UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2022
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-13677
MID PENN BANCORP, INC.
(Exact Name of Registrant as Specified in its Charter)
Pennsylvania
25-1666413
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification Number)
2407 Park Drive
Harrisburg, Pennsylvania
17110
(Address of Principal Executive Offices)
(Zip Code)
Registrant’s telephone number, including area code 1.866.642.7736
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading
Symbol(s)
Name of each exchange on which registered
Common Stock, $1.00 par value per share
MPB
The NASDAQ Stock Market LLC
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files) Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐
Accelerated filer ☒
Non-accelerated filer ☐
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
As of July 29, 2022, the registrant had 15,878,193 shares of common stock outstanding.
1
TABLE OF CONTENTS
PART 1 – FINANCIAL INFORMATION
Item 1 – Financial Statements
3
Consolidated Balance Sheets as of June 30, 2022 and December 31, 2021 (Unaudited)
Consolidated Statements of Income for the Three and Six Months Ended June 30, 2022 and June 30, 2021 (Unaudited)
4
Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2022 and June 30, 2021 (Unaudited)
5
Consolidated Statements of Changes in Shareholders’ Equity for the Three and Six Months Ended June 30, 2022 and June 30, 2021 (Unaudited)
6
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2022 and June 30, 2021 (Unaudited)
7
Notes to Consolidated Financial Statements (Unaudited)
9
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
47
Item 3 – Quantitative and Qualitative Disclosures about Market Risk
66
Item 4 – Controls and Procedures
PART II – OTHER INFORMATION
Item 1 – Legal Proceedings
67
Item 1A – Risk Factors
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
Item 3 – Defaults upon Senior Securities
Item 4 – Mine Safety Disclosures
Item 5 – Other Information
Item 6 – Exhibits
68
Signatures
69
Unless the context otherwise requires, the terms “Mid Penn”, “Corporation” “we”, “us”, and “our” refer to Mid Penn Bancorp, Inc. and its consolidated wholly-owned banking subsidiary and nonbank subsidiaries.
2
ITEM 1 – FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Dollars in thousands, except share data)
June 30, 2022
December 31, 2021
ASSETS
Cash and due from banks
$
64,440
41,100
Interest-bearing balances with other financial institutions
4,909
146,031
Federal funds sold
167,437
726,621
Total cash and cash equivalents
236,786
913,752
Investment securities held to maturity, at amortized cost (fair value $365,288 and $330,626)
399,032
329,257
Investment securities available for sale, at fair value
218,698
62,862
Equity securities available for sale, at fair value
454
500
Loans held for sale, at fair value
9,574
11,514
Loans and leases, net of unearned interest
3,180,033
3,104,396
Less: Allowance for loan and lease losses
(16,876
)
(14,597
Net loans and leases
3,163,157
3,089,799
Bank premises and equipment, net
33,732
33,232
Bank premises and equipment held for sale
2,574
3,907
Operating lease right of use asset
8,326
9,055
Finance lease right of use asset
2,997
3,087
Cash surrender value of life insurance
50,169
49,661
Restricted investment in bank stocks
4,234
9,134
Accrued interest receivable
12,902
11,328
Deferred income taxes
13,780
10,779
Goodwill
113,835
Core deposit and other intangibles, net
7,729
9,436
Foreclosed assets held for sale
—
Other assets
32,115
28,287
Total Assets
4,310,163
4,689,425
LIABILITIES & SHAREHOLDERS’ EQUITY
Deposits:
Noninterest-bearing demand
850,180
850,438
Interest-bearing demand
1,023,027
1,066,852
Money Market
999,556
1,076,593
Savings
354,677
381,476
Time
475,147
626,657
Total Deposits
3,702,587
4,002,016
Long-term debt
4,592
81,270
Subordinated debt and trust preferred securities
73,995
74,274
Operating lease liability
10,324
11,363
Accrued interest payable
1,542
1,791
Other liabilities
21,288
28,635
Total Liabilities
3,814,328
4,199,349
Shareholders' Equity:
Common stock, par value $1.00 per share; 20.0 million shares authorized;
16.1 million issued at June 30, 2022 and at December 31, 2021; 15.9 million
outstanding at June 30, 2022 and 16.0 million at December 31, 2021
16,081
16,056
Additional paid-in capital
386,128
384,742
Retained earnings
108,265
91,043
Accumulated other comprehensive (loss) income
(9,759
158
Treasury stock, at cost; 202,364 shares at June 30, 2022 and 98,452 shares at December 31, 2021
(4,880
(1,923
Total Shareholders’ Equity
495,835
490,076
Total Liabilities and Shareholders' Equity
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(Dollars in thousands, except per share data)
Three Months Ended June 30,
Six Months Ended June 30,
2022
2021
INTEREST INCOME
Interest and fees on loans and leases
34,264
29,835
69,280
58,165
Interest and dividends on investment securities:
U.S. Treasury and government agencies
2,329
225
3,865
403
State and political subdivision obligations, tax-exempt
379
278
715
555
Other securities
504
291
921
593
Total Interest and Dividends on Investment Securities
3,212
794
5,501
1,551
Interest on other interest-bearing balances
8
21
Interest on federal funds sold
736
98
1,050
177
Total Interest Income
38,220
30,729
75,852
59,897
INTEREST EXPENSE
Interest on deposits
2,019
2,916
4,313
5,882
Interest on short-term borrowings
232
406
Interest on long-term and subordinated debt
768
704
1,692
1,407
Total Interest Expense
2,787
3,852
6,005
7,695
Net Interest Income
35,433
26,877
69,847
52,202
PROVISION FOR LOAN AND LEASE LOSSES
1,725
1,150
2,225
2,150
Net Interest Income After Provision for Loan and Lease Losses
33,708
25,727
67,622
50,052
NONINTEREST INCOME
Mortgage banking income
305
2,841
834
5,220
Income from fiduciary and wealth management activities
1,205
542
2,257
1,098
Service charges on deposits
450
1,134
329
ATM debit card interchange income
1,128
656
2,185
1,224
Net gain on sales of SBA loans
119
355
110
455
Merchant services income
87
209
160
301
Earnings from cash surrender value of life insurance
262
75
508
149
Other income
1,674
797
3,792
1,588
Total Noninterest Income
5,230
5,652
10,980
10,364
NONINTEREST EXPENSE
Salaries and employee benefits
12,340
9,933
25,584
19,531
Occupancy expense, net
1,655
1,317
3,454
2,797
Equipment expense
1,112
741
2,123
1,492
Software licensing and utilization
1,821
1,497
3,927
2,942
FDIC Assessment
506
433
1,097
903
Legal and professional fees
694
1,333
981
Charitable contributions qualifying for State tax credits
125
365
190
635
Mortgage banking profit-sharing expense
33
745
178
865
Gain on sale or write-down of foreclosed assets, net
(15
(19
(31
Intangible amortization
521
276
1,002
557
Merger and acquisition expense
522
Post-acquisition restructuring expense
Other expenses
5,123
3,091
10,474
5,808
Total Noninterest Expense
23,915
19,456
49,660
37,014
INCOME BEFORE PROVISION FOR INCOME TAXES
15,023
11,923
28,942
23,402
Provision for income taxes
2,771
2,310
5,336
4,477
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS
12,252
9,613
23,606
18,925
PER COMMON SHARE DATA:
Basic and Diluted Earnings Per Common Share
0.77
0.93
1.48
2.02
Diluted Earnings Per Common Share
Cash Dividends Declared
0.20
0.40
0.39
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(Dollars in thousands)
Net income
Other comprehensive loss:
Unrealized (loss) income arising during the period on available-for-sale
securities, net of income taxes of ($1,279) and ($6), respectively
(4,812
Change in defined benefit plans, net of income taxes of $0 and ($80), respectively (a)
(302
Reclassification adjustment for settlement losses and other activity related to benefit
plans, net of income taxes of $0 and $0, respectively (b)
(1
Total other comprehensive loss
(4,813
(282
Total comprehensive income
7,439
9,331
Other comprehensive (loss) income:
securities, net of income taxes of ($2,669) and ($6), respectively
(10,042
22
Change in defined benefit plans, net of income tax impact of $33 and $79, respectively (b)
127
298
plans, net of income taxes of $0 and ($12), respectively (c)
(2
(44
Total other comprehensive (loss) income
(9,917
13,689
19,201
(a)
The change in defined benefit plans consists primarily of unrecognized actuarial gains (losses) on defined benefit plans during the period.
(b)
The reclassification adjustment for benefit plans includes settlement gains, amortization of prior service costs, and amortization of net gain or loss. Amounts are included in other income on the consolidated statements of income within total noninterest income. Please reference Note 11 – Defined Benefit Plans, for more information.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)
Accumulated
Additional
Other
Total
Common
Paid-in
Retained
Comprehensive
Treasury
Shareholders'
Stock
Capital
Earnings
Income (Loss)
Equity
Balance, January 1, 2022
11,354
Total other comprehensive loss, net of taxes
(5,104
Common stock cash dividends declared, $0.20 per share
(3,191
Riverview restricted stock adjustment
776
Employee Stock Purchase Plan (1,710 shares)
44
46
Director Stock Purchase Plan (1,377 shares)
35
36
Restricted stock activity
168
Balance, March 31, 2022
16,059
385,765
99,206
(4,946
494,161
(3,193
Repurchased stock (103,912 shares)
(2,957
Employee Stock Purchase Plan (1,899 shares)
49
51
Director Stock Purchase Plan (1,589 shares)
41
43
Restricted stock activity (17,200 shares)
18
273
Balance, June 30, 2022
Balance, January 1, 2021
8,512
178,853
70,175
(57
(1,795
255,688
9,312
Total other comprehensive income, net of taxes
558
Common stock cash dividends declared, $0.19 per share
(1,599
Repurchased stock (5,800 shares)
(128
Employee Stock Purchase Plan (1,647 shares)
38
40
Director Stock Purchase Plan (1,743 shares)
32
132
Balance, March 31, 2021
8,515
179,055
77,888
501
264,036
(2,281
Common shares issued through follow-on public offering (2,990,000 shares), net of underwriting discounts and offering expenses
2,990
67,248
70,238
Employee Stock Purchase Plan (2,365 shares)
37
Director Stock Purchase Plan (2,231 shares)
34
173
Balance, June 30, 2021
11,507
246,546
85,220
219
341,569
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Operating Activities:
Net Income
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan and lease losses
Depreciation
1,993
1,639
Amortization of intangibles
Net amortization of security discounts/premiums
384
326
Amortization of operating lease right of use assets
844
857
Amortization of finance lease right of use asset
90
Earnings on cash surrender value of life insurance
(508
(149
Mortgage loans originated for sale
(82,142
(178,492
Proceeds from sales of mortgage loans originated for sale
84,916
185,016
Gain on sale of mortgage loans
(834
(5,220
SBA loans originated for sale
(2,636
(4,894
Proceeds from sales of SBA loans originated for sale
2,807
5,349
Gain on sale of SBA loans
(110
(455
Gain on disposal or write-down of property, plant, and equipment
(71
(25
Gain on sale or write-down of foreclosed assets
Loss on sale of bank premises and equipment held for sale
Write-off of bank premises and equipment held for sale
705
Accretion of subordinated debt
(279
Stock compensation expense
459
Deferred income tax benefit
(206
(1,597
(Increase) decrease in accrued interest receivable
(1,574
2,333
(Increase) decrease in other assets
(3,828
3,633
(Decrease) increase in accrued interest payable
(249
115
Net change in operating lease liability
(1,154
(877
Decrease in other liabilities
(7,301
(1,570
Net Cash Provided By Operating Activities
19,441
27,997
Investing Activities:
Proceeds from the maturity or call of available-for-sale securities
5,439
2,500
Purchases of available-for-sale securities
(174,102
(4,892
Proceeds from the maturity or call of held-to-maturity securities
9,620
22,757
Purchases of held-to-maturity securities
(79,664
(47,818
Reduction of restricted investment in bank stock
4,900
778
Net increase in loans and leases
(75,753
(111,987
Purchases of bank premises and equipment
(2,549
(1,515
Proceeds from the sale of bank premises and equipment
29
Proceeds from the sale of foreclosed assets
71
162
Net Cash Used In Investing Activities
(311,911
(139,986
Financing Activities:
Net (decrease) increase in deposits
(299,429
307,544
Net increase in short-term borrowings
71,272
Common stock dividends paid
(6,384
(4,301
Proceeds from Employee Stock Purchase Plan stock issuance
97
78
Proceeds from Director Stock Purchase Plan stock issuance
79
Proceeds from follow-on common stock public offering
-
Treasury stock purchased
Net change in finance lease liability
(43
Long-term debt repayment
(76,634
(115
Net Cash (Used In) Provided By Financing Activities
(384,496
444,612
Net (decrease) increase in cash and cash equivalents
(676,966
332,623
Cash and cash equivalents, beginning of period
303,724
Cash and cash equivalents, end of period
636,347
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (continued)
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest
3,467
7,580
Cash paid for income taxes
3,500
5,820
Supplemental Noncash Disclosures:
Recognition of operating lease right of use assets
1,064
Recognition of operating lease liabilities
Obsolete Riverview asset writeoff
Loans transferred to foreclosed assets held for sale
109
20
Held-to-maturity securities purchased, not settled
524
Note 1 - Basis of Presentation
For all periods presented, the accompanying consolidated financial statements include the accounts of Mid Penn Bancorp, Inc. (“Mid Penn” or the “Corporation”), its wholly-owned subsidiary, Mid Penn Bank (the “Bank”), and three nonbank subsidiaries which were established during 2020, including MPB Financial Services, LLC, under which two additional nonbank subsidiaries have been established: (i) MPB Wealth Management, LLC, created to expand the wealth management services and capabilities of the Corporation, and (ii) MPB Risk Services, LLC, created to fulfill the insurance needs of both existing and potential customers of the Corporation. As of June 30, 2022, the accounts and activities of these nonbank subsidiaries established in 2020 were not material to warrant separate disclosure or segment reporting. As a result, Mid Penn has only one reportable segment for financial reporting purposes. All material intercompany accounts and transactions have been eliminated in consolidation.
On November 30, 2021, Mid Penn completed its acquisition of Riverview Financial Corporation (“Riverview”), pursuant to the previously announced Agreement and Plan of Merger dated as of June 30, 2021. On November 30, 2021, Riverview was merged with and into Mid Penn, with Mid Penn being the surviving corporation. Refer to Note 3, Acquisition of Riverview Financial Corporation, as well as the Company’s Current Report on Form 8-K filed on December 1, 2021, for more information.
The comparability of Mid Penn’s results of operations for the period ended June 30, 2022, compared to the periods ended June 30, 2021 and the year ended December 31, 2021, in general, has been materially impacted by this acquisition, as further described in Note 3. For comparative purposes, the June 30, 2021 and December 31, 2021 balances have been reclassified, when necessary, to conform to the 2022 presentation. Such reclassifications had no impact on net income or total shareholders’ equity. In the opinion of management, all adjustments necessary for fair presentation of the periods presented have been reflected in the accompanying consolidated financial statements. All such adjustments are of a normal, recurring nature. These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2021.
Mid Penn has evaluated events and transactions occurring subsequent to the balance sheet date of June 30, 2022, for items that should potentially be recognized or disclosed in these consolidated financial statements. The evaluation was conducted through the issuance date of these consolidated financial statements.
Note 2 - Summary of Significant Accounting Policies
The accounting and reporting policies of Mid Penn conform with accounting principles as required under GAAP and general practices within the financial industry. The following is a description of the more significant accounting policies.
Investment Securities
Securities to be held for indefinite periods, but not intended to be held to maturity, are classified as available for sale and carried at fair value. Securities held for indefinite periods include securities that management intends to use as part of its asset and liability management strategy and pledging requirements, and that may be sold in response to liquidity needs, changes in interest rates, resultant prepayment risk, reductions in pledging levels, and other factors related to effective portfolio management. Securities to be held to maturity are carried at amortized cost.
For available-for-sale debt securities, realized gains and losses on dispositions are based on the difference between net proceeds and the amortized cost of the securities sold, using the specific identification method. Unrealized gains and losses on debt securities are based on the difference between the amortized cost and fair value of each security as of the respective reporting date. Unrealized gains and losses are credited or charged to other comprehensive income on an after-tax basis, whereas realized gains and losses flow through Mid Penn’s consolidated statement of income for the respective period.
ASC Topic 320, Investments – Debt and Equity Securities, clarifies the interaction of the factors that should be considered when determining whether a debt security is other-than-temporarily impaired. For debt securities, management must assess, in addition to the credit condition of the underlying issuer, whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery. These steps are done before assessing whether the Corporation will recover the cost basis of the investment.
In instances when a determination is made that an other-than-temporary impairment of a debt security exists, but the Corporation does not intend to sell the debt security, and it is not more likely than not that it will be required to sell the debt security prior to its anticipated recovery, this guidance changes the presentation and amount of the other-than-temporary impairment recognized in the income statement. The other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss), and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.
Equity Securities
In accordance with ASC Topic 825, Financial Instruments, Mid Penn reports its equity securities with readily determinable fair values at fair value on the consolidated balance sheets, with realized and unrealized gains and losses reported in other expense on the consolidated statements of income. Mid Penn’s equity securities consisted of Community Reinvestment Act (“CRA”) funds with a fair value totaling $454,000 and $500,000 as of June 30, 2022 and December 31, 2021, respectively. No equity securities were sold during the three months or six months ended June 30, 2022 or June 30, 2021.
Loans
Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, net of an allowance for loan and lease losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) of the related loans, generally being amortized over the contractual life of the loan. Premiums and discounts on purchased loans are amortized as adjustments to interest income using the effective yield method.
The loan portfolio is segmented into commercial and consumer loans. Commercial loans consist of the following classes: commercial and industrial, commercial real estate, commercial real estate-construction and lease financing. Consumer loans consist of the following classes: residential mortgage loans, home equity loans and other consumer loans.
For all classes of loans, the accrual of interest generally is discontinued when the contractual payment of principal or interest has become 90 days or more past due, or management has serious doubts about further collectability of principal or interest even though the loan is currently performing. A loan past due 90 days or more may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest is credited to income. Interest received on nonaccrual loans, including impaired loans, is either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. Nonaccrual loans may be restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally, at least nine consecutive months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments.
Commercial and Industrial Loans
Mid Penn originates commercial and industrial loans. Most of the Bank’s commercial and industrial loans have been extended to finance local and regional businesses and include short-term loans to finance machinery and equipment purchases, inventory, and accounts receivable. Commercial loans also involve the extension of revolving credit for a combination of equipment acquisitions and working capital in expanding companies.
The maximum term for loans extended on machinery and equipment is based on the projected useful life of such machinery and equipment. Generally, the maximum term on non-mortgage lines of credit is one year. The loan-to-value ratio on such loans and lines of credit generally may not exceed 80% of the value of the collateral securing the loan. The Bank’s commercial business lending policy includes credit file documentation and analysis of the borrower’s character, capacity to repay the loan, the adequacy of the borrower’s capital and collateral, as well as an evaluation of conditions affecting the borrower. Analysis of the borrower’s past, present, and future cash flows is also an important aspect of the Bank’s current credit analysis. Nonetheless, such loans are believed to carry higher credit risk than other extensions of credit.
Commercial and industrial loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself, which, in turn, is likely to be dependent upon the general economic environment. Mid Penn’s commercial and industrial loans are usually, but not always, secured by business assets and personal guarantees. However, the collateral securing the loans may depreciate over time, may be difficult to appraise, and may fluctuate in value based on the success of the business.
Commercial Real Estate and Commercial Real Estate – Construction Loans
Commercial real estate and commercial real estate construction loans generally present a higher level of risk than loans secured by one-to-four family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. In addition, the repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced, the borrower’s ability to repay the loan may be impaired.
10
Residential Mortgage Loans
Mid Penn offers a wide array of residential mortgage loans for both permanent structures and those under construction. The Bank’s residential mortgage originations are secured primarily by properties located in its primary market and surrounding areas. Residential mortgage loans have terms up to a maximum of 30 years and with loan-to-value ratios up to 100% of the lesser of the appraised value of the security property or the contract price. Private mortgage insurance is generally required in an amount sufficient to reduce the Bank’s exposure to at or below the 85% loan to value level. Residential mortgage loans generally do not include prepayment penalties.
In underwriting residential mortgage loans, the Bank evaluates both the borrower’s ability to make monthly payments and the value of the property securing the loan. Most properties securing real estate loans made by Mid Penn are appraised by independent fee appraisers. The Bank generally requires borrowers to obtain title insurance and fire and property insurance (including flood insurance, if necessary) in an amount not less than the amount of the loan. Real estate loans originated by the Bank generally contain a “due on sale” clause allowing the Bank to declare the unpaid principal balance due and payable upon the sale of the security property.
The Bank underwrites residential mortgage loans to the standards established by the secondary mortgage market, i.e., Fannie Mae, Ginnie Mae, Freddie Mac, Federal Home Loan Bank, or Pennsylvania Housing Finance Agency standards, with the intention of selling the majority of residential mortgages originated into the secondary market. In the event that the facts and circumstances surrounding a residential mortgage application do not meet the required underwriting conditions of the secondary mortgage market, the Bank will evaluate the failed conditions and evaluate the potential risk of holding the residential mortgage in the Bank’s portfolio rather than rejecting the loan request. In the event that the loan is funded and held in the Bank’s portfolio, the interest rate on the residential mortgage would be increased to compensate for the added portfolio risk.
Consumer Loans, Including Home Equity Credits
Mid Penn offers a variety of secured consumer loans, including home equity, automobile, and deposit secured loans. In addition, the Bank offers other secured and unsecured consumer loans. Most consumer loans are originated in Mid Penn’s primary market and surrounding areas.
