FDBC

Business Context and Reporting Period

Fidelity D & D Bancorp, Inc. (FDBC) is a Pennsylvania-based bank holding company and parent of The Fidelity Deposit and Discount Bank. The company operates as a community bank with 21 branches primarily in Northeastern and Eastern Pennsylvania. This Form 10-Q covers the quarterly period ended June 30, 2024, and the six months ended June 30, 2024.

Key Financial Metrics

Key Ratios (YTD 2024 vs YTD 2023):

• Return on Average Assets (ROA): 0.82% vs 1.04%
• Return on Average Equity (ROE): 10.57% vs 14.52%
• Efficiency Ratio (Non-GAAP): 67.01% vs 61.10%
• Net Interest Margin (FTE): 2.70% vs 2.97%

Material Changes vs. Prior Period

• Net Income Decline: Net income decreased $2.4 million year-to-date, primarily driven by a $2.4 million reduction in net interest income and a $1.0 million increase in non-interest expenses.
• Net Interest Margin Compression: The FTE net interest margin decreased 27 basis points to 2.70%. Interest expense grew faster than interest income due to a 102 basis point increase in rates paid on interest-bearing deposits, partially offset by higher loan yields.
• Asset Growth: Gross loans and leases increased $42.7 million (3%) to $1.73 billion, driven by commercial and municipal lending. Conversely, the consumer portfolio decreased $12.3 million due to a strategic reduction in the auto loan portfolio.
• Investment Portfolio: The investment portfolio decreased $15.8 million due to principal paydowns and market value declines. The company holds significant unrealized losses on available-for-sale securities ($53.3 million) and held-to-maturity securities ($31.4 million).
• Non-Performing Assets: Non-performing assets increased 109% to $6.9 million, primarily due to a $2.9 million commercial loan and other specific loans moving to non-accrual status. Non-performing assets to total assets rose to 0.28% from 0.13%.

Guidance, Outlook, and Risks

• Interest Rate Outlook: Management expects a modestly declining interest rate environment in the second half of 2024, potentially accelerating in 2025. The company anticipates continued pressure on deposit costs and is focusing on disciplined loan pricing to mitigate margin compression.
• Liquidity Strategy: The company utilized short-term borrowings ($98.1 million) to fund loan growth. Management is actively managing liquidity to reduce reliance on borrowings as deposit growth stabilizes.
• Capital Position: The company remains well-capitalized, exceeding all regulatory requirements. Tangible Common Equity (TCE) ratio was 7.06%. Management notes that if unrealized losses on held-to-maturity securities were included, the adjusted TCE ratio would be 6.06%.
• Risks: Key risks include the impact of rising deposit costs on net interest income, potential credit deterioration in the commercial real estate portfolio, and volatility in public deposits (ARPA funds). The company is monitoring the local economic environment, particularly unemployment rates which have risen in its primary market areas.

Investor Verification Checklist

• Deposit Cost Trends: Verify if the cost of interest-bearing liabilities (currently 2.54% YTD) continues to rise or stabilizes, as this is the primary driver of margin compression.
• Non-Performing Loan Concentration: Review the specific details of the $2.9 million commercial loan added to non-accrual status and its impact on future charge-offs.
• Investment Portfolio Valuation: Assess the severity of unrealized losses ($84.4 million gross) and the company's intent to hold securities to maturity versus potential forced sales.
• Commercial Real Estate Exposure: Monitor the $355 million non-owner occupied CRE portfolio for signs of stress given the higher risk profile and recent reclassifications.
• Auto Loan Strategy: Confirm the execution of the strategic reduction in the indirect auto loan portfolio and its impact on future non-interest income from fees.