# FS Bancorp, Inc. (FSBW) FY 2023 MD&A Verbatim Item 7 Management's Discussion and Analysis from FS Bancorp, Inc.'s 10-K for fiscal year 2023. SEC filing source: https://www.sec.gov/Archives/edgar/data/1530249/000143774924008140/fsbw20221231_10k.htm Accession: 0001437749-24-008140 Filing date: 2024-03-15 Report date: 2023-12-31 Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture. Confidence: high Company profile: /company/FSBW/ All MD&A years: /company/FSBW/mda/ Previous year: /company/FSBW/mda/fy2022/ (FY 2022) Next year: /company/FSBW/mda/fy2024/ (FY 2024) Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations This discussion and analysis reviews our consolidated financial statements and other relevant statistical data and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the Consolidated Financial Statements and footnotes thereto that appear in Item 8. of this Form 10–K. The information contained in this section should be read in conjunction with these Consolidated Financial Statements and footnotes and the business and financial information provided in this Form 10–K. Overview FS Bancorp and its subsidiary bank, 1st Security Bank, have been serving the Puget Sound area since 1907. 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. The Company is relationship-driven, delivering banking and financial services to local families, local and regional businesses and industry niches in suburban communities in the greater Puget Sound area, the Kennewick-Pasco-Richland metropolitan area of Washington, also known as the Tri-Cities, Goldendale, Vancouver, and White Salmon, Washington and Manzanita, Newport, Ontario, Tillamook, and Waldport, Oregon.  On February 24, 2023, the Company completed its purchase of seven retail bank branches from Columbia State Bank (the “Branch Acquisition”) and acquired approximately $425.5 million in deposits and $66.1 million in loans. The seven acquired branches are in the communities of Goldendale and White Salmon, Washington, and Manzanita, Newport, Ontario, Tillamook, and Waldport, Oregon. The Branch Acquisition expanded our Puget Sound-focused retail footprint into southeast Washington and the state of Oregon as well as providing 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 primarily throughout the Western United States. 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's strategic focus involves diversifying revenues, expanding lending channels, and enhancing the banking franchise. Management is committed to establishing varied revenue streams considering credit, interest rate, and concentration risks. The business plan includes: [[GREPCENT_TABLE]] [["","\u25cf","Growing and diversifying our loan portfolio;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u25cf","Maintaining strong asset quality;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u25cf","Emphasizing lower cost core deposits to reduce the costs of funding our loan growth;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u25cf","Capturing customers\u2019 complete relationships through a broad array of products and services, leveraging community involvement, and selectively emphasizing offerings aligned with customers' banking needs; and"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u25cf","Expanding into new markets."]] [[/GREPCENT_TABLE]] As a diversified lender, the Company specializes in originating one-to-four-family loans, commercial real estate mortgages, second mortgages, consumer loans, marine lending, and commercial business loans. At December 31, 2023, the Company's loan portfolio included real estate loans, consumer loans, and commercial business loans representing 63.0%, 26.6%, and 10.5% of the total loan portfolio, respectively.  51 Table of Contents Fixture secured loans to finance window, gutter, siding replacement, solar panels, spas, and other improvement renovations are a large segment of the consumer loan portfolio. These fixture-secured consumer loans are dependent on the Company's contractor/dealer network of 114 active dealers located throughout Washington, Oregon, California, Idaho, Colorado, Nevada, Arizona, Minnesota, Texas, Utah, Massachusetts, Montana, and recently, New Hampshire.  Five of these contractor/dealers were responsible for 65.9% of the dollar volume of funded loans for the year ended December 31, 2023. To address concentration risks, management has consolidated any dealers owned by the same corporate entity under that entity as of December 31, 2023, rather than treating them as separate dealers.  The Company funded $205.3 million, or approximately 9,000 loans in the fixture-secured consumer loan category during the year ended December 31, 2023. The following table details fixture secured loan originations by state for the periods indicated: [[GREPCENT_TABLE]] [["(Dollars in thousands)","","For the Year Ended","","","For the Year Ended"],["","","December 31, 2023","","","December 31, 2022"],["State","","Amount","","","Percent","","","Amount","","","Percent"],["Washington","","$","72,166","","","","35.1","%","","$","102,981","","","","32.7","%"],["Oregon","","","48,831","","","","23.8","","","","73,110","","","","23.2"],["California","","","34,219","","","","16.7","","","","59,175","","","","18.8"],["Idaho","","","13,787","","","","6.7","","","","22,744","","","","7.2"],["Colorado","","","7,442","","","","3.6","","","","14,584","","","","4.6"],["Arizona","","","5,846","","","","2.8","","","","5,029","","","","1.6"],["Nevada","","","4,697","","","","2.3","","","","4,869","","","","1.5"],["Minnesota","","","8,312","","","","4.0","","","","28,503","","","","9.1"],["Texas","","","1,685","","","","0.8","","","","572","","","","0.2"],["Utah","","","5,062","","","","2.5","","","","2,674","","","","0.9"],["Massachusetts","","","778","","","","0.4","","","","137","","","","\u2014"],["Montana","","","2,200","","","","1.1","","","","577","","","","0.2"],["New Hampshire","","","322","","","","0.2","","","","\u2014","","","","\u2014"],["Total fixture secured loans","","$","205,347","","","","100.0","%","","$","314,955","","","","100.0","%"]] [[/GREPCENT_TABLE]] The Company originates one-to-four-family residential mortgage loans through referrals from real estate agents, financial planners, builders, and from existing customers. Retail banking customers are also an important source of the Company’s loan originations. The Company originated $527.7 million of one-to-four-family loans (which included loans held for sale, loans held for investment and second lien mortgages classified as home equity loans) in addition to $15.9 million of loans brokered to other institutions through the home lending segment during the year ended December 31, 2023, of which $408.0 million were sold to investors. Of the loans sold to investors, $241.5 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 December 31, 2023, one-to-four-family residential mortgage loans held for investment totaled $567.7 million, or 23.3% of the total gross loan portfolio, while loans held for sale totaled $25.7 million and home equity loans totaled $69.5 million at that date. For the year ended December 31, 2023, one-to-four-family loan originations and refinancing activity decreased as a result of increased market interest rates. Residential construction and development lending, while not as common as other loan origination options like one-to-four-family loans, continues to be an important element in our total loan portfolio, and we 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 have a maturity period of six to 18 months, with disbursements not fully realized at origination, leading to a short-term reduction in net loans receivable. The Company is significantly affected by prevailing economic conditions, as well as government policies and regulations concerning, among other things, monetary and fiscal affairs. 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 the interest rates paid on these deposits and borrowings. 52 Table of Contents The Company’s earnings are also affected by fee income from mortgage banking activities, the provision for (recovery of) credit losses, service charges and fees, gains from sales of assets, operating expenses and income taxes. Most notable of these factors, the Company recorded a provision for credit losses of $4.8 million for the year ended December 31, 2023, compared to $6.2 million for the same period one year ago.  The decreased provision in the current year was primarily due to a decrease in net loan growth, particularly in consumer loans and an increase in recoveries of reserves for unfunded commitments. Critical Accounting Estimates We prepare our consolidated financial statements in accordance with GAAP. In doing so, we have to make estimates and assumptions. Our critical accounting estimates are those estimates that involve a significant level of uncertainty at the time the estimate was made, and changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used in the current period, would have a material impact on our financial condition or results of operations. Accordingly, actual results could differ materially from our estimates. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We have reviewed our critical accounting estimates with the audit committee of our Board of Directors.  See Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10–K for a summary of significant accounting policies and the effect on our financial statements. Allowance for Credit Losses on Held-to-Maturity Securities. Management measures expected credit losses on held-to-maturity securities by individual security. Accrued interest receivable on held-to-maturity debt securities is excluded from the estimate of credit losses. The estimate of expected credit losses considers credit ratings and historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. The held-to-maturity portfolio consists entirely of corporate securities. Securities are generally rated investment grade or higher. Securities are analyzed individually to establish a reserve. Allowance for Credit Losses on Available-for-Sale Securities. For available-for-sale securities in an unrealized loss position, management first assesses whether it intends to sell, or is more likely than not to be required to sell, the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For debt securities available-for-sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACL is recorded, limited by the amount that the fair value is less than the amortized cost basis. Changes in the ACL are recorded as a provision for (reversal of) credit losses. Losses are charged against the ACL when management believes the uncollectability of an available-for-sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Accrued interest receivable on available-for-sale debt securities is not included in the estimate of credit losses. Allowance for Credit Losses on Loans. The ACL on loans is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the ACL when management believes the uncollectability of a loan balance is confirmed and recoveries are credited to the ACL when received. In the case of recoveries, amounts may not exceed the aggregate of amounts previously charged off. Management utilizes relevant available information, from internal and external sources, relating to past events, current conditions, historical loss experience, and reasonable and supportable forecasts. The lookback period in the analysis includes historical data from 2009 to present. Adjustments to historical loss information are made when management determines historical data is not likely reflective of the current portfolio such as limited data sets or lack of default or loss history. Management may selectively apply external market data to subjectively adjust the Company’s own loss history including index or peer data. Accrued interest receivable is excluded from the estimate of credit losses on loans. The ACL on loans is measured on a collective cohort basis when similar risk characteristics exist. Generally, collectively assessed loans are grouped by call report code and then risk-grade grouping. Risk grade is grouped within each call report code by pass, watch, special mention, substandard, and doubtful. Other loan types are separated into their own cohorts due to specific risk characteristics for that pool of loans. 53 Table of Contents The Company has elected a non-discounted cash flow methodology with probability of default (“PD”) and loss given default (“LGD”) for all call report code cohorts (“cohorts”), except for the indirect and marine portfolios which are evaluated under a vintage methodology. The vintage methodology measures the expected loss calculation for future periods based on historical performance by the origination period of loans with similar life cycles and risk characteristics. Guaranteed portions of loans are measured with zero risk due to cash collateral and full guaranty. The PD calculation looks at the historical loan portfolio at points in time (each month during the lookback period) to determine the probability that loans in a certain cohort will default over the next 12-month period. A default is defined as a loan that has moved to past due 90 days and greater, nonaccrual status, or experienced a charge-off during the period. In cohorts where the Company’s historical data is insufficient due to a minimal amount of default activity or zero defaults, management uses index PDs comprised of rates derived from the PD experience of other community banks in place of the Company’s historical PDs. Additionally, management reviews all other cohorts to determine if index PDs should be used outside of these criteria. The LGD calculation looks at actual losses (net charge-offs) experienced over the entire lookback period for each cohort of loans. The aggregate loss amount is divided by the exposure at default to determine an LGD rate. All loan defaults (non-accrual, charge-off, or greater than 90 days past due) occurring during the lookback period are included in the denominator, whether a loss occurred or not and exposure at default is determined by the loan balance immediately preceding the default event (i.e., nonaccrual or charge-off). Due to limited charge-off history, management uses index LGDs comprised of rates derived from the LGD experience of other community banks in place of the Company’s historical LGDs. The Company utilizes reasonable and supportable forecasts of future economic conditions when estimating the ACL on loans. The calculation includes a 12-month PD forecast based on the Company’s regression model comparing peer nonperforming loan ratios to the national unemployment rate. After the forecast period, PD rates revert on a straight-line basis back to long-term historical average rates over a 12-month period. Due to limited default history, management uses index PDs comprised of rates derived from the PD experience of other community banks in place of the Company’s historical PDs. The Company recognizes that all significant factors that affect the collectability of the loan portfolio must be considered to determine the estimated credit losses as of the evaluation date. Furthermore, the methodology, in and of itself and even when selectively adjusted by comparison to market and peer data, does not provide a sufficient basis to determine the estimated credit losses. The Company adjusts the modeled historical losses by qualitative and environmental adjustments to incorporate all significant risks to form a sufficient basis to estimate the credit losses. Loans classified as nonaccrual, are reviewed quarterly for potential individual assessment. Any loan classified as a nonaccrual that is not determined to need individual assessment is evaluated collectively within its respective cohort. Where the primary and/or expected source of repayment of a specific loan is believed to be the future liquidation of available collateral, impairment will generally be measured based upon expected future collateral proceeds, net of disposition expenses including sales commissions as well as other costs potentially necessary to sell the asset(s) (i.e., past due taxes, liens, etc.). Estimates of future collateral proceeds will be based upon available appraisals, reference to recent valuations of comparable properties, use of consultants or other professionals with relevant market and/or property-specific knowledge, and any other sources of information believed appropriate by management under the specific circumstances. When appraisals are ordered to support the impairment analysis of an impaired loan, the appraisal is reviewed by the Company’s internal appraisal reviewer. Where the primary and/or expected source of repayment of a specific loan is believed to be the receipt of principal and interest payments from the borrower and/or the refinancing of the loan by another creditor, impairment will generally be measured based upon the present value of expected proceeds discounted at the contractual interest rate. Expected refinancing proceeds may be estimated from review of term sheets received by the borrower from other creditors and/or from the Company’s knowledge of terms generally available from other banks. Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals and modifications. Prepayment assumptions will be determined by analysis of historical behavior by loan cohort. Allowance for Credit Losses on Unfunded Commitments. The Company estimates expected credit losses over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit unless that obligation is unconditionally cancellable by the Company. The ACL on unfunded commitments is adjusted through a provision for (recovery of) credit losses. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life. The estimate utilizes the same factors and assumptions as the ACL on loans and is applied at the same collective cohort level. 54 Table of Contents Business Combinations and Goodwill. Pursuant to applicable accounting guidance, the Company recognizes assets acquired, including identified intangible assets, and liabilities assumed in acquisitions at their fair values as of the acquisition date.  Transaction costs related to the acquisition are expensed in the period incurred. The determination of fair values involves estimates based on internal or third-party valuations, including appraisals, discounted cash flow analysis, and other techniques incorporating factors such as attrition, inflation, asset growth rates, discount rates, credit risk, and multiples of earnings. The determination of fair value may require us to make point-in-time estimates about discount rates, future expected cash flows, market conditions, and other future events that can be volatile in nature and challenging to assess. While we use the best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, the estimates are inherently uncertain and subject to refinement. In whole bank or bank branch acquisitions, the primary identifiable intangible asset recorded is the value of core deposit intangibles, representing the estimated value of long-term deposit relationships acquired. The determination involves assumptions and estimates, typically determined through discounted cash flow analysis, considering customer attrition/runoff, alternative funding costs, deposit servicing costs, and discount rates. Amortization of core deposit intangibles occurs over estimated useful lives reviewed periodically for reasonableness.  These estimated useful lives, typically ranging from seven to 10 years with an accelerated rate of amortization, are periodically reviewed for reasonableness.  