Fidelity D & D Bancorp, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Unaudited consolidated results. The company is a Pennsylvania bank holding company serving primarily Lackawanna and Luzerne Counties.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Interest income | $10.0M | $9.0M | $29.3M | $25.7M |
| Net interest income | $8.0M | $7.7M | $23.7M | $22.5M |
| Provision for loan losses | $0.3M | $0.4M | $0.8M | $1.1M |
| Other income | $2.6M | $2.3M | $7.6M | $6.9M |
| Other expenses | $6.6M | $6.2M | $19.8M | $18.5M |
| Net income | $3.1M | $2.9M | $8.9M | $8.2M |
| Diluted EPS | $0.80 | $0.75 | $2.32 | $2.15 |
- Q3 net income rose 7%; nine-month net income rose 9%. Growth reflected higher net interest and non-interest income and lower provision, partly offset by higher operating expenses.
- Net interest margin (FTE) was 3.49% in Q3 versus 3.56% a year earlier, and 3.55% year to date versus 3.61%. Net interest spread and margin narrowed as funding costs rose faster than asset yields. The efficiency ratio increased to 62.34% year to date from 61.91%.
- Return on average assets was 1.22% for Q3 and 1.21% year to date, unchanged from comparable 2018 periods. Return on average equity declined to 11.77% from 12.65% for Q3 and to 11.96% from 12.34% year to date.
Financial position, cash flow and liquidity
- Total assets were $1.011B at September 30, up $30.3M (3%) from year-end 2018. Net loans and leases were $739.3M, up from $718.3M; gross loans and leases increased 3%, led by residential real estate lending.
- Deposits increased $82.1M (11%) to $852.3M. Short-term borrowings fell to $24.4M from $76.4M and FHLB advances declined to $15.0M from $31.7M. Total borrowings were $39.4M, compared with $108.1M at year-end.
- Cash and cash equivalents were $18.7M. For the first nine months, operating cash flow was $21.6M, investing cash use was $31.0M, financing cash flow was $10.6M, and cash increased $1.2M.
- Management reported $681.4M of combined cash, available-for-sale investments and borrowing capacity, equal to 67% of assets, and considered liquidity strong and adequate. Available lines included $204.7M from FHLB, $21.0M from correspondent banks, $96.0M from the Federal Reserve and $150.0M from the Promontory program.
- Shareholders’ equity rose to $104.8M from $93.6M, including a $4.5M after-tax improvement in unrealized gains on securities. Regulatory capital ratios exceeded stated minimum requirements; consolidated total risk-based capital was 15.6% and Tier 1 leverage was 10.2%.
Material changes and asset quality
- Available-for-sale securities were $189.2M, with a $4.3M net unrealized gain at quarter-end versus a $1.4M net unrealized loss at December 31, 2018. Management attributed the change principally to interest-rate movements and reported no other-than-temporary impairment.
- Non-performing assets declined to $5.5M, or 0.55% of assets, from $6.3M, or 0.64%, at year-end. Non-accrual loans were $3.9M versus $4.3M; TDRs were $1.7M versus $3.5M. Foreclosed assets increased to $0.7M from $0.2M.
- The allowance for loan losses was $9.4M, 1.26% of loans, versus $9.7M, or 1.34%, at year-end. Nine-month net charge-offs rose to $1.1M from $0.4M, including a $0.4M charge-off to one commercial borrower and $0.3M of collection costs on residential loans sold to Fannie Mae. The company said it would pursue recovery of the latter costs.
- Loans 30–89 days past due totaled $2.5M; $7,000 was 90 days past due and still accruing. Management noted a significant commercial relationship could deteriorate from Special Mention to Substandard in Q4, though interest was being paid as agreed.
Outlook, commentary and risks
- Management expected a declining-rate environment in late 2019. It warned that yields on new and repricing assets could fall before deposit costs adjust, compressing margins; it planned to manage deposit pricing and pursue loan and low-cost deposit growth. Management expected continued residential loan growth and anticipated the October opening of its Mountaintop branch, with more than $2.0M of related 2019 investment.
- Management expected deposit costs to decline gradually, while noting potential growth in higher-rate money-market and certificate-of-deposit balances. Municipal and other public deposits may be volatile; $142.5M of public deposits were held at quarter-end, with $75.5M of securities pledged.
- Interest-rate simulations estimated net interest income would change +4.9% under an immediate +200 basis-point shock and −5.2% under a −200-basis-point shock. These model estimates depend on assumptions and are not guidance.
- Key disclosed risks include local economic and borrower-credit conditions, interest-rate and securities-market movements, deposit competition and funding costs, regulatory and capital requirements, litigation, technology and cybersecurity disruptions, and uncertainty in loan-loss and collateral estimates. Management said there were no material changes to the risk factors in its 2018 Form 10-K and no pending legal proceedings expected to have a material adverse effect.
- The company adopted lease accounting Topic 842 on January 1, 2019, recording right-of-use assets and lease liabilities; management reported no significant income-statement effect. CECL implementation was under evaluation; the filing said the expected effective-date deferral for smaller reporting companies would apply.
Important facts for investors to verify
- Whether deposit pricing declines quickly enough to limit further net interest margin compression.
- Credit performance and resolution of the identified commercial relationship, elevated net charge-offs, and recovery efforts on the Fannie Mae-related collection costs.
- Whether residential loan growth, deposit growth and branch investment produce returns sufficient to offset higher operating costs.
- Liquidity exposure to seasonal public deposits and the availability and terms of contingent borrowing sources.
- The eventual impact and timing of CECL adoption, and sensitivity of securities valuations and regulatory capital to interest-rate changes.