The largest component of Mid Penn’s consumer loan portfolio consists of fixed rate home equity loans and variable rate home equity lines of credit. Substantially all home equity loans and lines of credit are secured by junior lien mortgages on principal residences. The Bank will lend amounts, which, together with all prior liens, typically may be up to 85% of the appraised value of the property securing the loan. Home equity term loans may have maximum terms up to 20 years, while home equity lines of credit generally have maximum terms of ten years.
Consumer loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower. The underwriting standards employed by the Bank for consumer loans include an application, a determination of the applicant’s payment history on other debts, and an assessment of ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, in relation to the proposed loan amount.
Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles or recreational equipment. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
Junior liens inherently have more credit risk by virtue of the fact that another financial institution may have a higher security position in the case of foreclosure liquidation of collateral to extinguish the debt. Generally, foreclosure actions could become more prevalent if the real estate market weakens and property values deteriorate.
Payroll Protection Program (“PPP”) Loans
Included in total loans as of June 30, 2022, within the commercial and industrial loan portfolio classification, are $4,966,000 of PPP loans, net of deferred fees, which, as of June 30, 2022, were still outstanding as the remaining borrowers and the Small Business Administration (“SBA”) had not yet completed the loan forgiveness and repayment process. Comparatively, as of December 31, 2021, Mid Penn had $111,286,000 of PPP loans outstanding, net of deferred fees. Mid Penn has been a significant participating lender under the PPP, which was originally created when the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law on March 27, 2020, and extended by the signing of the Consolidated Appropriations Act, 2021 into law on December 27, 2020, and further extended to May 31, 2021 by the PPP Extension Act of 2021. The PPP loans, which are 100% guaranteed by the SBA, have up to a five-year term to maturity and carry a low interest rate of 1% throughout the loan term.
The SBA also provided a processing fee per loan to financial institutions who participated in the PPP, with the amount of such fee generally ranging from 1% to 5% as pre-determined by the SBA dependent upon the size of each respective credit. As of June 30, 2022, Mid Penn had received $42,520,000 of nonrefundable loan processing fees related to the loans disbursed as a result of Mid Penn’s participation in the PPP initiative, consisting of (i) $20,883,000 of loan processing fees received related to PPP loans funded during the
11
year ended December 31, 2020, (ii) $17,997,000 of loan processing fees received related to PPP loans funded during the year ended December 31, 2021, and (iii) $3,640,000 during the six months ended June 30, 2022. In addition to receiving and deferring the processing fees, Mid Penn recorded and deferred related loan origination costs, and in accordance with ASC 310-20, Receivables—Nonrefundable Fees and Other Costs, the processing fees and loan origination costs are being amortized to interest and fees on loans and leases on the consolidated statements of income over the life of each respective loan. As of June 30, 2022, Mid Penn had $171,000 of PPP deferred loan processing fees not yet realized as income. Comparatively, as of December 31, 2021, Mid Penn had PPP deferred loan processing fees not yet realized as income totaling $3,811,000. Mid Penn recognized $3,640,000 of PPP processing fees during the quarter ended June 30, 2022, compared to $6,244,000 of PPP processing fees for the same period of 2021. PPP processing fees are reflected within interest and fees on loans and leases on the consolidated statements of income.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses (“allowance”) and the related provision reflect Mid Penn’s continued application of the incurred loss method for estimating credit losses as Mid Penn is not required to adopt the current expected credit loss (“CECL”) accounting standard until January 1, 2023, and Mid Penn has not elected to early adopt CECL. The allowance consists of (i) the allowance for loan and lease losses, and (ii) the reserve for unfunded lending commitments. The allowance for loan and lease losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The reserve for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded loan commitments and is recorded in other liabilities on the consolidated balance sheet. The reserve for unfunded lending commitments was $74,000 at June 30, 2022 and $72,000 at December 31, 2021.
The allowance is increased by the provision for loan and lease losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Non-residential consumer loans are generally charged off no later than 120 days past due on a contractual basis, or earlier in the event of either bankruptcy or if there is an amount deemed uncollectible. Because all identified losses are immediately charged off, no portion of the allowance is restricted to any individual loan or groups of loans, and the entire allowance is available to absorb any and all loan losses.
The allowance is maintained at a level considered by management to be adequate to provide for losses that can be reasonably anticipated. Management performs a monthly evaluation of the adequacy of the allowance. The allowance is based on Mid Penn’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired. For loans that are classified as impaired, an allowance is established when the discounted cash flows, collateral value, or observable market price of the impaired loan is lower than the carrying value of that loan.
The general component covers pools of loans by loan class, including commercial loans not considered impaired, as well as smaller balance homogeneous loans, such as residential real estate, home equity and other consumer loans. These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these categories of loans, adjusted for qualitative factors. These qualitative risk factors include changes in economic conditions, fluctuations in loan quality measures, changes in collateral values, changes in the experience of the lending staff and loan review systems, changes in lending policies and procedures (including underwriting standards), changes in the mix and volume of loans originated, the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing loan portfolio, shifting industry or portfolio concentrations, and other relevant factors. Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in relevant analyses and a narrative accompanying the allowance for loan and lease loss calculation.
The unallocated component of the allowance for loan and lease losses covers several considerations that are not specifically measurable through the specific and general components. For example, at times Mid Penn could face increasing credit risks and uncertainties, not yet reflected in recent historical losses or qualitative factor assessments, associated with unpredictable changes in economic growth or business conditions in our markets or for certain industries in which we have commercial loan borrowers, or unanticipated stresses to the values of real estate held as collateral, or unforeseeable effects on the portfolio from other influences, inducing the long-term impact of the pandemic. Any or all of these additional issues can adversely affect our borrowers’ ability to timely repay their loans. Additionally, we have experienced continued strong commercial loan growth, including growth in newer markets where we have less of a loss history. Also, the unallocated component allocation recognizes the inherent imprecision in our allowance for loan and lease loss methodology, or any alternative methodology, for estimating specific and general loan losses. This includes, but is not limited to, (i) the unpredictable timing and amounts of charge-offs, (ii) the fact that historical loss averages don’t necessarily correlate to future loss trends, (iii) data and trends supporting qualitative factor judgements may not be indicative of the true nature of future period risks, and (iv) unexpected changes to specific-credit or general portfolio future cash flows and collateral values which could negatively impact unimpaired portfolio loss factors.
12
Mid Penn generally considers a commercial loan (consisting of commercial and industrial, commercial real estate, commercial real estate-construction, and lease financing loan classes) to be impaired when it becomes 90 days or more past due and not in the process of collection, or sooner when it is probable that Mid Penn will be unable to collect all contractual principal and interest due. This methodology assumes the borrower cannot or will not continue to make additional payments. At that time, the loan would generally be considered collateral dependent as the discounted cash flow method would generally indicate no operating income available for evaluating the collateral position; therefore, most impaired loans are deemed to be collateral dependent.
In addition, Mid Penn’s rating system assumes any loans classified as nonaccrual, included in the substandard rating, to be impaired, and most of these loans are considered collateral dependent; therefore, most of Mid Penn’s impaired loans, whether reporting a specific allocation or not, are considered collateral dependent.
Mid Penn evaluates loans for charge-off on a monthly basis. Policies that govern the recommendation for charge-off are unique to the type of loan being considered. Commercial loans classified as substandard nonaccrual, doubtful or having probable loss will first have a collateral evaluation completed in accordance with the guidance on impaired loans. Once the collateral evaluation has been completed, a specific allocation of allowance is made based upon the results of the evaluation. The remaining balance remains a nonperforming loan with the original terms and interest rate intact (not restructured). In the event the loan is unsecured, the loan would have been charged-off at the recognition of impairment. Commercial real estate loans determined to be impaired will also have an initial collateral evaluation completed in accordance with the guidance on impaired loans. An updated real estate valuation is ordered, and the collateral evaluation is modified to reflect any variations in value. A specific allocation of allowance is made for any anticipated collateral shortfall. The remaining balance remains a nonperforming loan with the original terms and interest rate intact (not restructured). The process of charging off a residential mortgage loan begins when a loan becomes delinquent for 90 days and is not in the process of collection. The existing appraisal is reviewed, and a lien search is obtained to determine lien position and any instances of intervening liens. A new appraisal of the property will be ordered if deemed necessary by management and a collateral evaluation is completed. The loan will then be charged down to the value indicated in the evaluation. Non-residential consumer loans are generally charged off no later than 120 days past due on a contractual basis, or earlier in the event of either bankruptcy or if there is an amount deemed uncollectible. The collateral shortfall of the consumer loan is recommended for charge-off at this point.
As noted above, Mid Penn assesses a specific allocation for commercial loans and commercial real estate loans. The remaining balance remains a nonperforming loan with the original terms and interest rate intact (not restructured). In addition, Mid Penn takes a preemptive step when any commercial loan becomes classified under its internal classification system. A preliminary collateral evaluation, in accordance with the guidance on impaired loans, is prepared using the existing collateral information in the loan file. This process allows Mid Penn to review both the credit and documentation files to determine the status of the information needed to make a collateral evaluation. This collateral evaluation is preliminary, but allows Mid Penn to determine if any potential collateral shortfalls exist.
It is Mid Penn’s policy to obtain updated third-party collateral valuations on all impaired loans secured by real estate as soon as practically possible following the credit being classified as substandard nonaccrual. Prior to receipt of the updated real estate valuation, Mid Penn will use any existing real estate valuation to determine any potential allowance issues; however, no allowance recommendation will be made until such time Mid Penn is in receipt of the updated valuation. The Asset Recovery department employs an electronic tracking system to monitor the receipt of and need for updated appraisals. To date, there have been no material time lapses noted with the above processes.
In some instances, Mid Penn is not holding real estate as collateral and is relying on business assets (personal property) for repayment. In these circumstances, a collateral inspection is performed by Mid Penn personnel to determine an estimated value. The value is based on net book value, as provided by the financial statements, and discounted accordingly based on determinations made by management. Occasionally, Mid Penn will employ an outside service to provide a fair estimate of value based on auction sales or private sales. Management reviews the estimates of these third parties and discounts them accordingly based on management’s judgment, if deemed necessary.
For impaired loans with no valuation allowance required, the independent third-party market valuations on the subject property obtained by Mid Penn as soon as practically possible following the credit being placed on nonaccrual status sometimes indicates that the loan-to-value ratio is sufficient to obviate the need for a specific allocation in spite of significant deterioration in real estate values in Mid Penn’s primary market area. These circumstances are determined on a case-by-case analysis of the impaired loans.
Mid Penn actively monitors the values of collateral on impaired loans. This monitoring may require the modification of collateral values over time or changing circumstances by some factor, either positive or negative, from the original values. All collateral values will be assessed by management at least every 12 months for possible revaluation by an independent third party.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, Mid Penn does not separately identify individual residential mortgage loans, home equity loans and other consumer loans for impairment disclosures, unless such loans are the subject of a troubled debt restructuring agreement.
Loans whose terms are modified are classified as troubled debt restructurings if the borrowers have been granted concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve a temporary reduction in interest rate or an extension of a loan’s stated maturity date. Nonaccrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for nine consecutive months after modification. Loans classified as troubled debt restructurings are designated as impaired.
13
The allowance calculation methodology includes segregation of loan classes into risk rating categories. The borrower’s overall financial condition, repayment sources, guarantors, and value of collateral, if appropriate, are evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful, and loss. Loans criticized as special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan and lease losses. Any loans not classified as noted above are rated pass.
In addition, federal and state regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance and may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. No such additions were required from any recent examinations.
Based on management’s comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan and lease losses is adequate.
Mid Penn had $4,966,000 and $111,286,000 of PPP loans outstanding, net of deferred fees, as of June 30, 2022 and December 31, 2021, respectively, which though they are classified as commercial and industrial credits, are guaranteed by the Small Business Administration and, thus, have no loss reserve allocated to them.
Acquired Loans
Loans that Mid Penn acquires in connection with business combinations are recorded at fair value with no carryover of the acquired entity’s related allowance for loan and lease losses. Loans acquired at fair value and included in the balance of loans and leases, net of unearned interest, on the consolidated balance sheets totaled $895,855,000 and $1,010,039,000 as of June 30, 2022 and December 31, 2021, respectively. The fair value of the acquired loans involves estimating the amount and timing of principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest.
The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable discount. These loans are accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. The nonaccretable discount includes estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows will require Mid Penn to evaluate the need for an additional allowance. Subsequent improvement in expected cash flows will result in the reversal of a corresponding amount of the nonaccretable discount which Mid Penn will then reclassify as accretable discount that will be recognized into interest income over the remaining life of the loan.
Loans acquired through business combinations that meet the specific criteria of ASC 310-30 are individually evaluated each period to analyze expected cash flows. To the extent that the expected cash flows of a loan have decreased due to credit deterioration, Mid Penn establishes an allowance.
Loans acquired through business combinations that do not meet the specific criteria of ASC 310-30 are accounted for under ASC 310-20. These loans are initially recorded at fair value and include credit and interest rate marks associated with acquisition accounting adjustments. Purchase premiums or discounts are subsequently amortized as an adjustment to yield over the estimated contractual lives of the loans. There is no allowance for loan and lease losses established at the acquisition date for acquired performing loans. An allowance for loan and lease losses is recorded for any credit deterioration in these loans subsequent to acquisition.
Acquired loans that met the criteria for impaired or nonaccrual of interest prior to the acquisition may be considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if Mid Penn expects to fully collect the new carrying value (i.e. fair value) of the loans. As such, Mid Penn may no longer consider the loan to be nonaccrual or nonperforming at the date of acquisition and may accrue interest on these loans, including the impact of any accretable discount. In addition, charge-offs on such loans would be first applied to the nonaccretable difference portion of the fair value adjustment.
Mortgage Banking Derivative Financial Instruments
During the third quarter of 2021, Mid Penn began using mortgage banking derivative financial instruments as part of our overall strategy to manage exposure to market risk within our mortgage banking operations, primarily due to fluctuations in interest rates, and to reduce the risk of price volatility of loans in the commitment phase.
In connection with its mortgage banking activities, Mid Penn enters into interest rate lock commitments (IRLCs) to extend credit to a mortgage applicant within a specified period of time, provided certain specified terms and conditions are met, and with both the interest rate and the maximum loan amount set prior to funding. This loan commitment binds Mid Penn (subject to approval of the loan) to fund the loan at the specified rate, regardless of whether interest rates have changed between the commitment date and the loan funding date.
14
Outstanding IRLCs may expose Mid Penn to the risk that the price of the mortgage loans underlying the commitments may decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan. As such, outstanding IRLCs are subject to interest rate risk and related price risk during the period from the date of the commitment through the loan funding date or expiration date. The IRLC does not contractually obligate the borrower to close the loan, regardless of whether Mid Penn approves the loan.
Mid Penn originates all mortgage loans with the intention that the loans will be held for sale in the secondary market. Mid Penn enters into forward mortgage loan sales commitments shortly after extending an IRLC to the borrower to mitigate interest rate risk related to the IRLC for mortgage loans originated for sale. Mid Penn enters into mortgage loan sales commitments as either (i) a mandatory commitment, meaning that the loan must be delivered at an agreed-upon price within a specified timeframe, or (ii) a best-effort commitment, meaning that the loan will be delivered if and when it closes, with a price that is typically less favorable than a mandatory commitment and often with a large markup. If a mandatory commitment is not delivered within the agreed-upon timeframe or price point, Mid Penn would likely be required to “pair out” of the commitment and may be subject to a pair-off fee. In addition, Mid Penn enters into forward commitments for the future sales or purchases of mortgage-backed securities to or from third-party counterparties to hedge the effect of changes in interest rates on the values of both the interest rate locks and mortgage loans held for sale.
Mandatory forward loan sales commitments are accounted for as freestanding derivative instruments and are carried at fair value equal to the amount required to settle the commitment as of the reporting date based on the underlying mortgage loans and the probability of commitments being exercised. Gross derivative assets and liabilities are recorded within other assets and other liabilities on the consolidated balance sheet, with changes in fair value during the period recorded in other noninterest income in the consolidated statements of income.
Best effort forward sales commitments are financial instruments which are carried at fair value under ASC 825 – Financial Instruments. Fair value is estimated as the amount required to settle the commitment as of the reporting date, which is based on the underlying mortgage loans and the probability of commitments being exercised. Gross derivative assets and liabilities are recorded within other assets and other liabilities on the consolidated balance sheet, with changes in fair value during the period in other noninterest income in the consolidated statements of income.
Loan-Level Interest Rate Swaps
Mid Penn enters into loan-level interest rate swaps (“swaps”) to facilitate certain customer transactions and meet their financing needs. These swaps qualify as derivatives but are not designated as hedging instruments. A loan-level interest rate swap is a contract in which the series of interest rate flows (fixed and variable) are exchanged over the term of a loan with certain qualifying commercial loan customers, and Mid Penn simultaneously enters into an interest rate swap with a dealer counterparty with identical notional amounts and terms. The net result of these swaps is that the customer pays a fixed interest rate and Mid Penn receives a floating interest rate. The swap positions with customers are equally offset with the dealer counterparties to minimize the potential impact on Mid Penn’s financial statements.
Pursuant to our agreements with the dealer counterparties, we may receive collateral or may be required to post collateral based upon mark-to-market positions. Beyond unsecured threshold levels, collateral in the form of cash or securities may be made available to counterparties of interest rate swap transactions. Based upon our current positions and related future collateral requirements relating to them, we believe any effect on our cash flow or liquidity position to be immaterial.
Derivatives contain an element of credit risk, including the possibility that we will incur a loss because a party to the agreements, which may be a dealer counterparty or a customer, fails to meet its contractual obligations. Derivative contracts may only be executed with dealer counterparties as approved by our Board of Directors. Similarly, derivatives with customers may only be executed with customers within credit exposure limits as approved by our Board of Directors. Loan-level interest rate swaps are considered derivatives but are not accounted for using hedge accounting.
Bank Premises and Equipment Held for Sale
Bank premises and equipment designated as held for sale are carried at the lower of cost or market value, and at June 30, 2022 and December 31, 2021, totaled $2,574,000 and $3,907,000, respectively. These balances are related to the December 7, 2021 announcement of a Retail Network Optimization Plan under which the Bank announced its intention to close certain retail locations throughout its expanded footprint. The branch closures occurred on March 4, 2022. Adjustments to record these held for sale assets at the lower of cost or fair value related to the held for sale properties were included in post-acquisition restructuring expenses and totaled $874,000 for the year ended December 31, 2021. During the six months ended June 30, 2022, Mid Penn had a write-off expense of obsolete bank premises and equipment held for sale of $705,000, as a result of branch closures during the first quarter of 2022, as previously announced on a Form 8-K dated December 7, 2021. There were no impairment charges recorded during the six months ended June 30, 2022 or 2021.
Foreclosed Assets Held for Sale
Foreclosed assets held for sale consist primarily of real estate acquired through, or in lieu of, foreclosure in settlement of debt, and are recorded at fair value less the selling costs at the date of transfer, establishing a new cost basis. Any valuation adjustments required at the date of transfer are charged to the allowance for loan and lease losses. Subsequent to acquisition, foreclosed assets are carried at fair value less estimated costs of disposal, based upon periodic evaluations that consider changes in market conditions and development and disposal
15
costs. Operating results from assets acquired in satisfaction of debt, including rental income less operating costs and gains or losses on the sale of, or the periodic evaluation of foreclosed assets, are recorded in noninterest expense.
As of June 30, 2022, Mid Penn had no residential real estate held in other real estate owned and $752,000 loans for which formal foreclosure proceedings were in process. As of December 31, 2021, Mid Penn had no residential real estate held in other real estate owned and no loans for which formal foreclosure proceedings were in process.
Leases
Mid Penn leases certain premises and equipment and adopted Accounting Standards Update 2016-02, Leases (Topic 842). In accordance with Accounting Standards Update (“ASU”) 2016-02, Mid Penn recognizes a right-of-use asset and a related lease liability for each distinct lease agreement. The lease right-of-use asset consists of the amount of the initial measurement of the lease liability, adjusted for (i) any lease payments made to the lessor at or before the commencement date, minus any lease incentives received, and (ii) any initial direct costs incurred by the lessee (defined as costs of a lease that would not have been incurred had the lease not been executed). The related lease liability is equal to the present value of the future lease payments, discounted using the rate implicit in the lease (or if that rate cannot be readily determined, the lessee’s incremental borrowing rate). Given that the rate implicit in the lease is rarely available, all lease liability amounts were calculated using Mid Penn’s incremental borrowing rate at lease inception, on a collateralized basis, for a similar term.
Operating lease expense, recognized as a component of occupancy expense on the consolidated statements of income, consists of a single lease cost calculated so that the remaining cost of the lease is allocated over the remaining lease term on a straight-line basis. Operating lease expense also includes variable lease payments not included in the lease liability, and any impairment of the right-of-use asset. Finance lease expense consists of the amortization of the right-of-use asset, recognized as a component of occupancy expense on the consolidated statements of income, and interest expense on the lease liability, which is recorded as a component of other interest expense on the consolidated statements of income.
In assessing whether a contract contains a lease, Mid Penn reviews third-party agreements to determine if the contract conveys the right to control the use of identified property, plant, or equipment (defined as an identified asset by Topic 842) for a period of time in exchange for consideration, and grants Mid Penn the right to both (i) obtain substantially all of the economic benefits from the identified asset’s use, and (ii) direct the use of the identified asset throughout the term of the agreement.
Upon identification that a lease agreement exists, Mid Penn performs an assessment of the consideration to be paid related to the identified asset and quantifies both the (i) lease components, consisting of consideration paid to transfer a good or service to Mid Penn, and (ii) non-lease components, consisting of consideration paid for distinct elements of the contract that are not related to securing the use of the leased asset, such as property taxes, common area maintenance, utilities, and insurance.
