Fidelity D & D Bancorp, Inc. — Q3 2018 Form 10-Q
Business context and period. Pennsylvania community bank holding company serving primarily Lackawanna and Luzerne Counties. This unaudited filing covers the quarter and nine months ended September 30, 2018; balance-sheet comparisons are to December 31, 2017. Dollar figures below are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $7.71 | $7.05 | $22.49 | $20.79 |
| Non-interest income | $2.28 | $2.25 | $6.94 | $6.48 |
| Net income | $2.86 | $2.23 | $8.16 | $6.39 |
| Diluted EPS | $0.75 | $0.60 | $2.15 | $1.72 |
| Net interest margin, FTE | 3.60% | 3.67% | 3.66% | 3.72% |
| Efficiency ratio, non-GAAP | 60.65% | 62.74% | 61.91% | 63.34% |
- Third-quarter net income rose 29%; nine-month net income rose 28%. Growth reflected higher net interest income, with the year-to-date comparison also benefiting from higher non-interest income and lower income taxes.
- Total assets were $949.9 million, up 10% since year-end 2017. Net loans and leases were $690.9 million, up $62.2 million; gross loans grew 10%, led by auto lending and leases. Available-for-sale securities were $171.5 million.
- Deposits increased 7% to $779.1 million. Non-interest-bearing deposits rose to $206.6 million, or 26.5% of deposits. Short-term borrowings were $40.3 million and FHLB advances were $31.7 million; total borrowings were $72.0 million versus $39.7 million at year-end.
- Cash and cash equivalents were $16.9 million at quarter-end. Nine-month operating cash flow was $10.3 million, investing cash use was $88.1 million, and financing cash provided was $78.9 million.
- Shareholders’ equity was $90.1 million. The company reported a 14.9% consolidated total risk-based capital ratio and a 9.9% leverage ratio; management said the company and bank exceeded applicable capital adequacy requirements.
Material changes and notable items
- Net interest income increased 8% year to date, but funding costs rose: the FTE net interest margin declined 6 basis points and the net interest spread declined 11 basis points versus the prior-year period. Management attributed pressure to deposit and borrowing rates rising faster than asset yields.
- The federal corporate tax rate fell from 34% to 21% effective January 1, 2018. The nine-month effective tax rate was 16.4%, versus 24.5% in 2017.
- Unrealized losses on available-for-sale debt securities reduced accumulated other comprehensive income by $4.3 million after tax during the first nine months. AOCI moved from $1.8 million of income at year-end 2017 to a $2.5 million loss at September 30, 2018. Management attributed the change primarily to interest rates and reported no other-than-temporary impairment.
- Asset quality was mixed: non-performing assets were $6.2 million, or 0.65% of assets, down from 0.73% at year-end; non-accrual loans rose to $3.8 million from $3.4 million. The allowance for loan losses was $9.9 million, 1.42% of loans, versus 1.44% at year-end.
- The company spent $1.2 million on a Back Mountain branch under construction and expected another $0.3 million of investment in Q4 2018. A Mountain Top branch was approved, with opening expected in the first half of 2019.
Outlook, risks and contingencies
- Management expected rising rates to support interest income from new and repricing assets, while warning that a flattening yield curve and higher deposit and borrowing costs could compress margins. It expected net interest income to improve for the remainder of 2018, supported by asset growth and active deposit pricing.
- Management expected auto loan growth to soften in Q4 as new production approached portfolio runoff; commercial lending was expected to show similar results to recent periods. Deposit growth was expected to fund asset expansion, supplemented by available borrowing capacity; public deposits may be volatile.
- Reported liquidity sources included $16.9 million in cash, $175.4 million in available-for-sale securities and loans held-for-sale, and stated additional borrowing capacity of $171.7 million from the FHLB, $21.0 million from correspondent banks, $90.6 million from the Federal Reserve and $46.2 million through CDARS. Management characterized liquidity as strong and adequate.
- Interest-rate simulations showed a 0.6% increase in net interest income under an immediate 200-basis-point rise, versus a 7.2% decline under a 200-basis-point fall. The modeled economic value of equity declined 3.4% in the rising-rate scenario and 25.2% in the falling-rate scenario.
- Key risks include local economic and borrower conditions, interest-rate and securities-market movements, competition, regulatory and capital requirements, technology and cybersecurity, and the accuracy of loan-loss and collateral estimates. The company said risk factors had not materially changed from its 2017 Form 10-K.
- Management estimated that adopting the new lease standard would add approximately $8 million in right-of-use assets and lease liabilities; it anticipated no significant income-statement effect. The expected impact could affect regulatory capital ratios and customer debt covenants.
- Ordinary-course litigation was disclosed; management stated no pending proceeding was expected to have a material adverse effect. No material legal actions by governmental authorities were known to management.
Most important facts for investors to verify
- Whether loan and deposit growth can continue without further margin compression, particularly as funding rates reset.
- Trends in auto-loan concentration, delinquencies, non-accrual loans, TDRs and the adequacy of the allowance as loans expand.
- The effect of interest-rate changes on securities values, AOCI, capital and realized losses; the portfolio had a $2.5 million after-tax unrealized loss at quarter-end.
- Execution, costs and funding for the Back Mountain and Mountain Top branch plans, and whether projected deposit growth materializes.
- Liquidity and funding dependence, including increased short-term borrowings and the timing and cost of replacing them with deposits.
- Actual lease-standard adoption effects and the assumptions underlying the company’s interest-rate simulations and loan-loss estimates.