Fidelity D & D Bancorp, Inc. — Q2 2011 Form 10-Q
Business context and reporting period. The company is the parent of Fidelity Deposit and Discount Bank, a Pennsylvania community bank serving consumers and businesses primarily in Lackawanna and Luzerne counties. This unaudited report covers the quarter and six months ended June 30, 2011; balance-sheet comparisons are against December 31, 2010. Amounts below are in U.S. dollars.
Key financial results
| Metric | Q2 2011 / June 30, 2011 | Comparable period / prior date |
|---|---|---|
| Net income | $1.289 million; diluted EPS $0.59 | Q2 2010: $0.719 million; $0.34 per diluted share |
| Six-month net income | $2.516 million; diluted EPS $1.15 | First half 2010: $1.275 million; $0.60 per diluted share |
| Net interest income | Q2: $5.318 million; first half: $10.551 million | Q2 2010: $5.217 million; first half 2010: $10.376 million |
| Provision for loan losses | Q2: $0.375 million; first half: $0.850 million | Q2 2010: $0.300 million; first half 2010: $0.875 million |
| Total assets | $588.684 million | $561.673 million at December 31, 2010 |
| Loans, gross | $406.331 million | $415.801 million at December 31, 2010 |
| Total deposits | $506.927 million | $482.448 million at December 31, 2010 |
| Shareholders’ equity | $50.346 million | $46.774 million at December 31, 2010 |
| Cash and cash equivalents | $46.676 million | $22.967 million at December 31, 2010 |
| Borrowings | $29.007 million total: $8.007 million short-term and $21.000 million long-term | $29.548 million total at December 31, 2010 |
- Second-quarter other income was $1.398 million, versus $0.640 million a year earlier; first-half other income was $2.736 million, versus $1.786 million. Lower securities impairment charges and stronger fees were important contributors.
- Other expenses were $4.620 million in Q2 and $9.110 million in the first half, down 2% and 7%, respectively, year over year. First-half 2010 expenses included $398,000 of severance and voluntary termination costs that did not recur.
- Net interest margin was 4.01% in Q2 and 4.03% for the first half, compared with 3.92% and 3.91%, respectively, in 2010. These are tax-equivalent margin measures.
- Return on average assets and equity were 0.87% and 10.44% for Q2, versus 0.49% and 6.10% a year earlier. First-half figures were 0.86% and 10.43%, versus 0.44% and 5.48%.
- Operating cash flow was $7.783 million for the first half; investing activities used $7.584 million and financing activities provided $23.510 million. Cash increased $23.709 million.
- The quarterly dividend was $0.25 per share and the first-half dividend was $0.50 per share, unchanged from the comparable 2010 periods.
Material changes versus comparable periods
- Net income rose 79% in Q2 and 97% in the first half. Management attributed the improvement to lower securities impairment charges, higher net interest income, and lower expenses, partly offset by higher income taxes.
- Net interest income increased modestly despite lower interest income: interest expense fell 27% in Q2 and 29% in the first half, reflecting lower deposit costs and reduced borrowings. Interest income declined 5% in Q2 and 6% in the first half, primarily due to lower commercial loan balances and investment yields.
- Loans declined 2.3% from year-end, including decreases in commercial and commercial real estate lending. Management cited payoffs, subdued demand, local economic conditions, and underwriting considerations. Deposits grew 5%, with growth in non-interest-bearing, savings, and money-market accounts partly offset by lower certificates of deposit.
- The allowance for loan losses rose to $8.144 million from $7.898 million; its ratio to loans increased to 2.00% from 1.90%. First-half net charge-offs fell to $604,000 from $925,000.
Credit, liquidity, capital, outlook, and risks
- Nonperforming loans were $10.170 million, or 2.50% of loans, versus $10.257 million and 2.47% at year-end. Nonperforming assets were $13.966 million, or 2.37% of assets, versus $13.392 million and 2.38%. Nonaccrual loans were $9.591 million.
- Troubled debt restructurings totaled $3.544 million, including $2.068 million of accruing commercial real estate loans and $1.476 million of nonaccrual commercial real estate loans. The filing also reports $2.068 million of accruing TDRs in its nonperforming-assets table; the nonaccrual TDR is included in nonaccrual loans.
- Foreclosed assets were $847,000, comprising three properties. A $65,600 write-down was recorded in Q2. Management says the allowance is adequate but cautions that economic weakness and pressure on property values could require further charge-offs or reserve increases.
- Pooled trust preferred securities had a $6.779 million book value and $1.321 million fair value, with $5.569 million of gross unrealized losses; the market was inactive and valuation relied on management estimates and other Level 3 inputs. The company recorded $75,000 of credit-related impairment in the first quarter and none in Q2; further impairment remains possible.
- Liquidity included $46.7 million in cash, $98.8 million in available-for-sale securities, loans held for sale, and approximately $173.3 million of available borrowing capacity. Management considered liquidity strong and reported no adverse liquidity issues. Some deposit growth came from seasonal municipal balances, which management describes as volatile and unpredictable.
- At June 30, consolidated regulatory capital ratios were 12.4% total risk-based capital, 11.1% Tier 1 risk-based capital, and 8.5% Tier 1 leverage. The company and bank met applicable capital adequacy requirements.
- Management expects less benefit from further deposit repricing and warns that prolonged low rates could pressure net interest margin. Its sensitivity analysis estimated that a 200-basis-point rate rise would increase 12-month net interest income 2.6%, while a 200-basis-point decline would reduce it 1.4%; estimated economic value of equity fell 22.8% in the rising-rate scenario.
- No formal earnings guidance is provided. Management described plans to grow loans and low-cost deposits while maintaining credit quality and margin, and said commercial loan balances could continue declining through Q3 based on expected maturities and payoffs.
- Risk factors include local economic deterioration and borrower repayment capacity, collateral values, interest-rate and market movements, regulatory and accounting changes, competition, and the valuation and credit performance of securities. The filing also notes the August 2011 U.S. sovereign credit-rating downgrade as a potential risk. Management reported no material pending legal proceedings and concluded disclosure controls were effective.
Important facts for investors to verify
- Track nonperforming loans, TDR performance, charge-offs, and whether the $8.144 million allowance remains sufficient as local conditions evolve.
- Review future valuations, cash-flow assumptions, and impairment decisions for pooled trust preferred securities, including the highly judgmental Level 3 valuation.
- Assess sustainability of deposit growth, particularly seasonal municipal funds, and monitor deposit pricing as rates change.
- Compare loan growth and asset yields with funding costs to test management’s margin outlook; note the filing’s interest-rate sensitivity assumptions.
- Reconcile the TDR disclosures: total TDRs of $3.544 million include $1.476 million on nonaccrual, while the nonperforming-assets table lists $2.068 million of accruing TDRs.