Many of Mid Penn’s lease agreements include options to extend or renew contracts subsequent to the expiration of the initial lease term. These renewal and extension options were not included in the calculation of the right-of-use assets and lease liabilities as Mid Penn is not reasonably certain that these renewals and extensions will be utilized. Additionally, for leases that contain escalation clauses related to consumer or other price indices, Mid Penn includes the known lease payment amount as of the commencement date in the calculation of right-of-use assets and related lease liabilities. Subsequent increases in rental payments over the known amount at the commencement date due to increase in the indices will be expensed as incurred.
None of Mid Penn’s lease agreements include residual value guarantees or material variable lease payments. Mid Penn does not have material restrictions or covenants imposed by leases that would impact Mid Penn’s ability to pay dividends or cause Mid Penn to incur additional financial obligations.
Investments in Limited Partnerships
Mid Penn is a limited partner in a partnership that provides low-income housing in Enola, Pennsylvania. The carrying value of Mid Penn’s investment in the limited partnership was $80,000 at June 30, 2022, and $102,000 at December 31, 2021, net of amortization, using the straight-line method. The investment in this limited partnership is reported in other assets on the consolidated balance sheets, and Mid Penn’s maximum exposure to loss is limited to the carrying value of the investment.
Mid Penn owns a limited partnership interest in a low-income housing project with thirty-seven apartments and common amenities in Dauphin County, Pennsylvania. The total investment in this limited partnership, net of amortization to date, was $5,585,000 and $5,962,000 on June 30, 2022 and December 31, 2021, respectively, and was included in the reported balance of other assets on the consolidated balance sheet. All of the units qualified for Federal Low-Income Housing Tax Credits (“LIHTCs”) as provided for in Section 42 of the Internal Revenue Code of 1986, as amended. Mid Penn’s limited partner capital contribution totaled $7,506,000 and the investment was fully funded within a three-year period beginning in 2018 and ending during the first quarter of 2021. The investment in the limited partnership is reported in other assets on the consolidated balance sheet and is being amortized over a ten-year period using the cost amortization method which began upon commencement of operations of the facility in December 2019. The project was formally awarded $8,530,000 in total LIHTCs by the Pennsylvania Housing Finance Agency, which will be recognized over the ten-year period from December 2019 through November 2029, with an annual LIHTC amount of $853,000 to be awarded to Mid Penn for the year-ended December 31, 2021.
16
Core Deposit Intangible
Core deposit intangible is a measure of the value of consumer demand and savings deposits acquired in business combinations accounted for as purchases. The carrying amount of core deposit intangible was $5,780,000 and $7,282,000 at June 30, 2022 and December 31, 2021, respectively. The core deposit intangible is being amortized over a ten-year period starting at each respective acquisition date and using the sum-of-the-year’s digits amortization method. The current balance of the core deposit intangible includes unamortized assets from (i) the Phoenix Bancorp, Inc. acquisition (“Phoenix”) in March 2015, (ii) The Scottdale Bank and Trust Company acquisition (“Scottdale”) in January 2018, (iii) the First Priority Financial Corp. acquisition (“First Priority) in July 2018, and (iv) the Riverview acquisition in November 2021. Core deposit amortization expense is reflected in the consolidated statements of income in intangible amortization and was $797,000 and $543,000 for the six months ended June 30, 2022 and 2021, respectively. Core deposit intangible assets are subject to impairment testing whenever events or changes in circumstances indicate the need for such evaluation. For much of the year ended December 31, 2021, and through the six months ended June 30, 2022, the novel coronavirus (“COVID-19”) global pandemic continued to impact the United States including the State of Pennsylvania and Mid Penn’s market area and communities and customers. Accordingly, Mid Penn management evaluated whether this ongoing COVID-19 pandemic resulted in any impairment to Mid Penn’s business and the value of its acquired consumer demand and savings deposit base. Management’s determination was that there was no impairment to its core deposit intangible to date as a result of the pandemic or related factors. Supporting this assertion, and as reflected in the consolidated balance sheets as of June 30, 2022 and December 31, 2021, Mid Penn has recognized a total core deposit increase, which excludes time deposits, of $711,680,000 or 28% during the first six months of 2022. Subsequent to June 30, 2022, and through the date of this filing, these increased deposit levels were sustained and continued to reflect no evidence of core deposit intangible impairment.
Goodwill is the excess of the purchase price over the fair value of assets acquired in connection with past business acquisitions. The goodwill balance was $113,835,000 at both June 30, 2022 and December 31, 2021 and was comprised of (i) $50,995,000 related to the November 30, 2021 Riverview acquisition, (ii) $39,744,000 related to the July 31, 2018 First Priority acquisition, (iii) $19,178,000 related to the January 8, 2018 Scottdale acquisition, and (iv) $3,918,000 recorded as a result of the Phoenix acquisition in 2015. Goodwill is evaluated annually for impairment; however, if certain events occur which indicate goodwill might be impaired between annual tests, goodwill would be tested for impairment when such events occur. In making a potential impairment assessment of goodwill, Mid Penn considers a number of factors including operating results, business plans, economic projections, anticipated future cash flows, current market data, stock price, etc. There are inherent uncertainties related to these factors and Mid Penn’s judgment in applying them to the analysis of goodwill impairment. Mid Penn did not identify any impairment on its outstanding goodwill from its most recent comprehensive impairment evaluation, which was performed as of October 31, 2021 and has been evaluated regularly for impairment given the ongoing pandemic.
Rabbi Trust
As a result of the November 30, 2021 acquisition of Riverview, Mid Penn assumed certain benefit plan liabilities related to compensation arrangements totaling $6,680,000 and $7,708,000 as of June 30, 2022 and December 31, 2021, respectively, within other liabilities on the consolidated balance sheets, including certain executive non-qualified retirement benefits, deferred compensation plans, and executive employment and separation agreements associated with Riverview. The obligations are fully funded through a Rabbi Trust having a cash balance of $6,706,000 and $7,708,000 within other assets on the consolidated balance sheets as of June 30, 2022 and December 31, 2021, respectively, to provide a source of funds in satisfying the obligations under the respective compensation arrangements.
Revenue from Contracts with Customers
Mid Penn recognizes revenues when earned based upon (i) contractual terms as transactions occur, or (ii) as related services are provided and collectability is reasonably assured. The largest source of revenue for Mid Penn is interest income, which is primarily recognized on an accrual basis according to a written contract, such as loan and lease agreements or investment securities contracts. Mid Penn earns noninterest income through a variety of financial and transactional services such as trust and wealth management services, deposit account transaction fees, ATM debit card fees, and mortgage banking fees. Revenue is recorded for noninterest income based on the contractual terms for the service or transaction performed. In certain circumstances, noninterest income is reported net of associated expenses.
Mid Penn adopted FASB Topic 606, Revenue from Contracts with Customers. This ASU establishes principles for reporting information about the nature, timing, and uncertainty of revenue and cash flows arising from the entity’s contracts to provide goods and services to customers. Topic 606 applies primarily to transactional-based non-interest income revenue streams and excludes mortgage banking income, earnings from cash surrender value of life insurance, and gains on SBA loans.
Mid Penn’s non-interest income revenue streams of income from fiduciary activities, service charges on deposits, ATM debit card interchange income, merchant service fees and certain components of other income are within the scope of Topic 606 and are discussed in greater detail below.
17
Income from Fiduciary and Wealth Management Activities
Income from fiduciary and wealth management activities consist of trust, wealth management, and investment management fee income, brokerage transaction fee income, and estate fee income. Trust, wealth management, and investment management fee income consists of advisory fees that are typically based on market values of clients’ managed portfolios and transaction fees for fiduciary services performed, both of which are recognized as earned. Brokerage transaction fee income includes advisory fees, which are recognized as earned on a monthly basis and transaction fees that are recognized when transactions occur. Payment is typically received in the following month. Estate fee income is recognized as services are performed over the service period, generally eighteen months.
Service Charges on Deposits
Service charges on deposits consist of cash management, overdraft, non-sufficient fund fees and other service charges on deposit accounts. Revenue is primarily transactional and recognized when earned, which is at the time the respective initiating transaction occurs and the related service charge is subsequently processed. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to the customers’ accounts.
ATM Debit Card Interchange Income
ATM debit card interchange income consists of interchange fees earned when Mid Penn’s debit cards are processed through card payments networks. The interchange fee is calculated as a percentage of the total electronic funds transfer (EFT) transaction plus a per-transaction fee, which varies based on the type of card used, the method used to process the EFT transaction, and the type of business at which the transaction was processed. Revenue is recognized daily as transactions occur and interchange fees are subsequently processed. Payment for most interchange activity is received daily, while some fees are aggregated, and payment is received in the following month.
Merchant Services Income
Merchant services income is processed through third party providers with whom Mid Penn has partnered to provide merchant services to its business customers. Fees are charged to merchants to process their debit card transactions, cash advance services, and other related products. Mid Penn receives a percentage of the revenue generated from each joint customer relationship after the respective third-party provider has collected the fee income from the merchant. Payment is primarily received in the following month.
Other Income
Certain aspects of other income, such as credit card royalties, check orders, and letter of credit fees, are within the scope of Topic 606. These fees are primarily transactional, and revenue is recognized when transactions occur, and the related services are subsequently processed. Payment is primarily received immediately or in the following month.
Mid Penn does not exercise significant judgements in the recognition of income, as typically income is not recognized until the performance obligation has been satisfied. Mid Penn has not recognized any assets from the costs to obtain or fulfill a contract with customers for revenue streams that fall within the guidance of Topic 606.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes changes in unrealized gains and losses on securities available for sale arising during the period and reclassification adjustments for realized gains and losses on securities available for sale included in net income. Mid Penn also recognizes other comprehensive income (loss) from an unfunded noncontributory defined benefit plan for directors and other postretirement benefit plans covering full-time employees. These plans utilize assumptions and methods to calculate the fair value of plan assets and Mid Penn recognizes the overfunded and underfunded status of the plans on its consolidated balance sheet. Gains and losses, prior service costs and credits are recognized in other comprehensive income (loss), net of tax, until they are amortized, or immediately upon curtailment.
The components of accumulated other comprehensive (loss) income, net of taxes, are as follows:
Unrealized Loss
on Securities
Defined Benefit
Plans
Accumulated Other
(Loss) Income
Balance - June 30, 2022
(10,297
538
Balance - December 31, 2021
(255
413
Earnings Per Common Share
Basic earnings per common share are computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during each of the periods presented. Diluted earnings per common share are calculated by dividing net
income available to common shareholders by the weighted average number of common shares outstanding plus common shares that would have been outstanding if dilutive potential common shares, consisting of unvested restricted stock, had been issued. The effect of dilutive unvested restricted stock was not material and did not result in a difference, when rounded to the whole cent, between the basic earnings per share compared to the diluted earnings per share for any of the periods presented.
As previously announced on a Form 8-K on May 4, 2021, Mid Penn completed an underwritten public offering of 2,990,000 shares of common stock at a price of $25.00 per share, with the aggregate gross proceeds of the offering totaling $74,750,000 before underwriting discounts and offering expenses. The net proceeds of the offering after deducting the underwriting discount and other offering expenses were $70,238,000. Additionally, as previously announced on a Form 8-K on December 1, 2021, Mid Penn issued 4,519,776 shares of common stock as a result of the merger with Riverview on November 30, 2021. The additional shares issued on May 4, 2021 and November 30, 2021 significantly impacted the weighted average number of shares outstanding used for the three and six months ended June 30, 2022 earnings per share calculations compared to the three and six months ended June 30, 2021.
The following data shows the amounts used in computing basic and diluted earnings per common share.
Weighted average common shares outstanding (basic)
15,935,003
10,321,838
15,946,459
9,373,978
Effect of dilutive unvested restricted stock grants
36,415
15,942
17,286
6,479
Weighted average common shares outstanding (diluted)
15,971,418
10,337,780
15,963,745
9,380,457
Basic earnings per common share
Diluted earnings per common share
There were no antidilutive instruments at June 30, 2022 and 2021.
Accounting Standards Pending Adoption
ASU 2016-13: The FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as further amended.
The ASU requires credit losses on most financial assets measured at amortized cost and certain other instruments to be measured using an expected credit loss model (referred to as the current expected credit loss (“CECL”) model). Under this model, entities will estimate credit losses over the entire contractual term of the instrument (considering estimated prepayments, but not expected extensions or modifications unless reasonable expectation of a troubled debt restructuring exists) from the date of initial recognition of that instrument.
The ASU also replaces the current accounting model for purchased credit impaired loans and debt securities. The allowance for purchased financial assets with a more-than insignificant amount of credit deterioration since origination (“PCD assets”) should be determined in a similar manner to other financial assets measured on an amortized cost basis. However, upon initial recognition, the allowance is added to the purchase price (“gross up approach”) to determine the initial amortized cost basis. The subsequent accounting for PCD assets is the same expected loss model described above.
Further, the ASU made certain targeted amendments to the existing impairment model for available-for-sale debt securities. For an AFS debt security for which there is neither the intent nor a more-likely-than-not requirement to sell, an entity will record credit losses as an allowance rather than a write-down of the amortized cost basis. Certain incremental disclosures are required.
Subsequently, the FASB issued ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-10, ASU 2019-11, and ASU 2020-02 to clarify, improve, or defer the adoption of ASU 2016-13.
In October 2019, the FASB issued ASU 2019-10 which deferred the implementation date of ASU 2016-13 for smaller reporting companies (SRCs) until January 1, 2023. Mid Penn qualified as an SRC as of the most recent measurement date of September 30, 2019; therefore, Mid Penn has chosen to delay the adoption of ASU 2016-13 until January 1, 2023.
Mid Penn intends to adopt this ASU effective January 1, 2023. Mid Penn expects that it is probable that total credit loss reserves will increase at the adoption date and that the magnitude of the increase will depend on the composition, characteristics and quality of its loan and lease portfolio and the allowance for debt securities, as well as economic conditions and forecasts at the time of adoption. Mid Penn is in the early stages of conducting parallel runs of its new processes and controls and is beginning its model validation process. Mid Penn will continue to make refinements to its credit loss model in advance of the January 1, 2023 adoption date.
19
ASU No. 2022-02: The FASB issued ASU 2022-02, Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures.
This ASU eliminates the TDR recognition and measurement guidance and, instead, requires that an entity evaluate (consistent with the accounting for other loan modifications) whether a modification represents a new loan or a continuation of an existing loan. In addition, this ASU enhances existing disclosure requirements and introduces new requirements related to certain modifications of receivables made to borrowers experiencing financial difficulty.
For public business entities, this ASU requires that an entity disclose current-period gross write-offs by year of origination for financing receivables and net investment in leases within the scope of Subtopic 326-20. Gross write-off information must be included in the vintage disclosures required for public business entities in accordance with paragraph 326-20-50-6, which requires that an entity disclose the amortized cost basis of financing receivables by credit quality indicator and class of financing receivable by year of origination.
For entities that have adopted the amendments in update 2016-13, the amendments in this update are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. For entities that have not yet adopted the amendments in update 2016-13, the effective dates for the amendments in this update are the same as the effective dates in Update 2016-13. The Corporation has not yet adopted this accounting standard as ASU 2016-13 has not been adopted. Management continues to evaluate the impact of its future adoption of this guidance on the Company’s financial statements.
Note 3 - Acquisition of Riverview Financial Corporation
On November 30, 2021, Mid Penn completed its acquisition of Riverview through the merger of Riverview with and into Mid Penn. In connection with this acquisition, Riverview Bank, Riverview’s wholly-owned bank subsidiary, merged with and into Mid Penn Bank.
Pursuant to the merger agreement, shareholders of Riverview common stock received, for each share of Riverview common stock held at the effective time of the merger, 0.4833 shares of Mid Penn common stock as merger consideration with an acquisition date fair value of $142,192,000 based on the closing stock price of Mid Penn’s common stock on November 30, 2021 of $31.46. This exchange ratio did not change as a result of changes in the Mid Penn share price. Additionally, outstanding options at the time of the merger were converted into the right to receive an amount in cash equal to the product obtained by multiplying the aggregate number of shares of Riverview common stock that were issuable upon exercise of each option outstanding, and the closing sale price of Mid Penn’s common stock on the fifth (5th) business day prior to the merger closing date multiplied by the exchange ratio, less the per share exercise price of each option outstanding, without interest. There were 172,964 options outstanding to purchase Riverview common stock and the closing price of Mid Penn common stock was at $30.76 per share on the fifth business day prior to the merger closing date. Additionally, 2,500 shares of restricted stock were paid out in cash, resulting in $776,000 of cash consideration relating to stock awards. Including $16,000 of cash paid in lieu of fractional shares, the total fair value of consideration paid was $142,984,000.
The assets and liabilities of Riverview were recorded on the consolidated balance sheets of Mid Penn at their estimated fair value as of November 30, 2021, and their results of operations have been included in the consolidated income statement of the Corporation since such date. Riverview has been fully integrated into Mid Penn; therefore, the amount of revenue and earnings of Riverview included in the consolidated income statement since the acquisition date is impracticable to provide.
The acquisition of Riverview resulted in the recognition and recording of intangible assets including $50,995,000 of goodwill, a core deposit intangible of $4,096,000, and a customer list intangible of $2,160,000. The core deposit intangible and customer list intangible will be amortized over a ten-year period using a sum of the years’ digits basis. The goodwill will not be amortized, but will be measured annually for impairment, or more frequently if circumstances require.
The allocation of the purchase price is as follows:
Assets acquired:
Cash and cash equivalents
316,079
Investment securities
226
Restricted stock
2,209
837,505
50,995
Core deposit intangible
4,096
Customer list intangible
2,160
Bank owned life insurance
32,120
Premises and equipment
11,819
7,110
1,919
6,683
Total assets acquired
1,272,921
Liabilities assumed:
182,291
371,283
152,365
176,294
199,414
6,500
36,308
439
5,043
Total liabilities assumed
1,129,937
Consideration paid
142,984
Cash paid
792
Fair value of common stock issued
142,192
Accounting Standards Codification (“ASC”) Topic 805, Business Combinations, allows for adjustments to goodwill up to one year after the merger date for information that becomes available during this post-merger period that reflects circumstances at the date of merger. The following table summarizes the estimated fair value of the assets acquired and liabilities and equity assumed in the Riverview transaction that management believes are final; however, these values could be adjusted under ASC 805 until November 30, 2022.
Total purchase price (consideration paid)
Net assets acquired:
(182,291
(371,283
(152,365
(176,294
(199,414
(6,500
(36,308
(439
(5,043
Net assets acquired
91,989
In general, factors contributing to goodwill recognized as a result of the Riverview acquisition include expected cost savings from combined operations, opportunities to expand into several new markets, and growth and profitability potential from the repositioning of short-term investments into higher-yielding loans. The goodwill acquired as a result of the Riverview acquisition is not tax deductible.
The fair value of the financial assets acquired included loans receivable with a net amortized cost basis of $837,505,000. The table below illustrates the fair value adjustments made to the amortized cost basis in order to present a fair value of the loans acquired.
Gross amortized cost basis at November 30, 2021
850,920
Market rate adjustment
529
Credit fair value adjustment on pools of homogeneous loans
(13,117
Credit fair value adjustment on impaired loans
(827
Fair value of purchased loans at November 30, 2021
The market rate adjustment represents the movement in market interest rates, irrespective of credit adjustments, compared to the contractual rates of the acquired loans. The credit adjustment made on pools of homogeneous loans represents the changes in credit quality of the underlying borrowers from loan inception to the acquisition date. The credit adjustment on impaired loans is derived in accordance with ASC 310-30-30 and represents the portion of the loan balance that has been deemed uncollectible based on our expectations of future cash flows for each respective loan.
The information about the acquired Riverview impaired loan portfolio as of November 30, 2021 is as follows:
Contractually required principal and interest at acquisition
5,591
Contractual cash flows not expected to be collected (nonaccretable discount)
(1,739
Expected cash flows at acquisition
Interest component of expected cash flows (accretable discount)
(541
Fair value of acquired loans
3,311
The following table presents pro forma information as if the merger between Mid Penn and Riverview had been completed on January 1, 2021. The pro forma information does not necessarily reflect the results of operations that would have occurred had Mid Penn merged with Riverview at the beginning of 2021. The pro forma financial information does not include the impact of possible business model changes, nor does it consider any potential impacts of current market conditions or revenues, expense efficiencies, or other factors.
Three Months Ended
Six Months Ended
June 30, 2021
Net interest income after loan loss provision
37,478
71,413
Noninterest income
9,347
16,582
Noninterest expense
31,910
60,708
14,915
27,287
Net income per common share
0.76
1.46
23
Note 4 - Investment Securities
The majority of the investment portfolio is comprised of securities issued by U.S. Treasury and government agencies, mortgage-backed U.S. government agencies, and state and political subdivision obligations. The amortized cost, fair value, and unrealized gains and losses on investment securities at June 30, 2022 and December 31, 2021 are as follows:
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
Available-for-sale debt securities:
U.S. Treasury and U.S. government agencies
34,475
76
525
34,026
Mortgage-backed U.S. government agencies
166,321
10,928
155,433
State and political subdivision obligations
4,366
697
3,669
Corporate debt securities
26,570
1,000
25,570
Total available-for-sale debt securities
231,732
116
13,150
Held-to-maturity debt securities:
239,605
28
21,516
218,117
55,180
4,857
50,324
88,250
6,673
81,645
15,997
796
15,202
Total held-to-maturity debt securities
33,842
365,288
630,764
214
46,992
583,986
49,760
283
49,480
3,899
26
3,914
9,525
57
9,468
63,184
351
178,136
1,165
176,997
61,157
440
272
61,325
75,958
2,305
27
78,236
14,006
133
14,068
2,904
1,535
330,626
392,441
2,933
1,886
393,488
Estimated fair values of debt securities are based on quoted market prices, where applicable. If quoted market prices are not available, fair values are based on quoted market prices of instruments of a similar type, credit quality and structure, adjusted for differences between the quoted instruments and the instruments being valued. Please refer to Note 7, Fair Value Measurement, for more information on the fair value of investment securities.
