10-Q: FS Bancorp Q3 Net Income Falls Amid Rising Credit Losses

FS Bancorp, Inc. reported a decrease in net income for the third quarter and first nine months of 2025, primarily driven by higher provisions for credit losses and increased income tax expense, despite growth in net interest income.

Summary

• Net income for the three months ended September 30, 2025, decreased to $9.177 million from $10.286 million in the prior year, a 10.78% decline.
• Basic earnings per share for the quarter fell to $1.20 from $1.32, and diluted EPS decreased to $1.18 from $1.29.
• For the nine months ended September 30, 2025, net income was $24.926 million, down from $27.642 million in the same period of 2024, a 9.82% decrease.
• Net interest income increased by $2.4 million (7.8%) to $33.690 million for the quarter and by $4.8 million (5.2%) to $96.784 million for the nine months.
• The provision for credit losses significantly increased to $2.309 million for the quarter (up 52.6%) and $5.922 million for the nine months (up 48.5%).
• Total assets grew by $179.6 million to $3.21 billion at September 30, 2025, from $3.03 billion at December 31, 2024.
• Loans receivable, net, increased by $97.7 million to $2.60 billion, with growth in CRE, residential real estate, and commercial business loans, partially offset by a $19.4 million decrease in consumer loans.
• Total deposits increased by $347.1 million to $2.69 billion, primarily due to a $270.9 million increase in Certificates of Deposit, including $226.4 million in brokered CDs.
• Borrowings decreased by $178.5 million to $129.3 million, reflecting a strategic shift to fund asset growth with lower-cost brokered deposits.
• Nonperforming loans (nonaccrual loans) increased by $4.8 million to $18.4 million at September 30, 2025, from $13.6 million at December 31, 2024, primarily in commercial construction and development, indirect home improvement, and one-to-four-family residential loans.
• The coverage ratio of the Allowance for Credit Losses (ACL) on loans to nonperforming loans decreased to 163.8% from 234.3% due to a partial charge-off on a CRE loan and the increase in nonperforming loans.
• The company's capital ratios remain strong, with the Bank categorized as 'well capitalized' under regulatory requirements.
• FS Bancorp ceased to qualify as a small bank holding company as of June 30, 2025, and is now subject to all regulatory requirements for larger bank holding companies.
• The Board of Directors approved an additional stock repurchase program of up to $5.0 million on October 27, 2025, adding to the $826,000 remaining from the prior program.
• The effective corporate income tax rate for the quarter was 20.8% compared to (4.3)% in the prior year, largely due to the absence of alternative energy tax credits.

Sentiment

Score: 4

Explanation: While net interest income and NIM showed improvement, net income and EPS declined due to higher provision for credit losses and increased income tax expense. Nonperforming loans and classified loans increased, and the ACL coverage ratio decreased, indicating some asset quality deterioration. The company maintains strong capital ratios and is actively managing its funding mix, but the negative trends in profitability and asset quality outweigh the positives.

Positives

• Net interest income increased by $2.4 million (7.8%) for the quarter and $4.8 million (5.2%) for the nine months, indicating strong core banking operations.
• Net interest margin (NIM) slightly improved by 2 basis points to 4.37% for the quarter and 3 basis points to 4.33% for the nine months, reflecting better yields on interest-earning assets.
• Total assets increased by $179.6 million to $3.21 billion, demonstrating continued balance sheet growth.
• Total deposits increased by $347.1 million, with a strategic shift towards brokered CDs to reduce reliance on higher-cost borrowings.
• Borrowings decreased by $178.5 million, improving the funding mix and reducing overall funding costs.
• The loan-to-deposit ratio improved to 99.3% from 109.5%, indicating a more balanced funding structure.
• Total loans 30 days or more past due decreased to 0.70% of total loans from 0.88%, reflecting continued repayment performance in parts of the loan portfolio.
• The efficiency ratio improved to 64.63% for the three months ended September 30, 2025, from 69.42% in the prior year, indicating better cost management relative to revenue growth for the quarter.
• The Bank remains 'well capitalized' with strong capital ratios exceeding regulatory minimums (Total risk-based capital 13.81%, Tier 1 risk-based capital 12.64%, Tier 1 leverage capital 10.96%, CET 1 capital 12.64%).
• Book value per common share increased to $40.43 from $38.26.
• An additional $5.0 million stock repurchase program was approved, signaling commitment to shareholder returns.

