Fidelity D & D Bancorp, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Unaudited consolidated results are for the Pennsylvania bank holding company and its wholly owned bank, serving Lackawanna and Luzerne Counties. Dollar figures below are in millions unless noted.
Financial performance and condition
- Q2 earnings: Net income was $1.928 million, up 8% from $1.780 million; diluted EPS was $0.79 versus $0.73. For the first half, net income was $3.629 million, up 8% from $3.353 million, and diluted EPS was $1.48 versus $1.37.
- Interest and other income: Q2 net interest income rose 6% to $6.141 million; first-half net interest income rose 8% to $12.279 million. Other income was $2.100 million in Q2 and $3.787 million for the half, up 15% and 6%, respectively. Higher deposit service charges contributed to the first-half increase.
- Margins and returns: Fully tax-equivalent net interest margin was 3.66% in Q2, down from 3.72%; first-half margin was unchanged at 3.68%. Q2 ROA was 1.03% and ROE 9.80%; first-half ROA was 0.97% and ROE 9.32%.
- Expenses, credit costs and taxes: Q2 non-interest expense fell 7% to $5.369 million, largely because the prior-year quarter included a $0.570 million FHLB prepayment fee. First-half expense declined 1% to $10.757 million. Loan-loss provision was $0.275 million in Q2 and $0.425 million for the half, versus $0.150 million and $0.300 million in 2015. First-half income-tax expense increased to $1.255 million from $0.497 million; Q2 2015 included an audit-related tax benefit, making the comparison unusually favorable to 2015.
- Balance sheet at June 30: Assets were $756.5 million, up 4% from year-end 2015; deposits rose 7% to $663.3 million. Net loans and leases were $552.0 million, up from $546.7 million. Shareholders’ equity increased to $80.4 million from $76.4 million.
- Funding and liquidity: Cash and cash equivalents were $27.9 million. Short-term borrowings fell to $7.3 million from $28.2 million; no long-term debt was reported at June 30. Management reported $460.9 million of cash, securities and loans held for sale plus available borrowing capacity, or 61% of assets. The company reported $122.0 million of pledged securities for public deposits and repurchase agreements.
- Cash flow, first half: Operating activities provided $5.9 million, investing activities used $10.8 million, and financing activities provided $20.4 million. Cash and cash equivalents increased $15.6 million to $27.9 million.
- Capital and distributions: Consolidated total risk-based capital ratio was 15.3%, Tier 1 common equity ratio 14.0%, and leverage ratio 10.2%. First-half dividends declared were $1.383 million; dividends per share were $0.56, versus $0.52 in the first half of 2015.
Material changes and credit quality
- Deposit growth, including public and transaction-account balances, funded investment growth and repayment of short-term borrowings. Management noted that public deposits can be seasonal and volatile.
- Consumer loans grew approximately $9 million from year-end, led by auto loans and leases, which increased about $8.1 million. Residential loans rose $4.8 million. Commercial and industrial loans fell $5.0 million and commercial real estate loans declined $3.8 million, largely reflecting several large payoffs; management anticipated possible further commercial-loan reductions.
- Non-performing assets were $9.871 million, or 1.30% of assets, down from $12.856 million, or 1.76%, at year-end. Non-accrual loans declined to $5.918 million from $9.003 million, primarily after payoff of a large commercial real estate loan. Foreclosed assets increased to $1.555 million from $1.074 million.
- The allowance for loan losses was $9.207 million, or 1.64% of loans, compared with $9.527 million, or 1.71%, at year-end. First-half net charge-offs were $0.745 million, up from $0.214 million in the 2015 comparable period.
- Troubled debt restructurings totaled about $2.5 million. Two previously restructured commercial real estate loans, with a combined recorded investment of $151,000, subsequently defaulted during the first half.
- Available-for-sale securities were $129.8 million, with a $5.6 million gross net unrealized gain before tax; accumulated other comprehensive income was $3.7 million after tax. Management reported no other-than-temporary impairment and attributed the limited unrealized losses to interest-rate movements.
Outlook, risks and unusual items
- Management expected moderate asset growth for the rest of 2016, primarily funded by transactional deposits, and anticipated improved net interest income as earning assets grew. It cautioned that margin could remain under pressure unless the yield curve steepened; deposit competition and faster increases in short-term rates could also compress spreads.
- Management described the local economy as challenging and said it would scrutinize growth with credit quality as a principal consideration. Key exposures include borrower repayment capacity, commercial real estate and residential property values, interest-rate changes, deposit outflows, and seasonal public deposits.
- In the company’s interest-rate simulation, a 200-basis-point increase was projected to raise 12-month net interest income 5.2%; a 200-basis-point decline was projected to reduce it 1.9%. Economic value of equity was projected to fall 27.2% under the declining-rate scenario. These are model estimates, not forecasts.
- The filing identifies risks from economic conditions, regulation and capital requirements, competition, technology and cybersecurity, litigation, market volatility, and the accuracy of loan-loss and asset-valuation estimates. Management said risk factors had not materially changed from the 2015 Form 10-K.
- The company adopted a stock-compensation accounting update in Q1 2016 and did not expect a material impact. It was evaluating the effect of the new expected-credit-loss standard, which could increase the allowance and accelerate loss recognition when adopted; the filing does not quantify that effect.
- The Eynon branch closed in Q1 2016. Management said the closure improved the cost structure with minimal customer disruption. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. No material pending legal proceedings were reported.
Important facts for investors to verify
- Whether deposit growth is durable, particularly given public-deposit seasonality, and how pledged collateral and borrowing capacity support liquidity.
- Whether the decline in non-accrual loans and non-performing assets persists, and whether commercial real estate loan quality, TDR performance, and charge-offs warrant further provision.
- Whether consumer and residential loan growth can offset anticipated commercial-loan payoffs without weakening underwriting or returns.
- How actual net interest income and margin respond to rate changes compared with management’s simulations, including deposit repricing and securities valuation effects.
- The effect of the prior-year tax audit adjustment and FHLB prepayment fee on period comparisons, and the eventual effect of the expected-credit-loss accounting standard.