FIDELITY D & D BANCORP INC quarterly report, Q1 FY2021

Fidelity D & D Bancorp, Inc. — Q1 2021 Form 10-Q

Reporting period: Three months ended March 31, 2021; balance-sheet comparisons are with December 31, 2020. The company is a Pennsylvania bank holding company operating Fidelity Deposit and Discount Bank. Amounts below are in U.S. dollars; financial statement amounts are generally in millions.

Financial performance

Metric	Q1 2021	Q1 2020
Net interest income	$13.45	$8.01
Provision for loan losses	$0.80	$0.30
Non-interest income	$5.52	$2.76
Non-interest expense	$11.46	$7.30
Income before taxes	$6.71	$3.16
Net income	$5.67	$2.63
Diluted EPS	$1.13	$0.69

• Net income rose 115%. Management attributed the increase principally to $5.4 million higher net interest income and $2.8 million higher non-interest income, partly offset by $4.2 million higher expenses and a $0.5 million increase in loan-loss provision.
• Net interest margin (FTE) was 3.39%, down from 3.47%; net interest spread increased to 3.30% from 3.21%. The cost of funds declined to 0.23% from 0.77%. Management cited asset growth, including the MNB acquisition, PPP lending and securities, alongside lower funding costs.
• Non-GAAP efficiency ratio improved to 59.11% from 66.69%. Return on average assets was 1.29% versus 1.04%; return on average equity was 13.75% versus 9.74%.
• Mortgage loan-sale gains increased to $2.35 million from $0.22 million. The company sold $80.7 million of residential mortgages during the quarter, compared with $12.9 million in Q1 2020.

Financial position, cash flow and asset quality

• Total assets were $1.913 billion, up $213.6 million (13%) from year-end. Loans and leases, net, were $1.127 billion; available-for-sale securities were $436.6 million.
• Deposits increased $213.4 million (14%) to $1.723 billion. Non-interest-bearing deposits were $518.4 million, or 30.1% of deposits. A $43.4 million seasonal public deposit left on April 1, 2021, after quarter-end.
• Cash and cash equivalents were $223.0 million, up from $69.3 million. Q1 operating cash flow was $25.7 million; investing cash outflow was $79.2 million, mainly reflecting securities purchases; financing cash inflow was $207.2 million, principally deposit growth.
• No FHLB advances or short-term borrowings remained at March 31; the company repaid $5.0 million of FHLB advances during the quarter. It reported $447.5 million of additional FHLB borrowing capacity. Management described liquidity as strong, citing $1.5 billion of cash, securities, loans held for sale and available borrowing capacity.
• Shareholders’ equity was $163.6 million, down $3.1 million from year-end. The $7.8 million after-tax decline in unrealized gains on securities outweighed quarterly net income in equity movements. The AFS portfolio remained in a net unrealized gain position of $1.2 million, versus $9.0 million at year-end.
• The allowance for loan losses was $14.8 million, 1.30% of total loans, compared with $14.2 million and 1.27% at year-end. Net charge-offs were $163,000. Non-accrual loans were $3.9 million; non-performing assets were $6.9 million, or 0.36% of assets. COVID-related temporary modifications totaled $0.7 million across five loans.
• Regulatory capital ratios exceeded stated requirements: consolidated total risk-based capital was 16.5%, Tier 1 common equity 15.2%, and Tier 1 leverage 8.7%. The quarterly dividend was $0.30 per share.

Material changes and notable items

• The Q1 2021 comparison includes the acquired MNB operations for the full quarter; MNB was acquired May 1, 2020. Consequently, year-over-year growth reflects acquisition-related expansion as well as organic activity. The 2020 acquisition added $451.4 million of assets at acquisition and issued approximately 1.177 million Fidelity shares.
• The company signed an agreement in February 2021 to acquire Landmark Bancorp for consideration of 0.272 Fidelity shares and $3.26 cash per Landmark share. The deal was valued at $43.4 million as of February 25, subject to shareholder and regulatory approvals and other conditions; closing was expected in Q3 2021.
• Q1 included $523,000 of Landmark-related merger expenses and a $369,000 FHLB prepayment penalty. Management expects another $3.2 million of Landmark-related costs during 2021. Excluding merger costs and the prepayment penalty, management reported non-GAAP adjusted net income of $6.47 million and adjusted diluted EPS of $1.29; these are non-GAAP measures.
• PPP loans outstanding were $149.1 million across 1,414 loans at March 31, up from $132.1 million at year-end. The company recognized $1.8 million of SBA fees in Q1 and reported $4.3 million of net unearned PPP fees remaining. It had submitted $159 million of forgiveness applications; $84 million had been approved and $75 million awaited approval at quarter-end.
• Unrealized losses on AFS securities increased amid rising market rates. Management attributed the change to interest rates, reported no other-than-temporary impairment, and said it had no intent to sell securities in unrealized-loss positions.

Outlook, commentary and risks

• No specific full-year earnings or revenue guidance is provided. Management expected a relatively low-rate environment, possible margin compression absent a sustained steepening yield curve, and continued loan and securities growth. It planned to manage funding costs and pursue low-cost deposits to mitigate pressure.
• Management said pandemic-related economic effects could impair some borrowers’ ability to repay, with local unemployment still above the national rate. It increased qualitative credit-reserve factors and said further provisioning may be needed if the pandemic’s duration or severity worsens.
• Rate sensitivity modeling estimated that an immediate 200-basis-point increase would raise projected 12-month net interest income 3.4%, while a 200-basis-point decrease would reduce it 2.0%. The modeled economic value of equity fell 27.9% under the downward-rate scenario; results depend on assumptions and are not forecasts.
• Key risks include COVID-19 and borrower credit quality, interest-rate and securities valuation changes, deposit volatility and public-fund outflows, acquisition approvals and integration, competition, regulatory requirements, and technology or cybersecurity disruption. Management reported no material change to previously disclosed risk factors and no pending legal proceeding it believed would materially affect the company.

Important facts for investors to verify

• How much of the reported earnings and balance-sheet growth is attributable to MNB, PPP fees, mortgage-sale gains, and other nonrecurring or acquisition-related effects.
• Landmark transaction approvals, closing timetable, final consideration, integration costs and expected benefits.
• PPP forgiveness timing, remaining deferred fees, and the effect of loan forgiveness on future loan balances and interest income.
• Credit trends, including reserve adequacy, criticized or classified commercial loans, non-accruals, borrower accommodations and the lagged effects of COVID-19.
• Deposit retention after seasonal and government-related inflows, especially the $43.4 million public deposit outflow after quarter-end, and the impact on liquidity and funding costs.
• Interest-rate effects on net interest margin, AFS securities values and equity; the filing notes that valuation and sensitivity estimates depend on assumptions.