Negatives

• Net income decreased by 10.78% for the three months and 9.82% for the nine months ended September 30, 2025, compared to the prior year.
• Basic and diluted earnings per share declined for both the three and nine-month periods.
• Provision for credit losses increased significantly by 52.6% for the quarter and 48.5% for the nine months, indicating higher expected loan losses.
• Nonperforming loans increased by $4.8 million to $18.4 million, representing 0.70% of total gross loans, up from 0.54% at December 31, 2024.
• The coverage ratio of the ACL on loans to nonperforming loans decreased to 163.8% from 234.3%, suggesting reduced buffer against potential losses.
• Classified loans (substandard) increased to $27.1 million from $22.9 million, indicating a deterioration in credit quality for some loans.
• Noninterest income decreased by $373,000 for the quarter and $1.1 million for the nine months, primarily due to lower loan sales activity and reduced service charges.
• The efficiency ratio weakened to 67.40% for the nine months ended September 30, 2025, from 67.21% in the prior year, indicating that expense growth outpaced revenue growth over the longer period.
• Income tax expense increased significantly due to the absence of alternative energy tax credits available in the prior year, impacting net income.

Risks

• Adverse impacts to economic conditions in local markets or other markets where the company has lending relationships, including effects of employment levels, labor shortages, persistent inflation, recessionary pressures, or slowing economic growth.
• Changes in interest rate levels and the duration of such changes, including actions by the Federal Reserve, which could adversely affect revenues, expenses, asset/obligation values, and capital/liquidity costs.
• Credit risks of lending activities, including loan delinquencies, write-offs, changes in the allowance for credit losses (ACL), and provision for credit losses, particularly with elevated losses in certain consumer loan portfolios.
• Secondary market conditions and the ability to originate and sell loans in the secondary market.
• Fluctuations in loan demand, unsold homes, land, and property values.
• Increased competitive pressures among financial services companies.
• Ability to attract and retain deposits, especially in a competitive rate environment.
• Bank failures or adverse developments at other banks and related negative press about the banking industry in general on investor and depositor sentiment.
• The ability to adapt to rapid technological changes, including advancements in artificial intelligence, digital banking, and cybersecurity.
• Legislation or regulatory changes, including shifts in capital requirements, banking regulation, tax laws, or consumer protection laws, especially as the company is now subject to requirements for larger bank holding companies.
• Vulnerabilities in information systems or third-party service providers, including disruptions, breaches, or attacks.

Future Outlook

The company expects to continue its current practice of paying quarterly cash dividends, subject to Board discretion. It also plans to utilize its newly approved stock repurchase program. Management anticipates continued economic volatility and is focused on managing credit, interest rate, and concentration risks while growing and diversifying its loan portfolio and emphasizing lower-cost core deposits. The company will also adapt to new regulatory requirements as it transitions from a small bank holding company.

Management Comments

• Management is committed to establishing varied revenue streams considering credit, interest rate, and concentration risks.
• Management believes that the Bank met all capital adequacy requirements as of September 30, 2025.
• 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.
• It is management's policy to offer deposit rates that are competitive with other local financial institutions, and management believes a majority of maturing relationship deposits will remain with the Bank.
• Our current quarterly common stock dividend rate is $0.28 per share, which we believe enables us to balance multiple objectives of managing and investing in the Bank and returning a substantial portion of cash to shareholders.

