Executive Summary / Key Takeaways

• FS Bancorp, Inc. (NASDAQ: FSBW) operates as a relationship-driven community bank in the Pacific Northwest, balancing traditional commercial and consumer banking with a significant home lending segment and a geographically diverse indirect home improvement lending platform.
• Recent performance in Q1 2025 reflects the impact of higher interest rates and competitive pressures, with net income slightly decreasing year-over-year despite growth in net interest income, primarily driven by increased noninterest expense and loan loss provision.
• The company is strategically managing its balance sheet by leveraging brokered deposits to reduce higher-cost borrowings, contributing to a modest increase in net interest margin despite rising funding costs.
• Credit quality metrics show some pressure, with increases in nonperforming loans and net charge-offs, particularly in indirect home improvement and construction segments, necessitating increased provision for credit losses.
• FSBW maintains robust regulatory capital ratios, well exceeding minimum requirements, and continues to return capital to shareholders through dividends and an active share repurchase program, signaling financial strength and management confidence.

Setting the Scene: Community Roots and Strategic Direction

FS Bancorp, Inc., the holding company for 1st Security Bank of Washington, traces its origins in the Puget Sound area back to 1907. This deep historical connection to its communities forms the bedrock of its identity as a relationship-driven financial institution. The Bank's evolution, including its conversion to stock ownership in 2012 and strategic acquisitions like the purchase of Bank of America (BAC) branches in 2016 and Anchor Bank in 2018, has shaped its current footprint of 27 full-service branches across suburban communities in Washington and Oregon.

The Company's overarching strategy centers on diversifying revenue streams, expanding lending channels, and enhancing its banking franchise. This involves growing its loan portfolio across various segments, maintaining strong asset quality, attracting lower-cost core deposits, and deepening customer relationships through a broad array of products and services. Geographic expansion, particularly through its indirect home improvement lending platform, is a key component of this strategy.

Within the competitive landscape of the Pacific Northwest, FSBW operates alongside larger regional players like Banner Corporation (BANR), Heritage Financial Corporation (HFWA), and Washington Federal, Inc. (WAFD), as well as smaller community banks and increasingly, fintech firms. While precise, directly comparable market share figures for all niche competitors are not publicly detailed, FSBW positions itself by emphasizing personalized service and local market expertise, particularly in suburban and rural areas. This community-focused approach is a core differentiator, fostering customer loyalty that can translate into more stable deposit bases and lending relationships compared to competitors focused purely on scale or digital efficiency.

However, this competitive environment presents challenges. Increased competitive pressures among financial services companies are noted as a risk factor. Larger regional banks like BANR and WAFD often possess greater scale and have invested heavily in digital transformation, potentially offering faster processing times and lower operating costs per unit in certain areas compared to FSBW's more traditional, branch-heavy model. Fintech firms, while indirect competitors, disrupt traditional banking by offering faster, cheaper digital alternatives, particularly in consumer lending, which could erode market share for banks like FSBW if they do not adapt. FSBW's management acknowledges the need to leverage online banking platforms, mobile banking apps, and telephone banking to serve customers, indicating an understanding of the importance of technology, though there is no detail provided regarding any unique, differentiated banking technology or significant R&D initiatives aimed at creating a technological moat beyond standard industry offerings. The strategic response appears to be focusing on enhancing existing digital channels to complement the strong relationship-based model, rather than leading with technological innovation.

Segment Performance and Operational Dynamics

FSBW operates through two primary reportable segments: Commercial and Consumer Banking and Home Lending.

The Commercial and Consumer Banking Segment is the larger of the two, encompassing traditional branch-based activities, deposit gathering, and a diverse range of lending including commercial real estate (CRE), residential real estate (excluding loans held for sale), consumer loans (excluding indirect home improvement and marine), and commercial business loans. For the three months ended March 31, 2025, this segment generated total income of $40.66 million, a modest increase from $40.37 million in the prior-year quarter. However, segment net income decreased to $7.78 million from $8.15 million, reflecting pressures on profitability within this core segment. Segment assets stood at $2.42 billion as of March 31, 2025, showing slight growth from $2.41 billion at December 31, 2024.

