UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM ~~10‑Q~~10-Q

(Mark One)

[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~September 30, 2017~~March 31, 2020 OR

[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001‑35589

FS BANCORP, INC.

(Exact name of registrant as specified in its charter)


Washington		45‑4585178
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

6920 220th Street SW, Mountlake Terrace, Washington 98043

(Address of principal executive offices; Zip Code)

(425) 771‑5299

(Registrant’s telephone number, including area code)

None

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $.01 per share	FSBW	The NASDAQ Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark whether the registrant has submitted electronically, ~~and posted on its corporate Web site, if any,~~ every Interactive Data File required to be submitted ~~and posted~~ pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit ~~and post~~ such files). Yes [X] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and ~~"emerging~~“emerging growth ~~company"~~company” in Rule 12b‑2 of the Exchange Act.


Large accelerated filer [ ]		Accelerated filer [ X ]
Non-accelerated filer [ ] ~~(Do not check if a smaller reporting company)~~		Smaller reporting company [ X ]
Emerging growth company [ X ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ~~[X]~~[ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act). Yes [ ] No [X]

~~APPLICABLE ONLY TO CORPORATE ISSUERS:~~

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: As of ~~November 3, 2017,~~April 30, 2020, there were ~~3,674,902~~4,281,541 outstanding shares of the registrant’s common stock.

Table of Contents

FS Bancorp, Inc.

Form 10‑Q

Table of Contents


		Page Number
PART I	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Balance Sheets at ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016~~2019 (Unaudited)	3

	Consolidated Statements of Income for the Three ~~and Nine~~ Months Ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019 (Unaudited)	4

	Consolidated Statements of Comprehensive Income for the Three ~~and Nine~~ Months Ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019 (Unaudited)	5

	Consolidated Statements of Changes in Stockholders’ Equity for the ~~Nine~~Three Months Ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019 (Unaudited)	6

	Consolidated Statements of Cash Flows for the ~~Nine~~Three Months Ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019 (Unaudited)	7 - 8

	Notes to Consolidated Financial Statements	89 - 4339

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	4441 - 5354

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	5354

Item 4.	Controls and Procedures	5354

PART II	OTHER INFORMATION	5554

Item 1.	Legal Proceedings	5554

Item 1A.	Risk Factors	55

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	5556

Item 3.	Defaults Upon Senior Securities	5556

Item 4.	Mine Safety Disclosures	5557

Item 5.	Other Information	5557

Item 6.	Exhibits	5658

SIGNATURES		5859

As used in this report, the terms “we,” “our,” “us,” “Company” and “FS Bancorp” refer to FS Bancorp, Inc. and its consolidated subsidiary, 1st Security Bank of Washington, unless the context indicates otherwise. When we refer to “Bank” in this report, we are referring to 1st Security Bank of Washington, the wholly owned subsidiary of FS ~~Bancorp, Inc.~~Bancorp.

Table of Contents

Item 1. Financial Statements

FS BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share amounts) (Unaudited)


	September 30,		December 31,
	2017		2016			March 31,		December 31,
ASSETS					ASSETS	2020			2019
Cash and due from banks	$	3,299	$	3,590	Cash and due from banks	$	12,928		$	13,175
Interest-bearing deposits at other financial institutions		27,996		32,866	Interest-bearing deposits at other financial institutions		35,993			32,603
Total cash and cash equivalents		31,295		36,456	Total cash and cash equivalents		48,921			45,778
Certificates of deposit at other financial institutions		18,108		15,248	Certificates of deposit at other financial institutions		17,926			20,902
Securities available-for-sale, at fair value		78,103		81,875	Securities available-for-sale, at fair value		156,466			126,057
Loans held for sale, at fair value		65,055		52,553	Loans held for sale, at fair value		115,632			69,699
Loans receivable, net		753,854		593,317	Loans receivable, net		1,393,070			1,336,346
Accrued interest receivable		3,217		2,524	Accrued interest receivable		6,326			5,908
Premises and equipment, net		15,463		16,012	Premises and equipment, net		28,655			28,770
Operating lease right-of-use (“ROU”) assets					Operating lease right-of-use (“ROU”) assets		4,692			5,016
Federal Home Loan Bank (“FHLB”) stock, at cost		3,047		2,719	Federal Home Loan Bank (“FHLB”) stock, at cost		10,921			8,045
Other real estate owned (“OREO”)					Other real estate owned (“OREO”)		90			168
Bank owned life insurance (“BOLI”), net		10,262		10,054	Bank owned life insurance (“BOLI”), net		35,572			35,356
Servicing rights, held at the lower of cost or fair value		5,811		8,459	Servicing rights, held at the lower of cost or fair value		10,626			11,560
Goodwill		2,312		2,312	Goodwill		2,312			2,312
Core deposit intangible, net		1,417		1,717	Core deposit intangible, net		5,281			5,457
Other assets		5,947		4,680	Other assets		10,678			11,682
TOTAL ASSETS	$	993,891	$	827,926	TOTAL ASSETS	$	1,847,168		$	1,713,056
LIABILITIES					LIABILITIES
Deposits:					Deposits:
Noninterest-bearing accounts	$	166,964	$	152,913	Noninterest-bearing accounts	$	285,566		$	273,602
Interest-bearing accounts		673,614		559,680	Interest-bearing accounts		1,160,703			1,118,806
Total deposits		840,578		712,593	Total deposits		1,446,269			1,392,408
Borrowings		10,270		12,670	Borrowings		159,114			84,864
Subordinated note:					Subordinated note:
Principal amount		10,000		10,000	Principal amount		10,000			10,000
Unamortized debt issuance costs		(160)		(175)	Unamortized debt issuance costs		(110)			(115)
Total subordinated note less unamortized debt issuance costs		9,840		9,825	Total subordinated note less unamortized debt issuance costs		9,890			9,885
Operating lease liabilities					Operating lease liabilities		4,898			5,214
Deferred tax liability, net					Deferred tax liability, net		2,260			1,971
Other liabilities		14,964		11,805	Other liabilities		23,908			18,472
Total liabilities		875,652		746,893	Total liabilities		1,646,339			1,512,814
COMMITMENTS AND CONTINGENCIES (NOTE 9)					COMMITMENTS AND CONTINGENCIES (NOTE 9)
STOCKHOLDERS’ EQUITY					STOCKHOLDERS’ EQUITY
Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued or outstanding		—		—	Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued or outstanding		—			—
Common stock, $.01 par value; 45,000,000 shares authorized; 3,674,902 and 3,059,503 shares issued and outstanding at September 30, 2017, and December 31, 2016, respectively		37		31
Common stock, $.01 par value; 45,000,000 shares authorized; 4,332,196 and 4,459,041 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively					Common stock, $.01 par value; 45,000,000 shares authorized; 4,332,196 and 4,459,041 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively		43			44
Additional paid-in capital		54,463		27,334	Additional paid-in capital		84,517			89,268
Retained earnings		65,049		55,584	Retained earnings		114,957			110,715
Accumulated other comprehensive loss, net of tax		(128)		(536)
Accumulated other comprehensive income, net of tax					Accumulated other comprehensive income, net of tax		1,819			788
Unearned shares – Employee Stock Ownership Plan (“ESOP”)		(1,182)		(1,380)	Unearned shares – Employee Stock Ownership Plan (“ESOP”)		(507)			(573)
Total stockholders’ equity		118,239		81,033	Total stockholders’ equity		200,829			200,242
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	993,891	$	827,926	TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	1,847,168		$	1,713,056

See accompanying notes to these consolidated financial statements.

Table of Contents

FS BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share amounts) (Unaudited)


	Three Months Ended				Nine Months Ended				Three Months Ended
	September 30,				September 30,				March 31,
	2017		2016		2017		2016		2020		2019
INTEREST INCOME
Loans receivable, including fees	$	11,715	$	9,241	$	31,488	$	26,014	$	20,740	$	21,109
Interest and dividends on investment securities, cash and cash equivalents, and certificates of deposit at other financial institutions		637		538		2,034		1,751		1,209		1,202
Total interest and dividend income		12,352		9,779		33,522		27,765		21,949		22,311
INTEREST EXPENSE
Deposits		1,045		808		2,793		2,411		3,807		3,710
Borrowings		114		50		259		177		497		744
Subordinated note		171		171		508		512		172		168
Total interest expense		1,330		1,029		3,560		3,100		4,476		4,622
NET INTEREST INCOME		11,022		8,750		29,962		24,665		17,473		17,689
PROVISION FOR LOAN LOSSES		450		600		450		1,800		3,686		750
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		10,572		8,150		29,512		22,865		13,787		16,939
NONINTEREST INCOME
Service charges and fee income		879		899		2,743		2,489		924		1,658
Gain on sale of loans		5,025		5,922		13,840		14,722		5,899		2,397
Gain on sale of investment securities		143		146		380		146
Gain on sale of mortgage servicing rights (“MSR”)		38		—		996		—
Earnings on cash surrender value of BOLI		68		71		208		211		216		215
Other noninterest income		274		210		637		557		1,852		285
Total noninterest income		6,427		7,248		18,804		18,125		8,891		4,555
NONINTEREST EXPENSE
Salaries and benefits		7,140		6,287		20,174		16,510		9,547		8,243
Operations		1,577		1,450		4,506		4,221		2,403		2,044
Occupancy		650		597		1,939		1,775		1,109		1,112
Data processing		651		537		1,811		1,576		980		1,286
Gain on sale of other real estate owned (“OREO”)		—		—		—		(150)
Loss (gain) on sale of OREO										2		(85)
OREO expenses										—		4
Loan costs		726		715		1,977		1,789		500		673
Professional and board fees		378		502		1,261		1,490		681		550
Federal Deposit Insurance Corporation (“FDIC”) insurance		175		98		428		306
Federal Deposit Insurance Corporation (“FDIC��) insurance										126		248
Marketing and advertising		192		202		512		553		146		135
Acquisition costs		—		—		—		389		—		374
Amortization of core deposit intangible		100		140		300		382		176		190
(Recovery) impairment on servicing rights		—		(216)		1		(2)
Impairment of servicing rights										514		23
Total noninterest expense		11,589		10,312		32,909		28,839		16,184		14,797
INCOME BEFORE PROVISION FOR INCOME TAXES		5,410		5,086		15,407		12,151		6,494		6,697
PROVISION FOR INCOME TAXES		1,956		1,629		5,001		4,198		1,327		1,505
NET INCOME	$	3,454	$	3,457	$	10,406	$	7,953	$	5,167	$	5,192
Basic earnings per share	$	1.13	$	1.21	$	3.53	$	2.74	$	1.16	$	1.19
Diluted earnings per share	$	1.07	$	1.18	$	3.31	$	2.66	$	1.14	$	1.15

See accompanying notes to these consolidated financial statements.

Table of Contents

FS BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands) (Unaudited)


	Three Months Ended				Nine Months Ended				Three Months Ended
	September 30,				September 30,				March 31,
	2017		2016		2017		2016		2020		2019
Net Income	$	3,454	$	3,457	$	10,406	$	7,953	$	5,167	$	5,192
Other comprehensive income, before tax:
Other comprehensive income:
Securities available-for-sale:
Unrealized holding gain during period		80		29		1,012		1,224		2,364		1,328
Income tax provision related to unrealized holding gain		(28)		(8)		(357)		(433)		(508)		(285)
Reclassification adjustment for realized gain included in net income		(143)		(146)		(380)		(146)
Income tax provision related to reclassification for realized gain		50		50		133		50
Other comprehensive (loss) income, net of tax		(41)		(75)		408		695
Cash flow hedges:
Unrealized holding loss during period										(1,052)		—
Reclassification for losses included in net income										1		—
Income tax benefit related to unrealized holding loss										226		—
Other comprehensive income, net of tax										1,031		1,043
COMPREHENSIVE INCOME	$	3,413	$	3,382	$	10,814	$	8,648	$	6,198	$	6,235

See accompanying notes to these consolidated financial statements.

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FS BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Dollars in thousands, except share amounts) (Unaudited)

Three Months Ended March 31, 2019 and 2020


								Accumulated													Accumulated
				Additional				Other		Unearned		Total									Other
	Common Stock			Paid-in		Retained		Comprehensive		ESOP		Stockholders’					Additional				Comprehensive		Unearned		Total
	Shares	Amount		Capital		Earnings		Income, Net of Tax		Shares		Equity		Common Stock			Paid-in		Retained		(Loss) Income,		ESOP		Stockholders’
BALANCE, January 1, 2016	3,242,120	$	32	$	30,692	$	46,175	$	78	$	(1,637)	$	75,340
														Shares	Amount		Capital		Earnings		Net of Tax		Shares		Equity
BALANCE, January 1, 2019														4,492,478	$	45	$	91,466	$	90,854	$	(1,479)	$	(848)	$	180,038
Net income	—	$	—		—		7,953		—		—	$	7,953	—	$	—		—		5,192		—		—	$	5,192
Dividends paid ($0.26 per share)	—	$	—		—		(802)		—		—	$	(802)
Dividends paid ($0.14 per share)														—	$	—		—		(663)		—		—	$	(663)
Share-based compensation	—	$	—		588		—		—		—	$	588	—	$	—		262		—		—		—	$	262
Restricted stock awards	4,500	$	—		—		—		—		—	$	—
Common stock repurchased	(198,167)	$	(1)		(4,902)		—		—		—	$	(4,903)
Stock options exercised	9,300	$	—		157		—		—		—	$	157
Common stock repurchased - repurchase plan														(6,036)	$	—		(285)		—		—		—	$	(285)
Stock options exercised, net														2,600	$	—		44		—		—		—	$	44
Other comprehensive income, net of tax	—	$	—		—		—		695		—	$	695	—	$	—		—		—		1,043		—	$	1,043
ESOP shares allocated	—	$	—		331		—		—		198	$	529	—	$	—		255		—		—		66	$	321
BALANCE, September 30, 2016	3,057,753	$	31	$	26,866	$	53,326	$	773	$	(1,439)	$	79,557
BALANCE, March 31, 2019														4,489,042	$	45	$	91,742	$	95,383	$	(436)	$	(782)	$	185,952

BALANCE, January 1, 2017	3,059,503	$	31	$	27,334	$	55,584	$	(536)	$	(1,380)	$	81,033
BALANCE, January 1, 2020														4,459,041	$	44	$	89,268	$	110,715	$	788	$	(573)	$	200,242
Net income	—	$	—		—		10,406		—		—	$	10,406	—	$	—		—		5,167		—		—	$	5,167
Dividends paid ($0.31 per share)	—	$	—		—		(941)		—		—	$	(941)
Proceeds from public offering, net of expenses	587,234	$	6		25,612		—		—		—	$	25,618
Dividends paid ($0.21 per share)														—	$	—		—		(925)		—		—	$	(925)
Share-based compensation	—	$	—		496		—		—		—	$	496	—	$	—		224		—		—		—	$	224
Common stock repurchased	(6,198)	$	—		(275)		—		—		—	$	(275)	(136,243)	$	(1)		(4,988)		—		—		—	$	(4,989)
Stock options exercised	34,363	$	—		580		—		—		—	$	580
Stock options exercised, net														9,398	$	—		(246)		—		—		—	$	(246)
Other comprehensive income, net of tax	—	$	—		—		—		408		—	$	408	—	$	—		—		—		1,031		—	$	1,031
ESOP shares allocated	—	$	—		716		—		—		198	$	914	—	$	—		259		—		—		66	$	325
BALANCE, September 30, 2017	3,674,902	$	37	$	54,463	$	65,049	$	(128)	$	(1,182)	$	118,239
BALANCE, March 31, 2020														4,332,196	$	43	$	84,517	$	114,957	$	1,819	$	(507)	$	200,829

See accompanying notes to these consolidated financial statements.

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FS BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands) (Unaudited)

Nine Months Ended September 30,


2017

2016
CASH FLOWS FROM OPERATING ACTIVITIES

Net income

$
10,406

$
7,953
Adjustments to reconcile net income to net cash from operating activities




Provision for loan losses

450

1,800
Depreciation, amortization and accretion

2,577

3,779
Compensation expense related to stock options and restricted stock awards

496

588
ESOP compensation expense for allocated shares

914

529
Increase in cash surrender value of BOLI

(208)

(211)
Gain on sale of loans held for sale

(13,840)

(14,722)
Gain on sale of investment securities

(380)

(146)
Gain on sale of OREO

—

(150)
Gain on sale of MSR

(996)

—
Origination of loans held for sale

(520,358)

(584,073)
Proceeds from sale of loans held for sale

520,091

564,218
Impairment (recovery) of servicing rights

1

(2)
Changes in operating assets and liabilities




Accrued interest receivable

(693)

(450)
Other assets

(79)

(7,481)
Other liabilities

2,668

5,063
Net cash from (used by) operating activities

1,049

(23,305)
CASH FLOWS FROM INVESTING ACTIVITIES




Activity in securities available-for-sale:




Proceeds from sale of investment securities

39,103

13,577
Maturities, prepayments, sales, and calls

6,531

9,039
Purchases

(41,320)

(47,432)
Maturities of certificates of deposit at other financial institutions

1,240

292
Purchase of certificates of deposit at other financial institutions

(4,102)

(1,882)
Loan originations and principal collections, net

(129,763)

(93,871)
Purchase of portfolio loans

(32,342)

—
Proceeds from sale of other real estate owned, net

—

682
Purchase of premises and equipment, net

(623)

(2,287)
FHLB stock, net

(328)

2,547
Proceeds from sale of MSR

4,827

—
Net cash received from acquisition

—

180,356
Net cash (used by) from investing activities

(156,777)

61,021
CASH FLOWS FROM FINANCING ACTIVITIES




Net increase in deposits

127,985

37,630
Borrowings, net

(2,400)

(77,740)
Dividends paid

(941)

(802)
Proceeds from stock options exercised

580

157
Common stock repurchased

(275)

(4,903)
Proceeds from issuance of common stock

25,618

—
Net cash from (used by) financing activities

150,567

(45,658)
NET DECREASE IN CASH AND CASH EQUIVALENTS

(5,161)

(7,942)
CASH AND CASH EQUIVALENTS, beginning of period

36,456

24,455
CASH AND CASH EQUIVALENTS, end of period

$
31,295

$
16,513

SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION




Cash paid during the period for:




Interest

$
3,528

$
2,931
Income taxes

$
5,800

$
4,420
Assets acquired in acquisition of branches (Note 2)

$
—

$
181,575
Liabilities assumed in acquisition of branches (Note 2)

$
—

$
186,393
SUPPLEMENTARY DISCLOSURES OF NONCASH OPERATING, INVESTING AND FINANCING ACTIVITIES


Change in unrealized gain on investment securities

$
631

$
1,079
Transfer portfolio loans to loans held for sale

$
1,886

$
—
Property received in settlement of loans

$
—

$
525
Retention of gross mortgage servicing rights from loan sales

$
3,569

$
2,927

~~See accompanying notes to these consolidated financial statements~~


	Three Months Ended March 31,
	2020		2019
CASH FLOWS (USED BY) FROM OPERATING ACTIVITIES
Net income	$	5,167	$	5,192
Adjustments to reconcile net income to net cash from operating activities
Provision for loan losses		3,686		750
Depreciation, amortization and accretion		2,178		2,321
Compensation expense related to stock options and restricted stock awards		224		262
ESOP compensation expense for allocated shares		325		321
Increase in cash surrender value of BOLI		(216)		(215)
Gain on sale of loans held for sale		(5,899)		(2,397)
Origination of loans held for sale		(259,191)		(125,281)
Proceeds from sale of loans held for sale		218,574		132,461
Impairment of servicing rights		514		23
Loss (gain) on sale of OREO		2		(85)
Changes in operating assets and liabilities
Accrued interest receivable		(418)		(51)
Other assets		5,058		(7,953)
Other liabilities		14		1,517
Net cash (used by) from operating activities		(29,982)		6,865
CASH FLOWS (USED BY) FROM INVESTING ACTIVITIES
Activity in securities available-for-sale:
Maturities, prepayments, and calls		12,002		4,659
Purchases		(40,236)		(6,005)
Maturities of certificates of deposit at other financial institutions		2,976		—
Loan originations and principal collections, net		(27,573)		26,997
Purchase of portfolio loans		(32,743)		(321)
Proceeds from sale of portfolio loans		—		538
Proceeds from sale of OREO, net		76		684
Purchase of premises and equipment, net		(583)		(860)
Change in FHLB stock, net		(2,876)		1,730
Net cash (used by) from investing activities		(88,957)		27,422
CASH FLOWS FROM (USED BY) FINANCING ACTIVITIES
Net increase in deposits		53,992		47,331
Proceeds from borrowings		203,750		155,306
Repayments of borrowings		(129,500)		(205,725)
Dividends paid on common stock		(925)		(663)
(Disbursements) proceeds from stock options exercised, net		(246)		44
Common stock repurchased		(4,989)		(285)
Net cash from (used by) financing activities		122,082		(3,992)
NET INCREASE IN CASH AND CASH EQUIVALENTS		3,143		30,295

CASH AND CASH EQUIVALENTS, beginning of period		45,778		32,779
CASH AND CASH EQUIVALENTS, end of period	$	48,921	$	63,074

SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest on deposits and borrowings	$	4,285	$	4,462
Income taxes		—		—

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FS BANCORP, INC. AND SUBSIDIARY

~~NOTES TO~~ CONSOLIDATED ~~FINANCIAL~~ STATEMENTS OF CASH FLOWS (Continued)

(In thousands) (Unaudited)

SUPPLEMENTARY DISCLOSURES OF NONCASH OPERATING, INVESTING AND FINANCING ACTIVITIES
Change in unrealized gain on investment securities, net	$	2,364	$	1,328
Change in unrealized loss on cash flow hedges, net		(1,051)		—
Retention of gross mortgage servicing rights from loan sales		1,185		844
Property taken in settlement of loans		—		92

See accompanying notes to these consolidated financial statements

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NOTE 1 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations - FS Bancorp, Inc. (the “Company”) was incorporated in September 2011 as the ~~proposed~~ holding company for 1st Security Bank of Washington (the “Bank” or “1st Security Bank”) in connection with the Bank’s conversion from the mutual to stock form of ownership which was completed on July 9, 2012. The Bank is a community-based savings bank with 1121 full-service bank branches, a headquarters that accepts deposits, and seven home loan production offices in suburban communities in the greater Puget Sound area which includes Snohomish, King, Pierce, Jefferson, Kitsap, Clallam, Grays Harbor, Thurston, and ~~Clallam~~Lewis counties, and one loan production office in the market area of the Tri-Cities, Washington. The Bank provides loan and deposit services to customers who are predominantly ~~small~~small- and middle-market businesses and individuals. The Bank acquired four retail bank branches from Bank of America, National Association (“Bank of America”) (two in Clallam and two in Jefferson counties) on January 22, 2016, and these branches opened as 1st Security Bank branches on January 25, 2016. The Company and its subsidiary are subject to regulation by certain federal and state agencies and undergo periodic examination by these regulatory agencies.

Pursuant to the Plan of Conversion (the “Plan”), the Company’s Board of Directors adopted an employee stock ownership plan (“ESOP”) which purchased 8% of the common stock in the open market or 259,210 shares. As provided for in the Plan, the Bank also established a liquidation account in the amount of retained earnings at December 31, 2011. The liquidation account is maintained for the benefit of eligible savings account holders at June 30, 2007, and supplemental eligible account holders as of March 31, 2012, who maintain deposit accounts at the Bank after the conversion. The conversion was accounted for as a change in corporate form with the historic basis of the Company’s assets, liabilities, and equity unchanged as a result.

Financial Statement Presentation - The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and in accordance with the instructions to Form 10‑Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”). It is recommended that these unaudited interim consolidated financial statements be read in conjunction with the Company’s Annual Report on Form 10‑K with all of the audited information and footnotes required by U.S. GAAP for complete financial statements for the year ended December 31, ~~2016,~~2019, as filed with the SEC on March 16, ~~2017.~~2020. In the opinion of management, all normal adjustments and recurring accruals considered necessary for a fair presentation of the financial position and results of operations for the periods presented have been included.

The results for the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, ~~2017,~~2020, or any other future period. The preparation of financial statements, in conformity with U.S. GAAP, requires management to make estimates and assumptions that affect amounts reported in the financial statements. Actual results could differ from these estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan and lease losses, fair value of financial instruments, ~~and~~ the valuation of servicing ~~rights.~~rights, deferred income taxes, and if needed, a deferred tax asset valuation allowance.

Amounts presented in the consolidated financial statements and footnote tables are rounded and presented into the nearest thousands of dollars except per share amounts. ~~In the narrative footnote discussion, amounts are rounded and presented in millions of dollars to one decimal point if~~If the amounts are above $1.0 ~~million. Amounts below $1.0~~ million, they are rounded one decimal point, and presented in dollars to the nearest thousands. Certain prior year amounts have been reclassified to conform to the 2017 presentation with no change to consolidated net income or stockholders’ equity previously reported.if they are above $1.0 billion, they are rounded two decimal points.

Principles of Consolidation - - The consolidated financial statements include the accounts of FS Bancorp, Inc. and its wholly owned subsidiary, 1st Security Bank of Washington. All material intercompany accounts have been eliminated in consolidation.

Segment Reporting - The Company operates in two business segments through the Bank: commercial and consumer banking and home lending. The Company’s business segments are determined based on the products and services provided, as well as the nature of the related business activities, and they reflect the manner in which financial information is regularly reviewed for the purpose of allocating resources and evaluating performance of the Company’s businesses. The results for these business segments are based on management’s accounting process, which assigns income statement

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

items and assets to each responsible operating segment. This process is dynamic and is based on management’s view of the Company’s operations. See ~~Note~~“Note 15 - Business Segments.”

Subsequent Events - The Company has evaluated events and transactions subsequent to ~~September 30, 2017,~~March 31, 2020 for potential recognition or disclosure.

RECENT ACCOUNTING PRONOUNCEMENTS

In ~~May 2014,~~June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) ~~No. 2014‑09,~~ ~~Revenue from Contracts with Customers (Topic 606),~~ ~~which creates Topic 606 and supersedes Topic 605, Revenue Recognition. In August 2015, FASB issued ASU No. 2015‑14,~~ ~~Revenue from Contracts with Customers (Topic 606), which postponed the effective date of 2014‑09. In March 2016, the FASB issued ASU 2016‑08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)~~, which amended the principal versus agent implementation guidance set for in ASU 2014‑09. Among other things, ASU 2016‑08 clarifies that an entity should evaluate whether it is the principal or the agent for each specified good or service promised in a contract with a customer. In April 2016, the FASB issued ASU No. 2016‑10, R~~evenue from Contracts with Customers (Topic 606):Identifying Performance Obligations and Licensing~~. The ASU amends certain aspects of the guidance set forth in the FASB’s new revenue standard related to identifying performance obligations and licensing implementation. The core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In general, the new guidance requires companies to use more judgment and make more estimates than under current guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In May 2016, the FASB issued ASU No. 2016‑12, ~~Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients,~~ which provides clarifying guidance in certain narrow areas and adds some practical expedients, but does not change the core revenue recognition principle in Topic 606. The ASU is effective for public entities for interim and annual periods beginning after December 15, 2017; early adoption is not permitted. For financial reporting purposes, the ASU allows for either full retrospective adoption, meaning the ASU is applied to all of the periods presented, or modified retrospective adoption, meaning the ASU is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. As a bank holding company, key revenue sources, such as interest income have been identified as out of the scope of this new guidance. The Company’s preliminary analysis suggests that the adoption of this accounting standard is not expected to have a material impact on the Company’s consolidated financial statements as substantially all of the Company’s other revenues are also excluded from the scope of the new guidance. New accounting guidance related to the adoption of this standard continues to be released by the FASB, which could impact the Company’s preliminary analysis of materiality and may change the preliminary conclusions reached as to the application of this new guidance.

~~In January 2016, the FASB issued ASU No. 2016‑01,~~ ~~Financial Instruments - Overall (Subtopic 825‑10), Recognition and Measurement of Financial Assets and Financial Liabilities.~~ The new guidance is intended to improve the recognition and measurement of financial instruments. This ASU requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. In addition, the amendments in this ASU require the exit price notion be used when measuring the fair value of financial instruments for disclosure purposes and requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. This ASU also eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The ASU also requires a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument specific credit risk (also referred to as “own credit”) when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. ASU No. 2016‑01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~those fiscal years. Early adoption is permitted for certain provisions. The adoption of ASU No. 2016-01 is not expected to have a material impact on the Company’s consolidated financial statements.~~

~~In February 2016, the FASB issued ASU No. 2016‑02,~~ ~~Leases (Topic 842)~~. ASU No. 2016‑02 requires lessees to recognize on the balance sheet the assets and liabilities arising from operating leases. A lessee should recognize a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. A lessee should include payments to be made in an optional period only if the lessee is reasonably certain to exercise an option to extend the lease or not to exercise an option to terminate the lease. For a finance lease, interest payments should be recognized separately from amortization of the right-of-use asset in the statement of comprehensive income. For operating leases, the lease cost should be allocated over the lease term on a generally straight-line basis. The amendments in ASU 2016‑02 are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application of the amendments in the ASU is permitted. Once adopted, we expect to report higher assets and liabilities as a result of including right-of-use assets and lease liabilities related to certain banking offices and certain equipment under noncancelable operating lease agreements, however, based on current leases, the adoption of ASU 2016‑02 is expected to increase the new lease asset and related lease liability on our Consolidated Balance Sheets by less than 5% and not to have a material impact on our regulatory capital ratios.

~~In June 2016, the FASB issued ASU~~ No. 2016‑13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial ~~Instruments.~~Instruments, as amended by ASU 2018-19, ASU 2019-10, and ASU 2019-11. The ASU is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the recognition and measurement of all current expected credit losses (“CECL”) for

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financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the ~~full amount of expected credit losses.~~approach under CECL. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. The ASU requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The ASU isand associated amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, ~~2019.~~2022. Early ~~application~~adoption will be permitted for fiscal years, and interim periods within those fiscal years, beginning after December 15, ~~2018.~~2019. The Company ~~is currently evaluating~~has selected a third-party vendor to assist in the implementation of this ASU and has run parallel computations as it continues to evaluate the impact of ~~this ASU~~adoption of the new standard. As part of the implementation, management is also evaluating economic variables and forecast time horizons it believes to be most relevant based on the ~~Company’s consolidated financial statements.~~composition of the loans portfolio to develop a reasonable and supportable forecast, likely to include forecasted levels of employment, gross domestic product, and home price index, depending on the nature of the loan segment, as well as various loss methodologies to estimate expected credit losses. In addition, management has kept current on evolving interpretations and industry practices related to ASU 2016-13 via webcasts, publications, and conferences. Once adopted, ~~we expect our~~the Company anticipates the allowance for loan losses to increase through a one‑time adjustment to retained earnings, however, until ~~our~~the evaluation is complete the magnitude of the potential increase will be unknown.

