the Dodd-
Frank Act. While the Act maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain
aspects of the regulatory framework for small depository institutions with assets of less than $10 billion and for large banks
with assets of more than $50 billion. Many of these changes could result in meaningful regulatory changes for community
banks such as the Bank, and their holding companies.
The Act, among other matters, expands the definition of qualified mortgages which may be held by a financial
institution and simplifies the regulatory capital rules for financial institutions and their holding companies with total
consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single “Community
Bank Leverage Ratio” (“CBLR”) of between 8 and 10 percent. Any qualifying depository institution or its holding
company that exceeds the CBLR will be considered to have met generally applicable leverage and risk-based regulatory
capital requirements and any qualifying depository institution that exceeds the new ratio will be considered to be “well
capitalized” under the prompt corrective action rules.
The Act also expands the category of holding companies that may rely on the “Small Bank Holding Company
and Savings and Loan Holding Company Policy Statement” by raising the maximum amount of assets a qualifying holding
company may have from $1 to $3 billion. The Federal Reserve made this change which became effective on August 30,
2018. In addition, the Act includes regulatory relief for community banks regarding regulatory examination cycles, call
reports, mortgage disclosures, and risk weights for certain high-risk commercial real estate loans.
It is difficult at this time to predict when or how any new standards under the Act will ultimately be applied to us
or what specific impact the Act and the yet-to-be-written implementing rules and regulations will have on community
banks.
Regulation of 1st Security Bank of Washington
General. 1st Security Bank of Washington, as a state-chartered savings bank, is subject to applicable provisions
of Washington law and to regulations and examinations of the DFI. As an insured institution, it also is subject to
examination and regulation by the FDIC, which insures the deposits of 1st Security Bank of Washington to the maximum
permitted by law. During these state or federal regulatory examinations, the examiners may require 1st Security Bank of
Washington to provide for higher general or specific loan loss reserves, which can impact capital and earnings. This
regulation of 1st Security Bank of Washington is intended for the protection of depositors and the Deposit Insurance Fund
(“DIF”) of the FDIC and not for the purpose of protecting shareholders of 1st Security Bank of Washington or FS Bancorp.
1st Security Bank of Washington is required to maintain minimum levels of regulatory capital and is subject to some
limitations on the payment of dividends to FS Bancorp. See below “Regulatory Capital Requirements” and “Restrictions
on Dividends and Stock Repurchases.”
34
Federal and State Enforcement Authority and Actions. As part of its supervisory authority over Washington-
chartered savings banks, the DFI may initiate enforcement proceedings to obtain a consent order to cease-and-desist against
an institution believed to have engaged in unsafe and unsound practices or to have violated a law, regulation, or other
regulatory limit, including a written agreement. The FDIC also has the authority to initiate enforcement actions against
insured institutions under its jurisdiction for similar reasons and may terminate the deposit insurance if it determines that
an institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition. Both these agencies may
also utilize less formal supervisory tools to address their concerns about the condition, operations or compliance status of
a savings bank.
Regulation by the Washington State Department of Financial Institutions. State law and regulations govern 1st
Security Bank of Washington’s ability to take deposits and pay interest, to make loans on or invest in residential and other
real estate, to make consumer loans, to invest in securities, to offer various banking services to its customers, and to
establish branch offices. As a state savings bank, 1st Security Bank of Washington must pay semi-annual assessments,
examination costs and certain other charges to the DFI.
Washington law generally provides the same powers for Washington savings banks as federally and other-state
chartered savings institutions and banks with branches in Washington, subject to the approval of the DFI. Washington law
allows Washington savings banks to charge the maximum interest rates on loans and other extensions of credit to
Washington residents which are allowable for a national bank in another state if higher than Washington limits. In addition,
the DFI may approve applications by Washington savings banks to engage in an otherwise unauthorized activity, if the
DFI determines that the activity is closely related to banking, and 1st Security Bank of Washington is otherwise qualified
under the statute. This additional authority, however, is subject to review and approval by the FDIC if the activity is not
permissible for national banks.
Insurance of Accounts and Regulation by the FDIC. Through the DIF, the FDIC insures deposit accounts in 1st
Security Bank of Washington up to $250,000 per separately insured deposit ownership right or category. As insurer, the
FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-
insured institutions. The Bank’s deposit insurance premiums for the year ended December 31, 2019, were $358,000.
During 2019, the premiums were reduced due to the application of small bank assessment credits in the amount of
$320,000. As of December 31, 2019, the Bank had a remaining balance of such credits of $26,000.
The FDIC’s deposit insurance assessments are based on the assessment base for a bank, which is equal to its total
average consolidated assets less average tangible capital. Based on the current reserve ratio of the DIF, FDIC assessment
rates applicable to 1st Security Bank range from three basis points to 30 basis points, subject to certain adjustments where
applicable for unsecured debt issued by the institution, brokered deposits, and unsecured debt of other FDIC-insured
institutions. Under current regulations, if the reserve ratio becomes equal to, or greater than 2.0% and less than 2.5%, the
assessment rates are scheduled to range from two basis points to 28 basis points (subject to adjustments as described
above), and further reductions in rates may occur if the reserve ratio increases to 2.5% or more.
The FDIC conducts examinations of and requires reporting by state non-member banks, such as 1st Security Bank
of Washington. The FDIC also may prohibit any insured institution from engaging in any activity determined by regulation
or order to pose a serious risk to the DIF. No institution may pay a dividend if it is in default on its federal deposit insurance
assessment.
In addition to the assessment for deposit insurance, institutions have been required to make payments on bonds
issued in the late 1980s by the Financing Corporation established in 1987 to recapitalize a predecessor deposit insurance
fund. These assessments were discontinued in March 2019.
The FDIC may terminate the deposit insurance of any insured depository institution, including 1st Security Bank
of Washington, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices,
is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any
condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily under certain
circumstances. Management is aware of no existing circumstances which would result in termination of 1st Security Bank
of Washington’s deposit insurance.
35
A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and
results of operations of 1st Security Bank of Washington. There can be no prediction as to what changes in insurance
assessment rates may be made in the future.
Prompt Corrective Action. Federal statutes establish a supervisory framework for FDIC-insured institutions
based on five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized
and critically undercapitalized. An institution’s category generally depends upon where its capital levels are in relation to
relevant capital measures, which include risk-based capital measures, a leverage ratio capital measure, and certain other
factors. The well capitalized category is described below in “Capital Requirements”. An institution that is not well
capitalized is subject to certain restrictions on brokered deposits, including restrictions on the rates it can offer on its
deposits generally. Any institution which is neither well capitalized nor adequately capitalized is considered under-
capitalized.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and
restrictions which become more extensive as an institution becomes more severely undercapitalized. Failure by 1st
Security Bank of Washington to comply with applicable capital requirements would, if unremedied, result in progressively
more severe restrictions on its activities and lead to enforcement actions, including, but not limited to, the issuance of a
capital directive to ensure the maintenance of required capital levels and, ultimately, the appointment of the FDIC as
receiver or conservator. Banking regulators will take prompt corrective action with respect to depository institutions that
do not meet minimum capital requirements. Additionally, approval of any regulatory application filed for their review may
be dependent on compliance with capital requirements.
At December 31, 2019, 1st Security Bank of Washington was categorized as well capitalized under the prompt
corrective action regulations of the FDIC. For additional information, see “Capital Requirements” below and “Note 15 -
Regulatory Capital” of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and
Supplementary Data,” of this Form 10-K.
Capital Requirements. 1st Security Bank of Washington is subject to capital regulations adopted by the FDIC,
which establish a required ratio for common equity Tier 1 (“CET1”) capital, minimum leverage and Tier 1 capital ratios,
risk-weightings of certain assets for purposes of the risk-based capital ratios, an additional capital conservation buffer over
the minimum capital ratios, and define what qualifies as capital for purposes of meeting the capital requirements. These
regulations implement the regulatory capital reforms required by the Dodd Frank Act and the “Basel III” requirements.
Under the capital regulations, the minimum capital ratios are: (1) a CET1 capital ratio of 4.5% of risk-weighted
assets; (2) a Tier 1 capital ratio of 6.0% of risk-weighted assets; (3) a total risk-based capital ratio of 8.0% of risk-weighted
assets; and (4) a leverage ratio (the ratio of Tier 1 capital to average total adjusted assets) of 4.0%. CET1 generally consists
of common stock; retained earnings; accumulated other comprehensive income (“AOCI”) ; and certain minority interests;
all subject to applicable regulatory adjustments and deductions. Tier 1 capital generally consists of CET1 and
noncumulative perpetual preferred stock. In addition, Tier 1 capital includes AOCI, which includes all unrealized gains
and losses on available for sale debt and equity securities, unless an institution elects to opt out of such inclusion, if eligible
to do so. We have elected to permanently opt-out of the inclusion of AOCI in our capital calculations. Tier 2 capital
generally consists of other preferred stock and subordinated debt meeting certain conditions plus an amount of the
allowance for loan and lease losses up to 1.25% of assets. Total capital is the sum of Tier 1 and Tier 2 capital.
In addition to the minimum capital requirements, a capital conservation buffer must be maintained by 1st Security
Bank of Washington which consists of additional CET1 capital greater than 2.5% of risk-weighted assets above the
required minimum levels in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary
bonuses.
To be considered well capitalized, a depository institution must have a Tier 1 risk-based capital ratio of at least
8.00%, a total risk-based capital ratio of at least 10%, a CET1 capital ratio of at least 6.50% and a leverage ratio of at least
5.00% and not be subject to an individualized order, directive or agreement under which its primary federal banking
regulator requires it to maintain a specific capital level.
36
At December 31, 2019, 1st Security Bank of Washington met the requirements to be well capitalized and met the
fully phased in capital conservation buffer requirement. Management monitors the capital levels of the Bank to provide
for current and future business opportunities and to meet regulatory guidelines for well capitalized institutions. The Bank’s
actual capital ratios at December 31, 2019 and 2018 are presented in the following tables:
At December 31, 2019
Total risk-based capital
(to risk-weighted assets)
Tier 1 risk-based capital
(to risk-weighted assets)
Tier 1 leverage capital
(to average assets)
CET1 capital
(to risk-weighted assets)
At December 31, 2018
Total risk-based capital
(to risk-weighted assets)
Tier 1 risk-based capital
(to risk-weighted assets)
Tier 1 leverage capital
(to average assets)
CET1 capital
(to risk-weighted assets)
For Capital
For Capital
Adequacy Adequacy with
Purposes
Ratio
Ratio
Actual
Ratio
Capital Buffer Action Provisions
To be Well
Capitalized
Under Prompt
Corrective
Ratio
14.64 %
8.00 %
10.50 %
10.00 %
13.70 %
6.00 %
8.50 %
8.00 %
11.56 %
4.00 %
N/A
5.00 %
13.70 %
4.50 %
7.00 %
6.50 %
For Capital
For Capital
Adequacy Adequacy with
Purposes
Ratio
Ratio
Actual
Ratio
Capital Buffer Action Provisions
To be Well
Capitalized
Under Prompt
Corrective
Ratio
13.52 %
8.00 %
9.88 %
10.00 %
12.62 %
6.00 %
7.88 %
8.00 %
10.67 %
4.00 %
N/A
5.00 %
12.62 %
4.50 %
6.38 %
6.50 %
The FDIC also has authority to establish individual minimum capital requirements in appropriate cases upon a
determination that an institution’s capital level is or may become inadequate in light of particular risks or circumstances.
Management of 1st Security Bank of Washington believes that, under the current regulations, 1st Security Bank of
Washington will continue to meet its minimum capital requirements in the foreseeable future.
Under the implementing regulations released on November 13, 2019 and effective on January 1, 2020, to be
eligible to use the CBLR, a banking organization must not be an advanced approaches organization and must have (i) a
leverage ratio of greater than 9%, (ii) total consolidated assets of less than $10 billion, (iii) total off-balance sheet exposures
of 25% or less of total consolidated assets, and (iv) total trading assets plus trading liabilities of 5% or less of total
consolidated assets, all as of the end of the most recent quarter. Banking organizations may first utilize the CBLR in their
bank call report for the first quarter of 2020, i.e., as of March 31, 2020. We have not yet determined whether or not we
will utilize the CBLR to meet our regulatory capital requirements.
The FASB has adopted a new accounting standard for U.S. GAAP that will be effective for us for our first fiscal
year beginning after December 15, 2022. This standard, referred to as Current Expected Credit Loss, or CECL, requires a
company to recognize credit losses expected over the life of certain financial assets. Upon adoption of CECL, a banking
organization must record a one-time adjustment to its credit loss allowances as of the beginning of the fiscal year of
adoption equal to the difference, if any, between the amount of credit loss allowances under the current methodology and
the amount required under CECL. Implementation of CECL may reduce retained earnings, and affect other items in a
manner that reduces its regulatory capital.
37
The federal banking regulators (the Federal Reserve, the Office of the Comptroller of the Currency and the FDIC)
have adopted a rule that gives a banking organization the option to phase in over a three-year period the day-one adverse
effects of CECL on its regulatory capital.
For a complete description of the Bank’s required and actual capital levels on December 31, 2019, see “Note 15
- Regulatory Capital” of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and
Supplementary Data,” of this Form 10-K.
Standards for Safety and Soundness. The federal banking regulatory agencies have prescribed, by regulation,
guidelines for all insured depository institutions relating to internal controls, information systems and internal audit
systems; loan documentation; credit underwriting; interest rate risk exposure; asset growth; asset quality; earnings; and
compensation, fees and benefits. The guidelines set forth the safety and soundness standards that the federal banking
agencies use to identify and address problems at insured depository institutions before capital becomes impaired. Each
insured depository institution must implement a comprehensive written information security program that includes
administrative, technical, and physical safeguards appropriate to the institution’s size and complexity and the nature and
scope of its activities. The information security program must be designed to ensure the security and confidentiality of
customer information, protect against any unanticipated threats or hazards to the security or integrity of such information,
protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to
any customer, and ensure the proper disposal of customer and consumer information. Each insured depository institution
must also develop and implement a risk-based response program to address incidents of unauthorized access to customer
information in customer information systems. If the FDIC determines that an institution fails to meet any of these
guidelines, it may require an institution to submit to the FDIC an acceptable plan to achieve compliance.
Federal Home Loan Bank System. The FHLB of Des Moines is one of 11 regional Federal Home Loan Banks
that administer the home financing credit function of savings institutions. The Federal Home Loan Banks are subject to
the oversight of the Federal Housing Finance Agency and each Federal Home Loan Bank serves as a reserve or central
bank for its members within its assigned region. The Federal Home Loan Banks are funded primarily from proceeds
derived from the sale of consolidated obligations of the Federal Home Loan Bank System and make loans or advances to
members in accordance with policies and procedures established by the Board of Directors of the Federal Home Loan
Bank, which are subject to the oversight of the Federal Housing Finance Agency. All advances are required to be fully
secured by sufficient collateral as determined by the Federal Home Loan Bank. In addition, members are required to
purchase stock equal to 4.0% of advances. That stock may be redeemed if advances are paid down. See “Business -
Deposit Activities and Other Sources of Funds - Debt.” At December 31, 2019, 1st Security Bank of Washington had $8.0
million in FHLB of Des Moines stock, which was in compliance with this requirement.
The FHLB pays dividends quarterly, and 1st Security Bank of Washington received $454,000 in dividends during
the year ended December 31, 2019.
The Federal Home Loan Banks continue to contribute to low- and moderately-priced housing programs through
direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing
projects. These contributions have adversely affected the level of Federal Home Loan Bank dividends paid and could
continue to do so in the future. These contributions could also have an adverse effect on the value of Federal Home Loan
Bank stock in the future. A reduction in value of 1st Security Bank of Washington’s FHLB stock may result in a decrease
in net income.
Commercial Real Estate Lending Concentrations. The federal banking agencies have issued guidance on sound
risk management practices for concentrations in commercial real estate lending. The particular focus is on exposure to
commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely
to be sensitive to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary
source of repayment or as an abundance of caution). The purpose of the guidance is not to limit a bank’s commercial real
estate lending but to guide banks in developing risk management practices and capital levels commensurate with the level
and nature of real estate concentrations. The guidance directs the FDIC and other federal bank regulatory agencies to focus
their supervisory resources on institutions that may have significant commercial real estate loan concentration risk. A bank
that has experienced rapid growth in commercial real estate lending, has notable exposure to a specific type of commercial
38
real estate loan, or is approaching or exceeding the following supervisory criteria may be identified for further supervisory
analysis with respect to real estate concentration risk:
Total reported loans for construction, land development and other land represent 100% or more of the Bank’s
total regulatory capital; or
Total commercial real estate loans (as defined in the guidance) represent 300% or more of the Bank’s total
regulatory capital and the outstanding balance of the Bank’s commercial real estate loan portfolio has increased 50% or
more during the prior 36 months.
The guidance provides that the strength of an institution’s lending and risk management practices with respect to
such concentrations will be taken into account in supervisory guidance on evaluation of capital adequacy. At December
31, 2019, 1st Security Bank of Washington’s aggregate recorded loan balances for construction, land development and
land loans were 85.7% of regulatory capital. In addition, at December 31, 2019, 1st Security Bank of Washington’s loans
on all commercial real estate, including construction, owner and non-owner occupied commercial real estate, and multi-
family lending, as defined by the FDIC, were 275.3% of regulatory capital.
Activities and Investments of Insured State-Chartered Financial Institutions. Federal law generally limits the
activities and equity investments of FDIC insured, state-chartered banks to those that are permissible for national banks.
An insured state bank is not prohibited from, among other things, (1) acquiring or retaining a majority interest in a
subsidiary, (2) investing as a limited partner in a partnership the sole purpose of which is direct or indirect investment in
the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership
investments may not exceed 2% of the bank’s total assets, (3) acquiring up to 10% of the voting stock of a company that
solely provides or reinsures directors’ and officers’ liability insurance coverage or bankers’ blanket bond group insurance
coverage for insured depository institutions, and (4) acquiring or retaining the voting shares of a depository institution if
certain requirements are met.
Dividends. Dividends from 1st Security Bank of Washington constitute a major source of funds for dividends in
future periods that may be paid by FS Bancorp to shareholders. The amount of dividends payable by 1st Security Bank of
Washington to FS Bancorp depends upon the Bank’s earnings and capital position, and is limited by federal and state laws,
regulations and policies. According to Washington law, 1st Security Bank of Washington may not declare or pay a cash
dividend on its capital stock if it would cause its net worth to be reduced below (1) the amount required for liquidation
accounts or (2) the net worth requirements, if any, imposed by the Director of the DFI. Dividends on 1st Security Bank of
Washington’s capital stock may not be paid in an aggregate amount greater than the aggregate retained earnings of 1st
Security Bank of Washington, without the approval of the Director of the DFI. The Bank paid $3.9 million in dividends
to the holding company in 2019.
The amount of dividends actually paid during any one period will be strongly affected by 1st Security Bank of
Washington’s policy of maintaining a strong capital position. Federal law further limits and can prohibit dividends when
an institution does not meet the capital conservation buffer requirement and provides that no insured depository institution
may pay a cash dividend if it would cause the institution to be “undercapitalized,” as defined in the prompt corrective
action regulations. Moreover, the federal bank regulatory agencies also have the general authority to limit the dividends
paid by insured banks if such payments are deemed to constitute an unsafe and unsound practice.
Affiliate Transactions. FS Bancorp and 1st Security Bank of Washington are separate and distinct legal entities.
FS Bancorp (and any non-bank subsidiary of FS Bancorp) is an affiliate of 1st Security Bank of Washington. Federal laws
strictly limit the ability of banks to engage in certain transactions with their affiliates. Transactions deemed to be “covered
transactions” under Section 23A of the Federal Reserve Act and between a bank and an affiliate are limited to 10% of the
bank subsidiary’s capital and surplus and, with respect to all affiliates, to an aggregate of 20% of the bank’s capital and
surplus. Further, covered transactions that are loans and extensions of credit generally are required to be secured by eligible
collateral in specified amounts. Federal law also requires that covered transactions and certain other transactions listed in
Section 23B of the Federal Reserve Act between a bank and its affiliates be on terms as favorable to the bank as transactions
with non-affiliates.
39
Community Reinvestment Act. 1st Security Bank of Washington is also subject to the provisions of the
Community Reinvestment Act of 1977 (“CRA”), which requires the appropriate federal bank regulatory agency to assess
a bank’s performance under the CRA in meeting the credit needs of the community serviced by the Bank, including low
and moderate income neighborhoods. The regulatory agency’s assessment of a bank’s record is made available to the
public. Further, a bank’s CRA performance rating must be considered in connection with a bank’s application to, among
other things, establish a new branch office that will accept deposits, relocate an existing office or merge or consolidate
with, or acquire the assets or assume the liabilities of, a federally regulated financial institution, and in connection with
certain applications by a bank holding company, such as bank acquisitions. 1st Security Bank of Washington received a
“satisfactory” rating during its most recent CRA examination.
Privacy Standards. 1st Security Bank of Washington is subject to FDIC regulations implementing the privacy
protection provisions of the Gramm-Leach-Bliley Act of 1999. These regulations require 1st Security Bank of Washington
to disclose its privacy policy, including informing consumers of its information sharing practices and informing consumers
of its rights to opt out of certain practices.
Environmental Issues Associated with Real Estate Lending. The Comprehensive Environmental Response,
Compensation and Liability Act (“CERCLA”) is a federal statute that generally imposes strict liability on, all prior and
present “owners and operators” of sites containing hazardous waste. However, Congress asked to protect secured creditors
by providing that the term “owner and operator” excludes a person whose ownership is limited to protecting its security
interest in the site. Since the enactment of the CERCLA, this “secured creditor exemption” has been the subject of judicial
interpretations which have left open the possibility that lenders could be liable for cleanup costs on contaminated property
that they hold as collateral for a loan. To the extent that legal uncertainty exists in this area, all creditors, including 1st
Security Bank of Washington, that have made loans secured by properties with potential hazardous waste contamination
(such as petroleum contamination) could be subject to liability for cleanup costs, which costs often substantially exceed
the value of the collateral property.
Federal Reserve System. The Federal Reserve requires that all depository institutions maintain reserves on
transaction accounts or non-personal time deposits. These reserves may be in the form of cash or noninterest-bearing
deposits with the regional Federal Reserve Bank. NOW accounts and other types of accounts that permit payments or
transfers to third parties fall within the definition of transaction accounts and are subject to the reserve requirements, as
are any non-personal time deposits at a savings bank. At December 31, 2019, 1st Security Bank of Washington’s deposit
with the Federal Reserve Bank and vault cash exceeded its reserve requirements.
Other Consumer Protection Laws and Regulations. The Dodd-Frank Act established the CFPB and empowered
it to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer
financial protection laws. 1st Security Bank of Washington is subject to consumer protection regulations issued by the
CFPB, but as a financial institution with assets of less than $10 billion, 1st Security Bank of Washington is generally
subject to supervision and enforcement by the FDIC and the DFI with respect to compliance with federal and state
consumer financial protection laws and regulations.
1st Security Bank of Washington is subject to a broad array of federal and state consumer protection laws and
regulations that govern almost every aspect of its business relationships with consumers. While the list set forth below is
not exhaustive, these include the Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the
Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement
Procedures Act, the Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act,
the Right to Financial Privacy Act, the Home Ownership and Equity Protection Act, the Consumer Leasing Act, the Fair
Credit Billing Act, the Homeowners Protection Act, the Check Clearing for the 21st Century Act, laws governing flood
insurance, laws governing consumer protections in connection with the sale of insurance, federal and state laws prohibiting
unfair and deceptive business practices, and various regulations that implement the foregoing. These laws and regulations
mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers
when taking deposits, making loans, collecting loans, and providing other services. Failure to comply with these laws and
regulations can subject 1st Security Bank of Washington to various penalties, including but not limited to, enforcement
actions, injunctions, fines, civil liability, criminal penalties, punitive damages, and the loss of certain contractual rights.
40
Regulation and Supervision of FS Bancorp
General. FS Bancorp is a bank holding company registered with the Federal Reserve and is the sole shareholder
of 1st Security Bank of Washington. Bank holding companies are subject to comprehensive regulation by the Federal
Reserve under the Bank Holding Company Act of 1956, as amended (“BHCA”), and the regulations promulgated there
under. This regulation and oversight is generally intended to ensure that FS Bancorp limits its activities to those allowed
by law and that it operates in a safe and sound manner without endangering the financial health of 1st Security Bank of
Washington.
As a bank holding company, FS Bancorp is required to file quarterly and annual reports with the Federal Reserve
and any additional information required by the Federal Reserve and is subject to regular examinations by the Federal
Reserve. The Federal Reserve also has extensive enforcement authority over bank holding companies, including the ability
to assess civil money penalties, to issue cease and desist or removal orders, and to require that a holding company divest
subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and
regulations and unsafe or unsound practices.
The Bank Holding Company Act. Under the BHCA, FS Bancorp is supervised by the Federal Reserve. The
Federal Reserve has a policy that a bank holding company is required to serve as a source of financial and managerial
strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, the Dodd-
Frank Act provides that a bank holding company should serve as a source of strength to its subsidiary banks by having the
ability to provide financial assistance to its subsidiary banks during periods of financial stress to the bank. A bank holding
company’s failure to meet its obligation to serve as a source of strength to its subsidiary banks will generally be considered
by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve’s regulations
or both. No regulations have yet been proposed by the Federal Reserve to implement the source of strength doctrine
required by the Dodd-Frank Act. FS Bancorp and any subsidiaries that it may control are considered “affiliates” of 1st
Security Bank of Washington within the meaning of the Federal Reserve Act, and transactions between 1st Security Bank
of Washington and its affiliates are subject to numerous restrictions. With some exceptions, FS Bancorp and its subsidiaries
are prohibited from tying the provision of various services, such as extensions of credit, to other services offered by FS
Bancorp or its subsidiaries.
Acquisitions. The BHCA prohibits a bank holding company, with certain exceptions, from acquiring ownership
or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from
engaging in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries.
Under the BHCA, the Federal Reserve may approve the ownership of shares by a bank holding company in any company,
the activities of which the Federal Reserve has determined to be so closely related to the business of banking or managing
or controlling banks as to be a proper incident thereto. These activities include: operating a savings institution, mortgage
company, finance company, credit card company or factoring company; performing certain data processing operations;
providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-
related insurance; leasing property on a full-payout, non-operating basis; selling money orders, travelers’ checks, and U.S.
Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject
to certain limitations, providing securities brokerage services for customers.
Regulatory Capital Requirements. As discussed above, pursuant to the Act, effective August 30, 2018, bank
holding companies with less than $3 billion in consolidated assets were generally no longer subject to the Federal Reserve’s
capital regulations, which are generally the same as the capital regulations applicable to 1st Security Bank of Washington.
At the time of this change, FS Bancorp was considered “well capitalized” (as defined for a bank holding company), and
was not subject to an individualized order, directive or agreement under which the Federal Reserve requires it to maintain
a specific capital level.
41
The Company’s regulatory capital amounts and ratios at December 31, 2019 are presented in the following table.
To be Well Capitalized
Actual
Adequacy Purposes
For Capital
For Capital Adequacy
with Capital Buffer
Under Prompt
Corrective
Action Provisions
Amount Ratio Amount Ratio Amount Ratio Amount Ratio
At December 31, 2019
Total risk-based capital
(to risk-weighted assets) $ 205,207 14.34 % $ 114,515
8.00 % $ 150,301
10.50 % $
143,144
10.00 %
Tier 1 risk-based capital
(to risk-weighted assets) $ 191,685 13.39 % $
85,887
6.00 % $ 121,673
8.50 % $
114,515
8.00 %
Tier 1 leverage capital
(to average assets)
CET1 capital
$ 191,685 11.30 % $
67,877
4.00 % $
N/A
N/A $
84,846
5.00 %
(to risk-weighted assets) $ 191,685 13.39 % $
64,415
4.50 % $ 100,201
7.00 % $
93,044
6.50 %
For additional information, see “Note 15 - Regulatory Capital” of the Notes to the Consolidated Financial
Statements contained in “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
Interstate Banking. The Federal Reserve may approve an application of a bank holding company to acquire
control of, or acquire all, or substantially all of the assets of a bank located in a state other than the holding company’s
home state, without regard to whether the transaction is prohibited by the laws of any state. The Federal Reserve may not
approve the acquisition of a bank that has not been in existence for the minimum time period, not exceeding five years,
specified by the law of the host state. Nor may the Federal Reserve approve an application if the applicant controls or
would control more than 10% of the insured deposits in the United States or 30% or more of the deposits in the target
bank’s home state or in any state in which the target bank maintains a branch. Federal law does not affect the authority of
states to limit the percentage of total insured deposits in the state that may be held or controlled by a bank holding company
to the extent such limitation does not discriminate against out-of-state banks or bank holding companies. Individual states
may also waive the 30% state-wide concentration limit contained in the federal law.
The federal banking agencies are generally authorized to approve interstate merger transactions without regard
to whether the transaction is prohibited by the law of any state. Interstate acquisitions of branches will be permitted only
if the law of the state in which the branch is located permits such acquisitions. Interstate mergers and branch acquisitions
are also subject to the nationwide and statewide insured deposit concentration amounts described above.
Restrictions on Dividends and Stock Repurchases. FS Bancorp’s ability to declare and pay dividends is subject
to the Federal Reserve limits and Washington law, and may depend on its ability to receive dividends from 1st Security
Bank of Washington.
Federal Reserve policy limits the payment of a cash dividend by a bank holding company if the holding
company’s net income for the past year is not sufficient to cover both the cash dividend and a rate of earnings retention
that is consistent with capital needs, asset quality and overall financial condition. A bank holding company that does not
meet any applicable capital standard would not be able to pay any cash dividends under this policy. A bank holding
company not subject to consolidated capital requirements is expected not to pay dividends unless its debt-to-equity ratio
is less than 1:1, and it meets certain additional criteria. The Federal Reserve also has indicated that it would be inappropriate
for a company experiencing serious financial problems to borrow funds to pay dividends.
Except for a company that meets the applicable standard to be considered a well capitalized and well-managed
bank holding company and is not subject to any unresolved supervisory issues, a bank holding company is required to give
the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the gross
consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or
redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth. The
Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an
unsafe or unsound practice or would violate any law, regulation or regulatory order, condition, or written agreement.
42
Under Washington corporate law, FS Bancorp generally may not pay dividends if after that payment it would not
be able to pay its liabilities as they become due in the usual course of business, or its total assets would be less than the
sum of its total liabilities.
Federal Securities Law. The stock of FS Bancorp is registered with the SEC under the Securities Exchange Act
of 1934, as amended. As a result, FS Bancorp is subject to the information, proxy solicitation, insider trading restrictions,
and other requirements under the Securities Exchange Act of 1934.
FS Bancorp stock held by persons who are affiliates of FS Bancorp may not be resold without registration unless
sold in accordance with certain resale restrictions. Affiliates are generally considered to be officers, directors, and principal
shareholders. If FS Bancorp meets specified current public information requirements, each affiliate of FS Bancorp will be
able to sell in the public market, without registration, a limited number of shares in any three-month period.
Sarbanes-Oxley Act of 2002. As a public company that files periodic reports with the SEC, under the Securities
Exchange Act of 1934, FS Bancorp is subject to the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”), which addresses,
among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely
disclosure of corporate information. The Sarbanes-Oxley Act represents significant federal involvement in matters
traditionally left to state regulatory systems, such as the regulation of the accounting profession and to state corporate law,
such as the relationship between a board of directors and management and between a board of directors and its committees.
Our policies and procedures have been updated to comply with the requirements of the Sarbanes-Oxley Act.
The Dodd-Frank Act. The Dodd-Frank Act imposed new restrictions and an expanded framework of regulatory
oversight for financial institutions, including depository institutions, and implements new capital regulations that FS
Bancorp and 1st Security Bank of Washington have and will become subject to and that are discussed above under the
section entitled “Regulation of 1st Security Bank of Washington - Capital Requirements.”
In addition, among other changes, the Dodd-Frank Act requires public companies like FS Bancorp, to (i) provide
their shareholders with a non-binding vote (a) at least once every three years on the compensation paid to executive officers
and (b) at least once every six years on whether they should have a “say on pay” vote every one, two, or three years;
(ii) have a separate, non-binding shareholder vote regarding golden parachutes for named executive officers when a
shareholder vote takes place on mergers, acquisitions, dispositions, or other transactions that would trigger the parachute
payments; (iii) provide disclosure in annual proxy materials concerning the relationship between the executive
compensation paid and the financial performance of the issuer; and (iv) amend Item 402 of Regulation S-K to require
companies to disclose the ratio of the Chief Executive Officer’s annual total compensation to the median annual total
compensation of all other employees. For certain of these changes, the implementing regulations have not been
promulgated, so the full impact of the Dodd-Frank Act on public companies cannot be determined at this time.
Federal Taxation
TAXATION
General. FS Bancorp and 1st Security Bank of Washington are subject to federal income taxation in the same
general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation
is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the
tax rules applicable to FS Bancorp. 1st Security Bank of Washington is no longer subject to U.S. federal income tax
examinations by tax authorities for years ended before 2016, and income tax returns have not been audited for the past
seven years, 2013 to 2019.
FS Bancorp files a consolidated federal income tax return with 1st Security Bank of Washington. Accordingly,
any cash distributions made by FS Bancorp to its shareholders would be considered to be taxable dividends and not as a
non-taxable return of capital to shareholders for federal and state tax purposes. For additional information, see “Note 12-
Income Taxes” of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and
Supplementary Data” of this Form 10 K.
Method of Accounting. For federal income tax purposes, FS Bancorp currently reports its income and expenses
on the accrual method of accounting and uses a fiscal year ending on December 31 for filing its federal income tax return.
