KBRA Affirms Ratings for FS Bancorp, Inc.

KBRA affirms the senior unsecured debt rating of BBB, the subordinated debt rating of BBB-, and the short-term debt rating of K3 for Mountlake Terrace, Washington-based FS Bancorp, Inc. (NASDAQ: FSBW) (“the company”). In addition, KBRA affirms the deposit and senior unsecured debt ratings of BBB+, the subordinated debt rating of BBB, and the short-term deposit and debt ratings of K2 for the subsidiary bank, 1st Security Bank of Washington. The Outlook for all long-term ratings is Stable.

Key Credit Considerations

The ratings are supported by the company’s above peer NIM the has historically hovered above 4.00% since 2012 (4.30% for FY24) supported by a balance sheet that has traditionally been more leveraged to loans, reinforced by loan-to-earning asset and loan-to-deposit ratios that are often above those of peers (89% and 107% respectively). Additionally, FSBW’s loan portfolio consists of a greater exposure to higher yielding, perceived higher risk lending sectors such as point-of-sale consumer and construction, which supports an above average portfolio loan yield at 6.85% for 4Q24 compared to 6.14% for peers. The company’s acquisition of seven branches and $425 million in deposits from Columbia Banking System, Inc. in 1Q23 continues to benefit FSBW’s deposit profile with the cost of deposits below peers despite being primarily funded by more costly CDs (44% of total deposits). As such, the company experienced comparatively more muted NIM compression throughout the Federal Reserve's most recent rising rate cycle. That said, we recognise that the company’s earnings have fallen amid the higher rate environment as mortgage banking revenues, historically a significant contributor to noninterest income and overall company revenues, have meaningfully declined from a peak of 40% of revenue in 2020 to 16% in 2024. Nonetheless, FSBW’s earnings remain solid with an ROA of 1.18% for 2024. KBRA’s evaluation of FSBW’s asset quality balances the company’s strong contemporary credit performance with a somewhat elevated risk profile, above average RWA density (86% at 4Q24), and indirect consumer lending exposure. Credit quality metrics have ticked up slightly through 2024, though remain manageable with NCOs totaling 0.23% of average loans, and NPAs remain contained at 0.54% of total loans. Additionally, delinquencies in FSBW’s consumer loan portfolio have ticked up modestly, increasing to 1.19% at 4Q24, though management suggested that the majority of delinquencies were to borrowers on the lower end of the FICO spectrum – a bucket to which FSBW’s overall exposure is fairly minor. The company maintains ample loan loss reserves at 1.26% of total loans, covering NPLs by over 200%. With respect to capital management, the company has steadily improved capital metrics nearly 100 bps over the past year with CET1 ratio at 11.4% for 4Q24. We expect management to maintain capital near or better than current levels with a loan portfolio that has a larger than peer exposure to more risky indirect consumer and construction lending.

Rating Sensitivities

The Stable Outlook reflects KBRA's view that positive rating changes are unlikely over the near term. However, upward rating momentum could occur should the company measurably enhance its funding profile, if combined with the elongated maintenance of capital at peer levels or higher and continued solid asset quality. Growth beyond its internal capital generation capabilities, resulting in a negative impact to its capital position or stressed funding, or material credit underperformance compared to peers, could result in rating pressure.

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