In ~~August 2016,~~April 2019, the FASB issued ASU ~~No. 2016-15,~~2019-04, ~~Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts~~Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, Derivatives and ~~Cash Payments~~Hedging, and Topic 825, Financial Instruments. This ASU ~~is intended to address the appropriate classification~~clarifies and improves areas of eight specific cash flow issues on the cash flow statement. Debt prepayment costs should be classified as an outflow for financing activities. Settlement of zero-coupon debt instruments divides the interest portion as an outflow for operating activities and the principal portion as an outflow for financing activities. Contingent consideration payments made after a business combination should be classified as outflows for financing and operating activities. Proceeds from the settlement of bank-owned life insurance policies should be classified as inflows from investing activities. Other specific areas are identified in the ASU asguidance related to the ~~appropriate classification of the cash inflows or outflows. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017,~~recently issued standards on credit losses, hedging, and recognition and measurement including ~~interim periods within those fiscal years.~~improvements resulting from various FASB Transition Resource Group meetings. Early adoption is permitted and must be applied using a retrospective transition method to each period presented. Adoption of ASU 2016-15 is not expected to have a material impact on the Company’s consolidated financial statements.

~~In January 2017, the FASB issued ASU 2017‑04,~~ ~~Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.~~ The ASU was issued to simplify the subsequent measurement of goodwill and the amendment eliminates Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment test is performed by

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. This ASU is effective for annual reporting periods beginning after December 31, 2019. Early adoption of the ASU is permitted. The Company ~~expects~~plans to adopt Topic 326 of this ASU, ~~to provide a simplified method of measuring goodwill impairment and does not expect this ASU to have a material impact on the Company’s consolidated financial statements.~~

~~In March 2017, the FASB issued~~in conjunction with ASU No. ~~2017‑08,~~ ~~Receivables - Nonrefundable Fees and Other Costs (Subtopic 310‑20): Premium Amortization~~2016-13, on ~~Purchased Callable Debt Securities~~. The ASU shortens the amortization period for certain callable debt securities held at a premium. The standard will take effect for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.January 1, 2023. The adoption of ~~ASU No. 2017‑08~~Topic 815 is not expected to have a material impact on the Company’s consolidated financial statements.

In May ~~2017,~~2019, the FASB issued ASU 2019-05, Financial Instruments-Credit Losses (Topic 326): Targeted Transition Relief. The amendments in this ASU provide entities that have certain instruments within the scope of Subtopic 326-20 with an option to irrevocably elect the fair value option in Subtopic 825-10, applied on an instrument-by-instrument basis for eligible instruments, upon the adoption of Topic 326. The fair value option election does not apply to held-to-maturity debt securities. An entity that elects the fair value option should subsequently measure those instruments at fair value with changes in fair value flowing through earnings. This ASU is effective for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. The ASU should be applied on a modified-retrospective basis by means of a cumulative-effect adjustment to the opening balance of retained earnings balance in the balance sheet. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-05 will have on its consolidated financial statements.

In December 2019, the FASB issued ASU No. ~~2017‑09,~~2019-12, ~~Compensation-Stock Compensation~~Income Taxes (Topic ~~718)~~740), Simplifying the Accounting for Income Taxes. The amendments in this ASU simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740, Income Taxes. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The Company does not expect the adoption of ASU 2019-12 to have a material impact on its consolidated financial statements.

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): ~~Scope~~Facilitation of ~~Modification Accounting~~.the Effects of reference Rate Reform on Financial Reporting. This ASU applies to contracts, hedging relationships and other transactions that reference LIBOR or other rate references expected to be discontinued because of reference rate reform. The ASU ~~was issued~~permits an entity to ~~provide clarity as~~make necessary modifications to ~~when to apply modification~~eligible contracts or transactions without requiring contract remeasurement or reassessment of a previous accounting ~~when there is~~determination. For a cash flow hedge, a change in the ~~terms or conditions of a share-based payment award. According~~method used to ~~this ASU, an entity should account for the effects of a modification unless the fair value, vesting conditions, and balance sheet classification~~assess hedge effectiveness will not result in dedesignation of the ~~award is the same after the modification as compared to the original award prior to the modification. The standard~~hedging relationship if certain criteria are met. This ASU is effective for ~~reporting periods beginning after~~all entities as of March 12, 2020 through December ~~15, 2017, with early adoption permitted.~~31, 2022. The ~~adoption~~Company is party to cash

Table of ~~ASU No. 2017‑09~~Contents

flow hedge arrangements where the hedge effectiveness is ~~not expected to have a material~~based on LIBOR. The Company is currently evaluating the impact of the reference rate reform on the Company’s consolidated financial statements.

~~In August 2017,~~Recent Events - On March 22, 2020, the federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus”. This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of the novel coronavirus of 2019 (“COVID-19”) pandemic. The guidance provides that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of a relief program are not Troubled Debt Restructurings (“TDRs”). The Coronavirus Aid, Relief, and Economic Security Act of 2020 signed into law on March 27, 2020 ("CARES Act") provided similar guidance around the modification of loans as a result of the COVID-19 pandemic, providing, among other criteria, that modifications made between March 1, 2020, and the earlier of December 31, 2020, or 60 days after the COVID-19 emergency is terminated, on a good faith basis to borrowers who were current as of December 31, 2019, are not TDRs. This includes modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment. Borrowers are considered current under the CARES Act if they are not more than 30 days past due on their contractual payments as of December 31, 2019. Through March 31, 2020, the Bank had applied the interagency statement guidance and modified 66 individual loans with aggregate principal balances totaling $12.5 million. More of these types of modifications are likely to be executed in the second quarter of 2020. The majority of these modifications involved short-term extensions and/or interest-only periods. For additional information, see “NOTE 18 - COVID - 19 Pandemic.”

Application of New Accounting Guidance Adopted in 2020

On January 1, 2020, the Company adopted FASB ~~issued~~ ASU No. ~~2017-12,~~2018-13, ~~Derivatives and Hedging~~Fair Value Measurement (Topic ~~815)~~820): ~~Targeted Improvements~~Disclosure Framework – Changes to ~~Accounting~~the Disclosure Requirements for ~~Hedging Activities~~Fair Value Measurement. This ASU ~~amends~~contains some technical adjustments related to the ~~hedge accounting recognition and presentation~~fair value disclosure requirements ~~in ASC 815 to (1) improve the transparency and understandability~~ of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities and (2) reduce the complexity of and simplify the application of hedge accounting by preparers. The amendmentspublic companies. Included in this ASU ~~permit hedge accounting~~is the additional disclosure requirement of unrealized gains and losses for ~~hedging relationships involving nonfinancial risk and interest rate risk by removing certain limitations~~the period in ~~cash flow and~~recurring level 3 fair value ~~hedging relationships. In addition,~~disclosures and the ~~ASU requires an entity to present the earnings effect~~range and weighted average of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018 and early adoption is permitted.significant unobservable inputs, among other technical changes. The adoption of ASU ~~No. 2017-12 is~~2018-13 did not ~~expected to~~ have a material impact on the Company's consolidated financial statements.

NOTE 2 - ~~BUSINESS COMBINATION~~

On January 22, 2016, the Company’s wholly-owned subsidiary, 1st Security Bank, completed the purchase of four branches (“Branch Purchase”) from Bank of America. The Branch Purchase included four retail bank branches located in the communities of Port Angeles, Sequim, Port Townsend, and Hadlock, Washington. In accordance with the Purchase and Assumption Agreement, dated as of September 1, 2015, between Bank of America and 1st Security Bank, the Bank acquired $186.4 million of deposits, a small portfolio of performing loans, two owned bank branches, three leases associated with the bank branches and parking facilities and certain other assets of the branches. In consideration of the purchased assets and transferred liabilities, 1st Security Bank paid (a) the unpaid principal balance and accrued interest of $419,000 for the loans acquired, (b) the net book value, or approximately $778,000, for the bank facilities and certain other assets associated with the acquired branches, and (c) a deposit premium of 2.50% on substantially all of the deposits assumed, which equated to approximately $4.8 million. The transaction was settled with Bank of America paying cash of $180.4 million to 1st Security Bank for the difference between these amounts and the total deposits assumed.

The Branch Purchase was accounted for under the acquisition method of accounting and accordingly, the assets and liabilities were recorded at their fair values on January 22, 2016, the date of acquisition. Determining the fair value of

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

assets and liabilities is a complicated process involving significant judgment regarding methods and assumptions used to calculate estimated fair values. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition as information relative to closing date fair values become available. During the second quarter of 2016, the Company completed a re-evaluation of the core deposit intangible because a portion of the core deposits were excluded from the original valuation. The updated valuation of the core deposit intangible increased the fair value adjustment by $100,000 to $2.2 million from $2.1 million resulting in a decrease of $100,000 to the fair value adjustment of goodwill. The impact to consolidated net income was an increase in the amortization of the core deposit intangible for the six months ended June 30, 2016 of $6,000 and was not considered material to the consolidated financial statements.

~~The following table summarizes the estimated fair values of assets acquired and liabilities assumed at the date of acquisition:~~

Acquired Book

Fair Value

Amount
January 22, 2016

Value

Adjustments

Recorded
Assets






Cash and cash equivalents

$
180,356

$
—

$
180,356
Loans receivable

417

—

417
Premises and equipment, net

697

267
(1)

964
Accrued interest receivable

2

—

2
Core deposit intangible

—

2,239
(2)

2,239
Goodwill

—

2,312
(3)

2,312
Other assets

103

—

103
Total assets acquired

$
181,575

$
4,818

$
186,393
Liabilities






Deposits:






Noninterest-bearing accounts

$
79,966

$
—

$
79,966
Interest-bearing accounts

106,398

—

106,398
Total deposits

186,364

—

186,364
Accrued interest payable

7

—

7
Other liabilities

22

—

22
Total liabilities assumed

$
186,393

$
—

$
186,393

~~Explanation of Fair Value Adjustments~~

~~(1)~~

The fair value adjustment represents the difference between the fair value of the acquired branches and the book value of the assets acquired. The Company utilized third-party valuations but did not receive appraisals to assist in the determination of fair value.

~~(2)~~

The fair value adjustment represents the value of the core deposit base assumed in the Branch Purchase based on a study performed by an independent consulting firm. This amount was recorded by the Company as an identifiable intangible asset and will be amortized as an expense on an accelerated basis over the average life of the core deposit base, which is estimated to be nine years.

~~(3)~~

~~The fair value adjustment represents the value of the goodwill calculated from the purchase based on the purchase price, less the fair value of assets acquired net of liabilities assumed.~~

~~Goodwill~~ ~~- The acquired goodwill represents the excess purchase price over the estimated fair value of the net assets acquired and was recorded at $2.3 million on January 22, 2016.~~

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~The following table summarizes the aggregate amount recognized for each major class of assets acquired and liabilities assumed by 1st Security Bank in the Branch Purchase:~~

At January 22,

2016
Purchase price (1)

$
6,015
Recognized amounts of identifiable assets acquired and (liabilities assumed), at fair value:

Cash and cash equivalents

186,371
Acquired loans

417
Premises and equipment, net

964
Accrued interest receivable

2
Core deposit intangible

2,239
Other assets

103
Deposits

(186,364)
Accrued interest payable

(7)
Other liabilities

(22)
Total fair value of identifiable net assets

3,703
Goodwill

$
2,312

~~(1)~~

~~Purchase price includes premium paid on the deposits, the aggregate net book value of all assets acquired, and the unpaid principal and accrued interest on loans acquired.~~

~~Core deposit intangible~~

The core deposit intangible represents the fair value of the acquired core deposit base. The core deposit intangible will be amortized on an accelerated basis over approximately nine years. Total amortization expense was $100,000 and $300,000 for the three and nine months ended September 30, 2017, and $140,000 and $382,000 for the same periods in 2016. Amortization expense for core deposit intangible is expected to be as follows at September 30, 2017:

Fourth Quarter 2017

$
100
2018

307
2019

235
2020

181
2021

166
Thereafter

428
Total

$
1,417

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~NOTE 3 - SECURITIES AVAILABLE-FOR-SALE~~INVESTMENTS

The following tables present the amortized costs, unrealized gains, unrealized losses, and estimated fair values of securities available-for-sale at ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016:~~2019:


	September 30, 2017
							Estimated		March 31, 2020
	Amortized		Unrealized		Unrealized		Fair								Estimated
	Cost		Gains		Losses		Values		Amortized		Unrealized		Unrealized		Fair
SECURITIES AVAILABLE-FOR-SALE									Cost		Gains		Losses		Values
U.S. agency securities	$	6,086	$	59	$	(23)	$	6,122	$	6,991	$	136	$	—	$	7,127
Corporate securities		7,123		29		(77)		7,075		19,858		144		(151)		19,851
Municipal bonds		11,342		213		(116)		11,439		31,062		475		(131)		31,406
Mortgage-backed securities		39,733		85		(344)		39,474		74,503		2,271		(41)		76,733
U.S. Small Business Administration securities		14,018		43		(68)		13,993		20,684		672		(7)		21,349
Total securities available-for-sale	$	78,302	$	429	$	(628)	$	78,103	$	153,098	$	3,698	$	(330)	$	156,466

December 31, 2016








Estimated

Amortized

Unrealized

Unrealized

Fair

Cost

Gains

Losses

Values
SECURITIES AVAILABLE-FOR-SALE

U.S. agency securities

$
8,150

$
12

$
(94)

$
8,068
Corporate securities

7,654

14

(168)

7,500
Municipal bonds

15,183

164

(83)

15,264
Mortgage-backed securities

45,856

52

(713)

45,195
U.S. Small Business Administration securities

5,862

27

(41)

5,848
Total securities available-for-sale

$
82,705

$
269

$
(1,099)

$
81,875

Table of Contents


	December 31, 2019
							Estimated
	Amortized		Unrealized		Unrealized		Fair
SECURITIES AVAILABLE-FOR-SALE	Cost		Gains		Losses		Values
U.S. agency securities	$	8,986	$	95	$	(15)	$	9,066
Corporate securities		10,525		52		(7)		10,570
Municipal bonds		20,516		604		—		21,120
Mortgage-backed securities		62,745		405		(300)		62,850
U.S. Small Business Administration securities		22,281		191		(21)		22,451
Total securities available-for-sale	$	125,053	$	1,347	$	(343)	$	126,057

At ~~September 30, 2017,~~March 31, 2020, the Bank ~~had~~ pledged ~~nine~~seven securities held at the FHLB of Des Moines with a carrying value of ~~$10.9~~$6.9 million to secure Washington State public deposits of ~~$5.2~~$11.4 million with a ~~$2.0~~$4.1 million collateral requirement by the Washington Public Deposit Protection Commission. At December 31, 2019, the Bank pledged seven securities held at the FHLB of Des Moines with a carrying value of $7.4 million to secure Washington State public deposits of $10.3 million with a $4.0 million minimum collateral requirement by the Washington Public Deposit Protection Commission.

Investment securities that were in an unrealized loss position at ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016~~2019 are presented in the following tables, based on the length of time individual securities have been in an unrealized loss position. Management believes that these securities are only temporarily impaired due to changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral.


	September 30, 2017
	Less than 12 Months				12 Months or Longer				Total				March 31, 2020
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized		Less than 12 Months				12 Months or Longer				Total
	Value		Losses		Value		Losses		Value		Losses		Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
SECURITIES AVAILABLE-FOR-SALE													Value		Losses		Value		Losses		Value		Losses
U.S. agency securities	$	3,014	$	(23)	$	—	$	—	$	3,014	$	(23)
Corporate securities		—		—		1,919		(77)		1,919		(77)	$	7,729	$	(151)	$	—	$	—	$	7,729	$	(151)
Municipal bonds		4,834		(116)		—		—		4,834		(116)		10,285		(131)		—		—		10,285		(131)
Mortgage-backed securities		22,266		(247)		4,773		(97)		27,039		(344)		4,578		(19)		2,411		(22)		6,989		(41)
U.S. Small Business Administration securities		9,425		(68)		—		—		9,425		(68)		1,955		(7)		—		—		1,955		(7)
Total	$	39,539	$	(454)	$	6,692	$	(174)	$	46,231	$	(628)	$	24,547	$	(308)	$	2,411	$	(22)	$	26,958	$	(330)

~~Table of Contents~~

~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~


	December 31, 2016
	Less than 12 Months				12 Months or Longer				Total				December 31, 2019
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized		Less than 12 Months				12 Months or Longer				Total
	Value		Losses		Value		Losses		Value		Losses		Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
SECURITIES AVAILABLE-FOR-SALE													Value		Losses		Value		Losses		Value		Losses
U.S. agency securities	$	6,998	$	(94)	$	—	$	—	$	6,998	$	(94)	$	2,977	$	(15)	$	—	$	—	$	2,977	$	(15)
Corporate securities		5,048		(106)		1,438		(62)		6,486		(168)		1,993		(7)		—		—		1,993		(7)
Municipal bonds		6,741		(83)		—		—		6,741		(83)
Mortgage-backed securities		39,373		(713)		—		—		39,373		(713)		12,345		(154)		11,459		(146)		23,804		(300)
U.S. Small Business Administration securities		2,963		(41)		—		—		2,963		(41)		4,395		(21)		—		—		4,395		(21)
Total	$	61,123	$	(1,037)	$	1,438	$	(62)	$	62,561	$	(1,099)	$	21,710	$	(197)	$	11,459	$	(146)	$	33,169	$	(343)

There were ~~28 investments with unrealized losses of less than one year, and five investments with unrealized losses of more than one year at September 30, 2017. There were 48~~14 investments with unrealized losses of less than one year, and two investments with unrealized losses of more than one year at March 31, 2020. There were 13 investments with unrealized losses of less than one year, and 10 investments with unrealized losses of more than one year at December 31, ~~2016.~~2019. The unrealized losses associated with these investments are believed to be caused by ~~changes in~~changing market ~~interest rates~~conditions that are considered to be temporary and the Company does not intend to sell the securities, and it is not likely to be required to sell these securities prior to maturity. NoBased on the Company’s evaluation of these securities, no other-than-temporary impairment was recorded for the ~~nine~~three months ended ~~September 30, 2017,~~March 31, 2020, or for the year ended December 31, ~~2016.~~

2019. Additional deterioration in market and

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

economic conditions related to the COVID-19 pandemic, may have an adverse impact on credit quality in the future and result in other-than-temporary impairment charges.

The contractual maturities of securities available-for-sale at ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016~~2019 are listed below. Expected maturities of mortgage-backed securities may differ from contractual maturities because borrowers may have the right to call or prepay the obligations; therefore, these securities are classified separately with no specific maturity date.


	September 30, 2017				December 31, 2016
	Amortized		Fair		Amortized		Fair		March 31, 2020				December 31, 2019
	Cost		Value		Cost		Value		Amortized		Fair		Amortized		Fair
U.S. agency securities									Cost		Value		Cost		Value
Due after one year through five years	$	—	$	—	$	4,000	$	3,956	$	992	$	1,068	$	996	$	1,036
Due after five years through ten years		4,086		4,141		4,150		4,112		3,999		4,041		3,997		4,027
Due after ten years		2,000		1,981		—		—		2,000		2,018		3,993		4,003
Subtotal		6,086		6,122		8,150		8,068		6,991		7,127		8,986		9,066
Corporate securities
Due in one year or less										5,024		5,003		5,034		5,044
Due after one year through five years		5,127		5,156		5,659		5,625		5,854		5,763		3,491		3,532
Due after five years through ten years		1,996		1,919		1,995		1,875		8,980		9,085		2,000		1,994
Subtotal		7,123		7,075		7,654		7,500		19,858		19,851		10,525		10,570
Municipal bonds
Due in one year or less		—		—		509		513
Due after one year through five years		2,013		2,059		5,326		5,386		3,768		3,680		3,774		3,833
Due after five years through ten years		3,297		3,420		7,476		7,492		5,215		5,301		3,162		3,307
Due after ten years		6,032		5,960		1,872		1,873		22,079		22,425		13,580		13,980
Subtotal		11,342		11,439		15,183		15,264		31,062		31,406		20,516		21,120
Mortgage-backed securities
Federal National Mortgage Association (“FNMA”)		22,287		22,187		23,522		23,197		51,139		52,933		42,131		42,333
Federal Home Loan Mortgage Corporation (“FHLMC”)		11,123		10,970		14,950		14,662		17,698		18,083		15,250		15,179
Government National Mortgage Association (“GNMA”)		6,323		6,317		7,384		7,336		5,666		5,717		5,364		5,338
Subtotal		39,733		39,474		45,856		45,195		74,503		76,733		62,745		62,850
U.S. Small Business Administration securities
Due after one year through five years										1,186		1,210		1,546		1,555
Due after five years through ten years		12,069		12,051		5,862		5,848		10,467		10,787		11,500		11,598
Due after ten years		1,949		1,942		—		—		9,031		9,352		9,235		9,298
Subtotal		14,018		13,993		5,862		5,848		20,684		21,349		22,281		22,451
Total	$	78,302	$	78,103	$	82,705	$	81,875	$	153,098	$	156,466	$	125,053	$	126,057

There were no sales proceeds, gains or losses for the three months ended March 31, 2020, or March 31, 2019, from securities available-for-sale.

The ~~proceeds~~Bank received 7,158 shares of Class B common stock in Visa, Inc. (“Visa”) at no cost as a result of the Visa initial public offering in March 2008. During the first quarter of 2020, a one-time net gain of $1.5 million on the sale of equity investment securities included in other noninterest income on the Consolidated Statements of Income related to the sale of Class B Visa stock was recognized, which had been held at a carrying cost and ~~resulting gains and losses, computed using specific identification, from sales~~fair value of ~~securities available-for-sale for~~zero due to the ~~three and nine months~~litigation liability associated with the stock. At March 31, 2020, the Bank no longer had any involvement or exposure to Visa litigation related to the shares sold during the quarter ended ~~September 30, 2017 and 2016 were as follows:~~

Three Months Ended

Nine Months Ended

September 30, 2017

September 30, 2017

Gross

Gross

Gross

Gross


Proceeds

Gains

(Losses)

Proceeds

Gains

(Losses)
Securities available-for-sale

$
9,115

$
143

$
-

$
39,103

$
413

$
(33)

Three Months Ended

Nine Months Ended

September 30, 2016

September 30, 2016

Gross

Gross

Gross

Gross


Proceeds

Gains

(Losses)

Proceeds

Gains

(Losses)
Securities available-for-sale

$
13,577

$
149

$
(3)

$
13,577

$
149

$
(3)

March 31, 2020.

1613

Table of Contents

~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

NOTE 43 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

The composition of the loan portfolio was as follows at ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016:~~2019:


		September 30,		December 31,
		2017		2016		March 31,		December 31,
REAL ESTATE LOANS	��					2020		2019
Commercial		$	63,180	$	55,871	$	220,509	$	210,749
Construction and development			129,407		94,462		168,658		179,654
Home equity			24,026		20,081		37,503		38,167
One-to-four-family (excludes loans held for sale)			170,187		124,009		305,436		261,539
Multi-family			43,408		37,527		130,570		133,931
Total real estate loans			430,208		331,950		862,676		824,040
CONSUMER LOANS
Indirect home improvement			124,387		107,759		261,566		254,691
Solar			40,082		36,503
Marine			35,173		28,549		69,473		67,179
Other consumer			2,032		1,915		4,056		4,340
Total consumer loans			201,674		174,726		335,095		326,210
COMMERCIAL BUSINESS LOANS
Commercial and industrial			83,221		65,841		149,086		140,531
Warehouse lending			50,468		32,898		65,017		61,112
Total commercial business loans			133,689		98,739		214,103		201,643
Total loans receivable, gross			765,571		605,415		1,411,874		1,351,893
Allowance for loan losses			(10,598)		(10,211)		(16,872)		(13,229)
Deferred costs, fees, premiums, and discounts, net			(1,119)		(1,887)
Deferred costs and fees, net							(3,425)		(3,273)
Premiums on purchased loans, net							1,493		955
Total loans receivable, net		$	753,854	$	593,317	$	1,393,070	$	1,336,346

Most of the Company’s commercial and multi-family real estate, construction, residential, and/or commercial business lending activities are with customers located in ~~the greater Puget Sound area~~Western Washington and near ~~our one~~the loan production office located in the Tri-Cities, Washington. The Company originates real estate, consumer, and commercial business loans and has concentrations in these areas, however, indirect home improvement loans, including solar-related home improvement loans, are originated through a network of home improvement contractors and dealers located throughout Washington, Oregon, California, Idaho, Colorado, Arizona, and ~~California. The Company also originates solar loans through contractors~~just recently, Minnesota and ~~dealers in the state of California.~~Nevada. Loans are generally secured by collateral and rights to collateral vary and are legally documented to the extent practicable. Local economic conditions may affect borrowers’ ability to meet the stated repayment terms.

At March 31, 2020, the Bank held approximately $706.4 million in loans that qualify as collateral for FHLB advances, compared to approximately $646.1 million at December 31, 2019. The Bank held approximately $327.4 million in loans that qualify as collateral for the Federal Reserve Bank line of credit at March 31, 2020, compared to approximately $318.8 million at December 31, 2019.

The Company has defined its loan portfolio into three segments that reflect the structure of the lending function, the Company’s strategic plan and the manner in which management monitors performance and credit quality. The three loan portfolio segments are: (a) Real Estate Loans, (b) Consumer Loans, and (c) Commercial Business Loans. Each of these segments is disaggregated into classes based on the risk characteristics of the borrower and/or the collateral type securing the loan. The following is a summary of each of the Company’s loan portfolio segments and classes:

Real Estate Loans

Commercial Lending. Loans originated by the Company primarily secured by income producing properties, including retail centers, warehouses, and office buildings located in our market areas.

Construction and Development Lending. Loans originated by the Company for the construction of, and secured by, commercial real estate, one-to-four-family, and multi-family residences and tracts of land for development that are not pre-

1714

Table of Contents

~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~generally not pre-sold.~~sold. A small portion of the one-to-four-family construction portfolio ~~are~~is custom construction loans to the intended occupant of the residence.

Home Equity Lending. Loans originated by the Company secured by second mortgages on one-to-four-family residences, including home equity lines of credit in our market areas.

One-to-Four-Family Real Estate Lending. One-to-four-family residential loans include owner occupied properties (including second homes), and non-owner occupied ~~properties.~~properties with four or less units. These loans originated by the Company or purchased from banks are secured by first mortgages on one-to-four-family residences in our market areas that the Company intends to hold (excludes loans held for sale).

Multi-Family Lending. Apartment term lending (five or more units) to current banking customers and community reinvestment loans for low to moderate income individuals in the Company’s footprint.

Consumer Loans

Indirect Home Improvement. Fixture secured loans for home improvement are originated by the Company through its network of home improvement contractors and dealers and are secured by the personal property installed in, on, or at the borrower’s real property, and may be perfected with a UCC‑2 financing statement filed in the county of the borrower’s residence. These indirect home improvement loans include replacement windows, siding, roofing, pools, and other home fixture ~~installations.~~

~~Solar.~~ ~~Fixture secured loans for~~installations, including solar related home improvement projects are originated by the Company through its network of contractors and dealers, and are secured by the personal property installed in, on, or at the borrower’s real property, and which may be perfected with a UCC‑2 financing statement filed in the county of the borrower’s residence.projects.

Marine. Loans originated by the Company, secured by boats, to borrowers primarily located in ~~its market areas.~~the states we originate consumer loans.

Other Consumer. Loans originated by the Company to consumers in our retail branch footprint, including automobiles, recreational vehicles, direct home improvement loans, loans on deposits, and other consumer loans, primarily consisting of personal lines of ~~credit.~~credit and credit cards.

Commercial Business Loans

Commercial and Industrial Lending (“C&I”). Loans originated by the Company to local ~~small~~small- and mid-sized businesses in our Puget Sound market area are secured primarily by accounts receivable, inventory, or personal property, ~~and~~ plant and equipment. ~~Commercial and industrial~~Some of the C&I loans purchased by the Company are outside of the Greater Puget Sound market area. C&I loans are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.

Warehouse Lending. Loans originated to non-depository financial institutions and secured by notes originated by the non-depository financial institution. The Company has two distinct warehouse lending divisions: commercial warehouse re-lending secured by notes on construction loans and mortgage warehouse re-lending secured by notes on one-to-four-family loans. The Company’s ~~mortgage and~~commercial construction warehouse lines are secured by notes on construction loans and typically guaranteed by principals with experience in construction lending. Mortgage warehouse lending ~~program~~loans are funded through ~~which~~third-party residential mortgage bankers. Under this program the Company ~~funds third-party lenders~~provides short-term funding to the mortgage banking companies for the purpose of originating residential mortgage ~~and construction~~ loans for sale into the secondary market and speculative construction loans for residential properties built for sale to single family households. These loans are secured by the notes and assigned deeds of trust associated with the residential mortgage and construction loans on properties primarily located in the Company’s market areas.market.