The Home Lending Segment focuses primarily on originating one-to-four-family residential mortgage loans. A significant portion of these loans are originated for sale into the secondary market, often with servicing rights retained, providing a recurring fee income stream. This segment also includes residential mortgage and home equity loans originated for the portfolio. This segment demonstrated stronger top-line growth, with total income increasing significantly to $11.26 million for the three months ended March 31, 2025, compared to $9.63 million in the same period of 2024, a nearly 17% increase. Despite this revenue growth, segment net income saw a slight decrease to $242,000 from $246,000, indicating that increased expenses or provision costs within the segment offset the revenue gains. Segment assets were $641.27 million at March 31, 2025, up from $618.40 million at December 31, 2024.

A notable operational detail is the Company's indirect home improvement lending platform. This operates through a network of contractors and dealers across multiple states, primarily in the Western U.S. While geographically diverse, this platform carries a concentration risk, with five contractor/dealers responsible for a significant 79.8% of the dollar volume of funded loans in this category during Q1 2025. Originations in this segment totaled $26.86 million in Q1 2025. This concentration highlights a potential vulnerability if relationships with key dealers are disrupted.

One-to-four-family loan originations, encompassing loans held for sale, portfolio loans, and brokered loans, totaled $145.40 million in Q1 2025, a decrease of 5.6% from $153.95 million in Q1 2024, reflecting economic volatility. The Company sold $91.90 million of these loans in Q1 2025, slightly down from $93.90 million in Q1 2024. The gross margin on home loan sales decreased to 3.26% in Q1 2025 from 3.43% in Q1 2024, indicating a more competitive market environment impacting profitability on sold loans.

Financial Performance and Balance Sheet Dynamics

FSBW's consolidated net income for the three months ended March 31, 2025, was $8.02 million, a decrease from $8.40 million in the comparable period of 2024. This decline was primarily driven by a $1.53 million increase in noninterest expense and a $193,000 increase in the provision for credit losses, partially offset by a $636,000 increase in net interest income and a $692,000 reduction in the provision for income taxes.

Net interest income increased to $30.98 million in Q1 2025 from $30.35 million in Q1 2024. This improvement was primarily due to a $1.91 million increase in total interest income, largely from a $2.31 million increase in interest income on loans. This loan income growth stemmed from both a higher average loan balance and a 17-basis point increase in the average yield earned on loans, as new originations and variable-rate loans repriced higher in the rising interest rate environment. However, total interest expense also increased by $1.27 million, driven by higher market interest rates and a shift in the deposit mix towards higher-cost brokered CDs. Despite rising funding costs, the net interest margin (annualized) increased by six basis points to 4.32% in Q1 2025, reflecting the asset yields outpacing the increase in funding costs, supported by a higher average capital base.

The provision for credit losses increased to $1.60 million in Q1 2025 from $1.40 million in Q1 2024. This increase reflects growth in the loan portfolio, an increase in nonperforming loans, and higher net charge-offs. Net loan charge-offs totaled $1.72 million in Q1 2025, up from $1.48 million in Q1 2024, primarily due to increased charge-offs in indirect home improvement and commercial business loans.

Noninterest income remained relatively flat at $5.13 million in Q1 2025 compared to $5.11 million in Q1 2024. Changes within this category included a reduction in service charges and fee income (partially due to the sale of MSRs in Q1 2024) and an increase in other noninterest income, boosted by unrealized gains on portfolio loans measured at fair value.

Noninterest expense increased by $1.53 million to $25.06 million in Q1 2025, up from $23.53 million in Q1 2024. This rise was mainly attributable to increases in salaries and benefits ($976,000) due to competitive wage adjustments, additional staffing, and higher benefit costs, as well as a $437,000 increase in operations expenses. This increase in operating costs outpaced revenue growth, leading to a weakening of the efficiency ratio to 69.39% in Q1 2025 from 66.36% in Q1 2024.

Total assets increased by $36.90 million to $3.07 billion at March 31, 2025, from $3.03 billion at December 31, 2024. This growth was primarily funded by a significant increase in deposits. Total deposits rose by $275.70 million to $2.62 billion, reflecting increases across all categories. Notably, non-retail CDs, primarily brokered CDs, increased by $196.80 million. The Company strategically utilized these brokered deposits to reduce higher-cost borrowings, which decreased by $239.00 million to $68.81 million at March 31, 2025. This shift in funding structure is a key balance sheet management tactic in the current rate environment.