Identifiable intangible assets, including core deposit intangibles, are assessed for impairment when events or changes suggest the carrying value may not be recoverable. The Company's policy dictates recognition of an impairment loss equal to the difference between the asset’s carrying amount and fair value if the expected undiscounted future cash flows are less than the carrying amount. Estimating future cash flows involves multiple estimates and assumptions, as previously mentioned. The ACL on purchase credit deteriorated (“PCD”) assets is recognized within business combination accounting with no initial impact to net income. Subsequent changes in estimates of expected credit losses on PCD loans are recognized through a provision for (reversal of) credit losses in subsequent periods as they arise. The ACL on non-PCD assets is recognized as provision expense in the same reporting period as the business combination. Estimated loan losses for acquired loans are determined using methodologies and applying estimates and assumptions that were described previously in the section above entitled, “Allowance for Credit Losses on Loans.” Non-PCD loans acquired are generally estimated at fair value using a discounted cash flow approach with differences from contractual unpaid principal balances referred to as “discounts.” These discounts are accreted to interest income over the loans' estimated remaining lives. Similar adjustments are made for premiums or discounts on acquired debt impacting interest expense over their remaining lives. Actual accretion or amortization may differ materially from our estimates impacting our operating results. Goodwill arising from business combinations represents the excess of the purchase price over the sum of the estimated fair values of the tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. Accounting for goodwill also involves a higher degree of judgment than most other significant accounting policies. ASC 350–10 establishes standards for an impairment assessment of goodwill. The initial recognition of goodwill and other intangible assets, along with subsequent analyses, necessitates subjective judgments from management.  These judgements involve estimating how acquired assets will perform in the future using valuation methods including discounted cash flow analysis. Additionally, the challenge arises as estimated cash flows may extend beyond 10 years, making them difficult to determine over an extended timeframe. Significant events and factors influencing these estimates include competitive forces, customer behaviors, attrition, changes in revenue growth trends, cost structures, technology, alterations in discount rates, and specific industry and market conditions. To validate assumptions in its estimates, the Company reviews the historical performance of underlying or similar assets, ensuring the reasonableness of cash flow estimates. The Company’s annual assessment of potential goodwill impairment was completed during the fourth quarter of 2023. Based on the results of this assessment, no goodwill impairment was recognized. Because of current economic conditions the Company continues to monitor goodwill and other intangible assets for impairment indicators throughout the year. 55 Table of Contents On an on-going basis, the Company evaluates its estimates. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company’s policies related to these estimates can be found in “Note 1 – Basis of Presentation and Summary of Significant Accounting Policies” of the Notes to the Consolidated Financial Statements included in “Item 8. Financial Statements and Supplementary Data” of this Form 10–K. The Company’s accounting policies are discussed in detail in “Note 1 – Basis of Presentation and Summary” of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and Supplementary Data” of this Form 10–K. Our Business and Operating Strategy and Goals The Company’s primary objective is to operate 1st Security Bank as a well-capitalized, profitable, independent, community-oriented financial institution, serving customers in its primary market area defined generally as the greater Puget Sound market area. The Company’s strategy is to provide innovative products and superior customer service to small businesses, industry and geographic niches, and individuals located in its primary market area. Services are currently provided to communities through the main office, 27 full-service bank branches and seven stand-alone loan production offices, which are supported with 24/7 access to on-line banking and participation in a worldwide ATM network. 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. The Board of Directors seeks to accomplish the Company’s objectives through the adoption of a strategy designed to improve profitability and maintain a strong capital position and high asset quality. This strategy primarily involves: Growing and diversifying the loan portfolio and revenue streams. The Company is a diversified lender that seeks to grow and maintain the current level of diversification in its portfolio. At December 31, 2023, the Company's loan portfolio included real estate loans, consumer loans, and commercial business loans representing 63.0%, 26.5%, and 10.5% of the total loan portfolio, respectively.  Maintaining strong asset quality. The Company believes that strong asset quality is a key to long-term financial success. The percentage of nonperforming loans to total gross loans were 0.45% and 0.39% at December 31, 2023 and 2022, respectively. The percentage of nonperforming assets to total assets were 0.37% and 0.35% at December 31, 2023 and 2022, respectively. Management actively addresses delinquent loans and nonperforming assets by pursuing aggressive collection efforts for consumer debts, marketing saleable foreclosed or repossessed properties, working on classified assets' resolutions and implementing loan charge-offs. In recent years, the Company focused on originating consumer loans for borrowers with higher credit scores, generally, over 720 while maintaining flexibility with its policy.  While the Company plans to emphasize specific lending products, including commercial and multi-family real estate loans, construction and development loans (including speculative residential construction loans), and commercial business loans, it remains committed to expanding the size of its one-to-four-family residential mortgage loans and consumer loan portfolios.  Throughout these initiatives, the Company maintains a conservative approach to lending and manages credit exposures by leveraging the expertise of experienced bankers. Emphasizing lower cost core deposits to reduce the costs of funding loan growth. The Company provides a range of financial products, including personal and business checking accounts, NOW accounts, and savings and money market accounts.  These accounts serve as lower-cost funding sources compared to certificates of deposit and are less sensitive to interest rate fluctuations. The Company employs several strategies to build a core deposit base. First, it actively encourages commercial loan customers to establish and maintain deposit relationships typically through business checking accounts. Second, periodic interest rate promotions are offered on savings and checking accounts to stimulate deposit growth. Third, the Company hires experienced personnel with established community relationships in the areas it serves to further enhance its deposit-building efforts. Capturing customers’ full relationship. The Company offers a wide range of products and services that provide diversification of revenue sources and solidify the relationship with the Bank’s customers. The Company focuses on core retail and business deposits, including savings and checking accounts, that lead to long-term customer retention. As part of the commercial lending process, cross-selling the entire business banking relationship, including deposit relationships and business banking products, such as online cash management, treasury management, wires, direct deposit, payment processing and remote deposit capture. The Company’s mortgage banking program also provides opportunities to cross-sell products to new customers. Expanding the Company’s markets. In addition to deepening relationships with existing customers, the Company intends to broaden its customer base by leveraging the Company’s well-established community involvement.  This strategy involves selectively emphasizing products and services tailored to meet the specific banking needs of new customers.  Additionally, the Company plans to extend its presence into other market areas through targeted expansion of its home lending network. 56 Table of Contents Comparison of Financial Condition at December 31, 2023 and December 31, 2022 Assets. Total assets increased $339.8 million, to $2.97 billion at December 31, 2023, from $2.63 billion at December 31, 2022. The increase was primarily due to increases in loans receivable, net of $210.6 million, securities available-for-sale of $63.7 million, total cash and cash equivalents of $24.3 million, certificates of deposit at other financial institutions of $19.5 million, and core deposit intangible of $14.0 million.  The Company also transferred $8.1 million of residential MSRs to held for sale during the fourth quarter of 2023. The increase in total assets was primarily funded by deposit growth during the year ended December 31, 2023. Loans receivable, net, increased $210.6 million, to $2.40 billion at December 31, 2023, from $2.19 billion at December 31, 2022. Total real estate loans increased $109.1 million, with increases in one-to-four-family portfolio loans of $98.3 million, commercial real estate loans of $32.3 million, home equity loans of $14.1 million, and multi-family loans of $4.0 million, offset by a decrease in construction and development loans of $39.5 million. Undisbursed construction and development loan commitments decreased $47.1 million, or 23.3%, to $154.6 million at December 31, 2023, as compared to $201.7 million at December 31, 2022. Consumer loans increased $77.2 million, primarily due to increases of $74.0 million in indirect home improvement loans and $2.7 million in marine loans. Additionally, commercial business loans increased $27.9 million due to an increase in commercial and industrial loans of $41.5 million, partially offset by a decrease in warehouse lending of $13.6 million due to higher residential mortgage interest rates and reduced refinance activity.  Loans held for sale, consisting of one-to-four-family loans, increased by $5.6 million, or 27.7%, to $25.7 million at December 31, 2023, compared to $20.1 million at December 31, 2022.  