Item 2. Management’s Discussion and Analysis
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 September 30, 2022, compared to year-end 2021, and the Results of Operations for the three and nine months ended September 30, 2022, compared to the same periods in 2021. For comparative purposes, the September 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;
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• 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.
Riverview Acquisition
On November 30, 2021, Mid Penn announced the successful completion of the merger acquisition of Riverview Financial Corporation ("Riverview Acquisition"). 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.
Results of Operations
Overview
Net income available to common shareholders was $15.5 million or $0.97 per common share basic and diluted for the quarter ended September 30, 2022, compared to net income of $9.8 million or $0.86 per common share basic and diluted for the quarter ended September 30, 2021. During the nine months ended September 30, 2022, net income available to common shareholders was $39.1 million or $2.45 per common share basic and diluted compared to net income of $28.7 million or $2.85 per common share basic and diluted for the nine months ended September 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):
Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
Return on average assets 1.42 % 1.11 % 1.16 % 1.14 %
Return on average equity 12.23 % 11.23 % 10.52 % 12.55 %
Net Interest Income
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.
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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 September 30, 2022 and 2021.
Average Balances, Income and Interest Rates on a Taxable-Equivalent Basis
For the Three Months Ended
September 30, 2022 September 30, 2021
(Dollars in thousands) Average Balance Interest (1)
Yield/
Rate Average Balance Interest (1)
Yield/
Rate
ASSETS:
Interest Bearing Balances $ 5,583 $ 12 0.85 % $ 2,491 $ 1 0.16 %
Investment Securities:
Taxable 546,439 3,369 2.45 % 102,259 504 1.96 %
Tax-Exempt 80,008 496 2.46 % 56,037 353 2.50 %
Total Investment Securities 626,447 3,865 2.45 % 158,296 857 2.15 %
Federal Funds Sold 131,089 736 2.23 % 715,365 308 0.17 %
Loans and Leases, Net 3,237,587 38,573 4.73 % 2,422,378 29,660 4.86 %
Restricted Investment in Bank Stocks 4,322 13 1.19 % 7,148 58 3.22 %
Total Interest-earning Assets 4,005,028 43,199 4.28 % 3,305,678 30,884 3.71 %
Cash and Due from Banks 69,751 39,852
Other Assets 265,004 163,227
Total Assets $ 4,339,783 $ 3,508,757
LIABILITIES & SHAREHOLDERS' EQUITY:
Interest-bearing Demand $ 1,072,496 $ 873 0.32 % $ 681,171 $ 625 0.36 %
Money Market 994,446 1,097 0.44 % 854,065 864 0.40 %
Savings 352,024 43 0.05 % 208,163 60 0.11 %
Time 464,273 823 0.70 % 446,256 1,360 1.21 %
Total Interest-bearing Deposits 2,883,239 2,836 0.39 % 2,189,655 2,909 0.53 %
Short-term Borrowings — — 0.00 % 149,505 133 0.35 %
Long-term Debt 4,537 150 13.12 % 74,888 205 1.09 %
Subordinated Debt 69,523 611 3.49 % 44,596 499 4.44 %
Total Interest-bearing Liabilities 2,957,299 3,597 0.48 % 2,458,644 3,746 0.60 %
Noninterest-bearing Demand 843,419 681,230
Other Liabilities 36,983 23,067
Shareholders' Equity 502,082 345,816
Total Liabilities & Shareholders' Equity $ 4,339,783 $ 3,508,757
Net Interest Income (taxable-equivalent basis) $ 39,602 $ 27,138
Taxable Equivalent Adjustment (193) (144)
Net Interest Income $ 39,409 $ 26,994
Total Yield on Earning Assets 4.28 % 3.71 %
Rate on Supporting Liabilities 0.48 % 0.60 %
Average Interest Spread 3.80 % 3.10 %
Net Interest Margin 3.92 % 3.26 %
(1) Presented on a fully taxable-equivalent basis using a 21% federal tax rate and statutory interest expense disallowances.
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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 September 30, 2022 in comparison to the same period in 2021:
Three months ended
September 30, 2022 vs. September 30, 2021
(Dollars in thousands on a Taxable-Equivalent Basis) Increase (decrease)
Volume Rate Net
INTEREST INCOME:
Interest Bearing Balances $ 1 $ 10 $ 11
Investment Securities:
Taxable 2,189 676 2,865
Tax-Exempt 151 (8) 143
Total Investment Securities 2,340 668 3,008
Federal Funds Sold (252) 680 428
Loans and Leases, Net 9,982 (1,069) 8,913
Restricted Investment Bank Stocks (23) (22) (45)
Total Interest Income 12,049 266 12,315
INTEREST EXPENSE:
Interest Bearing Deposits:
Interest Bearing Demand 359 (111) 248
Money Market 142 91 233
Savings 41 (58) (17)
Time 55 (592) (537)
Total Interest-Bearing Deposits 597 (670) (73)
Short-term Borrowings (133) — (133)
Long-term Debt (193) 138 (55)
Subordinated Debt 279 (167) 112
Total Interest Expense 551 (700) (149)
NET INTEREST INCOME $ 11,498 $ 966 $ 12,464
Mid Penn’s TE net interest margin for the three months ended September 30, 2022 was 3.92% compared to 3.26% for the three months ended September 30, 2021. TE net interest income was $39.6 million for the three months ended September 30, 2022, an increase of $12.5 million, or 45.9%, compared to the three months ended September 30, 2021. Average interest earning assets increased $699.4 million, or 21.16%, compared to the third quarter of 2021, primarily as a result of the Riverview Acquisition. This growth contributed $12.0 million to the increase in TE net interest income and higher yields on interest-earning assets contributed $266 thousand. The yield on interest earning assets increased 57 basis points ("bp") to 4.28%, for the third quarter of 2022 compared to 3.71% for the third quarter of 2021. The increase in the yield on interest-earning assets was the result of a combination of excess cash being re-deployed into higher yielding loans and investment securities and the increases in the federal fund rates during 2022. The Federal Reserve’s Federal Open Market Committee ("FOMC") has increased rates five times during the first nine months of 2022. Average investment securities increased $468.2 million and the yield on those investment securities increased 30 bp, contributing $2.3 million and $668 thousand, respectively, to the increase in interest income. Average loans and leases, net, increased $815.2 million, contributing $10.0 million to the increase in interest income, partially offset by a 13 bp decrease in the yield, or a $1.1 million decrease to interest income. The growth in the average loans and leases, net, balances was primarily due to the Riverview Acquisition. The lower yields on loans and leases, net, were the result of a decrease of $6.1 million in the recognition of Paycheck Protection Program ("PPP") loan processing fees generated as a result of Mid Penn’s participation in the PPP in the third quarter of 2022 compared to the same period 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 .