Credit quality indicators show some areas of concern. Classified loans, all substandard, increased slightly to $23.50 million at March 31, 2025, from $22.90 million at December 31, 2024. Nonperforming loans (nonaccrual loans) increased by $870,000 to $14.50 million, driven by increases in construction, indirect home improvement, and one-to-four-family segments, partially offset by decreases in CRE owner-occupied and commercial business loans. The ratio of nonperforming loans to total gross loans edged up to 0.57% from 0.54%. While these levels are not alarming, they warrant close monitoring, particularly given the increase in net charge-offs.

Capital Strength and Shareholder Returns

FSBW maintains a strong capital position, with both the Bank and the holding company exceeding all regulatory capital requirements and the capital conservation buffer as of March 31, 2025. The Bank's Tier 1 leverage, Tier 1 risk-based, total risk-based, and CET1 capital ratios were 11.30%, 13.20%, 14.40%, and 13.20%, respectively, well above the "well capitalized" thresholds. The Company's ratios were similarly robust at 9.90%, 11.50%, 14.70%, and 11.50%. This strong capital base provides a buffer against potential credit losses and supports future growth initiatives.

Total stockholders' equity increased by $3.07 million to $298.84 million at March 31, 2025, driven by net income and equity award compensation, partially offset by share repurchases and dividends. Book value per common share increased to $39.12 from $38.26 at December 31, 2024.

The Company continues its practice of returning capital to shareholders. It expects to continue paying quarterly cash dividends, subject to Board discretion, with the current rate at $0.28 per share. Based on current shares outstanding, this implies a quarterly payout of approximately $2.2 million. Furthermore, the Board authorized an additional $5.0 million share repurchase program in April 2025, adding to the approximately $873,000 remaining under a previous program as of March 31, 2025. These repurchases can enhance shareholder value by reducing the share count.

Outlook and Key Considerations

While the Company notes that Q1 2025 results are not necessarily indicative of future periods, several forward-looking elements are highlighted. The Company expects approximately $922,000 to be reclassified from accumulated other comprehensive loss as a decrease to interest expense over the next 12 months related to cash flow hedges, which could provide a modest tailwind to net interest income. Fixed operating lease payments are projected at $1.2 million for the remainder of 2025.

Management expects to utilize its significant borrowing capacity with the FHLB ($570.0 million unused at Q1 2025) and FRB ($270.6 million limit) to fund loan originations, deposit withdrawals, and other financial commitments as needed, subject to market conditions. The strategic use of brokered deposits is likely to continue as a liquidity management tool.

Key risks to the outlook include potential adverse impacts from national and local economic conditions, such as inflation, recession, or slowed growth, which could increase credit losses and negatively affect financial performance. Changes in interest rates remain a significant factor, influencing asset yields, funding costs, and the valuation of MSRs and investment securities. Competition from other financial institutions and fintechs could pressure margins and market share. Concentration risk in the indirect home improvement lending segment is also a factor to monitor.

The promotion of Phillip Whittington to Chief Financial Officer, effective May 1, 2025, represents a leadership transition that will be watched by investors.

Conclusion

FS Bancorp operates as a deeply embedded community bank in the Pacific Northwest, leveraging its relationship-based model and diversified lending activities to generate earnings. The Q1 2025 results reflect the current challenging environment of higher interest rates and increased competition, which pressured profitability despite growth in net interest income. The Company's strategic use of brokered deposits to manage funding costs and its strong capital position are key strengths in this landscape.

While facing headwinds from rising expenses and some deterioration in credit quality metrics, FSBW's robust capital levels and ongoing commitment to shareholder returns through dividends and share repurchases provide a degree of stability. The investment thesis hinges on the Company's ability to effectively manage credit risk in a potentially slowing economy, control operating expenses to improve efficiency, and continue to grow its loan portfolio and deposit base in a competitive market, leveraging its community focus while enhancing its digital capabilities. Investors should closely monitor trends in asset quality, net interest margin trajectory, and the effectiveness of cost management initiatives as key indicators of the Company's ability to navigate the current environment and execute its long-term strategy.