Editors' Note: This article covers a stock trading with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
Currently trading at 83% of book value, you would think FS Bancorp (NASDAQ:FSBW) is a sleepy low-growth bank with no potential. On the contrary, FS Bancorp has a high-growth and very profitable niche business, with a Net Interest Margin [NIM] of 5.42%. Just as importantly, it has a boatload of cash on the balance sheet, and we have good reason to believe it will begin buying back stock in the near term. We believe the price will quickly increase to book value, roughly 21, over the next couple of weeks after it announces a share buyback. We expect the price to continue to move up from there over the next year and beyond.
FS Bancorp is a $400 million bank in the Pacific Northwest. It takes deposits and makes residential and other loans like all banks, but what differentiates FS Bancorp is its "Indirect Home Improvement" business. FS Bancorp provides loans to homeowners for improvements such as new roofs, swimming pools and solar panels. The regional contractors send so much of this business to FS Bancorp that it can't keep most of it on the books. The business is so profitable that FS Bancorp repackages and sells the loans at 107% of par. The loans are second liens, but they are safe because they are only made when the total loan-to-value (LTV) of all loans on a residence is low, like 65% - 70% or less. The homeowner can't default on the improvement loan without defaulting on the first lien mortgage, so defaults are close to zero.
This niche business is high-growth and very profitable. In Q3 2013, noninterest income increased 46.2% to $2.2 million, from $1.5 million in Q3 2012 - mostly due to the repackaging and selling of these loans. But the loans that FS Bancorp retains are highly profitable as well. In Q3 2013 Return on Assets (ROA) was 1.07%. Total assets increased 16% to $396 million at September 30, 2013 from $341 million at September 30, 2012. Book value per share increased 12% to $20.56 at September 30, 2013 from $18.32 as of September 30, 2012. Further, FS Bancorp is well capitalized with Tier 1 RBC of 12.7% and Total RBC of 16.9% at the bank, and Total RBC of 20.6% at the company level. The company pays a $.20 annual dividend that we believe will be increased to $.40 later this year.
Because it's relatively small, and has no Wall Street coverage, FS Bancorp has gone unnoticed. We think that will change with the upcoming 4th quarter earnings release and conference call. At the Raymond James financial services conference, FS Bancorp announced that they requested regulatory approval to buy back stock. We believe that the company will let investors know that it got approval to buy back stock to offset ESOP stock grants and we believe they will announce this on the call. This represents about 5% of the shares outstanding - a significant amount of buying for this thinly traded stock. Because of the relatively large liquidity position of the bank ($76 million on September 30, 2013), the company may also get approval to buy back up to 10% of its stock outstanding. This would move the price dramatically.
The end game for FS Bancorp will likely be a takeover. Comparable northwest banks have been bought at 1.5 times book value. Witness the recent takeouts of Sterling and First State Bank, both at roughly 1.5 x book. In the meantime, we expect FS Bancorp to continue to grow book value at 10+% per year. At a current price of $17 per share (83% of book value), we believe that a fair take-out price would be $30, roughly a double over the current price. Anything close to this scenario would be a huge home run for investors.
Disclosure: I am long FSBW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.