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Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of
regular taxable income plus certain tax preferences, called alternative minimum taxable income. The alternative minimum
tax is payable to the extent such alternative minimum taxable income is in excess of an exemption amount. Net operating
losses can offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax
may be used as credits against regular tax liabilities in future years.
Corporate Dividends-Received Deduction. FS Bancorp may eliminate from its income dividends received from
1st Security Bank of Washington as a wholly owned subsidiary of FS Bancorp if it elects to file a consolidated return with
1st Security Bank of Washington. The corporate dividends-received deduction is 100%, or 80%, in the case of dividends
received from corporations with which a corporate recipient does not file a consolidated tax return, depending on the level
of stock ownership of the payor of the dividend. Corporations which own less than 20% of the stock of a corporation
distributing a dividend may deduct 70% of dividends received or accrued on their behalf.
Washington Taxation
The Company and the Bank are subject to a business and occupation tax which is imposed under Washington law
at the rate of 1.50% of gross receipts. Interest received on loans secured by mortgages or deeds of trust on residential
properties, residential mortgage-backed securities, and certain U.S. Government and agency securities are not subject to
this tax.
Item 1A. Risk Factors
An investment in our common stock is subject to risks inherent in our business. Before making an investment
decision, you should carefully consider the risks and uncertainties described below together with all of the other
information included in this report and our other filings with the SEC. In addition to the risks and uncertainties
described below, other risks and uncertainties not currently known to us or that we currently deem to be immaterial
also may materially and adversely affect our business, financial condition, capital levels, cash flows, liquidity, results
of operations, and prospects. The market price of our common stock could decline significantly due to any of these
identified or other risks, and you could lose some or all of your investment. The risks discussed below also include
forward-looking statements, and our actual results may differ substantially from those discussed in these forward-
looking statements. This report is qualified in its entirety by these risk factors.
Risks Related to Our Business
Our business may be adversely affected by downturns in the national economy and in the economies in our
market areas.
Our primary market areas are in the Puget Sound region of Washington and Kitsap, Clallam, Jefferson, Grays
Harbor, Thurston, Lewis, and Benton counties. Our business is directly affected by market conditions, trends in industry
and finance, legislative and regulatory changes, and changes in governmental monetary and fiscal policies, and inflation,
all of which are beyond our control. General economic conditions, including inflation, unemployment and money supply
fluctuations, also may affect our profitability adversely. A decline in the economies of the counties in which we operate
could have a material adverse effect on our business, financial condition, results of operations, and prospects. Weakness
in the global economy has adversely affected many businesses operating in our markets that are dependent upon
international trade and it is not known how changes in tariffs being imposed on international trade may also affect these
businesses. Changes in agreements or relationships between the United States and other countries may also affect these
businesses. The coronavirus outbreak may also have an adverse effect on our Company's customers directly or indirectly,
including those engaged in international trade, travel and tourism. These effects could include disruptions or restrictions
in customers' supply chains or employee productivity, closures of customer' facilities, decreases in demand for customers'
products and services or in other economic activities. Their businesses may be adversely affected by quarantines and travel
restrictions in countries most affected by the coronavirus. In addition, entire industries such as agriculture, may be
adversely impacted due to lower exports caused by reduced economic activity in the affected countries. If customers are
adversely affected, or if the virus leads to a widespread health crisis that impacts U.S. economic growth, our condition and
results of operations could be adversely affected.
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While real estate values and unemployment rates have recently improved, a deterioration in economic conditions
in the market areas we serve could result in loan losses beyond that which is provided for in our allowance for loan losses
and could result in the following consequences, any of which could have a material adverse effect on the business, financial
condition, and results of operations:
demand for our products and services may decline, possibly resulting in a decrease in our total loans or assets;
loan delinquencies, problem assets and foreclosures may increase;
we may increase our allowance for loan losses;
collateral for our loans may further decline in value, in turn reducing customer’s borrowing power, reducing
the value of assets and collateral associated with existing loans;
the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to
us; and
the amount of our low-cost or noninterest-bearing deposits may decrease.
A decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings
and capital of larger financial institutions whose real estate loan portfolios are geographically diverse. Many of the loans
in our portfolio are secured by real estate or fixtures attached to real estate. Deterioration in the real estate markets where
collateral for a mortgage loan is located could negatively affect the borrower’s ability to repay the loan and the value of
the collateral securing the loan. Real estate values are affected by various other factors, including changes in general or
regional economic conditions, governmental rules or policies, and natural disasters such as earthquakes. If we are required
to liquidate a significant amount of collateral during a period of reduced real estate values, our financial condition and
profitability could be adversely affected.
Adverse changes in the regional and general economy could reduce our growth rate, impair our ability to collect
loans, and generally have a negative effect on our financial condition and results of operations.
Our loan portfolio possesses increased risk due to a large percentage of consumer loans.
Our consumer loans accounted for $326.2 million, or 24.1% of our total gross loan portfolio as of December 31,
2019, of which $210.7 million (64.6% of total consumer loans) consisted of indirect home improvement loans (some of
which were not secured by a lien on the real property), $67.2 million (20.6% of total consumer loans) consisted of marine
loans secured by boats, $44.0 million (13.5% of total consumer loans) consisted of solar loans, and $4.3 million (1.3% of
total consumer loans) consisted of other consumer loans, which includes personal lines of credit, credit cards, automobile,
direct home improvement, loans on deposit, and recreational loans. Generally, we consider these types of loans to involve
a higher degree of risk compared to first mortgage loans on owner-occupied, one-to-four-family residential properties. As
a result of our large portfolio of consumer loans, it may become necessary to increase the level of provision for our loan
losses, which would reduce profits. Consumer loans generally entail greater risk than do one-to-four-family residential
mortgage loans, particularly in the case of loans that are secured by rapidly depreciable assets, such as automobiles and
boats. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of
the outstanding loan balance.
Most of our consumer loans are originated indirectly by or through third parties, which presents greater risk than
our direct lending products which involves direct contact between us and the borrower. Unlike a direct loan where the
borrower makes an application directly to us, in these loans the dealer, who has a direct financial interest in the loan
transaction, assists the borrower in preparing the loan application. Although we disburse the loan proceeds directly to the
dealer upon receipt of a “completion certificate” signed by the borrower, because we do not have direct contact with the
borrower, these loans may be more susceptible to a material misstatement on the loan application or having the loan
proceeds being misused by the borrower or the dealer. In addition, if the work is not properly performed, the borrower
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may cease payment on the loan until the problem is rectified. Although we file a UCC-2 financing statement to perfect the
security interest in the personal property collateral for most fixture and solar loans, there are no guarantees on our ability
to collect on that security interest or that the repossessed collateral for a defaulted fixture or solar loan will provide an
adequate source of repayment for the outstanding loan given the limited stand-alone value of the collateral.
Indirect home improvement, marine, and solar loans totaled $321.9 million, or 23.8% of our total gross loan
portfolio at December 31, 2019, and are originated through a network of 155 home improvement contractors and dealers
located in Washington, Oregon, California, Idaho, Colorado, and Arizona. In addition, we rely on 10 dealers for a majority,
or 62.3% of our loan volume so the loss of one of these dealers can have a significant effect on our loan origination volume.
See “Item 1. Business - Lending Activities - Consumer Lending” and “- Asset Quality.”
Our business could suffer if we are unsuccessful in making, continuing, and growing relationships with home
improvement contractors and dealers.
Our indirect home improvement lending, which is the largest component of our consumer loan portfolio, is reliant
on our relationships with home improvement contractors and dealers. In particular, our indirect home improvement loan
operations depend in large part upon our ability to establish and maintain relationships with reputable contractors and
dealers who originate loans at the point of sale. Our indirect home improvement contractor/dealer network is currently
comprised of 155 active contractors and dealers with businesses located throughout Washington, Oregon, California,
Idaho, Colorado, and Arizona, with approximately 10 contractors/dealers responsible for more than half of this loan
volume. Indirect home improvement and solar loans totaled $254.7 million, or 18.8% of our total gross loan portfolio, at
December 31, 2019, reflecting approximately 18,000 loans with an average balance of approximately $14,000.
We have relationships with home improvement contractors/dealers, however, the relationships generally are not
exclusive, some of them are newly established and they may be terminated at any time. If there is another economic
downturn and contraction of credit to both contractors/dealers and their customers, there could be an increase in business
closures and our existing contractor/dealer base could experience decreased sales and loan volume, which may have an
adverse effect on our business, results of operations and financial condition. In addition, if a competitor were to offer better
service or more attractive loan products to our contractor/dealer partners, it is possible that our partners would terminate
their relationships with us or recommend customers to our competitors. If we are unable to continue to grow our existing
relationships and develop new relationships, our results of operations and financial condition could be adversely affected.
A significant portion of our business involves commercial real estate lending which is subject to various risks that
could adversely impact our results of operations and financial condition.
At December 31, 2019, our loan portfolio included $210.8 million of commercial real estate loans, including
$149.5 million secured by non-owner occupied commercial real estate properties, and $133.9 million of multi-family real
estate loans, or 25.5% of our total gross loan portfolio, compared to $309.4 million, or 23.3%, at December 31, 2018. We
have been increasing and intend to continue to increase, subject to market demand, the origination of commercial and
multi-family real estate loans. The credit risk related to these types of loans is considered to be greater than the risk related
to one-to-four-family residential loans because the repayment of commercial and multi-family real estate loans typically
is dependent on the successful operation and income stream of the property securing the loan and the value of the real
estate securing the loan as collateral, which can be significantly affected by economic conditions.
Our focus on these types of loans will increase the risk profile relative to traditional one-to-four-family lenders
as we continue to implement our business strategy. Although commercial and multi-family real estate loans are intended
to enhance the average yield of the earning assets, they do involve a different, and possibly higher, level of risk of
delinquency or collection than generally associated with one-to-four-family loans for a number of reasons. Among other
factors, these loans involve larger balances to a single borrower or groups of related borrowers. Since commercial real
estate and multi-family real estate loans generally have large balances, if we make any errors in judgment in the
collectability of these loans, we may need to significantly increase the provision for loan losses since any resulting
charge-offs will be larger on a per loan basis. Consequently, this could materially adversely affect our future earnings.
Collateral evaluation for these types of loans also requires a more detailed analysis at the time of loan underwriting
and on an ongoing basis. In addition, most of our commercial and multi-family loans are not fully amortizing and include
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balloon payments upon maturity. Balloon payments may require the borrower to either sell or refinance the underlying
property in order to make the payment, which may increase the risk of default or non-payment. Finally, if foreclosure
occurs on a commercial real estate loan, the holding period for the collateral, if any, typically is longer than for a one-to-
four-family residence because the secondary market for most types of commercial and multi-family real estate is not
readily liquid, so we have less opportunity to mitigate credit risk by selling part or all of our interest in these assets. See
“Item 1. Business - Lending Activities - Commercial Real Estate Lending” of this Form 10-K.
Repayment of our commercial business loans is often dependent on the cash flows of the borrower, which may be
unpredictable, and the collateral securing these loans may fluctuate in value.
At December 31, 2019, our commercial business loan portfolio included commercial and industrial loans of
$140.5 million, or 10.4%, and warehouse lending of $61.1 million, or 4.5%, of our total gross loan portfolio compared to
commercial and industrial loans of $138.7 million, or 10.5%, and warehouse lending of $65.8 million, or 5.0% at December
31, 2018. Commercial business lending involves risks that are different from those associated with residential and
commercial real estate lending. Real estate lending is generally considered to be collateral-based lending with loan amounts
based on predetermined loan to collateral values and liquidation of the underlying real estate collateral being viewed as
the primary source of repayment in the event of borrower default. Our commercial and industrial business loans are
primarily made based on the cash flow of the borrower and secondarily on the underlying collateral provided by the
borrower. The borrowers’ cash flow may be unpredictable and collateral securing these loans may fluctuate in value. This
collateral may consist of equipment, inventory, accounts receivable, or other business assets. In the case of loans secured
by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the
ability of the borrower to collect amounts due from its customers. Other collateral securing these loans may depreciate
over time, may be difficult to appraise, may be illiquid, and may fluctuate in value based on the specific type of business
and equipment. As a result, the availability of funds for the repayment of commercial and industrial business loans may
be substantially dependent on the success of the business itself, which, in turn, is often dependent in part upon general
economic conditions and secondarily on the underlying collateral provided by the borrower. For additional information
related to the risks of warehouse lending, see “Our residential mortgage warehouse lending and construction warehouse
lending programs are subject to various risks that could adversely impact our results of operations and financial condition.”
We continue to focus on residential construction lending which is subject to various risks that could adversely
impact our results of operations and financial condition.
We make real estate construction loans to individuals and builders, primarily for the construction of residential
properties. We originate these loans whether or not the collateral property underlying the loan is under contract for sale.
At December 31, 2019, construction and development loans totaled $179.7 million, or 13.3% of our total gross loan
portfolio (excluding $95.0 million of unfunded construction loan commitments), of which $157.5 million were for
residential real estate projects. This compares to construction and development loans of $247.3 million, or 18.7% of our
total loan portfolio at December 31, 2018, or a decrease of 27.4% during the past year. In addition to these construction
and development loans, the Company had six commercial note-secured lines of credit to residential construction re-lenders
with combined commitments of $70.0 million, and an outstanding balance of $48.2 million at December 31, 2019. The
underlying collateral risks associated with our commercial construction warehouse lines are similar to the risks related to
our residential construction and development loans.
Construction financing is generally considered to involve a higher degree of credit risk than longer term financing
on improved, owner-occupied real estate. Construction lending involves additional risks when compared with permanent
residential lending because funds are advances upon the collateral for the project based on an estimate of costs that will
produce a future value at completion. Because of the uncertainties inherent in estimating construction costs, as well as the
market value of the complete project and the effects of governmental regulation on real property, it is relatively difficult
to evaluate accurately the total funds required to complete a project and the completed project loan-to-value ratio. Changes
in demand for new housing and higher than anticipated building costs may cause actual results to vary significantly from
those estimated. For these reasons, this type of lending also typically involves higher loan principal amounts and may be
concentrated with a small number of builders. A downturn in housing, or the real estate market, could increase
delinquencies, defaults and foreclosures, and significantly impair the value of our collateral and our ability to sell the
collateral upon foreclosure. Some of the builders we deal with have more than one loan outstanding with us. Consequently,
an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of
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loss. In addition, during the term of most of our construction loans, no payment from the borrower is required since the
accumulated interest is added to the principal of the loan through an interest reserve. As a result, these loans often involve
the disbursement of funds with repayment substantially dependent on the success of the ultimate project and the ability of
the borrower to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or
guarantor to repay principal and interest. If our appraisal of the value of a completed project proves to be overstated, we
may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur
a loss. Because construction loans require active monitoring of the building process, including cost comparisons and on-
site inspections, these loans are more difficult and costly to monitor.
Increases in market rates of interest may have a more pronounced effect on construction loans by rapidly
increasing the end-purchaser’s borrowing costs, thereby possibly reducing the homeowner's ability to finance the home
upon completion or the overall demand for the project. Properties under construction are often difficult to sell and typically
must be completed in order to be successfully sold which also complicates the process of working out problem construction
loans. This may require us to advance additional funds and/or contract with another builder to complete construction and
assume the market risk of selling the project at a future market price, which may or may not enable us to fully recover
unpaid loan funds and associated construction and liquidation costs. Furthermore, in the case of speculative construction
loans, there is the added risk associated with identifying an end-purchaser for the finished project. At December 31, 2019,
outstanding construction and development loans totaled $179.7 million of which $115.6 million was comprised of
speculative one-to-four-family construction loans and $10.6 million of land acquisition and development loans. Total
committed, including unfunded construction and development loans at December 31, 2019 was $274.7 million. Loans on
land under development or held for future construction pose additional risks because of the lack of income being produced
by the property and the potential illiquid nature of the collateral. These risks can be significantly impacted by supply and
demand. As a result, this type of lending often involves the disbursement of substantial funds with repayment dependent
on the success of the ultimate project and the ability of the borrower to sell or lease the property, rather than the ability of
the borrower or guarantor themselves to repay principal and interest. No real estate construction and development loans
were non-performing at December 31, 2019. A material increase in our non-performing construction and development
loans could have a material adverse effect on our financial condition and results of operation.
Our residential mortgage warehouse lending program is subject to various risks that could adversely impact our
results of operations and financial condition.
The Company has a residential mortgage warehouse lending program that focuses on four Pacific Northwest
mortgage banking companies. Short-term funding is provided to the mortgage banking companies for the purpose of
originating residential mortgage loans for sale into the secondary market. Our warehouse lending lines are secured by the
underlying notes associated with mortgage loans made to borrowers by the mortgage banking company and we generally
require guarantees from the principal shareholder(s) of the mortgage banking company. Because these loans are repaid
when the note is sold by the mortgage bank into the secondary market, with the proceeds from the sale used to pay down
our outstanding loan before being dispersed to the mortgage bank, interest rate fluctuation is also a key risk factor affecting
repayment. At December 31, 2019, we had approved residential warehouse lending lines in varying amounts from $4.0
million to $8.0 million with each of the four companies, for an aggregate amount of $25.0 million. At December 31, 2019,
there was $12.9 million in residential warehouse lines outstanding, compared to $4.4 million outstanding at December 31,
2018.
There are numerous risks associated with residential mortgage warehouse lending, which include, without
limitation, (i) credit risks relating to the mortgage bankers that borrow from us, (ii) the risk of intentional misrepresentation
or fraud by any of these mortgage bankers, (iii) changes in the market value of mortgage loans originated by the mortgage
banker, the sale of which is the expected source of repayment of the borrowings under the warehouse line of credit, due to
changes in interest rates during the time in warehouse, (iv) unsalable or impaired mortgage loans originated, which could
lead to decreased collateral value and the failure of a purchaser of the mortgage loan to purchase the loan from the mortgage
banker, and (v) the volatility of mortgage loan originations.
The underlying collateral risks associated with our residential mortgage warehouse lines are similar to the risks
related to our one-to-four-family residential mortgage loans. Additionally, the impact of interest rates on our residential
mortgage warehouse lending business is similar to the impact on our mortgage banking operations as discussed below
under “Revenue from mortgage banking operations are sensitive to changes in economic conditions, decreased economic
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activity, a slowdown in the housing market, higher interest rates or new legislation and may adversely impact our financial
condition and results of operations.”
The level of our commercial real estate loan portfolio may subject us to additional regulatory scrutiny.
The FDIC, the Federal Reserve and the Office of the Comptroller of the Currency have promulgated joint
guidance on sound risk management practices for financial institutions with concentrations in commercial real estate
lending. Under this guidance, a financial institution that, like us, is actively involved in commercial real estate lending
should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial
real estate lending if, among other factors (i) total reported loans for construction, land development and other land
represent 100% or more of total capital, or (ii) total reported loans secured by multi-family and non-farm non-residential
properties, loans for construction, land development and other land, and loans otherwise sensitive to the general
commercial real estate market, including loans to commercial real estate related entities, represent 300% or more of total
capital. The particular focus of the guidance is on exposure to commercial real estate loans that are dependent on the cash
flow from the real estate held as collateral and that are likely to be at greater risk to conditions in the commercial real estate
market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The
purpose of the guidance is to guide banks in developing risk management practices and capital levels commensurate with
the level and nature of real estate concentrations. The guidance states that management should employ heightened risk
management practices including board and management oversight and strategic planning, development of underwriting
standards, risk assessment and monitoring through market analysis and stress testing.
Based on factor (i) mentioned above, we have concluded that we have a concentration in commercial real estate
lending because our total reported loans for construction, land development, and other land at December 31, 2019 represent
100% or more of total capital. While we believe we have implemented policies and procedures with respect to our
commercial real estate loan portfolio consistent with this guidance, bank regulators could require us to implement
additional policies and procedures consistent with their interpretation of the guidance that may result in additional costs to
us.
Revenue from mortgage banking operations are sensitive to changes in economic conditions, decreased economic
activity, a slowdown in the housing market, higher interest rates or new legislation and may adversely impact our
financial condition and results of operations.
Our mortgage banking operations provide a significant portion of our non-interest income. We generate
mortgage banking revenues primarily from gains on the sale of one-to-four-family mortgage loans. The one-to-four-family
mortgage loans are sold pursuant to programs currently offered by Fannie Mae, Freddie Mac, Ginnie Mae, FHA, VA,
USDA Rural Housing, the FHLB, and non-Government Sponsored Enterprise (“GSE”) investors. These entities account
for a substantial portion of the secondary market in residential one-to-four-family mortgage loans. Any future changes in
the one-to-four-family programs, our eligibility to participate in these programs, the criteria for loans to be accepted or
laws that significantly affect the activity of such entities, could, in turn, materially adversely affect our results of
operations. Mortgage banking is generally considered a volatile source of income because it depends largely on the level
of loan volume which, in turn, depends largely on prevailing market interest rates. In a rising or higher interest rate
environment, our originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold to
investors. This would result in a decrease in mortgage banking revenues and a corresponding decrease in non-interest
income. In addition, our results of operations are affected by the amount of non-interest expense associated with mortgage
banking activities, such as salaries and employee benefits, occupancy, equipment and data processing expense, and other
operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent
that we are unable to reduce expenses commensurate with the decline in loan originations. In addition, although we sell
loans into the secondary market without recourse, we are required to give customary representations and warranties about
the loans to the buyers. If we breach those representations and warranties, the buyers may require us to repurchase the
loans and we may incur a loss on the repurchase.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could be reduced.
While conditions in the housing and real estate markets and economic conditions in our market areas have recently
improved, if slow economic conditions return or real estate values and sales deteriorate, we may experience higher
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delinquencies and credit losses. As a result, we could be required to increase our provision for loan losses and to charge-
off additional loans in the future. If charge-offs in future periods exceed the allowance for loan losses, we may need
additional provisions to replenish the allowance for loan and lease losses.
We maintain our allowance for loan losses at a level that management considers adequate to absorb probable loan
losses based on an analysis of our portfolio and market environment. We make various assumptions and judgments about
the collectability of our loan portfolio, including the creditworthiness of borrowers and the value of the real estate and
other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for
loan losses, we review loans and our historical loss and delinquency experience and evaluate economic conditions.
Management recognizes that significant new growth in loan portfolios, new loan products, and the refinancing of existing
loans can result in portfolios comprised of unseasoned loans that may not perform in a historical or projected manner and
will increase the risk that our allowance may be insufficient to absorb losses without significant additional provisions. If
our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover actual losses, resulting in
additional provisions for loan losses to replenish the allowance for loan losses. Deterioration in economic conditions, new
information regarding existing loans, identification of additional problem loans or relationships, and other factors, both
within and outside of our control, may increase our loan charge-offs and/or otherwise require an increase in our provision
for loan losses.
In addition, the FASB has adopted a new accounting standard referred to as Current Expected Credit Loss, or
CECL, which will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans,
and recognize the expected credit losses as allowances for credit losses. This will change the current method of providing
allowances for credit losses only when they have been incurred and are probable, which may require us to increase our
allowance for loan losses, and may greatly increase the types of data we would need to collect and review to determine
the appropriate level of the allowance for credit losses. This accounting pronouncement is expected to be applicable to us
for our first fiscal year after December 15, 2022. We are evaluating the impact the CECL accounting model will have on
our accounting, but expect to recognize a one-time cumulative-effect adjustment to the allowance for loan losses as of the
beginning of the first reporting period in which the new standard is effective. We cannot yet determine the magnitude of
any such one-time cumulative adjustment or of the overall impact of the new standard on our financial condition or results
of operations. The federal banking regulators, including the Federal Reserve and the FDIC, have adopted a rule that gives
a banking organization the option to phase in over a three-year period the day-one adverse effects of CECL on its regulatory
capital. Any increase in our allowance for loan losses or expenses incurred to determine the appropriate level of the
allowance for loan losses may have a material adverse effect on our financial condition and results of operations. For
more on this new accounting standard, see “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.
In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an
increase in the provision for possible loan losses or the recognition of further loan charge-offs based on their judgment
about information available to them at the time of their examination. Any increases in the provision for loan losses will
result in a decrease in net income and may have a material adverse effect on our financial condition, results of operations,
and capital.
Our business may be adversely affected by credit risk associated with residential property.
At December 31, 2019, $261.5 million, or 19.3% of our total loan portfolio was secured by first liens on one-to-
four-family residential loans and our home equity lines of credit totaled $38.2 million, or 2.8% of our total loan portfolio.
These types of loans are generally sensitive to regional and local economic conditions that significantly impact the ability
of borrowers to meet their loan payment obligations, making loss levels difficult to predict. A decline in residential real
estate values resulting from a downturn in the Washington housing markets in which our loans are concentrated may
reduce the value of the real estate collateral securing these types of loans and increase our risk of loss if borrowers default
on their loans. A decline in economic conditions or in the volume of real estate sales and/or the sales prices coupled with
elevated unemployment rates may result in higher than expected loan delinquencies or problem assets, and a decline in
demand for our products and services. In addition, residential loans with high combined loan-to-value ratios will be more
sensitive to the fluctuation of property values than those with lower combined loan-to-value ratios and therefore may
experience a higher incidence of default and severity of losses. Further, the majority of our home equity lines of credit
consist of second mortgage loans. For those home equity lines secured by a second mortgage, it is unlikely that we will be
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successful in recovering all or a portion of our loan proceeds in the event of default unless we are prepared to repay the
first mortgage loan and such repayment and the costs associated with a foreclosure are justified by the value of the property.
For these reasons, we may experience higher rates of delinquencies, defaults and losses which would adversely affect our
net income.
Uncertainty relating to the London Interbank Offered Rate ("LIBOR") calculation process and potential phasing
out of LIBOR may adversely affect our results of operations.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates
LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to
the administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis
cannot and will not be guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to
provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted
in the United Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may become acceptable
alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based
securities and variable rate loans, subordinated debentures, or other securities or financial arrangements, given LIBOR's
role in determining market interest rates globally. The Federal Reserve Board, in conjunction with the Alternative
Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing
U.S. dollar LIBOR with a new index calculated by short-term repurchase agreements, backed by Treasury securities
("SOFR"). SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology,
which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel
members. Given that SOFR is a secured rate backed by government securities, it will be a rate that does not consider bank
credit risk (as is the case with LIBOR). SOFR is therefore likely to be lower than LIBOR and is less likely to correlate
with the funding costs of financial institutions. Whether or not SOFR attains market traction as a LIBOR replacement tool
remains in question, although some transactions using SOFR have been completed in 2019, including by Fannie Mae.
Both Fannie Mae and Freddie Mac have recently announced that they will cease accepting adjustable rate mortgages tied
to LIBOR by the end of 2020 and will soon begin accepting mortgages based on SOFR. Continued uncertainty as to the
nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR
rates and the value of LIBOR-based loans, and to a lesser extent, securities in our portfolio, and may impact the availability
and cost of hedging instruments and borrowings. If LIBOR rates are no longer available, and we are required to implement
substitute indices for the calculation of interest rates under our loan agreements with our borrowers or our existing
borrowings, we may incur significant expenses in effecting the transition, and may be subject to disputes or litigation with
customers and creditors over the appropriateness or comparability to LIBOR of the substitute indices, which could have
an adverse effect on our results of operations.
Our securities portfolio may be negatively impacted by fluctuations in market value, changes in the tax code, and
interest rates.
Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause
potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency
actions in respect of the securities, defaults by, or other adverse events affecting, the issuer or with respect to the underlying
securities, and changes in market interest rates and continued instability in the capital markets. Any of these factors, among
others, could cause other-than-temporary impairments (“OTTI”) and realized and/or unrealized losses in future periods
and declines in other comprehensive income, which could have a material effect on our business, financial condition and
results of operations. The process for determining whether impairment of a security is other-than-temporary usually
requires complex, subjective judgments about the future financial performance and liquidity of the issuer and any collateral
underlying the security to assess the probability of receiving all contractual principal and interest payments on the security.
There can be no assurance that the declines in market value will not result in other-than-temporary impairments of these
assets, and would lead to accounting charges that could have a material adverse effect on our net income and capital levels.
For the year ended December 31, 2019, we did not incur any other-than-temporary impairments on our securities portfolio.
Hedging against interest rate exposure may adversely affect our earnings.
We employ techniques that limit, or “hedge,” the adverse effects of rising interest rates on our loans held for sale,
and originated interest rate locks to customers. Our hedging activity varies based on the level and volatility of interest rates
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and other changing market conditions. These techniques may include purchasing or selling forward contracts, purchasing
put and call options on securities or securities underlying futures contracts, or entering into other mortgage-backed
derivatives. There are, however, no perfect hedging strategies, and interest rate hedging may fail to protect us from loss.
Moreover, hedging activities could result in losses if the event against which we hedge does not materialize. Additionally,
interest rate hedging could fail to protect us or adversely affect us because, among other things:
available interest rate hedging may not correspond directly with the interest rate risk for which protection is
sought;
the duration of the hedge may not match the duration of the related liability;
the party owing money in the hedging transaction may default on its obligation to pay;
the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs
our ability to sell or assign our side of the hedging transaction;
the value of derivatives used for hedging may be adjusted from time to time in accordance with accounting
rules to reflect changes in fair value; and
downward adjustments, or “mark-to-market losses,” could reduce our stockholders’ equity.
If we suffer losses on our interest rate hedging derivatives, our business, financial condition and prospects may be
negatively affected, and our net income will decline.
Changes in interest rates may reduce our net interest income, and may result in higher defaults in a rising rate
environment.
Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive
to many factors that are beyond our control, including general economic conditions and policies of various governmental
and regulatory agencies and, in particular, the Federal Reserve Board. After steadily increasing the targeted federal funds
rate in 2018 and 2017, the Federal Reserve decreased the targeted federal funds rate 25 basis points three times during
2019 to 1.50% - 1.75% at December 31, 2019, in response to some recent weakness in economic data and indicated
possible further decreases, subject to economic conditions. In a rare emergency move, the Federal Reserve Board further
lowered the targeted federal funds rate in March, 2020, by a half-point to a range of 1% to 1.25% in response to the
evolving risks the coronavirus outbreak poses to the economy. Future increases in the targeted federal funds rate, may
negatively impact both the housing markets by reducing refinancing activity and new home purchases and the U.S.
economy. In addition, deflationary pressures, while possibly lowering our operating costs, could have a significant negative
effect on our borrowers, especially our business borrowers, and the values of collateral securing loans, which could
negatively affect our financial performance.
We principally manage interest rate risk by managing our volume and mix of our earning assets and funding
liabilities. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive
on loans and investments and the amount of interest we pay on deposits and borrowings, but these changes could also
affect (i) our ability to originate and/or sell loans and obtain deposits, (ii) the fair value of our financial assets and liabilities,
which could negatively impact shareholders’ equity, and our ability to realize gains from the sale of such assets, (iii) our
ability to obtain and retain deposits in competition with other available investment alternatives, (iv) the ability of our
borrowers to repay adjustable or variable rate loans, and (v) the average duration of our investment securities portfolio and
other interest-earning assets. If the interest rates paid on deposits and borrowings increase at a faster rate than the interest
rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected.
In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage
interest rate risk effectively, our business, financial condition, and results of operations could be materially affected.
Changes in interest rates could also have a negative impact on our results of operations by reducing the ability of
borrowers to repay their current loan obligations or by reducing our margins and profitability. Our net interest margin is
the difference between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of
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funding. Changes in interest rates-up or down-could adversely affect our net interest margin and, as a result, our net
interest income. Although the yield we earn on our assets and our funding costs tend to move in the same direction in
response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or
contract. Our liabilities tend to be shorter in duration than our assets, so they may adjust faster in response to changes in
interest rates. As a result, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets,
causing our net interest margin to contract until the yields on interest-earning assets catch up.
Changes in the slope of the “yield curve”, or the spread between short-term and long-term interest rates could
also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than
long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even
inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can
earn on our assets. Also, interest rate decreases can lead to increased prepayments of loans and mortgage-backed securities
as borrowers refinance their loans to reduce borrowing costs. Under these circumstances, we are subject to reinvestment
risk as we may have to redeploy such repayment proceeds into lower yielding investments, which would likely hurt our
income.
A sustained increase in market interest rates could adversely affect our earnings. As is the case with many
financial institutions, our emphasis on increasing the development of core deposits, those deposits bearing no or a relatively
low rate of interest with no stated maturity date, has resulted in an increasing percentage of our deposits being comprised
of deposits bearing no or a relatively low rate of interest and having a shorter duration than our assets. At December 31,
2019, we had $357.8 million in certificates of deposit that mature within one year and $840.9 million in non-interest
bearing, NOW checking, savings and money market accounts. We would incur a higher cost of funds to retain these
deposits in a rising interest rate environment. If the interest rates paid on deposits and other borrowings increase at a faster
rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could
be adversely affected. In addition, a substantial amount of our residential mortgage loans and home equity lines of credit
have adjustable interest rates. As a result, these loans may experience a higher rate of default in a rising interest rate
environment. Our net income can also be reduced by the impact that changes in interest rates can have on the fair value of
our capitalized mortgage servicing rights (“MSRs”). At December 31, 2019, we serviced $1.46 billion of loans sold to
third parties, and the servicing rights associated with such loans had an amortized cost of $11.6 million and an estimated
fair value, at that date, of $13.3 million. Because the estimated life and estimated income to be derived from servicing the
underlying loans generally increase with rising interest rates and decrease with falling interest rates, the value of MSRs
generally increases as interest rates rise and decreases as interest rates fall. For example, a decrease in mortgage interest
rates typically increases the prepayment speeds of MSRs and therefore decreases the fair value of the MSRs. Future
decreases in mortgage interest rates could decrease the fair value of our MSRs below their recorded amount, which would
decrease our earnings. Changes in interest rates also affect the value of our interest-earning assets and in particular, our
investment securities portfolio. Generally, the fair value of fixed-rate securities fluctuates inversely with changes in
interest rates. Unrealized gains and losses on securities available for sale are reported as a separate component of equity,
net of tax. Decreases in the fair value of securities available for sale resulting from increases in interest rates could have
an adverse effect on stockholders’ equity.
