FIDELITY D & D BANCORP INC

Previous wording

The following is management's discussion and analysis of the significant changes in the consolidated financial condition of the Company as of March 31, 2024 compared to December 31, 2023 and a comparison of the results of operations for the three months ended March 31, 2024 and 2023. Current performance may not be indicative of future results. This discussion should be read in conjunction with the Company’s 2023 Annual Report filed on Form 10-K.

Current wording

The following is management's discussion and analysis of the significant changes in the consolidated financial condition of the Company as of June 30, 2024 compared to December 31, 2023 and a comparison of the results of operations for the three and six months ended June 30, 2024 and 2023. Current performance may not be indicative of future results. This discussion should be read in conjunction with the Company’s 2023 Annual Report filed on Form 10-K.

Previous wording

The Company is a Pennsylvania corporation and a bank holding company, whose wholly-owned state chartered commercial bank and trust company is The Fidelity Deposit and Discount Bank. The Company is headquartered in Dunmore, Pennsylvania. We consider Lackawanna, Northampton and Luzerne Counties our primary marketplace.

Current wording

The Company is a Pennsylvania corporation and a bank holding company, whose wholly-owned state chartered commercial bank and trust subsidiary is The Fidelity Deposit and Discount Bank. The Company is headquartered in Dunmore, Pennsylvania. We consider Lackawanna, Northampton and Luzerne Counties our primary marketplace.

Previous wording

We are impacted by national, regional and market area economic factors, with commercial, commercial real estate and residential mortgage loans concentrated in Northeastern Pennsylvania, primarily in Lackawanna and Luzerne counties, and Eastern Pennsylvania, primarily Northampton county. The Federal Open Market Committee (FOMC) increased interest rates by 425 basis points during 2022 and another 100 basis points during 2023. According to the U.S. Bureau of Labor Statistics, the national unemployment rate for March 2024 was 3.8%, up 0.1 percentage point from December 2023. The unemployment rates in the Scranton - Wilkes-Barre – Hazleton (market area north) and the Allentown – Bethlehem – Easton (market area south) Metropolitan Statistical Areas (local)increased faster than the national unemployment rate. The local unemployment rates at March 31, 2024 were 4.0% in market area north and 3.6% in market area south, respectively, an increase of 0.5 percentage points and 0.4 percentage points from the 3.5% and 3.2%, respectively, at December 31, 2023. The median home values in the Scranton-Wilkes-Barre-Hazleton metro and Allentown-Bethlehem-Easton metro each increased 5.6% and 7.9% from a year ago, according to Zillow, an online database advertising firm providing access to its real estate search engines to various media outlets, and values are expected to grow 1.8% and 2.9% in the next year. In light of these expectations, we are uncertain if real estate values could continue to increase at these levels with the current elevated rate environment, however we will continue to monitor the economic climate in our region and scrutinize growth prospects with credit quality as a principal consideration.

Current wording

We are impacted by national, regional and market area economic factors, with commercial, commercial real estate and residential mortgage loans concentrated in Northeastern Pennsylvania, Lackawanna and Luzerne counties, and Eastern Pennsylvania, Northampton county. The Federal Open Market Committee (FOMC) increased interest rates by 425 basis points during 2022 and another 100 basis points during 2023; no change since prior year. According to the U.S. Bureau of Labor Statistics, the national unemployment rate for June 2024 was 4.1%, up 0.4 percentage points from December 2023. The unemployment rates in the Scranton - Wilkes-Barre – Hazleton (market area north) and the Allentown – Bethlehem – Easton (market area south) Metropolitan Statistical Areas (local) increased faster than the national unemployment rate. The local unemployment rates at June 30, 2024 were 4.3% in market area north and 3.9% in market area south, respectively, an increase of 0.8 percentage points and 0.7 percentage points from the 3.5% and 3.2%, respectively, at December 31, 2023. The median home values in the Scranton-Wilkes-Barre-Hazleton metro and Allentown-Bethlehem-Easton metro each increased 8.0% and 7.7% from a year ago, according to Zillow, an online database advertising firm providing access to its real estate search engines to various media outlets, and values are expected to grow 1.1% and 1.7% in the next year. In light of these expectations, we are uncertain if real estate values could continue to increase at these levels with the current elevated rate environment, however we will continue to monitor the economic climate in our region and scrutinize growth prospects with credit quality as a principal consideration.

Previous wording

For the three months ended March 31, 2024, net income was $5.1 million, or $0.88 diluted earnings per share, compared to $7.1 million, or $1.24 diluted earnings per share, for the three months ended March 31, 2023.

Current wording

For the six months ended June 30, 2024, net income was $10.0 million, or $1.73 diluted earnings per share, compared to $12.4 million, or $2.18 diluted earnings per share, for the six months ended June 30, 2023.

Previous wording

As of March 31, 2024 and March 31, 2023, tangible common book value per share (non-GAAP) was $29.80 and $27.33, respectively. See reconciliation on page 38. The increase in tangible book value was due primarily to an increase in retained earnings from net income. These non-GAAP measures should be reviewed in connection with the reconciliation of these non-GAAP ratios. See “Non-GAAP Financial Measures” located below within this management’s discussion and analysis.

Current wording

As of June 30, 2024 and June 30, 2023, tangible common book value per share (non-GAAP) was $30.52 and $27.59, respectively. See reconciliation on page 36. The increase in tangible book value was due primarily to an increase in retained earnings from net income. These non-GAAP measures should be reviewed in connection with the reconciliation of these non-GAAP ratios. See “Non-GAAP Financial Measures” located below within this management’s discussion and analysis.

Previous wording

Return on average assets (ROA) was 0.83% and 1.19% for the first quarters of 2024 and 2023, respectively. During the same time periods, return on average shareholders’ equity (ROE) was 10.71% and 17.00%, respectively. The decreases in ROA and ROE were primarily the result of the decline in net income during the first quarter of 2024. Pre-provision net revenue to average assets (non-GAAP) was 0.96% and 1.46% for the three months ended March 31, 2024 and 2023, respectively. For more information on the calculation of pre-provision net revenue to average assets, see “Non-GAAP Financial Measures” located above within this management’s discussion and analysis. The decrease was primarily due to a decline in pre-provision net revenue.