The Company continues to invest in its home lending operations and strategically adds production staff in the markets we serve. One-to-four-family loan originations for the year ended December 31, 2023, included $377.1 million of loans originated for sale, $150.5 million of portfolio loans including first and second liens, and $15.9 million of loans brokered to other institutions. Originations of one-to-four-family loans to purchase and to refinance a home for the periods indicated were as follows: [[GREPCENT_TABLE]] [["(Dollars in thousands)","","For the Year Ended December 31,"],["","","2023","","","2022"],["","","Amount","","","Percent","","","Amount","","","Percent","","","$ Change","","","% Change"],["Purchase","","$","497,669","","","","91.6","%","","$","664,361","","","","80.2","%","","$","(166,692",")","","","(25.1",")%"],["Refinance","","","45,925","","","","8.4","","","","164,380","","","","19.8","","","","(118,455",")","","","(72.1",")"],["Total","","$","543,594","","","","100.0","%","","$","828,741","","","","100.0","%","","$","(285,147",")","","","(34.4",")%"]] [[/GREPCENT_TABLE]] During the year ended December 31, 2023, the Company sold $408.0 million of one-to-four-family loans, compared to $715.6 million one year ago. The decrease in loan purchase and refinance activity, as well as sales activity, compared to the prior year reflects the impact of higher interest rates. The cash margin on loans sold, net of deferred fees and capitalized expenses, increased to 1.59% for the year ended December 31, 2023, compared to 1.39% for the year ended December 31, 2022. 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 gross cash margins on loans sold, were 3.07% and 2.78% for the years ended December 31, 2023 and 2022, respectively. Gross cash margins on loans sold is defined as the margin on loans sold without the impact of deferred loan costs. The ACL on loans was $31.5 million, or 1.30% of gross loans receivable, excluding loans held for sale at December 31, 2023, compared to $28.0 million, or 1.26% of gross loans receivable, excluding loans held for sale, at December 31, 2022. The increase was primarily due to organic loan growth, increases in nonperforming loans, and the addition of loans acquired in the Branch Acquisition. The ACL - unfunded loan commitments decreased $1.0 million to $1.5 million at December 31, 2023, from $2.5 million at December 31, 2022, primarily due to a decrease in unfunded construction loan commitments. At December 31, 2023, loans classified as substandard or worse increased to $24.9 million, consisting of $24.5 million classified as substandard and $399,000 as doubtful, compared to $20.2 million at December 31, 2022, all of which loans were classified as substandard. This increase in substandard loans was primarily due to increases of $4.7 million in construction and development loans and $787,000 in indirect home improvement loans, partially offset by a decrease of $1.5 million in commercial and industrial loans. 57 Table of Contents Nonperforming loans, consisting solely of nonaccrual loans, increased $2.3 million to $11.0 million at December 31, 2023, from $8.7 million at December 31, 2022.  This increase was primarily due to a $4.7 million increase in nonaccrual construction and development loans, a $1.1 million increase in nonaccrual commercial real estate loans, and a $787,000 increase in nonaccrual indirect home improvement loans, partially offset by a $3.7 million decrease in nonaccrual commercial business loans and an $842,000 decrease in nonaccrual one-to-four family loans. These increases and decreases were largely due to the payment performance on a few loans. At December 31, 2023, nonperforming loans consisted of $4.7 million in construction and development loans, $2.7 million in commercial business loans, $1.9 million in indirect home improvement loans, $1.1 million in commercial real estate loans, $342,000 in marine loans, $173,000 of home equity loans, $96,000 in one-to-four-family loans, and $8,000 in other consumer loans. The ratio of nonperforming loans to total gross loans was 0.45% at December 31, 2023, compared to 0.39% at December 31, 2022. There were no OREO properties at December 31, 2023, and one OREO property totaling $570,000 at December 31, 2022.  See “Item 1. Business – Lending Activities – Asset Quality” of this Form 10–K for additional information regarding the Company’s nonperforming loans. Liabilities. Total liabilities increased $307.0 million to $2.71 billion at December 31, 2022, from $2.40 billion at December 31, 2022, primarily due to $394.6 million in deposits, partially offset by a $92.8 million decrease in borrowings. Total deposits increased $394.6 million to $2.52 billion at December 31, 2023, from $2.13 billion at December 31, 2022, primarily as a result of the Branch Acquisition in which we acquired approximately $425.5 million in deposits. CDs increased $367.0 million to $1.10 billion at December 31, 2023, from $729.8 million at December 31, 2022. Transactional accounts (noninterest-bearing checking, interest-bearing checking, and escrow accounts) increased $225.6 million to $914.9 million at December 31, 2023, from $689.3 million at December 31, 2022, due to increases of $116.1 million in noninterest-bearing checking, $108.9 million in interest-bearing checking and $547,000 in escrow accounts (also noninterest bearing) related to mortgages serviced. Money market and savings accounts decreased $198.0 million, to $510.7 million at December 31, 2023, from $708.6 million at December 31, 2022 as depositors shifted to higher yielding CDs and other investment alternatives. Deposits are summarized as follows at the years indicated: [[GREPCENT_TABLE]] [["(Dollars in thousands)","","December 31,"],["","","2023","","","2022"],["Noninterest-bearing checking","","$","654,048","","","$","537,938"],["Interest-bearing checking (1)","","","244,028","","","","135,127"],["Savings","","","151,630","","","","134,358"],["Money market (2)","","","359,063","","","","574,290"],["Certificates of deposit less than $100,000 (3)","","","587,858","","","","440,785"],["Certificates of deposit of $100,000 through $250,000","","","429,373","","","","195,447"],["Certificates of deposit of $250,000 and over (4)","","","79,540","","","","93,560"],["Escrow accounts related to mortgages serviced","","","16,783","","","","16,236"],["Total","","$","2,522,323","","","$","2,127,741"]] [[/GREPCENT_TABLE]] _______________________________ [[GREPCENT_TABLE]] [["(1)","Includes $70.2 million and $2.3 million of brokered deposits at December 31, 2023 and December 31, 2022, respectively."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(2)","Includes $1,000 and $59.7 million of brokered deposits at December 31, 2023 and December 31, 2022, respectively."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(3)","Includes $361.3 million and $332.0 million of brokered CDs at December 31, 2023 and December 31, 2022, respectively."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(4)","CDs that meet or exceed the FDIC insurance limit."]] [[/GREPCENT_TABLE]] The Bank had uninsured deposits of approximately $606.5 million or 24.0% of total deposits, at December 31, 2023, compared to approximately $560.0 million or 26.3% of total deposits at December 31, 2022. The uninsured amounts are estimates based on the methodologies and assumptions used for the Bank’s regulatory reporting requirements. At December 31, 2023, borrowings totaled $93.7 million and were comprised of the FRB borrowings from the BTFP of $89.9 million and FHLB fixed-rate advances of $3.9 million.  Borrowings decreased $92.8 million to $93.7 million at December 31, 2023, from $186.5 million of FHLB advances at December 31, 2022.  The decrease was partially attributable to a shift in funding mix from overnight borrowings to wholesale brokered CDs, as well as liquidity from the Branch Acquisition utilized to pay down borrowings and brokered deposits. Stockholders’ Equity. Total stockholders’ equity increased $32.8 million to $264.5 million at December 31, 2023, from $231.7 million at December 31, 2022. The increase in stockholders’ equity was primarily due to net income of $36.1 million earned during 2023, partially offset by cash dividends paid during the year of $7.8 million. In addition, stockholders' equity was positively impacted by unrealized gains on fair value and cash flow hedges of $3.0 million, net of tax, and unrealized net gains in securities available-for-sale of $5.3 million, net of tax, reflecting changes in market interest rates during the period, resulting in a $2.3 million increase in accumulated other income.  Book value per common share was $34.36 at December 31, 2023, compared to $30.42 at December 31, 2022.  The calculation of book value per share at December 31, 2023, was based on 7,698,401 common shares, derived by subtracting the 102,144 unvested restricted stock shares from the 7,800,545 reported common shares outstanding as of that date. Similarly, the book value per share at December 31, 2022, was calculated based on 7,617,655 common shares, obtained by subtracting the 118,530 unvested restricted stock shares from the 7,736,185 reported common shares outstanding as of that date. 58 Table of Contents Average Balances, Interest and Average Yields/Cost The following table sets forth for the periods indicated, information regarding average balances of assets and liabilities, as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spread, net interest margin (otherwise known as net yield on interest-earning assets), and the ratio of average interest-earning assets to average interest-bearing liabilities. Also presented is the weighted average yield on interest-earning assets, rates paid on interest-bearing liabilities and the resultant spread at December 31, 2023. Income and all average balances are monthly average balances. Nonaccrual loans have been included in the table as loans carrying a zero yield. The yields on tax-exempt municipal bonds have not been computed on a tax equivalent basis. [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["","","2023","","","2022","","","2021"],["","","Average","","","","Interest","","","","","","","Average","","","Interest","","","","","","","Average","","","Interest"],["","","Balance","","","","Earned","","","Yield/","","","Balance","","","Earned","","","Yield/","","","Balance","","","Earned","","","Yield/"],["(Dollars