Although management believes it has implemented effective asset and liability management strategies to reduce
the potential effects of changes in interest rates on our results of operations, any substantial, unexpected, or prolonged
change in market interest rates could have a material adverse effect on our financial condition and results of operations.
Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the impact of
actual interest rate changes on our balance sheet or projected operating results. See “Item 7. Management’s Discussion
and Analysis of Financial Condition and Results of Operations - Asset and Liability Management and Market Risk” of
this Form 10-K.
We may experience future goodwill impairment, which could reduce our earnings.
We performed our test for goodwill impairment for fiscal year 2019 and the test concluded that recorded goodwill
was not impaired. Our test of goodwill for potential impairment is based on a qualitative assessment by management that
takes into consideration macroeconomic conditions, industry and market conditions, cost or margin factors, financial
performance and share price. Our evaluation of the fair value of goodwill involves a substantial amount of judgment. If
our judgment was incorrect, or if events or circumstances change, and an impairment of goodwill was deemed to exist, we
53
would be required to write down our goodwill resulting in a charge against operations, which would adversely affect our
results of operations, perhaps materially; however, it would have no impact on our liquidity, operations, or regulatory
capital.
Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial
condition and could result in further losses in the future.
At December 31, 2019, our non-performing assets (which consist of non-accruing loans, accruing loans 90 days
or more past due, other real estate owned (“OREO”), and other repossessed assets were $3.2 million, or 0.19% of total
assets. Nonperforming assets adversely affect our earnings in various ways. We do not record interest income on
nonaccrual loans or foreclosed assets, thereby adversely affecting our income and increasing our loan administration costs.
Upon foreclosure or similar proceedings, we record the repossessed asset at the estimated fair value, less costs to sell,
which may result in a write down or loss. If we experience increases in nonperforming loans and nonperforming assets,
our losses and troubled assets could increase significantly, which could have a material adverse effect on our financial
condition and results of operations, as our loan administration costs could increase, each of which could have an adverse
effect on our net income and related ratios, such as return on assets and equity. A significant increase in the level of
nonperforming assets from current levels would also increase our risk profile and may impact the capital levels our
regulators believe are appropriate in light of the increased risk profile. While we reduce problem assets through collection
efforts, asset sales, workouts and restructurings, decreases in the value of the underlying collateral, or in these borrowers’
performance or financial condition, whether or not due to economic and market conditions beyond our control, could
adversely affect our business, results of operations, and financial condition. In addition, the resolution of nonperforming
assets requires significant commitments of time from management and our directors, which can be detrimental to the
performance of their other responsibilities.
Ineffective liquidity management could adversely affect our financial results and condition.
Effective liquidity management is essential for the operation of our business. We require sufficient liquidity to
meet customer loan requests, customer deposit maturities/withdrawals, payments on our debt obligations as they come
due, and other cash commitments under both normal operating conditions and other unpredictable circumstances causing
industry or general financial market stress. Our access to funding sources in amounts adequate to finance our activities on
terms that are acceptable to us could be impaired by factors that affect us specifically, or the financial services industry or
economy generally. Factors that could detrimentally impact our access to liquidity sources include a downturn in the
geographic markets in which our loans and operations are concentrated or difficult credit markets. Our access to deposits
may also be affected by the liquidity needs of our depositors. In particular, a majority of our liabilities are checking
accounts and other liquid deposits, which are payable on demand or upon several days’ notice, while by comparison, a
substantial majority of our assets are loans, which cannot be called or sold in the same time frame. Although we have
historically been able to replace maturing deposits and advances as necessary, we might not be able to replace such funds
in the future, especially if a large number of our depositors seek to withdraw their accounts, regardless of the reason. A
failure to maintain adequate liquidity could materially and adversely affect our business, results of operations, or financial
condition. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity” of this Form 10-K.
Our ability to retain bankers and recruit additional successful bankers is critical to the success of our business
strategy and any failure to do so could impair our customer relationships and adversely affect our business and
results of operations.
Competition for qualified employees and personnel in the banking industry is intense and there are a limited
number of qualified persons with knowledge of, and experience in, the community banking industry where we conduct
our business. The process of recruiting personnel with the combination of skills and attributes required to carry out our
strategies is often lengthy. Our success depends to a significant degree upon our ability to attract and retain qualified
management, loan origination, finance, administrative, marketing, and technical personnel, and upon the continued
contributions of our management and personnel. Our ability to retain and grow our loans, deposits, and fee income depends
upon the business generation capabilities, reputation, and relationship management skills of our lenders. If we were to lose
the services of any of our bankers, including successful bankers employed by banks that we may acquire, to a new or
54
existing competitor, or otherwise, we may not be able to retain valuable relationships and some of our customers could
choose to use the services of a competitor instead of our services.
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be
available when it is needed or the cost of that capital may be very high.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our
operations. At some point, we may need to raise additional capital or issue additional debt to support our growth or
replenish future losses. Our ability to raise additional capital or issue additional debt depends on conditions in the capital
markets, economic conditions, and a number of other factors, including investor perceptions regarding the banking
industry, market conditions, and governmental activities, and on our financial condition and performance. Such borrowings
or additional capital, if sought, may not be available to us or, if available, may not be on favorable terms.
Accordingly, we cannot make assurances that we will be able to raise additional capital or issue additional debt
if needed on terms that are acceptable to us, or at all. If we cannot raise additional capital or issue additional debt when
needed, our ability to further expand our operations could be materially impaired and our financial condition and liquidity
could be materially and adversely affected. In addition, any additional capital we obtain may result in the dilution of the
interests of existing holders of our common stock. Further, if we are unable to raise additional capital when required by
our bank regulators, we may be subject to adverse regulatory action.
The Company’s ability to pay dividends and make subordinated debt payments is subject to the ability of the
Bank to make capital distributions to the Company.
The Company is a separate legal entity from its subsidiary and does not have significant operations of its own.
The long-term ability of the Company to pay dividends to its stockholders and debt payments is based primarily upon the
ability of the Bank to make capital distributions to the Company, and also on the availability of cash at the holding company
level. The availability of dividends from the Bank is limited by the Bank’s earnings and capital, as well as various statutes
and regulations. In the event, the Bank is unable to pay dividends to the Company, the Company may not be able to pay
dividends on its common stock or make payments on its outstanding debt. Consequently, the inability to receive dividends
from the Bank could adversely affect the Company’s financial condition, results of operations, and future prospects. At
December 31, 2019, FS Bancorp, Inc. had $5.6 million in unrestricted cash to support dividend and debt payments.
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in
fines or sanctions.
The USA PATRIOT and Bank Secrecy Acts and related regulations require financial institutions to develop
programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities
are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of
Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying
and verifying the identity of customers seeking to open new financial accounts and beneficial owners of accounts. Failure
to comply with these regulations could result in fines or sanctions. During the last few years, several banking institutions
have received large fines for non-compliance with these laws and regulations. While we have developed policies and
procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies
and procedures will be effective in preventing violations of these laws and regulations. If our policies and procedures are
deemed deficient, we would be subject to liability, including fines and regulatory actions, which may include restrictions
on our ability to pay dividends and the denial of regulatory approvals to proceed with certain aspects of our business plan.
Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could
also have serious reputational consequences for us. Any of these results could have a material adverse effect on our
business, financial condition, results of operations, and growth prospects.
We rely on other companies to provide key components of our business infrastructure.
We rely on numerous external vendors to provide us with products and services necessary to maintain our day-
to-day operations. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with
the contracted arrangements under service level agreements. The failure of an external vendor to perform in accordance
55
with the contracted arrangements under service level agreements because of changes in the vendor's organizational
structure, financial condition, support for existing products and services or strategic focus or for any other reason, could
be disruptive to our operations, which in turn could have a material negative impact on our financial condition and results
of operations. We also could be adversely affected to the extent such an agreement is not renewed by the third-party vendor
or is renewed on terms less favorable to us. Additionally, the bank regulatory agencies expect financial institutions to be
responsible for all aspects of our vendors’ performance, including aspects which they delegate to third parties. Disruptions
or failures in the physical infrastructure or operating systems that support our business and customers, or cyber-attacks or
security breaches of the networks, systems or devices that our customers use to access our products and services could
result in client attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other
compensation costs, and/or additional compliance costs, any of which could materially adversely affect our results of
operations or financial condition.
We are subject to certain risks in connection with our use of technology.
Our security measures may not be sufficient to mitigate the risk of a cyber attack. Communications and
information systems are essential to the conduct of our business, as we use such systems to manage our customer
relationships, our general ledger, and virtually all other aspects of our business. Our operations rely on the secure
processing, storage, and transmission of confidential and other information in our computer systems and networks.
Although we take protective measures and endeavor to modify them as circumstances warrant, the security of our computer
systems, software, and networks may be vulnerable to breaches, fraudulent or unauthorized access, denial or degradation
of service, attacks, misuse, computer viruses, malware, or other malicious code and cyber attacks that could have a security
impact. If one or more of these events occur, this could jeopardize our or our customers’ confidential and other information
processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or
malfunctions in our operations or the operations of our customers or counterparties. We may be required to expend
significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other
exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered
through any insurance maintained by us. We could also suffer significant reputational damage.
Security breaches in our internet banking activities could further expose us to possible liability and damage our
reputation. Increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries,
vulnerabilities in third party technologies (including browsers and operating systems), or other developments could result
in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions, and to
protect data about us, our clients, and underlying transactions. Any compromise of our security could deter customers from
using our internet banking services that involve the transmission of confidential information. We rely on standard internet
security systems to provide the security and authentication necessary to effect secure transmission of data. Although we
have developed and continue to invest in systems and processes that are designed to detect and prevent security breaches
and cyber attacks and periodically test our security, these precautions may not protect our systems from compromises or
breaches of our security measures, and could result in losses to us or our customers, our loss of business and/or customers,
damage to our reputation, the incurrence of additional expenses, disruption to our business, our inability to grow our online
services, or other businesses, additional regulatory scrutiny or penalties, or our exposure to civil litigation and possible
financial liability, any of which could have a material adverse effect on our business, financial condition and results of
operations.
Our security measures may not protect us from system failures or interruptions. While we have established
policies and procedures to prevent or limit the impact of systems failures and interruptions, there can be no assurance that
such events will not occur or that they will be adequately addressed if they do. In addition, we outsource certain aspects
of our data processing and other operational functions to certain third-party providers. While we select third-party vendors
carefully, we do not control their actions. If our third-party providers encounter difficulties including those resulting from
breakdowns or other disruptions in communication services provided by a vendor, failure of a vendor to handle current or
higher transaction volumes, cyber attacks and security breaches or if we otherwise have difficulty in communicating with
them, our ability to adequately process and account for transactions could be affected, and our ability to deliver products
and services to our customers and otherwise conduct business operations could be adversely impacted. Replacing these
third-party vendors could also entail significant delay and expense. Threats to information security also exist in the
processing of customer information through various other vendors and their personnel.
56
We cannot assure you that such breaches, failures or interruptions will not occur or, if they do occur, that they
will be adequately addressed by us or the third parties on which we rely. We may not be insured against all types of losses
as a result of third-party failures and insurance coverage may be inadequate to cover all losses resulting from breaches,
system failures, or other disruptions. If any of our third-party service providers experience financial, operational, or
technological difficulties, or if there is any other disruption in our relationships with them, we may be required to identify
alternative sources of such services, and we cannot assure you that we could negotiate terms that are as favorable to us, or
could obtain services with similar functionality as found in our existing systems without the need to expend substantial
resources, if at all. Further, the occurrence of any systems failure or interruption could damage our reputation and result
in a loss of customers and business, could subject us to additional regulatory scrutiny, or could expose us to legal liability.
Any of these occurrences could have a material adverse effect on our financial condition and results of operations.
The Board of Directors oversees the risk management process, including the risk of cybersecurity, and engages
with management on cybersecurity issues.
If our enterprise risk management framework is not effective at mitigating risk and loss to us, we could suffer
unexpected losses and our results of operations could be materially adversely affected.
Our enterprise risk management framework seeks to achieve an appropriate balance between risk and return,
which is critical to optimizing stockholder value. We have established processes and procedures intended to identify,
measure, monitor, report, analyze, and control the types of risk to which we are subject to. These risks include, among
others, liquidity, credit, market, interest rate, operational, legal and compliance, and reputational risk. Our framework also
includes financial or other modeling methodologies that involve management assumptions and judgment. We also
maintain a compliance program to identify measure, assess, and report on our adherence to applicable laws, policies, and
procedures. While we assess and improve these programs on an ongoing basis, there can be no assurance that our risk
management or compliance programs, along with other related controls, will effectively mitigate risk under all
circumstances, or that it will adequately mitigate any risk or loss to us. However, as with any risk management framework,
there are inherent limitations to our risk management strategies as they may exist, or develop in the future, including risks
that we have not appropriately anticipated or identified. If our risk management framework proves ineffective, we could
suffer unexpected losses and our business, financial condition, results of operations or growth prospects could be materially
adversely affected. We may also be subject to potentially adverse regulatory consequences.
We are subject to certain risks in connection with our data management or aggregation.
We are reliant on our ability to manage data and our ability to aggregate data in an accurate and timely manner
to ensure effective risk reporting and management. Our ability to manage data and aggregate data may be limited by the
effectiveness of our policies, programs, processes, and practices that govern how data is acquired, validated, stored,
protected, and processed. While we continuously update our policies, programs, processes, and practices, many of our data
management and aggregation processes are manual and subject to human error or system failure. Failure to manage data
effectively and to aggregate data in an accurate and timely manner may limit our ability to manage current and emerging
risks, as well as to manage changing business needs.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
As a bank, we are susceptible to fraudulent activity that may be committed against us or our customers, which
may result in financial losses or increased costs to us or our customers, disclosure or misuse of our information or our
customer’s information, misappropriation of assets, privacy breaches against our customers, litigation, and/or damage to
our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud,
phishing, social engineering, and other dishonest acts. Nationally, reported incidents of fraud and other financial crimes
have increased. We have also experienced losses due to apparent fraud and other financial crimes. While we have policies
and procedures designed to prevent such losses, there can be no assurance that such losses will not occur.
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The markets in which the Company operates are subject to the risk of flooding, mudslides, and other natural
disasters.
The Company’s offices are located in Washington. Also, most of the real and personal properties securing the
Company’s loans are located in Washington. Washington is prone to flooding, mudslides, brush fires, earthquakes, and
other natural disasters. In addition to possibly sustaining damage to its own properties, if there is a major flood, mudslide,
brush fire, earthquake or other natural disaster, the Company faces the risk that many of the Company’s borrowers may
experience uninsured property losses, or sustained job interruption and/or loss which may materially impair their ability
to meet the terms of their loan obligations. Therefore, a major flood, mudslide, brush fire, earthquake or other natural
disaster in Washington could have a material adverse effect on the Company’s business, financial condition, results of
operations, and cash flows.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
At December 31, 2019, the Company had one headquarter office and one administrative office which are owned
by the Company, one free-standing leased ATM, 21 full-service bank branches and five stand-alone loan production
offices, with an aggregate net book value of $28.8 million. The headquarters is located in Mountlake Terrace, in
Snohomish County, Washington. The administrative office is located in Aberdeen, in Grays Harbor County, Washington.
The 21 full-service bank branches are located in the following counties: three in Snohomish, two in King, two in Clallam,
two in Jefferson, two in Pierce, five in Grays Harbor, two in Thurston, one in Lewis, and two in Kitsap County. Of these
branch locations, 13 are owned and eight are leased facilities. Our stand-alone home lending offices are located in
Puyallup, in Pierce County, Bellevue, in King County, Port Orchard, in Kitsap County, and Everett, in Snohomish County
in the Puget Sound region and in the Tri-Cities (Kennewick), in Benton County in Eastern Washington. The stand-alone
loan production offices are leased facilities. The lease terms for our branch and loan production offices are not individually
material. The Company’s leases have remaining lease terms of four months to eight years, some of which include options
to extend the leases for up to five years. In the opinion of management, all properties are adequately covered by insurance,
are in a good state of repair and are suitable for the Company’s needs. For additional information see “Note 6 - Premises
and Equipment” of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and
Supplementary Data” of this Form 10 K.
The Company maintains depositor and borrower customer files on an on-line basis, utilizing a
telecommunications network, portions of which are leased. The book value of all data processing and computer equipment
utilized by the Company at December 31, 2019 was $821,000. Management has a business continuity plan in place with
respect to the data processing system, as well as the Company’s operations as a whole.
Item 3. Legal Proceedings
Because of the nature of our activities, the Company is subject to various pending and threatened legal actions,
which arise in the ordinary course of business. From time to time, subordination liens may create litigation which requires
us to defend our lien rights. In the opinion of management, liabilities arising from these claims, if any, will not have a
material effect on our financial position.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
The Company’s common stock is traded on The NASDAQ Stock Market LLC’s Global Market, under the symbol
“FSBW.” At December 31, 2019, there were 4,459,041 shares of common stock issued and outstanding and approximately
240 shareholders of record based upon securities position listings furnished to us by our transfer agent. This total does not
reflect the number of persons or entities who hold stock in nominee or “street name” accounts with brokers.
Common shares outstanding of 4,366,984 were calculated using shares outstanding at December 31, 2019, of
4,459,041, less 40,215 of unvested restricted stock shares, and 51,842 unallocated ESOP shares. Common shares of
4,371,294 were calculated using shares outstanding at December 31, 2018, of 4,492,478, less 43,421 of unvested restricted
stock shares, and 77,763 unallocated ESOP shares.
1st Security Bank of Washington is a wholly-owned subsidiary of FS Bancorp. Under federal regulations, the
dollar amount of dividends 1st Security Bank of Washington may pay to FS Bancorp depends upon its capital position and
recent net income. Generally, if 1st Security Bank of Washington satisfies its regulatory capital requirements, it may make
dividend payments up to the limits prescribed by state law and FDIC regulations. See “Item 1. Business - How We Are
Regulated - Regulation of 1st Security Bank of Washington - Dividends” and “Regulation and Supervision of FS Bancorp -
Restrictions on Dividends and Stock Repurchases.”
Our cash dividend policy is reviewed by management and the Board of Directors. Any dividends declared and
paid in the future would depend upon a number of factors including capital requirements, the Company’s financial
condition and results of operations, tax considerations, statutory and regulatory limitations, and general economic
conditions. No assurances can be given that any dividends will be paid or that, if paid, will not be reduced or eliminated
in future periods. Our future payment of dividends may depend, in part, upon receipt of dividends from the Bank, which
are restricted by federal regulations. Management’s projections show an expectation that cash dividends will continue for
the foreseeable future.
Issuer Purchases of Equity Securities.
On January 28, 2019, the Company announced that its Board of Directors authorized the repurchase of up to
225,000 shares of the Company’s common stock, or 5% of the Company’s outstanding shares authorized and outstanding
at December 31, 2019, from time to time over a 12-month period until January 24, 2020, depending on market conditions
and other factors. The following table summarizes common stock repurchases during the quarter ended December 31,
2019:
Maximum
Total Number Number of
Shares that
of Shares
Average Repurchased as May Yet Be
Price Part of Publicly Repurchased
Under the
Plan
125,616
122,616
—
122,616
Paid per
Share
$ 56.23
200
3,000
—
3,200
Announced
Plan
57.92
—
3,200 $ 57.81
Total Number
of Shares
Purchased
200
3,000
—
Period
October 1, 2019 - October 31, 2019
November 1, 2019 - November 30, 2019
December 1, 2019 - December 31, 2019
Total for the quarter
On January 28, 2020, the Company announced that its Board of Directors authorized the repurchase of up to
225,000 shares of the Company’s common stock, or 5% of the Company’s outstanding shares authorized and outstanding
59
at December 31, 2019, from time to time over a 12-month period until January 28, 2021, depending on market conditions
and other factors.
Equity Compensation Plan Information. The equity compensation plan information presented under
subparagraph (d) in Part III, Item 12 of this report is incorporated herein by reference.
Performance Graph. The following graph compares the cumulative total shareholder return on the Company’s
common stock with the cumulative total return on the NASDAQ S&P 500 Index (U.S. Stock), SNL U.S. Bank NASDAQ
Index, and the SNL Thrift Index. Total return assumes the reinvestment of all dividends and that the value of common
stock and bank index was $100 on December 31, 2014.
Source: SNL Financial LC, Charlottesville, VA
Index
FS Bancorp, Inc.
S&P 500 Index
SNL Bank $1B-$5B
SNL Thrift $1B-$5B
12/31/14 12/31/15 12/31/16 12/31/17 12/31/18 12/31/19
370.25
173.86
182.85
136.82
144.16
101.38
111.94
117.38
202.12
113.51
161.04
159.99
100.00
100.00
100.00
100.00
309.76
138.29
171.69
162.05
245.77
132.23
150.42
112.76
60
Item 6. Selected Financial Data
The following table sets forth certain information concerning the Company’s consolidated financial position and
results of operations at and for the dates indicated and have been derived from the audited consolidated financial
statements. The information below is qualified in its entirety by the detailed information included elsewhere herein and
should be read along with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations” and “Item 8. Financial Statements and Supplementary Data.”
(In thousands)
Selected Financial Condition Data:
Total assets
Loans receivable, net(1)
Loans held for sale, at fair value
Securities available-for-sale, at fair value
FHLB stock, at cost
Deposits
Borrowings
Subordinated note, net
Total stockholders’ equity
2019
At December 31,
2017
2018
2016
2015
$ 1,713,056 $ 1,621,644 $ 981,783 $ 827,926 $ 677,561
502,535
44,925
55,217
4,551
485,178
98,769
9,805
75,340
1,312,519
51,195
97,205
9,887
1,274,219
137,149
9,865
180,038
1,336,346
69,699
126,057
8,045
1,392,408
84,864
9,885
200,242
593,317
52,553
81,875
2,719
712,593
12,670
9,825
81,033
761,558
53,463
82,480
2,871
829,842
7,529
9,845
122,002
Year Ended December 31,
2016
2017
2018
2019
2015
$ 89,625 $ 62,326 $ 46,181 $ 38,020 $ 31,707
3,658
28,049
2,250
25,799
1,977
—
14,672
—
76
—
(In thousands)
Selected Operations Data:
Total interest and dividend income
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Service charges and fee income
Bargain purchase gain
Gain on sale of loans
Loss on disposed fixed assets
Gain on sale of investment securities
Gain on sale of mortgage servicing rights
Earnings on cash surrender value of Bank Owned Life
Insurance
Other noninterest income
Total noninterest income
Total noninterest expense
Income before provision for income taxes
Provision for income taxes
Net income
___________________________
(1) Net of allowances for loan losses, loans in process and deferred loan costs, fees, premiums, and discounts.
216
652
17,593
29,643
13,749
4,873
$ 22,717 $ 24,347 $ 14,085 $ 10,499 $ 8,876
4,933
41,248
750
40,498
3,548
—
17,985
—
380
1,062
4,163
33,857
2,400
31,457
3,391
—
19,058
—
146
—
10,228
52,098
1,540
50,558
3,233
7,414
14,861
(71)
171
—
19,317
70,308
2,880
67,428
6,554
—
14,248
(26)
32
—
274
825
24,074
43,993
20,579
6,494
282
692
23,569
38,923
16,103
5,604
413
829
26,850
48,838
28,570
4,223
872
1,355
23,035
62,333
28,130
5,413
61
At or For the
Year Ended December 31,
2017
2016
2018
2015
2019
1.52 %
1.38 %
2.07 %
1.31 %
1.53 %
136.88
67.35
2.50
134.60
61.86
2.42
131.42
66.78
1.74
12.73
5.67
0.83
4.84
5.01
5.07
13.84
4.97
0.74
4.23
4.43
4.87
14.80
5.21
0.76
4.45
4.65
4.76
18.15
5.52
1.22
4.30
4.61
4.16
11.92
5.77
1.64
4.13
4.53
3.78
Selected Financial Ratios and Other Data
Performance ratios:
Return on assets (ratio of net income to average
total assets)
Return on equity (ratio of net income to average
equity)
Yield on average interest-earning assets
Rate paid on average interest-bearing liabilities
Net interest rate spread
Net interest margin(1)
Operating expense to average total assets
Average interest-earning assets to average
interest-bearing liabilities
Efficiency ratio(2)
Margin on loans sold (3)
Asset quality ratios:
Non-performing assets to total assets at end of
period(4)
Non-performing loans to total gross loans(5)
Allowance for loan losses to non-performing
loans(5)
Allowance for loan losses to gross loans receivable
Capital ratios:
Equity to total assets at end of period
Average equity to average assets
Other data:
Number of full service offices
Full-time equivalent employees
Net income per common share:
Basic
Diluted
Book values:
Book value per common share
____________________________
(1) Net interest income divided by average interest-earning assets.
(2) Total noninterest expense as a percentage of net interest income and total other noninterest income.
(3) Cash margins on loans sold net of deferred fees/costs.
(4) Non-performing assets consists of non-performing loans (which include non-accruing loans and accruing loans more
127.09
64.95
2.58
135.96
67.78
2.64
$ 45.85 (10) $ 41.19 (9) $
436.17
0.98
1,416.23
1.69
1,035.23
1.39
28.32 (7) $ 25.18 (6)
12.43 %
10.30
11.10 %
11.42
11.69 %
11.55
317.13
0.93
765.49
1.52
$ 2.98
$ 2.93
9.79 %
9.49
0.11 %
0.13
0.09 %
0.12
0.19 %
0.22
0.28 %
0.29
11.12 %
11.94
0.15 %
0.20
11
306
11
326
21
424
21
452
5.13
5.01
3.63
3.51
6.58
6.29
4.55
4.28
7
239
34.47 (8) $
$
$
$
$
$
$
$
$
than 90 days past due), foreclosed real estate and other repossessed assets.
(5) Non-performing loans consists of non-accruing loans and accruing loans more than 90 days past due.
(6) Book value per common share was calculated using shares outstanding of 3,242,120 at December 31, 2015, less
94,684 shares of restricted stock, and unallocated employee stock ownership plan (“ESOP”) shares of 155,526.
(7) Book value per common share was calculated using shares outstanding of 3,242,120 at December 31, 2016, less
68,763 shares of restricted stock, and unallocated ESOP shares of 129,605.
(8) Book value per common share was calculated using shares outstanding of 3,680,152 at December 31, 2017, less
36,842 shares of restricted stock, and unallocated ESOP shares of 103,684.
(9) Book value per common share was calculated using shares outstanding of 4,492,478 at December 31, 2018, less
43,421 shares of restricted stock, and unallocated ESOP shares of 77,763.
(10) Book value per common share was calculated using shares outstanding of 4,459,041 at December 31, 2019, less
40,215 shares of restricted stock, and unallocated ESOP shares of 51,842.
62
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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, Inc. and its subsidiary bank, 1st Security Bank of Washington have been serving the Puget Sound area since
1936. Originally chartered as a credit union, known as Washington’s Credit Union, the credit union served various select
employment groups. On April 1, 2004, the credit union converted to a Washington state-chartered mutual savings bank.
On July 9, 2012, the Bank converted from mutual to stock ownership and became the wholly owned subsidiary of FS
Bancorp, Inc.
The Company is relationship-driven, delivering banking and financial services to local families, local and regional
businesses and industry niches within distinct Puget Sound area communities, and one loan production office located in
the Tri-Cities, Washington. On November 15, 2018, the Company completed the Anchor Acquisition and acquired $361.6
million in loans, $357.9 million in deposits, and recorded a bargain purchase gain of $7.4 million based on financial
information at that date. As a result of the Anchor Acquisition, Anchor’s shareholders received 725,518 shares of FS
Bancorp common stock and $30.8 million in cash for total consideration paid of $64.6 million. The Anchor Acquisition
added nine full-service bank branches within the communities of Aberdeen, Centralia, Elma, Lacey, Montesano, Ocean
Shores, Olympia, Puyallup, and Westport, Washington. The Anchor Acquisition expanded our Puget Sound-focused retail
footprint and provided an opportunity to extend our unique brand of community banking into these communities. For
additional details see “Note 2 - Business Combination” of the Notes to Consolidated Financial Statements included in
“Item 8. Financial Statements and Supplementary Date.”
The Company also maintains its long-standing indirect consumer lending platform which operates throughout the West
Coast. The Company emphasizes long-term relationships with families and businesses within the communities served,
working with them to meet their financial needs. The Company is also actively involved in community activities and
events within these market areas, which further strengthens our relationships within those markets.
The Company focuses on diversifying revenues, expanding lending channels, and growing the banking franchise.
Management remains focused on building diversified revenue streams based upon credit, interest rate, and concentration
risks. Our business plan remains as follows:
Growing and diversifying our loan portfolio;
Maintaining strong asset quality;
Emphasizing lower cost core deposits to reduce the costs of funding our loan growth;
Capturing our customers’ full relationship by offering a wide range of products and services by leveraging
our well-established involvement in our communities and by selectively emphasizing products and services
designed to meet our customers’ banking needs; and
Expanding the Company’s markets.
The Company is a diversified lender with a focus on the origination of one-to-four-family loans, commercial real estate
mortgage loans, second mortgage or home equity loan products, consumer loans, including home improvement (“fixture
secured”) loans, solar loans, marine lending, and commercial business loans, including warehouse lending credit
lines. 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 December 31,
2019, consumer loans represented 24.1% of the Company’s total gross loan portfolio, up from 20.8% at December 31,
2018, due in part to growth in indirect home improvement loans during the year ended December 31, 2019. In recent years,
63
the Company has placed more of an emphasis on real estate lending products, such as one-to-four-family loans, commercial
real estate loans, construction and development loans, including speculative residential construction loans, as well as
commercial business loans, including commercial construction warehouse lines of credit to re-lenders, while growing the
current size of the consumer loan portfolio. At December 31, 2019, real estate loans represented 61.0% of the Company’s
total gross loan portfolio.
Recently, improvements in the economy, employment rates, and interest rates has resulted in higher volumes of refinances
of one-to-four-family loans during 2019, and a surge in construction loans beginning in 2018 due to the lack of housing
inventory. We anticipate that residential construction and development lending will be a strong element of 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. Originations of construction and development loans increased to $246.6
million in 2019 from $205.6 million in 2018. 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. At
December 31, 2019, outstanding construction and development loans totaled $179.7 million, or 13.3%, of the gross loan
portfolio and consisted of loans for residential and commercial construction projects, primarily for vertical construction
and $10.6 million of land acquisition and development loans. Total committed, including unfunded construction and
development loans at December 31, 2019, was $274.7 million as compared to $333.2 million at December 31, 2018.
Indirect home improvement lending is dependent on the Bank’s relationships with home improvement contractors and
dealers. The Company funded $159.3 million, or approximately 7,800 loans during the year ended December 31, 2019,
using its indirect home improvement contractor/dealer network located throughout Washington, Oregon, California, Idaho,
Colorado, and Arizona with ten contractor/dealers responsible for 62.3% of the funded loans dollar volume. See “Item 1A.
Risk Factors - Our business could suffer if we are unsuccessful in making, continuing and growing relationships with
home improvement contractors and dealers” of this Form 10-K.
The Company is significantly affected by prevailing economic conditions, as well as government policies and regulations
concerning, among other things, monetary and fiscal affairs. Deposit flows are influenced by a number of factors, including
interest rates paid on time deposits, other investments, account maturities, and the overall level of personal income and
savings. Lending activities are influenced by the demand for funds, the number and quality of lenders, and regional
economic cycles. Sources of funds for lending activities include primarily deposits, including brokered deposits,
borrowings, payments on loans and income provided from operations.
The Company’s earnings are primarily dependent upon net interest income, the difference between interest income and
interest expense. Interest income is a function of the balances of loans and investments outstanding during a given period
and the yield earned on these loans and investments. Interest expense is a function of the amount of deposits and
borrowings outstanding during the same period and interest rates paid on these deposits and borrowings. Another
significant influence on the Company’s earnings is fee income from mortgage banking activities. The Company’s earnings
are also affected by the provision for loan losses, service charges and fees, gains/losses from sales of assets, operating
expenses, and income taxes.
Critical Accounting Policies and Estimates
Certain of the Company’s accounting policies are important to the portrayal of the Company’s financial condition, since
they require management to make difficult, complex or subjective judgments, some of which may relate to matters that
are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes
in facts and circumstances. Facts and circumstances which could affect these judgments include, but are not limited to,
changes in interest rates, changes in the performance of the economy, and changes in the financial condition of borrowers.
Management believes that its critical accounting policies include the following:
Allowance for Loan Loss (“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 allowance is established through the provision for loan
losses, which is charged to income. A high degree of judgment is necessary when determining the amount of the ALLL.
Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of
future cash flows on impacted loans; value of collateral; and determination of loss factors to be applied to the various
elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the
64
allowance at least quarterly and establishes the provision for loan losses based upon an evaluation of the portfolio, past
loss experience, current economic conditions, and other factors related to the collectability of the loan portfolio. Although
the Company believes that the best information available currently is used to establish the ALLL, future adjustments to
the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the
evaluation. As the Company adds new products to the loan portfolio and expands the Company’s market area, management
intends to enhance and adapt the methodology to keep pace with the size and complexity of the loan portfolio. Changes in
any of the above factors could have a significant effect on the calculation of the ALLL in any given period. Management
believes that its systematic methodology continues to be appropriate.
Servicing Rights. Servicing assets are recognized as separate assets when rights are acquired through the purchase or
through the sale of financial assets. Generally, purchased servicing rights are capitalized at the cost to acquire the rights.
