Executive Summary / Key Takeaways

• Community-Centric Growth with Strategic Diversification: FS Bancorp, through its 1st Security Bank subsidiary, maintains a strong community banking presence in the Pacific Northwest, strategically expanding its loan portfolio across commercial real estate, residential, consumer, and commercial business segments. This localized approach fosters deep customer relationships and underpins its stable deposit base.
• Adapting to Funding Dynamics: The company has effectively managed its funding mix by increasing lower-cost brokered Certificates of Deposit (CDs) to repay higher-cost borrowings, resulting in an improved loan-to-deposit ratio and a slight expansion in its Net Interest Margin (NIM) despite a competitive environment.
• Asset Quality Under Scrutiny: While overall loan growth is positive, FS Bancorp has experienced elevated net charge-offs in its consumer loan portfolio, particularly indirect home improvement loans, and an increase in nonperforming loans, signaling areas requiring close monitoring amidst strained economic conditions.
• Leveraging Digital for Broader Reach: FS Bancorp utilizes online and mobile banking platforms to enhance customer service and extends its lending footprint through an extensive indirect home improvement loan dealer network across multiple states, demonstrating a strategic blend of traditional and digitally-enabled operations.
• Leadership Transition and Shareholder Returns: A planned CEO succession for 1st Security Bank is underway, with Matthew D. Mullet taking the helm, while FS Bancorp continues to prioritize shareholder returns through a consistent dividend policy and an active share repurchase program.

A Community Bank's Enduring Strategy and Evolving Digital Footprint

FS Bancorp, Inc. (NASDAQ:FSBW), the holding company for 1st Security Bank of Washington, has cultivated a rich history rooted in community banking, serving the Puget Sound area since 1907. This foundational commitment to local families and businesses continues to define its operations across 27 full-service bank branches and various loan production offices in Washington and Oregon. The company's strategic evolution, marked by its conversion to stock ownership in 2012 and subsequent acquisitions, including Anchor Bank in 2018, has consistently aimed at diversifying revenue streams, expanding lending channels, and enhancing its banking franchise.

The overarching strategy for FS Bancorp is to grow and diversify its loan portfolio, maintain strong asset quality, emphasize lower-cost core deposits, and capture comprehensive customer relationships through a broad array of products and services. This is achieved by leveraging community involvement and selectively expanding into new markets. The company's loan portfolio at September 30, 2025, reflects this diversification, comprising commercial real estate (35.40%), residential real estate (29.10%), consumer loans (22.90%), and commercial business loans (12.40%). This balanced approach positions FS Bancorp to capitalize on various regional economic cycles while managing concentration risks.

In a broader industry context, prevailing economic conditions, government policies, and interest rate fluctuations significantly influence deposit flows and lending activities. The banking sector is currently experiencing increased competitive pressures, particularly from digital-first players and larger regional banks. FS Bancorp's ability to adapt to these dynamics, including shifts in consumer behavior towards digital banking and the impact of inflation or slowed economic growth, is crucial for its sustained performance.

Operational Technology and Strategic Digital Integration

While FS Bancorp does not detail a proprietary, breakthrough technology in the manner of a fintech innovator, its operational model strategically integrates digital capabilities to enhance its community banking and lending services. The Commercial and Consumer Banking segment provides services through "online banking platforms, mobile banking apps, and telephone banking". These digital channels are essential for meeting modern customer expectations and maintaining competitiveness in a banking landscape increasingly shaped by technological advancements.

A key operational differentiator for FS Bancorp lies in its indirect home improvement lending platform. This segment, a significant component of its consumer loan portfolio, operates through a network of 33 active contractor-dealers spanning 13 states across the Western U.S., including Washington, Oregon, California, and Idaho. This network effectively extends the company's lending reach far beyond its physical branch footprint, enabling geographic diversification of its loan originations without the overhead of traditional branches. While specific quantifiable benefits like cost reduction percentages or efficiency gains from this platform are not explicitly detailed, the strategic intent is clear: to leverage a scalable, digitally-enabled network for loan growth in a specialized consumer segment.