Industry Context

The banking industry continues to navigate a complex economic environment characterized by changing interest rates, persistent inflation, and potential recessionary pressures. FS Bancorp's strategic shift towards brokered Certificates of Deposit to repay higher-cost borrowings aligns with broader industry efforts to manage funding costs and liquidity in a rising rate environment. The increase in nonperforming loans and provision for credit losses, particularly in consumer and commercial construction segments, may reflect a broader trend of asset quality deterioration across the industry due to economic strain. The company's transition from a small bank holding company to a larger one subjects it to enhanced regulatory scrutiny, a trend seen across the financial sector as regulators tighten oversight.

Comparison to Industry Standards

• The company's net interest margin (NIM) of 4.37% for Q3 2025 is generally strong compared to many regional banks, which have seen NIMs fluctuate due to interest rate volatility and funding costs. For example, larger regional banks might report NIMs in the 3.0-4.0% range, while smaller community banks can sometimes achieve higher margins.
• The increase in nonperforming loans to 0.70% of total gross loans, while still manageable, indicates a potential softening in asset quality. This trend is being closely watched across the banking sector, with some institutions experiencing higher delinquencies in specific loan categories like commercial real estate or consumer loans.
• The ACL coverage ratio of 163.8% for nonperforming loans, while decreased, remains above 100%, which is a common benchmark for adequate coverage. However, it is lower than the 234.3% reported in the prior year, suggesting a reduced buffer compared to its own historical performance.
• FS Bancorp's capital ratios (e.g., CET 1 capital ratio of 12.64% for the Bank) are robust and comfortably exceed the 'well capitalized' thresholds, positioning it favorably against industry peers and regulatory expectations, especially as it transitions to a larger bank holding company status.

Corporate Governance

Legal Proceedings

• The company is occasionally involved in various legal proceedings in the normal course of business.
• Management believes any liability from such proceedings would not have a material adverse effect on the business or financial condition.
• No material pending legal actions were reported as of September 30, 2025.

Stakeholder Impact

• Shareholders: Experienced decreased EPS and net income, but saw an increase in book value per share. The new stock repurchase program could provide support for share price. Continued dividends are expected.
• Employees: Benefited from competitive wage adjustments and participate in share-based compensation plans.
• Customers: Continue to receive diversified financial products and services. The company is expanding into new markets. Elevated losses in indirect home improvement loans may indicate challenges for some customer segments.
• Depositors/Creditors: The company maintains strong capital ratios and is actively managing its funding structure. Uninsured deposits represent a notable portion (25.8%) of total deposits, which could be a factor for some depositors.

Next Steps

• Continue current practice of paying quarterly cash dividends on common stock, subject to Board discretion.
• Repurchase up to $5.0 million of common stock under the newly approved program, in addition to the remaining $826,000 from the prior program.
• Evaluate the impact of new FASB ASUs (2023-09, 2024-03, 2025-01) on consolidated financial statements.

Key Dates

Recommendation

The company presents mixed results. While net interest income and net interest margin improved, net income and EPS declined due to higher provisions for credit losses and increased income tax expense. Asset quality metrics, such as nonperforming loans and classified loans, deteriorated, and the ACL coverage ratio decreased. However, the company maintains strong capital ratios, exceeding regulatory requirements, and is actively managing its funding structure by reducing higher-cost borrowings with brokered deposits. The newly approved stock repurchase program is a positive signal for shareholder returns. Given the mixed signals and the current economic uncertainties, a 'Hold' recommendation is appropriate for investors to monitor asset quality trends and the effectiveness of funding strategies.

Keywords

FS Bancorp, 1st Security Bank, SEC 10-Q, Quarterly Report, Financial Results, Net Income, Earnings Per Share, Net Interest Income, Net Interest Margin, Credit Losses, Loan Portfolio, Deposits, Borrowings, Nonperforming Loans, Capital Ratios, Stock Repurchase, Banking Industry, Commercial Real Estate, Residential Lending, Consumer Loans, Mortgage Servicing Rights, Regulatory Capital