For sales of mortgage, commercial and consumer loans, a portion of the cost of originating the loan is allocated to the
servicing right based on relative fair value. Fair value is based on market prices for comparable mortgage, commercial, or
consumer servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present
value of estimated future net servicing income. The valuation model incorporates assumptions that market participants
would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings
rate, an inflation rate, ancillary income, prepayment speeds, and default rates and losses.
Servicing assets are evaluated quarterly for impairment based upon the fair value of the rights as compared to amortized
cost. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest
rate, loan type, and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the
extent that fair value is less than the capitalized amount for the tranches. If the Company later determines that all or a
portion of the impairment no longer exists for a particular tranche, a reduction of the allowance may be recorded as a
recovery and an increase to income. Capitalized servicing rights are stated separately on the Consolidated Balance Sheets
and are amortized into noninterest 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. The Company’s derivatives are
primarily the result of its mortgage banking activities in the form of commitments to extend credit, commitments to sell
loans, 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 in the Consolidated Statements of Income with offsets to other assets or other liabilities in the Consolidated
Balance Sheets.
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). See “Note 16 - Fair Value
Measurement” of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and
Supplementary Data” of this Form 10-K for additional information about the level of pricing transparency associated with
financial instruments carried at fair value.
65
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
deductible or payable in future periods. The Company had no net deferred tax assets and net deferred tax liabilities of $2.0
million and $361,000 at December 31, 2019 and 2018, respectively.
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 1st Security Bank of Washington as a well capitalized, profitable,
independent, community-oriented financial institution, serving customers in its primary market area defined generally as
the greater Puget 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 and 21 full-service bank branches 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 non-performing loans to total gross loans and the percentage of non-performing assets
to total assets were 0.22% at December 31, 2019 and 0.29% at December 31, 2018. The Company has actively
managed the delinquent loans and non-performing 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
66
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.
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. As an example, through the Anchor Acquisition in the fourth quarter of 2018, the
Company expanded its retail market area into the communities of Aberdeen, Centralia, Elma, Lacey, Montesano,
Ocean Shores, Olympia, Puyallup, and Westport, Washington. See “Note 2 - Business Combination” of the
Notes to the Consolidated Financial Statements included in “Item 8. Financial Statements and Supplementary
Data” of this Form 10-K.
Comparison of Financial Condition at December 31, 2019 and December 31, 2018
Assets. Total assets increased $91.4 million, to $1.71 billion at December 31, 2019, from $1.62 billion at December 31,
2018, primarily the result of increases in securities available-for-sale of $28.9 million, loans receivable, net of $23.8
million, loans held for sale of $18.5 million, total cash and cash equivalents of $13.0 million, operating lease right-of-use
asset of $5.0 million, other assets of $4.7 million, and servicing rights of $1.1 million, partially offset by decreases in
FHLB stock of $1.8 million and certificates of deposit at other financial institutions of $1.2 million. The increase in assets
was primarily funded by deposit growth.
Due to organic loan growth, loans receivable, net, increased $23.8 million, to $1.34 billion at December 31, 2019, from
$1.31 billion at December 31, 2018. The increase in loans receivable, net was primarily a result of a $50.7 million increase
in total consumer loans, including increases in indirect home improvement of $42.9 million and marine loans of $9.4
million, partially offset by decreases in other consumer loans of $1.1 million. These consumer loan increases were offset
by a $22.3 million decrease in total real estate loans, including a planned decrease in construction and development loans
of $67.7 million and a decrease in home equity loans of $2.1 million, partially offset by increases in multi-family loans of
$29.3 million, one-to-four-family loans of $12.1 million, and commercial real estate loans of $6.1 million. Total
commercial business loans decreased $2.8 million, mostly due to a decrease in warehouse lending of $4.6 million, offset
by a $1.8 million increase in commercial and industrial loans. The increase in commercial and industrial loans was reduced
by the sales of U.S. Department of Agriculture loans totaling $8.4 million, partially offset by purchases of $1.8 million
during the year. The undisbursed portion of construction and development loans in process increased by $18.1 million to
$95.0 million at December 31, 2019, as compared to $76.9 million at December 31, 2018.
67
Loans held for sale, consisting of one-to-four-family loans, increased by $18.5 million, or 36.1%, to $69.7 million at
December 31, 2019, compared to $51.2 million for the prior year primarily due to increased loan production. The Company
continues to expand its home lending operations by hiring additional lending staff and will continue selling one-to-four-
family mortgage loans into the secondary market for asset/liability management purposes.
One-to-four-family originations, including $804.6 million of loans held for sale, $76.3 million in portfolio loans including
first and second liens, and $10.5 million of loans brokered to other institutions, increased $179.4 million, or 25.2% to
$891.4 million during the year ended December 31, 2019, compared to $704.8 million for the prior year. Originations of
one-to-four-family loans to purchase a home (purchase production) decreased by $3.2 million, or 0.6% with $554.8 million
in loan purchase production closing during the year ended December 31, 2019, down from $558.0 million for the year
ended December 31, 2018. One-to-four-family loan originations for refinance (refinance production) increased $189.7
million, or 129.2% with $336.6 million in refinance production closing during the year ended December 31, 2019, up from
$146.8 million for the year ended December 31, 2018.
The ALLL at December 31, 2019 was $13.2 million, or 0.98% of gross loans receivable, excluding loans held for sale,
compared to $12.3 million, or 0.93% of gross loans receivable, excluding loans held for sale, at December 31, 2018. In
accordance with acquisition accounting, the ALLL does not include the recorded discount on loans acquired in the Anchor
Acquisition of $2.7 million on $198.5 million of gross loans at December 31, 2019. Substandard loans decreased $1.3
million, or 16.6%, to $6.7 million at December 31, 2019, compared to $8.0 million at December 31, 2018. The $1.3 million
decrease in substandard loans was primarily due to the charge-offs of a commercial line of credit of $1.2 million and one
commercial business relationship totaling $431,000. Non-performing loans, decreased $861,000, to $3.0 million at
December 31, 2019, from $3.9 million at December 31, 2018. At December 31, 2019, non-performing loans consisted of
$1.3 million of residential real estate loans, $1.1 million of commercial real estate loans, $493,000 of consumer loans, and
$190,000 of home equity loans.
Non-performing loans to total gross loans were 0.22% at December 31, 2019, compared to 0.29% at December 31, 2018.
There were two OREO properties totaling $168,000 at December 31, 2019, as compared to two OREO properties totaling
$689,000 at December 31, 2018. See “Item 1. Business - Lending Activities - Asset Quality” of this Form 10-K for
additional information regarding the Company’s non-performing loans.
Liabilities. Total liabilities increased $71.2 million, or 4.9%, to $1.51 billion at December 31, 2019, from $1.44 billion at
December 31, 2018, primarily due to growth in deposits. Deposits increased $118.2 million, or 9.3% to $1.39 billion at
December 31, 2019, from $1.27 billion at December 31, 2018. Relationship-based transactional accounts (noninterest-
bearing checking, interest-bearing checking, and escrow accounts) increased $65.9 million, or 17.1%, to $451.6 million at
December 31, 2019, from $385.6 million at December 31, 2018. Money market and savings accounts decreased $15.6
million, or 3.9%, to $389.3 million at December 31, 2019, from $404.9 million at December 31, 2018. Time deposits
increased $67.9 million, or 14.0%, to $551.5 million at December 31, 2019, from $483.6 million at December 31, 2018.
Non-retail certificates of deposit (“CDs”) which includes brokered CDs, online CDs, and public funds increased $18.7
million, or 14.7%, to $146.2 million, at December 31, 2019, compared to $127.5 million at December 31, 2018. The year
over year increase in non-retail CDs from $127.5 million at December 31, 2018, primarily reflects a $24.7 million increase
in brokered CDs, primarily offset by a $9.0 million decrease in public funds. Management remains focused on growth in
lower cost relationship-based deposits to fund long-term asset growth.
At December 31, 2019, borrowings decreased $52.3 million to $84.9 million, from $137.1 million at December 31, 2018,
primarily as a result of deposit growth and the use and repayments of FHLB advances in relation to our liquidity objectives.
Stockholders’ Equity. Total stockholders’ equity increased $20.2 million, or 11.2%, to $200.2 million at December 31,
2019, from $180.0 million at December 31, 2018. The increase in stockholders’ equity was primarily due to net income
of $22.7 million, and a decrease in accumulated other comprehensive loss to a gain, net of tax of $2.3 million, partially
offset by common stock repurchases of $5.0 million and dividends paid of $2.9 million. The Company repurchased
102,384 shares of its common stock during the year ended December 31, 2019, at an average price of $48.69 per share.
At December 31, 2019, 347,616 shares remained available for repurchase pursuant to our January 2019 Share Repurchase
Plan and January 2020 Share Repurchase Plan. Book value per common share was $45.85 at December 31, 2019,
compared to $41.19 at December 31, 2018.
68
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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. 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, 2019 vs. 2018 Year Ended December 31, 2018 vs. 2017
Increase (Decrease) Due to Total Increase
Rate
Volume
Increase (Decrease) Due to Total Increase
(Decrease) Volume
(Decrease)
Rate
(In thousands)
Interest-earning assets:
Loans receivable, net and
loans held for sale(1)
Mortgage-backed securities
Investment securities
FHLB stock
Interest-bearing deposits at
other financial institutions
$
$
22,828
8
92
72
3,262 $
142
(6)
3
26,090 $
150
86
75
13,386
62
200
109
$ 1,773 $
132
191
158
15,159
194
391
267
644
254
898
(40)
174
134
Total interest-earning
assets
$
23,644
$
3,655 $
27,299 $
13,717
$ 2,428 $
16,145
Interest-bearing
liabilities:
Savings and money market $
Interest-bearing checking
Certificates of deposit
Borrowings
Subordinated note
459
104
3,755
(99)
1
$
584 $
1,083
2,856
347
(1)
1,043 $
1,187
6,611
248
—
(19)
53
1,074
894
1
$
814 $
46
1,433
1,000
(1)
795
99
2,507
1,894
—
Total interest-bearing
liabilities
$
4,220
$
4,869 $
9,089 $
2,003
$ 3,292 $
5,295
Net change in net interest
income
__________________________
(1) The average loans receivable, net balances include non-accruing loans.
18,210
$
$
10,850
Comparison of Results of Operations for the Years Ended December 31, 2019 and 2018
General. Net income for the year ended December 31, 2019, decreased $1.6 million, or 6.7%, to $22.7 million, from $24.3
million for the year ended December 31, 2018. The decrease in net income was primarily a result of a $13.5 million, or
27.6% increase in noninterest expense, a $9.1 million increase in interest expense, a $3.8 million decrease in noninterest
income reflecting the absence of the nonrecurring $7.4 million bargain purchase gain in 2018, a $1.3 million increase in
the provision for loan losses, and a $1.2 million increase in provision for income tax expense, partially offset by a $27.3
million, or 43.8% increase in interest income.
Net Interest Income. Net interest income increased $18.2 million, or 35.0%, to $70.3 million for the year ended
December 31, 2019, from $52.1 million for the year ended December 31, 2018. The increase in net interest income was
primarily attributable to a $26.1 million, or 44.5% increase in interest income from loans receivable, including fees
resulting from a $381.7 million increase in average loans receivable, net and loans held for sale over the last year, and a
$1.2 million, or 32.6% increase in interest and dividends on investment securities, and cash and cash equivalents, partially
offset by a $9.1 million or 88.9% increase in total interest expense.
70
The net interest margin (“NIM”) decreased eight basis points to 4.53% for the year ended December 31, 2019, from 4.61%
for the same period last year. The decrease in NIM was primarily due to a shift from higher yielding construction loans to
lower yielding multi-family loans, as well as lower interest rates for recently originated real estate loans. Primarily due to
lower interest rates on construction and development loans that typically carry higher note rates than one-to-four-family
loans, partially offset by incremental interest accretion on loans acquired in the Anchor Acquisition of 15 basis points as
well as growth in lower yielding assets. In general, the lower interest rates are primarily due to the decline in targeted fed
funds rate and competition in the market place. The average cost of funds for total interest-bearing liabilities increased 42
basis points to 1.64% for the year ended December 31, 2019, from 1.22% for the year ended December 31, 2018. This
increase was predominantly due to increased competitive rates required to enable the growth in deposits. Management
remains focused on matching deposit/liability duration with the duration of loans/assets where appropriate.
Interest Income. Interest income for the year ended December 31, 2019, increased $27.3 million, or 43.8%, to $89.6
million, from $62.3 million for the year ended December 31, 2018. The increase during the year was primarily attributable
to an increase in the average balance of loans receivable, net and loans held for sale to $1.36 billion for the year ended
December 31, 2019, compared to $980.0 million for the year ended December 31, 2018, and a 25 basis point increase in
the average yield on interest-earning assets to 5.77% during the year ended December 31, 2019, from 5.52% for the
prior year. The increase in average yield on interest-earning assets compared to the prior year primarily reflects the growth
in the loan portfolio and the proportionally larger level of loans in the average interest-earning asset mix. The average
yield on loans receivable, net and loans held for sale increased to 6.22% during the year ended December 31, 2019, from
5.98% for the prior year.
The following table compares average earning asset balances, associated yields, and resulting changes in interest income
for the years ended December 31, 2019 and 2018:
Year Ended December 31,
2019
2018
(Dollars in thousands)
Loans receivable, net and loans held for sale (1)
Mortgage-backed securities
Investment securities
FHLB stock
Interest-bearing deposits at other financial institutions
Total interest-earning assets
Yield/
Average
Balance
Average
Balance
Increase in
Interest
Yield/
Outstanding Rate Outstanding Rate
Income
$ 1,361,616 6.22 % $ 979,958 5.98 % $ 26,090
150
2.43
86
2.79
75
5.31
1.75
898
5.52 % $ 27,299
49,065
2.71
49,850
2.78
7,143
5.34
2.07
42,923
5.77 % $ 1,128,939
49,422
53,127
8,500
79,749
$ 1,552,414
___________________________
(1) The average loans receivable, net balances include non-accruing loans.
Interest Expense. Interest expense increased $9.1 million, or 88.9%, to $19.3 million for the year ended December 31,
2019, from $10.2 million for the prior year. The increase was primarily attributable to an increase in interest expense on
deposits of $8.8 million, and an increase in interest on borrowings of $248,000. The average cost of funds for total interest-
bearing liabilities increased 42 basis points to 1.64% for the year ended December 31, 2019, compared to 1.22% for
the year ended December 31, 2018. The average cost of interest-bearing deposits increased 54 basis points to 1.51% for
the year ended December 31, 2019, compared to 0.97% for the year ended December 31, 2018, primarily reflecting
increases in both the average balance and the cost of certificates of deposit due to rising interest rates over the last year.
71
The following table details average balances for cost of funds on interest-bearing liabilities and the change in interest
expense for the years ended December 31, 2019 and 2018:
Year Ended December 31,
2019
2018
(Dollars in thousands)
Savings and money market
Interest-bearing checking
Certificates of deposit
Borrowings
Subordinated note
Total interest-bearing liabilities
Average
Balance
Average
Balance
Yield/
Yield/
Outstanding Rate Outstanding Rate
$
380,474
181,852
515,634
93,405
9,874
$ 1,181,239
0.81 % $ 310,913
124,714
0.78
295,439
2.26
97,788
2.65
9,855
6.88
1.64 % $ 838,709
Increase in
Interest
Expense
1,043
1,187
6,611
248
—
9,089
0.66 % $
0.18
1.71
2.28
6.89
1.22 % $
Provision for Loan Losses. The provision for loan losses was $2.9 million for the year ended December 31, 2019,
compared to $1.5 million for the year ended December 31, 2018. The increase in the provision was primarily due to loan
growth and higher net charge-offs. During the year ended December 31, 2019, net charge-offs totaled $2.0 million
compared to net recoveries of $53,000 during the year ended December 31, 2018. The increase in charge-offs during the
year ended December 31, 2019, was primarily due to the charge-off of a commercial line of credit of $1.2 million and one
commercial business lending relationship totaling $431,000.
The following table details activity and information related to the allowance for loan losses for the years ended
December 31, 2019 and 2018:
(Dollars in thousands)
Provision for loan losses
Net charge-offs (recoveries)
Allowance for loan losses
Allowance for loan losses as a percentage of total gross loans receivable at the end of
the year
Non-accrual and 90 days or more past due loans
Allowance for loan losses as a percentage of non-performing loans at end of year
Non-accrual and 90 days or more past due loans as a percentage of gross loans
receivable at the end of the year
Total gross loans
At or For the Year Ended
December 31,
$
$
$
$
2019
2,880
2,000
13,229
2018
1,540
(53)
12,349
$
$
$
0.98 %
$
3,033
436.2 %
0.93 %
3,894
317.1 %
0.22 %
0.29 %
$ 1,351,893
$ 1,326,238
Management considers the allowance for loan losses at December 31, 2019, to be adequate to cover estimated losses
inherent 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 adversely impact the Company’s financial condition and results of operations. In addition,
the determination of the amount of allowance for loan losses 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.
72
Noninterest Income. Noninterest income decreased $3.8 million, to $23.0 million for the year ended December 31, 2019,
from $26.9 million for the year ended December 31, 2018. The following table provides a detailed analysis of the changes
in the components of noninterest income:
Year Ended December 31,
(Dollars in thousands)
Service charges and fee income
Bargain purchase gain
Gain on sale of loans
Loss on disposed fixed assets
Gain on sale of investment securities
Earnings on cash surrender value of BOLI
Other noninterest income
Total noninterest income
2019
6,554
—
14,248
(26)
32
872
1,355
23,035
$
$
$
$
2018
Increase/(Decrease)
Amount Percent
102.7 %
(100.0)
(4.1)
(63.4)
(81.3)
111.1
63.4
(14.2)%
3,233 $ 3,321
(7,414)
7,414
(613)
14,861
45
(71)
(139)
171
459
413
526
829
26,850 $ (3,815)
Excluding the bargain purchase gain, the year over year increases included $3.3 million in service charges and fee income,
driven by the loans acquired in the Anchor Acquisition and organic loan growth, $526,000 in other noninterest income,
and $459,000 in earnings on the cash surrender value of BOLI, partially offset by a decrease of $613,000 in gain on sale
of loans. The increase in other noninterest income was primarily due to increases in collection fees and fees related to the
Anchor Acquisition. The decrease in the gain on sale of loans was primarily due to lower sale margins attributable to
competition in the markets we serve and increased costs to originate loans impacted by increased home values. During
the year ended December 31, 2019, the Company originated $891.4 million of one-to-four-family mortgages during 2019
and sold $785.4 million to secondary mortgage market investors, compared to sales of $637.7 million during the year
ended December 31, 2018.
Noninterest Expense. Noninterest expense increased $13.5 million, to $62.3 million for the year ended December 31,
2019, compared to $48.8 million for the year ended December 31, 2018. The following table provides an analysis of the
changes in the components of noninterest expense:
Year Ended December 31,
(Dollars in thousands)
Salaries and benefits
Operations
Occupancy
Data processing
Gain on sale of OREO
OREO expenses
Loan costs
Professional and board fees
FDIC insurance
Marketing and advertising
Acquisition costs
Amortization of core deposit intangible
Impairment of servicing rights
Total noninterest expense
2019
33,816
9,722
4,640
4,972
(138)
13
3,238
2,426
358
678
1,756
760
92
62,333
$
$
$
$
Increase/(Decrease)
Amount Percent
18.5 %
44.9
52.5
73.2
(100.0)
550.0
15.6
29.6
(30.8)
(9.2)
26.4
116.5
100.0
2018
28,538 $ 5,278
3,013
1,598
2,102
(138)
11
437
554
(159)
(69)
367
409
92
48,838 $ 13,495
6,709
3,042
2,870
—
2
2,801
1,872
517
747
1,389
351
—
27.6 %
Noninterest expense increased during the year primarily as a result of the full year impact of the Anchor Acquisition and
growth in our operations with increases of $5.3 million in salaries and benefits, including an increase of $1.9 million in
incentives and commissions, primarily due to loan production growth, $3.0 million in operations, $2.1 million in data
processing, and $1.6 million in occupancy expense. Acquisition costs were $1.8 million for the year ended December 31,
2019, compared to $1.4 million for last year, primarily due to the integration of the Anchor Bank core processing platform.
73
The efficiency ratio, which is noninterest expense as a percentage of net interest income and noninterest income, was
66.8% for the year ended December 31, 2019, compared to 61.9% for the year ended December 31, 2018. By definition,
a lower efficiency ratio would be an indication that the Company is more efficiently utilizing resources to generate income.
These two years were unique with the $7.4 million bargain purchase gain in the prior year which drove a stronger efficiency
ratio in 2018, compared to no bargain purchase gain and greater expenses related to the Anchor Bank Acquisition in 2019.
Provision for Income Tax. During the year ended December 31, 2019, the Company recorded a provision for income tax
expense of $5.4 million compared to $4.2 million for the year ended December 31, 2018. There was a net deferred tax
liability of $2.0 million and $361,000 at December 31, 2019 and 2018, respectively. The effective tax rate for the year
ended December 31, 2019 was 19.2%, compared to 14.8% for the year ended December 31, 2018. The 4.4% increase in
the rate primarily relates to the tax benefit from the bargain purchase gain recognized in 2018. For additional information
regarding income taxes, see “Note 12 - Income Taxes” of the Notes to Consolidated Financial Statements included in
“Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
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 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
74
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 1st Security Bank of Washington. Therefore, the Company will control the level of economic risk
by limiting the amount of long-term, fixed-rate assets the Company will have and by setting a limit on concentrations and
maturities of securities.
Interest Rate Risk. If the Federal Reserve Board changes the Fed Funds rate 100, 200 or 300 basis points, the Bank policy
dictates that a change in net interest income should not change more that 7.5%, 15% and 30%, respectively.
The table presented below, as of December 31, 2019, is an analysis prepared for 1st Security Bank of Washington 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. No rates in the model are allowed to go below zero. Given that the current targeted Fed Funds rate
is a range of 1.00% to 1.25%, a 200 or 300 basis point reduction in rates is not reported. 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 from December 31, 2019.
Change in
Interest
Rates in Basis Points
300bp
200bp
100bp
0bp
(100)bp
December 31, 2019
Net Interest Income
Amount
Change
Change
(Dollars in thousands)
$ 69,456 $ (1,448)
(490)
(82)
—
789
70,413
70,821
70,903
71,692
(2.04)%
(0.69)
(0.12)
—
1.11
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
75
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,
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 1st Security
Bank of Washington’s level of interest rate risk is acceptable under this approach.
In evaluating 1st Security Bank of Washington’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. 1st Security Bank of Washington considers all of these factors in
monitoring its exposure to interest rate risk.
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.
At December 31, 2019, the Bank’s total borrowing capacity was $477.2 million with the FHLB of Des Moines, with
unused borrowing capacity of $386.5 million. The FHLB borrowing limit is based on certain categories of loans, primarily
real estate loans that qualify as collateral for FHLB advances. At December 31, 2019, the Bank held approximately $646.1
million in loans that qualify as collateral for FHLB advances.
In addition to the availability of liquidity from the FHLB of Des Moines, the Bank maintained a short-term borrowing line
with the Federal Reserve Bank, with a current limit of $156.1 million, and a combined credit limit of $71.0 million in
written federal funds lines of credit through correspondent banking relationships as of December 31, 2019. The Federal
Reserve Bank borrowing limit is based on certain categories of loans, primarily consumer loans that qualify as collateral
for Federal Reserve Bank line of credit. At December 31, 2019, the Bank held approximately $318.8 million in loans that
qualify as collateral for the Federal Reserve Bank line of credit.
At December 31, 2019, $84.9 million in FHLB advances were outstanding, and no advances were outstanding against the
Federal Reserve Bank line of credit, or the federal funds lines of credit. The Bank’s Asset and Liability Management
Policy permits management to utilize brokered deposits up to 20% of deposits or $279.6 million as of December 31, 2019.
Total brokered deposits at December 31, 2019 were $147.6 million, or 10.6% of total deposits. Management utilizes
brokered deposits to mitigate interest rate risk exposure where appropriate.
Liquidity management is both a daily and long-term function of Company management. Excess liquidity is generally
invested in short-term investments, such as overnight deposits and federal funds. On a longer term basis, a strategy is
maintained of investing in various lending products and investment securities, including U.S. Government obligations and
U.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. At December 31, 2019, the approved outstanding loan
commitments, including unused lines of credit, amounted to $312.3 million. Certificates of deposit scheduled to mature in
one year or less at December 31, 2019, totaled $357.8 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 deposit relationships will remain with the Bank.
As a separate legal entity from the Bank, FS Bancorp, Inc. must provide for its own liquidity. Sources of capital and
liquidity for FS Bancorp, Inc. include distributions from the Bank and the issuance of debt or equity securities. Dividends
76
and other capital distributions from the Bank are subject to regulatory notice. At December 31, 2019, FS Bancorp, Inc.
had $5.6 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 13 - Commitments and Contingencies” of the Notes to Consolidated Financial Statements included in “Item 8.
Financial Statements and Supplementary Data” of this Form 10-K.
A summary of off-balance sheet commitments to extend credit at December 31, 2019 was as follows:
Off-balance sheet loan commitments:
Real estate secured (1)
Commercial business loans
Home equity loans and lines of credit
Consumer loans
Total commitments to extend credit
__________________________
(1) Includes held for sale interest rate lock commitments.
Capital Resources
(In thousands)
$ 135,597
106,619
47,880
22,176
$ 312,272
The Bank is subject to minimum capital requirements imposed by the FDIC. Based on its capital levels at December 31,
2019, the Bank exceeded these requirements as of that date. Consistent with our goals to operate a sound and profitable
organization, our policy is for the Bank to maintain a well capitalized status under the capital categories of the FDIC.
Based on capital levels at December 31, 2019, the Bank was considered to be well capitalized. At December 31, 2019, 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 (“CET1”) capital ratios of 11.6%, 13.7%, 14.6%, and 13.7%, respectively. For
additional information regarding the Bank’s regulatory capital compliance, see the discussion included in “Note 15 -
Regulatory Capital” of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and
Supplementary Data” of this Form 10-K.
As a bank holding company registered with the Federal Reserve, the Company is subject to the capital adequacy
requirements of the Federal Reserve. Bank holding companies with less than $3.0 billion in assets are generally not subject
to compliance with the Federal Reserve’s capital regulations, which are generally the same as the capital regulations
applicable to the Bank. The Federal 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 the Federal 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 at December 31,
2019, FS Bancorp would have exceeded all regulatory capital requirements.
77
The following table compares 1st Security Bank of Washington’s actual capital amounts at December 31, 2019, to its
minimum regulatory capital requirements at that date:
(Dollars in thousands)
As of December 31, 2019
Total risk-based capital
(to risk-weighted assets)
Tier 1 risk-based capital
(to risk-weighted assets)
Tier 1 leverage capital
(to average assets)
CET1 capital
(to risk-weighted assets)
Actual
Amount
Ratio
For Capital
Adequacy Purposes
Amount
Ratio
For Capital Adequacy
with Capital Buffer
Amount
Ratio
To be Well Capitalized
Under Prompt
Corrective
Action Provisions
Amount
Ratio
$ 209,535 14.64 % $ 114,502 8.00 % $ 150,283 10.50 % $ 143,127 10.00 %
$ 196,013 13.70 % $ 85,876 6.00 % $ 121,658
8.50 % $ 114,502
8.00 %
$ 196,013 11.56 % $ 67,808 4.00 %
N/A N/A $ 84,761
5.00 %
$ 196,013 13.70 % $ 64,407 4.50 % $ 100,189
7.00 % $ 93,033
6.50 %
Recent Accounting Pronouncements
For a discussion of recent accounting standards, please see “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.
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.
Item 8. Financial Statements and Supplementary Data
FS BANCORP, INC. AND SUBSIDIARY
INDEX TO FINANCIAL STATEMENTS
Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2019 and 2018
Consolidated Statements of Income For the Years Ended December 31, 2019 and 2018
Consolidated Statements of Comprehensive Income For the Years Ended December 31, 2019 and 2018
Consolidated Statements of Changes in Stockholders’ Equity For the Years Ended December 31, 2019 and
2018
Consolidated Statements of Cash Flows For the Years Ended December 31, 2019 and 2018
Notes to Consolidated Financial Statements
Page
79
81
82
83
84
85
87
78
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of
FS Bancorp, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of FS Bancorp, Inc. and subsidiary (“the Company”) as
of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, changes in
stockholders’ equity, and cash flows for the years then ended, and the related notes (collectively referred to as the
“consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of
December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the
consolidated financial position of the Company as of December 31, 2019 and 2018, and the consolidated results of its
operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the
United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework
(2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal
control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting,
included in the accompanying Management Report on Internal Control over Financial Reporting included in Item 9A. Our
responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the
Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with
the Public Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the
Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and
Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material
misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained
in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material
misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond
to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in
the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant
estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.
Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as
we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s internal control over financial reporting includes those policies
and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
79
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded
as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with authorizations of management
and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures my deteriorate.
/s/ Moss Adams LLP
Everett, Washington
March 16, 2020
We have served as the Company’s auditor since 2006.
80
FS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2019 AND 2018
(In thousands, except share data)
ASSETS
Cash and due from banks
Interest-bearing deposits at other financial institutions
Total cash and cash equivalents
Certificates of deposit at other financial institutions
Securities available-for-sale, at fair value
Loans held for sale, at fair value
Loans receivable, net
Accrued interest receivable
Premises and equipment, net
Operating lease right-of-use (“ROU”) assets
Federal Home Loan Bank (“FHLB”) stock, at cost
Other real estate owned (“OREO”)
Bank owned life insurance (“BOLI”), net
Servicing rights, held at the lower of cost or fair value
Goodwill
Core deposit intangible, net
Other assets
TOTAL ASSETS
LIABILITIES
Deposits:
Noninterest-bearing accounts
Interest-bearing accounts
Total deposits
Borrowings
Subordinated note:
Principal amount
Unamortized debt issuance costs
Total subordinated note less unamortized debt issuance costs
Operating lease liabilities
Deferred tax liability, net
Other liabilities
Total liabilities
December 31, December 31,
$
$
$
$
$
$
2019
13,175
32,603
45,778
20,902
126,057
69,699
1,336,346
5,908
28,770
5,016
8,045
168
35,356
11,560
2,312
5,457
11,682
1,713,056
273,602
1,118,806
1,392,408
84,864
10,000
(115)
9,885
5,214
1,971
18,472
1,512,814
2018
9,408
23,371
32,779
22,074
97,205
51,195
1,312,519
5,761
29,110
—
9,887
689
34,485
10,429
2,312
6,217
6,982
1,621,644
234,532
1,039,687
1,274,219
137,149
10,000
(135)
9,865
—
361
20,012
1,441,606
COMMITMENTS AND CONTINGENCIES (NOTE 10)
STOCKHOLDERS’ EQUITY
Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued or outstanding
Common stock, $.01 par value; 45,000,000 shares authorized; 4,459,041 and 4,492,478
shares issued and outstanding at December 31, 2019 and December 31, 2018, respectively
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (loss), net of tax
Unearned shares – Employee Stock Ownership Plan (“ESOP”)
Total stockholders’ equity
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
—
—
44
89,268
110,715
788
(573)
200,242
1,713,056
$
45
91,466
90,854
(1,479)
(848)
180,038
1,621,644
See accompanying notes to these consolidated financial statements.
81
FS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2019 and 2018
(In thousands, except earnings per share data)
_________________________________________________________________________________________________________________________
INTEREST INCOME
Loans receivable, including fees
Interest and dividends on investment securities, cash and cash equivalents, and
certificates of deposit at other financial institutions
Total interest and dividend income
INTEREST EXPENSE
Deposits
Borrowings
Subordinated note
Total interest expense
NET INTEREST INCOME
PROVISION FOR LOAN LOSSES
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
NONINTEREST INCOME
Service charges and fee income
Bargain purchase gain
Gain on sale of loans
Loss on disposed fixed assets
Gain on sale of investment securities
Earnings on cash surrender value of BOLI
Other noninterest income
Total noninterest income
NONINTEREST EXPENSE
Salaries and benefits
Operations
Occupancy
Data processing
Gain on sale of OREO
OREO expenses
Loan costs
Professional and board fees
Federal Deposit Insurance Corporation (“FDIC”) insurance
Marketing and advertising
Acquisition costs
Amortization of core deposit intangible
Impairment of servicing rights
Total noninterest expense
INCOME BEFORE PROVISION FOR INCOME TAXES
PROVISION FOR INCOME TAXES
NET INCOME
Basic earnings per share
Diluted earnings per share
See accompanying notes to these consolidated financial statements.
82
Year Ended
December 31,
2019
2018
$
84,706
$
58,616
4,919
89,625
16,162
2,476
679
19,317
70,308
2,880
67,428
6,554
—
14,248
(26)
32
872
1,355
23,035
33,816
9,722
4,640
4,972
(138)
13
3,238
2,426
358
678
1,756
760
92
62,333
28,130
5,413
22,717
5.13
5.01
$
$
$
3,710
62,326
7,321
2,228
679
10,228
52,098
1,540
50,558
3,233
7,414
14,861
(71)
171
413
829
26,850
28,538
6,709
3,042
2,870
—
2
2,801
1,872
517
747
1,389
351
—
48,838
28,570
4,223
24,347
6.58
6.29
$
$
$
FS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2019 and 2018
(In thousands)
Net Income
Other comprehensive income (loss):
Securities available-for-sale:
Unrealized holding gain (loss) during year
Income tax (provision) benefit related to unrealized holding gain (loss)
Reclassification adjustment for realized gains, net included in net income
Income tax provision related to reclassification for realized gains, net
Other comprehensive income (loss), net of tax
COMPREHENSIVE INCOME
See accompanying notes to these consolidated financial statements.
