Fidelity D & D Bancorp, Inc. — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. The filing is an annual report, not a standalone fourth-quarter report. Unless otherwise indicated, financial amounts below are in U.S. dollars.
Business context
Fidelity D & D Bancorp is a Pennsylvania bank holding company operating The Fidelity Deposit and Discount Bank. Its community banking, lending, trust and financial services primarily serve Lackawanna and Luzerne Counties in Northeastern Pennsylvania. At year-end, it operated 12 full-service offices and held 6.78% of deposits in the Scranton-Wilkes-Barre metro area.
Key financial metrics
| Metric | 2019 | 2018 |
|---|---|---|
| Total assets | $1,009.9 million | $981.1 million |
| Total deposits | $835.7 million | $770.2 million |
| Gross loans | $754.3 million | $729.1 million |
| Investment securities | $185.1 million | $182.8 million |
| Interest income | $39.3 million | $35.3 million |
| Interest expense | $7.6 million | $4.9 million |
| Net interest income | $31.7 million | $30.5 million |
| Provision for loan losses | $1.1 million | $1.5 million |
| Other income | $10.2 million | $9.2 million |
| Other operating expenses | $26.9 million | $25.1 million |
| Net income | $11.6 million | $11.0 million |
| Diluted earnings per share | $3.03 | $2.90 |
| Net interest margin (FTE) | 3.52% | 3.59% |
| Efficiency ratio (non-GAAP) | 63.11% | 62.10% |
| Return on average assets / equity | 1.18% / 11.49% | 1.20% / 12.36% |
| Shareholders’ equity | $106.8 million | $93.6 million |
| Cash and cash equivalents | $15.7 million | $17.5 million |
Operating cash flow was $25.8 million, compared with $13.7 million in 2018. Investing activities used $34.0 million and financing activities provided $6.4 million; cash and cash equivalents declined $1.8 million during the year. Total deposits grew 9%, led by money-market accounts. Year-end short-term borrowings were $37.8 million and FHLB advances were $15.0 million, for combined borrowings of $52.8 million, down from $108.1 million in 2018.
Liquidity sources reported by management included $15.7 million cash, $186.8 million in available-for-sale securities and loans held-for-sale, plus borrowing capacity from the FHLB, correspondent banks, the Federal Reserve and a deposit funding program. The company reported these sources totaled $672.8 million, or 67% of assets. The bank’s total risk-based capital ratio was 15.8% and leverage ratio was 10.3%; management stated the company and bank exceeded applicable capital requirements.
Changes versus the prior year
- Net income increased 5% to $11.6 million. Higher net interest income and non-interest income more than offset higher operating expenses.
- Net interest income rose 4% on a fully taxable equivalent basis, but funding costs rose faster: interest expense increased 55%, and net interest margin declined 7 basis points to 3.52%.
- Net interest income after the loan-loss provision increased to $30.6 million from $29.0 million. The provision declined 25% to $1.1 million.
- Gross loans increased 3%; residential real estate loans grew 14%, while consumer loans declined modestly. Non-performing assets fell to $5.0 million, or 0.50% of assets, from $6.3 million, or 0.64%.
- Net charge-offs increased 21% to $1.1 million, including a $0.4 million charge-off to one commercial borrower and $0.3 million in collection expenses on certain serviced residential loans. A commercial resolution generated a $0.3 million recovery late in the year.
- Available-for-sale securities moved from a $1.4 million net unrealized loss at year-end 2018 to a $4.5 million net unrealized gain at year-end 2019; the after-tax improvement added $4.7 million to other comprehensive income.
- Fourth-quarter net income was $2.7 million, versus $2.8 million in fourth-quarter 2018.
Outlook, risks and unusual items
- Management expected loan and deposit growth in 2020, with growth in the investment portfolio weighted toward mortgage-backed securities. It expected short-term borrowings to decline, FHLB advances to remain roughly flat, and net interest margin to decline slightly.
- Management identified deposit pricing and competition as key risks in a declining-rate environment: deposit costs may not fall as quickly as yields on loans and investments. The company’s positive one-year cumulative gap also exposes it to risk if rates fall.
- Local conditions were weaker than national conditions: Scranton-Wilkes-Barre unemployment rose to 5.6% from 4.7%, while management described the local economy as volatile and lagging national trends. The loan portfolio is concentrated geographically, with about 67% of gross loans secured by real estate.
- In December 2019, the company agreed to acquire MNB Corporation in a stock transaction valued at approximately $78.5 million as of December 6, subject to shareholder, regulatory and other approvals. Closing was expected in the second quarter of 2020. The company recorded $440,000 of merger-related expense in 2019 and estimated another $2.4 million of non-recurring merger and integration costs for 2020. Completion, integration, cost savings and customer retention were identified as uncertainties.
- CECL adoption was deferred for the company, as a smaller reporting company, until 2023. Management was evaluating the effect; the eventual allowance adjustment could not yet be quantified.
- The company invested $2.0 million in additional bank-owned life insurance during 2019. It also adopted lease accounting, recognizing operating lease right-of-use assets and liabilities.
- Management reported no pending legal proceedings expected to have a material effect. The external auditor issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective.
Important facts for investors to verify
- Whether the MNB transaction received required approvals and closed, and whether the announced integration costs and anticipated benefits were realized.
- Subsequent trends in net interest margin, deposit costs, loan yields and funding mix as interest rates changed.
- Credit quality developments, including commercial criticized and classified loans, non-performing assets, charge-offs, and the adequacy of the $9.7 million allowance.
- The company’s CECL adoption timing and the resulting allowance and capital impact.
- Whether local economic conditions, deposit concentration and liquidity needs affected loan performance or funding costs after year-end.
- Cash flow and capital implications of dividends, branch and technology spending, and merger-related payments.