Current wording

Return on average assets (ROA) was 0.81% and 0.89% for the second quarters of 2024 and 2023, respectively, and 0.82% and 1.04% for the six months ended June 30, 2024 and 2023, respectively. During the same time periods, return on average shareholders’ equity (ROE) was 10.44% and 12.19%, respectively, and 10.57% and 14.52%, respectively. The decreases in ROA and ROE were primarily the result of the decline in net income during the second quarter of 2024 and year-to-date 2024. Pre-provision net revenue to average assets (non-GAAP) was 1.00% and 1.10% for the three months ended June 30, 2024 and 2023, respectively, and 0.98% and 1.28% for the six months ended June 30, 2024 and 2023, respectively. The decreases were due to a decline in income before taxes quarter-over-quarter and year-over-year.

Previous wording

For the remainder of 2024, the Company currently expects to operate in a flat to modestly declining interest rate environment during the second half of the year. Management is primarily reliant on the Federal Open Market Committee's statements and forecast. The Company’s net interest income performance has been reduced by asset yields being outpaced by higher cost of funds compressing net interest spread. The risk to net interest income improvement is rapid acceleration of deposit rates in the Company's market area. The FOMC increased the federal funds rate by 425 basis points during 2022 and another 100 basis points in 2023, which had a disproportional effect on rates paid on interest-bearing liabilities in 2024. On the asset side, the Prime interest rate, the benchmark rate that banks use as a base rate for adjustable rate loans was also increased 425 basis points during 2022 and another 100 basis points through 2023. Consensus economic forecasts are predicting gradual declines in short-term rates towards the end of 2024. For the remainder of 2024, the Company currently maintains a loan pipeline which is expected to grow the loan portfolio funded by borrowing capacity until such time deposit growth will be able to pay down short-term borrowings. The focus is to manage net interest income through an elevated forecasted rate cycle by exercising disciplined and proactive loan pricing and managing deposit costs to maintain a reasonable spread, to the extent possible, in order to mitigate further margin compression.

Current wording

For the remainder of 2024, the Company currently expects to operate in a modestly declining interest rate environment during the second half of the year that may accelerate during 2025. Management is primarily reliant on the Federal Open Market Committee's statements and forecast. The Company’s net interest income performance has been reduced by asset yields being outpaced by higher cost of funds compressing net interest spread. The risk to net interest income improvement is rapid acceleration of deposit rates in the Company's market area. The FOMC increased the federal funds rate by 425 basis points during 2022 and another 100 basis points in 2023, which had a disproportional effect on rates paid on interest-bearing liabilities in 2024. On the asset side, the Prime interest rate, the benchmark rate that banks use as a base rate for adjustable-rate loans was also increased 425 basis points during 2022 and another 100 basis points through 2023. Consensus economic forecasts are predicting small declines between 25 to 50 basis points in the short-term rates towards the end of 2024, with at least another 100 basis points during 2025. For the remainder of 2024, the Company currently maintains a loan pipeline which is expected to grow the loan portfolio funded by utilizing borrowing capacity until such time deposit growth will be able to pay down short-term borrowings. The focus remains to manage net interest income through a declining forecasted rate cycle by exercising disciplined and proactive loan pricing and managing deposit costs to maintain a reasonable spread, to the extent possible, in order to mitigate further margin compression. Once interest rates begin to decline, focus shifts towards rebuilding net interest spread capacity to begin expanding margin back towards 3%.

Previous wording

The Company’s cost of interest-bearing liabilities was 2.51% for the three months ended March 31, 2024, or 118 basis points higher than the cost for the same 2023 period. The increase in interest paid on deposits contributed to the higher cost of interest-bearing liabilities. The FOMC is expected to hold the federal funds rate at current levels in the immediate future, but the Company may continue to experience pressure to further increase rates paid on deposits. To help mitigate the impact of the imminent change to the economic landscape, the Company has successfully developed and will continue to strengthen its association with existing customers, develop new business relationships and generate new loan volumes. Strategically deploying relationship deposits into interest earning-assets is an effective margin-preserving strategy that the Company expects to continue to pursue and expand to help stabilize net interest margin.

Current wording

The Company’s cost of interest-bearing liabilities was 2.58% and 2.54% for the three and six months ended June 30, 2024, respectively, compared to 1.84% and 1.59% for the same 2023 periods. The increase in interest paid on deposits contributed to the higher cost of interest-bearing liabilities. The FOMC is expected to continue holding the federal funds rate at current levels in the beginning of the third quarter of 2024, but the Company may continue to experience pressure to further increase rates paid on deposits. To help mitigate the impact of the imminent change to the economic landscape, the Company has successfully developed and will continue to strengthen its association with existing customers, develop new business relationships and generate new loan volumes. Strategically deploying relationship deposits into interest earning-assets is an effective margin-building strategy that the Company expects to pursue and expand to help enhance net interest margin.

Previous wording

The table that follows sets forth a comparison of average balances of assets and liabilities and their related net tax equivalent yields and rates for the years indicated. Within the table, interest income was FTE adjusted, using the corporate federal tax rate of 21% for March 31, 2024 and 2023 to recognize the income from tax-exempt interest-earning assets as if the interest was taxable. See “Non-GAAP Financial Measures” within this management’s discussion and analysis for the FTE adjustments. This treatment allows a uniform comparison among yields on interest-earning assets. Loans include loans held-for-sale (HFS) and non-accrual loans but exclude the allowance for credit losses. Home equity lines of credit (HELOC) are included in the residential real estate category since they are secured by real estate. Net deferred loan cost amortization of ($0.2 million) and ($0.2 million) for the three months ended March 31, 2024 and 2023, respectively, are included in interest income from loans. Merchants Bank of Bangor and Landmark Community Bank loan fair value purchase accounting adjustments of $0.5 million and $0.9 million are included in interest income from loans and $3 thousand and $11 thousand reduced interest expense on deposits and borrowings for the three months ended March 31, 2024 and 2023. Average balances are based on amortized cost and do not reflect net unrealized gains or losses. Residual values for direct finance leases are included in the average balances for consumer loans. Net interest margin is calculated by dividing net interest income-FTE by total average interest-earning assets. Cost of funds includes the effect of average non-interest bearing deposits as a funding source:

