Fidelity D & D Bancorp, Inc. — Q1 2019 Form 10-Q
Business context and reporting period. This unaudited filing covers the three months ended March 31, 2019, with balance-sheet comparisons to December 31, 2018. The Pennsylvania bank holding company operates through Fidelity Deposit and Discount Bank, serving Lackawanna and Luzerne Counties in northeastern Pennsylvania.
Financial performance and position
| Metric | Q1 2019 / March 31, 2019 | Comparable period / prior year-end |
|---|---|---|
| Net income | $2.80 million; diluted EPS $0.73 | Q1 2018: $2.53 million; diluted EPS $0.67 |
| Net interest income | $7.91 million | Q1 2018: $7.26 million |
| Net interest margin (FTE) | 3.62% | Q1 2018: 3.64% |
| Non-interest income / expense | $2.46 million / $6.77 million | Q1 2018: $2.28 million / $6.21 million |
| Efficiency ratio (non-GAAP) | 64.15% | Q1 2018: 63.95% |
| Total assets | $964.2 million | December 31, 2018: $981.1 million |
| Loans and leases, net | $703.0 million | December 31, 2018: $718.3 million |
| Total deposits | $825.3 million | December 31, 2018: $770.2 million |
| Borrowings | $27.6 million | December 31, 2018: $108.1 million |
| Shareholders’ equity | $97.7 million | December 31, 2018: $93.6 million |
| Cash and cash equivalents | $15.3 million | December 31, 2018: $17.5 million |
- Earnings and revenue: Net income rose 11% year over year. Net interest income increased 9%; total interest income rose $1.5 million, while interest expense increased $0.9 million. The provision for loan losses was $0.26 million versus $0.30 million.
- Profitability and costs: Return on average assets was 1.18% and return on average equity was 11.98%, versus 1.17% and 11.75%, respectively, in Q1 2018. Operating expenses increased 9%, primarily from salaries, new positions, branch costs and data processing.
- Cash flow: Operating activities provided $8.2 million and investing activities provided $15.8 million; financing activities used $26.2 million. Cash declined $2.2 million during the quarter.
- Credit quality: The allowance for loan losses was $9.5 million, or 1.34% of loans. Net charge-offs were $0.48 million, compared with $0.09 million in Q1 2018; the company attributed much of the increase to a single commercial borrower. Non-performing loans were $4.27 million and non-performing assets were $5.98 million, or 0.62% of assets.
- Capital and liquidity: The consolidated total risk-based capital ratio was 15.2%; management reported that the company and bank exceeded applicable capital requirements. Management described liquidity as strong and adequate, citing $697.9 million in cash, securities, loans held for sale and available borrowing capacity, equal to 72% of assets. This total includes contingent funding sources, not just cash.
Material changes versus comparable periods
- Average interest-earning assets grew $80.2 million year over year, and their yield increased 33 basis points. However, funding costs rose: the cost of interest-bearing liabilities increased 47 basis points, contributing to a 2-basis-point decline in FTE net interest margin.
- Deposits increased $55.1 million from year-end, including $35.9 million in non-interest-bearing deposits, partly reflecting seasonal public tax deposits. Borrowings fell $80.5 million as deposits grew and the company repaid $10 million of FHLB advances.
- Gross loans and leases declined $15.6 million from year-end, mainly from commercial loan payoffs and slower indirect auto originations. Non-accrual loans decreased to $3.75 million from $4.30 million, while loans 90 days or more past due and still accruing rose to $0.52 million from approximately zero.
- Available-for-sale securities had a $1.1 million net unrealized gain at quarter-end, compared with a $1.4 million net unrealized loss at year-end. The resulting $1.99 million after-tax other comprehensive income materially increased reported comprehensive income and equity.
Outlook, commentary and risks
- Management expected net interest income to improve over the remainder of 2019 as earning-asset growth offsets higher deposit and borrowing costs. It cautioned that a flat or inverted yield curve could compress margins; management also expected deposit funding costs to rise.
- Management reported increased new commercial lending opportunities in April and expected originations to pick up during the rest of 2019. It planned to focus on deposit growth to fund asset growth and reduce short-term borrowings, while noting seasonal public deposits may be volatile.
- The company planned to open a Mountaintop, Pennsylvania branch in Q3 2019, with approximately $1.5 million of expected 2019 investment, and anticipated remodeling the main branch. Management also expected premises and equipment to increase during 2019.
- Interest-rate simulations estimated that an immediate 200-basis-point increase would raise 12-month net interest income 1.5%, while a 200-basis-point decrease would reduce it 8.6%. The filing notes model assumptions and limitations; the results are estimates, not forecasts.
- Unrealized losses on certain securities were attributed by management to interest-rate movements and considered temporary; no other-than-temporary impairment was identified. A rising-rate environment could nevertheless reduce securities values.
- The company adopted lease accounting in Q1 2019, recognizing a $4.1 million right-of-use asset and approximately $4.6 million lease liability, with a $0.1 million reduction to equity and no significant income-statement effect. CECL was not yet adopted; management was assessing its effect and anticipated it could increase the allowance and accelerate loss recognition.
- Other disclosed risks include local economic and borrower conditions, competition, deposit pricing, interest-rate changes, credit-loss estimation, regulation, technology and cybersecurity, and litigation. Management reported no material change to previously disclosed risk factors and no pending litigation expected to materially affect financial condition.
Important facts for investors to verify
- Whether deposit growth, particularly seasonal public deposits, is sustained and how funding costs affect the net interest margin.
- Whether loan originations recover and whether elevated commercial charge-offs or past-due loans lead to further credit losses or allowance changes.
- The durability of reported earnings after higher operating expenses, and whether management’s 2019 net-interest-income outlook is achieved.
- Exposure to interest-rate movements, including securities valuation changes and the assumptions underlying the sensitivity simulations.
- Actual costs and timing of the Mountaintop branch and main-branch remodeling, and the eventual effect of CECL adoption on reserves and capital.