1815

Table of Contents

~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

The following tables detail activity in the allowance for loan losses by loan categories at or for the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2020 and ~~2016:~~2019:

At or For the Three Months Ended September 30, 2017






Commercial




Real Estate

Consumer

Business

Unallocated

Total
ALLOWANCE FOR LOAN LOSSES

Beginning balance

$
4,144

$
2,669

$
2,453

$
877

$
10,143
Provision for loan losses

481

65

(130)

34

450
Charge-offs

(55)

(152)

(33)

—

(240)
Recoveries

35

208

2

—

245
Net (charge-offs) recoveries

(20)

56

(31)

—

5
Ending balance

$
4,605

$
2,790

$
2,292

$
911

$
10,598
Period end amount allocated to:










Loans individually evaluated for impairment

$
—

$
—

$
—

$
—

$
—
Loans collectively evaluated for impairment

4,605

2,790

2,292

911

10,598
Ending balance

$
4,605

$
2,790

$
2,292

$
911

$
10,598
LOANS RECEIVABLE










Loans individually evaluated for impairment

$
210

$
—

$
551

$
—

$
761
Loans collectively evaluated for impairment

429,998

201,674

133,138

—

764,810
Ending balance

$
430,208

$
201,674

$
133,689

$
—

$
765,571

At or For the Nine Months Ended September 30, 2017






Commercial




Real Estate

Consumer

Business

Unallocated

Total
ALLOWANCE FOR LOAN LOSSES

Beginning balance

$
3,547

$
2,082

$
2,675

$
1,907

$
10,211
Provision for loan losses

1,077

726

(357)

(996)

450
Charge-offs

(55)

(536)

(33)

—

(624)
Recoveries

36

518

7

—

561
Net charge-offs

(19)

(18)

(26)

—

(63)
Ending balance

$
4,605

$
2,790

$
2,292

$
911

$
10,598
Period end amount allocated to:










Loans individually evaluated for impairment

$
—

$
—

$
—

$
—

$
—
Loans collectively evaluated for impairment

4,605

2,790

2,292

911

10,598
Ending balance

$
4,605

$
2,790

$
2,292

$
911

$
10,598
LOANS RECEIVABLE










Loans individually evaluated for impairment

$
210

$
—

$
551

$
—

$
761
Loans collectively evaluated for impairment

429,998

201,674

133,138

—

764,810
Ending balance

$
430,208

$
201,674

$
133,689

$
—

$
765,571

~~Table of Contents~~

~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

At or For the Three Months Ended September 30, 2016






Commercial




Real Estate

Consumer

Business

Unallocated

Total
ALLOWANCE FOR LOAN LOSSES

Beginning balance

$
3,477

$
2,039

$
1,823

$
1,612

$
8,951
Provision for loan losses

242

1

252

105

600
Charge-offs

(65)

(232)

—

—

(297)
Recoveries

64

262

6

—

332
Net (charge-offs) recoveries

(1)

30

6

—

35
Ending balance

$
3,718

$
2,070

$
2,081

$
1,717

$
9,586
Period end amount allocated to:










Loans individually evaluated for impairment

$
—

$
—

$
—

$
—

$
—
Loans collectively evaluated for impairment

3,718

2,070

2,081

1,717

9,586
Ending balance

$
3,718

$
2,070

$
2,081

$
1,717

$
9,586
LOANS RECEIVABLE










Loans individually evaluated for impairment

$
209

$
—

$
—

$
—

$
209
Loans collectively evaluated for impairment

316,309

170,576

117,124

—

604,009
Ending balance

$
316,518

$
170,576

$
117,124

$
—

$
604,218


	At or For the Nine Months Ended September 30, 2016
					Commercial						At or For the Three Months Ended March 31, 2020
	Real Estate		Consumer		Business		Unallocated		Total						Commercial
ALLOWANCE FOR LOAN LOSSES											Real Estate		Consumer		Business		Unallocated		Total
Beginning balance	$	2,874	$	1,681	$	1,396	$	1,834	$	7,785	$	6,206	$	3,766	$	3,254	$	3	$	13,229
Provision for loan losses		794		519		604		(117)		1,800		1,019		660		824		1,183		3,686
Charge-offs		(65)		(801)		—		—		(866)		—		(370)		(11)		—		(381)
Recoveries		115		671		81		—		867		18		143		177		—		338
Net recoveries (charge-offs)		50		(130)		81		—		1		18		(227)		166		—		(43)
Ending balance	$	3,718	$	2,070	$	2,081	$	1,717	$	9,586	$	7,243	$	4,199	$	4,244	$	1,186	$	16,872
Period end amount allocated to:
Loans individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	15	$	231	$	—	$	—	$	246
Loans collectively evaluated for impairment		3,718		2,070		2,081		1,717		9,586		7,228		3,968		4,244		1,186		16,626
Ending balance	$	3,718	$	2,070	$	2,081	$	1,717	$	9,586	$	7,243	$	4,199	$	4,244	$	1,186	$	16,872
LOANS RECEIVABLE
Loans individually evaluated for impairment	$	209	$	—	$	—	$	—	$	209	$	2,528	$	664	$	—	$	—	$	3,192
Loans collectively evaluated for impairment		316,309		170,576		117,124		—		604,009		860,148		334,431		214,103		—		1,408,682
Ending balance	$	316,518	$	170,576	$	117,124	$	—	$	604,218	$	862,676	$	335,095	$	214,103	$	—	$	1,411,874


	At or For the Three Months Ended March 31, 2019
					Commercial
ALLOWANCE FOR LOAN LOSSES	Real Estate		Consumer		Business		Unallocated		Total
Beginning balance	$	5,761	$	3,351	$	3,191	$	46	$	12,349
Provision (recapture) for loan losses		24		114		691		(79)		750
Charge-offs		—		(250)		(1,152)		—		(1,402)
Recoveries		—		148		—		—		148
Net charge-offs		—		(102)		(1,152)		—		(1,254)
Ending balance	$	5,785	$	3,363	$	2,730	$	(33)	$	11,845
Period end amount allocated to:
Loans individually evaluated for impairment	$	173	$	160	$	—	$	—	$	333
Loans collectively evaluated for impairment		5,612		3,203		2,730		(33)		11,512
Ending balance	$	5,785	$	3,363	$	2,730	$	(33)	$	11,845
LOANS RECEIVABLE
Loans individually evaluated for impairment	$	1,156	$	457	$	431	$	—	$	2,044
Loans collectively evaluated for impairment		832,259		283,959		178,808		—		1,295,026
Ending balance	$	833,415	$	284,416	$	179,239	$	—	$	1,297,070

~~Nonaccrual~~Non-accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are automatically placed on ~~nonaccrual~~non-accrual once the loan is 90 days past due or sooner if, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, or as required by regulatory authorities. The exception is the legacy Anchor Bank credit card portfolio which is serviced externally and loans are manually placed on non-accrual once the credit card payment is 90 days past due.

As a result of the negative impact on employment from the COVID-19 pandemic, we are anticipating higher levels of financial hardship for our customers, which we expect will lead to higher levels of forbearance, delinquency and defaults. We expect that, left unabated, this deterioration in forbearance, delinquency and default rates will persist until such time as the economy and employment return to relatively normal levels. We assist customers with an array of payment programs during periods of financial hardship, including forbearance. Forbearance allows a borrower to temporarily not make scheduled payments or to make smaller than scheduled payments, in each case for a specified period of time. Forbearance

2016

Table of Contents

~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

does not grant any reduction in the total principal or interest repayment obligation. While a loan is in forbearance status, interest continues to accrue and is repaid over a specified time period when the loan re-enters repayment status.

The following tables provide information pertaining to the aging analysis of contractually past due loans and ~~nonaccrual~~non-accrual loans at ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016:~~2019:


	September 30, 2017
	30-59		60-89												March 31, 2020
	Days		Days		90 Days		Total				Total				30-59		60-89
	Past		Past		or More		Past				Loans		Non-		Days		Days		90 Days		Total				Total
	Due		Due		Past Due		Due		Current		Receivable		Accrual		Past		Past		or More		Past				Loans		Non-
REAL ESTATE LOANS															Due		Due		Past Due		Due		Current		Receivable		Accrual
Commercial	$	—	$	—	$	—	$	—	$	63,180	$	63,180	$	—	$	—	$	—	$	—	$	—	$	220,509	$	220,509	$	1,083
Construction and development		—		—		—		—		129,407		129,407		—		—		—		—		—		168,658		168,658		—
Home equity		111		16		138		265		23,761		24,026		154		204		289		220		713		36,790		37,503		220
One-to-four-family		—		—		—		—		170,187		170,187		142		2,203		—		1,112		3,315		302,121		305,436		1,225
Multi-family		—		—		—		—		43,408		43,408		—		—		—		—		—		130,570		130,570		—
Total real estate loans		111		16		138		265		429,943		430,208		296		2,407		289		1,332		4,028		858,648		862,676		2,528
CONSUMER LOANS
Indirect home improvement		261		77		174		512		123,875		124,387		316		654		266		171		1,091		260,475		261,566		533
Solar		83		22		81		186		39,896		40,082		81
Marine		—		—		—		—		35,173		35,173		9		14		—		124		138		69,335		69,473		124
Other consumer		7		—		1		8		2,024		2,032		11		22		12		2		36		4,020		4,056		7
Total consumer loans		351		99		256		706		200,968		201,674		417		690		278		297		1,265		333,830		335,095		664
COMMERCIAL BUSINESS LOANS
Commercial and industrial		—		—		—		—		83,221		83,221		551		—		—		—		—		149,086		149,086		—
Warehouse lending		—		—		—		—		50,468		50,468		—		—		—		—		—		65,017		65,017		—
Total commercial business loans		—		—		—		—		133,689		133,689		551		—		—		—		—		214,103		214,103		—
Total loans	$	462	$	115	$	394	$	971	$	764,600	$	765,571	$	1,264	$	3,097	$	567	$	1,629	$	5,293	$	1,406,581	$	1,411,874	$	3,192


	December 31, 2016
	30-59		60-89												December 31, 2019
	Days		Days		90 Days		Total				Total				30-59		60-89
	Past		Past		or More		Past				Loans		Non-		Days		Days		90 Days		Total				Total
	Due		Due		Past Due		Due		Current		Receivable		Accrual		Past		Past		or More		Past				Loans		Non-
REAL ESTATE LOANS															Due		Due		Past Due		Due		Current		Receivable		Accrual
Commercial	$	—	$	—	$	—	$	—	$	55,871	$	55,871	$	—	$	—	$	—	$	—	$	—	$	210,749	$	210,749	$	1,086
Construction and development		—		—		—		—		94,462		94,462		—		533		—		—		533		179,121		179,654		—
Home equity		34		—		210		244		19,837		20,081		210		109		—		185		294		37,873		38,167		190
One-to-four-family		—		—		—		—		124,009		124,009		—		894		114		1,150		2,158		259,381		261,539		1,264
Multi-family		—		—		—		—		37,527		37,527		—		—		—		—		—		133,931		133,931		—
Total real estate loans		34		—		210		244		331,706		331,950		210		1,536		114		1,335		2,985		821,055		824,040		2,540
CONSUMER LOANS
Indirect home improvement		268		278		167		713		107,046		107,759		435		692		227		147		1,066		253,625		254,691		468
Solar		92		—		69		161		36,342		36,503		69
Marine		8		—		—		8		28,541		28,549		—		15		—		—		15		67,164		67,179		—
Other consumer		3		2		4		9		1,906		1,915		7		71		2		20		93		4,247		4,340		25
Total consumer loans		371		280		240		891		173,835		174,726		511		778		229		167		1,174		325,036		326,210		493
COMMERCIAL BUSINESS LOANS
Commercial and industrial		—		—		—		—		65,841		65,841		—		—		—		—		—		140,531		140,531		—
Warehouse lending		—		—		—		—		32,898		32,898		—		—		—		—		—		61,112		61,112		—
Total commercial business loans		—		—		—		—		98,739		98,739		—		—		—		—		—		201,643		201,643		—
Total loans	$	405	$	280	$	450	$	1,135	$	604,280	$	605,415	$	721	$	2,314	$	343	$	1,502	$	4,159	$	1,347,734	$	1,351,893	$	3,033

Table of Contents

There were no loans 90 days or more past due and still accruing interest at ~~September 30, 2017 and~~March 31, 2020, or at December 31, ~~2016.~~

~~Table of Contents~~

~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

2019.

The following tables provide additional information about our impaired loans that have been segregated to reflect loans for which an allowance for ~~credit~~loan losses has been provided and loans for which no allowance ~~has been~~was provided at ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016:~~2019:


	September 30, 2017
	Unpaid
	Principal		Write-		Recorded		Related		March 31, 2020
	Balance		downs		Investment		Allowance		Unpaid
WITH NO RELATED ALLOWANCE RECORDED									Principal		Recorded		Related
Real estate loans:									Balance		Investment		Allowance
Commercial									$	1,094	$	1,083	$	—
Home equity	$	154	$	—	$	154	$	—		271		220		—
One-to-four-family		68		(12)		56		—		1,193		1,165		—
Total real estate loans		222		(12)		210		—
WITH AN ALLOWANCE RECORDED
Commercial business loans		551		—		551		88
Consumer loans:
Other consumer										5		5		—
										2,563		2,473		—
WITH RELATED ALLOWANCE RECORDED
Real estate loans:
One-to-four-family										61		60		15
Consumer loans:
Indirect										533		533		187
Marine										124		124		43
Other consumer										2		2		1
										720		719		246
Total	$	773	$	(12)	$	761	$	88	$	3,283	$	3,192	$	246


	December 31, 2016
	Unpaid
	Principal		Write-		Recorded		Related		December 31, 2019
	Balance		downs		Investment		Allowance		Unpaid
WITH NO RELATED ALLOWANCE RECORDED									Principal		Recorded		Related
Real estate loans:									Balance		Investment		Allowance
Commercial									$	1,097	$	1,086	$	—
Home equity	$	137	$	—	$	137	$	—		278		225		—
One-to-four-family		69		(12)		57		—		1,293		1,264
Consumer loans
Other consumer										17		17		—
										2,685		2,592		—
WITH RELATED ALLOWANCE RECORDED
Real estate loans:
One-to-four-family										61		60		15
Consumer loans:
Indirect										468		468		164
Other consumer										8		8		3
										537		536		182
Total	$	206	$	(12)	$	194	$	—	$	3,222	$	3,128	$	182

Table of Contents

The following tables present the average recorded investment in loans individually evaluated for impairment and the interest income recognized and received for the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2020 and ~~2016:~~2019:


	Three Months Ended
	September 30, 2017				September 30, 2016
	Average Recorded		Interest Income		Average Recorded		Interest Income		At or For the Three Months Ended
	Investment		Recognized		Investment		Recognized		March 31, 2020				March 31, 2019
WITH NO RELATED ALLOWANCE RECORDED									Average Recorded		Interest Income		Average Recorded		Interest Income
Real estate loans:									Investment		Recognized		Investment		Recognized
Commercial									$	1,084	$	8	$	—	$	—
Home equity	$	201	$	—	$	152	$	—		220		—		267		—
One-to-four-family		56		1		58		1		1,230		5		830		15
Total real estate loans		257		1		210		1
WITH AN ALLOWANCE RECORDED
Commercial business loans		551		23		—		—
Consumer loans:
Other consumer										5		—		—		—
Commercial business loans:
Commercial and industrial										—		—		431		—
										2,539		13		1,528		15
WITH RELATED ALLOWANCE RECORDED
Real estate loans:
One-to-four-family										60		—		1,156		—
Consumer loans:
Indirect										548		13		441		9
Marine										41		—		13		—
Other consumer										1		—		5		—
Commercial business loans:
Commercial and industrial										—		—		1,152		7
										650		13		2,767		16
Total	$	808	$	24	$	210	$	1	$	3,189	$	26	$	4,295	$	31

~~Table of Contents~~

~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

Nine Months Ended

September 30, 2017

September 30, 2016


Average Recorded

Interest Income

Average Recorded

Interest Income

Investment

Recognized

Investment

Recognized
WITH NO RELATED ALLOWANCE RECORDED

Home equity

$
220

$
—

$
154

$
2
One-to-four-family

56

3

58

2
Total real estate loans

276

3

212

4
WITH AN ALLOWANCE RECORDED

Commercial business loans

551

23

—

—
Total

$
827

$
26

$
212

$
4

Credit Quality Indicators

As part of the Company’s on-going monitoring of credit quality of the loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grading of loans, (ii) the level of classified loans, (iii) net charge-offs, (iv) non-performing loans, and (v) the general economic conditions in the Company’s markets.

The Company utilizes a risk grading matrix to assign a risk grade to its real estate and commercial business loans. Loans are graded on a scale of 1 to 10, with loans in risk grades 1 to 6 considered “Pass” and loans in risk grades 7 to 10 are reported as classified loans in the Company’s allowance for loan loss analysis.

A description of the 10 risk grades is as follows:

Grades 1 and 2 - These grades include loans to very high quality borrowers with excellent or desirable business credit.

~~Grades 1 and 2 -~~ ~~These grades include loans to very high quality borrowers with excellent or desirable business credit.~~

Grade 3 - This grade includes loans to borrowers of good business credit with moderate risk.

Grades 4 and 5 - These grades include “Pass” grade loans to borrowers of average credit quality and risk.

Grade 6 - This grade includes loans on management’s “Watch” list and is intended to be utilized on a temporary basis for “Pass” grade borrowers where frequent and thorough monitoring is required due to credit weaknesses and where significant risk-modifying action is anticipated in the near term.

Grade 7 - This grade is for “Other Assets Especially Mentioned” (“OAEM”) in accordance with regulatory guidelines and includes borrowers where performance is poor or significantly less than expected.

Table of ~~good business credit with moderate risk.~~Contents

~~Grades 4 and 5 -~~ ~~These grades include “Pass” grade loans to borrowers of average credit quality and risk.~~

Grade 8 - This grade includes “Substandard” loans in accordance with regulatory guidelines which represent an unacceptable business credit where a loss is possible if loan weakness is not corrected.

Grade 9 - This grade includes “Doubtful” loans in accordance with regulatory guidelines where a loss is highly probable.

~~Grade 6 -~~ This grade includes loans on management’s “Watch” list and is intended to be utilized on a temporary basis for “Pass” grade borrowers where frequent and thorough monitoring is required due to credit weaknesses and where significant risk-modifying action is anticipated in the near term.

~~Grade 7 -~~ ~~This grade is for “Other Assets Especially Mentioned” (“OAEM”) in accordance with regulatory guidelines and includes borrowers where performance is poor or significantly less than expected.~~

~~Grade 8 -~~ ~~This grade includes “Substandard” loans in accordance with regulatory guidelines which represent an unacceptable business credit where a loss is possible if loan weakness is not corrected.~~

~~Grade 9 -~~ ~~This grade includes “Doubtful” loans in accordance with regulatory guidelines where a loss is highly probable.~~

Grade 10 - This grade includes “Loss” loans in accordance with regulatory guidelines for which total loss is expected and when identified are charged off.

Consumer, Home Equity, and One-to-Four-Family Real Estate Loans

Homogeneous loans are risk rated based upon the ~~FDIC’s~~Federal Financial Institutions Examination Council’s Uniform Retail Credit Classification and Account Management Policy. Loans classified under this policy at the Company are consumer loans which include indirect home improvement,

~~Table of Contents~~

~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

solar, marine, other consumer, and one-to-four-family first and second liens. Under the Uniform Retail Credit Classification Policy, loans that are current or less than 90 days past due are graded “Pass” and risk rated “4” or “5” internally. Loans that are past due more than 90 days are classified “Substandard” and risk rated “8” internally until the loan has demonstrated consistent performance, typically six months of contractual payments. Closed-end loans that are 120 days past due and open-end loans that are 180 days past due are charged off based on the value of the collateral less cost to sell.

Commercial real estate, construction and development, multi-family and commercial business loans are evaluated individually for their risk classification and may be classified as “Substandard” even if current on their loan payment obligations.

The following tables summarize risk rated loan balances by category at ~~September 30, 2017 and December 31, 2016:~~the dates indicated:


	September 30, 2017
					Special										March 31, 2020
	Pass		Watch		Mention		Substandard		Doubtful		Loss								Special
	(1 - 5)		(6)		(7)		(8)		(9)		(10)		Total		Pass		Watch		Mention		Substandard		Doubtful		Loss
REAL ESTATE LOANS															(1 - 5)		(6)		(7)		(8)		(9)		(10)		Total
Commercial	$	56,533	$	5,072	$	1,575	$	—	$	—	$	—	$	63,180	$	168,015	$	46,802	$	3,675	$	2,017	$	—	$	—	$	220,509
Construction and development		129,407		—		—		—		—		—		129,407		165,848		2,810		—		—		—		—		168,658
Home equity		23,872		—		—		154		—		—		24,026		37,283		—		—		220		—		—		37,503
One-to-four-family		169,352		—		693		142		—		—		170,187		304,046		165		—		1,225		—		—		305,436
Multi-family		43,408		—		—		—		—		—		43,408		130,570		—		—		—		—		—		130,570
Total real estate loans		422,572		5,072		2,268		296		—		—		430,208		805,762		49,777		3,675		3,462		—		—		862,676
CONSUMER LOANS
Indirect home improvement		124,071		—		—		316		—		—		124,387		261,033		—		—		533		—		—		261,566
Solar		40,001		—		—		81		—		—		40,082
Marine		35,164		—		—		9		—		—		35,173		69,349		—		—		124		—		—		69,473
Other consumer		1,961		—		—		71		—		—		2,032		4,049		—		—		7		—		—		4,056
Total consumer loans		201,197		—		—		477		—		—		201,674		334,431		—		—		664		—		—		335,095
COMMERCIAL BUSINESS LOANS
Commercial and industrial		76,302		306		828		5,785		—		—		83,221		105,396		32,119		8,058		3,513		—		—		149,086
Warehouse lending		44,969		5,499		—		—		—		—		50,468		61,202		3,815		—		—		—		—		65,017
Total commercial business loans		121,271		5,805		828		5,785		—		—		133,689		166,598		35,934		8,058		3,513		—		—		214,103
Total loans	$	745,040	$	10,877	$	3,096	$	6,558	$	—	$	—	$	765,571
Total loans receivable, gross															$	1,306,791	$	85,711	$	11,733	$	7,639	$	—	$	—	$	1,411,874

~~(1)~~

At September 30, 2017, the Company had agreed to sell a substandard shared/syndicated national credit at a slight discount to market. The $1.9 million loan was excluded from the substandard totals listed above as the loan was classified as held for sale at September 30, 2017. The transaction settled in October 2017 at the September 30, 2017 fair value.

2420

Table of Contents

~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~


	December 31, 2016
					Special										December 31, 2019
	Pass		Watch		Mention		Substandard		Doubtful		Loss								Special
	(1 - 5)		(6)		(7)		(8)		(9)		(10)		Total		Pass		Watch		Mention		Substandard		Doubtful		Loss
REAL ESTATE LOANS															(1 - 5)		(6)		(7)		(8)		(9)		(10)		Total
Commercial	$	53,234	$	2,637	$	—	$	—	$	—	$	—	$	55,871	$	203,703	$	2,274	$	3,686	$	1,086	$	—	$	—	$	210,749
Construction and development		94,462		—		—		—		—		—		94,462		177,109		2,545		—		—		—		—		179,654
Home equity		19,871		—		—		210		—		—		20,081		37,942		—		35		190		—		—		38,167
One-to-four-family		124,009		—		—		—		—		—		124,009		259,580		635		60		1,264		—		—		261,539
Multi-family		37,527		—		—		—		—		—		37,527		127,792		6,139		—		—		—		—		133,931
Total real estate loans		329,103		2,637		—		210		—		—		331,950		806,126		11,593		3,781		2,540		—		—		824,040
CONSUMER LOANS
Indirect home improvement		107,324		—		—		435		—		—		107,759		254,223		—		—		468		—		—		254,691
Solar		36,434		—		—		69		—		—		36,503
Marine		28,549		—		—		—		—		—		28,549		67,179		—		—		—		—		—		67,179
Other consumer		1,813		—		—		102		—		—		1,915		4,315		—		—		25		—		—		4,340
Total consumer loans		174,120		—		—		606		—		—		174,726		325,717		—		—		493		—		—		326,210
COMMERCIAL BUSINESS LOANS
Commercial and industrial		58,105		525		—		7,211		—		—		65,841		125,025		10,435		1,442		3,629		—		—		140,531
Warehouse lending		32,898		—		—		—		—		—		32,898		61,112		—		—		—		—		—		61,112
Total commercial business loans		91,003		525		—		7,211		—		—		98,739		186,137		10,435		1,442		3,629		—		—		201,643
Total loans	$	594,226	$	3,162	$	—	$	8,027	$	—	$	—	$	605,415
Total loans receivable, gross															$	1,317,980	$	22,028	$	5,223	$	6,662	$	—	$	—	$	1,351,893

~~Troubled Debt Restructured Loans~~

Troubled debt restructured (“TDR”) loans are loans for which the Company, for economic or legal reasons related to the borrower’s financial condition, has granted a significant concession to the borrower that it would otherwise not consider. The Company had one TDR loan on accrual and included in impaired loans at both September 30, 2017 and December 31, 2016, with a balance of $56,000 and $57,000, respectively, which was a one-to-four-family loan. The Company had no commitments to lend additional funds on this TDR loan at September 30, 2017.

~~For the three and nine months ended September 30, 2017 and 2016, there were no TDR loans that were modified in the previous 12 months that subsequently defaulted in the reporting period.~~

NOTE 54 - SERVICING RIGHTS

Loans serviced for others are not included on the Consolidated Balance Sheets. The unpaid principal balances of permanent loans serviced for others were ~~$662.0 million~~$1.49 billion and ~~$977.1 million~~$1.46 billion at ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016, respectively, and are carried at the lower of cost or market.~~

During the quarter ended June 30, 2017, the Company sold a portion of its mortgage servicing rights (“MSR”) with a book value of $4.8 million, generating an associated gain of $958,000. During the third quarter of 2017, a $38,000 adjustment was made to mortgage servicing rights resulting in a revised gain of $996,000 due to better than expected prepayments.

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

2019, respectively.

The following tables summarize servicing rights activity ~~and the respective book value at or~~ for the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2020 and ~~2016:~~2019:


	At or For the Three Months Ended				At or For the Three Months Ended
	September 30,				March 31,
	2017		2016		2020		2019
Beginning balance	$	4,899	$	6,751	$	11,560	$	10,429
Additions		1,326		1,095		1,185		844
Servicing rights amortized		(414)		(408)		(1,605)		(639)
Recovery on servicing rights		—		216
Impairment of servicing rights						(514)		(23)
Ending balance	$	5,811	$	7,654	$	10,626	$	10,611

At or For the Nine Months Ended

September 30,

2017

2016
Beginning balance

$
8,459

$
5,811
Additions

3,569

2,927
Sales

(4,751)

—
Servicing rights amortized

(1,465)

(1,086)
(Impairment) recovery on servicing rights

(1)

2
Ending balance

$
5,811

$
7,654

The fair market value of the ~~permanent~~ servicing rights’ assets was ~~$7.3~~$10.9 million and ~~$11.7~~$13.3 million at ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016,~~2019, respectively. Fair value adjustments to servicing rights are mainly due to ~~market based~~market-based assumptions associated with discounted cash flows, loan prepayment speeds, and changes in interest rates. A significant change in prepayments of the loans in the servicing portfolio could result in significant changes in the valuation adjustments, thus creating potential volatility in the carrying amount of servicing rights.

The following provides valuation assumptions used in determining the fair value of ~~MSR~~mortgage servicing rights (“MSR”) at the dates indicated:


	At September 30,
	2017		2016		At March 31,		At December 31,
Key assumptions:					2020		2019
Weighted average discount rate	9.5	%	9.5	%	9.1	%	9.7	%
Conditional prepayment rate (“CPR”)	11.3	%	16.4	%	23.3	%	17.1	%
Weighted average life in years	6.8		5.2		3.9		5.1

2621

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

Key economic assumptions ~~and the sensitivity~~ of the current fair value for single family MSR ~~to immediate adverse changes~~are presented in ~~those assumptions at September 30, 2017 and December 31, 2016 were as follows:~~

September 30, 2017

December 31, 2016

Aggregate portfolio principal balance



$
658,599

$
973,139

Weighted average rate of note



4.0
%

3.9
%

At September 30, 2017

Base

0.5%Adverse Rate Change

1.0%Adverse Rate Change

Conditional prepayment rate

11.3
%

18.2
%

25.4
%
Fair value MSR

$
7,283

$
5,764

$
4,682

Percentage of MSR

1.1
%

0.9
%

0.7
%

Discount rate

9.5
%

10.0
%

10.5
%
Fair value MSR

$
7,283

$
7,139

$
7,000

Percentage of MSR

1.1
%

1.1
%

1.1
%

At December 31, 2016

Base

0.5%Adverse Rate Change

1.0%Adverse Rate Change

Conditional prepayment rate

8.8
%

12.8
%

20.2
%
Fair value MSR

$
11,735

$
9,991

$
7,808

Percentage of MSR

1.2
%

1.0
%

0.8
%

Discount rate

9.5
%

10.0
%

10.5
%
Fair value MSR

$
11,735

$
11,480

$
11,235

Percentage of MSR

1.2
%

1.2
%

1.2
%

~~The above~~the table ~~shows~~below. Also presented is the sensitivity to market rate changes for the par rate coupon for a conventional one-to-four-family ~~FNMA/FHLMC/GNMA/~~FNMA, FHLMC, GNMA, or FHLB serviced home loan. The ~~above~~ table below references a 50 basis point and 100 basis point ~~decrease in note rates.~~adverse rate change and the impact on prepayment speeds and discount rates at March 31, 2020 and December 31, 2019:


				March 31, 2020			December 31, 2019
Aggregate portfolio principal balance				$	1,490,874		$	1,463,732
Weighted average rate of note					4.2	%		4.2	%

At March 31, 2020	Base			0.5% Adverse Rate Change			1.0% Adverse Rate Change
Conditional prepayment rate		23.3	%		31.9	%		36.4	%
Fair value MSR	$	10,855		$	8,638		$	7,796
Percentage of MSR		0.7	%		0.6	%		0.5	%

Discount rate		9.1	%		9.6	%		10.1	%
Fair value MSR	$	10,855		$	10,706		$	10,561
Percentage of MSR		0.7	%		0.7	%		0.7	%

At December 31, 2019	Base			0.5% Adverse Rate Change			1.0% Adverse Rate Change
Conditional prepayment rate		17.1	%		24.6	%		32.5	%
Fair value MSR	$	13,255		$	10,582		$	8,674
Percentage of MSR		0.9	%		0.7	%		0.6	%

Discount rate		9.7	%		10.2	%		10.7	%
Fair value MSR	$	13,255		$	13,037		$	12,826
Percentage of MSR		0.9	%		0.9	%		0.9	%

These sensitivities are hypothetical and should be used with caution as the tables above demonstrate the Company’s methodology for estimating the fair value of the MSR which is highly sensitive to changes in key assumptions. For example, actual prepayment experience may differ and any difference may have a material effect on MSR fair value. Changes in fair value resulting from changes in assumptions generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear. Also, in these tables, the effects of a variation in a particular assumption on the fair value of the MSR is calculated without changing any other assumption; in reality, changes in one factor may be associated with changes in another (for example, decreases in market interest rates may provide an incentive to ~~refinance;~~refinance, however, this may also indicate a slowing economy and an increase in the unemployment rate, which reduces the number of borrowers who qualify for refinancing), which may magnify or counteract the sensitivities. Thus, any measurement of MSR fair value is limited by the conditions existing and assumptions made at a particular point in time. Those assumptions may not be appropriate if they are applied to a different point in time.

