Fidelity D & D Bancorp, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; balance-sheet comparisons are to December 31, 2017. Unaudited consolidated results. Amounts are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
Business context
The company is a Pennsylvania bank holding company operating The Fidelity Deposit and Discount Bank, a community bank serving primarily Lackawanna and Luzerne Counties. Its business includes commercial, consumer and residential lending, deposit gathering, and trust and financial services. The company operated a 10-branch network and was building a Back Mountain branch, expected to open in Q3 2018; it had also sought regulatory approval for a Mountain Top branch.
Financial performance and condition
| Metric | Q1 2018 / March 31, 2018 | Comparable period / prior balance |
|---|---|---|
| Net interest income | $7.259 million | $6.678 million in Q1 2017; up 9% |
| Net interest income, fully tax-equivalent (FTE) | $7.424 million | $6.987 million in Q1 2017 |
| Other income | $2.283 million | $2.105 million in Q1 2017; up 8% |
| Provision for loan losses | $0.300 million | $0.325 million in Q1 2017 |
| Other expenses | $6.208 million | $5.797 million in Q1 2017; up 7% |
| Net income | $2.528 million; $0.67 basic and diluted EPS | $1.980 million; $0.53 EPS in Q1 2017 |
| FTE net interest margin / spread | 3.68% / 3.52% | 3.72% / 3.58% in Q1 2017 |
| Efficiency ratio (non-GAAP) | 63.95% | 63.76% in Q1 2017 |
| Cash flow from operations | $3.408 million | $4.836 million in Q1 2017 |
| Total assets | $897.417 million | $863.637 million at December 31, 2017 |
| Total loans and leases, gross | $641.857 million | $638.599 million at December 31, 2017 |
| Total deposits | $775.291 million | $730.146 million at December 31, 2017 |
| Borrowings | $27.346 million | $39.706 million at December 31, 2017 |
| Shareholders’ equity | $87.502 million | $87.383 million at December 31, 2017 |
Net income increased 28% year over year. Management attributed the improvement principally to higher net interest income, increased non-interest income and lower income-tax expense, partly offset by higher operating expenses. The effective tax rate was 16.7%, versus 25.6% in Q1 2017, following the federal corporate tax-rate reduction from 34% to 21%.
Cash and cash equivalents ended the quarter at $36.305 million, up $20.480 million from year-end. Financing activities provided $32.040 million, mainly reflecting the $45.145 million increase in deposits, partly offset by lower short-term borrowings and repayment of FHLB advances; investing activities used $14.968 million. Management reported $544.8 million of combined cash, available-for-sale securities and loan-sale assets plus stated borrowing capacity, or 61% of total assets, and considered liquidity strong and adequate. Available additional capacity included $208.4 million from the FHLB, $21.0 million from correspondent banks, $68.6 million from the Federal Reserve and $43.2 million through CDARS.
Consolidated total capital to risk-weighted assets was 15.2%, Tier 1 common equity was 13.9%, and the leverage ratio was 10.0%. The company and bank exceeded applicable capital requirements. The quarterly dividend was $0.24 per share, compared with $0.20 in Q1 2017.
Material changes and asset quality
- Loans and leases grew modestly from year-end. Consumer loans, particularly auto loans and leases, increased; commercial and industrial and commercial real estate lending declined amid soft demand, competition and loan payoffs. Deposits rose 6%, including approximately $17 million of non-interest-bearing deposits from a new business relationship and seasonal public tax deposits.
- Non-performing assets were $7.064 million, or 0.79% of assets, versus $6.291 million and 0.73% at December 31, 2017; they were down from $10.893 million and 1.28% a year earlier. Non-accrual loans were $2.907 million, down from $3.441 million at year-end. Foreclosed assets increased to $1.401 million from $0.973 million at year-end.
- The allowance for loan losses was $9.408 million, 1.47% of gross loans, versus $9.193 million and 1.44% at year-end. Q1 net charge-offs were $85,000, compared with $141,000 in Q1 2017. Management cited improved delinquency trends in certain home-equity and owner-occupied commercial real-estate loans, while noting risks from economic weakness, property values and higher rates.
- Available-for-sale debt securities had $2.487 million of gross unrealized losses at March 31. The after-tax AOCI balance moved from $1.804 million of income at year-end to a $0.579 million loss, primarily reflecting interest-rate-related market-value declines. Management reported no other-than-temporary impairment and believed the losses were not credit-related.
- The company adopted new revenue-recognition guidance and ASU 2016-01 on January 1, 2018. Management reported no material overall impact from revenue guidance; ASU 2016-01 moved equity-security fair-value changes into net income and included a reclassification of prior unrealized gains. The filing reported a $64,000 Q1 loss on equity securities.
Outlook, commentary and risks
Management expected a gradually rising-rate environment and anticipated net interest income improvement as earning assets grow, while warning that a flattening yield curve and competition for deposits could compress margins and increase funding costs. The company expected loan and investment growth to help offset higher deposit and borrowing costs, and planned to continue emphasizing core deposits and customer relationships. Management expected consumer-loan growth to soften in 2018 and projected approximately $2.2 million of investment in the Back Mountain branch during the year. These are management expectations, not guarantees.
The company’s interest-rate model estimated that an immediate 200-basis-point increase would raise 12-month net interest income by 4.8%, while a 200-basis-point decrease would reduce it by 9.6%. The model estimated economic value of equity would decline 27.6% in the down-rate scenario. Results depend on model assumptions, including deposit repricing and prepayments.
Disclosed risks include local economic and borrower credit conditions, interest-rate and securities-market volatility, deposit competition and liquidity variability, regulatory and accounting changes, technology and cybersecurity events, and execution or integration risks. Management said there were no material changes to the risk factors in the 2017 Form 10-K. It reported no pending legal proceeding expected to have a material adverse effect and stated that disclosure controls were effective.
Important facts for investors to verify
- Whether deposit growth, including the new business relationship and seasonal public deposits, is retained and supports sustainable funding.
- Whether loan delinquency, TDRs, foreclosed assets and the allowance for loan losses develop consistently with management’s credit-quality assessment.
- How rising rates, deposit repricing and a flatter yield curve affect net interest margin, funding costs and the company’s modeled rate sensitivity.
- Whether unrealized securities losses remain interest-rate-related and temporary, and how further fair-value changes affect AOCI and capital.
- Whether planned branch construction and expansion meet expected cost, timing and regulatory milestones.