Fidelity D & D Bancorp, Inc. — Q2 2017 Form 10-Q
Business context and reporting period. The Pennsylvania-based bank holding company operates Fidelity Deposit and Discount Bank, serving northeastern Pennsylvania. This unaudited quarterly report covers the three and six months ended June 30, 2017; balance-sheet comparisons are with December 31, 2016. Unless stated otherwise, dollar amounts below are in millions.
Financial performance and position
| Metric | Q2 2017 / June 30, 2017 | Comparable period / prior date |
|---|---|---|
| Net interest income | $7.07 Q2; $13.75 first half | $6.14 Q2 2016; $12.28 first half 2016 |
| Net income | $2.18 Q2; $4.16 first half | $1.93 Q2 2016; $3.63 first half 2016 |
| Diluted earnings per share | $0.88 Q2; $1.68 first half | $0.79 Q2 2016; $1.48 first half 2016 |
| Net interest margin, fully taxable equivalent | 3.76% Q2; 3.74% first half | 3.66% Q2 2016; 3.68% first half 2016 |
| Total assets | $855.5 | $792.9 at Dec. 31, 2016 |
| Gross loans and leases | $636.4 | $598.0 at Dec. 31, 2016 |
| Total deposits | $707.4 | $703.5 at Dec. 31, 2016 |
| Borrowings | $58.2: $34.5 short-term and $23.7 long-term | $4.2 short-term; no long-term debt at Dec. 31, 2016 |
| Shareholders’ equity | $84.1 | $80.6 at Dec. 31, 2016 |
- Second-quarter net income rose about 13%; first-half net income rose about 15%. First-half return on average assets was 1.01% versus 0.97% in 2016; return on average equity was 10.18% versus 9.32%.
- Q2 interest income was $7.85 million and other income was $2.13 million. First-half other income increased 12% to $4.24 million. Higher salaries and benefits, premises costs, professional services and other expenses contributed to first-half non-interest expense rising 10% to $11.85 million.
- First-half operating cash flow was $6.84 million; investing cash flow was negative $60.60 million and financing cash flow was positive $42.80 million. Cash and cash equivalents fell $10.97 million to $14.88 million.
- Management reported $478.2 million of liquidity resources, including cash, securities and loans held for sale, and available borrowing capacity. It characterized liquidity as strong and adequate.
- Regulatory capital ratios remained above stated minimums: consolidated total risk-based capital was 14.5%, Tier 1 common equity 13.3%, and Tier 1 leverage 9.7%.
Material changes versus comparable periods
- Loan and lease balances grew 6% from year-end, led by commercial and industrial lending, up 23%, and auto loans and leases. Investment securities rose $23.4 million to $153.4 million; bank-owned life insurance increased to $19.7 million after an $8.0 million policy purchase.
- Net interest income increased 15% in Q2 and 12% in the first half. Management attributed the growth principally to higher average earning assets, partly offset by higher funding costs. First-half average borrowings were substantially higher year over year.
- Non-performing assets were $9.48 million, or 1.11% of assets, compared with $10.52 million and 1.33% at year-end 2016. Non-accrual loans were $6.53 million; troubled debt restructurings increased to $4.15 million from $3.35 million at year-end.
- The company acquired Wayne Bank’s West Scranton branch on March 17, 2017, assuming about $13.8 million of deposits and acquiring $1.6 million of loans and branch assets; the branch was consolidated with a nearby office.
- The allowance for loan losses was $9.41 million, versus $9.36 million at year-end. First-half provision expense was $0.55 million; net charge-offs were $0.51 million, including a $0.30 million charge-off on one commercial real estate borrower.
Outlook, commentary, risks and unusual items
- Management expected gradual interest-rate increases and said asset growth could support net interest income, while warning that a flatter yield curve, faster increases in short-term rates and deposit competition could compress margins and raise funding costs. It expected core deposit growth to help reduce short-term borrowings in the second half.
- Management expected continued loan and investment growth, with commercial real estate growth at a slower pace, and projected 2017 asset growth to be funded through deposits and available borrowings. A new Dallas, Pennsylvania branch was under construction and expected to open in Q1 2018.
- Credit risks include borrower repayment capacity, local economic conditions, property values, loan concentrations and potential future charge-offs. Management considered the allowance adequate, but noted estimates are judgmental and may change. Two significant non-accrual commercial real estate loans totaling $2.5 million were foreclosed on during Q3; management expected to sell the collateral by quarter-end.
- Interest-rate sensitivity modeling estimated that an immediate 200-basis-point increase would raise next-twelve-month net interest income 2.3%, while a 200-basis-point decrease would reduce it 6.5%. These are model estimates, not guidance; results depend on assumptions.
- Other notable items included new executive retirement and split-dollar insurance benefits, and the $8.0 million BOLI purchase. The filing reported no material pending litigation, no material change in previously disclosed risk factors, and effective disclosure controls.
- Accounting changes under evaluation include the expected-credit-loss standard, effective for the company after December 15, 2019; management said adoption could increase the loan-loss allowance. Management did not expect the new revenue standard, effective January 1, 2018, to have a material financial effect, though disclosures may change.
Important facts for investors to verify
- Whether loan growth, especially commercial lending and auto lending, is accompanied by stable underwriting and credit performance; monitor non-accrual loans, TDRs, delinquency trends and charge-offs.
- Whether the allowance remains adequate as the portfolio grows and as the expected-credit-loss accounting standard approaches.
- How the substantially higher short- and long-term borrowings affect funding costs, liquidity and net interest margin, particularly if deposits grow more slowly or rates rise unevenly.
- Whether management’s margin and earnings expectations are borne out, given the sensitivity model’s estimated downside under falling rates and the stated risk of yield-curve flattening.
- Whether the acquired branch, BOLI investment, employee benefit arrangements and planned Dallas branch generate the intended benefits relative to their costs and capital needs.