The Company recorded ~~$430,000~~$977,000 and ~~$534,000~~$802,000 of gross contractually specified servicing fees, late fees, and other ancillary fees resulting from servicing of ~~mortgage and commercial~~ loans for the three months ended ~~September 30, 2017~~March 31, 2020 and ~~2016, respectively, and $1.8 million and $1.4 million for the nine months ended September 30, 2017 and 2016,~~2019, respectively. The income, net of amortization, or the reduction in income, if MSR amortization is greater than servicing fees, is reported in noninterest income on the Consolidated Statements of Income.

NOTE 65 - DERIVATIVES

The Company regularly enters into commitments to originate and sell loans held for sale. The Company has established a hedging strategy to protect itself against the risk of loss associated with interest rate movements on loan commitments. The Company enters into contracts to sell forward To-Be-Announced (“TBA”) mortgage-backed securities. These commitments and contracts are considered derivatives but have not been designated as hedging instruments for reporting purposes under U.S. GAAP. Rather, they are accounted for as free-standing derivatives, or economic hedges, with changes

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

in the fair value of the derivatives reported in noninterest ~~income.~~income or noninterest expense. The Company recognizes all derivative instruments as either other assets or other liabilities on the Consolidated Balance Sheets and measures those instruments at fair value.

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Derivative instruments not related to mortgage banking activities primarily relate to interest rate swap agreements. The Company's objectives in using certain interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

The Company has entered into interest rate swaps to reduce the exposure to variability in interest-related cash outflows attributable to changes in forecasted LIBOR-based FHLB borrowings and brokered deposits. These derivative instruments are designated as cash flow hedges. The hedged item is the LIBOR portion of the series of future adjustable rate borrowings and deposits over the term of the interest rate swap. Accordingly, changes to the amount of interest payment cash flows for the hedged transactions attributable to a change in credit risk are excluded from management’s assessment of hedge effectiveness. The Company tests for hedging effectiveness on a quarterly basis. The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The Company has not recorded any hedge ineffectiveness since inception. The Company has master netting agreements with derivative dealers with which it does business, but reflects gross assets and liabilities as other assets and other liabilities, respectively, on the Consolidated Balance Sheets.

The net unrealized loss on cash flow hedges recorded in accumulated other comprehensive income was $825,000 and $0, net of tax, at March 31, 2020 and December 31, 2019, respectively. The Company reclassified expense of $1,000 and $0 from accumulated other comprehensive income to interest expense related to these cash flow hedges for the three months ended March 31, 2020 and March 31, 2019, respectively. The Company expects that approximately $188,000 will be reclassified from accumulated other comprehensive income as an increase to interest expense over the next twelve months related to these cash flow hedges.

The following tables summarize the Company’s derivative instruments at the dates indicated:

September 30, 2017

Fair Value


Notional

Asset

Liability
Fallout adjusted interest rate lock commitments with customers

$
59,741

$
1,131

$
—
Mandatory and best effort forward commitments with investors

33,491

4

—
Forward TBA mortgage-backed securities

77,000

104

—
TBA mortgage-backed securities forward sales paired off with investors

32,500

—

140


	December 31, 2016						March 31, 2020
			Fair Value						Fair Value
	Notional		Asset		Liability
Cash flow hedges:							Notional		Asset		Liability
Interest rate swaps							$	60,000	$	—	$	1,051
Non-hedging derivatives:
Fallout adjusted interest rate lock commitments with customers	$	33,289	$	818	$	—		207,564		4,291		—
Mandatory and best effort forward commitments with investors		23,536		177		—		60,368		—		181
Forward TBA mortgage-backed securities		53,000		495		—		248,000		—		3,723
TBA mortgage-backed securities forward sales paired off with investors		44,000		747		—

The fair value of derivatives was impacted during the third quarter of 2017 by an increase in notional asset value partially offset by a decrease in the fair value on the derivative asset, specifically loan locks


	December 31, 2019
			Fair Value
Non-hedging derivatives:	Notional		Asset		Liability
Fallout adjusted interest rate lock commitments with customers	$	33,914	$	557	$	—
Mandatory and best effort forward commitments with investors		43,752		—		195
Forward TBA mortgage-backed securities		46,000		—		8

At March 31, 2020 and ~~loan commitments.~~

~~At September 30, 2017 and 2016,~~December 31, 2019, the Company had ~~$77.0~~$248.0 million and ~~$99.5~~$46.0 million of TBA trades with counterparties that required margin collateral of ~~$485,000~~$5.3 million and ~~$872,000,~~$1.2 million, respectively. At March 31, 2020, and December 31, 2019, interest rate swaps designated as cash flow hedges required margin collateral of $910,000 and $0.0, respectively. This restricted cash collateral is included in interest-bearing deposits at other financial institutions on the Consolidated Balance Sheets.

Changes in the fair value of the non-hedging derivatives recognized in other noninterest income on the Consolidated Statements of Income and included in gain on sale of loans resulted in net gains of ~~$374,000~~$1.7 million and ~~$697,000~~$299,000 for the three months ended ~~September 30, 2017~~March 31, 2020 and ~~2016, respectively,~~2019, respectively.

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NOTE 6 - LEASES

The Company has operating leases for retail bank and ~~net (loss) gain~~home lending branches, and certain equipment. The Company’s leases have remaining lease terms of ~~($7,000)~~one month to seven years and ~~$1.7 million~~six months, some of which include options to extend the leases for up to five years.

The components of lease cost (included in occupancy expense on the Consolidated Statements of Income) are as follows for the ~~nine~~three months ended ~~September~~March 31, 2020 and 2019:


	Three Months Ended		Three Months Ended
Lease cost:	March 31, 2020		March 31, 2019
Operating lease cost	$	343	$	308
Short-term lease cost		8		46
Total lease cost	$	351	$	354

The following table provides supplemental information related to operating leases at or for the three months ended March 31, 2020 and 2019:


Cash paid for amounts included in the measurement	At or For the Three Months Ended			At or For the Three Months Ended
of lease liabilities:	March 31, 2020			March 31, 2019
Operating cash flows from operating leases	$	336		$	334
Weighted average remaining lease term- operating leases		5.2	years		5.8	years
Weighted average discount rate- operating leases		2.97	%		3.08	%

The Company’s leases typically do not contain a discount rate implicit in the lease contract. As an alternative, the discount rate used in determining the lease liability for each individual lease was the FHLB of Des Moines’ fixed advance rate.

Maturities of operating lease liabilities at March 31, 2020 for future periods are as follows:



Remainder of 2020	$	944
2021		1,169
2022		1,065
2023		674
2024		614
Thereafter		884
Total lease payments		5,350
Less imputed interest		(452)
Total	$	4,898

The Company has secured one new lease commencing between April 1, 2020 and June 30, ~~2017~~2020. The initial lease term is 60 months and ~~2016, respectively.~~includes one option to extend for five years. This lease was not included in the ROU assets or operating lease liabilities at March 31, 2020.

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NOTE 7 - OTHER REAL ESTATE OWNED (“OREO”)

~~There was no OREO activity for the three months ended September 30, 2017 and 2016.~~ The following table presents the activity related to OREO at or for the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2020 and ~~2016:~~2019:


	At or For the Nine Months Ended
	September 30,				At or For the Three Months Ended
	2017		2016		March 31,
					2020		2019
Beginning balance	$	—	$	—	$	168	$	689
Net loans transferred to OREO		—		525
Capitalized costs		—		7
Additions						—		77
Gross proceeds from sale of OREO		—		(682)		(76)		(684)
Gain on sale of OREO		—		150
(Loss) gain on sale of OREO						(2)		85
Ending balance	$	—	$	—	$	90	$	167

There was one OREO property in the amount of $90,000 at March 31, 2020, and two OREO properties totaling $167,000 at March 31, 2019. There were no ~~OREO properties at September 30, 2017 and September 30, 2016. For the three and nine months ended September 30, 2017, and~~holding costs for the three months ended ~~September 30, 2016, the Company recorded no net gain or loss on the disposal of OREO. For the nine months ended September 30, 2016, the Company recorded a $150,000 net gain on the~~

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~disposal of OREO. There were no holding costs associated with OREO~~March 31, 2020, compared to $4,000 for the three ~~and nine~~ months ended ~~September 30, 2017 and 2016.~~March 31, 2019.

There were no$1.2 million in mortgage ~~loan properties in the process of foreclosure at September 30, 2017. At December 31, 2016, there was a $43,000 mortgage loan~~loans collateralized by residential real estate property in the process of ~~foreclosure.~~foreclosureat March 31, 2020.

NOTE 8 - DEPOSITS

Deposits are summarized as follows at ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016:~~2019:


	September 30,		December 31,		March 31,		December 31,
	2017(1)		2016(1)		2020		2019
Noninterest-bearing checking	$	156,017	$	143,236	$	267,966	$	260,131
Interest-bearing checking		115,775		66,119		208,952		177,972
Savings		72,974		54,995		123,052		118,845
Money market~~(4)~~		236,036		242,849		303,405		270,489
Certificates of deposit less than $100,000~~(2)~~		143,169		93,791		263,787		277,988
Certificates of deposit of $100,000 through $250,000		73,733		74,832		176,322		181,402
Certificates of deposit of $250,000 and over~~(3)~~		31,927		27,094		85,185		92,110
Escrow accounts related to mortgages serviced		10,947		9,677		17,600		13,471
Total	$	840,578	$	712,593	$	1,446,269	$	1,392,408

~~(1)~~

~~Includes $138.2 million of deposits acquired in the Branch Purchase at September 30, 2017 and $162.2 million at December 31, 2016.~~

~~(2)~~

~~Includes $92.2 million of brokered deposits at September 30, 2017 and $47.1 million at December 31, 2016.~~

~~(3)~~

~~Time deposits that meet or exceed the FDIC insurance limit.~~

~~(4)~~

~~Includes $10.0 million of brokered deposits at September 30, 2017 and none at December 31, 2016.~~

Federal Reserve regulations require that the Bank maintain reserves in the form of cash on hand ~~and~~when there are deposit balances with the Federal Reserve Bank based on a percentage of deposits. ~~The amounts of such balances at September 30, 2017~~At March 31, 2020 and December 31, ~~2016 were $19.3 million and $10.7 million, respectively.~~2019, the Bank had no reserve requirement based on its reserve calculation.

Scheduled maturities of time deposits at ~~September 30, 2017~~March 31, 2020 for future periods ending are as follows:


	At September 30, 2017		At March 31, 2020
Maturing in 2017	$	81,162
Maturing in 2018		75,057
Maturing in 2019		45,868
Maturing in 2020		14,980	$	273,650
Maturing in 2021		15,816		152,427
Maturing in 2022				63,458
Maturing in 2023				15,111
Maturing in 2024				17,505
Thereafter		15,946		3,143
Total	$	248,829	$	525,294

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Interest expense by deposit category for the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019 is as follows:


	Three Months Ended				Nine Months Ended				Three Months Ended
	September 30,				September 30,				March 31,
	2017		2016		2017		2016		2020		2019
Interest-bearing checking	$	44	$	7	$	66	$	20	$	136	$	196
Savings and money market		356		257		937		757		826		763
Certificates of deposit		645		544		1,790		1,634		2,845		2,751
Total	$	1,045	$	808	$	2,793	$	2,411	$	3,807	$	3,710

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

NOTE 9 - COMMITMENTS AND CONTINGENCIES

Commitments - The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized on the Consolidated Balance Sheets.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

The following table provides a summary of the Company’s commitments at ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016:~~2019:


	September 30,		December 31,
	2017		2016
COMMITMENTS TO EXTEND CREDIT					March 31,		December 31,
REAL ESTATE LOANS					2020		2019
Commercial	$	108	$	108	$	1,332	$	247
Construction and development		82,115		57,016		106,862		95,031
One-to-four-family (includes loans held for sale)		117,997		79,870
One-to-four-family (includes locks for salable loans)						218,244		39,697
Home equity		31,258		26,129		46,558		47,880
Multi-family		418		426		630		622
Total real estate loans		231,896		163,549		373,626		183,477
CONSUMER LOANS		10,025		8,527		22,331		22,176
COMMERCIAL BUSINESS LOANS
Commercial and industrial		46,912		31,775		82,202		72,731
Warehouse lending		58,231		51,102		26,983		33,888
Total commercial business loans		105,143		82,877		109,185		106,619
Total commitments to extend credit	$	347,064	$	254,953	$	505,142	$	312,272

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the amount of the total commitments do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon an extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate, and income-producing commercial properties.

Unfunded commitments under commercial lines of credit, revolving credit lines, and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are uncollateralized and usually do not contain a specified maturity date and ultimately may not be drawn upon to the total extent to which the Company is committed. The Company has established reserves for estimated losses from unfunded commitments of ~~$237,000~~$312,000 at ~~September 30, 2017~~March 31, 2020 and ~~$179,000~~$293,000 at December 31, ~~2016.~~2019. One-to-four-family commitments included in the table above are accounted for as fair value derivatives and do not carry an associated ~~loss reserve.~~holdback.

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The Company also sells one-to-four-family loans to the FHLB of Des Moines that require a limited level of recourse if the loans default and exceed a certain loss exposure. Specific to that recourse, the FHLB of Des Moines established a first loss account (“FLA”) related to the loans and required a credit enhancement (“CE”) obligation by the Bank to be utilized after the FLA is used. Based on loans sold through ~~September 30, 2017,~~March 31, 2020, the total loans sold to the FHLB were ~~$40.5~~$60.7 million with the FLA ~~being $433,000~~totaling $938,000 and the CE obligation at ~~$1.1 million~~$811,000 or ~~2.6%~~1.3% of the loans outstanding. Management has established a holdback of 10% of the outstanding CE, or ~~$110,000,~~$272,000, which is a part of the off-balance sheet holdback for loans sold.

~~Table~~ At March 31, 2020, there were $482,000 of ~~Contents~~

~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~There were no outstanding delinquencies on the~~ loans sold to the FHLB of Des Moines ~~at September~~greater than 30 ~~2017 and~~days past their contractual payment due date, compared to none at December 31, ~~2016.~~2019.

Contingent liabilities for loans held for sale - In the ordinary course of business, loans are sold with limited recourse against the Company and may have to subsequently be repurchased due to defects that occurred during the origination of the loan. The defects are categorized as documentation errors, underwriting errors, early payoff, early payment defaults, breach of representation or warranty, servicing errors, and/or fraud. When a loan sold to an investor without recourse fails to perform according to its contractual terms, the investor will typically review the loan file to determine whether defects in the origination process occurred. If a defect is identified, the Company may be required to either repurchase the loan or indemnify the investor for losses sustained. If there are no such defects, the Company has no commitment to repurchase the loan. The Company has recorded ~~reserves~~a holdback reserve of ~~$1.0~~$1.3 million ~~and $955,000~~ to cover loss exposure related to these guarantees for one-to-four-family loans sold into the secondary market at ~~September 30, 2017~~March 31, 2020, and $1.2 million at December 31, ~~2016,~~2019, which is included in other liabilities on the Consolidated Balance Sheets.

The Company has entered into a severance agreement with its Chief Executive ~~Officer.~~Officer (“CEO”). The severance agreement, subject to certain requirements, generally includes a lump sum payment to the ~~Chief Executive Officer~~CEO equal to 24 months of base compensation in the event his employment is involuntarily terminated, other than for cause or the executive terminates his employment with good reason, as defined in the severance agreement.

The Company has entered into change of control agreements with its Chief Financial ~~Officer,~~ Officer/Chief Operating Officer, Chief Lending Officer, ~~and two~~Chief Credit Officer, Chief Risk Officer, Chief Human Resources Officer, Senior Vice President Compliance Officer, Executive Vice ~~Presidents~~President of Retail Banking and Marketing, and the Executive Vice President of Home Lending. The change of control agreements, subject to certain requirements, generally remain in effect until canceled by either party upon at least 24 months prior written notice. Under the change of control agreements, the executive generally will be entitled to a change of control payment from the Company if the executive is involuntarily terminated within six months preceding or 12 months after a change in control (as defined in the change of control agreements). In such an event, the executives would each be entitled to receive a cash payment in an amount equal to 12 months of their then current salary, subject to certain requirements in the change of control agreements.

~~The Bank received 7,158 shares of Class B common stock in Visa, Inc. as~~As a result of the Visa initial public offering (“IPO”) in March 2008. These Class B shares of stock held by the Bank could be converted to Class A shares at a conversion rate of 1.6483 when all litigation pending as of the date of the IPO is concluded. However, at September 30, 2017, the date that litigation will be concluded cannot be determined. Until such time, the stock cannot be redeemed or sold by the Bank; therefore, it is not readily marketable and has a current carrying value of $0. Visa, Inc. Class A stock’s market value at September 30, 2017 and December 31, 2016 was $105.24 per share and $77.73 per share, respectively.

~~Due to~~ the nature of our activities, the Company is subject to various pending and threatened legal actions, which arise in the ordinary course of business. From time to time, subordination liens may create litigation which requires us to defend our lien rights. In the opinion of management, liabilities arising from these claims, if any, will not have a material effect on our financial position. The Company had no material pending legal actions at ~~September 30, 2017.~~March 31, 2020.

NOTE 10 - FAIR VALUE ~~OF FINANCIAL INSTRUMENTS~~MEASUREMENTS

The Company ~~assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. Consequently, the~~determines fair value ofbased on the Company’s consolidated financial instruments will change when interest rate levels change and that change may either be favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed interest rate obligations are less likely to prepayrequirements established in a rising interest rate environment and more likely to prepay in a falling interest rate environment. Conversely, depositors who are receiving fixed interest rates are more likely to withdraw funds before maturity in a rising interest rate environment and less likely to do so in a falling interest rate environment. Management monitors interest rates and maturities of assets and liabilities, and attempts to minimize interest rate risk by adjusting terms of new loans and deposits, and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

~~Table of Contents~~

~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

Accounting ~~guidance regarding fair value measurements defines fair value and establishes~~Standards Codification (“ASC”) Topic 820, Fair Value Measurements, which provides a framework for measuring fair value in accordance with U.S. ~~GAAP. Fair~~GAAP and requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. ASC 820 defines fair value isas the ~~exchange~~exit price, or the price that would be received for an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement ~~date.~~ date under current market conditions. ASU 2016-01, Financial Instruments - Overall (Subtopic 825‑10), Recognition and Measurement of Financial Assets and Financial Liabilities, requires us to use the exit price notion when measuring the fair value of instruments for disclosure purposes.

The following definitions describe the levels of inputs that may be used to measure fair value:

Level 1 - Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

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Level 2 - Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 - Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

~~Determination~~The following methods were used to estimate the fair value of ~~Fair Market Values:~~certain assets and liabilities on a recurring and nonrecurring basis:

Securities Available-for-Sale-The fair value of securities available-for-sale are recorded on a recurring basis. The fair value of investments and mortgage-backed securities are provided by a third-party pricing service. These valuations are based on market data using pricing models that vary by asset class and incorporate available current trade, bid, and other market information, and for structured securities, cash flow, and loan performance data. The pricing processes utilize benchmark curves, benchmarking of similar securities, sector groupings, and matrix pricing. Option adjusted spread models are also used to assess the impact of changes in interest rates and to develop prepayment ~~scenarios.~~scenarios (Level 2). Certain other corporate securities and municipal bonds are generally measured at fair value based on discounted cash flow models (Level 3). Transfers between the fair value hierarchy are determined through the third-party service provider which, from time to time will transfer between levels based on market conditions per the related security. All models and processes used take into account market ~~convention (Level 2).~~convention.

Mortgage ~~and Nonmortgage~~ Loans Held for Sale -The fair value of loans held for sale reflects the value of commitments with investors and/or the relative price as delivered into a TBA mortgage-backed security (Level 2).

Derivative Instruments - Fair values for derivative assets and liabilities are measured on a recurring basis. The primary use of derivative instruments is related to the mortgage banking activities of the Company. The fair value of the interest rate lock commitments and forward sales commitments are estimated using quoted or published market prices for similar instruments, adjusted for factors such as ~~pull-through~~pull-though rate assumptions based on historical information, where appropriate. TBA mortgage-backed securities are fair valued on similar contracts in active markets (Level 2), while locks and forwards with customers and investors are fair valued using similar contracts in the market and changes in the market interest rates ~~(Levels~~(Level 2 and 3). Derivative instruments not related to mortgage banking activities include interest rate swap agreements. The fair values of interest rate swap agreements are based on valuation models using observable market data as of the measurement date (Level 2). The Company’s derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including market transactions and third-party pricing services. The fair values of all interest rate swaps are determined from third-party pricing services without adjustment.

Impaired Loans -- Fair value adjustments to impaired collateral dependent loans are recorded to reflect partial write-downs based on the current appraised value of the collateral or internally developed models, which contain management’s assumptions. Management will utilize discounted ~~cash flow~~cashflow impairment for ~~TDRs~~troubled debt restructures when the change in terms results in a discount to the overall ~~cash flows~~cashflows to be received (Level 3).

Other Real Estate Owned-Fair value adjustments to OREO are recorded at the lower of carrying amount of the loan or fair value of the collateral less selling costs. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, management periodically performs valuations such that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell (Level 3).

Servicing Rights - The fair value of mortgage servicing rights are estimated using net present value of expected cash flows using a third party model that incorporates assumptions used in the industry to value such rights, adjusted for factors such as weighted average prepayments speeds based on historical information where appropriate (Level 3).

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The following tables present securities available-for-sale, mortgage loans held for sale, and derivative assets and liabilities measured at fair value on a recurring basis at ~~September 30, 2017 and December 31, 2016:~~the dates indicated:


	Securities Available-for-Sale
	Level 1		Level 2		Level 3		Total
At September 30, 2017
Financial Assets									At March 31, 2020
Securities available-for-sale:									Level 1		Level 2		Level 3		Total
U.S. agency securities	$	—	$	6,122	$	—	$	6,122	$	—	$	7,127	$	—	$	7,127
Corporate securities		—		7,075		—		7,075		—		18,815		1,036		19,851
Municipal bonds		—		11,439		—		11,439		—		31,271		135		31,406
Mortgage-backed securities		—		39,474		—		39,474		—		76,733		—		76,733
U.S. Small Business Administration securities		—		13,993		—		13,993		—		21,349		—		21,349
Total	$	—	$	78,103	$	—	$	78,103
Mortgage loans held for sale, at fair value										—		115,632		—		115,632
Derivatives:
Interest rate lock commitments with customers										—		—		4,291		4,291
Total assets measured at fair value									$	—	$	270,927	$	5,462	$	276,389
Financial Liabilities
Derivatives:
Individual forward sale commitments with investors									$	—	$	(3,723)	$	(181)	$	(3,904)
Interest rate swaps										—		(1,051)		—		(1,051)
Total liabilities measured at fair value									$	—	$	(3,723)	$	(181)	$	(3,904)

~~Table of Contents~~

~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

Securities Available-for-Sale


Level 1

Level 2

Level 3

Total
At December 31, 2016

U.S. agency securities

$
—

$
8,068

$
—

$
8,068
Corporate securities

—

7,500

—

7,500
Municipal bonds

—

15,264

—

15,264
Mortgage-backed securities

—

45,195

—

45,195
U.S. Small Business Administration securities

—

5,848

—

5,848
Total

$
—

$
81,875

$
—

$
81,875

~~The following table presents mortgage loans held for sale measured at fair value on a recurring basis at September 30, 2017 and December 31, 2016:~~

Mortgage Loans Held for Sale


Level 1

Level 2

Level 3

Total
September 30, 2017

$
—

$
65,055

$
—

$
65,055
December 31, 2016

$
—

$
52,553

$
—

$
52,553


Financial Assets	At December 31, 2019
Securities available-for-sale:	Level 1		Level 2		Level 3		Total
U.S. agency securities	$	—	$	9,066	$	—	$	9,066
Corporate securities		—		9,546		1,024		10,570
Municipal bonds		—		20,982		138		21,120
Mortgage-backed securities		—		62,850		—		62,850
U.S. Small Business Administration securities		—		22,451		—		22,451
Mortgage loans held for sale, at fair value		—		69,699		—		69,699
Derivatives:
Interest rate lock commitments with customers		—		—		557		557
Total assets measured at fair value	$	—	$	194,594	$	1,719	$	196,313
Financial Liabilities
Derivatives:
Individual forward sale commitments with investors	$	—	$	(8)	$	(195)	$	(203)
Total liabilities measured at fair value	$	—	$	(8)	$	(195)	$	(203)

The following tables present ~~the fair value of interest rate lock commitments with customers, individual forward sale commitments with investors,~~impaired loans, OREO, and ~~paired off commitments with investors measured at their fair value on a recurring basis at September 30, 2017 and December 31, 2016:~~

Interest Rate Lock Commitments with Customers


Level 1

Level 2

Level 3

Total
September 30, 2017

$
—

$
—

$
1,131

$
1,131
December 31, 2016

$
—

$
—

$
818

$
818

Individual Forward Sale Commitments with Investors


Level 1

Level 2

Level 3

Total
September 30, 2017

$
—

$
104

$
4

$
108
December 31, 2016

$
—

$
495

$
177

$
672

Paired Off Commitments with Investors


Level 1

Level 2

Level 3

Total
September 30, 2017

$
—

$
(140)

$
—

$
(140)
December 31, 2016

$
—

$
747

$
—

$
747

~~The following table presents impaired loans~~servicing rights measured at fair value on a nonrecurring basis for which a nonrecurring change in fair value has been recorded ~~at September 30, 2017 and December 31, 2016.~~during the reporting periods indicated. The amounts disclosed below represent the fair values at the time the nonrecurring fair value measurements were evaluated.

Impaired Loans


Level 1

Level 2

Level 3

Total
September 30, 2017

$
—

$
—

$
761

$
761
December 31, 2016

$
—

$
—

$
194

$
194


	March 31, 2020
	Level 1		Level 2		Level 3		Total
Impaired loans	$	—	$	—	$	3,192	$	3,192
OREO		—		—		90		90
Servicing rights		—		—		10,855		10,855


	December 31, 2019
	Level 1		Level 2		Level 3		Total
Impaired loans	$	—	$	—	$	3,128	$	3,128
OREO		—		—		168		168
Servicing rights		—		—		13,255		13,255

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

Quantitative Information about Level 3 Fair Value Measurements -- Shown in the table below is the fair value of financial instruments measured under a Level 3 unobservable input on a recurring and nonrecurring basis at ~~September 30, 2017:~~March 31, 2020 and December 31, 2019:


		~~Significant~~	~~Range~~	~~Weighted~~
~~Level 3 Fair Value Instrument~~	~~Valuation Technique~~	~~Unobservable Inputs~~	~~(Weighted Average)~~	~~Average~~
~~RECURRING~~
~~Interest rate lock commitments with customers~~	~~Quoted market prices~~	~~Pull-through expectations~~	~~80% - 99%~~	~~95.0~~	%
~~Individual forward sale commitments with investors~~	~~Quoted market prices~~	~~Pull-through expectations~~	~~80% - 99%~~	~~95.0~~	%
~~NONRECURRING~~
~~Impaired loans~~	~~Fair value of underlying collateral~~	~~Discount applied to the obtained appraisal~~	~~0% - 18.0%~~	~~11.6~~	%


Level 3		Significant		Weighted Average
Fair Value	Valuation	Unobservable		March 31,		December 31,
Instruments	Techniques	Inputs	Range	2020		2019
RECURRING
Interest rate lock commitments with customers	Quoted market prices	Pull-through expectations	80% - 99%	91.5	%	94.5	%
Individual forward sale commitments with investors	Quoted market prices	Pull-through expectations	80% - 99%	91.5	%	94.5	%
Corporate securities	Discounted cash flows	Discount rate	1.6%	1.6	%	2.1	%
Municipal bonds	Discounted cash flows	Discount rate	2.5% - 2.6%	2.6	%	3.4	%
NONRECURRING
Impaired loans	Fair value of underlying collateral	Discount applied to the obtained appraisal	10.0%	10.0	%	10.0	%
OREO	Fair value of collateral	Discount applied to the obtained appraisal	10.0%	10.0	%	10.0	%
Servicing rights	Industry sources	Pre-payment speeds	0% - 50%	23.3	%	17.1	%

An increase in the pull-through rate utilized in the fair value measurement of the interest rate lock commitments with customers and forward sale commitments with investors will result in positive fair value adjustments (and an increase in the fair value measurement). Conversely, a decrease in the pull-through rate will result in a negative fair value adjustment (and a decrease in the fair value measurement).

The following ~~table~~tables provides a reconciliation of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2020 and ~~2016:~~2019:


									Net change in fair					Purchases							Net change		Net change
									value for gains/		Beginning			and	Sales and		Transfers		Ending		in fair value		in fair value
			Purchases						(losses) relating to
	Beginning		and		Sales and		Ending		items held at end of
Three Months Ended September 30,	Balance		Issuances		Settlements		Balance		period
2017
2020											Balance			Issuances	Settlements		In		Balance		for gains/(losses) (1)		for gains (2)
Interest rate lock commitments with customers	$	1,212	$	3,891	$	(3,972)	$	1,131	$	(81)	$	557	$	7,411	$	(3,677)	$	—	$	4,291	$	3,734	$	—
Individual forward sale commitments with investors		83		40		(119)		4		(79)		(195)		(531)		545		—		(181)		14		—
2016
Securities available-for-sale, at fair value												1,162		12		(3)		—		1,171		—		12
2019
Interest rate lock commitments with customers	$	2,058	$	5,763	$	(5,971)	$	1,850	$	(208)	$	503	$	1,931	$	(1,748)	$	—	$	686	$	183	$	—
Individual forward sale commitments with investors		(3)		(60)		23		(40)		(37)		(34)		(162)		100		—		(96)		(62)		—

__________________________

Net change in fair

value for gains/

Purchases

(losses) relating to

Beginning

and

Sales and

Ending

items held at end of
Nine Months Ended September 30,

Balance

Issuances

Settlements

Balance

period
2017

Interest rate lock commitments with customers

$
818

$
11,440

$
(11,127)

$
1,131

$
313
Individual forward sale commitments with investors

177


(49)

(124)


4

(173)
2016


Interest rate lock commitments with customers

$
698

$
14,039

$
(12,887)

$
1,850

$
1,152
Individual forward sale commitments with investors

74


(267)

153


(40)

(114)

(1) Relating to items held at end of period included in income.

