Fidelity D & D Bancorp, Inc. — Q3 2015 Form 10-Q
Business context and period. Unaudited consolidated results for the quarter and nine months ended September 30, 2015; balance-sheet comparisons are against December 31, 2014. The company is a Pennsylvania community bank operating primarily in Lackawanna and Luzerne Counties through 11 branches. Unless otherwise noted, amounts below are in millions of dollars.
Key financial metrics
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Interest income | $6.612 | $6.295 | $19.354 | $18.442 |
| Net interest income | $6.032 | $5.565 | $17.430 | $16.284 |
| Provision for loan losses | $0.200 | $0.210 | $0.500 | $0.810 |
| Other income | $2.023 | $1.748 | $5.606 | $5.307 |
| Other expenses | $5.239 | $4.910 | $16.070 | $14.456 |
| Income before taxes | $2.616 | $2.193 | $6.466 | $6.325 |
| Income tax provision | $0.687 | $0.562 | $1.184 | $1.611 |
| Net income | $1.929 | $1.631 | $5.282 | $4.714 |
| Diluted earnings per share | $0.79 | $0.67 | $2.16 | $1.95 |
| Net interest margin, FTE | 3.72% | 3.78% | 3.69% | 3.79% |
| Return on average assets | 1.06% | 0.98% | 1.00% | 0.97% |
| Return on average equity | 10.26% | 9.17% | 9.57% | 9.15% |
- Balance sheet at September 30: assets $729.2, up 8% from year-end 2014; net loans and leases $533.2; available-for-sale securities $126.8; deposits $643.0; shareholders’ equity $75.6.
- Funding and debt: deposits rose $56.1, or 10%, since year-end. Non-interest-bearing deposits increased to $150.7 from $129.4. Short-term borrowings were $6.7, compared with $4.0 at year-end; the $10.0 long-term FHLB advance was repaid during 2015.
- Cash flow, nine months: operating activities provided $13.6, investing activities used $60.8, and financing activities provided $47.0. Cash and equivalents declined $0.2 to $25.7. Operating cash flow included a reported $3.2 tax refund.
- Credit and capital: allowance for loan losses was $9.1, or 1.69% of loans. Non-performing loans were $4.6; non-performing assets were $8.1, or 1.11% of assets. Consolidated total risk-based capital was 15.1%, Tier 1 capital 13.8%, and leverage ratio 10.1%.
Material changes versus comparable periods
- Net income increased 18% year over year in Q3 and 12% for the first nine months. Higher net interest income and other income supported earnings; nine-month results also benefited from lower loan-loss provision and income taxes.
- Nine-month net interest income grew 7%, while FTE net interest margin fell 10 basis points to 3.69%. Management attributed margin pressure to asset yields declining faster than funding costs. Higher average loan balances drove much of the increase in interest income.
- Other expenses rose 11% for the nine months, mainly due to higher salaries and benefits, branch-related costs, professional fees, data processing and a $0.57 FHLB prepayment fee.
- Loans grew $26.9 since year-end, including growth in commercial and industrial lending. Securities increased $28.9, with mortgage-backed securities a larger share of the portfolio. Deposits funded much of this expansion.
- Non-performing loans declined from $5.3 at year-end to $4.6, but troubled debt restructurings increased to approximately $3.0 from $1.6. The allowance remained close to year-end despite loan growth.
Outlook, commentary and risks
- No formal earnings guidance was provided. Management expected Q4 2015 net interest income to improve as earning-asset volumes grow, while continuing to pursue loan growth, investment growth and low-cost deposits.
- Management expected low rates to persist in the near term, with increases more likely in 2016. It cautioned that margin compression could continue absent sustained yield-curve steepening, and that rising deposit costs could pressure earnings.
- Interest-rate simulations estimated a 4.5% increase in net interest income under an immediate 200-basis-point rate rise and a 1.6% decline under a 200-basis-point fall. Economic value of equity was estimated to decline 8.6% and 20.3%, respectively, in those scenarios.
- Liquidity sources totaled approximately $439.2, or 60% of assets, including cash, available-for-sale securities and loans held-for-sale, plus borrowing capacity. Management considered liquidity adequate; public-fund deposits may be volatile.
- Notable items include the $0.57 FHLB debt prepayment fee and a $0.4 income-tax credit in Q2 from an IRS audit adjustment relating to the tax basis of trust-preferred securities sold in 2013. The 2015 reserve methodology changes reduced estimated reserve requirements; management cited reductions of about $1.13 in aggregate across the described changes.
- Risks highlighted include local economic and borrower credit conditions, interest-rate and securities-market movements, deposit competition, regulatory and Basel III changes, technology and cybersecurity, litigation, and uncertainty in loan-loss and collateral estimates. Management reported no material change to previously disclosed risk factors and no pending legal proceedings expected to materially affect financial condition.
Most important facts for investors to verify
- Whether loan and deposit growth can continue without further margin deterioration or materially higher funding costs.
- The quality and performance of the increased TDR balances, criticized commercial loans and loans transferred to held-for-sale.
- Whether the allowance remains adequate after loan growth and the reserve methodology changes, which lowered calculated reserve needs.
- The sustainability of earnings excluding the one-time tax credit and effects of the FHLB prepayment fee.
- Exposure to rate changes, securities valuation declines, and potential volatility in public-fund deposits and other liquidity sources.