Fidelity D & D Bancorp, Inc. — FY 2011 Form 10-K
Business context and reporting period
Annual report for the fiscal year ended December 31, 2011. Fidelity D & D Bancorp is a Pennsylvania bank holding company whose subsidiary provides commercial and retail banking, trust, and financial services, primarily in Lackawanna and Luzerne Counties. The bank operated 11 full-service offices.
Financial performance and condition
| Metric | 2011 | 2010 |
|---|---|---|
| Total assets | $606.7 million | $561.7 million |
| Total deposits | $515.8 million | $482.4 million |
| Net loans | $398.2 million | $407.9 million |
| Net interest income | $20.8 million | $20.8 million |
| Net income (loss) | $5.0 million | ($3.2 million) |
| Diluted earnings (loss) per share | $2.28 | ($1.50) |
| Net interest margin | 3.89% | 3.89% |
| Return on average assets / equity | 0.85% / 10.01% | (0.55%) / (6.69%) |
| Shareholders’ equity | $53.6 million | $46.8 million |
Interest income declined 7% to $25.6 million, while interest expense fell 30% to $4.8 million; lower funding costs largely offset reduced asset yields, leaving net interest income nearly flat. The loan-loss provision was $1.8 million, down from $2.1 million. Other income was $5.7 million, versus a $6.4 million loss in 2010; this turnaround primarily reflected lower credit-related impairment charges on pooled trust preferred securities ($0.2 million versus $11.8 million).
Cash provided by operating activities was $15.1 million. Cash and cash equivalents increased $29.2 million to $52.2 million. The company reported $9.5 million of short-term borrowings and $21.0 million of long-term debt at year-end. Regulatory capital ratios were 13.0% total risk-based capital, 11.7% Tier 1 risk-based capital, and 8.7% leverage. Management described liquidity as strong, reporting $333.8 million of cash, liquid assets, and available borrowing sources combined.
Material changes versus the prior year
- Returned to profitability, principally because pooled trust preferred securities impairment charges fell sharply from 2010.
- Assets increased 8%, supported by deposit growth of 7%; cash and securities rose, while net loans declined about $9.7 million.
- Asset quality weakened: non-performing assets increased to $21.7 million from $13.4 million, or 3.58% of assets versus 2.38%. Non-accrual loans rose to $14.0 million from $10.0 million, and troubled debt restructurings increased to $6.7 million from $0.8 million.
- Commercial and industrial loans declined 19.7% to $68.4 million. Residential real estate loans increased, while commercial real estate balances were lower.
- Shareholders’ equity increased 15%, reflecting net income and improved unrealized values in the investment portfolio, partly offset by $2.2 million of declared dividends.
Outlook, commentary, and risks
Management expected cautious, modest loan growth in 2012, funded mainly by organic deposit growth, and anticipated a somewhat lower net interest margin due to the prolonged low-rate environment and loan prepayments. It planned to focus on asset quality, strict underwriting, non-interest income, expense control, and capital strength. Management also expected mortgage originations to recede.
Key risks include the weak local economy and real estate market, elevated credit risk in commercial lending, further deterioration in non-performing loans or TDRs, and estimation uncertainty in the loan-loss allowance. The pooled trust preferred portfolio had $6.6 million amortized cost and $1.5 million estimated fair value; its fair value relies on Level 3 valuation assumptions, and further credit impairment could reduce earnings. Interest-rate sensitivity, competition, regulation including Dodd-Frank, and reliance on the bank subsidiary for holding-company dividends are additional risks.
After year-end, the company repaid $5.0 million of FHLB debt in February 2012 and incurred a $0.2 million prepayment fee. Management reported no material pending litigation. The independent auditor gave an unqualified opinion on the financial statements; the auditor did not provide an opinion on internal control effectiveness, while management stated its controls were effective.
Important facts for investors to verify
- Whether non-performing loans, TDRs, and collateral values improved after year-end, particularly the large commercial real estate relationship cited as a driver of deterioration.
- The adequacy of the $8.1 million allowance for loan losses relative to rising non-performing assets and local economic conditions.
- Valuation assumptions and subsequent credit performance of pooled trust preferred securities, including the potential for additional impairment charges.
- Whether deposit growth, funding costs, and the 2012 decline in net interest margin developed as management expected.
- Regulatory capital and liquidity after the February 2012 debt repayment, and the sustainability of the $1.00 annual dividend per share.