(2) Relating to items held at end of period included in other comprehensive income.

Gains (losses) on interest rate lock commitments carried at fair value are recorded in other noninterest income. Gains (losses) on forward sale commitments with investors carried at fair value are recorded within other noninterest ~~income.~~income or noninterest expense.

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~Fair Values of Financial Instruments -~~ ~~The following methods and assumptions were used by the Company in estimating the fair values of financial instruments disclosed in these financial statements:~~

~~Cash, and Cash Equivalents and Certificates of Deposit at Other Financial Institutions~~ ~~- The carrying amounts of cash and short-term instruments approximate their fair value (Level 1).~~

~~Federal Home Loan Bank stock~~ ~~- The par value of FHLB stock approximates its fair value (Level 2).~~

~~Bank-owned Life Insurance~~ ~~- The estimated fair value is equal to the cash surrender value of policies, net of surrender charges (Level 1).~~

~~Accrued Interest -~~ ~~The carrying amounts of accrued interest approximate its fair value (Level 2).~~

~~Loans Receivable, Net~~ - For variable rate loans that re-price frequently and have no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers or similar credit quality (Level 3).

~~Servicing Rights -~~ The fair value of mortgage, commercial, and consumer servicing rights are estimated using net present value of expected cash flows using a third party model that incorporates assumptions used in the industry to value such rights, adjusted for factors such as weighted average prepayments speeds based on historical information where appropriate (Level 3).

~~Deposits~~ - The fair value of deposits with no stated maturity date is included at the amount payable on demand. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation on interest rates currently offered on similar certificates (Level 2).

~~Borrowings -~~ The carrying amounts of advances maturing within 90 days approximate their fair values. The fair values of long-term advances are estimated using discounted cash flow analyses based on the Bank’s current incremental borrowing rates for similar types of borrowing arrangements (Level 2).

~~Subordinated Note -~~ ~~The fair value of the Subordinated Note is based upon the average yield of debt issuances for similarly sized issuances (Level 2).~~

~~Off-Balance Sheet Instruments -~~ The fair value of commitments to extend credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreement and the present creditworthiness of the customers. The majority of the Company’s off-balance sheet instruments consist of non-fee producing, variable-rate commitments, the Company has determined they do not have a distinguishable fair value. The fair value of loan lock commitments with customers and investors reflect an estimate of value based upon the interest rate lock date, the expected pull-through percentage for the commitment, and the interest rate at year end (Level 2 and 3).

~~Table of Contents~~

~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

The following table provides estimated fair values of the Company’s financial instruments at ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016:~~2019, whether or not recognized at fair value on the Consolidated Balance Sheets:


	September 30,				December 31,
	2017				2016
	Carrying		Fair		Carrying		Fair		March 31,				December 31,
	Amount		Value		Amount		Value		2020				2019
Financial Assets									Carrying		Fair		Carrying		Fair
Level 1 inputs:									Amount		Value		Amount		Value
Cash and cash equivalents	$	31,295	$	31,295	$	36,456	$	36,456	$	48,921	$	48,921	$	45,778	$	45,778
Certificates of deposit at other financial institutions		18,108		18,108		15,248		15,248		17,926		17,926		20,902		20,902
Level 2 inputs:
Securities available-for-sale, at fair value		78,103		78,103		81,875		81,875		155,295		155,295		124,895		124,895
Loans held for sale, at fair value		65,055		65,055		52,553		52,553		115,632		115,632		69,699		69,699
FHLB stock, at cost		3,047		3,047		2,719		2,719		10,921		10,921		8,045		8,045
Accrued interest receivable		3,217		3,217		2,524		2,524		6,326		6,326		5,908		5,908
Individual forward sale commitments with investors		104		104		495		495
Paired off commitments with investors		—		—		747		747
Level 3 inputs:
Securities available-for-sale, at fair value										1,171		1,171		1,162		1,162
Loans receivable, gross		765,571		779,284		605,415		670,183		1,411,874		1,413,954		1,351,893		1,377,408
Servicing rights, held at lower of cost or fair value		5,811		7,289		8,459		11,741		10,626		10,855		11,560		13,255
Fair value interest rate locks with customers		1,131		1,131		818		818		4,291		4,291		557		557
Individual forward sale commitments with investors		4		4		177		177
Financial Liabilities
Level 2 inputs:
Deposits		840,578		844,288		712,593		718,970		1,446,269		1,452,760		1,392,408		1,385,658
Borrowings		10,270		9,049		12,670		12,660		159,114		163,294		84,864		85,268
Subordinated note		9,840		9,805		9,825		9,805		9,890		10,599		9,885		10,599
Accrued interest payable		217		217		192		192		293		293		273		273
Paired off commitments with investors		140		140		—		—		112		112		71		71
Interest rate swaps										1,051		1,051		—		—
Individual forward sale commitments with investors										3,723		3,723		8		8
Level 3 inputs:
Individual forward sale commitments with investors										181		181		195		195

NOTE 11 - EMPLOYEE BENEFITS

Employee Stock Ownership Plan

On January 1, 2012, the Company established an ESOP for eligible employees of the Company and the Bank. Employees of the Company and the Bank are eligible to participate in the ESOP if they have been credited with at least 1,000 hours of service during the employees’ first 12‑month period and based on the employee’s anniversary date will be vested ~~into~~in the ESOP. ~~After~~The employee will be 100% vested in the ESOP after two years of working at least 1,000 hours in each of those two ~~years, the employee will be 100% vested in the ESOP.~~years.

The ESOP borrowed $2.6 million from FS Bancorp, Inc. and used those funds to acquire 259,210 shares of FS Bancorp, Inc. common stock in the open market at an average price of $10.17 per share during the second half of 2012. It is anticipated that the Bank will make contributions to the ESOP in amounts necessary to amortize the ESOP loan payable to FS Bancorp, Inc. over a period of 10 years, bearing interest at 2.30%. Intercompany expenses associated with the ESOP are eliminated in consolidation. Shares purchased by the ESOP with the loan proceeds are held in a suspense account and allocated to ESOP participants on a pro rata basis as principal and interest payments are made by the ESOP to FS Bancorp, Inc. The loan is secured by shares purchased with the loan proceeds and will be repaid by the ESOP with funds from the Bank’s discretionary contributions to the ESOP and earnings on the ESOP assets. Payments of principal and interest are due annually on December 31, the Company’s fiscal year end. On December 31, ~~2016,~~2019, the ESOP paid the ~~fifth~~eighth annual installment of principal in the amount of ~~$257,000,~~$275,000, plus accrued interest of ~~$38,000~~$20,000 pursuant to the ESOP loan agreement.

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

As shares are committed to be released from collateral, the Company reports compensation expense equal to the average daily market prices of the shares at ~~September 30, 2017~~March 31, 2020 for the prior 90 days. These shares become outstanding for earnings per share computations. The compensation expense is accrued monthly throughout the year. Dividends on allocated ESOP shares are recorded as a reduction of retained earnings; dividends on unallocated ESOP shares are recorded as a reduction of debt and accrued interest.

Compensation expense related to the ESOP for the three months ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019 was ~~$360,000~~$325,000 and ~~$204,000, respectively, and $914,000 and $529,000 for the nine months ended September 30, 2017 and 2016,~~$321,000, respectively.

Shares held by the ESOP at ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019 were as follows (shown as actual):


	Balances		Balances		Balances		Balances
	at September 30, 2017		at September 30, 2016		at March 31, 2020		at March 31, 2019
Allocated shares		126,589		102,359		189,511		176,809
Committed to be released shares		19,441		19,441		6,480		6,480
Unallocated shares		110,164		136,085		45,362		71,283
Total ESOP shares		256,194		257,885		241,353		254,572

Fair value of unallocated shares (in thousands)	$	5,180	$	3,703	$	2,276	$	3,530

NOTE 12 - EARNINGS PER SHARE

The Company computes earnings per share using the two-class method, which is an earnings allocation method for computing earnings per share that treats a participating security as having rights to earnings that would otherwise have been available to common shareholders. Basic earnings per share are computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Unvested share-based awards containing non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and are included in the computation of earnings per share pursuant to the two-class method. Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. For earnings per share calculations, the ESOP shares committed to be released are included as outstanding shares for both basic and diluted earnings per share.

The following table presents a reconciliation of the components used to compute basic and diluted earnings per share for the three ~~end nine~~ months ended ~~September 30, 2017~~March 31, 2020 and ~~2016:~~2019:


	At or For the Three Months Ended September 30,				At or For the Nine Months Ended September 30,				At or For the Three Months Ended March 31,
Numerator:	2017		2016		2017		2016
Net income (in thousands)	$	3,454	$	3,457	$	10,406	$	7,953
Denominator:
Numerator (in thousands):									2020		2019
Net income									$	5,167	$	5,192
Dividends and undistributed earnings allocated to participating securities										(56)		—
Net income available to common shareholders									$	5,111	$	5,192
Denominator (shown as actual):
Basic weighted average common shares outstanding		3,051,744		2,851,147		2,949,092		2,901,572		4,391,499		4,355,307
Dilutive shares		187,584		87,292		192,685		84,102		87,419		138,119
Diluted weighted average common shares outstanding		3,239,328		2,938,439		3,141,777		2,985,674		4,478,918		4,493,426
Basic earnings per share	$	1.13	$	1.21	$	3.53	$	2.74	$	1.16	$	1.19
Diluted earnings per share	$	1.07	$	1.18	$	3.31	$	2.66	$	1.14	$	1.15
Potentially dilutive weighted average share options that were not included in the computation of diluted earnings per share because to do so would be anti-dilutive										41,627		44,488

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NOTE 13 - STOCK-BASED COMPENSATION

Stock Options and Restricted Stock

On May 17, 2018, the shareholders of FS Bancorp, Inc. approved the 2018 Equity Incentive Plan (the “2018 Plan”) that authorizes 650,000 shares of the Company’s common stock to be awarded. The 2018 Plan provides for the grant of incentive stock options, non-qualified stock options, and up to 163,000 restricted stock awards (“RSAs”) to directors, emeritus directors, officers, employees or advisory directors of the Company. On August 15, 2019, the Company awarded grants of 20,215 RSAs and 50,655 stock options with an exercise price equal to the market price of FS Bancorp’s common stock on the grant date of $48.74 per share.

In September 2013, the shareholders of FS Bancorp, Inc. approved the FS Bancorp, Inc. 2013 Equity Incentive Plan (“(the “2013 Plan”). The Plan ~~provides~~provided for the grant of stock options and ~~restricted stock awards.~~

~~Total share-based compensation expense for the~~RSAs. The 2013 Plan ~~was $138,000 and $496,000 for the three and nine months ended September 30, 2017, respectively, and $195,000 and $588,000 for the three and nine months ended September 30, 2016, respectively.~~

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

~~Stock Options~~

~~The Plan authorizes~~authorized the grant of stock options totaling 324,013 shares of common stock to Company directors and employees inof which 322,000 ~~option share awards under the Plan~~stock options were granted with an exercise price equal to the market price of FS Bancorp’s common stock aton the grant date of May 8, 2014, of $16.89 per share. ~~These~~The 2013 Plan authorized the grant of RSAs totaling 129,605 shares to Company directors, advisory directors, emeritus directors, officers, and employees, all of which have been granted. All options and RSAs previously granted have vested as of March 31, 2020.

Total share-based compensation expense for the 2018 Plan was $224,000 for the three months ended March 31, 2020, and for the 2013 and 2018 Plans was $262,000 for the three months ended March 31, 2019.

Stock Options

Both plans consist of stock option ~~share~~ awards ~~were~~that may be granted as incentive stock options or non-qualified stock ~~options, having a vesting period of~~options. Stock option awards generally vest at one year for independent directors or over five years for employees and officers with 20% vesting on the anniversary date of each grant date ~~and a contractual life~~as long as the award recipient remains in service to the Company. The options are exercisable after vesting for up to the remaining term of the original grant. The maximum term of the options granted is 10 years. Any unexercised stock options will expire 10 years after the grant date or sooner in the event of the award recipient’s termination of service with the Company or the Bank. At ~~September 30, 2017, 2,013~~March 31, 2020, there were 336,345 and 6,013 stock option ~~share~~ awards ~~are~~ available to be ~~granted.~~granted under the 2018 Plan and the 2013 Plan, respectively.

The fair value of each stock option award is estimated on the grant date using a Black-Scholes Option pricing model that uses the following assumptions. The dividend yield is based on the current quarterly dividend in effect at the time of the grant. Historical employment data is used to estimate the forfeiture rate. The Company became a publicly held company in July 2012, therefore historical data was not available to calculate the volatility for FS Bancorp stock. Management utilized a proxy to determine the expected volatility of FS Bancorp’s stock at grant date for the majority of stock options granted in 2014. The proxy chosen was the NASDAQ Bank Index, or NASDAQ Bank (NASDAQ symbol: BANK). This index provides the volatility of the banking sector for NASDAQ traded banks. The majority of smaller banks are traded on the NASDAQ given the costs and daily interaction required with trading on the New York Stock Exchange. The Company utilized the comparable Treasury rate for the discount rate associated with the stock options granted. The Company elected to use Staff Accounting Bulletin 107, simplified expected term calculation for the “Share-Based Payments” method permitted by the SEC to calculate the expected term. This method uses the vesting term of an option along with the contractual term, setting the expected life at 5.5 years for one-year vesting and 6.5 ~~years.~~years for five-year vesting.

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The following table presents a summary of the Company’s stock option ~~plan~~ awards during the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2020 (shown as actual):


				Weighted-Average						Weighted-Average
		Weighted-		Remaining				Weighted-		Remaining
		Average		Contractual Term In	Aggregate			Average		Contractual Term In	Aggregate
	Shares	Exercise Price		Years	Intrinsic Value		Shares	Exercise Price		Years	Intrinsic Value
Outstanding at January 1, 2017	295,850	$	16.89	7.36	$	5,638,901
Outstanding at January 1, 2020							287,990	$	36.98	6.77	$	7,722,369
Granted	—		—	—		—	—		—	—		—
Less exercised	34,363	$	16.89	—	$	919,380	9,398	$	16.89	—	$	350,414
Forfeited or expired	—		—	—		—	—		—	—		—
Outstanding at September 30, 2017	261,487	$	16.89	6.61	$	9,089,288
Outstanding at March 31, 2020							278,592	$	37.65	6.57	$	2,444,876

Expected to vest, assuming a 0.31% annual forfeiture rate(1)	261,053	$	16.89	6.61	$	9,074,192	277,770	$	37.60	6.57	$	2,444,876

Exercisable at September 30, 2017	134,687	$	16.89	6.61	$	4,681,720
Exercisable at March 31, 2020							147,937	$	22.53	4.63	$	2,444,876

__________________________

(1) Forfeiture rate has been calculated and estimated to assume a forfeiture of 3.1% of the options forfeited over 10 years.

At ~~September 30, 2017,~~March 31, 2020, there was ~~$368,000~~$1.3 million of total unrecognized compensation cost related to nonvested stock options granted under ~~the Plan.~~both plans. The cost is expected to be recognized over the remaining weighted-average vesting period of ~~1.6~~3.7 years.

Restricted Stock Awards

The ~~Plan authorizes~~RSAs’ fair value is equal to the value of the stock based on the market price of FS Bancorp’s common stock on the grant ~~of restricted stock awards totaling 129,605 shares to Company directors~~date and employees, and 125,105 shares were granted on May 8, 2014 at a grant date fair value of $16.89 per share. The remaining 4,500 restricted stock awards were granted January 1, 2016 at a grant date fair value of $26.00 per share. Compensationcompensation expense is recognized over the vesting period of the awards based on the fair value of the restricted stock. ~~The restricted stock awards’ fair value is equal to~~Shares for the ~~value on the grant date. Shares awarded as restricted stock~~2018 Plan generally vest ~~ratably~~at one-year for independent directors or over ~~a three-year period for directors and~~ a five-year period for employees and officers beginning aton the grant date. Any unvested ~~restricted stock awards~~RSAs will expire after vesting or sooner in the event of the award recipient’s termination of service with the Company or the Bank.

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

The following table presents a summary of the Company’s nonvested awards during the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2020 (shown as actual):


		Weighted-Average					Weighted-Average
		Grant-Date Fair Value		Weighted-Average			Grant-Date Fair Value
Nonvested Shares	Shares	Per Share		Grant-Date Fair Value		Shares	Per Share
Nonvested at January 1, 2017	68,763	$	17.49	$	1,202,401
Nonvested at January 1, 2020						40,215	$	53.64
Granted	—		—		—	—	$	—
Less vested	31,921	$	17.32	$	552,810	—	$	—
Forfeited or expired	—		—		—	—		—
Nonvested at September 30, 2017	36,842	$	17.63	$	649,591
Nonvested at March 31, 2020						40,215	$	53.64

At ~~September 30, 2017,~~March 31, 2020, there was ~~$508,000~~$1.8 million of total unrecognized compensation ~~costs~~cost related to nonvested shares granted under the 2018 Plan as ~~restricted stock awards.~~RSAs. The cost is expected to be recognized over the remaining weighted-average vesting period of ~~1.6~~3.8 years.

NOTE 14 - REGULATORY CAPITAL

The ~~Company and the~~ Bank ~~are~~is subject to various regulatory capital requirements administered by the ~~federal banking agencies.~~Federal Reserve and the FDIC. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines of the regulatory framework for prompt corrective action, the Bank must meet specific capital adequacy guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance

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sheet items as calculated under regulatory accounting practices. The Bank’s capital classification is also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

~~Quantitative measures established by regulation to ensure~~The federal banking agencies jointly issued a final rule that provides for an optional, simplified measure of capital adequacy, ~~require~~ the ~~Bank~~community bank leverage ratio framework, for qualifying community banking organizations, consistent with Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act. This final rule is applicable to ~~maintain minimum amounts~~all non-advanced approaches FDIC-supervised institutions with less than $10 billion in total consolidated assets. The community bank leverage ratio (“CBLR”) final rule was effective on January 1, 2020, and ~~ratios (set forth~~will allow qualifying community banking organizations to calculate a leverage ratio to measure capital adequacy. Banks opting into the CBLR framework will not be required to calculate or report risk-based capital. A qualifying community banking organization is defined as having less than $10 billion in ~~the table below)~~total consolidated assets, a leverage ratio greater than 9%, off-balance sheet exposures of 25% or less of total consolidated assets, and trading assets and liabilities of 5% or less of total consolidated assets. The final rule adopts Tier 1 capital ~~(as defined~~and the existing leverage ratio into the community bank leverage ratio framework. A bank electing the framework will not be subject to other capital and leverage requirements. A bank electing the framework that ceases to meet any qualifying criteria in a future period and that has a leverage ratio greater than 8% will be allowed a grace period of two reporting periods to satisfy the ~~regulations)~~CBLR qualifying criteria or comply with the generally applicable capital requirements. A bank may opt out of the framework at any time, without restriction, by reverting to ~~total average assets (as defined),~~the generally applicable risk-based capital rule.

In response to the COVID-19 pandemic, the CARES Act was signed into law on March 27, 2020. Among other things, the CARES Act directs federal banking agencies to adopt interim final rules to lower the threshold under the CBLR from 9% to 8% and ~~minimum~~to provide a reasonable grace period for a community bank that falls below the threshold to regain compliance, in each case until the earlier of the termination date of the national emergency or December 31, 2020. In April 2020, the federal banking agencies issued two interim final rules implementing this directive. One interim final rule provides that, as of the second quarter 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) may elect to use the CBLR framework. It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR requirement, so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provides a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement. It establishes a minimum CBLR of 8% for the second through fourth quarters of 2020, 8.5% for 2021, and 9% thereafter, and maintains a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement.

The Bank qualified and elected the CBLR framework as of March 31, 2020. The Tier 1 ~~total~~leverage-based capital ~~(as defined) and common equity~~ratio calculated for the Bank at March 31, 2020 was 11.3%, compared to 11.6% at December 31, 2019. At March 31, 2020, the Bank had Tier 1 ~~(“CET 1”)~~ capital of $194.3 million and a minimum Tier 1 capital requirement of $138.0 million to ~~risk-weighted assets (as defined).~~

be considered well capitalized under the CBLR framework. At December 31, 2019, The Bank ~~must maintain minimum total risk-based,~~had Tier 1 ~~risk-based,~~capital of $196.0 million and a minimum Tier 1 ~~leverage ratios as set forth in the table below~~capital requirement of $84.8 million to be ~~categorized as~~considered well ~~capitalized.~~capitalized for the Tier 1 leverage-based ratio under the Basel Committee on Companying Supervision’s capital guidelines for U.S. Banks (“Basel III”) requirements. At ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016,~~2019, the Bank was categorized as well capitalized under applicable regulatory requirements. There are no conditions or events since that notification that management believes have changed the Bank’s category. Management believes, at ~~September 30 2017,~~March 31, 2020, that ~~the Company and~~ the Bank met all capital adequacy requirements.

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

The following table compares the Bank’s actual capital amounts and ratios at September 30, 2017 and December 31, 2016 to their minimum regulatory capital requirements and well capitalized regulatory capital at those dates (dollars in thousands):

To be Well Capitalized

Under Prompt

For Capital

Corrective

Actual

Adequacy Purposes

Action Provisions

Bank Only

Amount

Ratio

Amount

Ratio

Amount

Ratio

At September 30, 2017













Total risk-based capital













(to risk-weighted assets)

$
130,246

16.14
%
$
64,556

8.00
%
$
80,696

10.00
%
Tier 1 risk-based capital





(to risk-weighted assets)

$
120,150

14.89
%
$
48,417

6.00
%
$
64,556

8.00
%
Tier 1 leverage capital





(to average assets)

$
120,150

12.50
%
$
38,459

4.00
%
$
48,074

5.00
%
CET 1 capital





(to risk-weighted assets)

$
120,150

14.89
%
$
36,313

4.50
%
$
52,452

6.50
%

At December 31, 2016













Total risk-based capital













(to risk-weighted assets)

$
93,309

13.87
%
$
53,813

8.00
%
$
67,266

10.00
%
Tier 1 risk-based capital













(to risk-weighted assets)

$
84,876

12.62
%
$
40,360

6.00
%
$
53,813

8.00
%
Tier 1 leverage capital













(to average assets)

$
84,876

10.33
%
$
32,862

4.00
%
$
41,078

5.00
%
CET 1 capital













(to risk-weighted assets)

$
84,876

12.62
%
$
30,270

4.50
%
$
43,723

6.50
%

In addition to the minimum CET 1, Tier 1 and total capital ratios, the Bank has to maintain a capital conservation buffer consisting of additional CET 1 capital above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of eligible retained income that could be utilized for such actions. This new capital conservation buffer requirement was phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented to an amount equal to 2.5% of risk-weighted assets in January 2019. At September 30, 2017, the Bank’s CET1 capital exceeded the required capital conservation buffer of 1.25%.

FS Bancorp, Inc. is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to ~~the~~ capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. ~~For~~Bank holding companies with less than $3.0 billion in assets are generally not subject to compliance with the Federal Reserve’s capital regulations, which are generally the same as the capital regulations applicable to the Bank. The Federal Reserve has a policy that a bank holding company ~~with less than $1.0 billion in assets,~~is required to serve as a source of financial and managerial strength to the ~~capital guidelines apply on a~~holding company’s subsidiary bank ~~only basis~~ and ~~the Federal Reserve~~ expects the holding company’s subsidiary ~~banks~~bank to be well capitalized under the prompt corrective action regulations. If FS Bancorp, Inc. was subject to regulatory guidelines for bank holding companies with ~~$1.0~~$3.0 billion or more in assets at ~~September 30, 2017, the Company~~March 31, 2020, FS Bancorp, Inc. would have exceeded all regulatory capital requirements. The ~~regulatory~~Tier 1 leverage-based capital ~~ratios~~ratio calculated for FS Bancorp, Inc. at ~~September 30, 2017 were 11.9% for Tier 1 leverage-based capital, 14.2% for Tier 1 risk-based capital, 15.5% for total risk-based capital, and 14.2% for CET 1 capital ratio.~~March 31, 2020 was 11.1%, compared to 11.3% at December 31, 2019.

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NOTE 15 - BUSINESS SEGMENTS

The Company’s business segments are determined based on the products and services provided, as well as the nature of the related business activities, and they reflect the manner in which financial information is currently evaluated by management. This process is dynamic and is based on management’s current view of the Company’s operations and is not necessarily comparable with similar information for other financial institutions. ~~We define our~~The Company defines its business segments by

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

product type and customer segment which ~~we have~~it has organized into two lines of business: commercial and consumer banking and home lending.

~~We use~~The Company uses various management accounting methodologies to assign certain income statement items to the responsible operating segment, including:

a funds transfer pricing (“FTP”) system, which allocates interest income credits and funding charges between the segments, assigning to each segment a funding credit for its liabilities, such as deposits, and a charge to fund its assets;

a cost per loan serviced allocation based on the number of loans being serviced on the balance sheet and the number of loans serviced for third parties;

an allocation based upon the approximate square footage utilized by the home lending segment in Company owned locations;

an allocation of charges for services rendered to the segments by centralized functions, such as corporate overhead, which are generally based on the number of full time employees (“FTEs”) in each segment; and

an allocation of the Company’s consolidated income taxes which are based on the effective tax rate applied to the segment’s pretax income or loss.

The FTP methodology is based on management’s estimated cost of originating funds including the cost of overhead for deposit generation.

A description of the Company’s business segments and the products and services that they provide is as follows:

Commercial and Consumer Banking Segment

The commercial and consumer banking segment provides diversified financial products and services to ~~our~~its commercial and consumer customers through Bank branches, ~~ATMs,~~automated teller machines (“ATM”), online banking platforms, mobile banking apps, and telephone banking. These products and services include deposit products; residential, consumer, business and commercial real estate lending portfolios and cash management services. ~~We originate~~The Company originates consumer loans, commercial and multi-family real estate loans, construction loans onfor residential and multi-family construction, and commercial business loans. At ~~September 30, 2017, our~~March 31, 2020, the Company’s retail deposit branch network consisted of 1121 branches in the Pacific Northwest. At ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016, our~~2019, deposits totaled ~~$840.6 million~~$1.45 billion and ~~$712.6 million,~~$1.39 billion, respectively. This segment is also responsible for the management of ~~our~~the investment portfolio and other assets of the Bank.

Home Lending Segment

The home lending segment originates one-to-four-family residential mortgage loans primarily for sale in the secondary markets as well as originating adjustable rate mortgage (“ARM”) loans held for investment. The majority of ~~our~~ mortgage loans are sold to or securitized by FNMA, FHLMC, GNMA, or FHLB of Des Moines, while ~~we retain~~the Company retains the right to service these loans. Loans originated under the guidelines of the Federal Housing Administration or FHA, US Department of Veterans Affairs or VA, and United States Department of Agriculture or USDA are generally sold servicing released to a correspondent bank or mortgage company. ~~We have~~The Company has the option to sell loans on a servicing-released or servicing-retained basis to securitizers and correspondent lenders. A small percentage of ~~our~~its loans are brokered to other lenders. On occasion, wethe Company may sell a portion of ~~our~~its MSR portfolio and may sell small pools of loans initially originated to be held in the loan portfolio. ~~We manage~~The Company manages the loan funding and the interest rate risk associated with the secondary market loan sales and the retained one-to-four-family mortgage servicing rights within this business

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segment. One-to-four-family loans originated for investment are allocated to the home lending segment with a corresponding provision expense and FTP for cost of funds.