Current wording

The table that follows sets forth a comparison of average balances of assets and liabilities and their related net tax equivalent yields and rates for the periods indicated. Within the table, interest income was FTE adjusted, using the corporate federal tax rate of 21% for June 30, 2024 and 2023 to recognize the income from tax-exempt interest-earning assets as if the interest was taxable. See “Non-GAAP Financial Measures” within this management’s discussion and analysis for the FTE adjustments. This treatment allows a uniform comparison among yield on interest-earning assets. Loans include loans held-for-sale (HFS) and non-accrual loans but exclude the allowance for credit losses. Home equity lines of credit (HELOC) are included in the residential real estate category since they are secured by real estate. Net deferred loan cost amortization of $0.2 million and $0.2 million during the second quarters of 2024 and 2023, respectively, and $0.4 million and $0.5 million for the six months ended June 30, 2024 and 2023, respectively, are included in interest income from loans. Merchants Bank of Bangor and Landmark Community Bank loan fair value purchase accounting adjustments of $0.4 million and $0.7 million are included in interest income from loans and $1 thousand and $10 thousand reduced interest expense on deposits and borrowings for the three months ended June 30, 2024 and 2023. Merchants Bank of Bangor and Landmark Community Bank loan fair value purchase accounting adjustments of $0.9 million and $1.6 million are included in interest income from loans and $5 thousand and $21 thousand reduced interest expense on deposits and borrowings for the six months ended June 30, 2024 and 2023. Average balances are based on amortized cost and do not reflect net unrealized gains or losses. Residual values for direct finance leases are included in the average balances for consumer loans.

Previous wording

The provision for credit losses represents the necessary amount to charge against current earnings, the purpose of which is to increase the allowance for credit losses to a level that represents management’s best estimate of expected credit losses in the Company’s loan portfolio. Loans determined to be uncollectible are charged off against the allowance. The required amount of the provision for credit losses, based upon the adequate level of the allowance, is subject to the ongoing analysis of the loan portfolio. The Company’s Special Assets Committee meets periodically to review problem loans. The committee is comprised of management, including credit administration officers, loan officers, loan workout officers and collection personnel.

Current wording

The provision for credit losses represents the necessary amount to charge against current earnings, the purpose of which is to adjust the allowance for credit losses to a level that represents management’s best estimate of expected credit losses in the Company’s loan portfolio. Loans determined to be uncollectible are charged off against the allowance. The required amount of the provision for credit losses, based upon the adequate level of the allowance, is subject to the ongoing analysis of the loan portfolio. The Company’s Special Assets Committee meets periodically to review problem loans. The committee is comprised of management, including credit administration officers, loan officers, loan workout officers and collection personnel.

Previous wording

For the three months ended March 31, 2024, the provision for credit losses on loans was $0.1 million partially offset by a net benefit in the provision for credit losses on unfunded loan commitments of $50 thousand. For the three months ended March 31, 2024, the provision for credit losses on loans declined $0.1 million compared to the three months ended March 31, 2023. The decrease in the provision for credit losses on loans was due to lower growth in the loan portfolio and a reduction in net charge-offs due to a recovery of $0.1 million on a commercial real estate loan.

Current wording

For the three months ended June 30, 2024, the provision for credit losses on loans was $0.3 million and provision for credit losses on unfunded loan commitments was $0.1 million. For the three months ended June 30, 2024, the provision for credit losses on loans decreased $0.4 million compared to the three months ended June 30, 2023 due to lower growth in the loan portfolio and a reduction in net charge-offs. For the three months ended June 30, 2024, the provision for credit losses on unfunded loan commitments increased $0.2 million compared to the three months ended June 30, 2023 due to a higher growth in unfunded loan commitments, specifically commercial construction commitments.

Previous wording

For the three months ended March 31, 2024, the provision for credit losses on unfunded commitments decreased $0.3 million compared to the three months ended March 31, 2023. The change in the provision for credit losses on unfunded commitments was due to a reduction in unfunded commitments and a general decrease in loss rate and funding rate assumptions compared to the year earlier period.

Current wording

For the six months ended June 30, 2024, the provision for credit losses on loans was $0.4 million and the provision for credit losses on unfunded loan commitments was $0.1 million. For the six months ended June 30, 2024, the provision for credit losses on loans decreased $0.5 million compared to the six months ended June 30, 2023 due to lower growth in the loan portfolio and a reduction in net charge-offs. For the six months ended June 30, 2024, the provision for credit losses on unfunded loan commitments decreased $0.1 million compared to the six months ended June 30, 2023 due to a general decrease in loss rate and funding rate assumptions compared to the prior year period.

Previous wording

The provision for credit losses derives from the reserve required from the allowance for credit losses calculation. The Company continued provisioning for three months ended March 31, 2024 to maintain an allowance level that management deemed adequate.

Current wording

The provision for credit losses derives from the reserve required from the allowance for credit losses calculation. The Company continued provisioning for six months ended June 30, 2024 to maintain an allowance level that management deemed adequate.

Previous wording

The ratios of non-interest expense less non-interest income to average assets, known as the expense ratio, were 1.50% and 1.41% for the three months ended March 31, 2024 and 2023. The expense ratio increased because of higher non-interest expenses. The efficiency ratio (non-GAAP) increased from 57.72% at March 31, 2023 to 67.56% at March 31, 2024 due to the decline in net interest income and higher non-interest expenses during the first quarter of 2024. For more information on the calculation of the efficiency ratio, see “Non-GAAP Financial Measures” located within this management’s discussion and analysis.

Current wording

The ratios of non-interest expense less non-interest income to average assets, known as the expense ratio, were 1.48% and 1.45% for the six months ended June 30, 2024 and 2023. The expense ratio increased because of higher non-interest expenses. The efficiency ratio (non-GAAP) increased from 61.10% at June 30, 2023 to 67.01% at June 30, 2024 due to non-interest expenses increasing as net interest income declined. For more information on the calculation of the efficiency ratio, see “Non-GAAP Financial Measures” located within this management’s discussion and analysis.