The company's investment in "system upgrades" also indicates an ongoing commitment to enhancing its operational technology. This continuous improvement is vital for supporting its diverse product offerings, improving efficiency, and responding to the "digital expansions by competitors". For investors, this strategic integration of digital tools, particularly in indirect lending, contributes to FS Bancorp's competitive moat by enabling broader market access and potentially more efficient customer acquisition within its niche, even as it maintains its traditional community banking strengths.

Segment Performance: Pillars of Growth and Challenge

FS Bancorp operates through two primary segments: Commercial and Consumer Banking, and Home Lending. Both contribute to the company's overall financial health, albeit with varying dynamics.

The Commercial and Consumer Banking Segment provides diversified financial products and services, including deposit products and a range of lending portfolios. For the nine months ended September 30, 2025, this segment generated $126.51 million in total income, an increase of 3.68% from $122.02 million in the comparable period of 2024. Net income for this segment, however, saw a 7.15% decrease to $23.56 million for the nine months ended September 30, 2025, from $25.37 million in the prior year. Management commentary indicates that loan growth in this segment was concentrated in commercial construction and development, multi-family, and residential real estate, reflecting continued demand in those markets. Conversely, consumer loan balances, particularly indirect home improvement loans, declined, "presumably due to volatile economic conditions, as the Company continued to manage indirect exposures".

The Home Lending Segment primarily originates one-to-four-family residential mortgage loans for sale in secondary markets, often retaining servicing rights. This segment reported total income of $35.84 million for the nine months ended September 30, 2025, a robust 9.30% increase from $32.79 million in the same period of 2024. Despite this revenue growth, net income for the Home Lending segment decreased by 39.73% to $1.37 million for the nine months ended September 30, 2025, compared to $2.27 million in the prior year. Management noted that one-to-four-family loan originations and refinancing activity decreased in the third quarter of 2025 due to "economic volatility in the markets". The gross margin on home loan sales, however, improved to 3.14% for the nine months ended September 30, 2025, up from 3.06% in the prior year, indicating efficient execution on sales.

Financial Performance: A Closer Look at Recent Trends

FS Bancorp's recent financial performance reflects a mixed but strategically managed environment. For the nine months ended September 30, 2025, net income was $24.93 million, a decrease from $27.64 million in the comparable period of 2024. Diluted earnings per share (EPS) followed a similar trend, falling to $3.18 from $3.45 year-over-year. This decline was primarily attributed to increased noninterest expense, a higher provision for credit losses, and a significant increase in income tax provision, partially offset by an increase in net interest income.

Net interest income, a core driver of profitability for banks, increased by $4.80 million to $96.80 million for the nine months ended September 30, 2025, compared to $92.00 million in the prior year. This growth was primarily fueled by a higher average balance of loans outstanding and a 13-basis point increase in the average yield earned on loans, as new loans were originated at higher rates and variable-rate loans repriced higher. The annualized Net Interest Margin (NIM) also saw a slight improvement, rising three basis points to 4.33% for the nine months ended September 30, 2025, from 4.30% in the prior year. This indicates effective asset-liability management in a rising rate environment.

Interest expense, however, increased by $3.80 million to $49.70 million for the nine months ended September 30, 2025. This was largely a result of a strategic shift in the funding mix toward brokered CDs, which were utilized to repay higher-cost borrowings, aligning with the company's funding and liquidity strategy.

Noninterest income decreased by $1.10 million to $15.90 million for the nine months ended September 30, 2025. This was mainly due to lower service charges and fee income and the absence of Mortgage Servicing Rights (MSRs) sales in the current period, which had contributed $8.40 million in the prior year. Noninterest expense increased by $2.70 million to $75.90 million, primarily due to higher salaries and benefits and operations expenses, partially offset by a recovery in MSRs. The efficiency ratio, a measure of operational effectiveness, weakened slightly to 67.40% for the nine months ended September 30, 2025, from 67.21% in the prior year, as noninterest expense growth outpaced total revenue growth. The provision for income taxes significantly increased due to the absence of alternative energy tax credits available in the comparable prior-year periods under the Inflation Reduction Act of 2022.