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~

Segment Financial Results

The tables below summarize the financial results for each segment based primarily on the number of FTEs and assets within each segment for the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2020 and ~~2016:~~2019:

At or For the Three Months Ended September 30, 2017


Home Lending

Commercial and Consumer Banking

Total
Condensed income statement:

Net interest income (1)

$
812

$
10,210

$
11,022
Provision for loan losses

(127)

(323)

(450)
Noninterest income

5,014

1,413

6,427
Noninterest expense

(4,586)

(7,003)

(11,589)
Income before provision for income taxes

1,113

4,297

5,410
Provision for income taxes

(407)

(1,549)

(1,956)
Net income

$
706

$
2,748

$
3,454
Total average assets at period end

$
220,898

$
744,820

$
965,718
FTEs

119

204

323

At or For the Three Months Ended September 30, 2016


Home Lending

Commercial and Consumer Banking

Total
Condensed income statement:

Net interest income (1)

$
793

$
7,957

$
8,750
Provision for loan losses

(16)

(584)

(600)
Noninterest income

5,982

1,266

7,248
Noninterest expense

(3,861)

(6,451)

(10,312)
Income before provision for income taxes

2,898

2,188

5,086
Provision for income taxes

(948)

(681)

(1,629)
Net income

$
1,950

$
1,507

$
3,457
Total average assets at period end

$
168,722

$
634,735

$
803,457
FTEs

110

195

305


	At or For the Three Months Ended March 31, 2020
Condensed income statement:	Home Lending		Commercial and Consumer Banking		Total
Net interest income (1)	$	1,181	$	16,292	$	17,473
Provision for loan losses		(559)		(3,127)		(3,686)
Noninterest income		5,158		3,733		8,891
Noninterest expense		(4,162)		(12,022)		(16,184)
Income before provision for income taxes		1,618		4,876		6,494
Provision for income taxes		(331)		(996)		(1,327)
Net income	$	1,287	$	3,880	$	5,167
Total average assets for period ended	$	327,441	$	1,406,594	$	1,734,035
FTEs		127		317		444

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~~FS BANCORP, INC. AND SUBSIDIARY~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~


	At or For the Nine Months Ended September 30, 2017
	Home Lending		Commercial and Consumer Banking		Total		At or For the Three Months Ended March 31, 2019
Condensed income statement:							Home Lending		Commercial and Consumer Banking		Total
Net interest income (1)	$	1,857	$	28,105	$	29,962	$	1,071	$	16,618	$	17,689
Provision for loan losses		(324)		(126)		(450)		(59)		(691)		(750)
Noninterest income		14,863		3,941		18,804		2,419		2,136		4,555
Noninterest expense		(12,985)		(19,924)		(32,909)		(3,304)		(11,493)		(14,797)
Income before provision for income taxes		3,411		11,996		15,407		127		6,570		6,697
Provision for income taxes		(1,107)		(3,894)		(5,001)		(29)		(1,476)		(1,505)
Net income	$	2,304	$	8,102	$	10,406	$	98	$	5,094	$	5,192
Total average assets at period end	$	196,765	$	706,017	$	902,782
Total average assets for period ended							$	239,287	$	1,375,574	$	1,614,861
FTEs		119		204		323		112		314		426

____________________________

At or For the Nine Months Ended September 30, 2016


Home Lending

Commercial and Consumer Banking

Total
Condensed income statement:

Net interest income (1)

$
1,706

$
22,959

$
24,665
Provision for loan losses

(142)

(1,658)

(1,800)
Noninterest income

14,852

3,273

18,125
Noninterest expense

(10,593)

(18,246)

(28,839)
Income before provision for income taxes

5,823

6,328

12,151
Provision for income taxes

(2,012)

(2,186)

(4,198)
Net income

$
3,811

$
4,142

$
7,953
Total average assets at period end

$
147,873

$
642,283

$
790,156
FTEs

110

195

305

(1)

Net interest income is the difference between interest earned on assets and the cost of liabilities to fund those assets. Interest earned includes actual interest earned on segment assets and, if the segment has excess liabilities, interest credits for providing funding to the other segment. The cost of liabilities includes interest expense on segment liabilities and, if the segment does not have enough liabilities to fund its assets, a funding charge based on the cost of assigned liabilities to fund segment assets.

NOTE 16 - GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill and certain other intangibles generally arise from business combinations accounted for under the acquisition method of accounting. Goodwill totaled $2.3 million at March 31, 2020 and December 31, 2019, and represents the excess of the total acquisition price paid over the fair value of the assets acquired, net of the fair values of liabilities assumed as a result of the purchase of four retail bank branches from Bank of America, National Association on January 22, 2016 (“Branch Purchase”). Goodwill is not amortized but is evaluated for impairment on an annual basis at December 31 of each year or whenever events or changes in circumstances indicate the carrying value may not be recoverable. The Company performed an impairment analysis at December 31, 2019, and determined that no impairment of goodwill

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existed. No events or circumstances since the December 31, 2019 annual impairment test were noted that would indicate it was more likely than not a goodwill impairment existed at March 31, 2020.

As of March 31, 2020, the Company had positive equity, however, if adverse economic conditions as a result of the COVID-19 pandemic were to be deemed sustained rather than temporary, it may significantly affect the fair value of our goodwill. Accordingly, no assurances can be given that the Company will not record an impairment loss on goodwill in the future.

Core deposit intangible (“CDI”) is evaluated for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable, with any changes in estimated useful life accounted for prospectively over the revised remaining life. As of March 31, 2020, management believes that there have been no events or changes in the circumstances that would indicate a potential impairment of CDI.

The following table summarizes the changes in the Company’s other intangible assets comprised solely of CDI for the year ended December 31, 2019, and the three months ended March 31, 2020.


	Other Intangible Assets
			Accumulated
	Gross CDI		Amortization		Net CDI
Balance, December 31, 2018	$	7,490	$	(1,273)	$	6,217
Amortization		—		(760)		(760)
Balance, December 31, 2019		7,490		(2,033)		5,457
Amortization		—		(176)		(176)
Balance, March 31, 2020	$	7,490	$	(2,209)	$	5,281

The CDI represents the fair value of the intangible core deposit base acquired in business combinations. The CDI will be amortized on a straight-line basis over 10 years for the CDI related to the Anchor Merger on November 15, 2018 (“Anchor Acquisition”) and on an accelerated basis over approximately nine years for the CDI related to the Branch Purchase. Total amortization expense was $176,000 for the three months ended March 31, 2020, and $190,000 for the same period in 2019. Amortization expense for CDI is expected to be as follows at March 31, 2020:


Remainder of 2020	$	530
2021		691
2022		691
2023		691
2024		621
Thereafter		2,057
Total	$	5,281

NOTE 17 - REVENUE FROM CONTRACTS WITH CUSTOMERS

Revenue Recognition

In accordance with Topic 606, revenues are recognized when control of promised goods or services is transferred to customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of Topic 606, the Company performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the Company satisfies a performance obligation. The Company only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of Topic 606, the Company assesses the goods or services that are

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promised within each contract and identifies those that contain performance obligations, and assesses whether each promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

All of the Company’s revenue from contracts with customers in-scope of ASC 606 is recognized in noninterest income and included in our commercial and consumer banking segment. The following table presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three months ended March 31, 2020 and 2019.


(Dollars in thousands):	At or For the Three Months Ended March 31,
Noninterest income	2020		2019
In-scope of Topic 606:
Debit card interchange fees	$	435	$	423
Deposit service and account maintenance fees		266		271
Noninterest income (in-scope of Topic 606)		701		694
Noninterest income (out-of-scope of Topic 606)		8,190		3,861
Total noninterest income	$	8,891	$	4,555

Deposit Fees

The Bank earns fees from its deposit customers for account maintenance, transaction-based services, and overdraft charges. Account maintenance fees consist primarily of account fees and analyzed account fees charged on deposit accounts on a monthly basis. The performance obligation is satisfied and the fees are recognized on a monthly basis as the service period is completed. Transaction-based fees on deposit accounts are charged to deposit customers for specific services provided to the customer, such as wire fees, as well as charges against the account, such as fees for non-sufficient funds and overdrafts. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer.

Debit Interchange Income

Debit and ATM interchange income represent fees earned when a debit card issued by the Bank is used. The Bank earns interchange fees from debit cardholder transactions through the Visa payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholders’ debit card.

NOTE 18 - COVID-19 PANDEMIC

In response to the current global situation surrounding the COVID-19 pandemic, the Company is offering a variety of relief options designed to support our customers and the communities we serve.

The Company is following the Federal Housing Finance Agency guidelines for forbearance, foreclosure relief, and late payment reporting for the COVID-19 pandemic on all serviced loans and a modified format for portfolio loans. As of May 5, 2020, the amount of one-to-four-family loans that have entered into forbearance agreements with the borrowers is $59.1 million for serviced loans and $20.7 million for portfolio loans, and the amount of consumer loans that we have entered into a skip pay/interest deferral agreements with the borrower is $8.2 million.

All loans modified due to COVID-19 will be separately monitored and any request for continuation of relief beyond the initial modification will be reassessed at that time to determine if a further modification should be granted and if a downgrade in risk rating is appropriate.

The Company participated in the PPP and has secured 433 approvals and 414 fundings as of May 5, 2020 for borrowers in the communities we serve. The Company has funded over $72.0 million in PPP loans to date.

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We intend to utilize the FRB's Paycheck Protection Program Liquidity Facility (“PPPLF”), pursuant to which the Company will pledge its PPP loans as collateral to obtain FRB non-recourse loans. The PPPLF will take the PPP loans as collateral at face value. As of May 5, 2020 the Company has borrowed $63.3 million under the PPPLF, with additional unused borrowing capacity of $9.6 million.

All of our branches are open via drive thru and by appointment; and to enhance health and safety measures, approximately 70% of our staff have been approved to work remotely, where feasible.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This report ~~may contain~~contains forward-looking statements, which can be identified by the use of words such as “believes,” “expects,” “anticipates,” “estimates,” or similar expressions. Forward-looking statements include, but are not limited to:

statements of our goals, intentions, and expectations;

statements regarding our business plans, prospects, growth, and operating strategies;

statements regarding the quality of our loan and investment portfolios; and

estimates of our risks and future costs and benefits.

These forward-looking statements are subject to significant risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:

the effect of the COVID-19 pandemic, including on the Company’ credit quality and business operations, as well as its impact on general economic and financial market conditions and other uncertainties resulting from the COVID-19 pandemic, such as the extent and duration of the impact on public health, the U.S. and global economies, and consumer and corporate customers, including economic activity, employment levels and market liquidity;

general economic conditions either nationally or in our market area, that are worse than expected;

the credit risks of lending activities, including changes in the level and trend of loan delinquencies, write offs, changes in our allowance for loan losses, and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;

secondary market conditions and our ability to originate loans for sale and sell loans in the secondary market;

fluctuations in the demand for loans, the number of unsold homes, land and other properties, and fluctuations in real estate values in our market area;

~~increases~~staffing fluctuations in ~~premiums for deposit insurance;~~response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;

changes in the interest rate environment that reduce our interest margins or reduce the fair value of financial instruments;

uncertainty regarding the future of the London Interbank Offered Rate (“LIBOR”), and the potential transition away from LIBOR toward new interest rate benchmarks;

increased competitive pressures among financial services companies;

our ability to execute our plans to grow our residential construction lending, our home lending operations, our warehouse lending, and the geographic expansion of our indirect home improvement lending;

our ability to attract and retain deposits;

our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto;

our ability to control operating costs and expenses;

our ability to retain key members of our senior management team;

changes in consumer spending, borrowing, and savings habits;

our ability to successfully manage our growth;

legislative or regulatory changes that adversely affect our business, including the effect of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, changes in regulation policies and principles, an increase in regulatory capital requirements or change in the interpretation of regulatory capital or other rules, including as a result of Basel III;

adverse changes in the securities markets;

changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards ~~Board;~~Board (“FASB”);

costs and effects of litigation, including settlements and judgments;

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disruptions, security breaches, or other adverse events, failures, or interruptions in, or attacks on, our ~~ability to implement~~information technology systems or on the third-party vendors who perform several of our ~~branch expansion strategy;~~critical processing functions;

inability of key third-party vendors to perform their obligations to us; and

other economic, competitive, governmental, regulatory, and technical factors affecting our operations, pricing, products, and services, including the potential effects of the CARES Act, and other risks described elsewhere in this Form 10‑Q and our other reports filed with the U.S. Securities and Exchange Commission (“SEC”), including our Annual Report on Form 10‑K for the year ended December 31, ~~2016.~~2019.

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Any of the forward-looking statements made in this Form 10‑Q and in other public statements may turn out to be wrong because of inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot foresee. Forward-looking statements are based upon management’s beliefs and assumptions at the time they are made. The Company undertakes no obligation to update or revise any forward-looking statement included in this report or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur and you should not put undue reliance on any forward-looking statements.

Highlights in Response to the COVID-19 Pandemic:

Due to the current global situation surrounding the COVID-19 pandemic, the Company is offering a variety of relief options designed to support our customers and the communities we serve.

Paycheck Protection Program ("PPP") Participation. The Coronavirus Aid, Relief and Economic Security Act, or CARES Act, was signed into law on March 27, 2020, and authorized the Small Business Administration (“SBA”) to temporarily guarantee loans under a new loan program called the Paycheck Protection Program, or PPP. The goal of the PPP is to avoid as many layoffs as possible, and to encourage small businesses to maintain payrolls. As a qualified SBA lender, the Company was automatically authorized to originate PPP loans upon commencement of the program in April 2020. PPP loans have: (a) an interest rate of 1.0%, (b) a two-year loan term to maturity; and (c) principal and interest payments deferred for six months from the date of disbursement. The SBA guarantees 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrower’s PPP loan, including any accrued interest, is eligible to be forgiven and repaid by the SBA so long as employee and compensation levels of the business are maintained and 75% of the loan proceeds are used for payroll expenses, with the remaining 25% of the loan proceeds used for other qualifying expenses. The Company has accepted more than 400 applications for PPP loans, including applications from new and existing customers who are small to midsize businesses as well as independent contractors, sole proprietors and partnerships as allowed under the PPP guidance issued in April 2020.

Allowance for Loan Losses and Loan Modifications

The Company recorded a provision of $3.7 million for the first quarter of 2020, compared to $750,000 in the first quarter a year ago due primarily to credit deterioration incurred but not yet evident reflecting the probable future impact of COVID-19 on the economy. As of March 31, 2020, the Bank had modified 66 loans totaling $12.5 million due to COVID-19 related issues. These modifications were not classified as TDRs at March 31, 2020 in accordance with the guidance of the CARES Act. The CARES Act provided that the short-term modification of loans as a result of the COVID-19 pandemic, made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current under the CARES Act if they are less than 30 days past due on their contractual payments at the time a modification program is implemented.

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Branch Operations and Additional Client Support

We have taken various steps to ensure the safety of our customers and our personnel. Many of our employees are working remotely or have flexible work schedules, and we have established protective measures within our offices to help ensure the safety of those employees who must work on-site. The Family First Coronavirus Response Act also provides additional flexibility to our employees to help navigate their individual challenges.

The COVID-19 pandemic has caused significant disruptions to our branch operations resulting in the implementation of various social distancing measures at the Company to address client and community needs, including branch lobby closures. To ensure the safety of our customers and employees, services are offered through drive up facilities and/or by appointment.

Overdraft and fee reversals are waived on a case-by-case basis. We are cautious when paying overdrafts beyond the client's total deposit relationship, overdraft protection options or their overdraft coverage limits.

Overview

FS Bancorp, Inc. and its subsidiary bank, 1st Security Bank of Washington have been serving the Puget Sound area since 1936. Originally chartered as a credit union, known as Washington’s Credit Union, the credit union served various select employment groups. On April 1, 2004, the credit union converted to a Washington state-chartered mutual savings bank. On July 9, 2012, the Bank converted from mutual to stock ownership and became the wholly owned subsidiary of FS Bancorp, Inc.

The Company is relationship-driven, delivering banking and financial services to local families, local and regional businesses and industry niches within distinct Western Washington communities, predominately, the Puget Sound area, ~~communities,~~ and one loan production office located in the Tri-Cities, Washington. On January 22, 2016, the Company completed the Branch Purchase and acquired $186.4 million in deposits and $419,000 in loans based on financial information at that date. The four branches acquired are located in the communities of Port Angeles, Sequim, Port Townsend, and Hadlock, Washington. The Branch Purchase expanded our Puget Sound-focused retail footprint onto the Olympic Peninsula and provided an opportunity to extend our unique brand of community banking into those communities.

The Company also maintains its long-standing indirect consumer lending platform which operates throughout the West Coast. The Company emphasizes long-term relationships with families and businesses within the communities served, working with them to meet their financial needs. The Company is also actively involved in community activities and events within these market areas, which further strengthens our relationships within those markets.

The Company focuses on diversifying revenues, expanding lending channels, and growing the banking franchise. Management remains focused on building diversified revenue streams based upon credit, interest rate, and concentration risks. Our business plan remains as follows:

Growing and diversifying our loan portfolio;

Maintaining strong asset quality;

Emphasizing lower cost core deposits to reduce the costs of funding our loan growth;

Capturing our customers’ full relationship by offering a wide range of products and services by leveraging our well-established involvement in our communities and by selectively emphasizing products and services designed to meet our customers’ banking needs; and

Expanding the Company’s markets.

The Company is a diversified lender with a focus on the origination of ~~indirect home improvement loans, also referred to as fixture secured~~one-to-four-family loans, commercial real estate mortgage loans, ~~home loans, commercial business loans, and~~ second ~~mortgage/~~mortgage or home equity loan ~~products. Consumer~~products, consumer loans including indirect home improvement (“fixture secured”) loans which also include solar-related home improvement loans, marine lending, and commercial business loans. As part of our expanding lending products, the Company experienced growth in residential mortgage and commercial construction warehouse lending consistent with our business plan to further diversify revenues. Historically, consumer loans, in particular, ~~indirect home improvement~~fixture secured loans ~~to finance window replacement, gutter replacement, siding replacement, solar panels, and other improvement renovations, represent~~had represented the largest portion of the Company’s loan portfolio and ~~have~~had traditionally been the mainstay of ~~our~~the Company’s lending strategy. At ~~September 30, 2017,~~March 31, 2020, consumer loans represented ~~26.3%~~23.7% of the Company’s total gross loan portfolio, ~~down~~up from ~~28.9%~~21.9% at ~~December~~March 31, ~~2016, as~~2019. In recent years, the Company has placed more of an emphasis on real estate ~~and~~lending products, such as one-to-four-family loans, commercial real estate loans, including speculative residential construction loans, as well as commercial business ~~loan originations have increased at a faster pace than~~loans, while growing the current size of the consumer loan ~~originations.~~portfolio.

Indirect home improvement lending is dependent on the Bank’s relationships with home improvement contractors and dealers. The Company funded $24.6 million, or 1,490 loans during the quarter ended September 30, 2017, using its indirect home improvement contractor/dealer network located throughout Washington, Oregon, Idaho, and California with four contractors/dealers responsible for 45.5% of the funded loans dollar volume. During the nine months ended September 30,

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~~2017, the Company originated $15.5 million in the state of California,~~

Fixture secured loans to finance window, gutter, and ~~at September 30, 2017, held $42.9 million in California originated consumer loans. Management has established~~siding replacement, solar panels, pools, and other improvement renovations are a ~~concentration limit of no more than 100%~~large and regionally expanding segment of the consumer loan portfolio. These fixture secured consumer loans are dependent on the Bank’s ~~total risk-based capital~~contractor/dealer network of 85 active dealers located throughout Washington, Oregon, California, Idaho, Colorado, and Arizona, with four contractor/dealers responsible for 49.7% of the funded loans ~~originated in California. At September 30, 2017,~~dollar volume. The Company funded $34.3 million, or approximately 2,000 loans during the ~~limit was $130.2 million.~~quarter ended March 31, 2020. The following table details fixture secured loan originations by state for the periods indicated:


	For the Three Months Ended				For the Twelve Months Ended
	March 31, 2020				December 31, 2019
State	Amount		Percent		Amount		Percent
Washington	$	14,801	43.1	%	$	66,834	41.9	%
Oregon		8,048	23.5			43,036	27.0
California		7,836	22.8			34,027	21.4
Idaho		2,372	6.9			9,371	5.9
Colorado		908	2.6			3,493	2.2
Arizona		372	1.1			2,586	1.6
Total consumer loans	$	34,337	100.0	%	$	159,347	100.0	%

The Company originates one-to-four-family residential mortgage loans through referrals from real estate agents, financial planners, builders, and from existing customers. ~~Walk-in~~Retail banking customers are also an important source of the Company’s loan originations. ~~During the nine months ended, the~~The Company originated ~~$603.4~~$285.6 million of one-to-four-family loans which includes loans held for sale, ~~(“HFS”),~~ loans held for investment, and fixed seconds ~~and~~in addition to loans brokered to other institutions of $1.9 million through the home lending segment ~~including brokered loans of $5.7 million. During~~during the ~~nine~~three months ended ~~September 30, 2017, $511.8~~March 31, 2020, of which $212.4 million ~~of the loans originated~~ were sold to investors. Of the loans sold to investors, ~~of which $321.3~~$147.4 million were sold to the FNMA, FHLMC, FHLB, and/or GNMA with servicing rights retained for the purpose of further developing these customer relationships. At ~~September 30, 2017,~~March 31, 2020, one-to-four-family residential mortgage loans held for investment, which excludes loans held for sale of ~~$65.1~~$115.6 million, totaled ~~$170.2~~$305.4 million, or ~~22.2%~~21.6%, of the total gross loan portfolio.

The Company ~~generally underwrites~~purchased a pool of residential jumbo adjustable rate (“ARM”) loans in the ~~one-to-four-family loans based on the applicant’s ability to repay. This includes employment and credit history and the appraised value~~first quarter of ~~the subject property. The Company lends up to 100% of the lesser of the appraised value or purchase price~~2020 for one-to-four-family first mortgage loans. For first mortgage loans with a loan-to-value ratio in excess of 80%, the Company generally requires either private mortgage insurance or government sponsored insurance in order to mitigate the higher risk level associated with higher loan-to-value loans. Fixed-rate loans secured by one-to-four-family residences have contractual maturities of up to 30 years and are generally fully amortizing, with payments due monthly. Adjustable-rate mortgage loans may pose different credit risks than fixed-rate loans, primarily because as interest rates increase, the borrower’s payments rise, increasing the potential for default. Properties securing the one-to-four-family$28.1 million. Those loans are ~~appraised~~collateralized by ~~independent fee appraisers who are selected~~residential properties located in ~~accordance with industry~~the markets served and ~~regulatory standards. The Company requires borrowers~~were purchased to ~~obtain title~~supplement portfolio lending growth.

For the three months ended March 31, 2020, there were higher volumes of refinances and ~~hazard insurance, and flood insurance, if necessary. Loans are generally underwritten~~sales of one-to-four-family homes, compared to the ~~secondary market guidelines with additional requirements as determined by the internal underwriting department.~~

~~Since 2012, the Company has had an emphasis on diversifying lending products by expanding commercial real estate, commercial business~~prior years’ surge in construction loans due to lower housing inventories. Residential construction and ~~residential~~development lending, while maintaining the current volume of production and historical growth of the consumer loan portfolio. The Company’s lending strategies are intended to take advantage of: (1) historical strength in indirect consumer lending, (2) recent market consolidation that has created new lending opportunities and the availability of experienced bankers, and (3) strength in relationship lending. Retail depositsnot as common as other options like one-to-four-family loans, will continue to ~~serve as~~be an important element in our total loan portfolio, and we will continue to take a disciplined approach by concentrating our efforts on loans to builders and developers in our market areas known to us. These short-term loans typically mature in six to twelve months. In addition, the funding ~~source.~~is usually not fully disbursed at origination, thereby reducing our net loans receivable in the short-term.

The Company is significantly affected by prevailing economic conditions, as well as government policies and regulations concerning, among other things, monetary and fiscal affairs. ~~Retail deposits serve as an important funding source.~~ Deposit flows are influenced by a number of factors, including interest rates paid on time deposits, other investments, account maturities, and the overall level of personal income and savings. Lending activities are influenced by the demand for funds, the number and quality of lenders, and regional economic cycles. Sources of funds for lending activities include primarily deposits, including brokered deposits, borrowings, payments on loans, and income provided from operations.

The Company’s earnings are primarily dependent upon net interest income, the difference between interest income and interest expense. Interest income is a function of the balances of loans and investments outstanding during a given period and the yield earned on these loans and investments. Interest expense is a function of the amount of deposits and borrowings outstanding during the same period and interest rates paid on these deposits and borrowings. Because the length of the COVID-19 pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including the recent 150 basis point reductions in the targeted federal funds rate, until the pandemic subsides, the Company expects its net interest income and net interest margin will be adversely affected in 2020 and possibly longer.

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Another significant influence on the Company’s earnings is fee income from ~~home lending~~mortgage banking activities. The Company’s earnings are also affected by the provision for loan losses, service charges and fees, gains from sales of assets, operating expenses and income taxes. The Company recorded a provision of $3.7 million for the first quarter of 2020, compared to $750,000 in the first quarter a year ago due primarily to the incurred but not yet reported credit deterioration due to the impact of the COVID-19 pandemic, the increase in the loan portfolio due to organic growth and net charge-offs.

Critical Accounting Policies and Estimates

Certain of the Company’s accounting policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex, or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances which could affect these judgments include, but are not limited to,

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changes in interest rates, changes in the performance of the economy, and changes in the financial condition of borrowers. Management believes that its critical accounting policies include the following:

Allowance for Loan and Lease ~~Losses.~~Losses (“ALLL”). The ~~allowance for loan and lease losses (“ALLL”)~~ALLL is the amount estimated by management as necessary to cover probable losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. A high degree of judgment is necessary when determining the amount of the ~~allowance for loan losses.~~ALLL. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on impacted loans; value of collateral; and determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance at least quarterly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions, and other factors related to the collectability of the loan portfolio. Although the Company believes ~~it uses~~that use of the best information available ~~to establish~~currently establishes the ~~allowance for loan losses,~~ALLL, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. As the Company adds new products to the loan portfolio and expands the Company’s market area, management intends to enhance and adapt ~~our~~the methodology to keep pace with the size and complexity of the loan portfolio. Changes in any of the above factors could have a significant effect on the calculation of the ~~allowance for loan losses~~ALLL in any given period. Management believes that its systematic methodology continues to be ~~appropriate given the Company’s increased size and level of complexity.~~

~~Troubled Debt Restructured Loans.~~ TDRs are loans whose terms have been modified or restructured due to a borrower’s financial difficulty, including but not limited to: a reduction in the stated interest rate; an extension of the maturity at an interest rate below current market; a reduction in the face amount of the debt; a reduction in the accrued interest; or re-aging, extensions, deferrals and renewals. TDR loans are considered impaired loans and are individually evaluated for impairment. TDR loans can be classified as either accrual or non-accrual. TDR loans are classified as non-performing loans unless they have been performing in accordance with their modified terms for a period of at least six months in which case they are placed on accrual status.appropriate.

Servicing Rights. Servicing assets are recognized as separate assets when rights are acquired through the purchase or through the sale of financial assets. Generally, purchased servicing rights are capitalized at the cost to acquire the rights. For sales of mortgage, commercial and consumer loans, a portion of the cost of originating the loan is allocated to the servicing right based on relative fair value. Fair value is based on market prices for comparable mortgage, commercial, or consumer servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds, and default rates and losses.

Servicing assets are evaluated quarterly for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type, and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the capitalized ~~amount.~~amount for the tranches. If the Company later determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the allowance may be recorded as a recovery and an increase to income. Capitalized servicing rights are stated separately on the Consolidated Balance Sheets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.

Derivatives and Hedging Activity. ASC 815, “Derivatives and Hedging,” requires that derivatives of the Company be recorded in the consolidated financial statements at fair value. Management considers its accounting policy for derivatives to be a critical accounting policy because these instruments have certain interest rate risk characteristics that change in value based upon changes in the capital markets. Fair values for derivative assets and liabilities are measured on a recurring basis. The Company’s ~~derivatives~~primary use of derivative instruments are ~~primarily~~related to the ~~result of its home lending~~mortgage banking activities in the form of commitments to extend credit, commitments to sell loans, TBA ~~MBS~~mortgage-backed securities trades and option contracts to

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mitigate the risk of the commitments to extend credit. Estimates of the percentage of commitments to extend credit on loans to be held for sale that may not fund are based upon historical data and current market trends. The fair value adjustments of the derivatives are recorded onin the Consolidated Statements of Income with offsets to other assets or other liabilities on the Consolidated Balance Sheets.

Derivative instruments not related to mortgage banking activities primarily relate to interest rate swap agreements accounted for as cash flow hedges. To qualify for hedge accounting, derivatives must be highly effective at reducing the risk associated with the exposure being hedged and must be designated as a hedge at the inception of the derivative contract. If derivative instruments are designated as cash flow hedges, fair value adjustments related to the effective portion are recorded in other comprehensive income and are reclassified to earnings when the hedged transaction is reflected in earnings. Ineffective portions of cash flow hedges are reflected in earnings as they occur. Actual cash receipts and/or payments and related accruals on derivatives related to hedges are recorded as adjustments to the interest income or interest expense associated with the hedged item. During the life of the hedge, the Company formally assesses whether derivatives designated as hedging instruments continue to be highly effective in offsetting changes in the fair value or cash flows of hedged items. If it is determined that a hedge has ceased to be highly effective, the Company will discontinue hedge accounting prospectively. At such time, previous adjustments to the carrying value of the hedged item are reversed into current earnings and the derivative instrument is reclassified to a trading position recorded at fair value. For derivatives not designated as hedges, changes in fair value are recognized in earnings, in noninterest income.

Fair Value.ASC 820, “Fair Value Measurements and Disclosures~~Table~~,” establishes a hierarchical disclosure framework associated with the level of ~~Contents~~

pricing observability utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no pricing observability and a higher degree of judgment utilized in measuring fair value. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction. The objective of a fair value measurement is to estimate the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants at the measurement date under current market conditions (that is, an exit price at the measurement date from the perspective of a market participant that holds the asset or owes the liability). For additional details, see “Note 10 - Fair Value Measurements” of the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report.

Income Taxes. Income taxes are reflected in the Company’s consolidated financial statements to show the tax effects of the operations and transactions reported in the consolidated financial statements and consist of taxes currently payable plus deferred taxes. ~~Accounting Standards Codification,~~ ASC 740, “Accounting for Income Taxes,” requires the asset and liability approach for financial accounting and reporting for deferred income taxes. Deferred tax assets and liabilities result from temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. They are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled and are determined using the assets and liability method of accounting. The deferred income provision represents the difference between net deferred tax asset/liability at the beginning and end of the reported period. In formulating the deferred tax asset, the Company is required to estimate income and taxes in the jurisdiction in which the Company operates. This process involves estimating the actual current tax exposure for the reported period together with assessing temporary differences resulting from differing treatment of items, such as depreciation and the provision for loan losses, for tax and financial reporting purposes.

Deferred tax assets and liabilities occur when taxable income is larger or smaller than reported income on the income statements due to accounting valuation methods that differ from tax, as well as tax rate estimates and payments made quarterly and adjusted to actual at the end of the year. Deferred tax assets and liabilities are temporary differences deductible or payable in future periods. The Company had a net deferred tax ~~liability~~liabilities of ~~$1.4~~$2.3 million and ~~$1.2~~$2.0 million, at ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016,~~2019, respectively.

~~Comparison of Financial Condition at September 30, 2017 and December 31, 2016~~

~~Assets.~~ Total assets increased $166.0 million, or 20.0%, to $993.9 million at September 30, 2017, from $827.9 million at December 31, 2016, primarily as a result of a $160.5 million, or 27.1% increase in loans receivable, net, a $12.5 million, or 23.8% increase in loans HFS, a $2.9 million, or 18.8% increase in certificates of deposit at other financial institutions, and a $1.3 million, or 27.1% increase in other assets, partially offset by a $5.2 million, or 14.2% decrease in cash and cash equivalents, a $3.8 million, or 4.6% decrease in securities available-for-sale, and a $2.6 million, or 31.3% decrease in servicing rights.