Previous wording

The provision for income taxes decreased $0.5 million, or 43%, for the three months ended March 31, 2024 compared to the same 2023 period due to tax credits from plug-in hybrid electric vehicles and lower income before taxes. The Company's effective tax rate was 12.1% at March 31, 2024 compared to 14.7% at March 31, 2023. The difference between the effective rate and the enacted statutory corporate rate of 21% is due mostly to the effect of tax-exempt income in relation to the level of pre-tax income. The decrease in the effective tax rate was primarily due to lower pre-tax income and the aforementioned tax credits. If the federal corporate tax rate is increased, the Company’s net deferred tax liabilities and deferred tax assets will be re-valued upon adoption of the new tax rate. A federal tax rate increase will increase net deferred tax assets with a corresponding decrease to provision for income taxes.

Current wording

The provision for income taxes decreased $0.4 million during the six months ended June 30, 2024 compared to the same period in 2023 primarily due to lower income before taxes. The Company's effective tax rate was 12.7% at June 30, 2024 compared to 12.8% at June 30, 2023. The difference between the effective rate and the enacted statutory corporate rate of 21% is due mostly to the effect of tax-exempt income in relation to the level of pre-tax income. The decrease in the effective tax rate was primarily due to lower pre-tax income. If the federal corporate tax rate is increased, the Company’s net deferred tax liabilities and deferred tax assets will be re-valued upon adoption of the new tax rate. A federal tax rate increase will increase net deferred tax assets with a corresponding decrease to provision for income taxes.

Previous wording

At the time of purchase, management classifies investment securities into one of three categories: trading, available-for-sale (AFS) or held-to-maturity (HTM). To date, management has not purchased any securities for trading purposes. Some of the securities the Company purchases are classified as AFS even though there is no immediate intent to sell them. The AFS designation affords management the flexibility to sell securities and position the balance sheet in response to capital levels, liquidity needs or changes in market conditions. Debt securities AFS are carried at fair value on the consolidated balance sheets with unrealized gains and losses, net of deferred income taxes, reported separately within shareholders’ equity as a component of accumulated other comprehensive income (AOCI). Securities designated as HTM are carried at amortized cost and represent debt securities that the Company has the ability and intent to hold until maturity. For the three months ended March 31, 2024, AOCI declined by $1.4 million primarily due to the change in fair value of the Company's investment securities.

Current wording

At the time of purchase, management classifies investment securities into one of three categories: trading, available-for-sale (AFS) or held-to-maturity (HTM). To date, management has not purchased any securities for trading purposes. Some of the securities the Company purchases are classified as AFS even though there is no immediate intent to sell them. The AFS designation affords management the flexibility to sell securities and position the balance sheet in response to capital levels, liquidity needs or changes in market conditions. Debt securities AFS are carried at fair value on the consolidated balance sheets with unrealized gains and losses, net of deferred income taxes, reported separately within shareholders’ equity as a component of accumulated other comprehensive income (AOCI). Securities designated as HTM are carried at amortized cost and represent debt securities that the Company has the ability and intent to hold until maturity. For the six months ended June 30, 2024, AOCI declined by $0.5 million due to the change in fair value of the Company's investment securities.

Previous wording

On April 1, 2022, the Company transferred agency and municipal bonds with a book value of $245.5 million from AFS to HTM in order to apply the accounting for securities HTM to mitigate the effect AFS accounting has on the balance sheet. The bonds that were transferred had the highest price volatility and consisted of fixed-rate securities representing 70% of the agency portfolio, 70% of the taxable municipal portfolio each laddered out on the short to intermediate part of the yield curve and 35% of the tax-exempt municipal portfolio on the long end of the yield curve were identified as the best candidates given the Company’s ability to hold those bonds to maturity. The market value of the securities on the date of the transfer was $221.7 million, after netting unrealized losses totaling $18.9 million. The $18.9 million, net of deferred taxes, recorded discount will be accreted into interest income, offset by the amortization of previously recognized losses in AOCI, over the life of the bonds. As of March 31, 2024, the carrying value of held-to-maturity securities was $224.6 million, net of $15.2 million in remaining transferred discount.

Current wording

As of June 30, 2024, the carrying value of held-to-maturity securities was $225.0 million, net of $14.8 million in remaining transferred discount.

Previous wording

During September 2023, the Company entered into a $100 million interest rate swap with a third-party financial institution to limit the risk to the investment portfolio of rising interest rates. The interest rate swap was designated as a fair value hedge and utilized a pay fixed interest rate swap to hedge the change in fair value attributable to the movement in the Secured Overnight Financing Rate ("SOFR"). The Company designated $50 million of the swap's notional balance as a hedge against the closed portfolio of 20-year mortgage-backed securities and $50 million as a hedge against the closed portfolio of tax-free municipal bonds. As of March 31, 2024, the Company recorded the fair value of the swap of $0.6 million in accrued interest payable and other liabilities on the consolidated balance sheet offset by a $0.6 million increase to the carrying value of designated investment securities.

Current wording

During September 2023, the Company entered into a $100 million interest rate swap with a third-party financial institution to limit the risk to the investment portfolio of rising interest rates. The interest rate swap was designated as a fair value hedge and utilized a pay fixed interest rate swap to hedge the change in fair value attributable to the movement in the Secured Overnight Financing Rate ("SOFR"). The Company designated $50 million of the swap's notional balance as a hedge against the closed portfolio of 20-year mortgage-backed securities and $50 million as a hedge against the closed portfolio of tax-free municipal bonds. As of June 30, 2024, the Company recorded the fair value of the swap of $0.3 million in accrued interest payable and other liabilities on the consolidated balance sheet offset by a $0.3 million increase to the carrying value of designated investment securities.

Previous wording

As of March 31, 2024, the carrying value of investment securities amounted to $559.0 million, or 23% of total assets, compared to $568.3 million, or 23% of total assets, as of December 31, 2023. On March 31, 2024, 33% of the carrying value of the investment portfolio was comprised of U.S. Government Sponsored Enterprise residential mortgage-backed securities (MBS – GSE residential or mortgage-backed securities) that amortize and provide monthly cash flow that the Company can use for reinvestment, loan demand, unexpected deposit outflow, facility expansion or operations. The mortgage-backed securities portfolio includes only pass-through bonds issued by Fannie Mae, Freddie Mac and the Government National Mortgage Association (GNMA).