Year Ended
December 31,
2019
22,717 $
2018
24,347
$
2,920
(628)
(32)
7
2,267
24,984 $
(1,108)
238
(171)
37
(1,004)
23,343
$
83
FS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2019 and 2018
(In thousands, except share data)
Common Stock
Shares
Additional
Paid-in
Amount Capital
Retained
Earnings
Accumulated
Other
Comprehensive Unearned
(Loss) Income,
Net of Tax
ESOP
Shares
Total
Stockholders’
Equity
BALANCE, January 1, 2018
3,680,152 $ 37 $ 55,135 $ 68,422 $
Net income
Dividends paid ($0.53 per share)
Share-based compensation
Restricted stock awards
Common stock issued
Common stock repurchased for
employee/director taxes paid on
restricted stock awards
Stock options exercised
Other comprehensive loss, net of
tax
ESOP shares allocated
— $ —
— $ —
— $ —
25,000 $ —
7
725,518 $
—
—
767
—
33,759
24,347
(1,915)
—
—
—
(4,325) $ —
1
66,133 $
(251)
1,116
— $ —
— $ —
—
940
—
—
—
—
BALANCE, December 31, 2018
4,492,478 $ 45 $ 91,466 $ 90,854 $
BALANCE, January 1, 2019
4,492,478 $ 45 $ 91,466 $ 90,854 $
— $ —
— $ —
— $ —
20,215 $ —
—
—
869
—
22,717
(2,856)
—
—
(475) $ (1,117) $ 122,002
— $ 24,347
(1,915)
— $
— $
767
—
— $
— $ 33,766
—
—
—
—
—
—
—
— $
— $
(251)
1,117
(1,004)
—
(1,479) $
(1,004)
— $
1,209
269 $
(848) $ 180,038
(1,479) $
—
—
—
—
(848) $ 180,038
— $ 22,717
(2,856)
— $
869
— $
—
— $
(102,384) $
(1)
(4,799)
—
—
— $
(4,800)
Net income
Dividends paid ($0.65 per share)
Share-based compensation
Restricted stock awards
Common stock repurchased -
repurchase plan
Common stock repurchased for
employee/director taxes paid on
restricted stock awards
Stock options exercised
Other comprehensive income, net
of tax
ESOP shares allocated
(4,037) $ —
52,769 $ —
(204)
705
— $ —
— $ —
—
1,231
—
—
—
—
—
—
— $
— $
(204)
705
2,267
—
788 $
2,267
— $
275 $
1,506
(573) $ 200,242
BALANCE, December 31, 2019
4,459,041 $ 44 $ 89,268 $ 110,715 $
See accompanying notes to these consolidated financial statements.
84
FS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2019 and 2018
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income
Adjustments to reconcile net income to net cash from operating activities
Provision for loan losses
Depreciation, amortization and accretion
Compensation expense related to stock options and restricted stock awards
ESOP compensation expense for allocated shares
Provision for deferred income taxes
Increase in cash surrender value of BOLI
Bargain purchase gain
Gain on sale of loans held for sale
Gain on sale of portfolio loans
Gain on sale of investment securities
Loss on disposed fixed assets
Origination of loans held for sale
Proceeds from sale of loans held for sale
Impairment of servicing rights
Gain on sale of OREO
Changes in operating assets and liabilities
Accrued interest receivable
Other assets
Other liabilities
Net cash from operating activities
CASH FLOWS USED BY INVESTING ACTIVITIES
Activity in securities available-for-sale:
Proceeds from sale of investment securities
Maturities, prepayments, and calls
Purchases
Maturities of certificates of deposit at other financial institutions
Purchase of certificates of deposit at other financial institutions
Loan originations and principal collections, net
Purchase of portfolio loans
Proceeds from sale of portfolio loans
Proceeds from sale of OREO, net
Purchase of premises and equipment, net
Purchase of BOLI
Change in FHLB stock, net
Net cash acquired from Anchor Acquisition
Net cash used by investing activities
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits
Proceeds from borrowings
Repayments of borrowings
Dividends paid on common stock
Proceeds from stock options exercised
Common stock repurchased for employee/director taxes paid on restricted stock awards
Common stock repurchased
Net cash from financing activities
NET INCREASE IN CASH AND CASH EQUIVALENTS
85
Year Ended December 31,
2019
2018
$
22,717
$
24,347
2,880
12,003
869
1,506
988
(872)
—
(14,126)
(122)
(32)
26
(804,619)
795,184
92
(138)
(147)
(4,589)
(2,443)
9,177
10,554
24,293
(61,282)
3,650
(2,480)
(36,904)
(1,799)
8,487
901
(2,463)
—
1,842
—
(55,201)
118,714
401,447
(453,983)
(2,856)
705
(204)
(4,800)
59,023
12,999
1,540
5,263
767
1,209
768
(413)
(7,414)
(14,654)
(207)
(171)
71
(619,632)
631,309
—
—
(2,156)
2,862
(2,052)
21,437
24,312
10,243
(31,309)
992
(4,960)
(190,125)
(24,007)
17,952
—
(3,796)
(3,000)
(7,016)
23,753
(186,961)
87,566
917,239
(824,368)
(1,915)
1,117
(251)
—
179,388
13,864
FS BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2019 and 2018 (Continued)
CASH AND CASH EQUIVALENTS, beginning of year
CASH AND CASH EQUIVALENTS, end of year
SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest on deposits and borrowings
Income taxes
Anchor acquisition:
Assets acquired, excluding cash acquired
Liabilities assumed
SUPPLEMENTARY DISCLOSURES OF NONCASH OPERATING, INVESTING
AND FINANCING ACTIVITIES
Change in unrealized gain (loss) on investment securities, net
Property taken in settlement of loans
Retention of gross mortgage servicing rights from loan sales
Additional paid-in-capital from common stock issued
Right-of-use assets in exchange for lease liabilities
See accompanying notes to these consolidated financial statements.
$
$
$
$
$
$
32,779
45,778
18,709
4,351
—
—
2,888
312
5,400
—
6,232
18,915
32,779
10,098
2,902
420,305
402,878
(1,279)
—
5,971
33,766
—
86
NOTE 1 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations - FS Bancorp, Inc. (the “Company”) was incorporated in September 2011 as the holding company
for 1st Security Bank of Washington (the “Bank” or “1st Security Bank”) in connection with the Bank’s conversion from
the mutual to stock form of ownership which was completed on July 9, 2012. The Bank is a community-based savings
bank with 21 full-service bank branches, a headquarters that accepts deposits, and seven home loan production offices in
suburban communities in the greater Puget Sound area which includes Snohomish, King, Pierce, Jefferson, Kitsap,
Clallam, Grays Harbor, Thurston, and Lewis counties, and one home loan production office in the market area of the Tri-
Cities, Washington. The Bank provides loan and deposit services to customers who are predominantly small- and middle-
market businesses and individuals. The Company and its subsidiary are subject to regulation by certain federal and state
agencies and undergo periodic examination by these regulatory agencies.
On November 15, 2018, the Company completed its acquisition of Anchor Bancorp (“Anchor”), pursuant to the Agreement
and Plan of Merger dated as of July 17, 2018 (the “Merger Agreement”) by and between FS Bancorp and Anchor. Under
the terms of the Merger Agreement, Anchor merged with and into FS Bancorp (“Anchor Acquisition”), with FS Bancorp
as the surviving corporation. Immediately after the Anchor Acquisition, FS Bancorp merged Anchor Bank, a wholly-
owned subsidiary of Anchor, with and into 1st Security Bank of Washington, a wholly-owned subsidiary of FS Bancorp,
with 1st Security Bank of Washington as the surviving bank. For additional information, see “Note 2 - Business
Combination.”
Financial Statement Presentation - The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States (“U.S. GAAP”) and with prevailing practices within the
banking and securities industries. In preparing such financial statements, management is required to make certain estimates
and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
as of the date of the balance sheet and the reported amounts of revenues and expenses for the reporting period. Actual
results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant
change relate to the determination of the allowance for loan and lease losses, fair value of financial instruments, the
valuation of servicing rights, deferred income taxes, and if needed, a deferred tax asset valuation allowance.
Amounts presented in the consolidated financial statements and footnote tables are rounded and presented to the nearest
thousands of dollars except per share amounts. If the amounts are above $1.0 million, they are rounded one decimal point,
and if they are above $1.0 billion, they are rounded two decimal points.
Principles of Consolidation - The consolidated financial statements include the accounts of FS Bancorp, Inc. and its
wholly owned subsidiary, 1st Security Bank of Washington. All material intercompany accounts have been eliminated in
consolidation.
Segment Reporting - The Company operates in two business segments through the Bank: commercial and consumer
banking and home lending. The Company’s business segments are determined based on the products and services
provided, as well as the nature of the related business activities, and they reflect the manner in which financial information
is regularly reviewed for the purpose of allocating resources and evaluating performance of the Company’s businesses.
The results for these business segments are based on management’s accounting process, which assigns income statement
items and assets to each responsible operating segment. This process is dynamic and is based on management’s view of
the Company’s operations. See “Note 20 - Business Segments.”
Subsequent Events - The Company has evaluated events and transactions subsequent to December 31, 2019 for potential
recognition or disclosure.
Cash and Cash Equivalents - Cash and cash equivalents include cash and due from banks, and interest-bearing balances
due from other banks and the Federal Reserve Bank of San Francisco (“FRB”) and have an original maturity of 90 days
or less at the time of purchase. At times, cash balances may exceed Federal Deposit Insurance Corporation (“FDIC”)
insured limits. At December 31, 2019 and 2018, the Company had $8.6 million and $25,000, respectively, of cash and
due from banks and interest-bearing deposits at other financial institutions in excess of FDIC insured limits.
Securities Available-for-Sale - Securities available-for-sale consist of debt securities that the Company has the intent and
ability to hold for an indefinite period, but not necessarily to maturity. Such securities may be sold to implement the
87
Company’s asset/liability management strategies and in response to changes in interest rates and similar factors. Securities
available-for-sale are reported at fair value. Realized gains and losses on securities available-for-sale, determined using
the specific identification method, are included in results of operations. Amortization of premiums and accretion of
discounts are recognized as adjustments to yield over the contractual lives of the related securities with the exception of
premiums for non-contingently callable debt securities which are amortized to the earliest call date, rather than the
contractual maturity date.
Unrealized holding gains and losses, net of the related deferred tax effect, are reported as a net amount in a separate
component of equity entitled accumulated other comprehensive income (loss). Unrealized losses that are deemed to be
other than temporary are reflected in results of operations. Any declines in the values of these securities that are considered
to be other-than-temporary-impairment (“OTTI”) and credit-related are recognized in earnings. Noncredit-related OTTI
on securities not expected to be sold is recognized in other comprehensive income (loss). The review for OTTI is conducted
on an ongoing basis and takes into account the severity and duration of the impairment, recent events specific to the issuer
or industry, fair value in relationship to cost, extent and nature of change in fair value, creditworthiness of the issuer
including external credit ratings and recent downgrades, trends and volatility of earnings, current analysts’ evaluations,
and other key measures. In addition, the Company does not intend to sell the securities and it is more likely than not that
we will not be required to sell the securities before recovery of their amortized cost basis. In doing this, we take into
account our balance sheet management strategy and consideration of current and future market conditions. Dividends and
interest income are recognized when earned.
Federal Home Loan Bank Stock - The Bank’s investment in FHLB stock is carried at cost, which approximates fair value.
As a member of the FHLB system, the Bank is required to maintain an investment in capital stock of the FHLB in an
amount of $1.9 million and 4.0% of advances from the FHLB. The Bank’s required minimum level of investment in FHLB
stock is based on specific percentages of its outstanding mortgages, total assets, or FHLB advances. At December 31, 2019
and 2018, the Bank’s minimum level of investment requirement in FHLB stock was $8.0 million and $9.9 million,
respectively. The Bank was in compliance with the FHLB minimum investment requirement at December 31, 2019 and
2018.
Management evaluates FHLB stock for impairment as needed. Management’s determination of whether these investments
are impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines
in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such
as (1) the significance of any decline in net assets of the FHLB as compared with the capital stock amount for the FHLB
and the length of time this situation has persisted; (2) commitments by the FHLB to make payments required by law or
regulation and the level of such payments in relation to the operating performance of the FHLB; (3) the impact of
legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB; and (4) the liquidity
position of the FHLB. Based on its evaluation, management determined that there was no impairment of FHLB stock at
December 31, 2019 and 2018, respectively.
Loans Held for Sale - The Bank records all mortgage loans held-for-sale at fair value. Fair value is determined by
outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis.
Gains and losses on fair value changes of loans held for sale are recorded in the gain on sale of loans component of non-
interest income. Origination fees and costs are recognized in earnings at the time of origination. Mortgage loans held for
sale are sold with the mortgage service rights either released or retained by the Bank. Gains or losses on sales of mortgage
loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans
sold. All sales are made with limited recourse against the Company.
Other Real Estate Owned - Other real estate owned (“OREO”) consists of properties or assets acquired through or in lieu
of foreclosure, and are recorded initially at fair value less selling costs, with the initial charge made to the allowance for
loan losses. Costs relating to development and improvement of the properties or assets are capitalized while costs relating
to holding the properties or assets are expensed. Valuations are periodically performed by management, and a charge to
earnings is recorded if the recorded value of a property exceeds its estimated net realizable value.
Derivatives - Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward
commitments for the future delivery of these mortgage loans are accounted for as free-standing derivatives. The fair value
of the interest rate lock is recorded at the time the commitment to fund the mortgage loan is executed and is adjusted for
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the expected exercise of the commitments to fund the loans, the Company enters into forward commitments for the future
delivery of mortgage loans when interest rate locks are entered. Fair values of these mortgage derivatives are estimated
based on changes in mortgage interest rates from the date the interest on the loan is locked. Changes in the fair values of
these derivatives are reported in “Gain on sale of loans” on the Consolidated Statements of Income.
Loans Receivable - Loans receivable, are stated at the amount of unpaid principal reduced by an allowance for loan losses
and net deferred fees or costs. Interest on loans is calculated using the simple interest method based on the daily balance
of the principal amount outstanding and is credited to income as earned. Loan fees, net of direct origination costs, are
deferred and amortized over the life of the loan using the effective yield method. If the loan is repaid prior to maturity, the
remaining unamortized net deferred loan origination fee is recognized in income at the time of repayment.
Interest on loans is accrued daily based on the principal amount outstanding. Generally, the accrual of interest on loans is
discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due or when
they are past due 90 days as to either principal or interest (based on contractual terms), unless they are well secured and in
the process of collection. All interest accrued but not collected for loans that are placed on non-accrual status or charged
off are reversed against interest income. Subsequent collections on a cash basis are applied proportionately to past due
principal and interest, unless collectability of principal is in doubt, in which case all payments are applied to principal.
Loans are returned to accrual status when the loan is performing according to its contractual terms for at least six months
and the collectability of principal and interest is no longer doubtful.
Impaired Loans - A loan is considered impaired when it is probable the Company will be unable to collect all contractual
principal and interest payments due in accordance with the original or modified terms of the loan agreement. Impaired
loans are measured on a loan by loan basis based on the estimated fair value of the collateral less estimated cost to sell if
the loan is considered collateral dependent. Impaired loans not considered to be collateral dependent are measured based
on the present value of expected future cash flows. Regular credit reviews of the portfolio also identify loans that are
considered potentially impaired except for the smaller groups of homogeneous consumer loans.
The categories of non-accrual loans and impaired loans overlap, although they are not coextensive. The Company
considers all circumstances regarding the loan and borrower on an individual basis when determining whether an impaired
loan should be placed on non-accrual status, such as the financial strength of the borrower, the collateral value, reasons
for delay, payment record, the amount of past due and the number of days past due. Loans that experience insignificant
payment delays and payment shortfalls are generally not classified as impaired. Management determines the significance
of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior
payment record, and the amount of shortfall in relation to the principal and interest owed.
Troubled Debt Restructured Loans - Troubled debt restructured (“TDR”) loans are loans for which the Company, for
economic or legal reasons related to the borrower’s financial condition, has granted a significant concession to the
borrower that it would otherwise not consider. The loan terms which have been modified or restructured due to a
borrower’s financial difficulty include but are not limited to: a reduction in the stated interest rate; an extension of the
maturity at an interest rate below current market; a reduction in the face amount of the debt; a reduction in the accrued
interest; or re-aging, extensions, deferrals and renewals. TDR loans are considered impaired loans and are individually
evaluated for impairment and can be classified as either accrual or non-accrual. TDR loans are classified as non-
performing loans unless they have been performing in accordance with their modified terms for a period of at least six
months in which case they are placed on accrual status.
Allowance for Loan Losses (“ALLL”) - The ALLL is maintained at a level considered adequate to provide for probable
losses on existing loans based on evaluating known and inherent risks in the loan portfolio. The allowance is reduced by
loans charged off and increased by provisions charged to earnings and recoveries on loans previously charged-off. The
allowance is based on management’s periodic, and systematic evaluation of factors underlying the quality of the loan
portfolio including changes in the size and composition of the loan portfolio, the estimated value of any underlying
collateral, actual loan loss experience, current economic conditions, and detailed analysis of individual loans for which
full collectability may not be assured. This evaluation is inherently subjective as it requires estimates that are susceptible
to significant revision as more information becomes available. While management uses the best information available to
make its estimates, future adjustments to the allowance may be necessary if there is a significant change in economic and
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other conditions. The appropriateness of the ALLL is estimated based on these factors and trends identified by management
at the time the financial statements are prepared.
When available information confirms that specific loans or portions thereof are uncollectible, these amounts are charged-
off against the ALLL. The existence of some or all of the following criteria will generally confirm that a loss has been
incurred: the loan is significantly delinquent and the borrower has not evidenced the ability or intent to bring the loan
current; the Company has no recourse to the borrower, or if it does, the borrower has insufficient assets to pay the debt;
the estimated fair value of the loan collateral is significantly below the current loan balance, and there is little or no near-
term prospect for improvement.
A provision for loan losses is charged against income and added to the ALLL based on regular assessment of the loan
portfolio. The ALLL is allocated to certain loan categories based on the relative risk characteristics, asset classifications,
and actual loss experience within the loan portfolio. Although management has allocated the ALLL to various loan
portfolio segments, the allowance is general in nature and is available for the loan portfolio in its entirety.
The ultimate recovery of all loans is susceptible to future market factors beyond the Company’s control. These factors
may result in losses or recoveries differing significantly from those provided for in the financial statements. In addition,
regulatory agencies, as an integral part of their examination process, periodically review the Company’s ALLL, and may
require the Company to make additions to the allowance based on their judgment about information available to them at
the time of their examinations.
Reserve for Unfunded Loan Commitments - The reserve for unfunded loan commitments is maintained at a level believed
by management to be sufficient to absorb estimated probable losses related to these unfunded credit facilities. The
determination of the adequacy of the reserve is based on periodic evaluations of the unfunded credit facilities including an
assessment of the probability of commitment usage, credit risk factors for loans outstanding to these same customers, and
the terms and expiration dates of the unfunded credit facilities. The reserve for unfunded loan commitments is included in
other liabilities on the consolidated balance sheet, with changes to the balance charged against noninterest expense.
Premises and Equipment, Net - Land is carried at cost. Premises and equipment are stated at cost less accumulated
depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of
the assets. The estimated useful lives used to compute depreciation include building and building improvements from 25
to 40 years and furniture, fixtures, and equipment from 3 to 10 years. Leasehold and tenant improvements are amortized
using the straight-line method over the lesser of useful life or the life of the related lease. Gains or losses on dispositions
are reflected in Consolidated Statements of Income.
Management reviews buildings, improvements and equipment for impairment on an annual basis or whenever events or
changes in the circumstances indicate that the undiscounted cash flows for the property are less than its carrying value. If
identified, an impairment loss is recognized through a charge to earnings based on the fair value of the property.
Transfers of Financial Assets - Transfers of an entire financial asset, a group of entire financial assets, or participating
interest in an entire financial asset are accounted for as sales when control over the assets has been surrendered. Control
over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the
transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange
the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an
agreement to repurchase them before their maturity.
Servicing Rights - Servicing assets are recognized as separate assets when rights are acquired through purchase or through
sale of financial assets. Generally, purchased servicing rights are capitalized at the cost to acquire the rights. For sales of
mortgage, commercial and consumer loans, a portion of the cost of originating the loan is allocated to the servicing right
based on relative fair value. Fair value is based on market prices for comparable mortgage, commercial, or consumer
servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of
estimated future net servicing income. The valuation model incorporates assumptions that market participants would use
in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an
inflation rate, ancillary income, prepayment speeds, and default rates and losses.
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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 tranche. 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 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.
Income Taxes - The Company files a consolidated federal income tax return. Deferred federal income taxes result from
temporary differences between the tax basis of assets and liabilities, and their reported amounts in the financial statements.
These will result in differences between income for tax purposes and income for financial reporting purposes in
future years. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes. Valuation allowances are established to reduce the net recorded amount of deferred tax assets
if it is determined to be more likely than not, that all or some portion of the potential deferred tax asset will not be realized.
The Company follows the authoritative guidance issued related to accounting for uncertainty in income taxes. The
guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. It is the Company’s policy to record any
penalties or interest arising from federal or state taxes as a component of income tax expense.
Employee Stock Ownership Plan - Compensation expense recognized for the Company’s ESOP equals the fair value of
shares that have been allocated or committed to be released for allocation to participants. Any difference between the fair
value of the shares at the time and the ESOP’s original acquisition cost is charged or credited to stockholders’ equity
(additional paid-in capital). The cost of ESOP shares that have not yet been allocated or committed to be released is
deducted from stockholders’ equity.
Earnings Per Share (“EPS”) - Basic EPS are computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential
dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common
stock or resulted in the issuance of common stock that then shared in the earnings of the entity. For purposes of computing
basic and dilutive EPS, ESOP shares that have been committed to be released are outstanding and ESOP shares that have
not been committed to be released shall not be considered outstanding.
Comprehensive Income (Loss) - Comprehensive income (loss) is comprised of net income and other comprehensive
income (loss). Other comprehensive income (loss) includes unrealized holding gains and losses on securities available-
for-sale, net of tax recorded directly to equity.
Financial Instruments - In the ordinary course of business, the Company has entered into agreements for off-balance-
sheet financial instruments consisting of commitments to extend credit and stand-by letters of credit. Such financial
instruments are recorded in the financial statements when they are funded or related fees are incurred or received.
Restricted Assets - Regulations of the Board of Governors of the Federal Reserve System (“Federal Reserve”) require that
the Bank maintain reserves in the form of cash on hand and deposit balances with the FRB, based on a percentage of
deposits. The amounts of such balances for the years ended December 31, 2019 and 2018 were $0.0 and $17.4 million,
respectively, included in interest-bearing deposits at other financial institutions on the Consolidated Balance Sheets.
Marketing and Advertising Costs - The Company records marketing and advertising costs as expenses as they are
incurred. Total marketing and advertising expense was $678,000 and $747,000 for the years ended December 31, 2019
and 2018, respectively.
Stock-Based Compensation - Compensation cost is recognized for stock options and restricted stock awards, based on the
fair value of these awards at the grant date. A Black-Scholes model is utilized to estimate the fair value of stock options,
while the market price of the Company’s common stock at the grant date is used for restricted stock awards. Compensation
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cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting,
compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.
Goodwill - Goodwill is recorded upon completion of a business combination as the difference between the purchase price
and the fair value of net identifiable assets acquired. Goodwill was not recorded until the first quarter of 2016 in recognition
of the four retail branches purchased from Bank of America on January 22, 2016. The Company completes its annual
review of goodwill during the fourth quarter of each fiscal year. An assessment of qualitative factors is completed to
determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the qualitative
analysis concludes that further analysis is required, then a quantitative impairment test would be completed. The
quantitative goodwill impairment test is used to identify the existence of impairment and the amount of impairment loss
and compares the reporting unit’s estimated fair value, including goodwill, to its carrying amount. If the fair value exceeds
the carrying amount then goodwill is not considered impaired. If the carrying amount exceeds its fair value, an impairment
loss would be recognized equal to the amount of excess, limited to the amount of total goodwill allocated to that reporting
unit. There was no goodwill impairment at December 31, 2019 or 2018.
Business Combinations - The Company accounts for business combinations using the acquisition method of
accounting. The accounts of an acquired entity are included as of the date of acquisition, and any excess of purchase price
over the fair value of the net assets acquired is capitalized as goodwill. In the event that the fair value of net assets acquired
exceeds the purchase price, including fair value of liabilities assumed, a bargain purchase gain is recorded on that
acquisition. Under this method, all identifiable assets acquired, including purchased loans, and liabilities assumed are
recorded at fair value. The Company typically issues common stock and/or pays cash for an acquisition, depending on the
terms of the acquisition agreement. The value of shares of common stock issued is determined based on the market price
of the stock as of the closing of the acquisition.
Acquired Loans - Acquired loans are recorded at their initial fair value and adjusted for subsequent advances, pay downs,
amortization or accretion of any premium or discount on purchase, charge-offs and additional provisioning that may be
required.
Application of New Accounting Guidance in 2019
On January 1, 2019, the Company adopted Financial Accounting Standards Board (“FASB”) Accounting Standards
Update (“ASU”) No. 2016-02, Leases (Topic 842). ASU No. 2016-02 requires lessees to recognize on the balance sheet
the assets and liabilities arising from operating leases. A lessee should recognize a liability to make lease payments and an
ROU asset representing its right to use the underlying asset for the lease term. A lessee should include payments to be
made in an optional period only if the lessee is reasonably certain to exercise an option to extend the lease or not to exercise
an option to terminate the lease. For operating leases, the lease cost should be allocated over the lease term on a generally
straight-line basis. In July 2018, the FASB issued ASU No, 2018-10, Codification Improvements to Topic 842, Leases
and ASU No. 2018-11, Leases (Topic 842): Targeted Improvements. These ASUs contain clarifications to ASU 2016-02,
including providing a new transition method in addition to the existing transition method contained in ASU No. 2016-02
to allow entities to initially apply the new leases standard at the adoption date and recognize a cumulative-effect adjustment
to the opening balance of retained earnings in the period of adoption. These amendments have the same effective date as
ASU 2016-02. In March 2019, FASB issued ASU 2019-01, Leases (Topic 842), Codification Improvements. The
amendment in this ASU that is applicable to the Company clarifies interim disclosure requirements that allow omission of
required transition disclosures. For financial reporting purposes, the Company applied the modified retrospective transition
approach and elected to apply the transition option included in ASU 2018-11 on the effective date, January 1, 2019, which
eliminates the requirement for reporting comparative periods presented in the financial statements prior to that date.
The new standard provides for a number of practical expedients in transition. The Company elected the package of practical
expedients, which permits us to not reassess under the new standard our prior conclusions about lease identification, lease
classification and initial direct costs. The Company also elected the use-of-hindsight and elected the practical expedient to
not separate lease and non-lease components on our real estate leases where we are the lessee. The Company did not elect
the practical expedient pertaining to land easement as it is not applicable to us.
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The new standard also provides practical expedients for an entity's ongoing accounting. The Company has elected the
short-term lease recognition exemption for certain leases which are less than 12 months in duration or month-to-month.
This means, for those leases that qualify, ROU assets or lease liabilities will not be recognized.
The adoption of this ASU on January 1, 2019 created ROU assets of $5.1 million and operating lease liabilities of $5.2
million, and the related impact to the Company’s first quarter 2019 Consolidated Balance Sheet was approximately 0.3%
of total assets. Additional disclosures required by the ASU have been included in “Note 7 - Leases.”
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of
Credit Losses on Financial Instruments, as amended by ASU 2018-19, ASU 2019-10, and ASU 2019-11. The ASU is
intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial
instruments held by financial institutions and other organizations. The ASU requires the recognition and measurement of
all current expected credit losses (“CECL”) for financial assets held at the reporting date based on historical experience,
current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use
forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied
today will still be permitted, although the inputs to those techniques will change to reflect the full amount of CECL.
Organizations will continue to use judgment to determine which loss estimation method is appropriate for their
circumstances. The ASU requires enhanced disclosures to help investors and other financial statement users better
understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and
underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements
that provide additional information about the amounts recorded in the financial statements. In addition, the ASU amends
the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.
The ASU and associated amendments are effective for fiscal years, and interim periods within those fiscal years, beginning
after December 15, 2022, after the October 16, 2019 FASB board decision to approve extending the adoption date for
certain registrants, including the Company. Early adoption will be permitted for fiscal years, and interim periods within
those fiscal years, beginning after December 15, 2019. The Company has selected a third-party vendor to assist in the
implementation of this new ASU and has run parallel computations with the current GAAP incurred loss model. As part
of the implementation, the Company modeled the various methods prescribed in the ASU against the Company’s identified
loan segments. The Company anticipates continuing to run parallel computations as it continues to evaluate the impact of
adoption of the new standard. Once adopted, the Company anticipates the ALLL to increase through a one-time adjustment
to retained earnings, however, until the evaluation is complete the magnitude of the potential increase will be unknown.
In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments-Credit
Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. This ASU clarifies and improves
areas of guidance related to the recently issued standards on credit losses, hedging, and recognition and measurement
including improvements resulting from various FASB Transition Resource Group meetings. Early adoption is permitted.
The Company plans to adopt Topic 326 of this ASU, in conjunction with ASU No. 2016-13, on January 1, 2023. The
adoption of Topic 815 and Topic 825 is not expected to have a material impact on the Company’s consolidated financial
statements.
In May 2019, the FASB issued ASU 2019-05, Financial Instruments-Credit Losses (Topic 326): Targeted Transition
Relief. The amendments in this ASU provide entities that have certain instruments within the scope of Subtopic 326-20
with an option to irrevocably elect the fair value option in Subtopic 825-10, applied on an instrument-by-instrument basis
for eligible instruments, upon the adoption of Topic 326. The fair value option election does not apply to held-to-maturity
debt securities. An entity that elects the fair value option should subsequently measure those instruments at fair value with
changes in fair value flowing through earnings. Due to the October 16, 2019 FASB board decision to approve extending
the adoption date for certain registrants, including the Company, this ASU is effective for fiscal years beginning after
December 15, 2022, and interim periods within those fiscal years. The ASU should be applied on a modified-retrospective
basis by means of a cumulative-effect adjustment to the opening balance of retained earnings balance in the balance sheet.
Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-05 will have on its consolidated
financial statements.
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In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes
to the Disclosure Requirements for Fair Value Measurement. This ASU contains some technical adjustments related to
the fair value disclosure requirements of public companies. Included in this ASU is the additional disclosure requirement
of unrealized gains and losses for the period in recurring level 3 fair value disclosures and the range and weighted average
of significant unobservable inputs, among other technical changes. ASU 2018-13 is effective for fiscal years, and interim
periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted for any removed or
modified disclosures. The adoption of ASU 2018-13 is not expected to have a material impact on the Company's
consolidated financial statements.
In August 2018, FASB issued ASU 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud
Computing Arrangement That Is a Service Contract. The amendments in this ASU broaden the scope of ASC Subtopic
350-40 to include costs incurred to implement a hosting arrangement that is a service contract. The amendments align the
requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the
requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting
arrangements that include an internal-use software license). The costs are capitalized or expensed depending on the nature
of the costs and the project stage during which they are incurred, consistent with the accounting for costs for internal-use
software. The amendments in this ASU result in consistent capitalization of implementation costs of a hosting arrangement
that is a service contract and implementation costs incurred to develop or obtain internal-use software (and hosting
arrangements that include an internal-use software license). The accounting for the service element of a hosting
arrangement that is a service contract is not affected by the amendments in this ASU. This ASU is effective for fiscal years
beginning after December 15, 2019 and interim periods within those fiscal years. The amendments in this ASU should be
applied retrospectively to all implementation costs incurred after the date of adoption. Adoption of ASU 2018-15 is not
expected to have a material impact on the Company’s consolidated financial statements.
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740), Simplifying the Accounting for Income
Taxes. The amendments in this ASU simplify the accounting for income taxes by removing certain exceptions to the
general principles in Topic 740, Income Taxes. The amendments also improve consistent application or and simplify
GAAP for other areas of Topic 740 by clarifying and amending existing guidance. This ASU is effective for fiscal years,
and interim periods within those fiscal years, beginning after December 15, 2020. The Company does not expect the
adoption of ASU 2019-12 to have a material impact on its consolidated financial statements.
NOTE 2 - BUSINESS COMBINATION
On November 15, 2018, the Company completed its acquisition of Anchor Bancorp, pursuant to the Agreement and Plan
of Merger dated as of July 17, 2018 by and between FS Bancorp and Anchor. Under the terms of the Merger Agreement,
Anchor merged with and into FS Bancorp, with FS Bancorp as the surviving corporation. Immediately after the Anchor
Acquisition, FS Bancorp merged Anchor Bank, a wholly-owned subsidiary of Anchor, with and into 1st Security Bank of
Washington, a wholly-owned subsidiary of FS Bancorp, with 1st Security Bank of Washington as the surviving bank.
Anchor’s principal business activities prior to the acquisition were attracting retail deposits from the general public and
utilizing those deposits to originate loans including one-to-four-family residences, commercial real estate, and multi-
family residences located in Western Washington. Anchor’s principal lending activity had consisted of the origination of
loans secured by first mortgages on owner-occupied, one-to-four-family residences and loans for the construction of one-
to-four-family residences, as well as consumer loans, with an emphasis on home equity loans and lines of credit. The
primary objective for the acquisition was to significantly expand FS Bancorp’s presence throughout Western Washington,
increase nonmaturity deposits, and offer additional banking and lending products to former Anchor customers as well as
new customers.
The Anchor Acquisition was accounted for under the acquisition method of accounting and accordingly, the assets and
liabilities were recorded at their fair values on November 15, 2018, the date of acquisition. Determining the fair value of
assets and liabilities is a complicated process involving significant judgment regarding methods and assumptions used to
calculate estimated fair values. For the years ended December 31, 2019 and 2018, there were no refinements to the fair
value of these assets acquired and liabilities assumed.
