FS Bancorp’s Q1 Earnings Show Resilience Amid Rising Deposits, But Credit Risks Linger

FS Bancorp, Inc. (ticker: FSBK) reported first-quarter 2025 net income of $8.0 million, or $1.01 per diluted share, marking a slight year-over-year decline but a sequential improvement from the previous quarter. The results underscore the regional bank’s ability to navigate a challenging interest rate environment, though credit quality metrics and strategic shifts in funding sources warrant closer scrutiny.

Deposit Growth Drives Balance Sheet Expansion
The quarter’s standout performance came from deposits, which surged by 11.8% to $2.62 billion, driven by a $226.9 million influx in brokered deposits. This shift reflects the bank’s strategy to replace higher-cost borrowings with cheaper wholesale CDs, which likely contributed to the $239 million reduction in borrowings. Noninterest-bearing deposits also rose to $676.7 million, signaling stronger core customer relationships. This growth is critical as banks increasingly compete for deposits in a rising-rate environment.

However, the reliance on brokered deposits—a cheaper but less stable funding source—raises questions about liquidity risk. While the move reduces funding costs, it could leave the bank exposed if market conditions shift abruptly.

Loan Portfolio Stability Masks Sector-Specific Weakness
Total loans remained steady at $2.50 billion, with year-over-year growth of 3.5%. Yet, the consumer lending segment—a key focus for FS Bancorp—declined by $11.3 million (1.8%) sequentially. This drop was concentrated in home improvement loans, which make up 87.4% of the consumer portfolio. While originations skewed toward high-credit-quality borrowers (79.9% of loans to FICO scores above 720), the contraction hints at broader demand headwinds in residential construction.

Commercial real estate (CRE) loans, meanwhile, grew by $44.8 million year-over-year, accounting for 34.5% of the portfolio. This expansion aligns with FS Bancorp’s focus on construction and development lending, but it also amplifies sector-specific risks.

Credit Metrics Signal Early Stress
Nonperforming loans (NPLs) rose to $14.5 million, up $0.9 million sequentially and $2.4 million year-over-year. CRE construction loans and indirect home improvement loans were the primary culprits. Substandard loans also increased by $0.6 million to $23.5 million, suggesting heightened risks in these segments. While the allowance for credit losses (ACLL) dipped slightly to $31.7 million (1.25% of gross loans), it remains elevated year-over-year, implying management’s cautious stance.

The rise in problem loans is a red flag. CRE and construction lending are cyclical, and with the Federal Reserve’s rate-hike cycle still fresh, borrowers in these sectors may face cash flow strains.

Margin Pressure and Cost Inflation
The net interest margin (NIM) improved to 4.32% (annualized), a 6-basis-point increase from the prior year, driven by higher loan yields. However, noninterest expenses surged by $1.5 million to $25.0 million, largely due to rising salaries and operational costs. This expense growth could compress profitability if not controlled.

Dividend Sustainability and Capital Strength
FS Bancorp maintained its 49th consecutive quarterly dividend of $0.28 per share, supported by a solid capital base. The bank’s total risk-based capital ratio of 14.4% and CET1 ratio of 11.5% comfortably exceed “well-capitalized” thresholds. The recent $5.0 million share repurchase authorization further signals confidence in capital management.

Conclusion: A Mixed Picture for Investors
FS Bancorp’s Q1 results highlight a bank in transition. Deposit growth and capital strength are positives, while the rising NPLs and expense pressures pose risks. The CRE and construction lending focus could pay off if regional markets stabilize, but it also creates vulnerability to economic slowdowns.

Investors should monitor two key metrics:
1. Nonperforming Loans: A further rise in NPLs or substandard loans could signal deeper credit issues.
2. Cost Control: The $1.5 million expense increase must be tempered in future quarters to protect margins.

At its current valuation—trading at 1.2x tangible book value—FS Bancorp appears fairly priced. However, the stock’s performance will hinge on whether its construction lending bets pan out and credit metrics stabilize. For now, the bank remains a hold, with upside potential if regional economic conditions improve and expense growth slows.

The path forward is clear: manage credit risks, contain costs, and leverage deposit growth to offset margin pressures. Until those factors align, investors should proceed with caution.