Current wording

As of June 30, 2024, the carrying value of investment securities amounted to $552.5 million, or 22% of total assets, compared to $568.3 million, or 23% of total assets, as of December 31, 2023. On June 30, 2024, 33% of the carrying value of the investment portfolio was comprised of U.S. Government Sponsored Enterprise residential mortgage-backed securities (MBS – GSE residential or mortgage-backed securities) that amortize and provide monthly cash flow that the Company can use for reinvestment, loan demand, unexpected deposit outflow, facility expansion or operations. The mortgage-backed securities portfolio includes only pass-through bonds issued by Fannie Mae, Freddie Mac and the Government National Mortgage Association (GNMA).

Previous wording

The Company’s municipal (obligations of states and political subdivisions) portfolio is comprised of tax-free municipal bonds with a book value of $201.2 million ($181.2 million including the remaining net unrealized loss transferred on HTM securities) and taxable municipal bonds with a book value of $91.9 million ($82.8 million including the remaining net unrealized loss transferred on HTM securities). The overall credit ratings of these municipal bonds were as follows: 36% AAA, 62% AA, and 1% A. For municipal securities HTM, the Company utilized a third-party model to analyze whether a credit loss reserve is needed for these bonds. The amount of the credit loss reserve calculated was immaterial because of the underlying strong credit quality of the municipal portfolio.

Current wording

The Company’s municipal (obligations of states and political subdivisions) portfolio is comprised of tax-free municipal bonds with a book value of $187.2 million ($179.8 million including the remaining net unrealized loss transferred on HTM securities) and taxable municipal bonds with a book value of $88.6 million ($82.9 million including the remaining net unrealized loss transferred on HTM securities). The overall credit ratings of these municipal bonds were as follows: 37% AAA, 61% AA, and 1% A. For municipal securities HTM, the Company utilized a third-party model to analyze whether a credit loss reserve is needed for these bonds. The amount of the credit loss reserve calculated was immaterial because of the underlying strong credit quality of the municipal portfolio.

Previous wording

During the first quarter of 2024, the carrying value of total investments decreased $9.3 million, or 2%. The decline was primarily due to principal reductions totaling $5.0 million, a decline in the unrealized loss position of $2.4 million in the AFS portfolio and a $1.5 million decrease in the fair value of the swap. The Company attempts to maintain a well-diversified and proportionate investment portfolio that is structured to complement the strategic direction of the Company. Its growth typically supplements the lending activities but also considers the current and forecasted economic conditions, the Company’s liquidity needs and interest rate risk profile, to the extent possible.

Current wording

During the first six months of 2024, the carrying value of total investments decreased $15.8 million, or 3%. The decline was primarily due to principal reductions totaling $10.8 million, a decline in the unrealized loss position of $1.7 million in the AFS portfolio and a $1.8 million decrease in the fair value of the swap. The Company attempts to maintain a well-diversified and proportionate investment portfolio that is structured to complement the strategic direction of the Company. Its growth typically supplements the lending activities but also considers the current and forecasted economic conditions, the Company’s liquidity needs and interest rate risk profile, to the extent possible.

Previous wording

Investment securities were comprised of AFS and HTM securities as of March 31, 2024 and December 31, 2023. The AFS securities were recorded with a net unrealized loss of $54.0 million and a net unrealized loss of $51.6 million as of March 31, 2024 and December 31, 2023, respectively. Of the $2.4 million net decline; $0.5 million was attributable to municipal securities; $1.7 million was attributable to mortgage-backed securities and $0.1 million was attributable to agency securities. During 2022, securities with net unrealized losses totaling $23.9 million were transferred to HTM, of which $0.6 million and $0.6 million was accreted into other comprehensive income for the three months ended March 31, 2024 and 2023. The direction and magnitude of the change in value of the Company’s investment portfolio is attributable to the direction and magnitude of the change in interest rates along the treasury yield curve. Generally, the values of debt securities move in the opposite direction of the changes in interest rates. As interest rates along the treasury yield curve rise, especially at the intermediate and long end, the values of debt securities tend to decline. Whether or not the value of the Company’s investment portfolio will change above or below its amortized cost will be largely dependent on the direction and magnitude of interest rate movements and the duration of the debt securities within the Company’s investment portfolio. Management does not consider the reduction in value attributable to changes in credit quality. Correspondingly, when interest rates decline, the market values of the Company’s debt securities portfolio could be subject to market value increases.

Current wording

Investment securities were comprised of AFS and HTM securities as of June 30, 2024 and December 31, 2023. The AFS securities were recorded with a net unrealized loss of $53.3 million and a net unrealized loss of $51.6 million as of June 30, 2024 and December 31, 2023, respectively. Of the $1.7 million net decline; $0.6 million was attributable to municipal securities and $1.1 million was attributable to mortgage-backed securities. During 2022, securities with net unrealized losses totaling $23.9 million were transferred to HTM, of which $1.2 million and $1.1 million was accreted into other comprehensive income for the six months ended June 30, 2024 and 2023, respectively. The direction and magnitude of the change in value of the Company’s investment portfolio is attributable to the direction and magnitude of the change in interest rates along the treasury yield curve. Generally, the values of debt securities move in the opposite direction of the changes in interest rates. As interest rates along the treasury yield curve rise, especially at the intermediate and long end, the values of debt securities tend to decline. Whether or not the value of the Company’s investment portfolio will change above or below its amortized cost will be largely dependent on the direction and magnitude of interest rate movements and the duration of the debt securities within the Company’s investment portfolio. Management does not consider the reduction in value attributable to changes in credit quality. Correspondingly, when interest rates decline, the market values of the Company’s debt securities portfolio could be subject to market value increases.