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The following table summarizes the estimated fair values of assets acquired and liabilities assumed at the date of
acquisition:
November 15, 2018
Assets
Cash and cash equivalents
Securities available-for-sale
Loans receivable, net
Premises and equipment, net
Other real estate owned
Deferred tax asset
Mortgage servicing rights
Core deposit intangible ("CDI")
Other assets
Total assets acquired
Liabilities
Deposits
Borrowings
Other liabilities
Total liabilities assumed
Explanation of Fair Value Adjustments
Acquired Book Fair Value Amount
Adjustments Recorded
Value
$
$
$
$
54,558 $
19,609
361,596
8,411
689
4,097
218
—
25,231
474,409 $
— $ 54,558
19,555
(54)
(5,321)(1) 356,275
3,354 (2)
11,765
689
—
739
(3,358)
782
564
5,251 (3)
5,251
25,249
18
454 $ 474,863
357,863 $
37,000
9,286
404,149 $
(1,052)(4) $ 356,811
36,718
9,349
(1,271) $ 402,878
(282)
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(1) The fair value discount for acquired loans from Anchor was $5.3 million and was determined by separate adjustments
to reflect a credit risk and marketability component and a yield component reflecting the differential between portfolio
and market yields. The discount on acquired loans will be accreted back into interest income using the effective yield
method.
(2) The fair value adjustment represents the difference between the fair value of the premises and the book value of those
assets acquired. The Company utilized third-party valuations including appraisals, comparative market analysis, and tax-
assessed values to assist in the determination of the fair value.
(3) The fair value adjustment of $5.3 million represents the value of the core deposit base assumed. This amount was
recorded by the Company as an identifiable intangible asset and will be amortized as an expense on a straight-line basis
over an estimated 10 year life of the core deposit base and will be reviewed for impairment annually. See “Note 22-
Goodwill and Other Intangible Assets.”
(4) The fair value of transaction and savings accounts was determined to be equal to their carrying values. The fair value
of time deposits was calculated using a discounted cash flow analysis that calculated the present value of the projected
cash flows from the portfolio versus the present value of a similar portfolio with a similar maturity profile at current market
rates. As of the acquisition date, the portfolio of time deposits was valued at a pre-tax discount of $1.1 million, or 0.65%
of certificates of deposit acquired in the Anchor Acquisition of $162.9 million. This adjustment represents a difference in
interest rates from the time deposits acquired and the estimated wholesale funding rates used in the application of fair
value accounting. The discounted amount will be accreted into expense as an increase in interest expense over the maturity
profile of the acquired time deposits.
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The following table summarizes the consideration paid, the aggregate amount recognized for each major class of assets
acquired and liabilities assumed by 1st Security Bank in the Anchor Acquisition:
Purchase price of Anchor
Fair value of FS Bancorp common stock at $46.54 (1) per share for 725,518 shares
Cash paid
Total purchase price
Fair value of assets acquired:
Cash and cash equivalents
Securities available-for-sale
Loans receivable, net
Premises and equipment
OREO
Deferred tax asset
Mortgage servicing rights
Intangible assets – CDI
Other assets
Total assets and identifiable intangible assets acquired
Fair value of liabilities assumed:
Deposits
Borrowings
Other liabilities
Total liabilities assumed
At November 15, 2018
$
33,766
30,805
64,571
$
$
$
$
54,558
19,555
356,275
11,765
689
739
782
5,251
25,249
474,863
356,811
36,718
9,349
402,878
Fair value of net assets and identifiable intangible assets acquired
Bargain purchase gain
_________________________
(1) Stock price is as of the closing date.
71,985
(7,414)
$
The application of the acquisition method of accounting resulted in a bargain purchase gain of $7.4 million for the year
ended December 31, 2018 and was reported as a component of noninterest income on our Consolidated Statements of
Income. The bargain purchase gain was primarily due to the decline in the value of the stock portion of the merger
consideration between signing and closing the Anchor Acquisition which resulted in the purchase price for Anchor being
less than the fair market value of the net assets acquired. In the merger, each Anchor shareholder received 0.291 of a share
of FS Bancorp common stock for each share of Anchor common stock along with $12.40 in cash.
The Company determined that the disclosure requirements related to the amounts of revenues and earnings of Anchor
included in the consolidated statements of operations since the November 15, 2018 acquisition date is impracticable. The
financial activity and operating results of Anchor were commingled with the Company’s financial activity and operating
results as of the acquisition date.
96
NOTE 3 - SECURITIES AVAILABLE-FOR-SALE
The following tables present the amortized costs, unrealized gains, unrealized losses, and estimated fair values of securities
available-for-sale at December 31, 2019 and 2018:
December 31, 2019
Estimated
Amortized Unrealized Unrealized
Cost
Gains
Losses
Fair
Values
SECURITIES AVAILABLE-FOR-SALE
U.S. agency securities
Corporate securities
Municipal bonds
Mortgage-backed securities
U.S. Small Business Administration securities
Total securities available-for-sale
SECURITIES AVAILABLE-FOR-SALE
U.S. agency securities
Corporate securities
Municipal bonds
Mortgage-backed securities
U.S. Small Business Administration securities
Total securities available-for-sale
$
8,986 $
10,525
20,516
62,745
22,281
$ 125,053 $
95 $
52
604
405
191
1,347 $
(15) $ 9,066
10,570
(7)
21,120
—
62,850
(300)
22,451
(21)
(343) $ 126,057
December 31, 2018
Estimated
Amortized Unrealized Unrealized
Fair
Cost
Gains
Losses
Values
$ 16,052 $
7,074
14,446
45,827
15,690
$ 99,089 $
32 $
—
23
83
—
(197) $ 15,887
6,865
(209)
14,194
(275)
44,836
(1,074)
15,423
(267)
138 $ (2,022) $ 97,205
At December 31, 2019, the Bank pledged seven securities held at the FHLB of Des Moines with a carrying value of $7.4
million to secure Washington State public deposits of $10.3 million with a $4.0 million collateral requirement by the
Washington Public Deposit Protection Commission. At December 31, 2018, the Bank pledged 11 securities held at the
FHLB of Des Moines with a carrying value of $13.7 million to secure Washington State public deposits of $19.9 million
with an $8.4 million minimum collateral requirement by the Washington Public Deposit Protection Commission.
Investment securities that were in an unrealized loss position at December 31, 2019 and 2018 are presented in the following
tables, based on the length of time individual securities have been in an unrealized loss position. Management believes
that these securities are only temporarily impaired due to changes in market interest rates or the widening of market spreads
subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers
or the underlying collateral.
Less than 12 Months
December 31, 2019
12 Months or Longer
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized Fair
Losses
Value
Losses
Total
Unrealized
SECURITIES AVAILABLE-FOR-SALE
U.S. agency securities
Corporate securities
Mortgage-backed securities
U.S. Small Business Administration
securities
Total
$ 2,977 $
1,993
12,345
(15) $
(7)
(154)
— $
—
11,459
— $ 2,977 $
—
(146)
1,993
23,804
4,395
$ 21,710 $
(21)
—
—
4,395
(197) $ 11,459 $
(146) $ 33,169 $
(15)
(7)
(300)
(21)
(343)
97
Less than 12 Months
December 31, 2018
12 Months or Longer
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized Fair
Losses
Value
Losses
Total
Unrealized
SECURITIES AVAILABLE-FOR-SALE
U.S. agency securities
Corporate securities
Municipal bonds
Mortgage-backed securities
U.S. Small Business Administration
securities
Total
$ 6,018 $
975
2,098
6,266
(25) $ 4,822 $
(25)
(22)
(40)
5,890
8,787
32,537
(172) $ 10,840 $
(184)
(253)
(1,034)
6,865
10,885
38,803
(197)
(209)
(275)
(1,074)
1,958
$ 17,315 $
(11)
13,465
(123) $ 65,501 $
(256)
(267)
15,423
(1,899) $ 82,816 $ (2,022)
There were 13 investments with unrealized losses of less than one year and 10 investments with unrealized losses of more
than one year at December 31, 2019. There were 14 investments with unrealized losses of less than one year and 48
investments with unrealized losses of more than one year at December 31, 2018. The unrealized losses associated with
these investments are believed to be caused by changing market conditions that are considered to be temporary and the
Company does not intend to sell these securities, and it is not likely to be required to sell these securities prior to maturity.
Based on the Company’s evaluation of these securities, no OTTI was recorded for the years ended December 31, 2019
and 2018.
98
The contractual maturities of securities available-for-sale at December 31, 2019 and 2018 are listed below. Expected
maturities of mortgage-backed securities may differ from contractual maturities because borrowers may have the right to
call or prepay the obligations; therefore, these securities are classified separately with no specific maturity date.
December 31, 2019
Fair
Amortized
Value
Cost
December 31, 2018
Fair
Amortized
Value
Cost
U.S. agency securities
Due after one year through five years
Due after five years through ten years
Due after ten years
Subtotal
Corporate securities
Due in one year or less
Due after one year through five years
Due after five years through ten years
Subtotal
Municipal bonds
Due after one year through five years
Due after five years through ten years
Due after ten years
Subtotal
Mortgage-backed securities
Federal National Mortgage Association (“FNMA”)
Federal Home Loan Mortgage Corporation (“FHLMC”)
Government National Mortgage Association (“GNMA”)
Subtotal
U.S. Small Business Administration securities
Due after one year through five years
Due after five years through ten years
Due after ten years
Subtotal
Total
$
996 $
3,997
3,993
8,986
5,034
3,491
2,000
10,525
3,774
3,162
13,580
20,516
42,131
15,250
5,364
62,745
1,036 $
4,027
4,003
9,066
1,043 $ 1,040
9,941
4,906
15,887
10,011
4,998
16,052
5,044
3,532
1,994
10,570
—
6,077
997
7,074
—
5,947
918
6,865
3,833
3,307
13,980
21,120
2,659
2,610
9,177
14,446
2,570
2,592
9,032
14,194
42,333
15,179
5,338
62,850
30,554
10,301
4,972
45,827
30,026
9,961
4,849
44,836
1,546
11,500
9,235
22,281
—
13,581
1,842
15,423
$ 125,053 $ 126,057 $ 99,089 $ 97,205
1,555
11,598
9,298
22,451
—
13,828
1,862
15,690
The proceeds and resulting gains and losses, computed using specific identification from sales of securities available-for-
sale for the years ended December 31, 2019 and 2018 were as follows:
December 31, 2019
Proceeds Gross Gains Gross Losses
(59)
$
10,554 $
91 $
December 31, 2018
Proceeds Gross Gains Gross Losses
(14)
$
24,312 $
185 $
Securities available-for-sale
Securities available-for-sale
99
NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
The composition of the loan portfolio was as follows at December 31:
REAL ESTATE LOANS
Commercial
Construction and development
Home equity
One-to-four-family (excludes loans held for sale)
Multi-family
Total real estate loans
CONSUMER LOANS
Indirect home improvement
Solar
Marine
Other consumer
Total consumer loans
COMMERCIAL BUSINESS LOANS
Commercial and industrial
Warehouse lending
Total commercial business loans
Total loans receivable, gross
Allowance for loan losses
Deferred costs and fees, net
Premiums on purchased loans, net
Total loans receivable, net
December 31, December 31,
2019
2018
$
210,749 $
179,654
38,167
261,539
133,931
824,040
210,653
44,038
67,179
4,340
326,210
204,699
247,306
40,258
249,397
104,663
846,323
167,793
44,433
57,822
5,425
275,473
140,531
61,112
201,643
1,351,893
(13,229)
(3,273)
955
1,336,346 $
138,686
65,756
204,442
1,326,238
(12,349)
(2,907)
1,537
1,312,519
$
The Company has defined its loan portfolio into three segments that reflect the structure of the lending function, the
Company’s strategic plan and the manner in which management monitors performance and credit quality. The three loan
portfolio segments are: (a) Real Estate Loans, (b) Consumer Loans and (c) Commercial Business Loans. Each of these
segments is disaggregated into classes based on the risk characteristics of the borrower and/or the collateral type securing
the loan. The following is a summary of each of the Company’s loan portfolio segments and classes:
Real Estate Loans
Commercial Lending. Loans originated by the Company primarily secured by income producing properties, including
retail centers, warehouses, and office buildings located in our market areas.
Construction and Development Lending. Loans originated by the Company for the construction of, and secured by,
commercial real estate, one-to-four-family, and multi-family residences and tracts of land for development that are not
pre-sold. A small portion of the one-to-four-family construction portfolio is custom construction loans to the intended
occupant of the residence.
Home Equity Lending. Loans originated by the Company secured by second mortgages on one-to-four-family residences,
including home equity lines of credit in our market areas.
One-to-Four-Family Real Estate Lending. One-to-four-family residential loans include owner occupied properties
(including second homes), and non-owner occupied properties with four or less units. These loans originated by the
Company are secured by first mortgages on one-to-four-family residences in our market areas that the Company intends
to hold (excludes loans held for sale).
Multi-family Lending. Apartment term lending (five or more units) to current banking customers and community
reinvestment loans for low to moderate income individuals in the Company’s footprint.
100
Consumer Loans
Indirect Home Improvement. Fixture secured loans for home improvement are originated by the Company through its
network of home improvement contractors and dealers and are secured by the personal property installed in, on, or at the
borrower’s real property, and may be perfected with a UCC-2 financing statement filed in the county of the borrower’s
residence. These indirect home improvement loans include replacement windows, siding, roofing, pools, and other home
fixture installations.
Solar. Fixture secured loans for solar related home improvement projects are originated by the Company through its
network of contractors and dealers and are secured by the personal property installed in, on, or at the borrower’s real
property, and which may be perfected with a UCC-2 financing statement filed in the county of the borrower’s residence.
Marine. Loans originated by the Company, secured by boats, to borrowers primarily located in the states the Company
originates consumer loans.
Other Consumer. Loans originated by the Company to consumers in our retail branch footprint, including automobiles,
recreational vehicles, direct home improvement loans, loans on deposits, and other consumer loans, primarily consisting
of personal lines of credit and credit cards.
Commercial Business Loans
Commercial and Industrial Lending (“C&I”). Loans originated by the Company to local small- and mid-sized businesses
in our Puget Sound market area are secured primarily by accounts receivable, inventory, or personal property, plant and
equipment. Some of the C&I loans purchased by the Company are outside of the Greater Puget Sound market area. C&I
loans are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.
Warehouse Lending. Loans originated to non-depository financial institutions and secured by notes originated by the non-
depository financial institution. The Company has two distinct warehouse lending divisions: commercial warehouse re-
lending secured by notes on construction loans and mortgage warehouse re-lending secured by notes on one-to-four-family
loans. The Company’s commercial construction warehouse lines are secured by notes on construction loans and typically
guaranteed by principals with experience in construction lending. Mortgage warehouse lending loans are funded through
third-party residential mortgage bankers. Under this program, the Company provides short-term funding to the mortgage
banking companies for the purpose of originating residential mortgage loans for sale into the secondary market.
The following tables detail activity in the allowance for loan losses by loan categories for the years shown:
ALLOWANCE FOR LOAN LOSSES
Beginning balance
Provision (recapture) for loan losses
Charge-offs
Recoveries
Net recoveries (charge-offs)
Ending balance
Period end amount allocated to:
Loans individually evaluated for impairment
Loans collectively evaluated for impairment
Ending balance
LOANS RECEIVABLE
At or For the Year Ended December 31, 2019
Commercial
Real Estate Consumer
Business Unallocated
Total
$
5,761 $ 3,351 $
439
(5)
11
6
838
(1,040)
617
(423)
$
6,206 $ 3,766 $
3,191 $
1,646
(1,583)
—
(1,583)
3,254 $
46 $
(43)
—
—
—
3 $
12,349
2,880
(2,628)
628
(2,000)
13,229
$
$
15 $
167 $
6,191
6,206 $ 3,766 $
3,599
— $
3,254
3,254 $
— $
3
3 $
182
13,047
13,229
Loans individually evaluated for impairment
Loans collectively evaluated for impairment
$
2,635 $
493 $
— $
821,405
325,717
201,643
Ending balance
$ 824,040 $ 326,210 $ 201,643 $
3,128
— $
—
1,348,765
— $ 1,351,893
101
ALLOWANCE FOR LOAN LOSSES
Beginning balance
Provision (recapture) for loan losses
Charge-offs
Recoveries
Net recoveries
Ending balance
Period end amount allocated to:
Loans individually evaluated for impairment
Loans collectively evaluated for impairment
Ending balance
LOANS RECEIVABLE
At or For the Year Ended December 31, 2018
Commercial
Real Estate Consumer
Business Unallocated
Total
$
4,770 $ 2,814 $
953
(4)
42
38
526
(936)
947
11
$
5,761 $ 3,351 $
2,014 $
1,173
—
4
4
3,191 $
1,158 $
(1,112)
—
—
—
46 $
10,756
1,540
(940)
993
53
12,349
$
125 $
150 $
5,636
5,761 $ 3,351 $
3,201
$
700 $
2,491
3,191 $
— $
46
46 $
975
11,374
12,349
Loans individually evaluated for impairment
Loans collectively evaluated for impairment
$
834 $
428 $
1,685 $
845,489
275,045
202,757
Ending balance
$ 846,323 $ 275,473 $ 204,442 $
2,947
— $
—
1,323,291
— $ 1,326,238
Non-Accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not
been received as of the date such payments were due. Loans are automatically placed on non-accrual once the loan is
90 days past due or sooner if, in management’s opinion, the borrower may be unable to meet payment obligations as they
become due, or as required by regulatory authorities. The exception is the legacy Anchor credit card portfolio which is
serviced externally and loans are manually placed on non-accrual once the credit card payment is 90 days past due.
The following tables provide information pertaining to the aging analysis of contractually past due loans and non-accrual
loans for the years ended December 31, 2019 and 2018:
December 31, 2019
REAL ESTATE LOANS
Commercial
Construction and development
Home equity
One-to-four-family
Multi-family
Total real estate loans
CONSUMER LOANS
Indirect home improvement
Solar
Marine
Other consumer
Total consumer loans
COMMERCIAL BUSINESS LOANS
Commercial and industrial
Warehouse lending
Total commercial business loans
Total loans
30-59
Days
Past
Due
60-89
Days
Past
Due
90 Days
or More
Past Due
Total
Past
Due
$
— $ — $
— $
533
109
894
—
1,536
—
—
114
—
114
— $
—
185
1,150
—
1,335
533
294
2,158
—
2,985
Total
Loans
Receivable
Non-
Accrual
Current
210,749 $
179,121
37,873
259,381
133,931
821,055
210,749 $ 1,086
—
179,654
190
38,167
1,264
261,539
—
133,931
2,540
824,040
621
71
15
71
778
187
40
—
2
229
131
16
—
20
167
939
127
15
93
1,174
209,714
43,911
67,164
4,247
325,036
210,653
44,038
67,179
4,340
326,210
451
17
—
25
493
—
—
—
—
—
—
$ 2,314 $ 343 $ 1,502 $ 4,159 $ 1,347,734 $ 1,351,893 $ 3,033
140,531
61,112
201,643
140,531
61,112
201,643
—
—
—
—
—
—
—
—
—
102
REAL ESTATE LOANS
Commercial
Construction and development
Home equity
One-to-four-family
Multi-family
Total real estate loans
CONSUMER LOANS
Indirect home improvement
Solar
Marine
Other consumer
Total consumer loans
COMMERCIAL BUSINESS LOANS
Commercial and industrial
Warehouse lending
Total commercial business loans
Total loans
December 31, 2018
30-59
Days
Past
Due
60-89
Days
Past
Due
90 Days
or More
Past Due
Total
Past
Due
$
— $ — $
—
158
1,274
—
1,432
—
40
164
—
204
— $
—
229
1,358
—
1,587
— $
—
427
2,796
—
3,223
Total
Loans
Receivable
Non-
Accrual
Current
204,699 $
247,306
39,831
246,601
104,663
843,100
204,699 $
247,306
40,258
249,397
104,663
846,323
—
—
229
1,552
—
1,781
438
62
50
69
619
196
43
—
24
263
113
41
—
11
165
747
146
50
104
1,047
167,046
44,287
57,772
5,321
274,426
167,793
44,433
57,822
5,425
275,473
367
41
18
2
428
—
—
—
1,685
—
1,685
$ 2,051 $ 898 $ 1,752 $ 4,701 $ 1,321,537 $ 1,326,238 $ 3,894
138,686
65,756
204,442
138,255
65,756
204,011
431
—
431
431
—
431
—
—
—
There were no loans 90 days or more past due and still accruing interest at December 31, 2019, compared to two other
consumer loans 90 days or more past due of $11,000 and still accruing interest at December 31, 2018.
The following tables provide additional information about our impaired loans that have been segregated to reflect loans
for which an allowance for loan losses has been provided and loans for which no allowance was provided for the years
ended December 31, 2019 and 2018:
December 31, 2019
Unpaid
Principal
Balance
Recorded
Investment Allowance
Related
$
1,097 $
278
1,293
1,086 $
225
1,264
17
2,685
17
2,592
61
60
451
17
8
537
3,222 $
451
17
8
536
3,128 $
$
—
—
—
—
—
15
158
6
3
182
182
WITH NO RELATED ALLOWANCE RECORDED
Real estate loans:
Commercial
Home equity
One-to-four-family
Consumer loans:
Other consumer
WITH RELATED ALLOWANCE RECORDED
Real estate loans:
One-to-four-family
Consumer loans:
Indirect
Solar
Other consumer
Total
103
WITH NO RELATED ALLOWANCE RECORDED
Real estate loans:
Home equity
One-to-four-family
Commercial business loans:
Commercial and industrial
WITH RELATED ALLOWANCE RECORDED
Real estate loans:
One-to-four-family
Consumer loans:
Indirect
Solar
Marine
Other consumer
Commercial business loans:
Commercial and industrial
Total
December 31, 2018
Unpaid
Principal
Balance
Recorded
Investment Allowance
Related
$
305 $
991
229 $
718
431
1,727
431
1,378
834
367
41
18
2
834
367
41
18
2
1,254
2,516
4,243 $
1,254
2,516
3,894 $
$
—
—
—
125
128
15
6
1
700
975
975
104
The following table presents the average recorded investment in loans individually evaluated for impairment and the
interest income recognized and received for the years ended December 31, 2019 and 2018:
At or For the Year Ended
December 31, 2019
December 31, 2018
Average Recorded Interest Income Average Recorded Interest Income
Recognized
Recognized
Investment
Investment
WITH NO RELATED ALLOWANCE
RECORDED
Real estate loans:
Commercial
Home equity
One-to-four-family
Consumer loans:
Other consumer
Commercial business loans:
Commercial and industrial
WITH RELATED ALLOWANCE
RECORDED
Real estate loans:
One-to-four-family
Consumer loans:
Indirect
Solar
Marine
Other consumer
Commercial business loans:
Commercial and industrial
Total
$
Credit Quality Indicators
$
90 $
206
1,500
4
180
1,980
5
427
36
13
5
56 $
3
34
2
—
95
5
41
1
—
1
— $
404
719
—
431
1,554
1,030
295
31
11
1
—
8
—
—
22
30
28
32
3
2
—
96
582
2,562 $
—
48
143 $
757
2,125
3,679 $
59
124
154
As part of the Company’s on-going monitoring of credit quality of the loan portfolio, management tracks certain credit
quality indicators including trends related to (i) the risk grading of loans, (ii) the level of classified loans, (iii) net charge-
offs, (iv) non-performing loans and (v) the general economic conditions in the Company’s markets.
The Company utilizes a risk grading matrix to assign a risk grade to its real estate and commercial business loans. Loans
are graded on a scale of 1 to 10, with loans in risk grades 1 to 6 considered “Pass” and loans in risk grades 7 to 10 are
reported as classified loans in the Company’s allowance for loan loss analysis.
A description of the 10 risk grades is as follows:
Grades 1 and 2 - These grades include loans to very high quality borrowers with excellent or desirable business credit.
Grade 3 - This grade includes loans to borrowers of good business credit with moderate risk.
Grades 4 and 5 - These grades include “Pass” grade loans to borrowers of average credit quality and risk.
Grade 6 - This grade includes loans on management’s “Watch” list and is intended to be utilized on a temporary basis
for “Pass” grade borrowers where frequent and thorough monitoring is required due to credit weaknesses and where
significant risk-modifying action is anticipated in the near term.
105
Grade 7 - This grade is for “Other Assets Especially Mentioned (OAEM)” in accordance with regulatory guidelines
and includes borrowers where performance is poor or significantly less than expected.
Grade 8 - This grade includes “Substandard” loans in accordance with regulatory guidelines which represent an
unacceptable business credit where a loss is possible if loan weakness is not corrected.
Grade 9 - This grade includes “Doubtful” loans in accordance with regulatory guidelines where a loss is highly
probable.
Grade 10 - This grade includes “Loss” loans in accordance with regulatory guidelines for which total loss is expected
and when identified are charged off.
Homogeneous loans are risk rated based upon the Federal Financial Institutions Examination Council’s Uniform Retail
Credit Classification and Account Management Policy. Loans classified under this policy at the Company are consumer
loans which include indirect home improvement, solar, marine, other consumer, and one-to-four-family first and second
liens. Under the Uniform Retail Credit Classification Policy, loans that are current or less than 90 days past due are graded
“Pass” and risk graded “4” or “5” internally. Loans that are past due more than 90 days are classified “Substandard” risk
graded “8” internally until the loan has demonstrated consistent performance, typically six months of contractual
payments. Closed-end loans that are 120 days past due and open-end loans that are 180 days past due are charged off based
on the value of the collateral less cost to sell.
Commercial real estate, construction and development, multi-family and commercial business loans are evaluated
individually for their risk classification and may be classified as “Substandard” even if current on their loan payment
obligations.
The following tables summarize risk rated loan balances by category at the dates indicated:
December 31, 2019
Special
Pass
(1 - 5)
Watch Mention Substandard Doubtful Loss
(10)
(7)
(8)
(6)
(9)
Total
REAL ESTATE LOANS
Commercial
Construction and development
Home equity
One-to-four-family
Multi-family
Total real estate loans
CONSUMER LOANS
Indirect home improvement
Solar
Marine
Other consumer
Total consumer loans
COMMERCIAL BUSINESS
LOANS
Commercial and industrial
Warehouse lending
Total commercial business
loans
$ 203,703 $ 2,274 $ 3,686 $
2,545
—
635
6,139
11,593
177,109
37,942
259,580
127,792
806,126
—
35
60
—
3,781
1,086 $
—
190
1,264
—
2,540
— $ — $
—
—
—
—
—
—
—
—
—
—
210,749
179,654
38,167
261,539
133,931
824,040
210,202
44,021
67,179
4,315
325,717
—
—
—
—
—
—
—
—
—
—
451
17
—
25
493
—
—
—
—
—
—
—
—
—
—
210,653
44,038
67,179
4,340
326,210
125,025
61,112
10,435
—
1,442
—
3,629
—
—
—
—
—
140,531
61,112
3,629
6,662 $
—
201,643
—
— $ — $ 1,351,893
186,137
10,435
1,442
Total loans receivable, gross $ 1,317,980 $ 22,028 $ 5,223 $
106
December 31, 2018
Special
Pass
(1 - 5)
Watch Mention Substandard Doubtful Loss
(6)
(7)
(8)
(9)
(10)
Total
REAL ESTATE LOANS
$ 203,557 $ 1,142 $
Commercial
Construction and development
Home equity
One-to-four-family
Multi-family
Total real estate loans
CONSUMER LOANS
Indirect home improvement
Solar
Marine
Other consumer
Total consumer loans
COMMERCIAL BUSINESS
LOANS
Commercial and industrial
Warehouse lending
Total commercial business
loans
244,577
39,846
247,575
103,447
839,002
2,729
—
207
1,216
5,294
167,426
44,392
57,804
5,415
275,037
—
—
—
—
—
124,089
65,756
8,813
—
189,845
8,813
Total loans receivable, gross $ 1,303,884 $ 14,107 $
— $
—
183
63
—
246
— $
—
229
1,552
—
1,781
— $ — $
—
—
—
—
—
—
—
—
—
—
204,699
247,306
40,258
249,397
104,663
846,323
—
—
—
8
8
—
—
367
41
18
2
428
—
—
—
—
—
—
—
—
—
—
167,793
44,433
57,822
5,425
275,473
5,784
—
—
—
—
—
138,686
65,756
—
254 $
5,784
7,993 $
—
204,442
—
— $ — $ 1,326,238
At December 31, 2019, there were no troubled debt restructured loans (“TDRs”) that were modified in the previous 12
months that subsequently defaulted in the reporting year. The Company had no TDRs at December 31, 2019 or 2018.
Related Party Loans
Certain directors and executive officers or their related affiliates are customers of and have had banking transactions with
the Company. Total loans to directors, executive officers, and their affiliates are subject to regulatory limitations.
Outstanding loan balances were as follows and were within regulatory limitations:
Beginning balance
Additions
Repayments
Ending balance
At December 31,
2018
2019
3,325 $
—
(76)
3,249 $
655
2,688
(18)
3,325
$
$
The aggregate maximum loan balance of extended credit was $3.6 million at December 31, 2019 and December 31, 2018,
and includes the ending balances from the tables above.
These loans and lines of credit were made in compliance with applicable laws on substantially the same terms
(including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons and
do not involve more than the normal risk of collectability.
NOTE 5 - SERVICING RIGHTS
Loans serviced for others are not included on the Consolidated Balance Sheets. The unpaid principal balances of permanent
loans serviced for others were $1.46 billion and $1.19 billion at December 31, 2019 and 2018, respectively.
107
The following table summarizes servicing rights activity for the years ended December 31, 2019 and 2018:
Beginning balance
Additions
Servicing rights amortized
Impairment of servicing rights
Ending balance
2019
2018
$
$
10,429 $
5,400
(4,177)
(92)
11,560 $
6,795
5,971
(2,337)
—
10,429
The fair market value of the servicing rights’ assets was $13.3 million and $14.6 million at December 31, 2019 and
December 31, 2018, respectively. Fair value adjustments to servicing rights are mainly due to market-based assumptions
associated with discounted cash flows, loan prepayment speeds, and changes in interest rates. A significant change in
prepayments of the loans in the servicing portfolio could result in significant changes in the valuation adjustments, thus
creating potential volatility in the carrying amount of servicing rights.
The following provides valuation assumptions used in determining the fair value of mortgage servicing rights (“MSR”) at
the dates indicated:
Key assumptions:
Weighted average discount rate
Conditional prepayment rate (“CPR”)
Weighted average life in years
At December 31, At December 31,
2019
2018
9.7 %
17.1 %
5.1
9.6 %
9.4 %
7.7
Key economic assumptions and the sensitivity of the current fair value for single family MSR to immediate adverse
changes in those assumptions at December 31, 2019 and December 31, 2018 were as follows:
Aggregate portfolio principal balance
Weighted average rate of note
December 31, 2019
December 31, 2018
$
1,463,732 $
4.2 %
1,186,858
4.3 %
At December 31, 2019
Conditional prepayment rate
Fair value MSR
Percentage of MSR
Discount rate
Fair value MSR
Percentage of MSR
At December 31, 2018
Conditional prepayment rate
Fair value MSR
Percentage of MSR
Discount rate
Fair value MSR
Percentage of MSR
Base
17.1 %
$ 13,255 $
0.9 %
0.5% Adverse Rate Change 1.0% Adverse Rate Change
24.6 %
10,582 $
0.7 %
32.5 %
8,674
0.6 %
9.7 %
$ 13,255 $
0.9 %
10.2 %
13,037 $
0.9 %
10.7 %
12,826
0.9 %
Base
9.4 %
$ 14,218 $
1.2 %
0.5% Adverse Rate Change 1.0% Adverse Rate Change
11.6 %
12,723 $
1.1 %
10,358
17.7 %
0.9 %
9.6 %
$ 14,218 $
1.2 %
10.1 %
13,912 $
1.2 %
10.6 %
13,617
1.2 %
The above table shows the sensitivity to market rate changes for the par rate coupon for a conventional one-to-four-family
FNMA, FHLMC, GNMA, or FHLB serviced home loan. The above table references a 50 basis point and 100 basis point
decrease in note rates and the impact on prepayment speeds and discount rates.
108
These sensitivities are hypothetical and should be used with caution as the tables above demonstrate the Company’s
methodology for estimating the fair value of MSR which is highly sensitive to changes in key assumptions. For example,
actual prepayment experience may differ and any difference may have a material effect on MSR fair value. Changes in
fair value resulting from changes in assumptions generally cannot be extrapolated because the relationship of the change
in the assumption to the change in fair value may not be linear. Also, in these tables, the effects of a variation in a particular
assumption on the fair value of the MSR is calculated without changing any other assumption; in reality, changes in one
factor may be associated with changes in another (for example, decreases in market interest rates may provide an incentive
to refinance; however, this may also indicate a slowing economy and an increase in the unemployment rate, which reduces
the number of borrowers who qualify for refinancing), which may magnify or counteract the sensitivities. Thus, any
measurement of MSR fair value is limited by the conditions existing and assumptions made as a particular point in time.
Those assumptions may not be appropriate if they are applied to a different point in time.
The Company recorded $3.5 million and $2.4 million of gross contractually specified servicing fees, late fees, and other
ancillary fees resulting from servicing of loans for the years ended December 31, 2019 and 2018, respectively. The income,
net of amortization, is included in service charges and fee income on the Consolidated Statements of Income.
