Business context and reporting period
Fidelity D & D Bancorp, Inc. is a Pennsylvania bank holding company operating The Fidelity Deposit and Discount Bank. It provides banking, trust, wealth-management and related services, primarily in Lackawanna and Luzerne Counties. This Form 10-K covers the fiscal year ended December 31, 2017; comparative figures are for 2016 unless noted. The financial statements received an unqualified audit opinion, and the auditor also opined that internal control over financial reporting was effective.
Financial performance and condition
- Growth and balance sheet: Total assets rose 9% to $863.6 million. Gross loans and leases increased 7% to $638.6 million; deposits rose 4% to $730.1 million. Shareholders’ equity was $87.4 million, or 10.1% of assets.
- Earnings: Net income increased 13% to $8.7 million; diluted EPS was $2.33 versus $2.09. Net interest income grew 11% to $27.8 million, and non-interest income rose 5% to $8.4 million. Provision for loan losses was $1.45 million, up from $1.03 million.
- Margins and expenses: Net interest margin was 3.70%, down from 3.72%; the efficiency ratio worsened to 66.25% from 63.20%, as operating expenses rose 15% to $24.8 million. Return on average assets was 1.03% and return on average equity was 10.34%.
- Credit quality: Non-performing assets fell to $6.3 million, or 0.73% of assets, from $10.5 million, or 1.33%. Non-performing loans were 0.54% of loans versus 1.23%. The allowance was $9.2 million, equal to 1.44% of loans, down from 1.57%; net charge-offs rose to $1.62 million from $1.19 million.
- Funding, debt and liquidity: Year-end short-term borrowings were $18.5 million and FHLB advances were $21.2 million, compared with $4.2 million and no FHLB advances in 2016. Cash and cash equivalents were $15.8 million, down from $25.8 million. Management reported $513.4 million of cash, liquid assets and available borrowing capacity, equal to 59% of assets, and described liquidity as strong and adequate.
- Capital: Consolidated total risk-based capital was 14.9%, common equity Tier 1 was 13.7%, and the leverage ratio was 9.9%. The company and bank exceeded applicable capital requirements.
- Cash flow: Operating activities provided $13.9 million; investing activities used $69.8 million and financing activities provided $45.9 million. Cash and cash equivalents declined $10.0 million during the year.
Material changes versus 2016
- Net income improved, supported by higher net interest income and a $1.6 million reduction in income tax expense, despite increased operating expenses and loan-loss provision.
- The 2017 income tax provision included a $1.1 million benefit from remeasuring deferred taxes following enactment of the Tax Cuts and Jobs Act. The company also reported one-time fourth-quarter actions related to the tax change, including charitable giving, employee bonuses, securities sales at a loss and early termination of a former branch lease.
- Loan growth included a substantial increase in auto loans and leases, which rose to $83.5 million from $56.8 million. Investment securities increased 21% to $157.4 million, with mortgage-backed securities representing about 66% of the portfolio.
- The company acquired Wayne Bank’s West Scranton branch in March 2017, assuming approximately $13.8 million of deposits; it consolidated the acquired business into its nearby branch. A three-for-two stock split was effected as a 50% stock dividend in 2017.
Outlook, risks and contingencies
Management expected continued balance-sheet and loan growth in 2018, funded mainly by deposits and supplemented by borrowings. It projected about 6% commercial-loan growth and 10% consumer-loan growth, anticipated higher net interest income but a lower net interest margin, and planned to repay $4.5 million of FHLB advances. A new Dallas, Pennsylvania branch was expected to open in the third quarter of 2018, with approximately $2.2 million of investment planned. Management’s commentary on asset quality is mixed: it noted that non-accrual loans could increase in 2018, while also expressing an expectation of further improvement in asset quality.
Key risks include local economic weakness; borrower repayment and real-estate collateral risk; rising funding costs and interest-rate exposure; growing auto-loan exposure; competition; regulatory and compliance costs; cybersecurity and technology disruptions; and uncertainty in estimating loan-loss reserves and securities values. Management reported ordinary-course litigation but no pending matter expected to have a material adverse effect. The company also disclosed that the expected-credit-loss accounting standard could increase its allowance and accelerate loss recognition; its impact was still under evaluation.
Important facts for investors to verify
- How much of 2017 earnings growth was recurring versus attributable to the $1.1 million tax-related benefit and other one-time fourth-quarter items.
- Whether loan-loss reserves remain adequate as auto lending expands, net charge-offs rise and management cites possible increases in non-accrual loans.
- Deposit pricing, public-fund deposit volatility, borrowing needs and the effect of higher rates on net interest margin.
- Execution and cost of the planned Dallas branch, and progress toward management’s loan-growth and asset-quality objectives.
- Capital and liquidity metrics, including the availability and conditions attached to reported borrowing capacity; note that reported liquidity sources include both on-balance-sheet assets and contingent facilities.