Investment securities having a fair value of $380,649,000 at June 30, 2022 and $244,763,000 at December 31, 2021 were pledged to secure public deposits, some Trust department deposit accounts, and certain other borrowings. In accordance with legal provisions for alternatives other than pledging of investments, Mid Penn also obtains letters of credit from the Federal Home Loan Bank of Pittsburgh (“FHLB”) to secure certain public deposits. These FHLB letter of credit commitments totaled $205,100,000 as of June 30, 2022 and $450,850,000 as of December 31, 2021.
24
The following tables present gross unrealized losses and fair value of debt security investments aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2022 and December 31, 2021.
Less Than 12 Months
12 Months or More
Number
of
Securities
18,476
0
83
146,413
21,319
Total temporarily impaired available-for-sale debt securities
189,877
134
205,184
20,366
7,345
139
212,529
64
50,323
68,551
6,548
815
172
69,366
4,784
4,475
9,259
Total temporarily impaired held-to-maturity debt securities
369
328,842
32,043
12,635
1,799
382
341,477
484
518,719
45,193
497
531,354
25
Available-for-sale securities:
U.S. government agencies
45,476
1,168
4,943
Total temporarily impaired available-for-sale securities
30
51,587
Held-to-maturity securities:
91
149,425
39,995
5,302
255
5,557
6,928
Total temporarily impaired held to maturity securities
138
201,650
1,533
201,905
253,237
1,884
169
253,492
Management evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market concerns warrant such additional evaluation. Consideration is given to the length of time and the extent to which the fair value of the security has been less than amortized cost, as well as the overall financial condition of the issuer. In addition, for debt securities, Mid Penn considers (i) whether management has the intent to sell the security, (ii) whether it is more likely than not that management will be required to sell the security prior to its anticipated recovery, and (iii) whether management expects to recover the entire amortized cost basis. At June 30, 2022, the majority of securities in an unrealized loss position were U.S. government agency securities and mortgage-backed U.S. government agency securities. At December 31, 2021, the majority of securities in an unrealized loss position were attributable to mortgage-backed U.S. government agency securities.
Mid Penn had no securities considered by management to be other-than-temporarily impaired as of June 30, 2022, December 31, 2021, or June 30, 2021, and did not record any securities impairment charges in the respective periods ended on these dates. This determination reflects management’s assessment that no securities in its portfolio were impaired as a result of any COVID-19 pandemic impacts, to date, to the repayment ability of the underlying issuers of securities. Mid Penn does not consider the securities with unrealized losses on the respective dates to be other-than-temporarily impaired as the unrealized losses were deemed to be temporary changes in value related to market movements in interest yields at various periods similar to the maturity dates of holdings in the investment portfolio, and not reflective of an erosion of credit quality.
There were no gross realized gains and losses on sales of available-for-sale debt securities for the three and six months ended June 30, 2022 and 2021.
The table below illustrates the maturity distribution of investment securities at amortized cost and fair value as of June 30, 2022.
Available-for-sale
Held-to-maturity
Due in 1 year or less
250
451
Due after 1 year but within 5 years
32,976
32,649
69,605
67,815
Due after 5 years but within 10 years
28,121
26,955
230,019
209,494
Due after 10 years
4,064
3,411
43,778
37,204
65,411
63,265
343,852
314,964
Mortgage-backed securities
Note 5 - Loans and Allowance for Loan and Lease Losses
As of June 30, 2022 and December 31, 2021, the types of loans in Mid Penn’s portfolio, summarized using Mid Penn’s internal risk rating system between those rated “pass” (net of deferred fees and costs of $3,146,000 as of June 30, 2022 and $6,264,000 as of December 31, 2021), which comprise the vast majority of the portfolio, and those classified as “special mention” and “substandard”, are as follows:
Special
Pass
Mention
Substandard
Commercial and industrial
536,391
11,014
2,476
549,881
Commercial real estate
1,781,062
16,849
28,033
1,825,944
Commercial real estate - construction
374,888
1,229
376,117
Residential mortgage
296,636
204
3,496
300,336
Home equity
117,106
507
866
118,479
Consumer
9,276
3,115,359
28,574
36,100
606,484
10,321
2,757
619,562
1,601,196
35,508
31,438
1,668,142
371,337
1,397
372,734
319,862
294
3,067
323,223
106,853
534
2,919
110,306
10,429
3,016,161
46,657
41,578
All PPP loans, whether disbursed in 2020 or 2021, are included in commercial and industrial loans and are fully guaranteed by the SBA; therefore, all PPP loans outstanding (net of the related deferred PPP fees) are classified as “pass” within Mid Penn’s internal risk rating system as of June 30, 2022.
Mid Penn had no loans classified as “doubtful” as of June 30, 2022 and December 31, 2021.
Impaired loans by loan portfolio class as of June 30, 2022 and December 31, 2021 are summarized as follows:
Recorded Investment
Unpaid Principal Balance
Related Allowance
With no related allowance recorded:
31
637
1,038
854
1,243
1,314
1,355
1,259
1,295
99
2,377
With no related allowance recorded and acquired with credit deterioration:
2,109
2,231
2,909
1,221
1,467
1,196
1,469
1,285
1,771
1,362
1,847
85
105
86
111
With an allowance recorded:
118
308
339
688
892
287
359
121
Total Impaired Loans:
370
4,215
3,849
3,372
4,511
1,472
1,218
1,496
2,599
3,126
2,621
3,142
184
2,463
2,488
The average recorded investment of impaired loans and related interest income recognized for the three and six months ended June 30, 2022 and 2021 are summarized as follows:
Average Recorded Investment
Interest Income Recognized
72
604
211
1,392
759
100
2,336
2,147
1,398
1,335
300
503
221
735
1,793
293
3,486
3,969
1,416
2,727
1,059
502
719
3,257
148
1,379
858
2,346
1,948
1,406
1,214
1,294
309
84
513
596
1,491
679
3,263
6,154
2,673
1,087
942
Nonaccrual loans by loan portfolio class, including loans acquired with credit deterioration, as of June 30, 2022 and December 31, 2021 are summarized as follows:
1,357
2,297
2,164
2,186
7,551
9,547
The performance and credit quality of the loan portfolio is also monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The classes of the loan portfolio summarized by the past due status as of June 30, 2022 and December 31, 2021 are summarized as follows:
30-59
60-89
Greater
Receivable >
Days Past
than 90
Total Past
90 Days and
Due
Days
Current
Total Loans
Accruing
3,265
4,466
545,415
512
587
1,823,248
1,823,835
374,670
374,896
917
1,500
297,551
299,051
167
594
117,800
118,394
9,274
Loans acquired with credit deterioration:
851
867
1,242
106
52
327
485
800
5,455
1,028
3,522
10,005
3,170,028
1,378
62
404
1,844
617,718
96
55
769
856
1,665,055
1,665,911
205
371,333
371,538
1,246
2,453
319,408
321,861
212
2,780
107,440
110,220
10,419
1,628
1,631
600
54
818
872
490
3,119
7,205
10,651
3,093,745
515
The allowance for loan and lease losses and the related loan loss provision for the periods presented reflect Mid Penn’s continued application of the incurred loss method for estimating credit losses, as Mid Penn is not required to adopt the current expected credit loss (“CECL”) accounting standard until January 1, 2023, and Mid Penn has not elected to early adopt CECL. PPP loans, both those disbursed in 2020 and those disbursed in 2021, are included in the commercial and industrial classification and, as the PPP loans are fully guaranteed by the Small Business Administration, no allowance for loan and lease losses was recorded against the $4,966,000 balance of PPP loans outstanding (net of related deferred PPP fees) as of June 30, 2022.
The following tables summarize the allowance and recorded investments in loans receivable.
As of, and for the
three months ended,
Unallocated
Allowance for loan and lease losses:
Beginning balance,
April 1, 2022
3,811
9,991
483
562
257
15,147
Charge-offs
(9
Recoveries
Provisions (credits)
(140
2,000
(234
Ending balance,
3,671
11,991
641
16,876
six months ended,
Commercial
and
industrial
January 1, 2022
3,439
9,415
560
684
14,597
(66
65
120
Provisions
2,511
(16
(661
Individually evaluated for impairment
1,010
Ending balance:
Collectively evaluated for impairment
3,553
11,099
15,866
Loans receivables:
Ending balance
Ending balance: individually evaluated for impairment
2,106
4,026
Ending balance: acquired with credit deterioration
4,700
Ending balance: collectively evaluated for impairment
549,374
1,821,729
297,737
118,295
3,171,307
188
9,294
14,409
Loans receivable:
1,141
5,107
4,875
619,254
1,664,770
371,516
320,602
107,843
3,094,414
April 1, 2021
2,988
8,944
122
438
528
570
13,591
(23
(7
(39
176
1,023
60
(215
3,165
9,977
130
499
588
14,716
January 1, 2021
3,066
8,655
429
590
13,382
(859
(11
(12
(905
89
957
1,256
70
81
(235
1,332
1,394
collectively evaluated for impairment
3,103
8,645
13,322
783,106
1,147,089
282,776
196,691
77,272
8,258
2,495,192
218
3,673
2,339
7,012
1,381
289
1,670
782,888
1,142,035
282,753
195,643
74,933
2,486,510
Mid Penn entered into forbearance or modification agreements on loans currently classified as troubled debt restructures, and these agreements have resulted in additional principal repayment. The terms of these forbearance agreements vary and generally involve modifications from the original loan agreements, including either a reduction in the amount of principal payments for certain or extended periods, interest rate reductions, and/or the intent for the loan to be repaid as collateral is sold.
Mid Penn’s troubled debt restructured loans at June 30, 2022 totaled $742,000 and included: (i) two accruing impaired residential mortgage loans to unrelated borrowers in compliance with the terms of the modifications totaling $422,000, and (ii) $320,000 of troubled debt restructurings attributable to six loans among four relationships which were classified as nonaccrual impaired based upon a collateral evaluation in accordance with the guidance on impaired loans. The balance of these nonaccrual impaired troubled debt restructured loans as of June 30, 2022 was comprised of $292,000 in commercial real estate loans amongst two borrowers and two residential mortgage loans for $28,000. As of June 30, 2022, there were no defaulted troubled debt restructured loans, as all troubled debt restructured loans were current with respect to their associated forbearance agreements. In addition to contractual paydowns, the decrease in Mid Penn’s troubled debt restructured loan balance since December 31, 2021 reflects the successful workout of two nonaccrual impaired loans.
Mid Penn’s troubled debt restructured loans at December 31, 2021 totaled $819,000, and included (i) two accruing impaired residential mortgage loans to unrelated borrowers in compliance with the terms of the modifications totaling $435,000, and (ii) $384,000 of troubled debt restructurings attributable to eight loans among six relationships which were classified as nonaccrual impaired based upon a collateral evaluation in accordance with the guidance on impaired loans. The balance of these nonaccrual impaired troubled debt restructured loans as of December 31, 2021 was comprised of $320,000 in commercial real estate loans amongst two borrowers, one commercial real estate construction loan for $22,000, two residential mortgage loans for $37,000, and one commercial and industrial loan for $5,000. As of December 31, 2021, there were no defaulted troubled debt restructured loans, as all troubled debt restructured loans were current with respect to their associated forbearance agreements. There were also no defaults on troubled debt restructured loans within twelve months of restructure during 2021.
The recorded investments in troubled debt restructured loans at June 30, 2022 and December 31, 2021 are as follows:
Pre-Modification
Post-Modification
Outstanding Recorded Investment
1,213
1,115
292
647
645
1,860
1,760
742
320
472
1,909
1,808
819
The following tables provide activity for the accretable yield of acquired impaired loans from the Phoenix (March 2015), Scottdale (January 2018), First Priority (July 2018), and Riverview (November 2021) acquisitions for the three and six months ended June 30, 2022 and 2021.
Accretable yield, beginning of period
Accretable yield amortized to interest income
(28
Accretable yield, end of period
471
580
(109
Note 6 - Derivative Financial Instruments
As of June 30, 2022 and December 31, 2021, Mid Penn did not designate any derivative financial instruments as formal hedging relationships. Mid Penn’s free-standing derivative financial instruments are required to be carried at their fair value on consolidated balance sheets.
In connection with its mortgage banking activities, Mid Penn enters into commitments to originate certain fixed-rate residential mortgage loans for customers, also referred to as interest rate locks. In addition, Mid Penn enters into forward commitments for the future sales or purchases of mortgage-backed securities to or from third-party counterparties to hedge the effect of changes in interest rates on the values of both the interest rate locks and mortgage loans held for sale. Forward sales commitments may also be in the form of commitments to sell individual mortgage loans at a fixed price at a future date. The amount necessary to settle each interest rate lock is based on the price that secondary market investors would pay for loans with similar characteristics, including interest rate and term, as of the date fair value is measured.
The notional amount and fair value of Mid Penn’s mortgage banking derivative financial instruments as of June 30, 2022 and December 31, 2021 are presented below.
Notional Amount
Fair Value
Interest Rate Lock Commitments
9,742
16,107
56
Forward Commitments
16,193
(124
20,521
The following table presents Mid Penn’s mortgage banking derivative financial instruments, their fair values, and their location in the consolidated balance sheets as of June 30, 2022 and December 31, 2021.
Asset Derivatives
Liability Derivatives
124
88
The following table presents Mid Penn’s mortgage banking derivative financial instruments and the amount of the net gains or losses recognized within other noninterest income on the consolidated statement of income for the three and six months ended June 30, 2022 and 2021.
Three months ended
Six months ended
324
1,077
1,104
Loan-level Interest Rate Swaps
Mid Penn enters into loan-level interest rate swaps with certain qualifying, creditworthy commercial loan customers to provide a loan pricing structure that meets both Mid Penn’s and the customer’s interest rate risk management needs. Mid Penn simultaneously enters into parallel interest rate swaps with a dealer counterparty, with identical notional amounts and terms. The net result of the offsetting customer and dealer counterparty swap agreements is that the customer pays a fixed rate of interest and Mid Penn receives a floating rate. Mid Penn’s loan-level interest rate swaps are considered derivatives but are not accounted for using hedge accounting.
The fair value, notional amount, and collateral posted related to loan-level interest rate swaps are presented below.
Interest Rate Swap Contracts - Commercial Loans:
Fair Value (a)
8,487
102
112,389
109,577
Cash Collateral Posted (b)
1,600
Represents the total of the equal and offsetting fair value assets and liabilities related to the loan level interest rate swaps
Included in cash and due from banks on the consolidated balance sheet
The gross amounts of commercial loan swap derivatives, the amounts offset and the carrying values in the consolidated balance sheets, and the collateral pledged to support such agreements are presented below.
Gross amounts recognized
Gross amounts offset
Net Amounts Presented in the Consolidated Balance Sheets
Gross amounts not offset:
Financial instruments
Cash collateral
Net Amounts
Note 7 - Fair Value Measurement
Fair value measurement and disclosure guidance defines fair value as the price that would be received to sell the asset or transfer the liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. This guidance provides additional information on determining when the volume and level of activity for the asset or liability has significantly decreased. Information on identifying circumstances when a transaction may not be considered orderly is also included within the guidance.
Fair value measurement and disclosure guidance provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with the fair value measurement and disclosure guidance.
This guidance clarifies that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly. In those situations, the entity must evaluate the weight of the evidence to determine whether the transaction is orderly. The guidance provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.
Inputs to valuation techniques refer to the assumptions that market participants would use in measuring the fair value of an asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own belief about the assumptions market participants would use in pricing the asset or liability based upon the best information available in the circumstances. Fair value measurement and disclosure guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. An asset’s or liability’s placement in the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement or disclosure. The fair value hierarchy is as follows:
Level 1 Inputs - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2 Inputs - Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability;
Level 3 Inputs - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
There were no transfers of assets between fair value Level 1 and Level 2 during the three and six months ended June 30, 2022 and 2021.
The following tables illustrate the assets measured at fair value on a recurring basis segregated by hierarchy fair value levels.
Fair value measurements at June 30, 2022 using:
Total carrying value at
Quoted prices in active markets
Significant other
observable inputs
Significant
unobservable
inputs
Assets:
(Level 1)
(Level 2)
(Level 3)
Loans held for sale
Other assets:
Equity securities
Interest rate swap agreements
Mortgage banking derivative assets
237,296
236,842
Fair value measurements at December 31, 2021 using:
629
75,593
75,093
Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).
The following tables illustrate the assets measured at fair value on a nonrecurring basis segregated by hierarchy fair value levels.
Impaired Loans
1,043
The following tables present additional quantitative information about assets measured at fair value on a nonrecurring basis and for which Mid Penn has utilized Level 3 inputs to determine the fair value.
Fair Value Estimate
Valuation Technique
Unobservable Input
Range
Weighted Average
Appraisal of collateral (a), (b)
Appraisal adjustments (b)
22% - 77%
49%
21% - 69%
30%
Fair value is generally determined through independent appraisals of the underlying collateral, which generally includes various Level 3 inputs which are not observable.
Appraisals may be adjusted downward by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal. Higher downward adjustments are caused by negative changes to the collateral or conditions in the real estate market, actual offers or sales contracts received, or age of the appraisal.
There were no changes in unrealized gains and losses included in other comprehensive income during the six months ended June 30, 2022 or 2021 related to Level 3 recurring fair value measurements, as Mid Penn has no assets measured at fair value on a Level 3 recurring basis.
Mid Penn uses the following methodologies and assumptions to estimate the fair value of certain assets and liabilities.
The fair value of equity securities and debt securities classified as available for sale is determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities, but rather, relying on the securities’ relationship to other benchmark quoted prices.
Mortgage Banking Derivative Assets
Mortgage banking derivative assets represent the fair value of mortgage banking derivatives in the form of interest rate locks and forward commitments with secondary market investors and the fair value of interest rate swaps. The fair values of the Bank’s interest rate locks, forward commitments and interest rate swaps represent the amounts that would be required to settle the derivative financial instruments at the balance sheet date. These characteristics classify interest rate swap agreements as Level 2. See "Note 6 - Derivative Financial Instruments," for additional information.
Interest Rate Swap Agreements
Interest rate swap agreements are measured by alternative pricing sources with reasonable levels of price transparency in markets that are
not active. Based on the complex nature of interest rate swap agreements, the markets these instruments trade in are not as efficient and are less liquid than that of the more mature Level 1 markets. These markets do however have comparable, observable inputs in which an alternative pricing source values these assets in order to arrive at a fair market value. These characteristics classify interest rate swap agreements as Level 2.
Impaired Loans (included in “Net Loans and Leases” in the following tables)
All performing troubled debt restructured loans and loans classified as nonaccrual are deemed to be impaired, and all of these loans are considered collateral dependent; therefore, all of Mid Penn’s impaired loans, whether reporting a specific allowance allocation or not, are considered collateral dependent.
It is Mid Penn’s policy to obtain updated third-party collateral valuations on all impaired loans secured by real estate as soon as practically possible following the credit being classified as substandard nonaccrual. Prior to receipt of the updated real estate valuation, Mid Penn will use existing real estate valuations to determine any potential allowance for loan and lease loss issues and will update the allowance impact calculation upon receipt of the updated real estate valuation.
In some instances, Mid Penn is not holding real estate as collateral and is relying on business assets (personal property) for repayment. In these circumstances a collateral inspection is performed by Mid Penn personnel to determine an estimated value. The value is based on net book value, as provided by the financial statements, and discounted accordingly based on determinations made by management. Occasionally, Mid Penn will employ an outside service to provide a fair estimate of value based on auction sales or private sales. Management reviews the estimates of these third parties and discounts them accordingly based on management’s judgment, if deemed necessary. Mid Penn considers the estimates used in its impairment analysis to be Level 3 inputs.
Mid Penn actively monitors the values of collateral on impaired loans. This monitoring may require the modification of collateral values, either in a positive or negative way, due to the passage of time or some other change in one or more valuation inputs. Collateral values for impaired loans will be reassessed by management at least every 12 months for possible revaluation by an independent third party.
Certain assets included in foreclosed assets held for sale are carried at fair value and accordingly is presented as measured on a non-recurring basis. Values are estimated using Level 3 inputs, based on appraisals that consider the sales prices of property in the proximate vicinity.
The following table summarizes the carrying value and fair value of financial instruments at June 30, 2022 and December 31, 2021.
Carrying
Financial assets:
913,572
Available-for-sale investment securities
Held-to-maturity investment securities
11,787
3,130,912
3,118,416
Financial liabilities:
Deposits
3,692,662
4,046,217
Long-term debt (a)
317
77,890
77,455
Subordinated debt
70,684
74,553
Mortgage banking derivative liabilities
Long-term debt excludes finance lease obligations.
The Bank’s outstanding and unfunded credit commitments and financial standby letters of credit were deemed to have no significant fair value as of June 30, 2022 and December 31, 2021.
39
The following tables present the carrying amount, fair value, and placement in the fair value hierarchy of Mid Penn’s financial instruments as of June 30, 2022 and December 31, 2021. Carrying values approximate fair values for cash and cash equivalents, restricted investment in bank stocks, accrued interest receivable and payable, and short-term borrowings. Other than cash and cash equivalents, which are considered Level 1 Inputs, and mortgage servicing rights, which are Level 3 Inputs, these instruments are Level 2 Inputs. These tables exclude financial instruments for which the carrying amount approximates fair value, not previously disclosed.