Loans receivable, net increased $160.5 million, or 27.1% to $753.9 million at September 30, 2017, from $593.3 million at December 31, 2016. The increase in loans receivable, net was primarily a result of increases in real estate and commercial business loans. Real estate loan increases included one-to-four-family loans held for investment of $46.2 million, construction and development loans of $34.9 million, commercial real estate loans of $7.3 million, multi-family loans of $5.9 million, and home equity loans of $3.9 million. Changes in commercial business lending included a $17.6 million increase in commercial business loans associated with our warehouse lending program and a $17.4 million increase in commercial and industrial loans. Growth in consumer lending was $26.9 million, reflecting growth in the Bank’s long established indirect home improvement lending platform.

Loans HFS, consisting of one-to-four-family loans and one commercial and industrial loan, increased by $12.5 million, or 23.8% to $65.1 million at September 30, 2017, from $52.6 million at December 31, 2016 due to increased loan originations. The Company will continue selling one-to-four-family loans into the secondary market for asset/~~liability management purposes.~~

One-to-four-family loans originated through the home lending segment which includes loans HFS, loans held for investment, fixed seconds, and loans brokered to other institutions increased $27.3 million, or 12.6% to $244.1 million during the quarter ended September 30, 2017, compared to $232.9 million for the same quarter one year ago. One-to-four-family loans originated through the home lending segment increased $19.3 million, or 3.3% to $603.4 million during the nine months ended September 30, 2017, compared to $584.1 million during the nine months ended September 30, 2016. Originations of one-to-four-family loans to purchase a home (purchase production) increased by $68.0 million, or 17.2% with $464.3 million in loan purchase production closing during the nine months ended September 30, 2017, up from $396.3 million for the nine months ended September 30, 2016. One-to-four-family loan originations for refinance (refinance production) decreased $58.9 million, or 30.1% with $136.6 million in refinance production closing during the nine months ended September 30, 2017, down from $195.5 million for the nine months ended September 30, 2016. During the quarter ended September 30, 2017, the Company sold $204.3 million of one-to-four-family loans, compared to sales of $205.1 million for the same quarter one year ago. In addition, the margin on loans sold increased to 2.53% for the nine months ended September 30, 2017, from 2.48% for the nine months ended September 30, 2016.

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~~Purchase~~Comparison of Financial Condition at March 31, 2020 and December 31, 2019

Assets. Total assets increased $134.1 million, or 7.8%, to $1.85 billion at March 31, 2020, compared to $1.71 billion at December 31, 2019, primarily due to increases in loans receivable, net of $56.7 million, loans held for sale of $45.9 million, and securities available-for-sale, at fair value of $30.4 million, partially offset by decreases in certificates of deposit at other financial institutions of $3.0 million, other assets of $1.0 million, and servicing rights of $934,000. The increases in total assets were primarily funded by deposit growth and the use of FHLB advances.

Loans receivable, net increased $56.7 million to $1.39 billion at March 31, 2020, from $1.34 billion at December 31, 2019. Total real estate loans increased $38.6 million, including increases in one-to-four-family portfolio loans of $43.9 million, which includes the $28.1 million purchase of ARM loans, and commercial real estate loans of $9.8 million, partially offset by decreases in construction and development of $11.0 million and multi-family loans of $3.4 million. Undisbursed construction and development loan commitments increased $11.8 million, or 12.4%, to $106.9 million at March 31, 2020, as compared to $95.0 million at December 31, 2019. Commercial business loans increased $12.5 million, due to increases in commercial and industrial loans of $8.6 million, of which $3.7 million was associated with the purchase of a U.S. Department of Agriculture guaranteed loan, and warehouse lending of $3.9 million. Consumer loans increased $8.9 million, primarily due to increases of $6.9 million in indirect home improvement loans and $2.3 million in marine loans.

Loans held for sale, consisting of one-to-four-family loans, increased by $45.9 million, or 65.9%, to $115.6 million at March 31, 2020, from $69.7 million at December 31, 2019. The Company continues to build its home lending operations and strategically add production ~~was 76.1%~~staff in the markets we serve. In addition, lower market interest rates have increased the volume of refinance activity which subsequently increased the ~~total one-to-four-family~~balance of loans held for sale.

One-to-four-family loan originations, ~~versus 23.9%~~including $259.2 million of loans originated for ~~refinance production~~sale, $24.5 million of portfolio loans including first and second liens, and $1.9 million of loans brokered to other institutions, increased $141.9 million, or 98.8% to $285.6 million during the ~~third quarter of 2017,~~three months ended March 31, 2020, compared to ~~60.9% in~~$143.7 million during the three months ended March 31, 2019.

Originations of one-to-four-family loans to purchase ~~production versus 39.1% in~~and to refinance ~~production during~~a home for the periods indicated were as follows:


(Dollars in thousands)	For the Three Months Ended				For the Three Months Ended				Year		Year
	March 31, 2020				March 31, 2019				over Year		over Year
	Amount		Percent		Amount		Percent		$ Change		% Change
Purchase	$	114,652	40.1	%	$	105,518	73.4	%	$	9,134	8.7
Refinance		170,950	59.9			38,155	26.6			132,795	348.0
Total	$	285,602	100.0	%	$	143,673	100.0	%	$	141,929	98.8

During the three months ended March 31, 2020, the Company sold $212.4 million of one-to-four-family loans, compared to sales of $130.9 million for the same period ~~2016. Purchase production~~one year ago. In addition, the cash margin on loans sold increased to 1.71% for the ~~nine~~three months ended ~~September 30, 2017 was 77.3% of the total one-to-four-family loan originations versus 22.7% for refinance production,~~March 31, 2020, compared to ~~67.0% in purchase volume versus 33.0% in refinances~~1.51% for the ~~nine~~three months ended ~~September 30, 2016.~~March 31, 2019. Margin reported is based on actual loans sold into the secondary market and the related value of capitalized servicing, partially offset by recognized deferred loans fees and capitalized expenses. The ~~increase in originations~~gross cash margins on loans sold, excluding capitalized costs and ~~purchase activity was primarily associated with~~deferred fees, were 3.50% and 3.06% for the ~~strong home purchase demand in the Pacific Northwest, while the decline in refinance activity reflects the rise in mortgage interest rates over the past year.~~three months ended March 31, 2020 and 2019, respectively.

The ALLL ~~at September 30, 2017 increased to $10.6~~was $16.9 million, or ~~1.4%~~1.20% of gross loans receivable, excluding loans ~~HFS,~~held for sale at March 31, 2020, compared to ~~$10.2~~$13.2 million, or ~~1.7%~~0.98% of gross loans receivable, excluding loans ~~HFS,~~held for sale at December 31, ~~2016.~~2019. Substandard loans increased to $7.6 million at March 31, 2020, compared to $6.7 million at December 31, 2019. This increase in substandard loans was mostly driven by the down grade of a commercial real estate loan in the amount of $934,000 which was unrelated to the COVID-19 pandemic. Non-performing loans, consisting solely of ~~non-accrual~~non-accruing loans 90 days or more past due, increased to ~~$1.3~~$3.2 million at ~~September 30, 2017,~~March 31, 2020, from ~~$721,000~~$3.0 million at December 31, ~~2016.~~2019. At ~~September 30, 2017,~~March 31, 2020, non-performing loans consisted of ~~$551,000 of~~$1.2 million in one-to-four-family loans, $1.1 million in commercial ~~and industrial~~real estate loans, ~~$316,000~~$533,000 of indirect home improvement loans, ~~$154,000~~$220,000 of home equity loans, ~~$142,000~~$124,000 of ~~one-to-four-family~~marine loans, ~~$81,000 of solar loans, $11,000~~and $7,000 of other consumer ~~loans, and $9,000~~loans. The ratio of ~~marine loans. Non-performing~~non-performing loans to total gross loans was ~~0.2%~~0.23% at ~~September 30, 2017,~~ March 31, 2020,

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compared to ~~0.1%~~0.22% at December 31, ~~2016. Substandard loans decreased $1.5 million, or 18.3%, to $6.6 million~~2019. There was one OREO property in the amount of $90,000 at ~~September 30, 2017, compared to $8.0 million~~March 31, 2020, and two OREO properties totaling $168,000 at December 31, ~~2016, primarily due~~2019.

In accordance with acquisition accounting, the allowance does not include the recorded discount on loans acquired in the Anchor Acquisition of $2.3 million and $2.7 million on $178.2 million and $198.5 million of gross loans at March 31, 2020 and December 31, 2019, respectively.

In response to the ~~transfer~~COVID-19 pandemic, the commercial lending team identified risk rating downgrades at March 31, 2020, of ~~$1.9~~$84.4 million ~~in substandard shared national credits to~~of loans ~~HFS sold at a slight discount to market early in October 2017. The Company recorded the expected discount~~ based on the ~~sales price~~type of industry listed in the table below. Management downgraded $76.3 million to Watch, $6.8 million to Special Mention, and $1.3 million to Substandard.

Loans by type of industry downgraded as a ~~loan charge-off~~result of the COVID-19 pandemic are as follows:


Loan Types:	At March 31, 2020
Hospitality	$	15,578
Transportation		5,111
Food and beverage		12,988
Manufacturing		18,122
Other		32,600
Total	$	84,399

Additionally, management increased the economic factors of the ALLL associated with the consumer portfolio based on the growing unemployment reports. Management recognizes the potential impact on all of our customers and will continue to assess and evaluate our level of reserves against our homogenous residential and consumer portfolios during the ~~third quarter of 2017. The Company had no OREO at September 30, 2017, or at December 31, 2016.~~

The Company sold $9.0 million of securities AFS during the third quarter of 2017 realizing a gain of $143,000. Those sales primarily provided additional funds for loan growth during the quarter. The sales of lower coupon investments enabled us to capitalize on the lower Treasury rates for a gain during the third quarter of 2017. The average yield on sold securities AFS during the quarter was 2.48%.COVID-19 pandemic.

Liabilities. Total liabilities increased ~~$128.8~~$133.5 million ~~or 17.2%,~~ to ~~$875.7 million~~$1.65 billion at ~~September 30, 2017,~~March 31, 2020, from ~~$746.9 million~~$1.51 billion at December 31, ~~2016,~~2019, primarily due ~~primarily~~ to ~~an increase~~increases of $74.3 million in borrowings and $53.9 million in deposits.

Total deposits increased ~~$128.0~~$53.9 million ~~or 18.0%,~~ to ~~$840.6 million~~$1.45 billion at ~~September 30, 2017,~~March 31, 2020, from ~~$712.6 million~~$1.39 billion at December 31, ~~2016.~~2019. Relationship-based transactional accounts (noninterest-bearing checking, interest-bearing checking, and escrow accounts) increased ~~$63.7~~$42.9 million ~~or 29.1%,~~ to ~~$282.7~~$494.5 million at ~~September 30, 2017,~~March 31, 2020, from ~~$219.0~~$451.6 million at December 31, ~~2016.~~2019, primarily due to a $31.0 million increase in interest-bearing checking, a $7.8 million increase in noninterest-bearing checking, and a $4.1 million increase in escrow deposits. Money market and savings accounts increased ~~$11.2~~$37.1 million ~~or 3.7%,~~ to ~~$309.0~~$426.5 million at ~~September 30, 2017,~~March 31, 2020, from ~~$297.8~~$389.3 million at December 31, ~~2016.~~2019. Time deposits ~~increased $53.1~~decreased $26.2 million ~~or 27.1%,~~ to ~~$248.8~~$525.3 million at ~~September 30, 2017,~~March 31, 2020, from ~~$195.7~~$551.5 million at December 31, ~~2016.~~2019. Non-retail certificates of deposit (“CDs”) which includes brokered ~~certificates of deposit,~~CDs, online ~~certificates of deposit,~~CDs, and public funds ~~increased $39.4~~decreased $17.4 million ~~or 65.5%,~~ to ~~$99.7~~$128.8 million at ~~September 30, 2017,~~March 31, 2020, compared to ~~$60.2~~$146.2 million at December 31, ~~2016. Wholesale funding (brokered deposits) were utilized~~2019, primarily due to ~~bridge short-term asset growth such as loans HFS and pay down higher cost short-term Federal Home Loan Bank (“FHLB”) Fed Funds advances. Approximately $138.2~~an $18.0 million of the acquired deposits from the Branch Purchase remain at 1st Security Bank at September 30, 2017. These branch locations have attracted new deposits with an aggregated total of $220.8 million, including public funds at September 30, 2017.decreases in brokered CDs. Management remains focused on ~~growth in~~increasing its lower cost relationship-based deposits to fund long-term asset growth.

Deposits are summarized as follows at the periods indicated:


	March 31,		December 31,
	2020 (1)(2)		2019(1)(2)
Noninterest-bearing checking	$	267,966	$	260,131
Interest-bearing checking		208,952		177,972
Savings		123,052		118,845
Money market (3)		303,405		270,489
Certificates of deposit less than $100,000(4)		263,787		277,988
Certificates of deposit of $100,000 through $250,000		176,322		181,402
Certificates of deposit of $250,000 and over(5)		85,185		92,110
Escrow accounts related to mortgages serviced		17,600		13,471
Total	$	1,446,269	$	1,392,408

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(1)

Includes $113.7 million of deposits at March 31, 2020 from the Branch Purchase and $117.1 million at December 31, 2019.

(2)

Includes $282.4 million and $299.0 million of deposits at March 31, 2020 and December 31, 2019, respectively, from the Anchor Acquisition.

(3)

Includes $20.0 million and $6.2 million of brokered deposits at March 31, 2020 and December 31, 2019, respectively.

(4)

Includes $123.4 and $141.4 million of brokered deposits at March 31, 2020 and December 31, 2019, respectively.

(5)

Time deposits that meet or exceed the FDIC insurance limit.

Borrowings ~~decreased $2.4~~increased $74.3 million ~~or 18.9%,~~ to ~~$10.3~~$159.1 million at ~~September 30, 2017,~~March 31, 2020, from ~~$12.7~~$84.9 million at December 31, ~~2016,~~2019, primarily ~~due~~related to the ~~repayment~~use of FHLB ~~Fed Funds advances.~~advances in relation to the fluctuating activity in deposits.

Management entered into two liability interest rate swap arrangements in the first quarter of 2020 to lock the expense costs associated with $30.0 million in deposits and $30.0 million in borrowings. The average cost of these $60 million in notional pay fixed for four years interest rate swap agreements was 91 basis points for which the Bank will pay a fixed rate of 91 basis points to the interest rate swap counterparty, compared to the quarterly reset of three month LIBOR that will adjust quarterly. Management will continue to implement processes to match balance sheet funding duration and minimize interest rate risk and costs.

Stockholders’ Equity. Total stockholders’ equity increased ~~$37.2 million, or 45.9%~~$587,000 to ~~$118.2~~$200.8 million at ~~September 30, 2017,~~March 31, 2020, from ~~$81.0~~$200.2 million at December 31, ~~2016.~~2019. The increase in stockholders’ equity during the ~~nine~~three months ended ~~September 30, 2017,~~March 31, 2020, was primarily due to ~~the issuance during the third quarter of 2017 of 587,234 shares of common stock at a price of $47.00 per share for net proceeds of $25.6 million and~~ net income of ~~$10.4~~$5.2 million and $1.0 million of other comprehensive income, net, partially offset by the common stock repurchase of $5.4 million. The Company repurchased 136,243 shares of its common stock during the three months ended March 31, 2020, at an average price of $39.30 per share. Book value per common share was ~~$33.52~~$47.29 at ~~September 30, 2017,~~March 31, 2020, compared to ~~$28.32~~$45.85 at December 31, ~~2016.~~2019.

Net proceeds received from the stock offering were used to fund the majority of a $26.0 million contribution to the Bank at the end of the third quarter 2017 to provide additional Tier 1 capital for growth planned over the next 24 months. Management expects continued lending growth due to strong economic factors in the Pacific Northwest and, specifically, the communities we serve.

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We ~~have~~calculated book value based on common shares outstanding of ~~3,527,896 that were calculated using shares outstanding of 3,674,902~~4,332,196 at ~~September 30, 2017,~~March 31, 2020, less ~~36,842~~40,215 unvested restricted stock shares, and ~~110,164~~45,362 of unallocated ESOP ~~shares.~~shares for the reported common shares outstanding of 4,246,619. Common shares ~~of 2,861,135 were~~outstanding was calculated using 4,459,041 shares ~~outstanding~~ at December 31, ~~2016 of 3,059,503,~~2019, less ~~68,763~~40,215 unvested restricted stock shares, and ~~129,605~~51,842 of unallocated ESOP ~~shares.~~shares for the reported common shares outstanding of 4,366,984.

Comparison of Results of Operations for the Three ~~and Nine~~ Months Ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019

General. Net income was virtually unchanged at ~~$3.5~~$5.2 million for ~~both~~ the three months ended ~~September 30, 2017~~March 31, 2020, and ~~2016 as~~ the ~~$2.4~~three months ended March 31, 2019. Net income for the three months ended March 31, 2020 was primarily impacted by a $4.3 million, or 95.2% increase in noninterest income, partially offset by a $3.2 million, or 18.6% decrease in net interest income after provision for loan losses ~~was offset by~~and a ~~decline in noninterest income, an~~$1.4 million, or 9.4% increase in noninterest ~~expense, and an increase in provision for income taxes. Net income~~expense. Earnings for the ~~nine months ended September 30, 2017, increased $2.5 million, or 30.8%, to $10.4 million, from $8.0 million for~~quarter also reflect the ~~nine months ended September 30, 2016. The increase~~impact of the COVID-19 pandemic which resulted in ~~net income was primarily a result~~the closing of ~~a $6.6 million, or 29.1% increase~~businesses in ~~net interest income, after provision for loan losses, partially offset by a $4.1 million, or 14.1% increase in noninterest expense.~~the market areas we operate.

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The following table sets forth the average balances of all major categories of interest-earning assets and interest-bearing liabilities to calculate the comparison of results of operations for the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2020 and ~~2016:~~2019:


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,				For the Three Months Ended						For the Three Months Ended
Average Balances	2017		2016		2017		2016
Assets
Loans receivable, net (1)	$	803,399	$	643,989	$	725,247	$	600,343
Securities available-for-sale, at fair value		79,377		83,643		90,206		80,214
Interest-bearing deposits and certificates of deposit at other financial institutions		42,990		36,744		46,153		74,573
FHLB stock, at cost		4,034		1,407		3,658		2,004
									March 31, 2020						March 31, 2019
(Dollars in thousands)									Average Balance Outstanding			Interest Earned/ Paid		Yield/ Rate	Average Balance Outstanding		Interest Earned/ Paid		Yield/ Rate
ASSETS
Loans receivable, net deferred loan fees (1)									$		1,420,227	$	20,740	5.87%	$	1,348,418	$	21,109	6.35%
Mortgage-backed securities											66,670		383	2.31%		46,786		320	2.77%
Investment securities											69,590		446	2.58%		52,864		375	2.88%
Federal Home Loan Bank stock											8,259		107	5.21%		8,930		130	5.90%
Interest-bearing deposits at other financial institutions											69,763		273	1.57%		68,169		377	2.24%
Total interest-earning assets		929,800		765,783		865,264		757,134			1,634,509		21,949	5.40%		1,525,167		22,311	5.93%
Noninterest-earning assets (2)		35,868		37,674		37,501		33,022
Noninterest-earning assets											99,526					89,694
Total assets	$	965,668	$	803,457	$	902,765	$	790,156	$	1,734,035					$	1,614,861
Liabilities and stockholders’ equity
Interest-bearing accounts	$	642,811	$	532,069	$	603,449	$	517,625
LIABILITIES AND STOCKHOLDERS' EQUITY
Savings and money market									$		405,354	$	826	0.82%	$	395,315	$	763	0.78%
Interest-bearing checking											180,472		136	0.30%		163,244		196	0.49%
Certificates of deposit											545,293		2,845	2.10%		495,590		2,751	2.25%
Borrowings		34,372		20,239		27,994		28,660			92,611		497	2.16%		110,445		744	2.73%
Subordinated note		9,837		9,817		9,832		9,812			9,887		172	7.00%		9,867		168	6.91%
Total interest-bearing liabilities		687,020		562,125		641,275		556,097		1,233,617			4,476	1.46%		1,174,461		4,622	1.60%
Noninterest-bearing accounts		169,367		153,209		163,079		147,848			273,442					239,598
Other noninterest-bearing liabilities		13,966		12,048		11,318		11,222			23,806					17,082
Stockholders’ equity		95,315		76,075		87,093		74,989			203,170					183,720
Total liabilities and stockholders’ equity	$	965,668	$	803,457	$	902,765	$	790,156	$		1,734,035				$	1,614,861
Net interest income												$	17,473				$	17,689
Net interest rate spread														3.94%					4.34%
Net earning assets									$		400,892				$	350,706
Net interest margin														4.30%					4.70%
Average interest-earning assets to average interest-bearing liabilities											132.50%					129.86%

_______________________

(1)

Includes loans held for ~~sale~~sale.

~~(2)~~

~~Includes BOLI, goodwill, and CDI~~

Net Interest Income. Net interest income ~~increased $2.3 million, or 26.0%,~~decreased $216,000 to ~~$11.0~~$17.5 million for the three months ended ~~September 30, 2017,~~March 31, 2020, from ~~$8.8~~$17.7 million for the three months ended ~~September 30, 2016. The increase in net interest income~~March 31, 2019. This decline was primarily due to a ~~$2.5 million,~~$369,000, or ~~26.8% increase~~1.7% decrease in loans receivable interest income, ~~due to an increase~~impacted by the reduction of higher interest rate and recognition of deferred fee income loans, particularly construction and development loans, and the impact of refinances of one-to-four-family loans, partially offset by a $247,000, or 33.2% reduction in ~~the average loans receivable, net balance.~~

~~Net~~ interest income increased $5.3 million, or 21.5%, to $30.0 million for the nine months ended September 30, 2017, from $24.7 million for the nine months ended September 30, 2016. The increase in net interest income wasexpense on borrowings, primarily due to ~~a $5.5 million, or 21.0% increase in loans receivable~~the reduction of interest ~~income, due to an increase in~~rates for the ~~average loans receivable, net balance.~~use of FHLB advances and FHLB federal funds.

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The net interest margin (“NIM”) ~~increased 15~~decreased 40 basis points to ~~4.70%~~4.30% for the three months ended ~~September 30, 2017,~~March 31, 2020, from ~~4.55%~~4.70% for the ~~three months ended September 30, 2016,~~same period in the prior year. The decrease in NIM was primarily impacted by lower note rates on recent fixed-rate real estate loan originations and increased 27 basis points to 4.63% for the nine months ended September 30, 2017, from 4.36% for the nine months ended September 30, 2016. The increased NIM reflects growth in higher yielding loans, compared to short term investments and cash.adjustable-rate commercial loans. Management remains focused on matching ~~deposit~~deposit/liability duration with the duration of ~~earning~~ loans/assets where appropriate.

Interest Income. Interest income for the three months ended ~~September 30, 2017, increased $2.6 million, or 26.3%,~~March 31, 2020, decreased $362,000, to ~~$12.4~~$21.9 million, from ~~$9.8~~$22.3 million for the three months ended ~~September 30, 2016.~~March 31, 2019. The ~~increase~~decrease during the period was primarily attributable to ~~the increase~~a 53 basis point decrease in the average ~~balance of loans receivable~~yield on interest-earning assets to ~~$803.4 million~~5.40% for the three months ended ~~September 30, 2017,~~March 31, 2020, compared to ~~$644.0 million~~5.93% for the three months ended ~~September 30, 2016.~~March 31, 2019. The average yield on interest-earning assets increased 18 basis points to 5.27% for the three months ended September 30, 2017, compared to 5.09% for the three months ended September 30, 2016. The increasedecrease in average yield on interest-earning assets compared to the same period a year earlier primarily reflects the ~~growth in the loan portfolio~~reduction of higher interest rate and fee income loans, particularly construction and development loans, and the ~~proportionally larger level~~impact of ~~loans~~refinances of one-to-four-family loans.

The following table compares average earning asset balances, associated yields, and resulting changes in ~~the average interest-earning asset mix.~~

~~Interest~~interest income for the ~~nine~~three months ended September 30, 2017, increased $5.8 million, or 20.7%, to $33.5 million, from $27.8 million for the nine months ended September 30, 2016. The increase during the period was primarily attributable to the increase in the average balance of loans receivable to $725.2 million for the nine months ended September 30, 2017, compared to $600.3 million for the nine months ended September 30, 2016. The average yield on interest-earning assets increased 27 basis points to 5.18% for the nine months ended September 30, 2017, compared to 4.91% for the nine months ended September 30, 2016. The increase in average yield on interest-earning assets compared to the same period a year earlier primarily reflects the growth in the loan portfolioMarch 31, 2020 and ~~the proportionally larger level of loans in the average interest-earning asset mix.~~2019:


	Three Months Ended March 31,
	2020				2019				(Decrease)/
	Average				Average				Increase
	Balance		Yield/		Balance		Yield/		in Interest
(Dollars in thousands)	Outstanding		Rate		Outstanding		Rate		Income
Loans receivable, net and loans held for sale	$	1,420,227	5.87	%	$	1,348,418	6.35	%	$	(369)
Mortgage-backed securities		66,670	2.31			46,786	2.77			63
Investment securities		69,590	2.58			52,864	2.88			71
FHLB stock		8,259	5.21			8,930	5.90			(23)
Interest-bearing deposits at other financial institutions		69,763	1.57			68,169	2.24			(104)
Total interest-earning assets	$	1,634,509	5.40	%	$	1,525,167	5.93	%	$	(362)

Interest Expense. Interest expense ~~increased $301,000, or 29.3%,~~decreased $146,000, to ~~$1.3~~$4.5 million for the three months ended ~~September 30, 2017,~~March 31, 2020, from ~~$1.0~~$4.6 million for the same prior year period, primarily due to decreased interest expense on borrowings of ~~the prior year.~~$247,000, partially offset by an increase in interest expense on deposits of $97,000. The average cost of funds ~~increased four~~for total interest-bearing liabilities decreased 14 basis points to ~~0.61%~~1.46% for the three months ended ~~September 30, 2017, compared to 0.57%~~March 31, 2020, from 1.60% for the three months ended ~~September 30, 2016~~March 31, 2019. The decrease was predominantly due to repricing CD deposits and lowered borrowing interest expense, primarily due to the ~~growth in interest-bearing deposits.~~reduction of interest rates for the use of FHLB advances and FHLB federal funds. The average cost of total deposits ~~increased~~decreased four basis points to ~~0.51%~~1.09%, for the three months ended ~~September 30, 2017,~~March 31, 2020, compared to ~~0.47%~~1.13%, for the three months ended ~~September 30, 2016,~~March 31, 2019, reflecting ~~rising~~lower market interest rates ~~over the last year~~primarily in interest-bearing checking, brokered CDs, and ~~the increase in non-retail certificates of deposit.~~CDs.

~~Interest expense increased $460,000, or 14.8%, to $3.6 million~~The following table details average balances for ~~the nine months ended September 30, 2017, from $3.1 million for the same period of the prior year, primarily due to growth in deposits. The average~~ cost of funds ~~was unchanged at 0.59%~~on interest-bearing liabilities and the change in interest expense for the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2020 and 2016. The average cost of deposits was also unchanged at 0.48% for both the nine months ended September 30, 2017 and 2016, reflecting steady deposit interest rates year over year. Management remains focused on matching deposit duration with the duration of earning assets where appropriate.2019:


	Three Months Ended March 31,
	2020				2019				Increase/
	Average				Average				(Decrease)
	Balance		Yield/		Balance		Yield/		in Interest
(Dollars in thousands)	Outstanding		Rate		Outstanding		Rate		Expense
Savings and money market	$	405,354	0.82	%	$	395,315	0.78	%	$	63
Interest-bearing checking		180,472	0.30			163,244	0.49			(60)
Certificates of deposit		545,293	2.10			495,590	2.25			94
Borrowings		92,611	2.16			110,445	2.73			(247)
Subordinated note		9,887	7.00			9,867	6.91			4
Total interest-bearing liabilities	$	1,233,617	1.46	%	$	1,174,461	1.60	%	$	(146)

Provision for Loan ~~Losses~~ Losses.For the three ~~and nine~~ months ended ~~September 30, 2017,~~March 31, 2020, the provision for loan losses was ~~$450,000,~~$3.7 million, compared to $600,000 and $1.8 million, for the three and nine months ended September 30, 2016, respectively. The reduced provision for loan losses for the three and nine months ended September 30, 2017 was a result of the low level of charge-offs and the relatively low level of delinquent, nonperforming and classified loans, as well as the increasing percentage of real estate loans and improving real estate values in our market areas. Management also reviewed during the quarter the historical loss activity over the past 17 quarters and incorporated the decrease in the level of historical loss as a factor in determining a reduction in the required unallocated allowance for loan and lease losses at September 30, 2017. During the three months ended September 30, 2017, net recoveries totaled $5,000 compared to $35,000 during the three months ended September 30, 2016. Net charge-offs totaled $63,000 during the nine months ended September 30, 2017, compared to net recoveries of $1,000 during the nine months ended September 30, 2016.

~~Noninterest Income.~~ ~~Noninterest income decreased $821,000, or 11.3%, to $6.4 million~~$750,000 for the three months ended ~~September 30, 2017, from $7.2 million for~~March 31, 2019, due primarily to the three months ended September 30, 2016. The decrease during the period was due to an $897,000 reduction in gain on sale of loans, primarily associated with a decrease in the volume of loans/locks fair valued, and a reduction of gain on sale margins associated with the product mix in the Pacific Northwest, partially offset by a $64,000 increase in other noninterest income. incurred but not yet reported credit

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deterioration due to the impact of the COVID-19 pandemic, the increase in the loan portfolio due to organic growth and net charge-offs. During the three months ended March 31, 2020, net loan charge-offs totaled $43,000, compared to net loan charge-offs of $1.3 million during the three months ended March 31, 2019, primarily due to a commercial business loan charge-off of $1.2 million during the three months ended March 31, 2019. A further decline in national and local economic conditions, as a result of the COVID-19 pandemic or other factors, could result in a material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and results of operations.