Previous wording

As of March 31, 2024, the Companyhad $294.4 million in public depo sits, or 13% of total deposits. Pennsylvania state law requires the Company to maintain pledged securities on public and trust deposits or otherwise obtain a FHLB letter of credit or FDIC insurance for these customers. The Company also pledges securities for derivative instruments and certain borrowed funds. As of March 31, 2024, the balance of pledged securities required was $362.0 million, or 65% oftotal securities.

Current wording

As of June 30, 2024, the Company had $275.3 million in public deposits, or 13% of total deposits. Pennsylvania state law requires the Company to maintain pledged securities on public and trust deposits or otherwise obtain a FHLB letter of credit or FDIC insurance for these customers. The Company also pledges securities for derivative instruments and certain borrowed funds. As of June 30, 2024, the balance of pledged securities required was $335.4 million, or 61% of total securities.

Previous wording

Quarterly, management performs a review of the investment portfolio to determine the causes of declines in the fair value of each security. The Company uses inputs provided by independent third parties to determine the fair value of its investment securities portfolio. Inputs provided by the third parties are reviewed and corroborated by management. Evaluations of the causes of the unrealized losses are performed to determine whether credit losses on debt securities exist. Considerations such as the Company’s intent and ability to hold the securities until or sell prior to maturity, recoverability of the invested amounts over the intended holding period, the length of time and the severity in pricing decline below cost, the interest rate environment, the receipt of amounts contractually due and whether or not there is an active market for the securities, for example, are applied, along with an analysis of the financial condition of the issuer for management to make a realistic judgment of the probability that the Company will be unable to collect all amounts (principal and interest) due in determining whether a security has credit losses. If a decline in value is deemed to be a credit loss, a contra-asset is recorded on both HTM and AFS securities, limited by the amount that the fair value is less than the amortized cost basis. During the quarter ended March 31, 2024, the Company did not incur any credit losses on debt securities from its investment securities portfolio.

Current wording

Quarterly, management performs a review of the investment portfolio to determine the causes of declines in the fair value of each security. The Company uses inputs provided by independent third parties to determine the fair value of its investment securities portfolio. Inputs provided by the third parties are reviewed and corroborated by management. Evaluations of the causes of the unrealized losses are performed to determine whether credit losses on debt securities exist. Considerations such as the Company’s intent and ability to hold the securities until or sell prior to maturity, recoverability of the invested amounts over the intended holding period, the length of time and the severity in pricing decline below cost, the interest rate environment, the receipt of amounts contractually due and whether or not there is an active market for the securities, for example, are applied, along with an analysis of the financial condition of the issuer for management to make a realistic judgment of the probability that the Company will be unable to collect all amounts (principal and interest) due in determining whether a security has credit losses. If a decline in value is deemed to be a credit loss, a contra-asset is recorded on both HTM and AFS securities, limited by the amount that the fair value is less than the amortized cost basis. During the six months ended June 30, 2024, the Company did not incur any credit losses on debt securities from its investment securities portfolio.

Previous wording

During January 2023 with the 10-year U.S. Treasury yield declining, $31.2 million of securities were able to be sold yielding 3.62% (FTE yield of 4.33%) at a breakeven level. These proceeds were used to pay down FHLB overnight borrowings costing 4.80% at that time. Due to volatility in the levels of borrowings during October 2023 and the increasing expected dependency on borrowing capacity from experiencing deposit fluctuations while funding loan growth, the Company evaluated a liquidity strategy to deleverage the reliance on short-term borrowings. As a result of this evaluation, in November 2023, the Company sold longer term available-for-sale general market tax-free municipal securities with a carrying value of $35.6 million with a weighted average yield of 1.28% with a 13.5 year weighted average maturity as part of a liquidity and net interest margin enhancement strategy for a $6.5 million loss recognized in gain (loss) on sale of available-for-sale debt securities. The $29.1 million in proceeds received were used to retire short-term borrowings with a cost of approximately 5.50%. While the Company has ample funding sources available, management felt it prudent to create additional capacity for the borrowings over the near term should the banking industry again experience funding pressures as it did in March of this past year. In addition, since the municipal securities sold were purchased in a much lower rate environment, there is an immediate improvement in net interest margin (NIM) of over 5 bps as a result of paying down the borrowing with the sale proceeds. The sale removes a 422 basis point negative spread and will contribute towards incrementally improving net interest income, earnings per share and NIM every year starting in 2024. The cost savings from paying down the advances with the sale of low yielding bonds will also allow the pre-tax loss of $6.5 million realized on the sale to be fully recouped prior to the term of the bonds sold.

Current wording

During January 2023 with the 10-year U.S. Treasury yield declining, $31.2 million of securities were able to be sold yielding 3.62% (FTE yield of 4.33%) at a breakeven level. These proceeds were used to pay down FHLB overnight borrowings costing 4.80% at that time. Due to volatility in the levels of borrowings during October 2023 and the increasing expected dependency on borrowing capacity from experiencing deposit fluctuations while funding loan growth, the Company evaluated a liquidity strategy to deleverage the reliance on short-term borrowings. As a result of this evaluation, in November 2023, the Company sold longer term available-for-sale general market tax-free municipal securities with a carrying value of $35.6 million with a weighted average yield of 1.28% with a 13.5 year weighted average maturity as part of a liquidity and net interest margin enhancement strategy for a $6.5 million loss recognized in gain (loss) on sale of available-for-sale debt securities. The $29.1 million in proceeds received were used to retire short-term borrowings with a cost of approximately 5.50%. While the Company has ample funding sources available, management felt it prudent to create additional capacity for the borrowings over the near term should the banking industry again experience funding pressures as it did in March of 2023. In addition, since the municipal securities sold were purchased in a much lower rate environment, there is an immediate improvement in net interest margin (NIM) of over 5 bps as a result of paying down the borrowing with the sale proceeds. The sale removed a 422 basis point negative spread and will contribute towards incrementally improving net interest income, earnings per share and NIM every year starting in 2024. The cost savings from paying down the advances with the sale of low yielding bonds will also allow the pre-tax loss of $6.5 million realized on the sale to be fully recouped prior to the term of the bonds sold.