in thousands)","","Outstanding","","","","Paid","","","Rate","","","Outstanding","","","Paid","","","Rate","","","Outstanding","","","Paid","","","Rate"],["Interest-earning assets:"],["Loans receivable, net and loans held for sale (1) (2)","","$","2,384,577","","","","$","154,945","","","","6.50","%","","$","2,014,017","","","$","111,648","","","","5.54","%","","$","1,762,832","","","$","90,737","","","","5.15","%"],["Taxable mortgage-backed securities","","","93,661","","","","","1,596","","","","1.70","","","","86,626","","","","1,842","","","","2.13","","","","75,493","","","","1,690","","","","2.24"],["Taxable AFS investment securities","","","65,704","","","","","4,578","","","","6.97","","","","60,729","","","","1,431","","","","2.36","","","","56,063","","","","1,152","","","","2.05"],["Tax-exempt AFS investment securities","","","128,787","","","","","2,503","","","","1.94","","","","130,744","","","","2,488","","","","1.90","","","","97,471","","","","1,733","","","","1.78"],["Taxable HTM Investment securities","","","8,500","","","","","430","","","","5.06","","","","8,084","","","","409","","","","5.06","","","","7,500","","","","380","","","","5.07"],["FHLB stock","","","4,740","","","","","245","","","","5.17","","","","7,231","","","","401","","","","5.55","","","","5,494","","","","256","","","","4.66"],["Interest-bearing deposits at other financial institutions","","","67,063","","","","","2,895","","","","4.32","","","","32,689","","","","475","","","","1.45","","","","93,435","","","","426","","","","0.46"],["Total interest-earning assets","","","2,753,032","","","","","167,192","","","","6.07","","","","2,340,120","","","","118,694","","","","5.07","","","","2,098,288","","","","96,374","","","","4.59"],["Interest-bearing liabilities:"],["Savings and money market","","","612,430","","","","","5,511","","","","0.90","","","","781,763","","","","3,775","","","","0.48","","","","661,199","","","","1,604","","","","0.24"],["Interest-bearing checking","","","189,107","","","","","2,586","","","","1.37","","","","176,204","","","","495","","","","0.28","","","","203,230","","","","282","","","","0.14"],["Certificates of deposit","","","930,805","","","","","28,654","","","","3.08","","","","459,594","","","","5,150","","","","1.12","","","","464,921","","","","5,043","","","","1.08"],["Borrowings","","","110,328","","","","","5,196","","","","4.71","","","","102,571","","","","3,052","","","","2.98","","","","63,128","","","","1,074","","","","1.70"],["Subordinated note","","","49,492","","","","","1,942","","","","3.92","","","","49,425","","","","1,942","","","","3.93","","","","44,160","","","","1,722","","","","3.90"],["Total interest-bearing liabilities","","","1,892,162","","","","","43,889","","","","2.32","%","","","1,569,557","","","","14,414","","","","0.92","%","","","1,436,638","","","","9,725","","","","0.68","%"],["Net interest income","","","","","","","$","123,303","","","","","","","","","","","$","104,280","","","","","","","","","","","$","86,649"],["Net interest rate spread","","","","","","","","","","","","3.75","%","","","","","","","","","","","4.15","%","","","","","","","","","","","3.91","%"],["Net earning assets","","$","860,870","","","","","","","","","","","","$","770,563","","","","","","","","","","","$","661,650"],["Net interest margin","","","","","","","","","","","","4.48","%","","","","","","","","","","","4.46","%","","","","","","","","","","","4.13","%"],["Average interest-earning assets to average interest-bearing liabilities","","","145.50","%","","","","","","","","","","","","149.09","%","","","","","","","","","","","146.06","%"]] [[/GREPCENT_TABLE]] ____________________________ [[GREPCENT_TABLE]] [["(1)","The average loans receivable, net balances include nonaccrual loans, which carry a zero yield."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(2)","Includes net deferred fee recognition of $6.0 million, $8.3 million and $9.4 million for the years ended December 31, 2023, 2022, 2021, respectively."]] [[/GREPCENT_TABLE]] 59 Table of Contents Rate/Volume Analysis The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities for the periods indicated. It distinguishes between the changes related to outstanding balances and that due to the changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate. [[GREPCENT_TABLE]] [["","","Year Ended December 31, 2023 vs. 2022","","","Year Ended December 31, 2022 vs. 2021"],["","","Increase (Decrease) Due to","","","Total Increase","","","Increase (Decrease) Due to","","","Total Increase"],["(Dollars in thousands)","","Volume","","","Rate","","","(Decrease)","","","Volume","","","Rate","","","(Decrease)"],["Interest-earning assets:"],["Loans receivable, net and loans held for sale(1)","","$","20,542","","","$","22,755","","","$","43,297","","","$","12,929","","","$","7,982","","","$","20,911"],["Taxable mortgage-backed securities","","","150","","","","(396",")","","","(246",")","","","249","","","","(97",")","","","152"],["Taxable AFS Investment securities","","","117","","","","3,030","","","","3,147","","","","96","","","","183","","","","279"],["Tax-exempt AFS investment securities","","","(38",")","","","53","","","","15","","","","592","","","","163","","","","755"],["Taxable HTM Investment securities","","","21","","","","\u2014","","","","21","","","","30","","","","(1",")","","","29"],["FHLB stock","","","(138",")","","","(18",")","","","(156",")","","","81","","","","64","","","","145"],["Interest-bearing deposits at other financial institutions","","","500","","","","1,920","","","","2,420","","","","(277",")","","","326","","","","49"],["Total interest-earning assets","","$","21,154","","","$","27,344","","","$","48,498","","","$","13,700","","","$","8,620","","","$","22,320"],["Interest-bearing liabilities:"],["Savings and money market","","$","(818",")","","$","2,554","","","$","1,736","","","$","292","","","$","1,879","","","$","2,171"],["Interest-bearing checking","","","36","","","","2,055","","","","2,091","","","","(38",")","","","251","","","","213"],["Certificates of deposit","","","5,280","","","","18,224","","","","23,504","","","","(58",")","","","165","","","","107"],["Borrowings","","","231","","","","1,913","","","","2,144","","","","671","","","","1,307","","","","1,978"],["Subordinated note","","","2","","","","(2",")","","","\u2014","","","","205","","","","15","","","","220"],["Total interest-bearing liabilities","","$","4,731","","","$","24,744","","","$","29,475","","","$","1,072","","","$","3,617","","","$","4,689"],["Net change in net interest income","","","","","","","","","","$","19,023","","","","","","","","","","","$","17,631"]] [[/GREPCENT_TABLE]] __________________________ [[GREPCENT_TABLE]] [["(1)","The average loans receivable, net balances include nonaccrual loans."]] [[/GREPCENT_TABLE]] Comparison of Results of Operations for the Years Ended December 31, 2023 and 2022 General. Net income was $36.1 million for the year ended December 31, 2023, and $29.6 million for the year ended December 31, 2022. The $6.4 million, or 21.6%, increase in net income was primarily due to a $19.0 million, or 18.2% increase in net interest income, a $2.4 million, or 13.2%, increase in noninterest income, and a $1.4 million, or 23.2%, decrease in the provision for credit losses, partially offset by a $14.6 million, or 18.4%, increase in noninterest expense and a $1.9 million, or 25.6%, increase in the provision for income taxes. Net Interest Income. Net interest income increased $19.0 million to $123.3 million for the year ended December 31, 2023, from $104.3 million for the year ended December 31, 2022. This increase was primarily attributed to an increase in interest income earned on loans, resulting from both an increase in the average balance of loans and an improved yield on loans.  Additionally, there were minor contributions to the increase in interest income from taxable available-for-sale (“AFS”) investment securities and interest-bearing deposits at other financial institutions.  These increases were partially offset by a $29.5 million increase in interest expense during the same period, primarily as a result of higher interest rates, higher utilization of borrowings and a shift in deposit mix from transactional accounts to higher cost CDs. 60 Table of Contents The net interest margin (“NIM”) increased two basis points to 4.48% for the year ended December 31, 2023, from 4.46% for the prior year. The increase in NIM reflects new loan originations at higher market interest rates, variable rate interest-earning assets repricing higher following increases in market interest rates. The benefit of the higher rates and increase in interest-earning assets was partially offset by rising deposit and borrowing costs. Increases in average balances of higher costing CDs and borrowings placed additional pressure on the NIM.  Interest Income. Interest income for the year ended December 31, 2023, increased $48.5 million, to $167.2 million, from $118.7 million for the year ended December 31, 2022. The increase during the year was primarily attributable to a $412.9 million increase in the average balance of total interest-earning assets, primarily loans, and a 100-basis point increase in the average yield on total interest-earning assets. Interest income on loans receivable, including fees, increased $43.3 million, 38.8%, for the year ended December 31, 2023, compared to the prior year due to an increase in the average balance of loans outstanding during the period and to new loans being originated at higher rates, and variable-rate loans repricing higher following increases in market interest rates.  