Noninterest Income. Noninterest income increased ~~$679,000,~~$4.3 million, or ~~3.7%~~95.2%, to ~~$18.8~~$8.9 million for the ~~nine~~three months ended ~~September 30, 2017,~~March 31, 2020, from ~~$18.1~~$4.6 million for the ~~nine~~three months ended ~~September 30, 2016.~~March 31, 2019. The increase ~~during the period~~between periods was ~~primarily due to increases in gain on sale of servicing rights of $996,000, service charges and fee income of $254,000, and gain on sale of investment securities of $234,000, primarily offset~~driven by a ~~decrease~~$3.5 million increase in gain on sale of loans, primarily due to higher sales volume, and a $1.6 million, or 549.8% increase in other noninterest income, mostly due to the net gain from a one-time sale of ~~$882,000 primarily associated with~~Class B Visa stock shares of $1.5 million, partially offset by a $734,000, or 44.3% decrease in net service charges and fee income, primarily due to an increase in amortization expense attributable to the ~~volume~~Bank’s mortgage servicing rights. The increased amortization was primarily a result of ~~loans/locks fair valued, and a reduction~~higher volumes of ~~gain on sale margins associated with the product mix~~payoffs in the ~~Pacific Northwest.~~underlying servicing portfolio.

Noninterest Expense. Noninterest expense increased ~~$1.3~~$1.4 million, or ~~12.4%~~9.4%, to ~~$11.6~~$16.2 million for the three months ended ~~September 30, 2017,~~March 31, 2020, from ~~$10.3~~$14.8 million for the three months ended ~~September 30, 2016.~~March 31, 2019. The increase ~~in noninterest expense~~ was primarily as a result of strong loan production growth during the quarter with an ~~$853,000~~ increase of $1.3 million in salaries and benefits, which included ~~$42,000~~a $1.6 million increase in incentives and commissions, ~~for the loan production staff associated with continued strong loan production growth, a $216,000 decrease~~as well as increases in ~~recovery~~impairment of ~~mortgage~~ servicing rights ~~a $127,000 increase in~~of $491,000 and operations ~~and a $114,000 increase in data processing,~~of $359,000, partially offset by ~~a $124,000 decrease~~no acquisition costs in ~~professional and board fees.~~

~~Noninterest expense increased $4.1 million 14.1%,~~the current quarter, compared to ~~$32.9 million~~$374,000 for the ~~nine~~comparable period last year, and a decrease of $306,000 in data processing. Data processing expenses for the three months ended ~~September 30, 2017,~~March 31, 2019, included conversion costs from ~~$28.8 million for~~ the ~~nine months ended September 30, 2016. The increase in noninterest expense was~~Anchor Acquisition. In addition, FDIC insurance decreased $122,000, primarily as a result of ~~a $3.7 million increase~~the FDIC’s small bank credit of $26,000 in ~~salaries and benefits, which included $935,000 in incentives and commissions for~~ the ~~loan production staff, a $285,000 increase in operations, a $235,000 increase in data processing, a $188,000 increase in loan costs,~~first quarter of 2020, and a ~~$164,000 increase in occupancy expense, partially offset by a $389,000~~ decrease in ~~acquisition costs and a $229,000 decrease in professional and board fees.~~the year over year quarterly assessment rate.

The efficiency ratio, which is noninterest expense as a percentage of net interest income and noninterest income, ~~weakened slightly~~improved to ~~66.4%~~61.39% for the three months ended ~~September 30, 2017,~~March 31, 2020, compared to ~~64.5%~~66.52% for the three months ended ~~September 30, 2016, and 67.5% for the nine months ended September 30, 2017, compared to 67.4% for the nine months ended September 30, 2016,~~March 31, 2019, representing a greater increase in net interest income and noninterest ~~expense~~income, as compared to a smaller ~~increase~~increases in ~~interest and~~ noninterest ~~income.~~expense.

Provision for Income Tax.For the three months ended ~~September 30, 2017,~~March 31, 2020, the Company recorded a provision for income tax expense of ~~$2.0~~$1.3 million on pre-tax income as compared to ~~$1.6~~$1.5 million for the three months ended ~~September 30, 2016.~~March 31, 2019. The effective corporate income tax rates for the three months ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019 were ~~36.2%~~20.4% and ~~32.0%~~22.5%, respectively. ~~For~~The decrease in the ~~nine~~tax provision is primarily due to a $203,000 decrease in pre-tax income and the lack of non-deductible acquisition costs during the three months ended ~~September 30, 2017, the Company recorded a provision for income tax expense of $5.0 million on pre-tax income as~~March 31, 2020, compared to ~~$4.2 million for~~non-deductible acquisition costs of $374,000 during the ~~nine months ended September 30, 2016. The effective tax rates for the nine months ended September 30, 2017 and 2016 were 32.5% and 34.5%, respectively.~~same period last year.

Liquidity

Management maintains a liquidity position that it believes will adequately provide funding for loan demand and deposit runoff that may occur in the normal course of business. The Company relies on a number of different sources in order to meet ~~its~~ potential liquidity demands. The primary sources are increases in deposit accounts, FHLB advances, purchases of ~~Fed Funds,~~federal funds, sale of securities available-for-sale, cash flows from loan payments, sales of one-to-four-family loans ~~HFS,~~held for sale, and maturing securities.

At ~~September 30, 2017,~~March 31, 2020, the Bank’s total borrowing capacity was ~~$247.1~~$521.6 million with the FHLB of Des Moines, with unused borrowing capacity of ~~$235.8~~$356.6 million. The FHLB borrowing limit is based on certain categories of loans, primarily real estate loans that qualify as collateral for FHLB advances. At ~~September 30, 2017,~~March 31, 2020, the Bank held approximately ~~$320.1~~$706.4 million in loans that qualify as collateral for FHLB advances.

In addition to the availability of liquidity from the FHLB of Des Moines, the Bank maintained a short-term borrowing line with the Federal Reserve Bank, with a current limit of ~~$96.0~~$160.3 million, and a combined credit limit of ~~$43.0~~$71.0 million in written ~~Fed Funds~~federal funds lines of credit through correspondent banking relationships at ~~September 30, 2017.~~March 31, 2020. The Federal Reserve Bank borrowing limit is based on certain categories of loans, primarily consumer loans that qualify as collateral for Federal

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Reserve Bank line of credit. At ~~September 30, 2017,~~March 31, 2020, the Bank held approximately ~~$195.3~~$327.4 million in loans that qualify as collateral for the Federal Reserve Bank line of credit.

At ~~September 30, 2017, $10.3~~March 31, 2020, $159.1 million in FHLB advances were outstanding, and no advances were outstanding against the Federal Reserve Bank line of credit, or the ~~Fed Funds~~federal funds lines of credit. The Bank’s Asset and Liability Management Policy permits management to utilize brokered deposits up to 20% of ~~Bank~~ deposits or ~~$168.8~~$290.6 million at ~~September 30, 2017.~~

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March 31, 2020. Total brokered deposits at ~~September 30, 2017~~March 31, 2020 were ~~$102.2~~$123.4 million. Management utilizes brokered deposits to mitigate interest rate risk and liquidity risk exposure when appropriate.

Liquidity management is both a daily and long-term function of ~~Company~~the Company’s management. Excess liquidity is generally invested in short-term investments, such as overnight deposits and ~~Fed Funds.~~federal funds. On a longer term basis, a strategy is maintained of investing in various lending products and investment securities, including U.S. Government obligations and ~~federal~~U.S. agency securities. The Company uses sources of funds primarily to meet ongoing commitments, pay maturing deposits, fund withdrawals, and to fund loan commitments. At ~~September 30, 2017,~~March 31, 2020, the approved outstanding loan commitments, including unused lines of credit amounted to ~~$347.1 million, including undisbursed construction and development loans in process totaling $82.1~~$505.1 million. Certificates of deposit scheduled to mature in three months or less at ~~September 30, 2017,~~March 31, 2020, totaled ~~$81.2~~$97.2 million. It is management’s policy to offer deposit rates that are competitive with other local financial institutions. Based on this management strategy, the Company believes that a majority of maturing relationship deposits will remain with the Bank.

As a separate legal entity from the Bank, FS Bancorp, Inc. must provide for its own liquidity. Sources of capital and liquidity for FS Bancorp, Inc. include distributions from the Bank and the issuance of debt or equity securities. Dividends and other capital distributions from the Bank are subject to regulatory notice. At ~~September 30, 2017,~~March 31, 2020, FS Bancorp, Inc. had ~~$3.7~~$6.8 million in unrestricted cash to meet liquidity needs.

Commitments and Off-Balance Sheet Arrangements

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the financing needs of its customers. For information regarding our commitments and off-balance sheet arrangements, see ~~Note~~“Note 9 - Commitments and Contingencies” of the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report.

Capital Resources

The Bank is subject to minimum capital requirements imposed by the FDIC. Based on its capital levels at ~~September 30, 2017,~~March 31, 2020, the Bank exceeded these requirements as of that date. Consistent with our goals to operate a sound and profitable organization, our policy is for the Bank to maintain a well capitalized status under the capital categories of the FDIC. Based on capital levels at ~~September 30, 2017,~~March 31, 2020, the Bank was considered to be well capitalized. Effective January 1, 2020, a bank that elects to use the Community Bank Leverage Ratio (“CBLR”) will generally be considered well-capitalized and to have met the risk-based and leverage capital requirements of the capital regulations if it has a leverage ratio greater than 9.0%. At ~~September 30, 2017,~~March 31, 2020, the Bank qualified and elected to use the CBLR to measure capital adequacy. The Tier 1 leverage-based capital ratio calculated for the Bank at March 31, 2020 was 11.3%, compared to 11.6% at December 31, 2019. As required by the CARES Act, the FDIC has temporarily lowered the CBLR to 8% beginning in the second quarter of 2020 through the end of the year. Beginning in 2021, the CBLR will increase to 8.5% for that calendar year. The CBLR will return to 9% on Jan. 1, 2022.

As a bank holding company registered with the Federal Reserve, the Company is subject to the capital adequacy requirements of the Federal Reserve. Bank holding companies with less than $3.0 billion in assets are generally not subject to compliance with the Federal Reserve’s capital regulations, which are generally the same as the capital regulations applicable to the Bank. The Federal Reserve has a policy that a bank holding company is required to serve as a source of financial and managerial strength to the holding company’s subsidiary bank and the Federal Reserve expects the holding company’s subsidiary bank to be well capitalized under the prompt corrective action regulations. If FS Bancorp, Inc. were subject to regulatory capital guidelines for bank holding companies with $3.0 billion or more in assets at March 31, 2020, FS Bancorp, Inc. would have exceeded all regulatory capital ~~requirements with~~requirements. The Tier 1 leverage-based capital ~~Tier 1 risk-based capital, total risk-based capital, and common equity Tier 1 capital ratios of 12.5%, 14.9%, 16.1%, and 14.9%, respectively.~~ratio calculated for FS Bancorp, Inc. at March 31, 2020 was 11.1%. For additional information regarding ~~the Bank’s~~ regulatory capital

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compliance, see the discussion included in ~~Note~~“Note 14 - Regulatory Capital” to the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report.

For a bank holding company with less than $1 billion in consolidated assets, such as FS Bancorp, Inc., the capital guidelines apply on a bank only basis and the Federal Reserve requires the holding company’s subsidiary banks to be well capitalized under the prompt corrective action regulations. If FS Bancorp, Inc. was subject to regulatory guidelines for bank holding companies with $1 billion or more in assets, at September 30, 2017, FS Bancorp, Inc. would have exceeded all regulatory capital requirements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

~~Not required~~There have been no material changes in the market risk disclosures contained in FS Bancorp’s Annual Report on Form 10-K for ~~smaller reporting companies.~~the fiscal year ended December 31, 2019.

Item 4. Controls and Procedures

(a)Evaluation of Disclosure Controls and Procedures

An evaluation of the disclosure controls and procedures ~~(as~~as defined in Rule 13a‑15(e) of the Securities Exchange Act of 1934, as amended (the ~~“Act”~~“Exchange Act”)~~) at September 30, 2017~~ was carried out as of March 31, 2020 under the supervision and with the participation of the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) and several other members of the Company’s senior management. ~~The Company’s Chief Executive Officer~~In designing and ~~Chief Financial Officer concluded that~~evaluating the Company’s disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in ~~effect~~designing disclosure controls and procedures, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

The Company’s CEO and CFO concluded that based on their evaluation at ~~September 30, 2017~~March 31, 2020, the Company’s disclosure controls and procedures were effective in ensuring that ~~the~~ information we are required to ~~be disclosed by the Company~~disclose in the reports ~~it files~~we file or ~~submits~~submit under the Exchange Act ~~is: (i) accumulated and communicated to the Company’s~~

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~~management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner and (ii)~~is (1) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and (2) accumulated and communicated to FS Bancorp management, including its CEO and CFO, as appropriate to allow timely decisions regarding required disclosure, specified in the SEC’s rules and forms.

(b)Changes in Internal Controls

There ~~have been~~were no significant changes in the Company’s internal control over financial reporting ~~(as defined in Rule 13a‑15(f) of the Act)~~ that occurred during the three months ended ~~September 30, 2017,~~March 31, 2020, that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls may be circumvented by the individual acts of some persons, by collusion of two or more people, or by override of the control. The design of any control procedure is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

In the normal course of business, the Company occasionally becomes involved in various legal proceedings. In the opinion of management, any liability from such proceedings would not have a material adverse effect on the business or financial condition of the Company.

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Item 1A. Risk Factors

~~There have been no material changes~~In light of recent developments relating to the novel coronavirus of 2019 (“COVID-19”), the Company is supplementing its risk factors ~~set forth~~contained in ~~Part I.~~ Item 1A of ~~the Company’s~~its Annual Report on Form ~~10‑K~~10-K for the year ended December 31, ~~2016.~~2019, as filed with the Securities and Exchange Commission on March 16, 2020. The following risk factor should be read in conjunction with the risk factors described in FS Bancorp’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

The COVID-19 pandemic has significantly affected some of our operations and the way we provide banking services to businesses and individuals, most of whom are currently under government issued stay-at-home orders. As an essential business, we continue to provide banking and financial services to our customers with drive-thru access available at the majority of our branch locations and in-person services available by appointment. In addition, we continue to provide access to banking and financial services through online banking, ATMs and by telephone. If the COVID-19 pandemic worsens it could potentially limit or disrupt our ability to provide banking and financial services to our customers. The ultimate impact of the COVID-19 pandemic will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.

In response to the stay-at-home orders, the majority our employees currently are working remotely to enable us to continue to provide banking services to our customers. Heightened cybersecurity, information security and operational risks may result from these remote work-from-home arrangements. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of the COVID-19 pandemic. We also rely upon our third-party vendors to conduct business and to process, record and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our customers. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.

There is pervasive uncertainty surrounding the future economic conditions that will emerge in the months and years following the start of the pandemic. As a result, management is confronted with a significant and unfamiliar degree of uncertainty in estimating the impact of the pandemic on credit quality, revenues and asset values. To date, the COVID-19 pandemic has resulted in declines in loan demand and loan originations, other than through government sponsored programs such as the Payroll Protection Program (“PPP”), deposit availability, market interest rates and negatively impacted many of our business and consumer borrower’s ability to make their loan payments. Because the length of the pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including recent reductions in the targeted federal funds rate, until the pandemic subsides, we expect our net interest income and net interest margin will be unfavorably affected in the near term, if not longer. Many of our borrowers have become unemployed or may face unemployment, and certain businesses are at risk of insolvency as their revenues decline precipitously, especially in businesses related to travel, hospitality, leisure and physical personal services. Businesses may ultimately not reopen as there is a significant level of uncertainty regarding the level of economic activity that will return to our markets over time, the impact of governmental assistance, the speed of economic recovery, the resurgence of COVID-19 in subsequent seasons and changes to demographic and social norms that will take place.

The impact of the pandemic is expected to continue to unfavorably affect us during 2020 and possibly longer as the ability of many of our customers to make loan payments has been significantly affected. Although the Company makes estimates of loan losses related to the pandemic as part of its evaluation of the allowance for loan losses, such estimates involve significant judgment and are made in the context of significant uncertainty as to the impact the pandemic will have on the credit quality of our loan portfolio. It is likely that increased loan delinquencies, adversely classified loans and loan charge-offs will increase in the future as a result of the pandemic. Consistent with guidance provided by banking regulators, we have modified loans by providing various loan payment deferral options to our borrowers affected by the COVID-19 pandemic. Notwithstanding these modifications, these borrowers may not be able to resume making full payments on their loans once the COVID-19 pandemic is resolved. Any increases in the allowance for credit losses will result in a decrease in net income and, most likely, capital, and may have a material negative effect on our financial condition and results of operations.

The PPP loans made by the Bank are guaranteed by the SBA and, if used by the borrower for authorized purposes, may be fully forgiven. However, in the event of a loss resulting from a default on a PPP loan and a determination by the SBA that

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there was a deficiency in the manner in which the PPP loan was originated, funded or serviced by the Bank, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty or, if it has already made payment under the guaranty, seek recovery of any loss related to the deficiency from the Bank. In addition, since the commencement of the PPP, several larger banks have been subject to litigation regarding their processing of PPP loan applications. The Bank may be exposed to the risk of similar litigation, from both customers and non-customers that approached the Bank seeking PPP loans. PPP lenders, including the Bank, may also be subject to the risk of litigation in connection with other aspects of the PPP, including but not limited to borrowers seeking forgiveness of their loans. If any such litigation is filed against the Bank, it may result in significant financial or reputational harm to us.

In accordance with GAAP, we record assets acquired and liabilities assumed at their fair value with the excess of the purchase consideration over the net assets acquired resulting in the recognition of goodwill. If adverse economic conditions or the recent decrease in our stock price and market capitalization as a result of the pandemic were to be deemed sustained rather than temporary, it may significantly affect the fair value of our goodwill and may trigger impairment charges. Any impairment charge could have a material adverse effect on our results of operations and financial condition. Even after the COVID-19 pandemic subsides, the U.S. economy will likely require some time to recover from its effects, the length of which is unknown, and during which we may experience a recession. As a result, we anticipate our business may be materially and adversely affected during this recovery. To the extent the effects of the COVID-19 pandemic adversely impact our business, financial condition, liquidity or results of operations, it may also have the effect of heightening many of the other risks described in the section entitled "Risk Factors" in FS Bancorp’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019 and any subsequent Quarterly Reports on Form 10-Q.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(a)

Not applicable

(b)

Not applicable

(c)

~~Not applicable~~The following table summarizes common stock repurchases during the three months ended March 31, 2020:


					Maximum
				Total Number	Number of
				of Shares	Shares that
		Average		Repurchased as	May Yet Be
	Total Number	Price		Part of Publicly	Repurchased
	of Shares	Paid per		Announced	Under the
Period	Purchased	Share		Plan	Plan
January 1, 2020 - January 31, 2020	4,798	$	55.22	—	220,202
February 1, 2020 - February 29, 2020	12,124		51.02	9,524	208,078
March 1, 2020 - March 31, 2020	119,321		37.47	119,321	87,757
Total for the quarter	136,243	$	39.30	128,845	87,757

On January 28, 2020, the Company announced that its Board of Directors authorized the repurchase of up to 225,000 shares of the Company’s common stock, or 5% of the Company’s outstanding shares authorized and outstanding at December 31, 2019. The repurchase program permits shares to be repurchased in open market or private transactions, through block trades, from time to time over a 12-month period until January 28, 2021, depending on market conditions and other factors, and pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Commission.

Item 3. Defaults Upon Senior Securities

Not applicable.

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Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

5557

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Item 6. Exhibits


2.1		Agreement and Plan of Merger, dated as of July 17, 2018, by and between FS Bancorp, Inc. and Anchor Bancorp (1)
3.1		Articles of Incorporation of FS Bancorp, Inc. ~~(1)~~(2)
3.2		Bylaws of FS Bancorp, Inc. ~~(2)~~(3)
4.1		Form of Common Stock Certificate of FS Bancorp, Inc. ~~(1)~~(2)
10.1		Severance Agreement between 1st Security Bank of Washington and Joseph C. Adams ~~(1)~~(2)
10.2		Form of Change of Control Agreement between 1st Security Bank of Washington and ~~each of Joseph C. Adams,~~ Matthew D. Mullet ~~Drew B. Ness, and Dennis V. O’Leary (1)~~(2)
10.3		FS Bancorp, Inc. 2013 Equity Incentive Plan (the “2013 Plan”) ~~(3)~~(4)
10.4		Form of Incentive Stock Option Agreement under the 2013 Plan ~~(3)~~(4)
10.5		Form of Non-Qualified Stock Option Agreement under the 2013 Plan ~~(3)~~(4)
10.6		Form of Restricted Stock Agreement under the 2013 Plan ~~(3)~~(4)
10.7		Purchase and Assumption Agreement between Bank of America, National Association and 1st Security Bank dated September 1, 2015 ~~(4)~~(5)
10.8		Subordinated Loan Agreement dated September 30, 2015 by and among Community Funding CLO, Ltd. and the Company ~~(5)~~(6)
10.9		Form of change of control agreement with Donn C. Costa, Dennis O’Leary, Rob Fuller, Erin Burr, Victoria Jarman, Kelli Nielsen, and ~~Debbie L. Steck (6)~~May-Ling Sowell (7)
10.10		FS Bancorp, Inc. 2018 Equity Incentive Plan (8)
10.11		Form of Incentive Stock Option Award Agreement under the 2018 Equity Incentive Plan (8)
10.12		Form of Non-Qualified Stock Option Award Agreement under the 2018 Equity Incentive Plan (8)
10.13		Form of Restricted Stock Award Agreement under the 2018 Equity Incentive Plan (8)
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101		The following materials from the Company’s Quarterly Report on Form 10‑Q for the quarter ended ~~September 30, 2017~~March 31, 2020 formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Statements of Income; (3) Consolidated Statements of Comprehensive Income; (4) Consolidated Statements of Changes in Stockholders’ Equity; (5) Consolidated Statements of Cash Flows; and (6) Notes to Consolidated Financial Statements.
(1)		Filed as an exhibit to the Registrant’s Current Report on Form 8-K filed on July 18, 2018 (File No. 001-35589) and incorporated by reference.
(2)		Filed as an exhibit to the Registrant’s Registration Statement on Form S‑1 (333‑177125) filed on October 3, 2011, and incorporated by reference.
~~(2)~~(3)		Filed as an exhibit to the Registrant’s Current Report on Form 8‑K filed on July 10, 2013 (File No. 001‑35589). and incorporated by reference.
~~(3)~~(4)		Filed as an exhibit to the Registrant’s Registration Statement on Form S‑8 (333‑192990) filed on December 20, 2013, and incorporated by reference.
~~(4)~~(5)		Filed as an exhibit to the Registrant’s Current Report on Form 8‑K filed on September 2, 2015 (File No. 001‑35589). and incorporated by reference.
~~(5)~~(6)		Filed as an exhibit to the Registrant’s Current Report on Form 8‑K filed on October 19, 2015 (File No. 001‑35589). and incorporated by reference.
~~(6)~~(7)		Filed as an exhibit to the Registrant’s Current Report on Form 8‑K filed on February 1, 2016 (File No. 001‑35589). and incorporated by reference.
(8)		Filed as an exhibit to the Registrant’s Registration Statement on Form S-8 (333-225135) filed on May 23, 2018.

5658

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~~Exhibit Index~~


~~Exhibit No~~.		~~Description~~
~~31.1~~		~~Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002~~
~~31.2~~		~~Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002~~
~~32.1~~		~~Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002~~
~~32.2~~		~~Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002~~
~~101~~		The following materials from the Company’s Quarterly Report on Form 10‑Q for the quarter ended September 30, 2017 formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Statements of Income; (3) Consolidated Statements of Comprehensive Income; (4) Consolidated Statements of Changes in Stockholders’ Equity; (5) Consolidated Statements of Cash Flows; and (6) Notes to Consolidated Financial Statements.

~~Table of Contents~~

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	FS BANCORP, INC.


Date: ~~November 13, 2017~~May 11, 2020	By:	/s/Joseph C. Adams
		Joseph C. Adams,
		Chief Executive Officer
		(Duly Authorized Officer)

Date: ~~November 13, 2017~~May 11, 2020	By:	/s/Matthew D. Mullet
		Matthew D. Mullet
		Secretary, Treasurer and
		Chief Financial Officer
		(Principal Financial and Accounting Officer)

5859


	Nine Months Ended September 30,
	2017		2016
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	10,406	$	7,953
Adjustments to reconcile net income to net cash from operating activities
Provision for loan losses		450		1,800
Depreciation, amortization and accretion		2,577		3,779
Compensation expense related to stock options and restricted stock awards		496		588
ESOP compensation expense for allocated shares		914		529
Increase in cash surrender value of BOLI		(208)		(211)
Gain on sale of loans held for sale		(13,840)		(14,722)
Gain on sale of investment securities		(380)		(146)
Gain on sale of OREO		—		(150)
Gain on sale of MSR		(996)		—
Origination of loans held for sale		(520,358)		(584,073)
Proceeds from sale of loans held for sale		520,091		564,218
Impairment (recovery) of servicing rights		1		(2)
Changes in operating assets and liabilities
Accrued interest receivable		(693)		(450)
Other assets		(79)		(7,481)
Other liabilities		2,668		5,063
Net cash from (used by) operating activities		1,049		(23,305)
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in securities available-for-sale:
Proceeds from sale of investment securities		39,103		13,577
Maturities, prepayments, sales, and calls		6,531		9,039
Purchases		(41,320)		(47,432)
Maturities of certificates of deposit at other financial institutions		1,240		292
Purchase of certificates of deposit at other financial institutions		(4,102)		(1,882)
Loan originations and principal collections, net		(129,763)		(93,871)
Purchase of portfolio loans		(32,342)		—
Proceeds from sale of other real estate owned, net		—		682
Purchase of premises and equipment, net		(623)		(2,287)
FHLB stock, net		(328)		2,547
Proceeds from sale of MSR		4,827		—
Net cash received from acquisition		—		180,356
Net cash (used by) from investing activities		(156,777)		61,021
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits		127,985		37,630
Borrowings, net		(2,400)		(77,740)
Dividends paid		(941)		(802)
Proceeds from stock options exercised		580		157
Common stock repurchased		(275)		(4,903)
Proceeds from issuance of common stock		25,618		—
Net cash from (used by) financing activities		150,567		(45,658)
NET DECREASE IN CASH AND CASH EQUIVALENTS		(5,161)		(7,942)
CASH AND CASH EQUIVALENTS, beginning of period		36,456		24,455
CASH AND CASH EQUIVALENTS, end of period	$	31,295	$	16,513

SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest	$	3,528	$	2,931
Income taxes	$	5,800	$	4,420
Assets acquired in acquisition of branches (Note 2)	$	—	$	181,575
Liabilities assumed in acquisition of branches (Note 2)	$	—	$	186,393
SUPPLEMENTARY DISCLOSURES OF NONCASH OPERATING, INVESTING AND FINANCING ACTIVITIES
Change in unrealized gain on investment securities	$	631	$	1,079
Transfer portfolio loans to loans held for sale	$	1,886	$	—
Property received in settlement of loans	$	—	$	525
Retention of gross mortgage servicing rights from loan sales	$	3,569	$	2,927


	Acquired Book		Fair Value			Amount
January 22, 2016	Value		Adjustments			Recorded
Assets
Cash and cash equivalents	$	180,356	$	—		$	180,356
Loans receivable		417		—			417
Premises and equipment, net		697		267	(1)		964
Accrued interest receivable		2		—			2
Core deposit intangible		—		2,239	(2)		2,239
Goodwill		—		2,312	(3)		2,312
Other assets		103		—			103
Total assets acquired	$	181,575	$	4,818		$	186,393
Liabilities
Deposits:
Noninterest-bearing accounts	$	79,966	$	—		$	79,966
Interest-bearing accounts		106,398		—			106,398
Total deposits		186,364		—			186,364
Accrued interest payable		7		—			7
Other liabilities		22		—			22
Total liabilities assumed	$	186,393	$	—		$	186,393


	At January 22,
	2016
Purchase price (1)	$	6,015
Recognized amounts of identifiable assets acquired and (liabilities assumed), at fair value:
Cash and cash equivalents		186,371
Acquired loans		417
Premises and equipment, net		964
Accrued interest receivable		2
Core deposit intangible		2,239
Other assets		103
Deposits		(186,364)
Accrued interest payable		(7)
Other liabilities		(22)
Total fair value of identifiable net assets		3,703
Goodwill	$	2,312


Fourth Quarter 2017	$	100
2018		307
2019		235
2020		181
2021		166
Thereafter		428
Total	$	1,417


	Mortgage Loans Held for Sale
	Level 1		Level 2		Level 3		Total
September 30, 2017	$	—	$	65,055	$	—	$	65,055
December 31, 2016	$	—	$	52,553	$	—	$	52,553


									To be Well Capitalized
									Under Prompt
					For Capital				Corrective
	Actual				Adequacy Purposes				Action Provisions
Bank Only	Amount		Ratio		Amount		Ratio		Amount		Ratio
At September 30, 2017
Total risk-based capital
(to risk-weighted assets)	$	130,246	16.14	%	$	64,556	8.00	%	$	80,696	10.00	%
Tier 1 risk-based capital
(to risk-weighted assets)	$	120,150	14.89	%	$	48,417	6.00	%	$	64,556	8.00	%
Tier 1 leverage capital
(to average assets)	$	120,150	12.50	%	$	38,459	4.00	%	$	48,074	5.00	%
CET 1 capital
(to risk-weighted assets)	$	120,150	14.89	%	$	36,313	4.50	%	$	52,452	6.50	%

At December 31, 2016
Total risk-based capital
(to risk-weighted assets)	$	93,309	13.87	%	$	53,813	8.00	%	$	67,266	10.00	%
Tier 1 risk-based capital
(to risk-weighted assets)	$	84,876	12.62	%	$	40,360	6.00	%	$	53,813	8.00	%
Tier 1 leverage capital
(to average assets)	$	84,876	10.33	%	$	32,862	4.00	%	$	41,078	5.00	%
CET 1 capital
(to risk-weighted assets)	$	84,876	12.62	%	$	30,270	4.50	%	$	43,723	6.50	%