Fair Value Measurements
Quoted Prices
in Active Markets
for Identical Assets
Significant Other
Unobservable
or Liabilities
Observable Inputs
Inputs
Amount
Financial instruments - assets
Held-to-maturity investment
securities
Financial instruments -
liabilities
Note 8 - Guarantees, Commitments, and Contingencies
Guarantees
In the normal course of business, Mid Penn makes various commitments and incurs certain contingent liabilities which are not reflected in the accompanying consolidated financial statements. The commitments include various guarantees and commitments to extend credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Mid Penn evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the customer. Standby letters of credit and financial guarantees written are conditional commitments to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Mid Penn had $54,179,000 and $55,609,000 of standby letters of credit outstanding as of June 30, 2022 and December 31, 2021, respectively. Mid Penn does not anticipate any losses because of these transactions. The amount of the liability as of June 30, 2022 and December 31, 2021 for payment under standby letters of credit issued was not considered material.
Commitments
As of June 30, 2021, Mid Penn’s Board of Directors had approved Mid Penn Bank to enter into a commitment to purchase a limited partnership interest in a low-income housing project to construct thirty-nine apartments and common amenities in Cumberland County, Pennsylvania. All of the units are expected to qualify for Federal Low-Income Housing Tax Credits (“LIHTCs”) as provided for in Section 42 of the Internal Revenue Code of 1986, as amended. Mid Penn’s limited partner capital contribution commitment is expected to be $10,805,000, which will be paid in installments over the course of construction of the low-income housing facilities. The investment in the limited partnership will be reported in other assets on the balance sheet and amortized over a ten-year period. The project has been conditionally awarded $1,205,000 in annual LIHTCs by the Pennsylvania Housing Finance Agency, with a total anticipated LIHTC amount of $12,046,000 to be received by Mid Penn over the ten-year amortization period. Mid Penn’s commitment to purchase the limited partnership interest is conditional upon (i) the review and approval of all closing documents, (ii) an opinion letter for tax counsel to the Partnership that the project qualifies for the LIHTCs, and (iii) review and approval by Mid Penn of other documents it may deem necessary.
As a result of the Riverview acquisition on November 30, 2021, Mid Penn assumed a commitment to purchase a limited partnership interest in a low-income housing project to preserve and rehabilitate three buildings consisting of seventeen apartments and two commercial shops in Schuylkill County, Pennsylvania. All the units are expected to qualify for LIHTCs. Mid Penn’s limited partner capital contribution commitment is expected to be $4,356,000, which will be paid in installments over the course of construction of the low-income housing facilities. The investment in the limited partnership will be reported in other assets on the balance sheet and amortized over a ten-year period. Additionally, the agreement commits Mid Penn to a construction loan in the maximum principal amount of $3,500,000 which will bear interest at 5.5% annum with a term of twenty-four months. The project has been conditionally awarded $484,000 in annual LIHTCs by the Pennsylvania Housing Finance Agency, with a total anticipated LIHTC amount of $4,840,000 to be received by Mid Penn over the ten-year amortization period. Mid Penn’s commitment to purchase the limited partnership interest is conditional upon (i) the review and approval of all closing documents, (ii) an opinion letter for tax counsel to the Partnership that the project qualifies for the LIHTCs, and (iii) review and approval by Mid Penn of other documents it may deem necessary.
Contingencies
As of June 30, 2022, Mid Penn had received $42,520,000 of nonrefundable loan processing fees related to the loans disbursed as a result of Mid Penn’s participation in the SBA’s PPP, consisting of (i) $20,883,000 of loan processing fees received during the year ended December 31, 2020, (ii) $17,997,000 of loan processing fees received during the year ended December 31, 2021, and (iii) $3,640,000 during the six months ended June 30, 2022. These PPP loan processing fees, and any offsetting loan origination costs, were deferred in accordance with FASB ASC 310-20, Receivables—Nonrefundable Fees and Other Costs, and have been, and will continue to be, amortized to interest and fees on loans and leases on the consolidated statement of income over the life of the respective loans.
The processing fees received from the SBA for administering the application for, and disbursing of, the PPP loans may be subject to clawback (or if the SBA has not yet paid the fee, the fee may not be paid), after full disbursement of a PPP loan if (i) the PPP loan is cancelled or voluntarily terminated and repaid after disbursement but before the borrower certification safe harbor date, (ii) the PPP loan is cancelled, terminated, or repaid after disbursement (and after the borrower certification safe harbor date) because the SBA conducted a loan review and determined that the borrower was ineligible for a PPP loan, or (iii) the lender has not fulfilled its obligations under the PPP regulations.
As of June 30, 2022, Mid Penn is not aware of any PPP loans outstanding, for which fees have been received from the SBA, that have been cancelled, terminated, or repaid due to a borrower being determined to be ineligible for a PPP loan.
Litigation
Mid Penn is subject to lawsuits and claims arising out of its normal conduct of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial condition of Mid Penn.
Note 9 - Debt
Short-term FHLB and Correspondent Bank Borrowings
Short-term borrowings generally consist of federal funds purchased and advances from the FHLB with an original maturity of less than a year. Federal funds purchased from correspondent banks mature in one business day and reprice daily based on the Federal Funds rate. Advances from the FHLB are collateralized by the Bank’s investment in the common stock of the FHLB and by a blanket lien on selected loan receivables comprised principally of real estate secured loans within the Bank’s portfolio totaling $2,024,652,000 at June 30, 2022. The Bank had a short-term borrowing capacity from the FHLB as of June 30, 2022 up to the Bank’s unused borrowing capacity of $1,206,604,000 (equal to $1,414,751,000 of maximum borrowing capacity, less the aggregate amount of FHLB letter of credits securing public funds deposits, and other FHLB advances and obligations outstanding) upon satisfaction of any stock purchase requirements of the FHLB. No draws were outstanding on short-term FHLB or correspondent bank borrowings as of June 30, 2022 and December 31, 2021.
The Bank also has unused overnight lines of credit with other correspondent banks amounting to $35,000,000 at June 30, 2022. No draws have been made on these lines of credit and accordingly the balance was zero on both June 30, 2022 and December 31, 2021.
Short-term PPPLF Borrowings
As of June 30, 2022 and December 31, 2021, the Bank paid all funding obtained from the Federal Reserve through the Paycheck Protection Program Liquidity Facility (“PPPLF”). The PPPLF allowed banks to pledge PPP loans as collateral to borrow funds for up to a term of five years (to match the term of the respective PPP loans) at an interest rate of 0.35%.
Long-term Debt
As of June 30, 2022, and December 31, 2021, the Bank had long-term debt outstanding in the amount of $4,592,000 and $81,270,000, respectively, consisting primarily of FHLB fixed rate instruments, as well as one finance lease obligation.
As a member of the FHLB, the Bank can access a number of credit products which are utilized to provide liquidity. The FHLB fixed rate instruments obtained by the Bank are secured under the terms of a blanket collateral agreement with the FHLB consisting of FHLB stock and qualifying Bank loan receivables, principally real estate secured loans. The Bank also obtains letters of credit from the FHLB to secure certain public fund deposits of municipality and school district customers who agree to use of the FHLB letters of credit as a legally allowable alternative to investment pledging. These FHLB letter of credit commitments totaled $205,100,000 as of June 30, 2022 and $450,850,000 as of December 31, 2021.
The following table presents a summary of long-term debt as of June 30, 2022 and December 31, 2021.
FHLB fixed rate instruments:
Due April 2022, 0.86343%
70,000
Due March 2023, 0.7514%
Due August 2026, 4.80%
1,222
1,353
Due February 2027, 6.71%
Total FHLB fixed rate instruments
Lease obligations included in long-term debt
3,336
3,380
Total long-term debt
Note 10 - Subordinated Debt and Trust Preferred Securities
Subordinated Debt Assumed November 2021 with the Riverview Acquisition
On November 30, 2021, Mid Penn completed its acquisition of Riverview and assumed $25,000,000 of Subordinated Notes (the “Riverview Notes”). In accordance with purchase accounting principles, the Riverview Notes were assigned a fair value premium of $2,302,000. The notes are treated as Tier 2 capital for regulatory reporting purposes.
The Riverview Notes were entered into by Riverview on October 6, 2020 with certain qualified institutional buyers and accredited institutional investors. The Riverview Notes have a maturity date of October 15, 2030 and initially bear interest, payable semi-annually, at a fixed annual rate of 5.75% per annum until October 15, 2025. Commencing on that date, the interest rate applicable to the outstanding principal amount due will be reset quarterly to an interest rate per annum equal to the then current three-month secured overnight financing rate (“SOFR”) plus 563 basis points, payable quarterly until maturity. Mid Penn may redeem the Notes at par, in whole or in part, at its option, anytime beginning on October 15, 2025.
Trust Preferred Securities Assumed November 2021 with the Riverview Acquisition
As a result of the merger with Riverview, Mid Penn assumed the subordinated debentures that Riverview had assumed in its acquisition of CBT Financial Corp. (“CBT”) on October 1, 2017 (the “CBT 2017 Notes”). In 2003, a trust formed by CBT issued $5,155,000 of floating rate trust preferred securities as part of a pooled offering of such securities, which are adjusted quarterly to the three-month LIBOR rate plus 2.95%. CBT issued subordinated debentures to the trust in exchange for ownership of all of the common securities of the trust and the proceeds of the offering; the debentures represent the sole asset of the trust. CBT became eligible to redeem the subordinated debentures, in whole but not in part, beginning in 2008 at a price of 100% of face value. The subordinated debentures must be redeemed no later than 2033.
Similarly, in 2005, a trust formed by CBT issued $4,124,000 of fixed rate trust preferred securities as part of a pooled offering of such securities (the “CBT 2015 Notes”). CBT issued subordinated debentures to the trust in exchange for ownership of all of the common securities of the trust and the proceeds of the offering; the debentures represent the sole asset of the trust. CBT became eligible to redeem the subordinated debentures, in whole but not in part, beginning in 2010 at a price of 100% of face value. Interest payments on the debentures may be deferred at any time at the election of Mid Penn for up to 20 consecutive quarterly periods. Interest on the debentures
42
will accrue during the extension period, and all accrued principal and interest must be paid at the end of the extension period. During an extension period, Mid Penn may not declare or pay any dividends or distributions on, or redeem, purchase, acquire, or make a liquidation payment with respect to any of Mid Penn’s capital stock.
In accordance with purchase accounting principles, the CBT 2017 Notes and CBT 2015 Notes assumed from Riverview were assigned a fair value premium of $6,000. The subordinated debentures are treated as Tier 1 capital for regulatory reporting purposes.
Subordinated Debt Issued December 2020
On December 22, 2020, Mid Penn entered into agreements for and sold, at 100% of their principal amount, an aggregate of $12,150,000 of its Subordinated Notes due December 2030 (the “December 2020 Notes”) on a private placement basis to accredited investors. The December 2020 Notes are treated as Tier 2 capital for regulatory capital purposes.
The December 2020 Notes bear interest at a rate of 4.5% per year for the first five years and then float at the Wall Street Journal’s Prime Rate, provided that the interest rate applicable to the outstanding principal balance during the period the December 2020 Notes are floating will at no time be less than 4.5%. Interest is payable quarterly in arrears on March 31, June 30, September 30 and December 31 of each year, beginning on March 31, 2021. The December 2020 Notes will mature on December 31, 2030 and are redeemable, in whole or in part, without premium or penalty, on any interest payment date on or after December 31, 2025 and prior to December 31, 2030, subject to any required regulatory approvals. Additionally, if (i) all or any portion of the December 2020 Notes cease to be deemed Tier 2 Capital, (ii) interest on the December 2020 Notes fails to be deductible for United States federal income tax purposes, or (iii) Mid Penn will be considered an “investment company,” Mid Penn may redeem the December 2020 Notes, in whole but not in part, by giving 10 days’ notice to the holders of the December 2020 Notes. In the event of a redemption described in the previous sentence, Mid Penn will redeem the December 2020 Notes at 100% of the principal amount of the December 2020 Notes, plus accrued and unpaid interest thereon to but excluding the date of redemption.
Holders of the December 2020 Notes may not accelerate the maturity of the December 2020 Notes, except upon the bankruptcy, insolvency, liquidation, receivership or similar event of Mid Penn or Mid Penn Bank, its principal banking subsidiary. Related parties held $750,000 of the December 2020 Notes as of June 30, 2022 and December 31, 2021.
Subordinated Debt Issued March 2020
On March 20, 2020, Mid Penn Bancorp, Inc. entered into agreements with accredited investors who purchased $15,000,000 aggregate principal amount of Mid Penn Subordinated Notes due March 2030 (the “March 2020 Notes”). As a result of Mid Penn’s merger with Riverview on November 30, 2021, $6,870,000 of the March 2020 Notes balance was redeemed as Riverview was a holder of the March 2020 Notes. The balance of March 2020 Notes outstanding as of June 30, 2022 was $8,130,000. The March 2020 Notes are intended to be treated as Tier 2 capital for regulatory capital purposes.
The March 2020 Notes bear interest at a rate of 4.0% per year for the first five years and then float at the Wall Street Journal’s Prime Rate, provided that the interest rate applicable to the outstanding principal balance during the period the March 2020 Notes are floating will at no time be less than 4.25%. Interest is payable semi-annually in arrears on June 30 and December 30 of each year, beginning on June 30, 2020, for the first five years after issuance and will be payable quarterly in arrears thereafter on March 30, June 30, September 30 and December 30. The March 2020 Notes will mature on March 30, 2030 and are redeemable in whole or in part, without premium or penalty, at any time on or after March 30, 2025 and prior to March 30, 2030. Additionally, if all or any portion of the March 2020 Notes cease to be deemed Tier 2 Capital, Mid Penn may redeem, on any interest payment date, all or part of the 2020 Notes. In the event of a redemption described in the previous sentence, Mid Penn will redeem the March 2020 Notes at 100% of the principal amount of the March 2020 Notes, plus accrued and unpaid interest thereon to but excluding the date of redemption.
Holders of the March 2020 Notes may not accelerate the maturity of the March 2020 Notes, except upon the bankruptcy, insolvency, liquidation, receivership or similar event of Mid Penn or Mid Penn Bank, its principal banking subsidiary. Related parties held $1,700,000 of the March 2020 Notes as of June 30, 2022 and December 31, 2021.
Subordinated Debt Issued December 2017
On December 19, 2017, Mid Penn Bancorp, Inc. entered into agreements with investors to purchase $10,000,000 aggregate principal amount of its Subordinated Notes due 2028 (the “2017 Notes”). The 2017 Notes are intended to be treated as Tier 2 capital for regulatory capital purposes. The offering closed in December 2017.
The 2017 Notes bear interest at a rate of 5.25% per year for the first five years and then float at the Wall Street Journal’s Prime Rate plus 0.50%, provided that the interest rate applicable to the outstanding principal balance will at no time be less than 5.0%. Interest is payable semi-annually in arrears on January 15 and July 15 of each year, beginning on July 15, 2018, for the first five years after issuance and will be payable quarterly in arrears thereafter on January 15, April 15, July 15, and October 15. The 2017 Notes will mature on January 1, 2028 and are redeemable in whole or in part, without premium or penalty, at any time on or after December 21, 2022, and prior to January 1, 2028. Additionally, Mid Penn may redeem the 2017 Notes in whole at any time, or in part from time to time, upon at least 30 days’ notice if: (i) a change or prospective change in law occurs that could prevent Mid Penn from deducting interest payable on the 2017 Notes for U.S. federal income tax purposes; (ii) an event occurs that precludes the 2017 Notes from being recognized as Tier 2 capital for regulatory capital purposes; or (iii) Mid Penn becomes required to register as an investment company under the Investment Company Act of 1940, as amended. In the event of a redemption described in the previous sentence, Mid Penn will redeem the 2017 Notes at 100% of the principal amount of the 2017 Notes, plus accrued and unpaid interest thereon to but excluding the date of redemption.
Holders of the 2017 Notes may not accelerate the maturity of the 2017 Notes, except upon the bankruptcy, insolvency, liquidation, receivership or similar event of Mid Penn or Mid Penn Bank, its principal banking subsidiary. Related parties held $1,450,000 of the 2017 Notes as of June 30, 2022 and December 31, 2021.
Subordinated Debt Issued December 2015
On December 9, 2015, Mid Penn Bancorp, Inc. sold $7,500,000 aggregate principal amount of Subordinated Debt (the “2015 Notes”) due in 2025. Given that the 2015 Notes are in the sixth year since issuance, eighty percent of the principal balance of the notes is treated as Tier 2 capital for regulatory capital purposes as of June 30, 2022.
The 2015 Notes paid interest at a rate of 5.15% per year for the first five years outstanding, including the three months ended March 31, 2020. Beginning January 1, 2021, the 2015 Notes bear interest at a floating rate based on the Wall Street Journal’s Prime Rate plus 0.50%, provided that the interest rate applicable to the outstanding principal balance will at no time be less than 4.0%. Interest is payable quarterly in arrears on January 1, April 1, July 1 and October 1 of each year, beginning on January 1, 2016. The 2015 Notes will mature on December 9, 2025 and are redeemable in whole or in part, without premium or penalty, at any time on or after December 9, 2020, and prior to December 9, 2025. Additionally, Mid Penn may redeem the 2015 Notes in whole at any time, or in part from time to time, upon at least 30 days’ notice if: (i) a change or prospective change in law occurs that could prevent Mid Penn from deducting interest payable on the 2015 Notes for U.S. federal income tax purposes; (ii) an event occurs that precludes the 2015 Notes from being recognized as Tier 2 capital for regulatory capital purposes; or (iii) Mid Penn becomes required to register as an investment company under the Investment Company Act of 1940, as amended, in each case at 100% of the principal amount of the 2015 Notes, plus accrued and unpaid interest thereon to but excluding the date of redemption.
Holders of the 2015 Notes may not accelerate the maturity of the 2015 Notes, except upon Mid Penn’s or Mid Penn Bank’s bankruptcy, insolvency, liquidation, receivership or similar event. Related parties held $1,930,000 of the 2015 Notes as of June 30, 2022 and December 31, 2021.
ASC Subtopic 835-30, Simplifying the Presentation of Debt Issuance Costs, requires that debt issuance costs be reported in the balance sheet as a direct deduction from the face amount of the related liability. The unamortized debt issuance costs associated with the 2015 Notes and the 2017 Notes were collectively $31,000 at June 30, 2022 and $44,000 at December 31, 2021.
Note 11 - Defined Benefit Plans
Mid Penn has an unfunded noncontributory defined benefit retirement plan for directors. The plan provides defined benefits based on years of service. Mid Penn also sponsors a defined benefit healthcare plan that provides post-retirement medical benefits and life insurance to qualifying full-time employees. These healthcare and life insurance plans are noncontributory and each plan uses a December 31 measurement date.
As a result of the acquisition of Scottdale on January 8, 2018, Mid Penn assumed a noncontributory defined benefit pension plan covering certain former employees of Scottdale. Mid Penn does not expect any necessary contributions to this defined benefit plan during the year ended 2022. A December 31 measurement date for the plan is used.
The components of net periodic benefit costs from these defined benefit plans are as follows:
Pension Benefits
Other Benefits
Service cost
Interest cost
Expected return on plan assets
(59
Accretion of prior service cost
(5
Amortization of net (gain) loss
Net periodic benefit expense
80
(118
(113
(10
(4
Settlement gain
(49
Net periodic benefit expense (income)
(17
Service costs are reported as a component of salaries and employee benefits on the consolidated statement of income, while interest costs, expected return on plan assets and amortization (accretion) of prior service cost are reported as a component of other income.
Note 12 - Common Stock
Treasury Stock Repurchase Program
Mid Penn adopted a treasury stock repurchase program (“Program”) initially effective March 19, 2020, and the buyback remains available as it was extended through March 19, 2023 by Mid Penn’s Board of Directors on March 23, 2022. The Program authorized the repurchase of up to $15,000,000 of Mid Penn’s outstanding common stock, which represented approximately 3.5% of the issued shares based on Mid Penn’s closing stock price and shares issued as of March 31, 2022. Under the Program, Mid Penn may conduct repurchases of its common stock through open market transactions (which may be by means of a trading plan adopted under SEC Rule 10b5-1) or in privately negotiated transactions. Repurchases under the Program are made at the discretion of management and are subject to market conditions and other factors. There is no guarantee as to the exact number of shares that Mid Penn may repurchase.
The Program may be modified, suspended or terminated at any time, in Mid Penn’s discretion, based upon a number of factors, including liquidity, market conditions, the availability of alternative investment opportunities and other factors Mid Penn deems appropriate. The Program does not obligate Mid Penn to repurchase any shares.
During the second quarter of 2022, Mid Penn repurchased 103,912 shares of outstanding common stock at an average price of $26.88 under the Program. As of June 30, 2022, Mid Penn had repurchased 202,364 shares of common stock at an average price of $23.31 per share under the Program. The Program has $10,284,000 remaining available for repurchase.
Shares Converted Pursuant to Riverview Merger
As announced on a Form 8-K on December 1, 2021, pursuant to the terms of the merger agreement, each share of Riverview common stock issued and outstanding as of November 30, 2021 was converted into the right to receive 0.4833 shares of Mid Penn common stock. Cash was paid to Riverview shareholders in lieu of any fractional shares. As a result of the merger, Mid Penn issued 4,519,776 shares of Mid Penn common stock. The additional shares issued on November 30, 2021 significantly impacted the weighted average number of shares outstanding used for the earnings per share calculation for the three and six months ended June 30, 2022 compared to the three and six months ended June 30, 2021.
Underwritten Public Follow-On Common Stock Offering
As previously announced on a Form 8-K on May 4, 2021, Mid Penn completed an underwritten public offering of 2,990,000 shares of common stock at a price of $25.00 per share, with the aggregate gross proceeds of the offering totaling $74,750,000 before underwriting discounts and offering expenses. The net proceeds of the offering, after deducting $4,512,000 of combined underwriting discounts and other offering expenses, were $70,238,000. The additional shares issued on May 4, 2021 significantly impacted the weighted average number of shares outstanding used for the earnings per share calculation for the three and six months ended June 30, 2022 compared to the three and six months ended June 30, 2021.
