Fidelity D & D Bancorp, Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. The Pennsylvania bank holding company completed its acquisition of MNB Corporation on May 1, 2020; post-acquisition results include MNB from that date. Unless noted, amounts are consolidated and in U.S. dollars.
Financial performance and condition
| Metric | Q2 / June 30, 2020 | Comparable period / prior date |
|---|---|---|
| Net interest income | $10.8 million for Q2; $18.8 million for first half | Q2 2019: $7.8 million; first half 2019: $15.7 million |
| Net income | $0.3 million Q2; $2.9 million first half | Q2 2019: $3.0 million; first half 2019: $5.8 million |
| Diluted EPS | $0.05 Q2; $0.68 first half | Q2 2019: $0.79; first half 2019: $1.52 |
| Net interest margin (FTE) | 3.34% Q2; 3.39% first half | 3.54% and 3.58%, respectively, in 2019 |
| Efficiency ratio (non-GAAP) | 82.29% Q2; 75.37% first half | 61.47% and 62.82%, respectively, in 2019 |
| Total assets | $1.802 billion | $1.010 billion at December 31, 2019 |
| Loans and leases, net | $1.113 billion | $743.7 million at December 31, 2019 |
| Deposits | $1.434 billion | $835.7 million at December 31, 2019 |
| Shareholders’ equity | $157.2 million | $106.8 million at December 31, 2019 |
- First-half interest income rose to $22.0 million from $19.3 million, while interest expense fell to $3.1 million from $3.6 million. Net interest income growth reflected higher average earning assets, partly offset by lower yields.
- First-half provision for loan losses was $2.2 million, versus $0.5 million in 2019; Q2 provision was $1.9 million, versus $0.3 million. The allowance was $11.7 million, or 1.04% of reported loans, at June 30.
- First-half non-interest income increased to $5.5 million from $4.9 million. Non-interest expense rose to $18.6 million from $13.2 million, including merger costs and a $0.5 million FHLB prepayment penalty.
- First-half operating cash flow was negative $2.5 million, versus positive $12.8 million in 2019. Investing cash flow was negative $55.8 million and financing cash flow positive $307.4 million. Cash and cash equivalents ended at $264.8 million.
- Borrowings totaled $157.8 million: $152.8 million under the Paycheck Protection Program Liquidity Facility (PPPLF) and $5.0 million of FHLB advances. The company reported $157.2 million of total shareholders’ equity and a 15.9% consolidated total risk-based capital ratio.
- GAAP return on average assets and equity were 0.07% and 0.71% for Q2, and 0.46% and 4.63% for the first half. Management’s adjusted, non-GAAP first-half net income was $5.1 million and adjusted diluted EPS was $1.21, excluding merger expenses and the FHLB prepayment penalty.
Material changes and business developments
- The MNB acquisition expanded the company’s footprint into Northampton County and the Lehigh Valley. The company issued approximately 1.177 million shares valued at $45.4 million, recorded $6.8 million of goodwill, and reported preliminary acquisition-date assets of approximately $444.5 million and deposits assumed of $395.6 million.
- Gross loans increased 49% from year-end, mainly from approximately $232 million of acquired loans and $157 million of PPP lending. Excluding acquired and PPP loans, company-originated loans declined year to date.
- PPP lending comprised 1,439 loans totaling $157.1 million. Approximately $5.2 million of net fee income was received; $0.8 million was recognized in Q2 and $4.4 million remained unearned at quarter-end.
- Deposits increased 72% from year-end, reflecting the acquisition and elevated balances associated with PPP proceeds and other pandemic relief. Non-interest-bearing deposits rose to $414.9 million, 28.9% of total deposits.
- COVID-19 accommodations covered 1,429 loans with balances of $201.8 million, or 17.9% of reported loan balances. Commercial accommodations were $150.2 million, including substantial commercial real estate exposure.
- Non-performing assets were $5.6 million, 0.31% of assets, versus $5.0 million and 0.50% at year-end. Non-accrual loans increased to $4.3 million from $3.7 million.
Outlook, commentary, and risks
- Management expects a low interest-rate environment for the remainder of 2020 and warned that margin may compress if asset yields decline faster than funding costs. It plans to manage deposit pricing, grow low-cost deposits, and deploy them into earning assets. No specific earnings or revenue guidance was provided.
- Management expects PPP fee recognition and MNB loan growth to support interest income, and expects most PPP loans to be forgiven before year-end. It anticipated approximately $0.2 million of additional non-recurring merger and integration costs in 2020.
- Management stated that COVID-19’s duration and economic effects remained uncertain and could impair borrowers’ ability to repay. It increased qualitative credit-risk factors and said further provisioning may be required if economic conditions worsen. Local unemployment was reported at 15.3% in Scranton–Wilkes-Barre and 13.9% in Allentown–Bethlehem–Easton at June 30.
- The allowance-to-loans ratio was lower partly because PPP and acquired loans—about 34% of the portfolio—did not carry an initial allowance under the accounting treatment described. Acquired loan fair-value estimates were preliminary and subject to refinement.
- Management characterized liquidity as strong: reported cash, available-for-sale securities and loans held-for-sale, plus stated borrowing capacity, totaled approximately $1.1 billion, or 62% of assets. The company also noted public-deposit volatility, pledged securities, interest-rate risk, and risks from acquisition integration and pandemic-related credit deterioration.
- Q2 GAAP results included $1.9 million of merger-related expense and the $0.5 million FHLB prepayment penalty. Management’s non-GAAP adjusted Q2 net income was $2.2 million and adjusted diluted EPS $0.48; these measures are not substitutes for GAAP results.
Important facts for investors to verify
- Track subsequent performance and allowance needs for COVID-19-modified loans, especially commercial real estate exposures, and the status of repeat forbearance requests.
- Review acquired-loan credit performance, final purchase-accounting adjustments, integration costs, and whether expected synergies materialize.
- Monitor PPP forgiveness, fee recognition, and the associated PPPLF funding and repayment.
- Assess deposit retention after relief funds are spent, funding costs, liquidity needs, and sensitivity to interest-rate changes.
- Compare future GAAP earnings with management’s adjusted non-GAAP figures and assess whether cost increases are recurring or acquisition-related.