Asset Quality and Risk Management

FS Bancorp's loan portfolio totaled $2.63 billion at September 30, 2025, with an Allowance for Credit Losses (ACL) on loans of $30.06 million, representing 1.14% of gross loans receivable. While the ACL on loans decreased from $31.87 million at December 31, 2024, the provision for credit losses increased for both the three and nine months ended September 30, 2025. This increase was primarily driven by elevated net charge-offs in the consumer loan portfolio, particularly indirect home improvement loans, and a $2.30 million partial charge-off on a commercial construction loan that had been previously reserved.

Nonperforming loans, consisting solely of nonaccrual loans, increased by $4.80 million to $18.40 million at September 30, 2025, from $13.60 million at December 31, 2024. This rise was mainly observed in construction and development CRE loans, indirect home improvement loans, and one-to-four-family residential loans. Management attributes this to "continued elevated losses in certain consumer loans due to strained economic conditions and in construction and development loans due to a collateral deficiency on a commercial construction project". The ratio of nonperforming loans to total gross loans consequently rose to 0.70% at September 30, 2025, from 0.54% at December 31, 2024. This trend highlights the ongoing credit risks in certain segments, particularly sensitive to economic volatility.

To mitigate economic risks, including interest rate, liquidity, and credit risk, FS Bancorp actively manages its assets and liabilities and utilizes derivative financial instruments such as interest rate swaps for cash flow and fair value hedges. The company also employs brokered deposits "to mitigate interest rate risk and to enhance liquidity when appropriate".

Liquidity and Capital Strength

FS Bancorp maintains a robust liquidity position, with total assets increasing by $179.60 million to $3.21 billion at September 30, 2025, primarily funded by brokered deposits. Total liabilities increased by $174.90 million to $2.91 billion, driven by a $347.10 million increase in deposits, largely offset by a $178.50 million decrease in borrowings. This strategic shift is reflected in the improved loan-to-deposit ratio, which decreased to approximately 99.30% at September 30, 2025, from 109.50% at December 31, 2024. The increase in non-retail CDs, including brokered CDs, aligns with the company's strategy "to manage interest rate risk and liquidity by accessing larger and more diversified funding sources at competitive rates that were only slightly higher than local market rates, and to reduce reliance on higher cost borrowings".

The company's borrowing capacity remains strong, with $504 million in unused capacity from the Federal Home Loan Bank (FHLB) of Des Moines and a $265.50 million short-term borrowing line with the Federal Reserve Bank (FRB) of San Francisco. Uninsured deposits constituted approximately 25.80% of total deposits at September 30, 2025.

From a capital perspective, FS Bancorp and its subsidiary, 1st Security Bank, are categorized as "well capitalized" under applicable regulatory requirements, exceeding all minimum capital ratios. As of June 30, 2025, the company's total consolidated assets exceeded $3 billion, reclassifying it as a larger bank holding company subject to enhanced regulatory requirements for reporting, capital, and governance. At September 30, 2025, FS Bancorp's regulatory capital ratios were 9.50% for Tier 1 leverage, 11% for Tier 1 risk-based, 13.90% for total risk-based, and 11% for Common Equity Tier 1 (CET1) capital.

Competitive Landscape: Standing Tall in the Pacific Northwest

FS Bancorp operates within a competitive regional banking landscape in the Pacific Northwest, facing both direct and indirect rivals. Direct competitors include established regional banks such as Washington Federal Inc. , Banner Corporation , and Heritage Financial Corporation , all vying for market share in commercial and consumer banking, as well as home lending.

FSBW's market positioning is characterized by its community-focused approach and specialized lending expertise. While precise, directly comparable market share figures for all niche competitors are not publicly detailed, the company's strong performance in targeted segments suggests effective penetration. Compared to a larger regional player like Washington Federal Inc. (WAFD), FSBW's emphasis on personalized service and deep local ties may foster greater customer loyalty in suburban communities, potentially leading to more stable deposit bases and stronger relationship-based lending. WAFD, with its broader geographic footprint, might offer greater scalability, but could lack the hyper-local responsiveness that FSBW cultivates. In terms of valuation, FSBW's P/E ratio of 9.12 is lower than WAFD's 11.43, and its P/B ratio of 0.98 is higher than WAFD's 0.80, suggesting a different market perception of growth versus asset value.