45
Dividend Reinvestment Plan
Under Mid Penn’s amended and restated dividend reinvestment plan (“DRIP”), 330,750 shares of Mid Penn’s authorized but unissued common stock are reserved for issuance. The DRIP also allows for voluntary cash payments, within specified limits, to be used for the purchase of additional shares.
Restricted Stock Plan
Under Mid Penn’s 2014 Restricted Stock Plan, which was amended in 2020, Mid Penn may grant awards not exceeding, in the aggregate, 200,000 shares of common stock. The Plan was established for employees and directors of Mid Penn and the Bank, selected by the Compensation Committee of the Board of Directors, to align the interest of plan participants with those of Mid Penn’s shareholders. The plan provides those persons who have a responsibility for its growth with additional incentives by allowing them to acquire an ownership interest in Mid Penn and thereby encouraging them to contribute to the success of the company.
As of June 30, 2022, a total of 164,537 restricted shares were granted under the Plan, of which 5,073 shares were forfeited and available for reissuance, 83,574 shares were vested, and the remaining 75,890 shares were unvested. The Plan shares granted and vested resulted in $289,000 and $457,000 in share-based compensation expense for the three and six months ended June 30, 2022, respectively, and $173,000 and $305,000 of share-based compensation expense was recorded for the three and six months ended June 30, 2022, 2021, respectively.
Share-based compensation expense relating to restricted stock is calculated using grant date fair value and is recognized on a straight-line basis over the vesting periods of the awards. Restricted shares granted to employees vest in equal amounts on the anniversary of the grant date over the vesting period and the expense is a component of salaries and benefits expense on the consolidated statement of income. The employee grant vesting period is determined by the terms of each respective grant, with vesting periods generally between one and four years. Restricted shares granted to directors have a twelve-month vesting period, and the expense is a component of directors’ fees and benefits within the other expense line item on the consolidated statement of income.
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is Management’s Discussion and Analysis of Consolidated Financial Condition as of June 30, 2022, compared to year-end 2021, and the Results of Operations for the three and six months ended June 30, 2022, compared to the same periods in 2021. For comparative purposes, the June 30, 2021 and December 31, 2021 balances have been reclassified when, and if necessary, to conform to the 2022 presentation. Such reclassifications had no impact on net income or shareholders’ equity. This discussion should be read in conjunction with the financial tables, statistics, and the audited financial statements and notes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2021 (the “2021 Annual Report”). The results of operations for interim periods are not necessarily indicative of operating results expected for the full year.
Caution About Forward-Looking Statements
Forward-looking statements involve risks, uncertainties and assumptions. Although Mid Penn generally does not make forward-looking statements unless Mid Penn’s management believes its management has a reasonable basis for doing so, Mid Penn cannot guarantee the accuracy of any forward-looking statements. Actual results may differ materially from those expressed in any forward-looking statements due to a number of uncertainties and risks, including the risks described in this Quarterly Report on Form 10-Q, the 2021 Annual Report, and other unforeseen risks. You should not put undue reliance on any forward-looking statements. These statements speak only as of the date of this Quarterly Report on Form 10-Q, even if subsequently made available by us on Mid Penn’s website or otherwise, and Mid Penn undertakes no obligation to update or revise these statements to reflect events or circumstances occurring after the date of this Quarterly Report on Form 10-Q.
Certain of the matters discussed in this document and in documents incorporated by reference herein, including matters discussed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, may constitute forward-looking statements for purposes of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and as such may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of Mid Penn to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. The words “expect”, “anticipates”, “intend”, “plan”, “believe”, “estimate”, and similar expressions are intended to identify such forward-looking statements. Mid Penn’s actual results may differ materially from the results anticipated in these forward-looking statements due to a variety of factors, including, without limitation:
•
the effects of potentially slowing or volatile future economic conditions on Mid Penn and its customers;
governmental monetary and fiscal policies, as well as legislative and regulatory changes;
future actions or inactions of the federal or state governments, including a failure to increase the government debt limit or a prolonged shutdown of the federal government, or a federal or state government-mandated shutdown of significant segments of the economy;
business or economic disruptions from national or global epidemic or pandemic events, including those from the COVID-19 pandemic;
the risks associated with our acquisition of Riverview, including we may fail to realize the anticipated benefits of the merger, and the future results of the combined company may suffer if the expanded operations are not effectively managed;
an increase in the Pennsylvania Bank Shares Tax to which Mid Penn Bank’s capital stock is currently subject, or imposition of any additional taxes on Mid Penn or Mid Penn Bank;
changes in the capitalization of the Corporation, including the impacts of any capital and liquidity requirements imposed by regulatory pronouncements and rules;
the effect of changes in accounting policies and practices, as may be adopted by the supervisory agencies, as well as the Public Company Accounting Oversight Board, Financial Accounting Standards Board, and other accounting standard setters;
the risks of changes in interest rates and the yield curve on the level and composition of deposits and other funding sources, loan demand and yields, values of loan collateral, securities and yields, and interest rate protection agreements;
the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in Mid Penn’s market area and elsewhere, including institutions operating locally, regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the internet;
the costs and effects of litigation and of unexpected or adverse outcomes in such litigation;
technological changes and changes to data security systems including those with third-party information technology providers;
our ability to implement business strategies, including our acquisition strategy;
our ability to implement organic branch, product and service expansion strategies;
our current and future acquisition strategies may not be successful in locating or acquiring advantageous targets at favorable prices;
our ability to successfully integrate any banks, companies, assets, liabilities, customers, systems and management personnel we acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames;
potential goodwill impairment charges, future impairment charges and fluctuations in the fair values of reporting units or of assets in the event projected financial results are not achieved within expected time frames;
our ability to attract and retain qualified management and personnel;
our ability to maintain the value and image of our brand and protect our intellectual property rights;
results of regulatory examination and supervision processes;
our ability to maintain compliance with the exchange rules of The NASDAQ Stock Market LLC;
the failure of assumptions underlying the establishment of reserves for loan and lease losses and estimations of values of collateral and various financial assets and liabilities;
acts of war or terrorism; disruptions due to flooding, severe weather, or other natural disasters or Acts of God
volatility in the securities markets; and
other risks and uncertainties, including those detailed in our Annual Report on Form 10-K for the year ended December 31, 2021, under the sections “Risk Factors” and “Management Discussion and Analysis of Financial Condition and Results of Operations” and in subsequent filings with the SEC.
The above list of factors that may affect future performance is illustrative, but by no means exhaustive. Accordingly, all forward-looking statements should be evaluated with this understanding of inherent uncertainty.
Critical Accounting Estimates
Mid Penn’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and conform to general practices within the banking industry. Application of these principles involves significant judgments and estimates by management that have a material impact on the carrying value of certain assets and liabilities. The judgments and estimates that we used are also based on historical experiences and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and estimates that we have made, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities and the results of our operations. Management of the Corporation considers the accounting judgments relating to the allowance, the evaluation of the Corporation’s investment securities for other-than-temporary impairment, the valuation of the Corporation’s goodwill and other merger-related intangible assets for impairment, and the valuation of assets acquired and liabilities assumed in business combinations, to be the accounting areas that require the most subjective and complex judgments.
The allowance represents management’s estimate of probable incurred credit losses inherent in the loan and lease portfolio. Determining the amount of the allowance is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan and lease portfolio also represents the largest asset type on the consolidated balance sheet. Throughout the remainder of this report, the terms “loan” or “loans” refers to both loans and leases.
Valuations for the investment portfolio are determined using quoted market prices, where available. If quoted market prices are not available, investment valuation is based on pricing models, quotes for similar investment securities, and observable yield curves and spreads. In addition to securities valuation, management must assess whether there are any declines in value below the carrying value of the investments that should be considered other than temporary or require an adjustment in carrying value and recognition of the loss in the consolidated statement of income.
Certain intangible assets generated in connection with acquisitions are periodically assessed for impairment. Goodwill is tested annually for impairment, and if certain events occur which indicate goodwill might be impaired between annual tests, goodwill must be tested when such events occur. In making this assessment, Mid Penn considers a number of factors including operating results, business plans, economic projections, anticipated future cash flows, current market data, stock price, etc. Similarly, the amortized basis of the core deposit intangible asset is periodically assessed for impairment. There are inherent uncertainties related to these factors and Mid Penn’s judgment in applying them to the analysis of core deposit intangible, trade name intangible, and goodwill impairment. Changes in economic and operating conditions could result in goodwill, core deposit intangible, customer list intangible, or trade name intangible impairment in future periods.
Valuations of assets acquired and liabilities assumed in business combinations are measured at fair value as of the acquisition date. In many cases, determining the fair value of the assets acquired and liabilities assumed requires Mid Penn to estimate cash flows expected to result from these assets and liabilities and to discount these cash flows at appropriate rates of interest, which require the utilization of significant estimates and judgment in accounting for the acquisition.
See “Note 2 - Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements for additional information.
Riverview Acquisition
On November 30, 2021, Mid Penn announced the successful completion of the merger acquisition of Riverview Financial Corporation. The acquisition of Riverview impacted periods presented within this report. Refer to “Note 3 - Acquisition of Riverview Financial Corporation” in the Notes to Consolidated Financial Statements, as well as the Company’s Current Report on Form 8-K filed on December 1, 2021, for more information.
COVID-19 Pandemic
The COVID-19 pandemic has caused substantial disruption in economic and social activity, both in the United States and abroad. While the overt impacts from the pandemic have diminished, there remains uncertainty concerning the breadth and duration of the disruptions and their impact on the U.S. economy. For example, the adverse economic effects of the pandemic may lead to an increase in credit risk on the Corporation’s commercial and residential loan portfolios. Additionally, management continues to monitor the fluctuations in the markets as it pertains to interest rates and the fair value of our investments and is actively monitoring the global situation on the Corporation’s financial condition, liquidity, capital position, operations, industry, and workforce. If the pandemic continues to cause significant negative impacts to economic conditions, Mid Penn’s results of operations, financial condition, capital position, or liquidity for fiscal year 2022 may be adversely impacted.
48
Coronavirus Aid, Relief, and Economic Security Act
Mid Penn has been a significant participating lender under the Paycheck Protection Program (“PPP”), which was created when the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law on March 27, 2020 and concluded August 8, 2020. The PPP program was reinstated under the Consolidated Appropriations Act, 2021, which was signed into law on December 27, 2020 and concluded on May 31, 2021.
Results of Operations
Overview
Net income available to common shareholders was $12,252,000 or $0.77 per common share basic and diluted for the quarter ended June 30, 2022, compared to net income of $9,313,000 or $0.93 per common share basic and diluted for the quarter ended June 30, 2021. During the six months ended June 30, 2022, net income available to common shareholders was $23,606,000 or $1.48 per common share basic and diluted compared to net income of $18,925,000 or $2.02 per common share basic and diluted for the six months ended June 30, 2021.
Net income as a percentage of average assets (return on average assets, or “ROA”) and net income as a percentage of shareholders' equity (return on average equity, or “ROE”) were as follows (calculated and reported on an annualized basis):
Return on average assets
1.10
%
1.12
1.04
1.15
Return on average equity
9.91
12.36
9.62
13.36
Net interest income, Mid Penn’s primary source of revenue, is the amount by which interest income on loans and investments exceeds interest incurred on deposits and borrowings. The amount of net interest income is affected by changes in interest rates and changes in the volume and mix of interest-sensitive assets and liabilities. Net interest income and corresponding yields are presented in the analysis below on a taxable-equivalent basis (“TE”). Income from tax-exempt assets, primarily loans to or securities issued by state and local governments, is adjusted by an amount equivalent to the federal income taxes which would have been paid if the income received on these assets was taxable at the statutory rate of 21% for the periods presented.
The following table includes average balances, amounts, and yields of interest income and rates of expense, interest rate spread, and net interest margin for the three months ended June 30, 2022 and 2021.
Average Balances, Income and Interest Rates on a Taxable-Equivalent Basis
For the Three Months Ended
Average
Yield/
Balance
Interest
Rate
ASSETS:
Interest Bearing Balances
5,920
0.54
1,284
0.62
Investment Securities:
Taxable
501,631
2,740
2.19
93,161
430
1.85
Tax-Exempt
78,775
480
2.44
55,811
352
2.53
Total Securities
580,406
3,220
2.23
148,972
782
2.11
Federal Funds Sold
415,405
0.71
477,001
0.08
Loans and Leases, Net
3,129,334
34,354
4.40
2,609,803
29,908
4.60
Restricted Investment in Bank Stocks
4,854
94
7.77
6,865
5.02
Total Interest-earning Assets
4,135,919
38,412
3.73
3,243,925
30,876
3.82
Cash and Due from Banks
59,822
34,683
Other Assets
270,165
159,084
4,465,906
3,437,692
LIABILITIES & SHAREHOLDERS' EQUITY:
Interest-bearing Demand
1,030,237
462
0.18
614,435
579
0.38
1,079,900
584
0.22
791,498
0.42
357,433
0.05
203,468
58
0.11
516,346
930
0.72
432,739
1,460
1.35
Total Interest-bearing Deposits
2,983,916
0.27
2,042,140
0.57
Short-term Borrowings
0.00
264,661
0.35
9,238
107
4.65
74,976
1.09
Subordinated Debt
74,062
661
3.58
44,589
4.50
Total Interest-bearing Liabilities
3,067,216
0.36
2,426,366
0.64
Noninterest-bearing Demand
853,219
673,735
Other Liabilities
49,790
25,585
Shareholders' Equity
495,681
312,006
Total Liabilities & Shareholders' Equity
Net Interest Income (taxable-equivalent basis)
35,625
27,024
Taxable Equivalent Adjustment
(192
(147
Total Yield on Earning Assets
Rate on Supporting Liabilities
Average Interest Spread
3.36
3.18
Net Interest Margin
3.45
3.34
Includes TE adjustments (calculated using statutory rates of 21%) of $101,000 and $74,000 for the three months ended June 30, 2022 and 2021, respectively, resulting from tax-free municipal securities in the investment portfolio.
Includes TE adjustments (calculated using statutory rates of 21%) of $91,000 and $73,000 for the three months ended June 30, 2022 and 2021, respectively, resulting from tax-free municipal loans in the commercial loan portfolio.
50
The following table summarizes the changes in TE interest income and interest expense resulting from changes in average balances, volume, and changes in rates for the three months ended June 30, 2022 in comparison to the same period in 2021:
June 30, 2022 vs. June 30, 2021
(Dollars in thousands on a Taxable-Equivalent Basis)
Increase (decrease)
Volume
Net
INTEREST INCOME:
1,885
425
145
128
2,030
408
2,438
(13
651
638
5,954
(1,508
4,446
Restricted Investment Bank Stocks
7,953
(417
7,536
INTEREST EXPENSE:
Interest Bearing Deposits:
Interest Bearing Demand
392
(509
(117
(533
282
(812
(530
Total Interest-Bearing Deposits
1,016
(1,913
(897
(232
(179
82
(97
330
(169
161
935
(2,000
(1,065
NET INTEREST INCOME
7,018
1,583
8,601
Mid Penn’s TE net interest margin for the three months ended June 30, 2022 was 3.45% and compared to 3.34% for the three months ended June 30, 2021. TE net interest income was $35,625,000 for the three months ended June 30, 2022, an increase of $8,601,000, or 31.2%, compared to the three months ended June 30, 2021. Average interest earning assets increased $891,994,000, or 27.5%, compared to the second quarter of 2021, primarily as a result of the Riverview acquisition. This growth contributed $7,953,000 to the increase in TE net interest income and was partially offset by the lower yield on interest-earning assets, which decreased from 3.82% for the second quarter of 2021 to 3.73% for the second quarter of 2022. The lower yields on loans and leases, net were the result of a decrease of $3,457,000 in the recognition of PPP loan processing fees generated as a result of Mid Penn’s participation in the PPP compared to the second quarter of 2021. These PPP fees are recognized into interest income over the term of the respective loan, or sooner if the loans are forgiven by the Small Business Administration (“SBA”), or the borrowers otherwise pay down principal prior to a loan’s stated maturity. Mid Penn systematically added to its investment portfolio during the second quarter of 2022 to better utilize excess funds held in lower yielding accounts with the Federal Reserve, contributing to the growth in TE net interest income.
Interest expense decreased $1,065,000 during the second quarter of 2022 compared to the second quarter of 2021. The rate of interest-bearing liabilities decreased from 0.64% for the second quarter of 2021 to 0.36% for the second quarter of 2022. The decrease in rate was primarily a result of a lag in the repricing of deposits as well as the strategic decision to allow higher cost time deposits obtained through the Riverview acquisition to run-off, partially offset by an increase of $935,000 in interest expense due to the $640,850,000, or 26.4%, increase in interest-bearing liabilities compared to the same period of 2021.
The following table includes average balances, amounts, and yields of interest income and rates of expense, interest rate spread, and net interest margin for the six months ended June 30, 2022 and 2021:
For the Six Months Ended
48,495
0.09
1,342
0.60
445,644
4,561
2.06
85,849
1.91
76,208
905
2.39
55,377
702
2.56
521,852
5,466
141,226
1,517
2.17
560,105
396,041
3,116,473
69,477
2,571,075
58,314
4.57
6,590
6.89
6,958
181
5.25
4,253,515
76,239
3.61
3,116,642
60,193
3.89
54,177
34,363
272,922
161,661
4,580,614
3,312,666
1,037,915
923
608,259
1,157
1,102,372
1,184
767,877
1,597
366,668
101
0.06
200,686
0.12
554,378
2,105
423,259
3,006
1.43
3,061,333
0.28
2,000,081
0.59
234,258
42,513
391
75,019
74,126
1,301
3.54
44,586
999
4.52
3,177,972
2,353,944
0.66
856,324
648,537
51,612
24,529
494,706
285,656
70,234
52,498
(387
(296
3.23
3.24
3.33
3.40
Includes TE adjustments (calculated using statutory rates of 21%) of $190,000 and $147,000 for the six months ended June 30, 2022 and 2021, respectively, resulting from tax-free municipal securities in the investment portfolio.
Includes TE adjustments (calculated using statutory rates of 21%) of $197,000 and $149,000 for the six months ended June 30, 2022 and 2021, respectively, resulting from tax-free municipal loans in the commercial loan portfolio.
The following table summarizes the changes in TE interest income and interest expense resulting from changes in average balances, volume, and changes in rates for the six months ended June 30, 2022 in comparison to the same period in 2021:
141
3,416
3,746
264
(61
203
3,680
269
3,949
73
873
12,370
(1,207
11,163
16,254
(208
16,046
817
(1,051
696
(1,109
(413
(122
(21
931
(1,832
(901
2,545
(4,114
(1,569
(406
(177
662
(360
302
2,624
(4,314
(1,690
13,630
4,106
17,736
Mid Penn’s TE net interest margin for the six months ended June 30, 2022 was 3.33% and compared to 3.40% for the six months ended June 30, 2021. TE net interest income was $70,234,000 for the six months ended June 30, 2022, an increase of $17,736,000, or 33.8%, compared to $52,202,000 of TE net interest income for the six months ended June 30, 2021. Average interest-earning assets increased $1,136,873,000, or 36.5%, compared to the first half of 2021, primarily as a result of the Riverview acquisition. This growth contributed $16,254,000 to the increase in TE net interest income and was partially offset by the lower yield on interest-earning assets, which decreased from 3.89% for the first half of 2021 to 3.61% for the first half of 2022. The lower yields on loans and leases, net were the result of a decrease of $7,650,000 in the recognition of PPP loan processing fees generated as a result of Mid Penn’s participation in PPP compared to the first six months of 2021. Mid Penn systematically added to its investment portfolio during the first half of 2022 to better utilize excess funds held in lower yielding accounts with the Federal Reserve, contributing to the growth in TE net interest income.
Interest expense decreased $1,690,000 during the first six months of 2022 compared to the same period of 2021. The rate of interest-bearing liabilities decreased from 0.66% for the first six months of 2021 to 0.38% for the first six months of 2022. The decrease in rate was primarily a result of a lag in the repricing of deposits as well as the strategic decision to allow higher cost time deposits obtained through the Riverview acquisition to run-off. The decrease in interest expense as a result of the lower rate of interest-bearing liabilities was partially offset by an increase of $2,624,000 in interest expense as a result of a $640,850,000, or 26.4%, increase in interest-bearing liabilities compared to the same period of 2021.
Although the effective interest rate impact on interest-earning assets and funding sources can be reasonably estimated at current interest rate levels, the interest-bearing product and pricing options selected by customers, and the future mix of the loan, investment, and deposit products in the Bank's portfolios, may significantly change the estimates used in Mid Penn’s asset and liability management and related interest rate risk simulation models. In addition, our net interest income may be impacted by further interest rate actions of the Federal Reserve’s Federal Open Market Committee (“FOMC”).
53
Provision for Loan Losses
The provision for loan and lease losses is the expense necessary to maintain the allowance at a level adequate to absorb management’s estimate of probable losses in the loan and lease portfolio. Mid Penn’s provision for loan and lease losses is based upon management’s monthly review of the loan portfolio. The purpose of the review is to assess loan quality, identify impaired loans and leases, analyze delinquencies, ascertain loan and lease growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets Mid Penn serves.
Mid Penn has maintained the allowance in accordance with Mid Penn’s assessment process, which takes into consideration, among other relevant factors, the risk characteristics of the loan portfolio, the growth in the loan portfolio during the first six months of 2022, economic and external factor changes, and shifting collateral values from December 31, 2021 to June 30, 2022.