NOTE 6 - PREMISES AND EQUIPMENT
Premises and equipment at December 31, 2019 and 2018 were as follows:
Land
Buildings
Furniture, fixtures, and equipment
Leasehold improvements
Building improvements
Projects in process
Subtotal
Less accumulated depreciation and amortization
Total
2019
5,227 $
16,769
13,562
2,848
6,572
407
45,385
(16,615)
28,770 $
2018
5,227
16,772
12,039
2,422
5,897
674
43,031
(13,921)
29,110
$
$
Depreciation and amortization expense for these assets totaled $2.8 million and $1.8 million for the years ended
December 31, 2019 and 2018, respectively.
NOTE 7 - LEASES
The Company has operating leases for retail bank and home lending branches, and certain equipment. The ROU assets
obtained in exchange for operating lease obligations totaled $5.1 million at January 1, 2019, the adoption date for ASU
No. 2016-02. During 2019, the Company obtained additional ROU assets of $1.0 million related to operating lease
obligations. The Company’s leases have remaining lease terms of four months to eight years, some of which include
options to extend the leases for up to five years.
The components of lease cost (included in occupancy expense on the Consolidated Statements of Income) are as follows
for the year ended December 31, 2019:
Lease cost:
Operating lease cost
Short-term lease cost
Total lease cost
Year Ended
December 31, 2019
$
$
1,285
166
1,451
109
The following table provides supplemental information related to operating leases at or for the year ended December 31,
2019:
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
Weighted average remaining lease term- operating leases
Weighted average discount rate- operating leases
At or For the Year Ended
December 31, 2019
$
1,331
5.3 years
3.0 %
The Company’s leases typically do not contain a discount rate implicit in the lease contract. As an alternative, the discount
rate used in determining the lease liability for each individual lease was the FHLB of Des Moines’ fixed advance rate
which corresponded with the remaining lease term as of December 31, 2018, for leases that existed at adoption and at the
lease commencement date for leases entered into subsequent to adoption. Prior to the adoption of ASU 2016-02, rent
expense for the year ending December 31, 2018 was $1.2 million.
Maturities of operating lease liabilities at December 31, 2019 for future periods are as follows:
2020
2021
2022
2023
2024
Thereafter
Total lease payments
Less imputed interest
Total
$
$
1,298
1,169
1,065
674
614
884
5,704
(490)
5,214
NOTE 8 - OTHER REAL ESTATE OWNED
The following table presents the activity related to OREO at and for the years ended December 31:
Beginning balance
Additions
Gross proceeds from sale of OREO
Gain on sale of OREO
Ending balance
At or For the Year Ended
December 31,
2019
2018
$
$
689 $
242
(901)
138
168 $
—
689
—
—
689
There were $168,000 and $689,000 in OREO properties at December 31, 2019 and 2018, respectively. Holding costs
were $13,000 and $2,000 for the years ended December 31, 2019 and 2018, respectively.
There were $1.0 million and $261,000 in mortgage loans collateralized by residential real estate property in the process of
foreclosure at December 31, 2019, and 2018, respectively.
110
NOTE 9 - DEPOSITS
Deposits are summarized as follows at December 31:
Noninterest-bearing checking
Interest-bearing checking
Savings
Money market (3)
Certificates of deposit less than $100,000(4)
Certificates of deposit of $100,000 through $250,000
Certificates of deposit of $250,000 and over(5)
Escrow accounts related to mortgages serviced
Total
December 31, December 31,
2019 (1)(2)
2018(1)(2)
$
$
260,131 $
177,972
118,845
270,489
277,988
181,402
92,110
13,471
1,392,408 $
221,107
151,103
122,344
282,595
243,193
154,095
86,357
13,425
1,274,219
________________________
(1) Includes $117.1 million and $120.0 million of deposits at December 31, 2019 and 2018, respectively, remaining from
the January 22, 2016 purchase of four retail bank branches from Bank of America, N.A. (the “Branch Purchase”).
(2) Includes $299.0 million and $321.1 million of deposits at December 31, 2019 and 2018, respectively, from the Anchor
Acquisition.
(3) Includes $6.2 million and $1,000 of brokered deposits at December 31, 2019 and 2018, respectively.
(4) Includes $141.4 million and $116.7 million of brokered deposits at December 31, 2019 and 2018, respectively.
(5) Time deposits that meet or exceed the FDIC insurance limit.
Scheduled maturities of time deposits at December 31, 2019 for future years ending are as follows:
Maturing in 2020
Maturing in 2021
Maturing in 2022
Maturing in 2023
Maturing in 2024
Thereafter
Total
At December 31, 2019
357,786
$
103,560
57,972
15,120
17,062
—
551,500
$
Interest expense by deposit category for the years ended December 31, 2019 and 2018 is as follows:
Interest-bearing checking
Savings and money market
Certificates of deposit
Total
2018
2019
$ 1,414 $
227
3,098
2,054
5,040
11,650
$ 16,162 $ 7,321
The Company had related party deposits of approximately $3.3 million and $6.2 million at December 31, 2019 and 2018,
respectively, which includes deposits held for directors and executive officers.
NOTE 10 - DEBT
Borrowings
The Bank is a member of the FHLB of Des Moines, which entitles it to certain benefits including a variety of borrowing
options consisting of a secured credit line that allows both fixed and variable rate advances. The FHLB borrowings at
December 31, 2019 and 2018, consisted of a warehouse securities credit line (“securities line”), which allows advances
with interest rates fixed at the time of borrowing and a warehouse federal funds (“Fed Funds”) advance, which allows
111
daily advances at variable interest rates. Credit capacity is primarily determined by the value of assets collateralized at the
FHLB, funds on deposit at the FHLB, and stock owned by the Bank.
Credit is limited to 45% of the Company’s total assets and available pledged assets. The Bank entered into an Advanced,
Pledges and Security Agreement with the FHLB for which specific loans are pledged to secure these credit lines. At
December 31, 2019, loans of approximately $646.1 million were pledged to the FHLB. At December 31, 2019, the Bank’s
total borrowing capacity was $477.2 million with the FHLB of Des Moines, with unused borrowing capacity of $386.5
million. In addition, all FHLB stock owned by the Company is collateral for credit lines.
The Bank maintains a short-term borrowing line with the FRB with total credit based on eligible collateral. The Bank can
borrow under the Term Auction or Term Facility at rates published by the San Francisco FRB. At December 31, 2019 and
2018, the Bank had approximately $318.8 million and $265.2 million, respectively, in pledged consumer loans with a
Term Auction or Term Facility borrowing capacity of $156.1 million and $127.7 million, respectively, of which none was
outstanding at either date. The Bank also had $71.0 million unsecured Fed Funds lines of credit with other financial
institutions of which none was outstanding at December 31, 2019.
Advances on these lines at December 31, 2019 and 2018 were as follows:
Federal Home Loan Bank - (interest rates ranging from 1.58% to 2.87% and 1.15% to
2.87% at December 31, 2019 and 2018, respectively)
Total
Subordinated Note
2019
2018
$ 84,864 $ 137,149
$ 84,864 $ 137,149
On October 15, 2015 (the “Closing Date”), FS Bancorp, Inc. issued an unsecured subordinated term note in the aggregate
principal amount of $10.0 million due October 1, 2025 (the “Subordinated Note”) pursuant to a Subordinated Loan
Agreement with Community Funding CLO, Ltd. The Subordinated Note bears interest at an annual interest rate of 6.50%,
payable by the Company quarterly in arrears on January 1, April 1, July 1 and October 1 of each year, commencing on the
first such date following the Closing Date and on the maturity date.
The Subordinated Note will mature on October 1, 2025 but may be prepaid at the Company’s option and with regulatory
approval at any time on or after five years after the Closing Date or at any time upon certain events, such as a change in
the regulatory capital treatment of the Subordinated Note or the interest on the Subordinated Note no longer being
deductible by the Company for United States federal income tax purposes. The Company contributed $9.0 million of the
proceeds from the Subordinated Note as additional capital to the Bank in the fourth quarter of 2015 and used the balance
to fund general working capital and operating expenses.
112
The maximum and average outstanding and weighted average interest rates on debt during the years ended December 31,
2019 and 2018 were as follows:
Maximum balance:
Federal Home Loan Bank advances and Fed Funds
Federal Reserve Bank
Fed Funds lines of credit
Subordinated note
Average balance:
Federal Home Loan Bank advances and Fed Funds
Federal Reserve Bank
Fed Funds lines of credit
Subordinated note
Weighted average interest rate:
Federal Home Loan Bank advances and Fed Funds
Federal Reserve Bank
Fed Funds lines of credit
Subordinated note
Scheduled maturities of Federal Home Loan Bank advances were as follows:
2019
2018
$ 186,401
5,000
$
$
5,000
$ 10,000
$ 180,025
$
—
$ 21,016
$ 10,000
$ 93,653
167
$
$
318
$ 10,000
$ 96,044
—
$
$
5,286
$ 10,000
2.61 %
2.96 %
2.09 %
6.50 %
2.02 %
— %
1.93 %
6.50 %
Years Ending December 31,
2020
2021
2022
2023
2024
Total
NOTE 11 - EMPLOYEE BENEFITS
Employee Stock Ownership Plan
Interest
Balances Rates
2.46 %
$ 12,336
2.48 %
45,000
— %
—
2.03 %
13,633
13,895
1.77 %
$ 84,864
On January 1, 2012, the Company established an ESOP for eligible employees of the Company and the Bank. Employees
of the Company and the Bank are eligible to participate in the ESOP if they have been credited with at least 1,000 hours
of service during the employees’ first 12-month period and based on the employee’s anniversary date will be vested in the
ESOP. The employee will be 100% vested in the ESOP after two years of working at least 1,000 hours in each of those
two years.
The ESOP borrowed $2.6 million from FS Bancorp, Inc. and used those funds to acquire 259,210 shares of FS
Bancorp, Inc. common stock in the open market at an average price of $10.17 per share during the second half of 2012. It
is anticipated that the Bank will make contributions to the ESOP in amounts necessary to amortize the ESOP loan payable
to FS Bancorp, Inc. over a period of 10 years, bearing interest at 2.30%. Intercompany expenses associated with the ESOP
are eliminated in consolidation. Shares purchased by the ESOP with the loan proceeds are held in a suspense account and
allocated to ESOP participants on a pro rata basis as principal and interest payments are made by the ESOP to FS
Bancorp, Inc. The loan is secured by shares purchased with the loan proceeds and will be repaid by the ESOP with funds
from the Bank’s discretionary contributions to the ESOP and earnings on the ESOP assets. Payments of principal and
interest are due annually on December 31, the Company’s fiscal year end. On December 31, 2019, the ESOP paid the
eighth annual installment of principal in the amount of $275,000, plus accrued interest of $20,000 pursuant to the ESOP
loan agreement.
113
As shares are committed to be released from collateral, the Company reports compensation expense equal to the average
daily market prices of the shares at December 31, 2019 for the prior 90 days. These shares become outstanding for earnings
per share computations. The compensation expense is accrued monthly throughout the year. Dividends on allocated ESOP
shares are recorded as a reduction of retained earnings; dividends on unallocated ESOP shares are recorded as a reduction
of debt and accrued interest.
Compensation expense related to the ESOP for the years ended December 31, 2019 and 2018, was $1.5 million, and $1.2
million, respectively.
Shares held by the ESOP at December 31, 2019 and December 31, 2018, were as follows (shown as actual):
Allocated shares
Committed to be released shares
Unallocated shares
Total ESOP shares
Balances
Balances
at December 31, 2019 at December 31, 2018
176,809
—
77,763
254,572
189,511
—
51,842
241,353
Fair value of unallocated shares (in thousands)
$
3,006 $
3,627
401(k) Plan
The Company has a salary deferral 401(k) Plan covering substantially all of its employees. Employees are eligible to
participate in the 401(k) plan at the date of hire if they are 18 years of age. Eligible employees may contribute through
payroll deductions and are 100% vested at all times in their deferral contributions account. The Company matches 100%
for contributions of 1% to 3%, and 50% for contributions of 4% to 5%. There was a $1.2 million and $917,000 matching
contribution for the years ended December 31, 2019 and 2018, respectively.
NOTE 12 - INCOME TAXES
The components of income tax expense for the years ended December 31, 2019 and 2018, were as follows:
Provision for income taxes
Current
Deferred
Total provision for income taxes
2019
2018
$
$
4,425 $
988
5,413 $
3,455
768
4,223
A reconciliation of the effective income tax rate with the federal statutory tax rates at December 31, 2019 and 2018 was
as follows:
2019
2018
Income tax provision at statutory rate
Tax exempt income
Nondeductible items resulting in increase in tax
Decrease in tax resulting from other items
Equity compensation
Executive compensation
Bargain purchase gain
ESOP
Total
114
Amount
$ 5,907 21.0 % $ 6,000 21.0 %
Rate
Amount
Rate
(225)
129
(78)
(691)
112
—
259
(0.8)
0.5
(0.3)
(2.5)
0.4
—
0.9
(129)
279
(87)
(571)
135
(1,594)
190
(0.5)
1.0
(0.3)
(2.0)
0.5
(5.6)
0.7
$ 5,413 19.2 % $ 4,223 14.8 %
Total deferred tax assets and liabilities at December 31, 2019 and 2018 were as follows:
Deferred Tax Assets
Net operating loss carryforward
Allowance for loan losses
Purchase accounting adjustments
Other real estate owned
Non-accrued loan interest
Restricted stock awards
Non-qualified stock options
Securities available-for-sale
Lease liability
Other
Total deferred tax assets
Deferred Tax Liabilities
Loan origination costs
Servicing rights
Prepaids
Stock dividend - FHLB stock
Property, plant, and equipment
Purchase accounting adjustments
Securities available-for-sale
Lease right-of-use assets
Other
Total deferred tax liabilities
Net deferred tax liabilities
2019
2018
$
864 $ 1,201
2,301
776
127
115
54
71
405
—
473
5,523
2,844
466
126
13
68
185
—
1,121
351
6,038
(1,341)
(2,525)
—
(59)
(1,362)
(1,404)
(216)
(1,078)
(24)
(8,009)
$ (1,971) $
(626)
(2,241)
(166)
(73)
(1,489)
(1,289)
—
—
—
(5,884)
(361)
At December 31, 2019, the Company had a net operating loss carryforward of approximately $4.0 million, which begins
to expire in 2035. The Company files a U.S. Federal income tax return and Oregon State return, which are subject to
examination by tax authorities for years 2016 and later. At December 31, 2019 and 2018, the Company had no uncertain
tax positions. The Company recognizes interest and penalties in tax expense and at December 31, 2019 and 2018, the
Company recognized no interest and penalties.
NOTE 13 - COMMITMENTS AND CONTINGENCIES
Commitments - The Company is party to financial instruments with off-balance-sheet risk in the normal course of business
to meet the financing needs of its customers. These financial instruments include commitments to extend credit. These
instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized on the Consolidated
Balance Sheets.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for
commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same
credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
115
The following table provides a summary of the Company’s commitments at December 31, 2019 and 2018:
COMMITMENTS TO EXTEND CREDIT
REAL ESTATE LOANS
Commercial
Construction and development
One-to-four-family (includes locks for salable loans)
Home equity
Multi-family
Total real estate loans
CONSUMER LOANS
COMMERCIAL BUSINESS LOANS
Commercial and industrial
Warehouse lending
Total commercial business loans
Total commitments to extend credit
December 31, December 31,
2019
2018
$
247 $
95,031
39,697
47,880
622
183,477
22,176
72,731
33,888
106,619
312,272 $
$
5,836
76,889
35,714
41,204
515
160,158
18,560
72,880
44,243
117,123
295,841
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition
established in the contract. Since many of the commitments are expected to expire without being drawn upon, the amount
of the total commitments do not necessarily represent future cash requirements. The Company evaluates each customer’s
creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon
extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include
accounts receivable, inventory, property and equipment, residential real estate, and income-producing commercial
properties.
Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are
commitments for possible future extensions of credit to existing customers. These lines of credit are uncollateralized and
usually do not contain a specified maturity date and ultimately may not be drawn upon to the total extent to which the
Company is committed. The Company has established reserves for estimated losses from unfunded commitments of
$293,000 and $299,000 at December 31, 2019 and 2018, respectively. One-to-four-family commitments included in the
table above are accounted for as fair value derivatives and do not carry an associated holdback.
The Company also sells one-to-four-family loans to the FHLB of Des Moines that require a limited level of recourse if the
loans default and exceed a certain loss exposure. Specific to that recourse, the FHLB of Des Moines established a first loss
account (“FLA”) related to the loans and required a credit enhancement (“CE”) obligation by the Bank to be utilized after
the FLA is used. Based on loans sold through December 31, 2019, the total loans sold to the FHLB were $66.4 million
with the FLA being $938,000 and the CE obligation at $811,000 or 1.2% of the loans outstanding. Management has
established a holdback of 10% of the outstanding CE obligation, or $272,000, which is a part of the off-balance sheet
holdback for loans sold. There were no outstanding delinquencies on the loans sold to the FHLB of Des Moines at
December 31, 2019 and December 31, 2018.
Contingent liabilities for loans held for sale - In the ordinary course of business, loans are sold with limited recourse
against the Company and may have to subsequently be repurchased due to defects that occurred during the origination of
the loan. The defects are categorized as documentation errors, underwriting errors, early payoff, early payment defaults,
breach of representation or warranty, servicing errors, and/or fraud. When a loan sold to an investor without recourse fails
to perform according to its contractual terms, the investor will typically review the loan file to determine whether defects
in the origination process occurred. If a defect is identified, the Company may be required to either repurchase the loan or
indemnify the investor for losses sustained. If there are no such defects, the Company has no commitment to repurchase
the loan. The Company has recorded a holdback reserve of $1.2 million and $1.0 million to cover loss exposure related to
these guarantees for one-to-four-family loans sold into the secondary market at December 31, 2019 and 2018, respectively,
which is included in other liabilities in the Consolidated Balance Sheets.
116
The Company has entered into a severance agreement with its Chief Executive Officer (“CEO”). The severance agreement,
subject to certain requirements, generally includes a lump sum payment to the CEO equal to 24 months of base
compensation in the event their employment is involuntarily terminated, other than for cause or the executive terminates
his employment with good reason, as defined in the severance agreement.
The Company has entered into change of control agreements with its Chief Financial Officer/Chief Operating Officer,
Chief Lending Officer, Chief Credit Officer, Chief Risk Officer, Chief Human Resources Officer, Senior Vice President
Compliance Officer, Executive Vice President of Retail Banking and Marketing, and the Executive Vice President of
Home Lending. The change of control agreements, subject to certain requirements, generally remain in effect until
canceled by either party upon at least 24 months prior written notice. Under the change of control agreements, the executive
generally will be entitled to a change of control payment from the Company if the executive is involuntarily terminated
within six months preceding or 12 months after a change in control (as defined in the change of control agreements). In
such an event, the executives would each be entitled to receive a cash payment in an amount equal to 12 months of their
then current salary, subject to certain requirements in the change of control agreements.
The Bank received 7,158 shares of Class B common stock in Visa, Inc. at no cost as a result of the Visa initial public
offering (“IPO”) in March 2008. These Class B shares of stock held by the Bank could be converted to Class A shares at
a conversion rate of 1.6228 (reduced from a conversion rate of 1.6298 previously reported), when all litigation pending as
of the date of the IPO is concluded. At December 31, 2019, the date that litigation will be concluded cannot be determined.
Until such time, the stock cannot be redeemed and the sale of Class B shares is restricted. These shares are considered an
equity security without a readily determinable market value and the Bank’s current carrying value is $0. Visa, Inc. Class A
stock’s market value at December 31, 2019 and December 31, 2018 was $187.90 per share and $131.94 per share,
respectively.
As a result of the nature of our activities, the Company is subject to various pending and threatened legal actions, which
arise in the ordinary course of business. From time to time, subordination liens may create litigation which requires us to
defend our lien rights. In the opinion of management, liabilities arising from these claims, if any, will not have a material
effect on our financial position. The Company had no material pending legal actions at December 31, 2019.
NOTE 14 - SIGNIFICANT CONCENTRATION OF CREDIT RISK
Most of the Company’s commercial and multi-family real estate, construction, residential, and/or commercial business
lending activities are with customers located in Western Washington and near the one loan production office located in
the Tri-Cities, Washington. The Company originates real estate, consumer, and commercial business loans and has
concentrations in these areas, however, indirect home improvement loans and solar loans are originated through a network
of home improvement contractors and dealers located throughout Washington, Oregon, California, Idaho, Colorado, and
Arizona. Loans are generally secured by collateral and rights to collateral vary and are legally documented to the extent
practicable. The concentration on commercial real estate remains below the 300% of Risk Based Capital regulatory
threshold and the subset of construction concentration, excluding owner-occupied loans is within Board approved
limits. The construction, land development, and other land concentration represents less than 100% of the Bank’s total
regulatory capital at 85.7% and is focused on in city, in fill vertical construction financing in King and Snohomish counties.
Local economic conditions may affect borrowers’ ability to meet the stated repayment terms.
NOTE 15 - REGULATORY CAPITAL
The Bank is subject to various regulatory capital requirements administered by the Federal Reserve and the FDIC. Failure
to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements.
Under capital adequacy guidelines of the regulatory framework for prompt corrective action, the Bank must meet specific
capital adequacy guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance
sheet items as calculated under regulatory accounting practices. The Bank’s capital classification is also subject to
qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts
and ratios (set forth in the table below) of Tier 1 capital (as defined in the regulations) to total average assets (as defined),
117
and minimum ratios of Tier 1 total capital (as defined) and common equity Tier 1 (“CET 1”) capital to risk-weighted assets
(as defined).
The Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage, and CET 1 capital ratios as set
forth in the table below to be categorized as well capitalized. At December 31, 2019 and December 31, 2018, the Bank
was categorized as well capitalized under applicable regulatory requirements. There are no conditions or events since that
notification that management believes have changed the Bank’s category. Management believes, at December 31, 2019,
that the Company and the Bank met all capital adequacy requirements.
The following table compares the Bank’s actual capital amounts and ratios at December 31, 2019 and 2018 to their
minimum regulatory capital requirements and well capitalized regulatory capital at those dates (dollars in thousands):
Actual
Adequacy Purposes
For Capital
For Capital Adequacy
with Capital Buffer
Amount Ratio Amount Ratio Amount Ratio Amount
To be Well Capitalized
Under Prompt
Corrective
Action Provisions
Ratio
Bank Only
At December 31, 2019
Total risk-based capital
(to risk-weighted
assets)
Tier 1 risk-based
capital
(to risk-weighted
assets)
$ 209,535
14.64 % $ 114,502
8.00 % $
150,283
10.50 % $
143,127
10.00 %
$ 196,013
13.70 % $
85,876
6.00 % $
121,658
8.50 % $
114,502
8.00 %
Tier 1 leverage capital
(to average assets)
$ 196,013
11.56 % $
67,808
4.00 % $
N/A
N/A
$
84,761
5.00 %
CET 1 capital
(to risk-weighted
assets)
$ 196,013
13.70 % $
64,407
4.50 % $
100,189
7.00 % $
93,033
6.50 %
At December 31, 2018
Total risk-based capital
(to risk-weighted
assets)
Tier 1 risk-based
capital
(to risk-weighted
assets)
$ 188,472
13.52 % $ 111,493
8.00 % $
137,694
9.88 % $
139,366
10.00 %
$ 175,824
12.62 % $
83,620
6.00 % $
109,820
7.88 % $
111,493
8.00 %
Tier 1 leverage capital
(to average assets)
$ 175,824
10.67 % $
65,884
4.00 % $
N/A
N/A
$
82,355
5.00 %
CET 1 capital
(to risk-weighted
assets)
$ 175,824
12.62 % $
62,715
4.50 % $
88,846
6.38 % $
90,588
6.50 %
In addition to the minimum CET 1, Tier 1, total capital, and leverage ratios, the Bank is required to maintain a capital
conservation buffer consisting of additional CET 1 capital greater than 2.5% of risk-weighted assets above the required
minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary
bonuses on percentages of eligible retained income that could be utilized for such actions. At December 31, 2019, the
Bank’s capital conservation buffer was 2.5%.
FS Bancorp, Inc. is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to
capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and
the regulations of the Federal Reserve. Bank holding companies with less than $3.0 billion in assets are generally not
subject to compliance with the Federal Reserve’s capital regulations, which are generally the same as the capital
regulations applicable to the Bank. The Federal 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 expects the holding company’s
118
subsidiary bank to be well capitalized under the prompt corrective action regulations. If FS Bancorp, Inc. was subject to
regulatory guidelines for bank holding companies with $3.0 billion or more in assets at December 31, 2019, FS Bancorp,
Inc. would have exceeded all regulatory capital requirements. The regulatory capital ratios calculated for FS Bancorp Inc.
at December 31, 2019 were 11.3% for Tier 1 leverage-based capital, 13.4% for Tier 1 risk-based capital, 14.3% for total
risk-based capital, and 13.4% for CET 1 capital ratio, compared to 12.1%, 12.4%, 13.3%, and 12.4% at December 31,
2018, respectively.
NOTE 16 - FAIR VALUE MEASUREMENTS
The Company determines fair value based on the requirements established in Accounting Standards Codification (“ASC”)
Topic 820, Fair Value Measurements, which provides a framework for measuring fair value in accordance with U.S.
GAAP and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when
measuring fair value. ASC 820 defines fair value as the exit price, or the price that would be received for an asset or paid
to transfer a liability, in the principal or most advantageous market for the asset or liability in an orderly transaction
between market participants on the measurement date under current market conditions. ASU 2016-01, Financial
Instruments - Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities,
requires us to use the exit price notion when measuring the fair value of instruments for disclosure purposes.
The following definitions describe the levels of inputs that may be used to measure fair value:
Level 1 - Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active
markets.
Level 2 - Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and
inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial
instrument.
Level 3 - Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The following methods were used to estimate the fair value of certain assets and liabilities on a recurring and
nonrecurring basis.
Securities Available-for-Sale - The fair value of securities available-for-sale are recorded on a recurring basis. The fair
value of investments and mortgage-backed securities are provided by a third-party pricing service. These valuations are
based on market data using pricing models that vary by asset class and incorporate available current trade, bid and other
market information, and for structured securities, cash flow, and loan performance data. The pricing processes utilize
benchmark curves, benchmarking of similar securities, sector groupings, and matrix pricing. Option adjusted spread
models are also used to assess the impact of changes in interest rates and to develop prepayment scenarios (Level 2).
Certain other corporate securities and municipal bonds are generally measured at fair value based on discounted cash flow
models (Level 3). Transfers between the fair value hierarchy are determined through the third-party service provider
which, from time to time will transfer between levels based on market conditions per the related security. All models and
processes used take into account market convention.
Mortgage Loans Held for Sale - The fair value of loans held for sale reflects the value of commitments with investors
and/or the relative price as delivered into a To-Be-Announced (“TBA”) mortgage-backed security (Level 2).
Derivative Instruments - The fair value of the interest rate lock commitments and forward sales commitments are
estimated using quoted or published market prices for similar instruments, adjusted for factors such as pull-through rate
assumptions based on historical information, where appropriate. TBA mortgage-backed securities are fair valued on
similar contracts in active markets (Level 2) while locks and forwards with customers and investors are fair valued using
similar contracts in the market and changes in the market interest rates (Level 2 and 3).
Impaired Loans - Fair value adjustments to impaired collateral dependent loans are recorded to reflect partial write-downs
based on the current appraised value of the collateral or internally developed models, which contain management’s
assumptions. Management will utilize discounted cashflow impairment for TDRs when the change in terms results in a
discount to the overall cashflows to be received (Level 3).
119
Other Real Estate Owned - Fair value adjustments to OREO are recorded at the lower of carrying amount of the loan or
fair value of the collateral less selling costs. Any write-downs based on the asset’s fair value at the date of acquisition are
charged to the allowance for loan losses. After foreclosure, management periodically performs valuations such that the
real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell (Level 3).
Servicing Rights - The fair value of mortgage servicing rights are estimated using net present value of expected cash flows
using a third party model that incorporates assumptions used in the industry to value such rights, adjusted for factors such
as weighted average prepayments speeds based on historical information where appropriate (Level 3).
The following table presents assets and liabilities measured at fair value on a recurring basis at the dates indicated:
Financial Assets
Securities available-for-sale
U.S. agency securities
Corporate securities
Municipal bonds
Mortgage-backed securities
U.S. Small Business Administration securities
Mortgage loans held for sale, at fair value
Derivatives
Interest rate lock commitments with customers
Total assets measured at fair value
Financial Liabilities
Derivatives
At December 31, 2019
Level 1 Level 2 Level 3 Total
$
$
— $
— $ 9,066 $
—
—
—
—
—
9,546
20,982
62,850
22,451
69,699
1,024
138
—
—
—
9,066
10,570
21,120
62,850
22,451
69,699
—
557
— $ 194,594 $ 1,719 $ 196,313
557
—
Individual forward sale commitments with investors
Total liabilities measured at fair value
$
$
— $
— $
(8) $ (195) $
(8) $ (195) $
(203)
(203)
Financial Assets
Securities available-for-sale
U.S. agency securities
Corporate securities
Municipal bonds
Mortgage-backed securities
U.S. Small Business Administration securities
Mortgage loans held for sale, at fair value
Derivatives
Interest rate lock commitments with customers
Total assets measured at fair value
Financial Liabilities
Derivatives
At December 31, 2018
Level 1 Level 2 Level 3 Total
$
$
— $ 15,887 $
—
—
—
—
—
6,865
14,194
44,836
15,423
51,195
— $ 15,887
6,865
—
14,194
—
44,836
—
15,423
—
51,195
—
—
503
— $ 148,400 $ 503 $ 148,903
503
—
Individual forward sale commitments with investors
Total liabilities measured at fair value
$
$
— $
— $
(540) $ (34) $
(540) $ (34) $
(574)
(574)
During the year ended December 31, 2019, $1.0 million of corporate securities and $138,000 of municipal bonds available
for sale were transferred from Level 2 to Level 3. The transfers were due to a lack of observable inputs and trade activity
for those securities. There were no transfers between levels during the year ended December 31, 2018.
120
The following table presents impaired loans, OREO, and servicing rights measured at fair value on a nonrecurring basis
for which a nonrecurring change in fair value has been recorded during the reporting periods indicated. The amounts
disclosed below represent the fair values at the time the nonrecurring fair value measurements were evaluated.
December 31, 2019
Impaired loans
OREO
Servicing rights
Impaired loans
OREO
Servicing rights
Level 1 Level 2 Level 3 Total
$ — $ — $ 3,128 $ 3,128
168
— — 13,255 13,255
168
—
—
December 31, 2018
Level 1 Level 2 Level 3 Total
$ — $ — $ 3,894 $ 3,894
689
— — 14,593 14,593
689
—
—
Quantitative Information about Level 3 Fair Value Measurements - Shown in the table below is the fair value of financial
instruments measured under a Level 3 unobservable input on a recurring and nonrecurring basis at December 31, 2019
and 2018:
Level 3
Fair Value
Instruments
RECURRING
Interest rate lock
commitments with
customers
Individual forward sale
commitments with
investors
Corporate securities
Municipal bonds
NONRECURRING
Impaired loans
OREO
Servicing rights
Valuation
Techniques
Significant
Unobservable
Inputs
Weighted Average
Range
December 31,
2019
December 31,
2018
Quoted market prices Pull-through expectations 80% - 99%
94.5 %
95.2 %
Quoted market prices Pull-through expectations 80% - 99%
94.5 %
95.2 %
Discounted cash
flows
Discounted cash
flows
Discount rate
2.1%
Discount rate
3.0% - 3.7%
2.1 %
3.4 %
—
—
Fair value of
underlying collateral
Fair value of
collateral
Discount applied to the
obtained appraisal
Discount applied to the
obtained appraisal
Pre-payment speeds
Industry sources
0% - 50%
10.0 %
10.0 %
0% - 75%
0% - 50%
10.0 %
17.1 %
10.0 %
9.4 %
An increase in the pull-through rate utilized in the fair value measurement of the interest rate lock commitments with
customers and forward sale commitments with investors will result in positive fair value adjustments (and an increase in
the fair value measurement). Conversely, a decrease in the pull-through rate will result in a negative fair value adjustment
(and a decrease in the fair value measurement).
121
The following table provides a reconciliation of assets and liabilities measured at fair value using significant unobservable
inputs (Level 3) on a recurring basis during the years ended December 31, 2019 and 2018.
Purchases
Beginning
and
Balance Issuances Settlements
Sales and Transfers Ending year included in
In
Balance
income
Net change in fair
value for gains/
(losses) relating to
items held at end of
2019
Interest rate lock commitments with customers
Individual forward sale commitments with investors
Securities available-for-sale, at fair value
2018
Interest rate lock commitments with customers
Individual forward sale commitments with investors
$
$
503 $ 11,063 $ (11,009) $
(34)
—
(1,444)
—
1,283
—
— $
—
557 $
(195)
1,162 1,162
726 $ 9,722 $
850
51
(9,945) $
(935)
— $
—
503 $
(34)
54
(161)
—
(223)
(85)
Gains (losses) on interest rate lock commitments carried at fair value are recorded in other noninterest income. Gains
(losses) on forward sale commitments with investors carried at fair value are recorded within other noninterest income.
