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

In a year where bank earnings broadly experienced a number of acute headwinds, FSBW’s ratings are supported by an earnings profile that has displayed comparative stability. In this regard, FSBW’s 2023 ROA of 1.27% marks a modest improvement compared to 2022 (1.22%) and was supported, in no small part, by the fortuitous timing of the company’s 1Q23 acquisition of ~$380 million of low-cost deposits from Columbia Banking System, Inc. (NASDAQ: COLB), just weeks before the failure of a number of regional U.S. community banks spurred one of the most competitive funding environments in recent memory. Resultingly, the company was spared the worst of funding pressures endured by most peers in the immediate aftermath of March 2023, and FSBW’s deposit costs, which have historically exhibited a higher beta than peers, have risen more modestly than most through 2023 (+117 bps to 1.95% in 4Q23). NIM compression in recent periods has, therefore, naturally been more modest (-38 bps through 4Q23 to 4.24%) and helped support headline earnings. 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, and indirect consumer lending exposure. Credit quality metrics have remained strong through 2023, with NCOs totaling 0.09% of average loans, and NPAs remain contained at 0.37% of total loans. Furthermore, when examining early indicators of potential credit stress in FSBW’s loan portfolio, we highlight that while criticized loans have risen 23% from 2022 levels, they remain limited at 1% of total loans. Additionally, though delinquencies in FSBW’s consumer loan portfolio have ticked up modestly in the back half of 2023 (related ratio of 0.50% in June 2023 vs. 0.71% at YE23), 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.

With respect to capital management, the closing of the COLB branch acquisition in 1Q23 contributed to a temporary 100 bp decline in FSBW’s CET1 ratio (to 9.7% in 1Q23). Since the closing of the branch acquisition, FSBW’s CET1 capital ratio has rebounded higher by 80 bps to 10.5% in 4Q23, though remains lower than pre-acquisition. While we appreciate the incremental capital build, KBRA notes that a CET1 ratio of 10.5%, which we believe is on the higher end of management’s targeted range, would still trail peer averages. Furthermore, we add that evaluation of FSBW’s capital profile is made in conjunction with a loan portfolio that has a larger than peer exposure to 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 with deposit costs falling in line with rated peers, if coupled with the elongated maintenance of capital at peer levels or higher and continued solid asset quality. Alternatively, 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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