In addition, interest income on taxable AFS investment securities and interest-bearing deposits at other financial institutions increased $3.1 million and $2.4 million, respectively, during the year ended December 31, 2023, compared to the prior year, primarily due to increases in market interest rates. The following table compares average earning asset balances, associated yields, and resulting changes in interest income for the years ended December 31, 2023 and 2022: [[GREPCENT_TABLE]] [["(Dollars in thousands)","","Year Ended December 31,"],["","","2023","","","2022"],["","","Average","","","","","","","Average","","","","","","","$ Change"],["","","Balance","","","Yield/","","","Balance","","","Yield/","","","in Interest"],["","","Outstanding","","","Rate","","","Outstanding","","","Rate","","","Income"],["Loans receivable, net and loans held for sale (1)","","$","2,384,577","","","","6.50","%","","$","2,014,017","","","","5.54","%","","$","43,297"],["Taxable mortgage-backed securities","","","93,661","","","","1.70","","","","86,626","","","","2.13","","","","(246",")"],["Taxable AFS investment securities","","","65,704","","","","6.97","","","","60,729","","","","2.36","","","","3,147"],["Tax-exempt AFS investment securities","","","128,787","","","","1.94","","","","130,744","","","","1.90","","","","15"],["Taxable HTM investment securities","","","8,500","","","","5.06","","","","8,084","","","","5.06","","","","21"],["FHLB stock","","","4,740","","","","5.17","","","","7,231","","","","5.55","","","","(156",")"],["Interest-bearing deposits at other financial institutions","","","67,063","","","","4.32","","","","32,689","","","","1.45","","","","2,420"],["Total interest-earning assets","","$","2,753,032","","","","6.07","%","","$","2,340,120","","","","5.07","%","","$","48,498"]] [[/GREPCENT_TABLE]] ___________________________ [[GREPCENT_TABLE]] [["(1)","The average loans receivable, net balances include nonaccrual loans."]] [[/GREPCENT_TABLE]] Interest Expense. Interest expense increased $29.5 million, to $43.9 million for the year ended December 31, 2023, from $14.4 million for the prior year, primarily due to an increase in interest expense on deposits of $27.3 million, primarily higher costing CDs, and on borrowings of $2.1 million. The average cost of funds for total interest-bearing liabilities increased 140 basis points to 2.32% for the year ended December 31, 2023, from 0.92% for the year ended December 31, 2022. The increase in interest expense was predominantly due to the increase in market rate for deposits and borrowings, and a shift in deposits to higher costing CDs. The average cost of total interest-bearing deposits increased 146 basis points to 2.12% for the year ended December 31, 2023, compared to 0.66% for the year ended December 31, 2022. The average cost of funds, including noninterest-bearing checking, increased 105 basis points to 1.72% for the year ended December 31, 2023, from 0.67% for the year ended December 31, 2022.  The average balance of noninterest-bearing deposits, which include noninterest-bearing checking and escrow accounts, totaled $672.2 million and $580.0 million for the years ended December 31, 2023 and 2022, respectively. 61 Table of Contents The following table details average balances of interest-bearing liabilities, associated rates and resulting change in interest expense for the years ended December 31, 2023 and 2022: [[GREPCENT_TABLE]] [["(Dollars in thousands)","","Year Ended December 31,"],["","","2023","","","2022"],["","","Average","","","","","","","Average","","","","","","","$ Change"],["","","Balance","","","Yield/","","","Balance","","","Yield/","","","in Interest"],["","","Outstanding","","","Rate","","","Outstanding","","","Rate","","","Expense"],["Savings and money market","","$","612,430","","","","0.90","%","","$","781,763","","","","0.48","%","","$","1,736"],["Interest-bearing checking","","","189,107","","","","1.37","","","","176,204","","","","0.28","","","","2,091"],["Certificates of deposit","","","930,805","","","","3.08","","","","459,594","","","","1.12","","","","23,504"],["Borrowings","","","110,328","","","","4.71","","","","102,571","","","","2.98","","","","2,144"],["Subordinated note","","","49,492","","","","3.92","","","","49,425","","","","3.93","","","","\u2014"],["Total interest-bearing liabilities","","$","1,892,162","","","","2.32","%","","$","1,569,557","","","","0.92","%","","$","29,475"]] [[/GREPCENT_TABLE]] Provision for Credit Losses. For the year ended December 31, 2023, the provision for credit losses was $4.8 million consisting of a $5.8 million provision for credit losses on loans partially offset by a $1.0 million reversal of the ACL on unfunded loan commitments, compared to a $6.2 million provision for credit losses, consisting of a $6.6 million provision for credit losses on loans partially offset by a $365,000 reversal of the ACL on unfunded loan commitments for the year ended December 31, 2022. The provision for credit losses on loans reflects the increase in total loans receivable, increased net charge-offs, and increased reserves on individually evaluated nonaccrual loans.  The reversals of the allowance for credit losses on unfunded loan commitments for the years indicated above were a result of decreases in total unfunded commitments during those periods. During the year ended December 31, 2023, net charge-offs totaled $2.2 million, compared to $1.4 million during the year ended December 31, 2022. The increase was primarily due to increases in net charge-offs of $1.3 million in indirect home improvement loans, partially offset by a decrease in net charge-offs of $395,000 in deposit accounts and overdrafts.  A further decline in national and local economic conditions, as a result of the effects of inflation, a potential recession or slowed economic growth, among other factors, could result in a material increase in the ACL on loans and may adversely affect the Company’s financial condition and result of operations. The following table details activity and information related to the ACL on loans for the years ended December 31, 2023 and 2022: [[GREPCENT_TABLE]] [["","","At or For the Year Ended December 31,"],["(Dollars in thousands)","","2023","","","2022"],["Provision for credit losses on loans","","$","5,770","","","$","6,623"],["Net charge-offs","","$","2,228","","","$","1,407"],["ACL on loans","","$","31,534","","","$","27,992"],["ACL on loans as a percentage of total gross loans receivable at year end","","","1.30","%","","","1.26","%"],["Nonperforming loans","","$","10,952","","","$","8,652"],["ACL on loans as a percentage of nonperforming loans at year end","","","288.11","%","","","303.50","%"],["Nonperforming loans as a percentage of gross loans receivable at year end","","","0.45","%","","","0.39"],["Total gross loans","","$","2,433,015","","","$","2,218,852"]] [[/GREPCENT_TABLE]] Management considers the ACL on loans at December 31, 2023, to be adequate to cover forecasted losses in the loan portfolio based on the assessment of the above-mentioned factors affecting the loan portfolio. While management believes that the estimates and assumptions used in its determination of the adequacy of the ACL on loans are reasonable, it is important to acknowledge the inherent uncertainties.  There is no assurance that these estimates and assumptions will not be proven incorrect in the future.  Additionally, there is the possibility that the actual amount of future provisions may exceed past provisions, and any potential increased provisions could adversely impact the Company's financial condition and results of operations. Furthermore, the determination of the amount of the Company's ACL on loans is subject to review by bank regulators as part of the routine examination process.  The regulators may adjust the ACL based on their judgment and the information available to them at the time of their examination.  This regulatory scrutiny adds an additional layer of evaluation and potential adjustment to the Company's credit loss provisions. 62 Table of Contents Noninterest Income. Noninterest income increased $2.4 million to $20.5 million for the year ended December 31, 2023, from $18.1 million for the year ended December 31, 2022. The following table provides a detailed analysis of the changes in the components of noninterest income: [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","Increase/(Decrease)"],["(Dollars in thousands)","","2023","","","2022","","","Amount","","","Percent"],["Service charges and fee income","","$","11,138","","","$","8,525","","","$","2,613","","","","30.7","%"],["Gain on sale of loans","","","6,711","","","","7,917","","","","(1,206",")","","","(15.2",")"],["Earnings on cash surrender value of BOLI","","","920","","","","876","","","","44","","","","5.0"],["Other noninterest income","","","1,721","","","","790","","","","931","","","","117.8"],["Total noninterest income","","$","20,490","","","$","18,108","","","$","2,382","","","","13.2","%"]] [[/GREPCENT_TABLE]] The year over year increase include a $2.6 million increase in service charges and fee income as a result of less amortization of MSRs reflecting increased market interest rates and increased servicing fees from non-portfolio serviced loans and a $931,000 increase in other noninterest income, partially offset by a $1.2 million, or 15.2%, decrease in gain on sale of loans, primarily due to a reduction in origination and sales volume of loans held for sale and a reduction in gross margins of sold loans. Gross margins on home loan sales increased to 3.07% for the year ended December 31, 2023, from 2.78% for the year ended December 31, 2022. Noninterest Expense. Noninterest expense increased $14.6 million to $93.7 million for the year ended December 31, 2023, from $79.2 million for the year ended December 31, 2022. The following table provides an analysis of the changes in the components of noninterest expense: [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","Increase/(Decrease)"],["(Dollars in thousands)","","2023","","","2022","","","Amount","","","Percent"],["Salaries and benefits","","$","53,622","","","$","47,632","","","$","5,990","","","","12.6"],["Operations","","","13,070","","","","10,743","","","","2,327","","","","21.7"],["Occupancy","","","6,378","","","","5,165","","","","1,213","","","","23.5"],["Data processing","","","6,852","","","","6,062","","","","790","","","","13.0"],["Gain on sale of OREO","","","(148",")","","","\u2014","","","","(148",")","","","NM"],["Loan costs","","","2,574","","","","2,718","","","","(144",")","","","(5.3",")"],["Professional and board fees","","","2,584","","","","3,154","","","","(570",")","","","(18.1",")"],["FDIC insurance","","","2,392","","","","1,224","","","","1,168","","","","95.4"],["Marketing and advertising","","","1,349","","","","897","","","","452","","","","50.4"],["Acquisition costs","","","1,562","","","","898","","","","664","","","","73.9"],["Amortization of core deposit intangible","","","3,464","","","","691","","","","2,773","","","","401.3"],["Impairment (recovery) of MSRs","","","48","","","","(1",")","","","49","","","","(4,900.0",")"],["Total noninterest expense","","$","93,747","","","$","79,183","","","$","14,564","","","","18.4"]] [[/GREPCENT_TABLE]] The increase in noninterest expense was primarily a result of a $6.0 million increase in salaries and benefits largely due to an increase in the number of FTEs as a result of the Branch Acquisition.  