FIDELITY D & D BANCORP INC quarterly report, Q3 FY2013

Full document

Fidelity D&D Bancorp, Inc. — Q3 2013 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2013; financial statements are unaudited. The company operates Fidelity Deposit and Discount Bank, a Pennsylvania community bank serving customers in Lackawanna and Luzerne counties.

Financial performance and position

  • Q3 earnings: Net income was $1.505 million, or $0.64 per diluted share, versus $1.399 million and $0.61 a year earlier. For the first nine months, net income was $4.412 million, up 11% from $3.973 million; diluted EPS was $1.88 versus $1.74.
  • Interest income and margin: Q3 net interest income was $5.206 million, up 0.7% year over year; nine-month net interest income was $15.619 million, up 1%. On a fully taxable-equivalent basis, Q3 net interest margin declined to 3.74% from 3.79%; the nine-month margin rose to 3.81% from 3.78%.
  • Other income and costs: Other income was $1.908 million in Q3, little changed year over year, and $6.027 million for nine months, up 4%. Other expenses rose 4% in Q3 to $4.644 million and 1% for nine months to $14.131 million. Management cited compensation, card-processing and other costs.
  • Returns and dividends: Q3 ROA and ROE were 0.96% and 9.85%; nine-month figures were 0.96% and 9.78%. Dividends were $0.25 per share for Q3 and $0.75 for nine months, unchanged from comparable 2012 periods.
  • Balance sheet growth: Total assets were $640.3 million, up 6% from December 31, 2012. Gross loans and leases were $463.2 million, up 7%; deposits were $544.8 million, up 6%. Shareholders’ equity was $61.8 million, compared with $58.9 million at year-end 2012.
  • Funding and debt: Interest-bearing deposits totaled $410.7 million and non-interest-bearing deposits $134.1 million. Short-term borrowings were $14.2 million, up from $8.1 million; long-term debt remained $16.0 million. Total liabilities were $578.5 million.
  • Cash flow and liquidity: Nine-month operating cash flow was $19.3 million, investing cash outflow was $40.8 million and financing cash inflow was $35.6 million. Cash and cash equivalents ended at $35.9 million, up from $21.8 million at year-end. Management reported $374.5 million of cash, specified liquid assets and available borrowing capacity, or 58% of assets, and considered liquidity adequate.
  • Capital: The company and bank reported total risk-based capital ratios of 13.9%, Tier 1 risk-based ratios of 12.6%, and leverage ratios of 10.0%; management said both exceeded applicable capital requirements.

Material changes and credit quality

  • Loan growth was concentrated in commercial real estate (up $11.3 million), residential real estate (up $12.0 million), and consumer loans (up $4.8 million). Automobile loans and leases increased $3.4 million; auto leasing operations began in Q1 2013.
  • Non-performing loans declined to $6.5 million from $13.8 million at year-end 2012. Non-performing assets fell to $11.7 million from $17.7 million, or 1.82% of assets versus 2.94%.
  • The allowance for loan losses was $8.4 million, down from $9.0 million at year-end; provision expense was $1.6 million for nine months versus $2.0 million. Nine-month net charge-offs were $2.2 million, compared with $2.0 million in 2012. Foreclosed assets increased to $3.0 million from $1.6 million.
  • Available-for-sale securities were $102.9 million. The portfolio moved from a $0.2 million accumulated unrealized gain at year-end to a $0.7 million accumulated unrealized loss, net of tax, at September 30. Management attributed much of the securities volatility to interest rates and illiquidity. Pooled trust preferred securities had $6.1 million amortized cost and $2.9 million fair value; no credit-related impairment charge was recorded in 2013.
  • Operating cash flow improved from $8.7 million in the first nine months of 2012, while cash at period-end was below the prior-year $45.6 million. Loan growth and securities purchases contributed to investing outflows; deposit growth and borrowings supported funding.

Outlook, commentary and risks

  • No specific earnings or financial guidance was provided. Management expected low interest rates to continue pressuring asset yields and potentially the net interest margin. It described gradually rising market rates as a possible source of higher deposit costs, while loan rates may not rise as quickly.
  • Management plans to pursue loan growth and attract low-cost, non-interest-bearing deposits. It described local economic improvement as slow and noted local unemployment remained elevated and area foreclosures rose nearly 26% year over year in Q3 2013.
  • Management identified risks from borrower repayment capacity, local real estate conditions, interest-rate movements, securities-market volatility, competition, regulation and changes in capital and liquidity requirements. A positive one-year cumulative interest-rate gap was reported; modeled +200-basis-point rates increased projected 12-month net interest income 7.6%, while -200 basis points reduced it 3.2%.
  • Basel III rules were expected to phase in for community banks beginning in 2015; the company was assessing their effects. Management reported effective disclosure controls and no material changes to internal control over financial reporting. It reported no material pending legal proceedings and no material changes to previously disclosed risk factors.
  • Unusual or judgment-sensitive items include the Level 3 valuation of illiquid pooled trust preferred securities, allowance estimates, and the increase in foreclosed assets. Management cautioned that future securities analyses could result in additional impairment charges.

Important facts for investors to verify

  • Whether improvement in non-performing loans is sustained, and how charge-offs, foreclosed assets and the allowance develop relative to loan growth.
  • The sensitivity of earnings and funding costs to changing interest rates, including the assumptions underlying the company’s interest-rate simulations.
  • The valuation and expected cash flows of pooled trust preferred securities, including the substantial difference between amortized cost and fair value.
  • Whether deposit growth and available borrowing capacity remain sufficient to fund continued loan growth and seasonal public-deposit volatility.
  • The future effects of Basel III implementation and the company’s plans for capital, expenses and margin management.