Fidelity D & D Bancorp, Inc. — 2016 Form 10-K
Business and period: Pennsylvania bank holding company operating The Fidelity Deposit and Discount Bank, a community bank serving Lackawanna and Luzerne Counties. The filing covers the fiscal year ended December 31, 2016; amounts below are in U.S. dollars. The bank operated 10 full-service offices and reported 167 full-time-equivalent employees. Its core business is commercial, consumer and residential lending, deposits, trust and financial services.
Financial and operating performance
| Metric | 2016 | 2015 | Change or context |
|---|---|---|---|
| Total assets | $792.9 million | $729.4 million | Up 9% |
| Total loans and leases, gross | $598.0 million | $556.5 million | Up $41.4 million, or 7%; net loans were $588.1 million |
| Total deposits | $703.5 million | $620.7 million | Up $82.8 million, or 13% |
| Net interest income | $25.1 million | $23.5 million | Up 7% |
| Net interest margin | 3.72% | 3.70% | Up 2 basis points |
| Net income | $7.7 million | $7.1 million | Up 8%; diluted EPS was $3.13 versus $2.90 |
| Return on average assets / equity | 1.02% / 9.64% | 1.00% / 9.55% | Both improved slightly |
| Other income / operating expense | $8.0 million / $21.7 million | $7.5 million / $21.0 million | Income up 6%; expense up 3% |
| Provision for loan losses | $1.0 million | $1.1 million | Lower despite loan growth |
| Cash and cash equivalents | $25.8 million | $12.3 million | Year-end balance; cash increased $13.6 million during 2016 |
Net cash provided by operating activities was $15.9 million; investing activities used $58.2 million and financing activities provided $55.9 million. The allowance for loan losses was $9.4 million, or 1.57% of loans, compared with $9.5 million, or 1.71%, in 2015. Net charge-offs rose to $1.2 million from $0.7 million.
Debt, liquidity and capital: Year-end short-term borrowings were $4.2 million, down from $28.2 million; the company had no long-term debt. It reported $194.3 million of available FHLB borrowing capacity and total stated liquidity sources of $453.5 million, or 57% of assets, including cash, securities and other borrowing facilities. Consolidated total risk-based capital was 14.9%, Tier 1 common equity was 13.6%, and the leverage ratio was 10.3%; the company and bank exceeded applicable capital requirements. Shareholders’ equity was $80.6 million, 10.2% of assets.
Material changes and notable items
- Net income increased primarily because net interest income rose $1.7 million and non-interest income rose $0.5 million, partly offset by a $0.6 million increase in operating expenses.
- Deposit growth included a $48.7 million temporary non-interest-bearing deposit received at year-end and transferred to a trust escrow account in January 2017. The deposit materially boosted reported year-end deposits and was not expected to remain as ordinary funding.
- Consumer loans grew $35.3 million, or 31%, largely from auto lending; auto loans and leases increased about $27.1 million. Commercial and industrial loans declined $4.2 million, while commercial real estate loans increased $2.4 million.
- Non-performing assets declined to $10.5 million, or 1.33% of assets, from $12.9 million, or 1.76%. Non-performing loans were $7.4 million, down from $9.4 million. Troubled debt restructurings increased to $3.4 million from $2.4 million; two 2016 TDRs totaling approximately $1.5 million were on non-accrual, and one modified HELOC subsequently defaulted.
- Available-for-sale securities had a $1.2 million pre-tax decline in net unrealized gains; accumulated other comprehensive income fell to $1.4 million from $2.2 million. Management attributed market-value declines to interest-rate movements and reported no other-than-temporary impairment charges.
- The effective tax rate rose to 26.5% from 20.4%. The 2015 comparison included a $0.4 million IRS audit-related tax credit; 2016 had no corresponding benefit. In 2015 the company also incurred a $0.6 million prepayment fee to retire high-cost long-term debt.
Outlook, risks and contingencies
Management expected modest overall loan portfolio growth of about 7.1% in 2017, with emphasis on commercial and consumer lending, and planned further investment portfolio growth weighted toward mortgage-backed securities. It expected net interest income to improve with balance-sheet growth but anticipated net interest margin to decline amid higher deposit and borrowing costs and a potentially flatter yield curve. Management also expected non-accrual loans and foreclosures to increase in 2017, despite its stated expectation of longer-term asset-quality improvement.
- A branch-deposit transaction, including certain loans and fixed assets, was expected to close in the first quarter of 2017; the filing does not provide a clear purchase price. The company also expected to assume bank trust accounts, increasing annual trust fees by about $0.4 million. A new Dallas branch was targeted for the fourth quarter of 2017.
- Management identified local economic weakness as a key credit risk: Scranton-Wilkes-Barre unemployment increased to 5.5% from 4.7%, despite improvement in the national rate. The loan book is geographically concentrated, and about 73% of loans were secured by real estate.
- Other principal risks include borrower defaults and collateral values, interest-rate and securities-price movements, deposit volatility and competition, regulatory and compliance costs, cybersecurity and technology disruptions, and the adequacy of the loan-loss allowance. A 200-basis-point rate increase was modeled to increase 12-month net interest income by 2.9%; a 200-basis-point decrease was modeled to reduce it by 4.0%. The model is assumption-dependent.
- Off-balance-sheet commitments included $128.5 million to extend credit and $7.6 million of standby letters of credit. Management reported no pending legal proceedings expected to have a material adverse effect, beyond routine litigation.
- The board approved purchasing up to $8.0 million of additional bank-owned life insurance in 2017. The company also declared $1.24 per share of dividends for 2016, including a $0.10 special dividend in the fourth quarter; future dividends remain subject to earnings, capital and regulatory considerations.
The independent auditor gave an unqualified opinion on the consolidated financial statements. The auditor did not attest to internal control over financial reporting; management concluded those controls were effective as of December 31, 2016.
Important facts for investors to verify
- How much of reported deposit growth and year-end liquidity depended on the temporary $48.7 million deposit, and how funding changed after its January transfer.
- Whether rapid auto-loan growth maintained the credit quality and loss performance assumed by management, and how charge-offs, delinquencies and the allowance evolve.
- Progress and final terms of the branch-deposit transaction, trust-account transfer, and Dallas branch opening, including realized costs and revenue contributions.
- Actual 2017 net interest margin, deposit pricing and loan growth compared with management’s outlook, especially under changing interest rates.
- Whether the rise in TDRs and management’s expected increase in non-accrual loans and foreclosures materialized, and whether capital and liquidity remain adequate as growth continues.