Previous wording

Investment in Federal Home Loan Bank (FHLB) stock is required for membership in the organization and is carried at cost since there is no market value available. The amount the Company is required to invest is dependent upon the relative size of outstanding borrowings the Company has with the FHLB of Pittsburgh. Excess stock is repurchased from the Company at par if the amount of borrowings decline to a predetermined level. In addition, the Company earns a return or dividend based on the amount invested. Atlantic Community Bankers Bank (ACBB) stock totaled $82 thousand as of March 31, 2024 and December 31, 2023. The balance in FHLB stock was $4.0 million and $3.9 million as of March 31, 2024 and December 31, 2023, respectively. The dividends received from the FHLB totaled $73 thousand and $65 thousand for the three months ended March 31, 2024 and 2023, respectively.

Current wording

Investment in Federal Home Loan Bank (FHLB) stock is required for membership in the organization and is carried at cost since there is no market value available. The amount the Company is required to invest is dependent upon the relative size of outstanding borrowings the Company has with the FHLB of Pittsburgh. Excess stock is repurchased from the Company at par if the amount of borrowings decline to a predetermined level. In addition, the Company earns a return or dividend based on the amount invested. Atlantic Community Bankers Bank (ACBB) stock totaled $82 thousand as of June 30, 2024 and December 31, 2023. The balance in FHLB stock was $3.9 million and $3.8 million as of June 30, 2024 and December 31, 2023, respectively. The dividends received from the FHLB totaled $148 thousand and $161 thousand for the six months ended June 30, 2024 and 2023, respectively.

Previous wording

As of March 31, 2024 and December 31, 2023, loans HFS consisted of residential mortgages with carrying amounts of $0.3 million and $1.5 million, respectively, which approximated their fair values. During the three months ended March 31, 2024, residential mortgage loans with principal balances of $10.8 million were sold into the secondary market and the Company recognized net gains of $0.2 million, compared to $11.1 million and $0.1 million, respectively, during the three months ended March 31, 2023.

Current wording

As of June 30, 2024 and December 31, 2023, loans HFS consisted of residential mortgages with carrying amounts of $0.7 million and $1.5 million, respectively, which approximated their fair values. During the six months ended June 30, 2024, residential mortgage loans with principal balances of $25.5 million were sold into the secondary market and the Company recognized net gains of $0.5 million, compared to $23.2 million and $0.4 million, respectively, during the six months ended June 30, 2023.

Previous wording

The Company retains mortgage servicing rights (MSRs) on loans sold into the secondary market. MSRs are retained so that the Company can foster relationships. At March 31, 2024 and December 31, 2023, the servicing portfolio balance of sold residential mortgage loans was $479.3 million and $477.7 million, respectively, with mortgage servicing rights of $1.4 million and $1.5 million for the same periods, respectively.

Current wording

The Company retains mortgage servicing rights (MSRs) on loans sold into the secondary market. MSRs are retained so that the Company can foster relationships. At June 30, 2024 and December 31, 2023, the servicing portfolio balance of sold residential mortgage loans was $483.9 million and $477.7 million, respectively, with mortgage servicing rights of $1.4 million and $1.5 million for the same periods, respectively.

Previous wording

As of March 31, 2024, the Company had gross loans and leases totaling $1.7 billion, an increase of $12.0 million, or 1%, compared to $1.7 billion at December 31, 2023.

Current wording

As of June 30, 2024, the Company had gross loans and leases totaling $1.7 billion, an increase of $42.7 million, or 3%, compared to $1.7 billion at December 31, 2023.

Previous wording

During the three months ended March 31, 2024, the growth in the portfolio was primarily attributed to a $16.7 million increase in the commercial portfolio due to an origination to a single municipal borrower totaling $15 million and standard portfolio growth and a $7.3 million increase in the residential portfolio, the result of a higher percentage of adjustable-rate mortgages recorded as held-for-investment during this period. This growth was offset by the $12.1 million reduction in the consumer portfolio attributed to a strategic reduction in the auto portfolio.

Current wording

During the six months ended June 30, 2024, the growth in the portfolio was primarily attributed to a $42.0 million increase in the commercial portfolio due to an origination to a single municipal borrower totaling $15 million, the origination of three commercial real estate non-owner occupied loans to three different borrowers totaling $23 million and portfolio growth. The Company also experienced a $13.1 million increase in the residential portfolio, the result of a higher percentage of adjustable-rate mortgages recorded as held-for-investment during this period. This growth was offset by the $12.3 million reduction in the consumer portfolio attributed to a strategic reduction in the auto portfolio.

Previous wording

As of March 31, 2024, the commercial portfolio increased by $16.7 million, or 2%, to $919.8 million compared to the December 31, 2023 balance of $903.1 million due to growth of $18.6 million in commercial and industrial loans partially offset by a $1.9 million reduction in commercial real estate loans.

Current wording

As of June 30, 2024, the commercial portfolio increased by $42.0 million, or 5%, to $945.1 million compared to the December 31, 2023 balance of $903.1 million. The increase was due to growth of $14.0 million in commercial and industrial loans and growth of $28.0 million in commercial real estate loans.

Previous wording

For the three months ended March 31, 2024, commercial and industrial (non-municipal) loans increased $0.3 million from $152.6 million at December 31, 2023 to $152.9 million at March 31, 2024, which was the result of originations and advances outpacing scheduled payments and curtailments.

Current wording

For the six months ended June 30, 2024, commercial and industrial (non-municipal) loans increased $1.5 million from $152.6 million at December 31, 2023 to $154.1 million at June 30, 2024, which was the result of originations and advances outpacing scheduled payments and curtailments.

Previous wording

For the three months ended March 31, 2024, municipal loans increased $18.3 million, or 19%, from $94.7 million at December 31, 2023 to $113.0 million at March 31, 2024, which was attributed to the origination of a Tax Anticipation Note to a single municipal borrower totaling $15 million.

Current wording

For the six months ended June 30, 2024, municipal loans increased $12.5 million, or 13%, from $94.7 million on December 31, 2023, to $107.2 million at June 30, 2024 which was attributed to the origination of a Tax Anticipation Note to a single municipal borrower totaling $15 million.