Management performed a current evaluation of the adequacy of the loan and lease loss allowance and, based on this evaluation, a loan and lease loss provision of $1,725,000 and $1,150,000 was recorded for the three months ended June 30, 2022 and 2021, respectively. During the six months ended June 30, 2022, the provision for the loan and lease losses was $2,225,000 compared to $2,150,000 for the six months ended June 30, 2021. The allowance for loan and lease losses and the related provision reflect Mid Penn’s continued application of the incurred loss method for estimating credit losses as Mid Penn is not yet required to adopt the current expected credit loss (“CECL”) accounting standard. The increase in the allowance for loan and lease loss from $14,597,000 at December 31, 2021 to $16,876,000 at June 30, 2022 was primarily the result of providing for core loan growth, as well as the result of one legacy commercial relationship being downgraded from substandard accrual to substandard non-accrual during the six months ended June 30, 2022.
Noninterest Income
For the three months ended June 30, 2022, noninterest income totaled $5,230,000, a decrease of $422,000 or 7.5%, compared to noninterest income of $5,652,000 for the same period in 2021. For the six months ended June 30, 2022, noninterest income totaled $10,980,000, an increase of $616,000 or 5.9%, compared to noninterest income of $10,364,000 for the same period in 2021. Several components of noninterest income increased as a result of higher account and transaction volume due to both the Riverview acquisition and organic growth.
The following components of noninterest income showed significant changes:
(Dollars in Thousands)
$ Variance
% Variance
(2,536
-89
663
154
187
249
877
(4,386
-84
1,159
805
245
961
241
(345
-76
2,204
Mortgage banking income was $834,000 for the six months ended June 30, 2022, a decrease of $4,386,000, compared to the $5,220,000 of mortgage banking income for the six months ended June 30, 2021. Mortgage loan originations and secondary-market loan sales and gains slowed during the first half of 2022 as a result of increases in interest rates. During the first half of 2022, the FOMC announced three rate increases, and anticipates several additional increases throughout the remainder of 2022. As a result of the corresponding mortgage rate increases and an increase in property values driven by supply shortfalls and high liquidity levels among buyers, the mortgage loan refinancing market has slowed and purchase money mortgage originations have slowed relative to the lending volumes experienced during the first half of 2021.
Income from fiduciary and wealth management activities was $2,257,000 for the six months ended June 30, 2022, an increase of $1,159,000 compared to $1,098,000 during the six months ended June 30, 2021. The additional revenue was attributable to favorable growth in trust assets under management and increased sales of retail investments products, as well as the Riverview acquisition.
Service charges on deposits were $1,134,000 for the six months ended June 30, 2022, an increase of $805,000, compared to $329,000 for the same period in 2021. This increase was driven by an increase in collected charges on a higher volume of transactional deposit accounts, including deposit accounts assumed in the Riverview acquisition.
ATM debit card interchange income was $2,185,000 for the six months ended June 30, 2022, an increase of $961,000 compared to the six months ended June 30, 2021. The additional income is a result of an increased volume of checking accounts and an increase in Mid Penn ATM and debit card activity, which included an increase in transaction volume resulting from the accounts assumed in the Riverview acquisition.
Earnings from cash surrender value of life insurance was $508,000 for the six months ended June 30, 2022, an increase of $359,000, compared to $149,000 for the same period of 2021. The increase is a result of additional policies assumed in the Riverview acquisition.
Other income was $3,792,000 for the six months ended June 30, 2022, an increase of $2,204,000, compared to $1,588,000 during the six months ended June 30, 2021. A mortgage hedging program was established in the latter half of 2021, generating $1,134,000 in mortgage hedging gains for the six months ended June 30, 2022, while no similar gains were recognized during the same six months of the prior year. Mid Penn also reflected increases in other miscellaneous income amounts as a result of the Riverview acquisition.
Noninterest Expense
For the three months ended June 30, 2022, noninterest expense totaled $23,915,000, an increase of $4,459,000, or 22.9%, compared to noninterest expense of $19,456,000 for the same period in 2021. For the six months ended June 30, 2022, noninterest expense totaled $49,660,000, an increase of $12,646,000, or 34.2%, compared to noninterest expense of $37,014,000 for the same period in 2021. Several components of noninterest expense increased as a result of higher fixed and variable expenses due to the Riverview acquisition and organic growth.
The changes were primarily a result of the following components of noninterest expense, which had significant variances when comparing results for periods ending in 2022 versus the corresponding period in 2021:
2,407
338
371
(240
-66
(712
-96
(522
-100
2,032
6,053
657
631
985
194
(445
-70
(687
-79
445
Post-acquisition restructuring expenses
4,666
Salaries and employee benefits were $25,584,000 for the six months ended June 30, 2022, an increase of $6,053,000 versus the same period in 2021, with the increase attributable to (i) the retail staff additions at the seven retail locations added through the Riverview acquisition; (ii) the retention of various Riverview team members through the completion of the systems integration, which occurred on March 4, 2022; and (iii) the addition of wealth management professionals, commercial lending professionals, and other staff additions in alignment with Mid Penn’s core banking and nonbanking growth initiatives.
Occupancy expenses increased $657,000 during the first six months of 2022 compared to the same period in 2021. Similarly, equipment expense increased $631,000 during the six months ended June 30, 2022, compared to the six months ended June 30, 2021. These increases were driven by the facility operating costs and increased depreciation expense for building, furniture, and equipment associated with the Riverview acquisition.
Software licensing and utilization costs were $3,927,000 for the six months ended June 30, 2022, an increase of $985,000 compared to $2,942,000 for the six months ended June 30, 2021. The increase is a result of additional costs to license (i) the additional Riverview branches, (ii) upgrades to internal systems, networks, storage capabilities, cybersecurity management, and data security mechanisms to enhance data management and security capabilities responsive to both the larger company profile and the increasing complexity of information technology management, and (iii) increases in certain core processing fees as our customer base and transaction volume continue to grow.
FDIC assessment expense was $1,097,000 for the six months ended June 30, 2022, an increase of $194,000 compared to $903,000 for the six months ended June 30, 2021. As a result of the Riverview acquisition and organic growth, the increased FDIC assessment aligns with the year-over-year growth of the average assets of the Bank on which the assessment is based.
Legal and professional fees were $1,333,000 for the six months ended June 30, 2022, an increase of $352,000 compared to $981,000 for the six months ended June 30, 2021, with this increase being attributable to consulting expenses related to personnel arrangements facilitating the assimilation of Riverview. Additionally, fees were incurred for expanded loan review coverage and software consulting services in the compliance area.
Charitable contributions qualifying for state tax credits were $190,000 for the six months ended June 30, 2022, compared to $635,000 for the same six-month period during 2021. Mid Penn continues to maximize the amount of contributions qualifying for state credits that can be made during 2022 and makes qualifying contributions, as allowable.
Intangible amortization increased from $557,000 during the first half of 2021 to $1,002,000 during the first half of 2022 as a result of the customer list and core deposit intangible assets added from the Riverview acquisition.
Merger and acquisition expenses were $522,000 during the first half of 2021 prior to the completion of the Riverview acquisition. During the first six months of 2022, post-acquisition restructuring expenses were $329,000 and primarily consisted of contract termination fees related to the Riverview acquisition.
Other expenses increased $4,666,000 from $5,808,000 during the six months ended June 30, 2021, to $10,474,000 for the same period in 2022. Several categories within other expense experienced increases as a result of the Riverview acquisition and organic growth, including Pennsylvania Bank Shares taxes, marketing, telephone, postage, courier, ATM and card processing, payroll processing, employee travel costs, and director fees. In addition, the six months ended June 30, 2022, contained an impaired asset write-off of $664,000, representing the disposal of certain fixed assets and leasehold improvements from Riverview offices not being retained.
Income Taxes
The provision for income taxes was $5,336,000 during the six months ended June 30, 2022, compared to $4,477,000 of income tax provision recorded for the same period in 2021. The provision for income taxes for the six months ended June 30, 2022, reflects a combined Federal and State effective tax rate of 18.4% compared to 19.1% for the six months ended June 30, 2021. The decrease in the effective tax rate reflects (i) higher tax-exempt interest recognized due to an increase in tax-exempt securities being held in the investment security portfolio when compared to the prior year, and (ii) the favorable treatment of the increase in cash surrender value on bank owned life insurance policies, which are nontaxable for federal tax purposes. Generally, Mid Penn’s effective tax rate is below the federal statutory rate due to earnings on tax-exempt loans, investments, and earnings from the cash surrender value of life insurance, as well as the impact of federal income tax credits, including those awarded from Mid Penn’s low-income housing investments. The realization of Mid Penn’s deferred tax assets is dependent on future earnings. Mid Penn currently anticipates that future earnings will be adequate to fully realize the currently recorded deferred tax assets.
Financial Condition
Mid Penn’s total assets were $4,310,163,000 as of June 30, 2022, reflecting a decrease of $379,262,000, or 8.1%, compared to total assets of $4,689,425,000 as of December 31, 2021. Included in total assets as of June 30, 2022 are $4,966,000 of PPP loans, net of deferred fees. Comparatively, as of December 31, 2021, Mid Penn had $111,286,000 of PPP loans outstanding, net of deferred fees.
Total loans and leases, net of unearned interest totaled $3,180,033,000 as of June 30, 2022, an increase of $75,637,000, or 2.4% since December 31, 2021. The growth occurred primarily within the commercial real estate loan portfolio. Core banking loans (a non-GAAP measure calculated as loans and leases, net of unearned interest less PPP loans outstanding) totaled $3,175,067,000 as of June 30, 2022, an increase of $181,957,000, or 6.1% since December 31, 2021. The growth in core banking loans occurred primarily within the commercial real estate loan portfolio. Please refer to the section included herein under the heading “Reconciliation of Non-GAAP Measures (Unaudited)” for a discussion of our use of non-GAAP adjusted financial information, which includes a table reconciling GAAP and non-GAAP adjusted financial measures for these and certain other periods ended from June 30, 2021 through June 30, 2022.
Total deposits decreased $299,429,000 or 7.5%, from $4,002,016,000 on December 31, 2021, to $3,702,587,000 at June 30, 2022. The decrease in total deposits since December 31, 2021 was attributable to the maturity of certificates of deposit, which have renewed into lower rates, migrated to other deposit or retail investment products, or exited the Bank.
Loans and Leases, net of unearned interest
Total loans and leases, net of unearned interest as of June 30, 2022 were $3,180,033,000 compared to $3,104,396,000 as of December 31, 2021. This increase was driven by organic loan growth within Mid Penn’s commercial real estate portfolio, net of PPP loan forgiveness.
17.3
20.0
57.5
53.7
11.8
12.0
9.4
10.4
3.7
3.6
0.3
0.5
100.0
Credit Quality, Credit Risk, and Allowance for Loan and Lease Losses
The allowance for loan and lease losses and the related loan and lease loss provision for the periods presented reflect Mid Penn’s continued application of the incurred loss method for estimating credit losses, as Mid Penn is not required to adopt CECL until January 1, 2023, and Mid Penn has not elected to early adopt CECL. PPP loans, both those disbursed in 2020 and those disbursed in 2021, are included in the commercial and industrial classification and, as the PPP loans are fully guaranteed by the SBA, no allowance for loan and lease losses was recorded against the $4,966,000 balance of PPP loans outstanding, net of deferred fees as of June 30, 2022.
For the six months ended June 30, 2022, Mid Penn had net recoveries of $54,000 compared to net loan charge-offs of $816,000 during the same period in 2021. Mid Penn may need to make future adjustments to the allowance and the provision for loan and lease losses if economic conditions or loan credit quality differs substantially from the assumptions used in making Mid Penn’s evaluation of the level of the allowance for loan and lease losses as compared to the balance of outstanding loans.
Changes in the allowance for the three and six months ended June 30, 2022 and 2021 are summarized as follows:
Balance, beginning of period
Loans charged off during period
Recoveries of loans previously charged off
Net recoveries (charge-offs)
(816
Balance, end of period
Ratio of net loan (recoveries) charge-offs to average loans outstanding (annualized)
-0.001
0.004
-0.003
0.060
Ratio of allowance for loan losses to net loans at end of period
0.53
Other than as described herein, Mid Penn does not believe there are any trends or events at this time that are reasonably expected to have a material impact on future results of operations, liquidity, or capital resources. Based on known information, Mid Penn believes that the effects of current and past economic conditions and other unfavorable business conditions may eventually impact some borrowers’ abilities to comply with their repayment terms. Accordingly, Mid Penn has adjusted its qualitative factors for economic and external conditions as part of its general component determination primarily in response to the current economic conditions. Mid Penn continues to monitor closely the financial strength of borrowers and the economic conditions impacting them.
Mid Penn does not ordinarily engage in practices which may be used to artificially shield certain borrowers from the negative economic or business cycle effects that may compromise their ability to repay. Mid Penn does not normally structure construction loans with interest reserve components. Mid Penn has not in the past performed any commercial real estate or other type of loan workouts whereby an existing loan was restructured into multiple new loans. Also, Mid Penn does not extend loans at maturity solely due to the existence of guarantees, without recognizing the credit as impaired. While the existence of a guarantee may be a mitigating factor in determining the proper level of allowance once impairment has been identified, the guarantee does not affect the impairment analysis.
The following table presents the change in nonperforming asset categories as of June 30, 2022, December 31, 2021, and June 30, 2021.
Nonperforming Assets:
Nonaccrual loans
8,233
Accruing troubled debt restructured loans
422
435
449
Total nonperforming loans
7,973
9,982
8,682
Foreclosed real estate
Total non-performing assets
8,042
8,693
Accruing loans 90 days or more past due
Total risk elements
10,497
Nonperforming loans as a % of total
loans outstanding
0.25
0.32
Nonperforming assets as a % of total
loans outstanding and other real estate
Ratio of allowance for loan losses
to nonperforming loans
211.66
146.23
169.50
In the table above, troubled debt restructured loans that are no longer accruing interest are included in nonaccrual loans.
Total nonperforming assets were $8,042,000 at June 30, 2022, a decrease compared to nonperforming assets of $10,497,000 and $8,693,000 at December 31, 2021 and at June 30, 2021, respectively. The decrease in nonperforming assets since December 31, 2021 was primarily the result of the successful workout of two nonaccrual home equity loans amongst one relationship totaling $2,278,000 during the first quarter of 2022. The nonperforming assets included acquired impaired loans assumed in the Riverview transaction of $3,289,000 as of December 31, 2021. One nonaccrual relationship that was resolved during the first quarter is discussed in detail below.
During the first quarter of 2022, an unrelated party acquired the real estate collateral for an amount sufficient to completely payoff the contractual outstanding principal balance of a nonaccrual loan relationship, comprised of two home equity loans acquired in 2018, totaling $2,278,000. As of June 30, 2022, the outstanding principal, any interest due, and all fees were paid off entirely, with no charge-off related to this loan relationship. These loans were transferred from accrual to nonaccrual status during the second quarter of 2020.
Given this credit, nonperforming assets were 0.25% of the total of loans plus other real estate assets as of June 30, 2022, a favorable reduction compared to 0.32% and 0.35% at December 31, 2021 and June 30, 2021, respectively. Loan loss reserves as a percentage of nonperforming loans increased to 211.66% at June 30, 2022, compared to 146.23% and 169.5% at December 31, 2021 and June 30, 2021, respectively.
The contractual outstanding principal balance of one commercial real estate-construction loan relationship accounts for $1,221,000 of the nonperforming loan balance as of June 30, 2022. This loan was acquired in the Riverview transaction in November 2021 while in nonaccrual status. This loan is collateralized primarily by commercial real estate, and given that the fair value of the remaining collateral exceeds the outstanding principal balance, no specific allowance allocation has been currently assigned to this relationship. Management expects to recover the remaining outstanding balance through the sale of real estate collateral pledged in support of the loan.
Mid Penn assesses a specific allocation for both commercial loans and commercial real estate loans prior to writing down or charging off the loan. Once the write-down is taken, the remaining balance remains a nonperforming loan with the original terms and interest rate intact and is not treated as a restructured credit.
The following table provides additional analysis of partially charged-off loans.
Period ending total loans outstanding
Allowance for loan and lease losses
Nonperforming and impaired loans with partial charge-offs
129
Ratio of nonperforming loans with partial charge-offs
to total loans
0.000
to total nonperforming loans
1.62
1.07
Coverage ratio net of nonperforming loans with
partial charge-offs
215.15
147.82
Ratio of total allowance to total loans less
nonperforming loans with partial charge-offs
0.47
Mid Penn considers a commercial loan or commercial real estate loan to be impaired when it becomes 90 days or more past due and not well-secured or otherwise not probable for collection. This methodology assumes the borrower cannot or will not continue to make additional payments. At that time the loan would be considered collateral dependent as the discounted cash flow method indicates no operating income is available for evaluating the collateral position; therefore, most impaired loans are deemed to be collateral dependent.
Mid Penn evaluates loans for charge-off on a monthly basis. Policies that govern the recommendation for charge-off are unique to the type of loan being considered. Commercial loans rated as nonaccrual or lower will first have a collateral evaluation completed in accordance with the guidance on impaired loans. Once the collateral evaluation has been completed, a specific allocation of allowance is made based upon the results of the evaluation. The balance remains a nonperforming loan with the original terms and interest rate intact (not restructured). In the event the loan is unsecured, the loan would have been charged-off at the recognition of impairment. Commercial real estate loans rated as impaired will also have an initial collateral evaluation completed in accordance with the guidance on impaired loans. An updated real estate valuation is ordered, and the collateral evaluation is modified to reflect any variation in value. A specific allocation of allowance is made for any anticipated collateral shortfall. The balance remains a nonperforming loan with the original terms and interest rate intact (not restructured). The process of charge-off for residential mortgage loans begins upon a loan becoming delinquent for 90 days and not in the process of collection. The existing appraisal is reviewed, and a lien search is obtained to determine lien position and any instances of intervening liens. A new appraisal of the property will be ordered if deemed necessary by management and a collateral evaluation is completed. The loan will then be charged down to the value indicated in the evaluation. Consumer loans are recommended for charge-off after reaching delinquency of 90 days and the loan is not well-secured or otherwise not probable for collection. The collateral shortfall of the consumer loan is recommended for charge-off at this point.
As noted above, Mid Penn assesses a specific allocation for both commercial loans and commercial real estate loans. The balance remains a nonperforming loan with the original terms and interest rate intact (not restructured). In addition, Mid Penn takes a preemptive step when any commercial loan or commercial real estate loan becomes classified under its internal classification system. A preliminary collateral evaluation in accordance with the guidance on impaired loans is prepared using the existing collateral information in the loan file. This process allows Mid Penn to review both the credit and documentation files to determine the status of the information needed to make a collateral evaluation. This collateral evaluation is preliminary but allows Mid Penn to determine if any potential collateral shortfalls exist.
Larger groups of small-balance loans, such as residential mortgages and consumer installment loans, are collectively evaluated for impairment. Accordingly, individual consumer and residential loans are not separately identified for impairment disclosures unless such loans are the subject of a restructuring agreement.
Mid Penn’s rating system assumes any loans classified as substandard nonaccrual to be impaired, and most of these loans are considered collateral dependent; therefore, most of Mid Penn’s impaired loans, whether reporting a specific allocation or not, are considered collateral dependent.
It is Mid Penn’s policy to obtain updated third-party valuations on all impaired loans collateralized by real estate as soon as practically possible following the credit being classified as substandard nonaccrual. Prior to receipt of the updated real estate valuation Mid Penn will use any existing real estate valuation to determine any potential allowance issues; however, no allowance recommendation will be made until such time Mid Penn is in receipt of the updated valuation. The Asset Recovery department employs an electronic tracking system to monitor the receipt of and need for updated appraisals. To date, there have been no material time lapses noted with the above processes.
59
In some instances, Mid Penn is not holding real estate as collateral and is relying on business assets (personal property) for repayment. In these circumstances a collateral inspection is performed by Mid Penn personnel to determine an estimated value. The value is based on net book value, as provided by the financial statements, and discounted accordingly based on determinations made by management. Occasionally, Mid Penn will employ an outside service to provide a fair estimate of value based on auction or private sales. Management reviews the estimates of these third parties and discounts them accordingly based on management’s judgment, if deemed necessary.
For impaired loans with no valuation allowance required, Mid Penn’s practice of obtaining independent third-party market valuations on the subject property as soon as practically possible of being placed on nonaccrual status sometimes indicates that the loan to value ratio is sufficient to obviate the need for a specific allocation in spite of significant deterioration in real estate values in Mid Penn’s primary market area. These circumstances are determined on a case-by-case analysis of the impaired loans.
Mid Penn had loans with an aggregate balance of $8,726,000 which were deemed by management to be impaired at June 30, 2022, including $4,700,000 in loans acquired with credit deterioration in connection with the closing of the Phoenix acquisition in 2015, the Scottdale and First Priority acquisitions in 2018, and the Riverview acquisition in 2021. Of the $4,026,000 of impaired loan relationships excluding the loans acquired with credit deterioration, $507,000 were commercial and industrial relationships, $2,106,000 were commercial real estate relationships, $99,000 were home equity relationships, and $1,314,000 were residential relationships. There were specific loan loss reserve allocations of $892,000 against $1,469,000 of commercial real estate loan relationships and $118,000 of specific loan loss reserve allocations against $507,000 of commercial and industrial loan relationships. Management currently believes that the specific reserves are adequate to cover probable future losses related to these relationships.
The allowance is a reserve established in the form of a provision expense for loan and lease losses and is reduced by loan charge-offs net of recoveries. In conjunction with an internal loan review function that operates independently of the lending function, management monitors the loan portfolio to identify risk on a monthly basis so that an appropriate allowance is maintained. Based on an evaluation of the loan portfolio, management presents a monthly review of the allowance to the Board of Directors, indicating any changes in the allowance since the last review. In making the evaluation, management considers the results of recent regulatory examinations, which typically include a review of the allowance as an integral part of the examination process. As part of the examination process, federal or state regulatory agencies may require Mid Penn to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management.
