Fidelity D & D Bancorp, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods unless otherwise noted. The company is a Pennsylvania community bank holding company operating primarily in Lackawanna and Luzerne Counties. Dollar amounts below are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income | $7.05 | $6.42 | $20.79 | $18.70 |
| Other income | $2.25 | $2.02 | $6.48 | $5.81 |
| Provision for loan losses | $0.38 | $0.23 | $0.93 | $0.65 |
| Income before taxes | $2.88 | $2.81 | $8.47 | $7.70 |
| Net income | $2.23 | $2.04 | $6.39 | $5.66 |
| Diluted EPS | $0.60 | $0.55 | $1.72 | $1.54 |
Net income rose 9% for the quarter and 13% year to date. Management attributed the gains to higher revenue, which more than offset increased operating expenses and loan-loss provisions. Q3 non-interest expense rose 12% to $6.04 million; nine-month expense rose 11% to $17.88 million. The nine-month effective tax provision was broadly unchanged despite higher pretax income, partly reflecting tax benefits from exercised stock options and increased tax-exempt income.
- Margins and returns: Fully tax-equivalent net interest margin was 3.67% for Q3 (3.78% in 2016) and 3.72% year to date (3.71% in 2016). ROA was 1.03% and 1.02%, respectively; ROE was 10.36% and 10.24%.
- Balance sheet at September 30: Assets were $878.3 million, up 11% from year-end 2016. Net loans were $625.1 million; available-for-sale securities were $152.0 million; cash and equivalents were $41.9 million. Deposits were $748.6 million, up $45.1 million since year-end. Shareholders’ equity was $86.3 million.
- Funding and liquidity: Short-term borrowings were $12.9 million and FHLB advances were $23.7 million, versus $4.2 million and no FHLB advances, respectively, at year-end 2016. Management reported $525.9 million of cash, securities, loans held for sale and borrowing capacity, equal to 60% of assets, and described liquidity as strong and adequate.
- Cash flows, nine months: Operating activities provided $11.5 million; investing activities used $57.6 million, including $39.3 million of net loan growth, $36.8 million of securities purchases and an $8.0 million BOLI purchase; financing activities provided $62.2 million. Cash and equivalents increased $16.0 million to $41.9 million.
- Capital: Consolidated total risk-based capital was 14.8%, Tier 1 risk-based capital 13.5%, and Tier 1 leverage 9.8%. The company and bank exceeded applicable regulatory capital requirements.
Material changes and notable items
- Gross loans increased 6% to $635.1 million from year-end, including 14% growth in commercial and industrial loans and substantial growth in auto loans and leases. Growth was partly offset in Q3 by approximately $6 million of cash received from two commercial real estate loan payoffs.
- Asset quality improved on several reported measures: non-accrual loans declined to $3.9 million from $7.4 million at year-end; non-performing loans were 0.61% of total loans versus 1.23%. The allowance was $9.4 million, or 1.47% of loans, compared with 1.56% at year-end. Net charge-offs for the first nine months were $0.93 million.
- Total troubled debt restructurings increased to $3.9 million from $3.3 million at year-end; four TDRs totaling $2.0 million were on non-accrual. Management cited six new accruing CRE TDRs as the principal source of the increase.
- On March 17, 2017, the company acquired Wayne Bank’s West Scranton branch deposits, certain loans and premises, then closed and consolidated the acquired branch. The transaction included $13.8 million of assumed liabilities and $0.2 million of goodwill.
- The company purchased $8.0 million of BOLI in March and introduced supplemental executive retirement and split-dollar life benefit arrangements in 2017. It also declared a three-for-two stock split, distributed September 28; comparative per-share data were adjusted retroactively.
- Dividends were $0.21 per share for Q3 and $0.62 per share for nine months; the nine-month payout ratio was 36.2%.
Outlook, risks and contingencies
- Management expected gradual rate increases and anticipated loan and securities growth could support net interest income. It also warned that a flatter yield curve, faster increases in short-term rates, and competition for deposits could raise funding costs and compress margins.
- The company reported a positive one-year cumulative interest-rate gap of $75.2 million. Its model estimated that an immediate 200-basis-point increase would raise 12-month net interest income 5.5%, while a 200-basis-point decrease would reduce it 7.8%. The modeled economic value of equity changed +0.5% and -29.8%, respectively; management noted the limitations and assumptions inherent in these models.
- Management expected modest loan growth for the rest of 2017, with deposit growth intended to fund lending and reduce borrowings. A new Dallas, Pennsylvania branch was under construction and expected to open in Q3 2018.
- Credit risks include local economic conditions, commercial real estate values, elevated regional residential-property delinquency and negative-equity measures cited by management, and borrowers’ ability to repay if rates rise. Management said the allowance was adequate but acknowledged estimates may change and future charge-offs or reserve increases could be required.
- The filing identifies regulatory, competitive, cybersecurity, interest-rate, market, litigation, acquisition-integration and accounting-change risks. No material legal proceeding or material change to previously disclosed risk factors was reported. Management stated disclosure controls were effective and reported no material quarterly change in internal control over financial reporting.
- Accounting standards under evaluation include expected credit losses (ASU 2016-13), leases (ASU 2016-02) and other new guidance. Management said the expected-credit-loss standard could increase the allowance; the lease standard could significantly affect the balance sheet. No formal earnings guidance was provided.
Most important facts for investors to verify
- Whether loan growth, especially in commercial lending and auto loans, is accompanied by stable underwriting and credit performance; track non-accruals, TDRs, charge-offs and reserve coverage.
- Whether deposit growth can fund asset growth and reduce reliance on borrowings without materially increasing deposit costs or compressing the net interest margin.
- How actual results compare with management’s rate-sensitivity scenarios, particularly if short-term rates rise faster than longer-term rates.
- The returns and balance-sheet effects of the securities purchases, additional BOLI, branch construction and executive benefit arrangements.
- Regulatory capital and liquidity measures, and the eventual financial effects of new credit-loss and lease accounting standards.