The following table provides estimated fair values of the Company’s financial instruments at December 31, 2019 and
2018, whether or not recognized at fair value in the Consolidated Balance Sheets:
December 31,
2019
December 31,
2018
Carrying
Amount
Fair
Value
Carrying
Amount
Fair
Value
Financial Assets
Level 1 inputs:
Cash and cash equivalents
Certificates of deposit at other financial institutions
$
45,778 $
20,902
45,778 $
20,902
32,779 $
22,074
32,779
22,074
Level 2 inputs:
Securities available-for-sale, at fair value
Loans held for sale, at fair value
FHLB stock, at cost
Accrued interest receivable
Level 3 inputs:
124,895
69,699
8,045
5,908
124,895
69,699
8,045
5,908
97,205
51,195
9,887
5,761
97,205
51,195
9,887
5,761
Securities available-for-sale, at fair value
Loans receivable, gross
Servicing rights, held at lower of cost or fair value
Fair value interest rate locks with customers
1,162
1,351,893
11,560
557
1,162
1,377,408
13,255
557
—
1,326,238
10,429
503
—
1,320,341
14,593
503
Financial Liabilities
Level 2 inputs:
Deposits
Borrowings
Subordinated note
Accrued interest payable
Paired off commitments with investors
Individual forward sale commitments with investors
Level 3 inputs:
1,392,408
84,864
9,885
273
71
8
1,385,658
85,268
10,599
273
71
8
1,274,219
137,149
9,865
344
64
540
1,261,096
136,873
10,242
344
64
540
Individual forward sale commitments with investors
195
195
34
34
122
NOTE 17 - EARNINGS PER SHARE
The Company computes earnings per share using the two-class method, which is an earnings allocation method for
computing earnings per share that treats a participating security as having rights to earnings that would otherwise have
been available to common shareholders. Basic earnings per share are computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding for the period. Unvested share-based awards
containing non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities
and are included in the computation of earnings per share pursuant to the two-class method. Diluted earnings per share
reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.
For earnings per share calculations, the ESOP shares committed to be released are included as outstanding shares for both
basic and diluted earnings per share.
The following table presents a reconciliation of the components used to compute basic and diluted earnings per share for
the years ended December 31, 2019 and 2018:
At or For the Year Ended
December 31,
Numerator (in thousands):
Net income
Dividends and undistributed earnings allocated to participating securities
Net income available to common shareholders
Denominator (shown as actual):
Basic weighted average common shares outstanding
Dilutive shares
Diluted weighted average common shares outstanding
Basic earnings per share
Diluted earnings per share
Potentially dilutive weighted average share options that were not included in the
computation of diluted earnings per share because to do so would be anti-dilutive
$
$
2019
22,717
$
(73)
$
22,644
2018
24,347
—
24,347
$
$
4,414,032
108,992
4,523,024
3,698,623
171,166
3,869,789
6.58
6.29
5.13 $
5.01 $
36,337
11,326
NOTE 18 - DERIVATIVES
The Company regularly enters into commitments to originate and sell loans held for sale. The Company has established a
hedging strategy to protect itself against the risk of loss associated with interest rate movements on loan commitments.
The Company enters into contracts to sell forward TBA mortgage-backed securities. The Company also enters into best
efforts and mandatory delivery forward loan sale commitments with third party investors. These commitments and
contracts are considered derivatives but have not been designated as hedging instruments for reporting purposes under
U.S. GAAP. Rather, they are accounted for as free-standing derivatives, or economic hedges, with changes in the fair
value of the derivatives reported in noninterest income or noninterest expense. The Company recognizes all derivative
instruments as either other assets or other liabilities on the Consolidated Balance Sheets and measures those instruments
at fair value.
The following tables summarize the Company’s derivative instruments at the dates indicated:
December 31, 2019
Fair Value
Fallout adjusted interest rate lock commitments with customers
Mandatory and best effort forward commitments with investors
Forward TBA mortgage-backed securities
123
Notional Asset
$ 33,914 $
43,752
46,000
—
—
Liability
—
195
8
557 $
Fallout adjusted interest rate lock commitments with customers
Mandatory and best effort forward commitments with investors
Forward TBA mortgage-backed securities
December 31, 2018
Fair Value
Notional Asset
$ 29,432 $
24,776
51,500
503
—
—
Liability
—
34
540
$
At December 31, 2019 and 2018, the Company had $46.0 million and $51.5 million of TBA trades with counterparties
that required margin collateral of $1.2 million and $460,000, respectively. This collateral is included in interest-bearing
deposits at other financial institutions on the Consolidated Balance Sheets.
Changes in the fair value of the derivatives recognized in other noninterest income on the Consolidated Statements of
Income and included in gain on sale of loans resulted in a net gain of $303,000 and net loss of ($702,000) for the years
ended December 31, 2019 and 2018, respectively.
NOTE 19 - STOCK-BASED COMPENSATION
Stock Options and Restricted Stock
On May 17, 2018, the shareholders of FS Bancorp, Inc. approved the 2018 Equity Incentive Plan (the “2018 Plan”) that
authorizes 650,000 shares of the Company’s common stock to be awarded. The 2018 Plan provides for the grant of
incentive stock options, non-qualified stock options, and up to 163,000 restricted stock awards (“RSAs”) to directors,
emeritus directors, officers, employees or advisory directors of the Company. On August 15, 2019, the Company awarded
grants of 20,215 RSAs and 50,655 stock options with an exercise price equal to the market price of FS Bancorp’s common
stock on the grant date of $48.74 per share. On August 15, 2018, the Company awarded grants of 25,000 RSAs and
100,000 stock options with an exercise price equal to the market price of FS Bancorp’s common stock at the grant date of
$58.60 per share.
In September 2013, the shareholders of FS Bancorp, Inc. approved the FS Bancorp, Inc. 2013 Equity Incentive Plan (the
“2013 Plan”). The Plan provides for the grant of stock options and RSAs. The 2013 Plan authorizes the grant of stock
options totaling 324,013 shares of common stock to Company directors and employees of which 322,000 stock options
were granted with an exercise price equal to the market price of FS Bancorp’s common stock at the grant date of May 8,
2014, of $16.89 per share. The 2013 Plan authorizes the grant of RSAs totaling 129,605 shares to Company directors,
advisory directors, emeritus directors, officers, and employees, and 125,105 shares were granted on May 8, 2014 at a grant
date fair value of $16.89 per share. The remaining 4,500 RSAs were granted January 1, 2016 at a grant date fair value of
$26.00 per share. All options and RSAs previously granted have vested as of December 31, 2019.
Total share-based compensation expense for both plans was $869,000 for the year ended December 31, 2019, and
$767,000 for the year ended December 31, 2018. The related income tax benefit was $182,000 and $161,000 for the years
ended December 31, 2019 and 2018, respectively.
Stock Options
Both plans consist of stock option awards that may be granted as incentive stock options or non-qualified stock options.
Stock option awards generally vest at one year for independent directors or over five years for employees and officers with
20% vesting on the anniversary date of each grant date as long as the award recipient remains in service to the Company.
The options are exercisable after vesting for up to the remaining term of the original grant. The maximum term of the
options granted is 10 years. Any unexercised stock options will expire 10 years after the grant date or sooner in the event
of the award recipient’s termination of service with the Company or the Bank. At December 31, 2019, there were 336,345
and 6,013 stock option awards available to be granted under the 2018 Plan and the 2013 Plan, respectively.
The fair value of each stock option award is estimated on the grant date using a Black-Scholes Option pricing model that
uses the following assumptions. The dividend yield is based on the current quarterly dividend in effect at the time of the
grant. Historical employment data is used to estimate the forfeiture rate. The Company elected to use Staff Accounting
Bulletin 107, simplified expected term calculation for the “Share-Based Payments” method permitted by the SEC to
124
calculate the expected term. This method uses the vesting term of an option along with the contractual term, setting the
expected life at 5.5 years for one-year vesting and 6.5 years for five-year vesting.
The fair value of options granted was determined using the following weighted-average assumptions as of the grant date
for the years ended December 31, 2019 and 2018.
Year Ended December 31, Year Ended December 31,
2019
2018
Dividend yield
Expected volatility
Risk-free interest rate
Expected term in years
Weighted-average grant date fair value per option granted
$
1.23%
18.90%
1.45%
6.5
8.80 $
0.95%
18.80%
2.77%
6.5
13.22
The following table presents a summary of the Company’s stock option plan awards during the year ended December 31,
2019 (shown as actual):
Outstanding at January 1, 2019
Granted
Less exercised
Forfeited or expired
Outstanding at December 31, 2019
Weighted-
Average
Shares Exercise Price
31.27
290,104 $
48.74
50,655
16.89
52,769 $
—
—
36.98
287,990 $
Weighted-Average
Remaining
Contractual Term In
Years
Aggregate
Intrinsic Value
4,940,803
—
1,799,754
—
7,722,369
6.83 $
—
— $
—
6.77 $
Expected to vest, assuming a 0.31% annual forfeiture
rate (1)
287,067 $
36.92
6.76 $
7,713,673
Exercisable at December 31, 2019
_________________________
(1) Forfeiture rate has been calculated and estimated to assume a forfeiture of 3.1% of the options forfeited over 10
years.
157,335 $
4.90 $
22.19
6,544,812
At December 31, 2019, there was $1.4 million of total unrecognized compensation cost related to nonvested stock options
granted under both plans. The cost is expected to be recognized over the remaining weighted-average vesting period of
3.9 years.
Restricted Stock Awards
The RSAs’ fair value is equal to the value of the stock based on the market price of FS Bancorp’s common stock on the
grant date and compensation expense is recognized over the vesting period of the awards based on the fair value of the
restricted stock. Shares in the 2013 Plan awarded as restricted stock generally vested over a three-year period for directors
and a five-year period for employees, beginning at the grant date. Shares for the 2018 Plan, shares generally vest at one
year for independent directors or over a five-year period for employees and officers beginning on the grant date. Any
unvested RSAs will expire after vesting or sooner in the event of the award recipient’s termination of service with the
Company or the Bank.
125
The following table presents a summary of the Company’s nonvested awards during the year ended December 31, 2019
(shown as actual):
Nonvested Shares
Nonvested at January 1, 2019
Granted
Less vested
Forfeited or expired
Nonvested at December 31, 2019
Weighted-Average
Grant-Date Fair Value
Per Share
Shares
43,421 $
20,215 $
23,421 $
—
40,215 $
41.22
48.74
26.38
—
53.64
At December 31, 2019, there was $2.0 million of total unrecognized compensation costs related to nonvested shares
granted under both plans as RSAs. The cost is expected to be recognized over the remaining weighted-average vesting
period of 4.0 years. The total fair value of shares vested for the years ended December 31, 2019 and 2018 was $1.2 million
and $1.1 million, respectively.
NOTE 20 - BUSINESS SEGMENTS
The Company’s business segments are determined based on the products and services provided, as well as the nature of
the related business activities, and they reflect the manner in which financial information is currently evaluated by
management. This process is dynamic and is based on management’s current view of the Company’s operations and is not
necessarily comparable with similar information for other financial institutions. The Company defines its business
segments by product type and customer segment which it has organized into two lines of business: commercial and
consumer banking and home lending.
The Company uses various management accounting methodologies to assign certain income statement items to the
responsible operating segment, including:
a funds transfer pricing (“FTP”) system, which allocates interest income credits and funding charges between the
segments, assigning to each segment a funding credit for its liabilities, such as deposits, and a charge to fund its assets;
a cost per loan serviced allocation based on the number of loans being serviced on the balance sheet and the number
of loans serviced for third parties;
an allocation based upon the approximate square footage utilized by the home lending segment in Company owned
locations;
an allocation of charges for services rendered to the segments by centralized functions, such as corporate overhead,
which are generally based on the number of full time employees (“FTEs”) in each segment; and
an allocation of the Company’s consolidated income taxes which are based on the effective tax rate applied to the
segment’s pretax income or loss.
The FTP methodology is based on management’s estimated cost of originating funds including the cost of overhead for
deposit generation.
A description of the Company’s business segments and the products and services that they provide is as follows:
Commercial and Consumer Banking Segment
The commercial and consumer banking segment provides diversified financial products and services to our commercial
and consumer customers through Bank branches, automated teller machines (“ATM”), online banking platforms, mobile
banking apps, and telephone banking. These products and services include deposit products; residential, consumer,
business and commercial real estate lending portfolios and cash management services. The Company originates consumer
126
loans, commercial and multi-family real estate loans, construction loans for residential and multi-family construction, and
commercial business loans. At December 31, 2019, the Company’s retail deposit branch network consisted of 21 branches
in the Pacific Northwest. At December 31, 2019 and December 31, 2018, deposits totaled $1.39 billion and $1.27 billion,
respectively. This segment is also responsible for the management of the investment portfolio and other assets of the Bank.
Home Lending Segment
The home lending segment originates one-to-four-family residential mortgage loans primarily for sale in the secondary
markets as well as originating adjustable rate mortgage (“ARM”) loans held for investment. The majority of mortgage
loans are sold to or securitized by FNMA, FHLMC, GNMA or the FHLB of Des Moines, while the Company retains the
right to service these loans. Loans originated under the guidelines of the Federal Housing Administration or FHA, US
Department of Veterans Affairs or VA, and United States Department of Agriculture or USDA are generally sold servicing
released to a correspondent bank or mortgage company. The Company has the option to sell loans on a servicing-released
or servicing-retained basis to securitizers and correspondent lenders. A small percentage of loans are brokered to other
lenders. On occasion, the Company may sell a portion of its MSR portfolio and may sell small pools of loans initially
originated to be held in the loan portfolio. The Company manages the loan funding and the interest rate risk associated
with the secondary market loan sales and the retained one-to-four-family mortgage servicing rights within this business
segment. One-to-four-family loans originated for investment are allocated to the home lending segment with a
corresponding provision expense and FTP for cost of funds.
Segment Financial Results
The tables below summarize the financial results for each segment based primarily on the number of FTEs and assets
within each segment for the years ended December 31, 2019 and 2018:
At or For the Year Ended December 31, 2019
Commercial
and
Consumer
Banking
Home Lending
Total
64,001 $
(2,447)
9,826
(48,050)
23,330
(4,489)
18,841 $
6,307 $
(433)
13,209
(14,283)
4,800
(924)
3,876 $
70,308
(2,880)
23,035
(62,333)
28,130
(5,413)
22,717
312,404 $ 1,400,652 $ 1,713,056
272,901 $ 1,377,468 $ 1,650,369
452
127
325
Condensed income statement:
Net interest income (1)
Provision for loan losses (2)
Noninterest income
Noninterest expense
Income before provision for income taxes
Provision for income taxes
Net income
Total assets
Total average assets for year ended
FTEs
$
$
$
$
127
At or For the Year Ended December 31, 2018
Commercial
and
Consumer
Banking
Home Lending
Total
$
3,324 $
(224)
14,025
(15,894)
1,231
(182)
1,049 $
Condensed income statement:
Net interest income (1)
Provision for loan losses
Noninterest income (3)
Noninterest expense
Income before provision for income taxes
Provision for income taxes
Net income
Total assets
Total average assets for year ended
FTEs
___________________________
(1) Net interest income is the difference between interest earned on assets and the cost of liabilities to fund those assets.
Interest earned includes actual interest earned on segment assets and, if the segment has excess liabilities, interest credits
for providing funding to the other segment. The cost of liabilities includes interest expense on segment liabilities and, if
the segment does not have enough liabilities to fund its assets, a funding charge based on the cost of assigned liabilities to
fund segment assets.
(2) The allocated provision for loan losses is partially associated with one-to-four-family, and home equity loans acquired
from Anchor Bank totaling $198.5 million at December 31, 2019.
52,098
(1,540)
26,850
(48,838)
28,570
(4,223)
24,347
246,280 $ 1,375,364 $ 1,621,644
945,052 $ 1,174,713
229,661 $
424
115
48,774 $
(1,316)
12,825
(32,944)
27,339
(4,041)
23,298 $
$
$
$
309
(3) Bargain purchase gain of $7.4 million was included in the commercial and consumer banking segment.
NOTE 21 - REVENUE FROM CONTRACTS WITH CUSTOMERS
Revenue Recognition
In accordance with Topic 606, revenues are recognized when control of promised goods or services is transferred to
customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods
or services. To determine revenue recognition for arrangements that an entity determines are within the scope of Topic
606, the Company performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the
performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the
performance obligations in the contract; and (v) recognize revenue when (or as) the Company satisfies a performance
obligation. The Company only applies the five-step model to contracts when it is probable that the entity will collect the
consideration it is entitled to in exchange for the goods or services it transfers to the customer. At contract inception, once
the contract is determined to be within the scope of Topic 606, the Company assesses the goods or services that are
promised within each contract and identifies those that contain performance obligations, and assesses whether each
promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is
allocated to the respective performance obligation when (or as) the performance obligation is satisfied.
128
All of the Company’s revenue from contracts with customers in-scope of ASC 606 is recognized in noninterest income
and included in our commercial and consumer banking segment. The following table presents noninterest income,
segregated by revenue streams in-scope and out-of-scope of Topic 606, for the years ended December 31, 2019 and 2018:
(Dollars in thousands):
Noninterest Income
In-scope of Topic 606:
Debit card interchange fees
Fees from non-sufficient funds
Noninterest Income (in-scope of Topic 606)
Noninterest Income (out-of-scope of Topic 606)
Total Noninterest Income
Deposit Fees
At or For the Year Ended
December 31,
2019
2018
$
1,848 $
1,065
2,913
20,122
$ 23,035 $
1,184
561
1,745
25,105
26,850
The Bank earns fees from its deposit customers for account maintenance, transaction-based services and overdraft
charges. Account maintenance fees consist primarily of account fees and analyzed account fees charged on deposit
accounts on a monthly basis. The performance obligation is satisfied and the fees are recognized on a monthly basis as
the service period is completed. Transaction-based fees on deposits accounts are charged to deposit customers for specific
services provided to the customer, such as wire fees, as well as charges against the account, such as fees for non-sufficient
funds and overdrafts. The performance obligation is completed as the transaction occurs and the fees are recognized at the
time each specific service is provided to the customer.
Debit Interchange Income
Debit and ATM interchange income represent fees earned when a debit card issued by the Bank is used. The Bank earns
interchange fees from debit cardholder transactions through the Visa payment network. Interchange fees from cardholder
transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the
transaction processing services provided to the cardholder. The performance obligation is satisfied and the fees are earned
when the cost of the transaction is charged to the cardholders’ debit card.
NOTE 22 - GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and certain other intangibles generally arise from business combinations accounted for under the acquisition
method of accounting. Goodwill totaled $2.3 million at December 31, 2019 and 2018, and represents the excess of the
total acquisition price paid over the fair value of the assets acquired, net of the fair values of liabilities assumed as a result
of the Branch Purchase in 2016. Goodwill is not amortized but is evaluated for impairment on an annual basis at December
31 of each year or whenever events or changes in circumstances indicate the carrying value may not be recoverable. The
Company performed an impairment analysis at December 31, 2019, and 2018 and determined that no impairment of
goodwill existed.
129
The following table summarizes the changes in the Company’s other intangible assets comprised solely of CDI for the
years ended December 31, 2019, and December 31, 2018.
Balance, December 31, 2017
Amortization
Additions as a result of the Anchor Acquisition
Balance, December 31, 2018
Amortization
Balance, December 31, 2019
Other Intangible Assets
Accumulated
Gross CDI Amortization Net CDI
$
(922) $ 1,317
(307)
(307)
5,207
(44)
6,217
(1,273)
(760)
(760)
(2,033) $ 5,457
2,239 $
—
5,251
7,490
—
7,490 $
$
The CDI represents the fair value of the intangible core deposit base acquired in business combinations. The CDI will be
amortized on a straight-line basis over 10 years for the CDI related to the Anchor Acquisition and on an accelerated basis
over approximately nine years for the CDI related to the Branch Purchase. Total amortization expense was $760,000 for
the year ended December 31, 2019, and $351,000 for the same period in 2018. Amortization expense for the CDI is
expected to be as follows for the years ended December 31:
2020
2021
2022
2023
2024
Thereafter
Total
$
$
706
691
691
691
621
2,057
5,457
NOTE 23 - PARENT COMPANY ONLY FINANCIAL INFORMATION
The Condensed Balance Sheets, Statements of Income, and Statements of Cash Flows for FS Bancorp, Inc. (Parent Only)
are presented below:
Condensed Balance Sheets
Assets
Cash and due from banks
Investment in subsidiary
Other assets
Total assets
Liabilities and Stockholders' Equity
Subordinated note, net
Other liabilities
Total liabilities
Stockholders' equity
Total liabilities and stockholders' equity
December 31,
2019
5,568 $
204,570
172
210,310 $
$
$
9,885
183
10,068
200,242
210,310 $
$
2018
7,026
182,874
175
190,075
9,865
172
10,037
180,038
190,075
130
Condensed Statements of Income
Interest from subsidiary
Interest expense on subordinated note
Dividends received from subsidiary
Other expenses
Income before income tax benefit and equity in undistributed net income of subsidiary
Income tax benefit
Equity in undistributed earnings of subsidiary
Net income
$
$
Year Ended December 31,
2019
2018
2 $
(679)
3,935
(142)
3,116
172
19,429
22,717 $
2
(679)
1,436
(157)
602
175
23,570
24,347
Condensed Statements of Cash Flows
Cash flows from operating activities:
Net income
Equity in undistributed net income of subsidiary
Amortization
ESOP compensation expense for allocated shares
Share-based compensation expense related to stock options and restricted stock
Other assets
Other liabilities
Net cash from operating activities
Cash flows from investing activities:
Net proceeds from ESOP
Net cash from investing activities
Cash flows (used by) from financing activities:
Proceeds from stock options exercised
Common stock repurchased for employee/director taxes paid on restricted stock
awards
Common stock repurchased
Dividends paid on common stock
Net cash (used by) from financing activities
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
Year Ended December 31,
2019
2018
$
$
22,717
(19,429)
20
1,231
869
3
11
5,422
275
275
705
(204)
(4,800)
(2,856)
(7,155)
(1,458)
7,026
5,568
$
$
24,347
(23,570)
20
940
767
115
6
2,625
269
269
1,117
(251)
—
(1,915)
(1,049)
1,845
5,181
7,026
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
(i) Disclosure Controls and Procedures.
An evaluation of the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) of the Securities
Exchange Act of 1934, as amended (the “Exchange Act”) was carried out as of December 31, 2019 under the supervision
and with the participation of the Company’s Chief Executive Officer (“CEO”), Chief Financial Officer (“CFO”), and
several other members of the Company’s senior management. The CEO (Principal Executive Officer) and CFO (Principal
Financial Officer) concluded that, as of December 31, 2019, FS Bancorp’s disclosure controls and procedures were
effective in ensuring that information the Company is required to disclose in the reports it files or submits under the
Exchange Act is (1) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules
131
and forms, and (2) accumulated and communicated to FS Bancorp management, including its CEO and CFO, as
appropriate to allow timely decisions regarding required disclosure, specified in the SEC’s rules and forms.
a) Management’s Report on internal control over financial reporting.
FS Bancorp’s management is responsible for establishing and maintaining adequate internal control over financial
reporting, as defined in Rule 13a-15(f) of the Exchange Act. FS Bancorp’s internal control system is designed to provide
reasonable assurance to our management and the Board of Directors regarding the preparation and fair presentation of
published financial statements for external purposes in accordance with generally accepted accounting principles.
This process includes policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions of FS Bancorp; (ii) provide reasonable assurance that transactions are recorded
as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of FS Bancorp are being made only in accordance with authorizations of management
and directors of FS Bancorp; and (iii) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of FS Bancorp’s assets that could have a material effect on the financial
statements. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Also, because of the inherent limitations in all control
procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any,
within the Company have been detected. Additionally, in designing disclosure controls and procedures, FS Bancorp’s
management was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls
and procedures. The design of any disclosure controls and procedures is also based in part upon certain assumptions about
the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions. As a result of these inherent limitations, internal control over financial reporting may
not prevent or detect misstatements. Furthermore, projections of any evaluation of effectiveness to future periods are
subject to risk that controls may become inadequate because of changes in conditions or that the degree of compliance
with the policies or procedures may deteriorate.
FS Bancorp’s management assessed the effectiveness of FS Bancorp’s internal control over financial reporting as of
December 31, 2019. In making this assessment, management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013 Framework). Based on
management’s assessment, it was concluded that, as of December 31, 2019, FS Bancorp’s internal control over financial
reporting was effective based on those criteria. Moss Adams LLP, an independent registered public accounting firm, has
audited FS Bancorp’s consolidated financial statements and the effectiveness of its internal control over financial reporting
as of December 31, 2019, which is included in “Item 8. Financial Statements and Supplementary Data” of this Annual
Report on Form 10 K.
b) Attestation report of the registered public accounting firm.
The “Report of Independent Registered Public Accounting Firm” included in “Item 8. Financial Statements and
Supplementary Data” of this Annual Report on Form 10-K is incorporated herein by reference.
c) Changes in internal control over financial reporting.
There were no significant changes in FS Bancorp’s internal control over financial reporting during FS Bancorp’s most
recent fiscal quarter that have materially affected or are reasonably likely to materially affect, FS Bancorp’s internal control
over financial reporting.
Item 9B. Other Information
None.
132
Item 10. Directors, Executive Officers and Corporate Governance
PART III
The information required by this item regarding the Company’s Board of Directors is incorporated herein by reference
from the section captioned “Proposal I - Election of Directors” in the Company’s Proxy Statement, a copy of which will
be filed with the SEC no later than 120 days after the Company’s fiscal year end.
The executive officers of the Company and the Bank are elected annually and hold office until their respective successors
have been elected and qualified or until death, resignation or removal by the Board of Directors. For information regarding
the Company’s executive officers, see “Item 1. Business - Executive Officers” included in this Form 10-K.
Code of Ethics for Senior Financial Officers
The Board of Directors has adopted a Code of Ethics for the Company’s officers (including its senior financial officers),
directors and employees. The Code is applicable to the Company’s principal executive officer and senior financial officers.
The Company’s Code of Ethics is posted on its website at www.fsbwa.com under the Investor Relations tab.
Audit Committee Financial Expert
The Audit Committee of the Company is composed of Directors Leech (Chairperson), Mansfield and Cofer-Wildsmith.
Each member of the Audit Committee is “independent” as defined in the Nasdaq Stock Market listing standards. The
Board of Directors has determined that Mr. Leech and Mr. Mansfield meet the definition of “audit committee financial
expert,” as defined by the SEC.
Item 11. Executive Compensation
The information required by this item is incorporated herein by reference from the sections captioned “Executive
Compensation” and “Directors’ Compensation” in the Proxy Statement, a copy of which will be filed with the SEC no
later than 120 days after the Company’s fiscal year end.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a) Security Ownership of Certain Beneficial Owners.
The information required by this item is incorporated herein by reference from the section captioned “Security Ownership
of Certain Beneficial Owners and Management” in the Company’s Proxy Statement, a copy of which will be filed with
the SEC no later than 120 days after the Company’s fiscal year end.
(b) Security Ownership of Management.
The information required by this item is incorporated herein by reference from the sections captioned “Security Ownership
of Certain Beneficial Owners and Management” and “Proposal I - Election of Directors” in the Company’s Proxy
Statement, a copy of which will be filed with the SEC no later than 120 days after the Company’s fiscal year end.
(c) Changes in Control.
The Company is not aware of any arrangements, including any pledge by any person of securities of the Company, the
operation of which may at a subsequent date result in a change in control of the Company.
133
d) Equity Compensation Plan Information. The following table summarizes share and exercise price information about
FS Bancorp’s equity compensation plans as of December 31, 2019:
Plan category
Number of securities
remaining available for
future issuance under
equity compensation
Number of securities to Weighted-average
be issued upon exercise
exercise price of
of outstanding options, outstanding options, securities reflected in
warrants, and rights
warrants, and rights
(b)
column (a))
(c)
plans (excluding
(a)
137,335 $
150,655
Equity compensation plans (stock options) approved by
security holders:
2013 Equity Incentive Plan(1)
2018 Equity Incentive Plan(2)
Equity compensation plans not approved by security
holders
Total
_____________________________
(1) The restricted shares granted under the 2013 Equity Incentive Plan were purchased by FS Bancorp in open market
transactions and subsequently issued to the Company’s directors and certain employees. At December 31, 2019, there were
129,605 restricted shares granted pursuant to the 2013 Equity Incentive Plan and no shares were available for future grants
of restricted stock.
(2) The restricted shares granted under the 2018 Equity Incentive Plan were purchased by FS Bancorp in open market
transactions and subsequently issued to the Company’s directors and certain employees. At December 31, 2019, there were
45,215 restricted shares granted pursuant to the 2018 Equity Incentive Plan and 117,785 shares were available for future
grants of restricted stock.
N/A
287,990 $
N/A
460,143
6,013
454,130
N/A
36.98
16.89
55.28
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item is incorporated herein by reference from the section captioned “Transactions with
Management” in the Company’s Proxy Statement, a copy of which will be filed with the SEC no later than 120 days after
the Company’s fiscal year end.
Item 14. Principal Accounting Fees and Services
The information required by this item is incorporated herein by reference from the section captioned “Proposal 3 -
Ratification of Appointment of Independent Auditor” in the Company’s Proxy Statement, a copy of which will be filed
with the SEC no later than 120 days after the Company’s fiscal year end.
134
Item 15. Exhibits and Financial Statement Schedules
(a) 1. Financial Statements
PART IV
For a list of the financial statements filed as part of this report see “Part II - Item 8. Financial Statements and
Supplementary Data.”
2. Financial Statement Schedules
Schedules to the Consolidated Financial Statements have been omitted as the required information is
inapplicable.
(b) Exhibits
Exhibits are available from the Company by written request
2.1 Agreement and Plan of Merger, dated as of July 17, 2018, by and between FS Bancorp, Inc. and
Anchor Bancorp (1)
3.1 Articles of Incorporation for FS Bancorp, Inc. (2)
3.2 Bylaws for FS Bancorp, Inc. (3)
4.1 Form of Common Stock Certificate of FS Bancorp, Inc. (2)
4.2 Description of Capital Stock of FS Bancorp, Inc.
10.1 Severance Agreement between 1st Security Bank of Washington and Joseph C. Adams (2)
10.2 Form of Change of Control Agreement between 1st Security Bank of Washington and Matthew D.
Mullet (2)
10.3 FS Bancorp, Inc. 2013 Equity Incentive Plan (the “2013 Plan”) (4)
10.4 Form of Incentive Stock Option Agreement under the 2013 Plan (4)
10.5 Form of Non-Qualified Stock Option Agreement under the 2013 Plan (4)
10.6 Form of Restricted Stock Agreement under the 2013 Plan (4)
10.7 Purchase and Assumption Agreement between Bank of America, National Association and 1st
Security Bank dated September 1, 2015 (6)
10.8 Subordinated Loan Agreement dated September 30, 2015 by and among Community Funding
CLO, Ltd. and the Company. (7)
10.9 Form of Change of Control Agreement with Donn C. Costa, Dennis O’Leary, Rob Fuller, Erin Burr,
Victoria Jarman, Kelli Nielsen, and May-Ling Sowell (8)
10.10 FS Bancorp, Inc. 2018 Equity Incentive Plan (9)
10.11 Form of Incentive Stock Option Award Agreement under the 2018 Equity Incentive Plan (9)
10.12 Form of Non-Qualified Stock Option Award Agreement under the 2018 Equity Incentive Plan (9)
10.13 Form of Restricted Stock Award Agreement under the 2018 Equity Incentive Plan (9)
14 Code of Ethics and Conduct Policy (5)
21 Subsidiaries of Registrant
23 Consent of Independent Registered Public Accounting Firm
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101 The following materials from the Company’s Annual Report on Form 10-K for the fiscal year ended
December 31, 2019, formatted in Extensible Business Reporting Language (XBRL):
(1) Consolidated Balance Sheets; (2) Consolidated Statements of Income; (3) Consolidated
Statements of Comprehensive Income; (4) Consolidated Statements of Stockholders’ Equity;
(5) Consolidated Statements of Cash Flows; and (6) Notes to Consolidated Financial Statements.
(1) Filed as an exhibit to the Registrant’s Current Report on Form 8-K filed on July 18, 2018 (File No. 001-35589) and
incorporated by reference.
(2) Filed as an exhibit to the Registrant’s Registration Statement on Form S-1 (333-177125) filed on October 3, 2011,
and incorporated by reference.
(3) Filed as an exhibit to the Registrant’s Current Report on Form 8-K filed on July 10, 2013 (File No. 001-355589).
135
(4) Filed as an exhibit to the Registrant’s Registration Statement on Form S-8 (333-192990) filed on December 20, 2013
and incorporated by reference.
(5) Registrant elects to satisfy Regulation S-K §229.406(c) by posting its Code of Ethics on its website at www.fsbwa.com
in the section titled Investor Relations: Corporate Governance.
(6) Filed as an exhibit to the Registrant’s Current Report on Form 8-K filed on September 2, 2015 (File No. 001-35589).
(7) Filed as an exhibit to the Registrant’s Current Report on Form 8-K filed on October 19, 2015 (File No. 001-35589).
(8) Filed as an exhibit to the Registrant’s Current Report on Form 8-K filed on February 1, 2016 (File No. 001-35589).
(9) Filed as an exhibit to the Registrant’s Registration Statement on Form S-8 (333-22513) filed on May 23, 2018.
Item 16. Form 10-K Summary
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 16, 2020
FS Bancorp, Inc.
/s/Joseph C. Adams
Joseph C. Adams
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURES
TITLE
DATE
/s/Joseph C. Adams
Joseph C. Adams
/s/Matthew D. Mullet
Matthew D. Mullet
/s/Ted A. Leech
Ted A. Leech
/s/Margaret R. Piesik
Margaret R. Piesik
/s/Joseph P. Zavaglia
Joseph P. Zavaglia
/s/Michael J. Mansfield
Michael J. Mansfield
/s/Marina Cofer-Wildsmith
Marina Cofer-Wildsmith, MA
/s/Mark H. Tueffers
Mark H. Tueffers
Director and Chief Executive Officer
(Principal Executive Officer)
Chief Financial Officer, Treasurer and Secretary
(Principal Financial and Accounting Officer)
Chairman of the Board
Director
Director
Director
Director
Director
136
March 16, 2020
March 16, 2020
March 16, 2020
March 16, 2020
March 16, 2020
March 16, 2020
March 16, 2020
March 16, 2020
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