In establishing the allowance, management evaluates on a quantitative basis individual classified loans and nonaccrual loans and determines an aggregate reserve for those loans based on that review. In addition, an allowance for the remainder of the loan and lease portfolio is determined based on historical loss experience within certain components of the portfolio. These allocations may be modified if current conditions indicate that loan and lease losses may differ from historical experience.
In addition, a portion of the allowance is established for losses inherent in the loan and lease portfolio which have not been identified by the quantitative processes described above. This determination inherently involves a higher degree of subjectivity and considers risk factors that may not have yet manifested themselves in historical loss experience. These factors include:
changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments (and the potential adverse impacts on the economy from the COVID-19 pandemic);
changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans;
changes in the value of underlying collateral for collateral-dependent loans;
changes in the experience, ability, and depth of lending management and other relevant staff;
changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses;
changes in the quality of the institution's loan review system;
changes in the nature and volume of the portfolio and in the terms of loans;
the effect of other external factors such as competition, legal and regulatory requirements, governmental restrictions impacting business activity as a result of the COVID-19 pandemic, and other factors beyond the control of Mid Penn which could affect the level of estimated credit losses in the institution's existing portfolio; and
the existence and effect of any concentrations of credit and changes in the level of such concentrations.
While the allowance is maintained at a level believed to be adequate by management to provide for probable losses inherent in the loan and lease portfolio, determination of the allowance is inherently subjective, as it requires estimates, all of which may be susceptible to significant change. The unallocated component of the allowance for loan and lease losses covers several considerations that are not specifically measurable through either the specific or general components. For example, we believe that we could face increasing credit risks and uncertainties, not yet reflected in recent historical losses or qualitative factor assessments and underlying data and evaluations, associated with unpredictable changes in economic growth or business conditions in our markets or for certain industries in which we have commercial loan borrowers, or unanticipated stresses to the values of real estate held as collateral, including the prospective unknown impacts of the persisting COVID-19 pandemic and inflationary environment. Any or
all of these additional issues can adversely affect our borrowers’ ability to timely repay their loans. Additionally, we have experienced continued strong commercial loan growth, including growth in newer markets where we have less of a loss history. Also, the unallocated component allocation recognizes the inherent imprecision in our allowance for loan and lease loss methodology, or any alternative methodology, for estimating specific and general loan losses, including the unpredictable timing and amounts of charge-offs, the fact that historical loss averages don’t necessarily correlate to future loss trends, and unexpected changes to specific-credit or general portfolio future cash flows and collateral values which could negatively impact unimpaired portfolio loss factors. Changes from these various other uncertainties and considerations may impact the provisions charged to expense in future periods.
Management believes, based on information currently available, that the allowance for loan and lease losses of $16,876,000 is adequate as of June 30, 2022 to cover specifically identifiable loan losses, as well as estimated losses inherent in our portfolio for which certain losses are probable but not specifically identifiable.
Liquidity
Mid Penn’s objective is to maintain adequate liquidity to meet funding needs at a reasonable cost and to provide contingency plans to meet unanticipated funding needs or a loss of funding sources, while minimizing interest rate risk. Adequate liquidity provides resources for credit needs of borrowers, for depositor withdrawals, and for funding corporate operations. Sources of liquidity are as follows:
a growing core deposit base;
proceeds from the sale or maturity of investment securities;
payments received on loans and mortgage-backed securities;
overnight correspondent bank borrowings on various credit lines; and
borrowing capacity available from the FHLB and the Federal Reserve Discount Window available to Mid Penn.
Mid Penn believes its core deposits are generally stable even in periods of changing interest rates. Liquidity is measured and monitored daily, allowing management to better understand and react to balance sheet trends. These measurements indicate that liquidity generally remains stable and exceeds our minimum defined levels of adequacy. Other than the trends of continued competitive pressures and volatile interest rates, and the uncertain impact of the current inflationary environment, there are no known demands, commitments, events, or uncertainties that will result in, or that are reasonably likely to result in, liquidity increasing or decreasing in any material way.
On at least a quarterly basis, a comprehensive liquidity analysis is reviewed by the Asset Liability Committee and Board of Directors. The analysis provides a summary of the current liquidity measurements, projections, and future liquidity positions given various levels of liquidity stress. Management also maintains a detailed Contingency Funding Plan designed to respond to overall stress in the financial condition of the banking industry or a prospective liquidity problem specific to Mid Penn.
The consolidated statements of cash flows provide additional information. Mid Penn’s operating activities during the first six months of 2022 provided $19,441,000 of cash mainly due to net income, partially offset by other operating activities. Cash used in investing activities during the first six months of 2022 was $311,911,000, mainly the result of purchases of investment securities and the net increase in loans and leases. Cash used in financing activities during the first six months of 2022 totaled $384,496,000 primarily the result of a decrease in net deposits and long-term debt repayment.
As a result of the merger with Riverview, Mid Penn assumed the subordinated debentures that Riverview had assumed in its acquisition of CBT Financial Corp. (“CBT”) on October 1, 2017 (the “CBT 2017 Notes”). In 2003, a trust formed by CBT issued $5,155,000 of floating rate trust preferred securities as part of a pooled offering of such securities. The interest rate prior to Riverview entering into a fixed interest rate swap in 2020 adjusted quarterly to the three-month LIBOR rate plus 2.95%. CBT issued subordinated debentures to the trust in exchange for ownership of all of the common securities of the trust and the proceeds of the offering; the debentures represent the sole asset of the trust. CBT became eligible to redeem the subordinated debentures, in whole but not in part, beginning in 2008 at a price of 100% of face value. The subordinated debentures must be redeemed no later than 2033.
61
Similarly, in 2005, a trust formed by CBT issued $4,124,000 of fixed rate trust preferred securities as part of a pooled offering of such securities (the “CBT 2015 Notes”). CBT issued subordinated debentures to the trust in exchange for ownership of all of the common securities of the trust and the proceeds of the offering; the debentures represent the sole asset of the trust. CBT became eligible to redeem the subordinated debentures, in whole but not in part, beginning in 2010 at a price of 100% of face value. Interest payments on the debentures may be deferred at any time at the election of Mid Penn for up to 20 consecutive quarterly periods. Interest on the debentures will accrue during the extension period, and all accrued principal and interest must be paid at the end of the extension period. During an extension period, Mid Penn may not declare or pay any dividends or distributions on, or redeem, purchase, acquire, or make a liquidation payment with respect to any of Mid Penn’s capital stock.
On December 22, 2020, Mid Penn Bancorp, Inc. entered into agreements for and sold, at 100% of their principal amount, an aggregate of $12,150,000 of its Subordinated Notes due December 2030 (the “December 2020 Notes”) on a private placement basis to accredited investors. The December 2020 Notes are treated as Tier 2 capital for regulatory capital purposes.
The 2017 Notes bear interest at a rate of 5.25% per year for the first five years and then float at the Wall Street Journal’s Prime Rate plus 0.50%, provided that the interest rate applicable to the outstanding principal balance will at no time be less than 5.0%. Interest is payable semi-annually in arrears on January 15 and July 15 of each year, beginning on July 15, 2018, for the first five years after issuance and will be payable quarterly in arrears thereafter on January 15, April 15, July 15, and October 15. The 2017 Notes will mature on January 1, 2028 and are redeemable in whole or in part, without premium or penalty, at any time on or after December 21, 2022, and prior to January 1, 2028. Additionally, Mid Penn may redeem the 2017 Notes in whole at any time, or in part from time to time, upon at least 30 days’ notice if: (i) a change or prospective change in law occurs
that could prevent Mid Penn from deducting interest payable on the 2017 Notes for U.S. federal income tax purposes; (ii) an event occurs that precludes the 2017 Notes from being recognized as Tier 2 capital for regulatory capital purposes; or (iii) Mid Penn becomes required to register as an investment company under the Investment Company Act of 1940, as amended. In the event of a redemption described in the previous sentence, Mid Penn will redeem the 2017 Notes at 100% of the principal amount of the 2017 Notes, plus accrued and unpaid interest thereon to but excluding the date of redemption.
The 2015 Notes paid interest at a rate of 5.15% per year for the first five years outstanding, including the three months ended June 30, 2020. Beginning January 1, 2021, the 2015 Notes bear interest at a floating rate based on the Wall Street Journal’s Prime Rate plus 0.50%, provided that the interest rate applicable to the outstanding principal balance will at no time be less than 4.0%. Interest is payable quarterly in arrears on January 1, April 1, July 1 and October 1 of each year, beginning on January 1, 2016. The 2015 Notes will mature on December 9, 2025 and are redeemable in whole or in part, without premium or penalty, at any time on or after December 9, 2020, and prior to December 9, 2025. Additionally, Mid Penn may redeem the 2015 Notes in whole at any time, or in part from time to time, upon at least 30 days’ notice if: (i) a change or prospective change in law occurs that could prevent Mid Penn from deducting interest payable on the 2015 Notes for U.S. federal income tax purposes; (ii) an event occurs that precludes the 2015 Notes from being recognized as Tier 2 capital for regulatory capital purposes; or (iii) Mid Penn becomes required to register as an investment company under the Investment Company Act of 1940, as amended, in each case at 100% of the principal amount of the 2015 Notes, plus accrued and unpaid interest thereon to but excluding the date of redemption.
Regulatory Capital Changes
In July 2013, the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The final rules implemented higher minimum capital requirements, added a new common equity Tier 1 capital requirement, and established criteria that instruments must meet to be considered common equity Tier 1 capital, additional Tier 1 capital or Tier 2 capital. Under the new rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity Tier 1 capital above its minimum risk-based capital requirements, which amount must be greater than 2.5% of total risk-weighted assets.
A summary of the payout restrictions based on the capital conservation buffer is as follows:
Capital Conservation Buffer
(as a % of risk-weighted assets)
Maximum Payout
(as a % of eligible retained income)
> 2.5%
No payout limitation applies
≤2.5% and >1.875%
60%
≤1.875% and >1.25%
40%
≤1.25% and >0.625%
20%
≤0.625%
0%
The final rules allowed community banks to make a one-time election not to include the additional components of accumulated other comprehensive income (“AOCI”) in regulatory capital and instead use the existing treatment under the general risk-based capital rules that excludes most AOCI components from regulatory capital. Mid Penn made the election not to include the additional components of AOCI in regulatory capital.
Consistent with the Dodd-Frank Act, the new rules replaced the ratings-based approach to securitization exposures, which is based on external credit ratings, with the simplified supervisory formula approach in order to determine the appropriate risk weights for these exposures. Alternatively, banking organizations may use the existing gross-ups approach to assign securitization exposures to a risk weight category or choose to assign such exposures a 1,250% risk weight.
Under the new rules, mortgage servicing assets and certain deferred tax assets are subject to stricter limitations than those applicable under the current general risk-based capital rule. The new rules also increase the risk weights for past-due loans, certain risk weights and credit conversion factors.
63
Mid Penn has implemented these changes in determining and reporting the regulatory ratios of Mid Penn and the Bank and has concluded that the new rules do not have a material adverse effect on Mid Penn’s financial condition.
Capital Resources
Shareholders' equity, or capital, is evaluated in relation to total assets and the risk associated with those assets, and the desire to collectively maintain and enhance shareholders’ value, and satisfactorily address regulatory capital requirements. Accordingly, capital management has been, and will continue to be, of paramount importance to Mid Penn.
Shareholders’ equity increased by $5,759,000, or 1.2%, from $490,076,000 as of December 31, 2021 to $495,832,000 as of June 30, 2022, primarily due to earnings of $23,606,000 partially offset by a decrease in the carrying value of the available-for-sale investment portfolio of $9,917,000, dividends declared of $6,384,000 and stock repurchases of $2,181,000. As previously announced, Mid Penn completed a public offering of 2,990,000 shares of common stock at a price of $25.00 per share in May 2021, with the aggregate gross proceeds of the offering totaling $74,750,000. The net proceeds of the offering after deducting the underwriting discount and offering expenses were $70,238,000. The additional shares issued on May 4, 2021 significantly impacted the weighted average number of shares outstanding used for the earnings per share calculation for the three and six months ended June 30, 2022 compared to the three and six months ended June 30, 2021.
Banks are evaluated for capital adequacy by regulatory supervisory agencies based on the ratio of capital to risk-weighted assets and total assets. The minimum capital to risk-weighted assets requirements, including the capital conservation buffers, which became effective for Mid Penn and the Bank on January 1, 2016 are illustrated below. At June 30, 2022, regulatory capital ratios for both Mid Penn and the Bank met the definition of a “well-capitalized” institution under the regulatory framework for prompt corrective action, and exceeded the minimum capital requirements under Basel III.
Mid Penn and Mid Penn Bank maintained the following regulatory capital levels, leverage ratios, and risk-based capital ratios as of June 30, 2022 and December 31, 2021:
Capital Adequacy
To Be Well-Capitalized
Minimum for
Under Prompt
Basel III Capital
Corrective
Actual
Adequacy (a)
Action Provisions
Ratio
Mid Penn Bancorp, Inc.
As of June 30, 2022:
Tier 1 Capital (to Average Assets)
392,961
9.0
174,184
4.0
N/A
Common Equity Tier 1 Capital (to Risk Weighted Assets)
383,682
11.5
233,414
7.0
Tier 1 Capital (to Risk Weighted Assets)
283,431
8.5
Total Capital (to Risk Weighted Assets)
471,627
14.1
350,121
10.5
Mid Penn Bank
427,342
9.8
174,048
217,560
5.0
12.8
233,130
216,478
6.5
283,086
266,434
8.0
444,292
13.3
349,695
333,043
10.0
As of December 31, 2021:
374,368
8.1
185,764
365,084
11.7
217,579
264,203
452,527
14.6
326,369
398,773
8.6
185,721
232,151
217,446
201,914
264,041
248,510
413,442
326,169
310,637
Minimum amounts and ratios include the full phase in of the capital conservation buffer of 2.5% required by the Basel III framework.
RECONCILIATION OF NON-GAAP MEASURES (Unaudited):
This Form 10-Q contains financial information determined by methods other than in accordance with GAAP. Mid Penn believes that reporting core banking loans is useful to investors as they reflect portfolio loans and related growth from traditional bank activities and excludes short-term or nonrecurring loans from special programs like the PPP. The ratio of the allowance for loan and lease losses to core banking loans is useful to investors as it highlights the true coverage ratio of the allowance excluding those loans that are 100% guaranteed by the SBA through the PPP and, therefore, do not require an allowance assessment. These non-GAAP disclosures have limitations as an analytical tool, should not be viewed as a substitute for financial measures determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of Mid Penn’s results and financial condition as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies. Management believes that this non-GAAP supplemental information will be helpful in understanding Mid Penn’s ongoing operating results. This supplemental presentation should not be construed as an inference that Mid Penn’s future results will be unaffected by similar adjustments to be determined in accordance with GAAP.
Core Banking Loans
June 30,
December 31,
Less: PPP loans, net of deferred fees
4,966
111,286
391,826
Core banking loans
3,175,067
2,993,110
2,103,366
Ratio of allowance for loan and lease losses to net loans at end of period
Ratio of allowance for loan and lease losses to non-PPP core banking loans at end of period
0.49
0.70
ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a financial institution, Mid Penn’s primary source of market risk is interest rate risk. Interest rate risk is the exposure to fluctuations in Mid Penn’s future earnings, earnings at risk, resulting from changes in interest rates. This exposure or sensitivity is a function of the repricing characteristics of Mid Penn's portfolio of assets and liabilities. Each asset and liability reprices either at maturity or during the life of the instrument. Interest rate sensitivity is measured as the difference between the volume of assets and liabilities that are subject to repricing in a future period of time.
The principal purpose of asset-liability management is to maximize current and future net interest income within acceptable levels of interest rate risk while satisfying liquidity and capital requirements. Net interest income is increased by increasing the net interest margin and by volume growth. Thus, the goal of interest rate risk management is to maintain a balance between risk and reward such that net interest income is maximized while risk is maintained at an acceptable level.
Mid Penn utilizes an asset-liability management model to measure the impact of interest rate movements on its interest rate sensitivity position. Mid Penn’s management also reviews the traditional maturity gap analysis regularly. Mid Penn does not always attempt to achieve an exact match between interest sensitive assets and liabilities because it believes that an actively managed amount of interest rate risk is inherent and appropriate in the management of Mid Penn’s profitability.
Modeling techniques and simulation analysis involve assumptions and estimates that inherently cannot be measured with complete precision. Key assumptions in the analyses include maturity and repricing characteristics of assets and liabilities, prepayments on amortizing assets, non-maturing deposit sensitivity, and loan and deposit pricing. These assumptions are inherently uncertain due to the timing, magnitude and frequency of rate changes and changes in market conditions and management strategies, among other factors. However, the analyses are useful in quantifying risk and provide a relative gauge of Mid Penn’s interest rate risk position over time.
Management reviews interest rate risk on a quarterly basis. This analysis includes earnings scenarios whereby interest rates are increased by 100, 200, 300 and 400 basis points and decreased by 100 basis points. These scenarios, detailed in the table below, indicate that Mid Penn would experience enhanced net interest income over a one-year time frame due to upward interest rate changes, while a reduction in interest rates would result in a decline in net interest income over a one-year time frame; however, actual results could vary significantly from the calculations prepared by management. At June 30, 2022, all interest rate risk levels according to the model were within the tolerance limits of the Board-approved policy.
% Change in
Change in
Net Interest
Policy
Basis Points
Income
Risk Limit
400
19.63%
≥ -30%
15.96%
≥ -25%
200
11.14%
≥ -20%
5.57%
≥ -15%
(100)
-5.96%
≥ -10%
ITEM 4 – CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Mid Penn maintains controls and procedures designed to ensure that information required to be disclosed in the reports that Mid Penn files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls and procedures as of June 30, 2022, Mid Penn’s management, with the participation of the Principal Executive Officer and Principal Financial Officer, concluded that the disclosure controls and procedures were effective as of such date.
Changes in Internal Controls
There were no changes in Mid Penn’s internal control over financial reporting that have materially affected, or are reasonable likely to materially affect, Mid Penn’s internal control over financial reporting during the six months ended June 30, 2022.
ITEM 1 – LEGAL PROCEEDINGS
Based on information currently available, management is not aware of any litigation that would reasonably be expected to have a material adverse effect on the consolidated financial position of Mid Penn or its subsidiaries taken as a whole. There are no proceedings pending other than ordinary routine litigation occurring in the normal course of business. In addition, management does not know of any material proceedings contemplated by governmental authorities against Mid Penn or any of its properties.
ITEM 1A – RISK FACTORS
Management has reviewed the risk factors that were previously disclosed in the Annual Report on Form 10-K for the fiscal year ended December 31, 2021, to determine if there were material changes applicable to the six months ended June 30, 2022. There are no material changes to such risk factors.
ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
Approximate Dollar
Total Number of Shares
Value of Shares That
Total Number
Purchased as Part of
May Yet Be
of Shares
Price
Publicly Announced
Purchased Under
Period
Purchased
Per Share
Plans or Programs
the Plans or Programs
April 1 - April 30, 2022
13,077,211
May 1 - May 31, 2022
40,600
26.39
12,005,777
June 1 - June 30, 2022
63,312
27.20
10,283,691
Mid Penn adopted a treasury stock repurchase program initially effective March 19, 2020, and the program remains available as it was extended through March 19, 2023 by Mid Penn’s Board of Directors on March 23, 2022. The treasury stock repurchase program authorizes the repurchase of up to $15,000,000 of Mid Penn’s outstanding common stock, which represented approximately 3.5% of the issued shares based on Mid Penn’s closing stock price and shares issued as of March 31, 2022. Under the program, Mid Penn may conduct repurchases of its common stock through open market transactions (which may be by means of a trading plan adopted under SEC Rule 10b5-1) or in privately negotiated transactions. Repurchases under the program are made at the discretion of management and are subject to market conditions and other factors. There is no guarantee as to the exact number of shares that Mid Penn may repurchase.
ITEM 3 – DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4 – MINE SAFETY DISCLOSURES
Not Applicable
ITEM 5 – OTHER INFORMATION
ITEM 6 – EXHIBITS
Exhibit 3(i) – The Registrant’s amended Articles of Incorporation (Incorporated by reference to Exhibit 3(i) to Registrant’s Quarterly Report on Form 10-Q filed for the quarterly period ended June 30, 2019).
Exhibit 3(ii) – The Registrant’s By-laws (Incorporated by reference to Exhibit 3.1 to Registrant’s Current Report on Form 8-K filed with the SEC on February 24, 2020.)
Exhibit 31.1 – Certification of Principal Executive Officer Pursuant to Exchange Act Rules 13a-14(a)/15d-14(a) as added by Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2 - Certification of Principal Financial Officer Pursuant to Exchange Act Rules 13a-14(a)/15d-14(a) as added by Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32 – Certification of Principal Executive Officer and Principal Financial Officer Pursuant to 18 U.S.C. Section 1350 as added by Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 101.SCH – Inline XBRL Taxonomy Extension Schema Document
Exhibit 101.CAL – Inline XBRL Taxonomy Extension Calculation Linkbase Document
Exhibit 101.DEF – Inline XBRL Taxonomy Extension Definition Linkbase Document
Exhibit 101.LAB – Inline XBRL Taxonomy Extension Label Linkbase Document
Exhibit 101.PRE – Inline XBRL Taxonomy Extension Presentation Linkbase Document
Exhibit 104 – Cover Page Interactive Data File (formatted in inline XBRL and contained in Exhibit 101)
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
By:
/s/ Rory G. Ritrievi
Rory G. Ritrievi
President and CEO
(Principal Executive Officer)
Date:
August 5, 2022
/s/ Allison S. Johnson
Allison S. Johnson
Chief Financial Officer
(Principal Financial Officer)