Fidelity D & D Bancorp, Inc. — Q2 2022 Form 10-Q
Reporting period: Three and six months ended June 30, 2022. The company is a Pennsylvania bank holding company; its bank serves northeastern and eastern Pennsylvania. Comparisons below are against Q2 and first-half 2021, or December 31, 2021 for balance-sheet figures.
Financial performance
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Net interest income | $18.1 million | $13.3 million | $35.4 million | $26.8 million |
| Net income | $7.7 million | $5.7 million | $15.2 million | $11.4 million |
| Diluted EPS | $1.35 | $1.13 | $2.67 | $2.26 |
| Non-interest income | $4.3 million | $4.6 million | $8.8 million | $10.1 million |
| Provision for loan losses | $0.5 million | $0.3 million | $1.1 million | $1.1 million |
| Non-interest expenses | $12.8 million | $10.9 million | $25.5 million | $22.3 million |
| FTE net interest margin | 3.34% | 3.10% | 3.26% | 3.24% |
Second-quarter and first-half net income increased 35% and 34%, respectively. Management attributed the improvement mainly to higher net interest income, reflecting growth in average earning assets and the larger post-Landmark franchise. Q2 return on average assets was 1.29% and return on average equity was 18.16%; first-half figures were 1.28% and 16.45%, respectively. The non-GAAP efficiency ratio improved to 55.45% for Q2 and 55.82% for the first half, from 59.01% and 59.06% in the comparable periods.
Lower mortgage activity reduced gains on loan sales: first-half gains were $1.2 million versus $3.5 million a year earlier. First-half salary and benefits expense rose $3.1 million, primarily due to staffing and lower deferral of loan origination costs. The effective tax rate was 14.4% for the first half, compared with 15.6%, mainly reflecting tax-exempt interest income.
Financial position, cash flow and liquidity
- Assets and loans: Total assets were $2.415 billion, broadly flat with year-end 2021. Gross loans and leases increased 4% to $1.492 billion; net loans were $1.474 billion. Residential real estate loans and consumer loans grew, while commercial and industrial balances declined partly as PPP loans were forgiven.
- Deposits: Deposits rose 2% to $2.218 billion. The increase included funds from wealth-management trust accounts placed in a pledged money-market account. Non-interest-bearing deposits were $611.0 million, or 27.6% of deposits. Management expected deposits to decline during the rest of 2022 as customers sought higher returns elsewhere.
- Debt: Short-term borrowings were only $10,000; secured borrowings were $7.7 million. The company had no FHLB advances at quarter-end. Lease liabilities were $10.7 million in total (finance and operating).
- Cash flow: For the first half, operating activities provided $27.8 million, investing activities used $56.5 million, and financing activities provided $41.0 million. Cash and cash equivalents increased $12.2 million to $109.1 million.
- Liquidity: Management reported approximately $1.7 billion of combined cash, eligible assets and available borrowing capacity, equal to 69% of assets, and considered liquidity adequate. Available capacity included FHLB, Federal Reserve and correspondent-bank facilities, among other sources. These are reported capacities, not cash on hand.
- Capital: Shareholders’ equity fell to $162.6 million from $211.7 million at year-end, largely due to securities-related accumulated other comprehensive losses. The company and bank remained above regulatory capital requirements; consolidated total risk-based capital was 14.3% and Tier 1 leverage was 8.4%.
Material changes and unusual items
- During Q2, the company transferred $245.5 million of securities from available-for-sale (AFS) to held-to-maturity (HTM). At June 30, AFS securities were $452.8 million and HTM securities had $222.0 million amortized cost but $199.4 million fair value. Management said the unrealized losses primarily reflected higher interest rates, not credit deterioration, and reported no other-than-temporary impairment or intent to sell securities in unrealized-loss positions.
- Net-of-tax accumulated other comprehensive loss moved from income of $0.2 million at year-end to a loss of $60.9 million. Management cautioned that further rate increases could cause additional securities-value declines. Tangible common book value per share was $24.99, down from $33.68 at year-end.
- The Landmark acquisition closed July 1, 2021; the acquired franchise contributed to year-over-year changes in scale, staffing and expenses. No merger-related costs were recorded in the first half of 2022; the 2021 comparison included $0.9 million of merger costs and a $0.4 million FHLB prepayment fee.
- The board authorized repurchases of up to 3% of outstanding common stock, subject to a $5 million limit or termination by August 9, 2023. The company repurchased 10,294 shares for $0.4 million through June 30.
- The company expected to spend about $15.8 million in net remaining costs over approximately two years on its planned Scranton headquarters project. It also planned branch work, including a Main Branch remodel estimated at $3 million.
Outlook, risks and contingencies
Management expected a rising-rate environment to support asset yields and net interest income, while recognizing pressure to raise deposit rates and the possibility of margin compression. Its plans emphasized loan growth, low-cost core deposits and active asset-liability management. The filing provides no formal earnings or EPS guidance. Management also anticipated that higher rates could weaken residential mortgage demand.
Key risks include interest-rate and securities valuation exposure, deposit outflows and seasonal public-deposit volatility, local economic conditions and inflation, borrower repayment and collateral risks, competition, cybersecurity and technology disruption, regulation, and acquisition integration. The company estimated $995.5 million of uninsured deposits; public deposits were $367.7 million and required pledged securities. Its one-year cumulative interest-rate gap was liability-sensitive by $34.4 million. The filing’s model estimated net interest income would decline 3.0% under an immediate 200-basis-point increase and 7.4% under a 200-basis-point decrease.
The allowance for loan losses was $16.6 million, or 1.11% of loans. Non-accrual loans were $3.2 million; non-performing assets were $4.7 million, or 0.20% of assets. Management stated its allowance was adequate but noted the estimate is judgmental and may change with economic conditions. The company had approximately $43 million of LIBOR-linked loans and was working to modify those contracts. CECL adoption was expected in 2023, with parallel model runs planned in 2022. Management reported no material change to previously disclosed risk factors, no pending legal proceeding expected to have a material adverse effect, and effective disclosure controls.
Most important facts for investors to verify
- How the large unrealized securities losses, the AFS-to-HTM transfer, and rising rates affect capital, liquidity and future earnings.
- Whether deposit balances remain stable, particularly given management’s expected runoff, uninsured deposits and reliance on public and trust accounts.
- Whether loan growth is accompanied by stable credit quality, and whether the allowance remains sufficient as rates and economic conditions change.
- Whether deposit repricing and asset yields develop as management expects, given the liability-sensitive gap and modeled rate scenarios.
- The timing, total cost and funding of the Scranton headquarters and planned branch projects.