Against Banner Corporation (BANR), which focuses on regional expansion and digital transformation, FSBW's community-oriented strategy could provide an edge in customer relationships, while BANR might lead in the speed of technological innovation and broader digital accessibility. FSBW's specialized home lending segment, with its unique product variety, could differentiate it, but BANR's integrated digital tools might offer superior efficiency in standardized services. BANR's P/E of 10.71 and P/B of 1.07 suggest a slightly higher valuation than FSBW.

Heritage Financial Corporation (HFWA) shares many similarities with FSBW as a regional player focused on small to mid-sized businesses and real estate lending. FSBW's branch network and specialized home lending could lead in customer accessibility and product depth for specific niches. HFWA's P/E of 13.08 and P/B of 0.83 indicate a higher P/E but lower P/B compared to FSBW.

Indirect competitors, including fintech companies, online banks, and alternative lending platforms, pose a different challenge by offering accessible and potentially cheaper digital-first services. These entities could erode market share in consumer and small business lending, pressuring FSBW's revenue opportunities. However, FSBW's established branch network and relationship-based model provide a counter-balance, particularly for customers who value in-person service and local expertise. The company's strategy to increase non-retail CDs at competitive rates, "only slightly higher than local market rates", demonstrates its ability to attract funding while managing interest rate risk, directly addressing competitive pressures for deposits.

Outlook and Strategic Initiatives

FS Bancorp's outlook is shaped by its commitment to strategic growth, shareholder returns, and effective leadership transition. The company anticipates continuing its current practice of paying quarterly cash dividends on common stock, currently at $0.28 per share, a rate believed to balance investments in the bank with returning a substantial portion of cash to shareholders.

In a move to enhance shareholder value, the Board of Directors authorized an additional stock repurchase program of up to $5.0 million on October 27, 2025, supplementing the remaining $826,000 under the existing program. This program is slated for execution over a 12-month period, reflecting management's confidence in the company's intrinsic value.

A significant leadership transition is underway, with Matthew D. Mullet having been named President and CEO of 1st Security Bank, effective September 1, 2025. Joseph C. Adams, who has served as CEO of the Bank since 2004, will retire from that position but will continue as CEO of FS Bancorp, Inc. until May 2026. This planned succession aims to ensure continuity and leverage Mullet's extensive financial services experience and deep knowledge of community banking.

Looking ahead, FS Bancorp expects to utilize its borrowing facilities from the FHLB and FRB to fund loan originations, deposit withdrawals, satisfy financial commitments, and capitalize on investment opportunities, subject to market conditions. The company also projects fixed commitments of $491,000 for operating lease payments for the remainder of 2025.

Conclusion

FS Bancorp, Inc. stands as a resilient community bank, strategically deepening its roots in the Pacific Northwest while extending its reach through digitally-enabled lending channels. The core investment thesis rests on its ability to leverage strong local relationships and a diversified loan portfolio to generate stable net interest income, even amidst a challenging economic backdrop. While recent financial results reflect pressures from increased credit loss provisions and higher operating expenses, the company's proactive management of its funding mix and a slight expansion in NIM demonstrate operational agility.

The planned leadership transition and ongoing commitment to shareholder returns through dividends and share repurchases underscore a forward-looking approach. Despite facing competitive pressures from both traditional regional banks and emerging fintech players, FS Bancorp's blend of community focus and strategic digital integration, particularly in its indirect home improvement lending, provides a distinct competitive advantage. Investors should monitor asset quality trends, especially in consumer and construction loan segments, and the continued effectiveness of its digital strategies in driving growth and efficiency. FS Bancorp's enduring commitment to its community-centric model, coupled with a pragmatic approach to market dynamics and technological adoption, positions it for continued relevance and value creation in the evolving banking landscape.