Previous wording

For the three months ended March 31, 2024, owner occupied commercial real estate decreased $5.0 million, or 2%, from $304.4 million on December 31, 2023, to $299.4 million at March 31, 2024, which was attributed to scheduled monthly payments.

Current wording

For the six months ended June 30, 2024, owner occupied commercial real estate loans decreased $3.5 million, or 1%, from $278.3 million on December 31, 2023, to $274.8 million at June 30, 2024, which was attributed to scheduled monthly payments.

Previous wording

Owner occupied commercial real estate loans rely on income generated from the respective owners’ businesses. Therefore, underwriting on owner occupied CRE loans emphasizes the owner’s cash flow and financial conditions while the real estate typically represents the owners' primary business location. As such, management considers owner occupied CRE loans as having a lower risk profile than non-owner occupied CRE loans.

Current wording

Owner occupied commercial real estate loans rely on income generated from the respective owners’ businesses. Therefore, underwriting on owner occupied CRE loans emphasizes the owner’s cash flow and financial conditions while the real estate typically represents the owners' primary business location. Since cash flows from operations are the primary source of repayment for owner-occupied commercial real estate loans, this segment is considered less risky.

Previous wording

Non-owner occupied CRE loans are commercial loans not occupied by their owners and thus rely on income from third parties, including multi-family residential tenants and commercial tenants representing various industries. Underwriting on non-owner occupied CRE loans evaluates cash flow derived from the respective tenants and the industries they occupy. As such, management considers non-owner occupied CRE loans as having a higher risk profile than owner occupied CRE loans. In keeping with its risk appetite and relationship management strategy, the Company avoids speculative commercial office space and prefers loans to projects that have sufficient equity, or loan to value, and have either S&P rated tenants with long term leases, loans structured with personal guarantees of owners whose personal financial strength provides meaningful cash flow support to supplement rental income volatility, residential projects with stable rents in desirable locations, or projects with sufficient diversity and industries proven to provide lower risk over the long term.

Current wording

Non-owner occupied CRE loans are commercial loans not occupied by their owners and thus rely on income from third parties, including multi-family residential tenants and commercial tenants representing various industries. Underwriting on non-owner occupied CRE loans evaluates cash flow derived from the respective tenants and the industries they occupy. As such, management considers non-owner occupied CRE loans as having a higher risk profile than owner occupied CRE loans. In keeping with its risk appetite and relationship management strategy, the Company avoids speculative commercial office space and prefers loans for projects with the following characteristics: sufficient equity, or loan to value, and have either S&P rated tenants with long term leases, loans structured with personal guarantees of owners whose personal financial strength provides meaningful cash flow support to supplement rental income volatility, residential projects with stable rents in desirable locations, or projects with sufficient diversity and industries proven to provide lower risk over the long term.

Previous wording

Construction lending consists of commercial and residential site development loans, as well as commercial building construction and residential housing construction loans. Management prefers lending to well-established developers with a proven track record and strong business and guaranteed with owners’ personal financial conditions.

Current wording

Construction lending consists of commercial and residential site development loans, as well as commercial building construction and residential housing construction loans. Management prefers lending to well-established developers with a proven track record and strong business and guaranteed with owners’ personal financial conditions. As of June 30, 2024, the commercial construction portfolio of $54.0 million consisted of $41.2 million, or 76%, of non-owner-occupied loans and $12.8 million, or 24%, of owner-occupied loans.

Previous wording

For the three months ended March 31, 2024, commercial construction loans increased $8.7 million, or 22%, from $39.8 million on December 31, 2023 to $48.5 million at March 31, 2024. This increase was attributed to $4.8 million in commercial construction commitments originated during the quarter and $8.1 million in advances during the quarter on commercial construction loan availability booked prior to December 31, 2023. These advances were partially offset by $1.9 million of pay downs and $2.3 million in projects that stabilized and were converted to owner and non-owner commercial real estate loans during the quarter.

Current wording

For the six months ended June 30, 2024, commercial construction loans increased $14.1 million, or 35%, from $39.8 million on December 31, 2023 to $52.9 million at June 30, 2024. This increase was attributed to $7.1 million in commercial construction commitments originated during the year and $12.0 million in advances during the year on commercial construction loan availability booked prior to December 31, 2023. These advances were partially offset by $3.1 million of paydowns/payoffs and $1.9 million in projects that stabilized and were converted to owner and non-owner commercial real estate loans during the six months ended June 30, 2024.

Previous wording

As of March 31, 2024, the total consumer loan portfolio decreased by $12.1 million, or 4%, to $270.4 million compared to the December 31, 2023 balance of $282.5 million, primarily due to a strategic reduction in the indirect auto portfolio resulting from payoffs/paydowns with minimal originations. For the remainder of 2024, the Company expects maturities of approximately $37 million in the dealer portfolio with minimal originations.

Current wording

As of June 30, 2024, the total consumer loan portfolio decreased by $12.3 million, or 4%, to $270.1 million compared to the December 31, 2023 balance of $282.4 million, primarily due to a management strategic determination to reduce in the indirect auto portfolio totaling $22 million resulting from payoffs/paydowns with minimal originations. Offsetting the reduction in the indirect auto portfolio was growth of $5 million in the HELOC portfolio due to a sales campaign done during the year and growth of $7 million in the consumer other portfolio due to $6 million in personal loans purchased from Banker Healthcare Group (BHG) during the year along with standard portfolio growth. For the remainder of 2024, the Company expects maturities of approximately $24 million in the dealer portfolio with minimal originations.

Previous wording

As of March 31, 2024, the residential loan portfolio increased by $7.3 million, or 1%, to $508.9 million compared to the December 31, 2023 balance of $501.6 million. The increase was due to a shift from mortgage loans sold in the secondary market to loans held-for-investment, primarily jumbo mortgages with rates fixed for 5, 7 or 10 years with adjustable rates thereafter.

Current wording

As of June 30, 2024, the residential loan portfolio increased by $13.1 million, or 3%, to $514.6 million compared to the December 31, 2023 balance of $501.5 million. The increase was due to a shift from mortgage loans sold in the secondary market to loans held-for-investment, primarily jumbo mortgages with rates fixed for 5, 7 or 10 years with adjustable rates thereafter.