Fidelity D & D Bancorp, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019; unaudited consolidated results. The company is a Pennsylvania bank holding company operating primarily in Lackawanna and Luzerne Counties through Fidelity Deposit and Discount Bank.
Financial performance and position
| Metric | Q2 2019 / June 30, 2019 | Comparable period / prior year-end |
|---|---|---|
| Net income | $3.0 million; $0.79 diluted EPS | Q2 2018: $2.8 million; $0.73 diluted EPS |
| Six-month net income | $5.8 million; $1.52 diluted EPS | Six months 2018: $5.3 million; $1.40 diluted EPS |
| Net interest income | Q2: $7.8 million; six months: $15.7 million | Q2 2018: $7.5 million; six months 2018: $14.8 million |
| Interest and other income | Q2 interest income $9.7 million; other income $2.5 million | Q2 2018: $8.5 million and $2.4 million, respectively |
| Provision for loan losses | Q2: $255,000; six months: $510,000 | Q2 2018: $425,000; six months 2018: $725,000 |
| Net interest margin, FTE | Q2: 3.54%; six months: 3.58% | Q2 2018: 3.65%; six months 2018: 3.64% |
| Efficiency ratio | Q2: 61.47%; six months: 62.82% | Q2 2018: 61.20%; six months 2018: 62.55% |
| Return on average assets / equity | Q2: 1.25% / 12.16%; six months: 1.21% / 12.07% | Q2 2018: 1.24% / 12.60%; six months 2018: 1.20% / 12.18% |
At June 30, total assets were $997.0 million, up 2% from December 31, 2018. Deposits rose 9% to $839.6 million; loans and leases, net of allowance and unearned lease revenue, were $724.7 million, up from $718.3 million. Shareholders’ equity increased 8% to $101.4 million. Cash and cash equivalents were $19.2 million.
For the first six months, operating activities provided $12.8 million of cash; investing activities used $14.8 million and financing activities provided $3.6 million. Cash increased $1.7 million to $19.2 million. Total borrowings declined to $44.1 million from $108.1 million at year-end, principally as deposit growth funded repayment of short-term borrowings and FHLB advances. The company reported $201.4 million of additional FHLB borrowing capacity and stated total identified liquidity sources were approximately $662.9 million.
Regulatory capital remained above minimum requirements: consolidated total risk-based capital was 15.0%, Tier 1 common equity 13.8%, and leverage capital 10.3%. The company declared dividends of $0.26 per share in Q2 and $0.52 per share for the first half.
Changes versus comparable periods
- Q2 net income rose 8%; first-half net income rose 10%. Higher net interest and non-interest income and lower loan-loss provisions more than offset higher operating expenses.
- Net interest income increased, but funding costs rose faster than asset yields: first-half interest expense increased to $3.6 million from $1.9 million. The FTE net interest spread and margin narrowed year over year.
- First-half non-interest expense increased 7% to $13.2 million, including higher personnel, premises, data-processing and loan-collection costs; lower professional fees partially offset these increases.
- Nonperforming assets were $6.2 million, or 0.62% of assets, versus $6.3 million and 0.64% at year-end. Non-accrual loans were $4.1 million; the allowance was $9.5 million, or 1.29% of loans, versus 1.34% at year-end.
- Available-for-sale securities increased to $189.9 million. Their net unrealized position improved to a $3.0 million pretax gain from a $1.4 million loss at year-end, primarily reflecting interest-rate movements. Management reported no other-than-temporary impairment.
Outlook, risks and notable items
- Management expected a declining-rate environment and warned that lower yields on floating-rate and repricing assets could compress margins. It planned to manage deposit costs, pursue low-cost deposits and continue loan and securities growth. The filing reports a 25-basis-point Federal Reserve rate cut in July 2019, after quarter-end.
- Management expected modest single-digit commercial loan growth in the second half of 2019, continued residential loan growth, and deposit growth to fund assets and reduce borrowings. A new Mountaintop branch was scheduled to open in Q3 2019; branch construction and planned Main Branch remodeling were expected to increase investment and expenses.
- Reported first-half loan growth was affected by an $11.0 million commercial draw on June 26 that was repaid shortly after quarter-end. Excluding it, gross loans would have declined about $5.0 million from year-end.
- Credit risks include local economic conditions, commercial real estate exposure, and uncertainty in estimating the loan-loss allowance. Net charge-offs rose to $762,000 from $391,000 in the first half of 2018, largely due to a charge-off to one commercial borrower. Management said it expected a resolution of a non-accrual commercial loan in Q3 that could result in a $300,000 recovery and $100,000 of lost interest recognized.
- The company was evaluating the expected-credit-loss standard (CECL), effective for it beginning in 2020 under the then-current timetable; adoption could increase the allowance and accelerate loss recognition. A possible implementation delay was under consideration by the FASB.
- Interest-rate sensitivity modeling estimated that an immediate 200-basis-point rate decline could reduce 12-month net interest income by 6.5% and economic value of equity by 41.0%; a 200-basis-point increase had a much smaller modeled impact. These are model estimates, not forecasts.
- Management reported effective disclosure controls, no material change in internal controls, and no pending legal matter expected to have a material adverse effect. It reported no material changes to the risk factors in the 2018 Form 10-K.
Key facts for investors to verify
- Whether deposit growth is durable, particularly given seasonal public deposits and the temporary business deposit identified in the filing.
- How loan growth, the post-quarter repayment of the $11.0 million commercial draw, and subsequent originations affect reported balances and portfolio mix.
- Whether credit quality and charge-offs support the $9.5 million allowance, including developments in criticized commercial credits and the anticipated borrower resolution.
- How falling rates, deposit repricing and competitive funding costs affect net interest margin and earnings.
- The eventual CECL adoption date and quantified effect on the allowance, capital and retained earnings; the filing does not provide a clear estimated impact.
- Execution, costs and timing of the Mountaintop branch opening and Main Branch remodeling.