Other increases included a $2.8 million in amortization of core deposit intangible, $2.3 million in operations, $1.2 million in occupancy, $1.2 million in FDIC insurance, $790,000 in data processing, and $664,000 in acquisition costs, partially offset by a decrease of $570,000 in professional and board fees. The efficiency ratio, which is noninterest expense as a percentage of net interest income and noninterest income, improved slightly to 62.47% for the year ended December 31, 2023, compared to 64.70% for the year ended December 31, 2022, primarily due to the growth in revenues outpacing the increase in noninterest expenses. Provision for Income Taxes. For the year ended December 31, 2023, the Company recorded a provision for income taxes of $9.2 million on pre-tax income of $45.3 million, as compared to a provision of income taxes of $7.3 million on pre-tax income of $37.0 million for the year ended December 31, 2022. There was a net deferred tax asset of $6.7 million at both December 31, 2023 and 2022. The effective corporate income tax rates for the years ended December 31, 2023 and 2022 were 20.4% and 19.8%, respectively. The increase in effective tax rate was partially attributable to an increase in disallowed interest expense on tax exempt assets due to an increase in the cost of funds. Disallowed interest expense was $1.9 million and $587,000 for the years ended December 31, 2023 and 2022, respectively. For additional information regarding income taxes, see “Note 12 – Income Taxes” of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and Supplementary Data” of this Form 10–K. 63 Table of Contents Comparison of Results of Operations for the Years Ended December 31, 2022 and 2021 See Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10–K for the year ended December 31, 2022 filed with the SEC. Asset and Liability Management and Market Risk Risk When Interest Rates Change. The rates of interest the Company earns on assets and pays on liabilities generally is established contractually for a period of time. Market rates change over time. Like other financial institutions, the Company’s results of operations are impacted by changes in interest rates and the interest rate sensitivity of the Company’s assets and liabilities. The risk associated with changes in interest rates and the Company’s ability to adapt to these changes is known as interest rate risk and is the most significant market risk. The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. Consequently, the fair value of 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 prepay 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. How The Company Measures Risk of Interest Rate Changes. As part of an attempt to manage exposure to changes in interest rates and comply with applicable regulations, the Company monitors interest rate risk. In doing so, the Company analyzes and manages assets and liabilities based on their interest rates and payment streams, timing of maturities, repricing opportunities, and sensitivity to actual or potential changes in market interest rates. The Company is subject to interest rate risk to the extent that its interest-bearing liabilities, primarily deposits, subordinated notes, and FHLB advances, reprice more rapidly or at different rates than the interest-earning assets. In order to minimize the potential for adverse effects of material prolonged increases or decreases in interest rates on the Company’s results of operations, the Company has adopted an Asset and Liability Management Policy. The Board of Directors sets the Asset and Liability Management Policy for the Bank, which is implemented by the Asset/Liability Committee (“ALCO”), an internal management committee. The board-level oversight of the ALCO is performed by the Audit Committee of the Board of Directors. The purpose of the ALCO is to communicate, coordinate, and control asset/liability management consistent with the business plan and board-approved policies. The committee establishes and monitors the volume and mix of assets and funding sources, taking into account relative costs and spreads, interest rate sensitivity and liquidity needs. The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, growth, risk, and profitability goals. The ALCO generally meets monthly to, among other things, protect capital through earnings stability over the interest rate cycle; maintain the Bank’s well capitalized status; and provide a reasonable return on investment. The committee recommends appropriate strategy changes based on this review. Additionally, the ALCO is responsible for reviewing and reporting the effects of the policy implementations and strategies to the Board of Directors at least quarterly. The Chief Financial Officer oversees this process on a daily basis. A key element of the Bank’s asset/liability management plan is to protect net earnings by managing the maturity or repricing mismatch between interest-earning assets and rate-sensitive liabilities. The Company seeks to accomplish this by extending funding maturities through wholesale funding sources, including the use of FHLB advances and brokered certificates of deposit, and through asset management, including the use of adjustable-rate loans and selling certain fixed-rate loans in the secondary market. Management is also focused on matching deposit duration with the duration of earning assets as appropriate. As part of the efforts to monitor and manage interest rate risk, a number of indicators are used to monitor overall risk. Among the measurements are: Market Risk. Market risk is the potential change in the value of investment securities if interest rates change. This change in value impacts the value of the Company and the liquidity of the securities. Market risk is controlled by setting a maximum average maturity/average life of the securities portfolio to 10 years. 64 Table of Contents Economic Risk. Economic risk is the risk that the underlying value of a bank will change when rates change. This can be caused by a change in value of the existing assets and liabilities (this is called Economic Value of Equity or EVE), or a change in the earnings stream (this is caused by interest rate risk). The Company takes economic risk primarily when fixed rate loans are made, or purchase fixed-rate investments, or issue long term certificates of deposit or take fixed-rate FHLB advances. It is the risk that interest rates will change and these fixed-rate assets and liabilities will change in value. This change in value usually is not recognized in the earnings, or equity (other than marking to market securities available-for-sale or fair value adjustments on loans held for sale). The change is recognized only when the assets and liabilities are liquidated. Although the change in market value is usually not recognized in earnings or in capital, the impact is real to the long-term value of the Company. Therefore, the Company will control the level of economic risk by limiting the amount of long-term, fixed-rate assets it will have and by setting a limit on concentrations and maturities of securities. Interest Rate Risk. The table presented below, as of December 31, 2023, is an analysis prepared for the Company by a third-party consultant.  The analysis employs various market and actual experience-based assumptions and depicts a static shock. to net interest income through instantaneous and sustained shifts in the yield curve, with adjustments in 100 basis point increments, both up and down by 300 basis points. The results present a projected income statement with minimal exposure to immediate changes in interest rates. These outcomes rely on historical prepayment speeds within the consumer lending portfolio, coupled with the above average yields associated with the consumer portfolio if prepayments do not occur. The table illustrates the estimated change in net interest income over the next 12 months, starting from December 31, 2023. [[GREPCENT_TABLE]] [["Change in Interest","","Net Interest Income"],["Rates in Basis Points","","Amount","","","Change","","","Change"],["","","(Dollars in thousands)"],["+300bp","","$","116,799","","","$","(4,006",")","","","(3.32",")%"],["+200bp","","","118,376","","","","(2,429",")","","","(2.01",")"],["+100bp","","","119,629","","","","(1,176",")","","","(0.97",")"],["0bp","","","120,805","","","","\u2014","","","","\u2014"],["-100bp","","","120,489","","","","(316",")","","","(0.26",")"],["-200bp","","","119,999","","","","(806",")","","","(0.67",")"],["-300bp","","","118,928","","","","(1,877",")","","","(1.55",")"]] [[/GREPCENT_TABLE]] In managing the assets/liability mix the Company typically places an equal emphasis on maximizing net interest margin and matching the interest rate sensitivity of the assets and liabilities. From time to time, however, depending on the relationship between long- and short-term interest rates, market conditions and consumer preference, the Company may place somewhat greater emphasis on maximizing net interest margin than on strict dollar for dollar categories matching the interest rate sensitivity of the assets and liabilities. Management also believes that the increased net income which may result from a prepayment assumption mismatch in the actual maturity or repricing of the asset and liability portfolios can, during periods of changing interest rates, provide sufficient returns to justify the increased exposure to sudden and unexpected increases in interest rates which may result from such a mismatch. Management believes that 1st Security Bank’s level of interest rate risk is acceptable under this approach. In evaluating the Company’s exposure to interest rate movements, certain shortcomings inherent in the method of analysis presented in the foregoing table must be considered. For example, although certain assets and liabilities may have similar maturities or repricing periods, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in interest rates. Additionally, certain assets, such as adjustable-rate mortgages, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a significant change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed above. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. The Company considers all of these factors in monitoring its exposure to interest rate risk. Liquidity and Capital Resources 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 potential liquidity demands. The primary sources are increases in deposit accounts, FHLB advances, purchases of federal funds, sale of securities available-for-sale, cash flows from loan payments, sales of one-to-four-family loans held for sale, and maturing securities. While the maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. 65 Table of Contents The Bank must maintain an adequate level of liquidity to ensure the availability of sufficient funds to fund its operations. The Bank generally maintains sufficient cash and short-term investments to meet short-term liquidity needs. At December 31, 2023, the Bank’s total borrowing capacity was $686.2 million with the FHLB of Des Moines, with unused borrowing capacity of $681.9 million. The FHLB borrowing limit is based on certain categories of loans, primarily real estate loans, that qualify as collateral for FHLB advances. At December 31, 2023, the Bank held approximately $1.07 billion 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 of credit with the FRB, with a current limit of $351.6 million, and a combined credit limit of $101.0 million in written federal funds lines of credit through correspondent banking relationships at December 31, 2023. The FRB borrowing limit is based on certain categories of loans, primarily consumer loans, that qualify as collateral for FRB line of credit. At December 31, 2023, the Bank held approximately $631.1 million in loans that qualify as collateral for the FRB line of credit. Additionally, securities with a carrying value of $77.0 million at December 31, 2023, were pledged primarily to provide contingent liquidity through the BTFP at the FRB, with a current limit of $90.5 million and unused borrowing capacity of $620,000. Subject to market conditions, we expect to utilize these borrowing facilities from time to time in the future to fund loan originations and deposit withdrawals, to satisfy other financial commitments, repay maturing debt and to take advantage of investment opportunities to the extent feasible. The Bank’s Asset and Liability Management Policy permits management to utilize brokered deposits up to 20% of total deposits or $506.3 million at December 31, 2023. Total brokered deposits at December 31, 2023 were $431.5 million. Management utilizes brokered deposits to mitigate interest rate risk and to enhance liquidity when appropriate. Liquidity management is both a daily and long-term function of the Company’s management. Excess liquidity is generally invested in short-term investments, such as overnight deposits and 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 U.S. agency securities. The Company uses sources of funds primarily to meet ongoing commitments, pay maturing deposits and fund withdrawals, and to fund loan commitments. At December 31, 2023, the outstanding loan commitments totaled $535.0 million, which included $154.6 million of undisbursed construction and development loan commitments. For information regarding our commitments and off-balance sheet arrangements, see “Note 13 – Commitments and Contingencies” of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and Supplementary Data” of this Form 10–K. Securities purchased during the years ended December 31, 2023 and 2022 totaled $76.0 million and $24.0 million, respectively, and securities repayments, maturities and sales in those periods were $17.3 million and $21.2 million, respectively. The Bank’s liquidity is also affected by the volume of loans sold and loan principal payments. During the years ended December 31, 2023 and 2022, the Bank sold $405.0 million and $740.4 million in loans, respectively. During the years ended December 31, 2023 and 2022, the Bank received $652.7 million and $737.3 million in principal repayments on loans, respectively. The Bank’s liquidity has been positively impacted by increases in deposit levels. During the years ended December 31, 2023 and 2022, deposits increased by $394.6 million and $212.0 million, respectively. Our liquid assets in the form of cash and cash equivalents, CDs at other financial institutions and investment securities increased to $391.2 million at December 31, 2023 from $283.9 million at December 31, 2022. CDs scheduled to mature in one year or less at December 31, 2023, totaled $863.4 million. It is management’s policy to offer deposit rates that are competitive with other local financial institutions. Based on this management strategy, the Bank believes that a majority of maturing relationship deposits will remain with the Bank. We incur capital expenditures on an ongoing basis to expand and improve our product offerings, enhance and modernize our technology infrastructure, and to introduce new technology-based products to compete effectively in our markets. We evaluate capital expenditure projects based on a variety of factors, including expected strategic impacts (such as forecasted impact on revenue growth, productivity, expenses, service levels and customer retention) and our expected return on investment. The amount of capital investment is influenced by, among other things, current and projected demand for our services and products, cash flow generated by operating activities, cash required for other purposes and regulatory considerations. Based on current capital allocation objectives, there are no projects scheduled for capital investments in premises and equipment during the year ending December 31, 2024 that would materially impact liquidity. We also have purchase obligations, with remaining terms generally less than three years and contracts with various vendors to provide services, including information processing.  These contracts typically extend for periods ranging from one to five years, and our financial obligations are contingent upon satisfactory performance by the vendor. For the year ending December 31, 2024, we project that fixed commitments will include $1.9 million of operating lease payments and $93.7 million of scheduled payments and maturities of FHLB advances and FRB borrowing. For information regarding our operating leases and borrowings, see “Note 7 – Leases” and “Note 11 – Debt”, respectively, of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and Supplementary Data” of this Form 10–K. 66 Table of Contents The Bank's management believes that the Company's liquid assets combined with its available lines of credit provide adequate liquidity to meet current financial obligations for at least the next 12 months. As a separate legal entity from the Bank, FS Bancorp must provide for its own liquidity. Sources of capital and liquidity for FS Bancorp 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 December 31, 2023, FS Bancorp, Inc. had $9.1 million in unrestricted cash to meet liquidity needs. The Company currently expects to continue the current practice of paying quarterly cash dividends on common stock subject to the Board of Directors' discretion to modify or terminate this practice at any time and for any reason without prior notice. Our current quarterly common stock dividend rate is $0.26 per share, which we believe is a dividend rate per share which enables us to balance our multiple objectives of managing and investing in the Bank and returning a substantial portion of our cash to our shareholders. Assuming continued cash dividend payment during 2024 at this rate of $0.26 per share, our average total dividend paid each quarter would be approximately $2.0 million based on the number of our current outstanding shares as of December 31, 2023. The Bank is subject to minimum capital requirements imposed by the FDIC. Based on its capital levels at December 31, 2023, 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 December 31, 2023, the Bank was considered to be well capitalized. At December 31, 2023, the Bank exceeded all regulatory capital requirements with Tier 1 leverage-based capital, Tier 1 risk-based capital, total risk-based capital, and common equity Tier 1 capital ratios of 10.4%, 12.1%, 13.4%, and 12.1%, respectively. 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 were subject to regulatory capital guidelines for bank holding companies with $3.0 billion or more in assets at December 31, 2023, FS Bancorp would have exceeded all regulatory capital requirements. For informational purposes, the regulatory capital ratios calculated for FS Bancorp at December 31, 2023 were 9.0% for Tier 1 leverage-based capital, 10.5% for Tier 1 risk-based capital, 13.7% for total risk-based capital, and 10.5% for CET 1 capital ratio. For additional information regarding regulatory capital compliance, see the discussion included in “Note 15 – Regulatory Capital” of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and Supplementary Data” of this Form 10–K. Recent Accounting Pronouncements For a discussion of recent accounting standards, please see “Note 1– Basis of Presentation and Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements included in “Item 8. Financial Statements and Supplementary Data” of this Form 10–K.