Interest expense decreased $149 thousand during the third quarter of 2022 compared to the third quarter of 2021. The rate of interest-bearing liabilities decreased from 0.60% for the third quarter of 2021 to 0.48% for the third 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 $551 thousand in interest expense due to the $498.7 million, or 20.3%, increase in interest-bearing liabilities compared to the same period of 2021.
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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 nine months ended September 30, 2022 and 2021:
Average Balances, Income and Interest Rates on a Taxable-Equivalent Basis
For the Nine Months Ended
September 30, 2022 September 30, 2021
(Dollars in thousands) Average Balance Interest (1)
Yield/
Rate Average Balance Interest (1)
Yield/
Rate
ASSETS:
Interest Bearing Balances $ 34,034 $ 33 0.13 % $ 1,729 $ 5 0.39 %
Investment Securities:
Taxable 479,611 7,930 2.21 % 91,379 1,319 1.93 %
Tax-Exempt 77,489 1,401 2.42 % 55,599 1,056 2.54 %
Total Investment Securities 557,100 9,331 2.24 % 146,978 2,375 2.16 %
Federal Funds Sold 415,528 1,786 0.57 % 503,652 485 0.13 %
Loans and Leases, Net 3,157,288 108,050 4.58 % 2,520,965 87,974 4.67 %
Restricted Investment in Bank Stocks 5,826 238 5.46 % 7,022 239 4.55 %
Total Interest-earning Assets 4,169,776 119,438 3.83 % 3,180,346 91,078 3.83 %
Cash and Due from Banks 62,369 36,213
Other Assets 267,309 162,189
Total Assets $ 4,499,454 $ 3,378,748
LIABILITIES & SHAREHOLDERS' EQUITY:
Interest-bearing Demand $ 1,049,569 $ 1,796 0.23 % $ 632,830 $ 1,782 0.38 %
Money Market 1,066,001 2,281 0.29 % 796,922 2,461 0.41 %
Savings 361,733 144 0.05 % 203,206 182 0.12 %
Time 524,013 2,928 0.75 % 431,009 4,366 1.35 %
Total Interest-bearing Deposits 3,001,316 7,149 0.32 % 2,063,967 8,791 0.57 %
Short-term Borrowings — — 0.00 % 205,697 539 0.35 %
Long-term Debt 29,715 541 2.43 % 74,975 613 1.09 %
Subordinated Debt 72,574 1,912 3.52 % 44,589 1,498 4.49 %
Total Interest-bearing Liabilities 3,103,605 9,602 0.41 % 2,389,228 11,441 0.64 %
Noninterest-bearing Demand 851,975 659,554
Other Liabilities 46,960 24,037
Shareholders' Equity 496,914 305,929
Total Liabilities & Shareholders' Equity $ 4,499,454 $ 3,378,748
Net Interest Income (taxable-equivalent basis) $ 109,836 $ 79,637
Taxable Equivalent Adjustment (580) (441)
Net Interest Income $ 109,256 $ 79,196
Total Yield on Earning Assets 3.83 % 3.83 %
Rate on Supporting Liabilities 0.41 % 0.64 %
Average Interest Spread 3.42 % 3.19 %
Net Interest Margin 3.52 % 3.35 %
(1) Presented on a fully taxable-equivalent basis using a 21% federal tax rate and statutory interest expense disallowances.
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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 nine months ended September 30, 2022 in comparison to the same period in 2021:
Nine months ended
September 30, 2022 vs. September 30, 2021
(Dollars in thousands on a Taxable-Equivalent Basis) Increase (decrease)
Volume Rate Net
INTEREST INCOME:
Interest Bearing Balances $ 93 $ (65) $ 28
Investment Securities:
Taxable 5,604 1,007 6,611
Tax-Exempt 416 (71) 345
Total Investment Securities 6,020 936 6,956
Federal Funds Sold (85) 1,386 1,301
Loans and Leases, Net 22,206 (2,130) 20,076
Restricted Investment Bank Stocks (41) 40 (1)
Total Interest Income 28,193 167 28,360
INTEREST EXPENSE:
Interest Bearing Deposits:
Interest Bearing Demand 1,174 (1,160) 14
Money Market 831 (1,011) (180)
Savings 142 (180) (38)
Time 942 (2,380) (1,438)
Total Interest-Bearing Deposits 3,089 (4,731) (1,642)
Short-term Borrowings (539) — (539)
Long-term Debt (370) 298 (72)
Subordinated Debt 940 (526) 414
Total Interest Expense 3,120 (4,959) (1,839)
NET INTEREST INCOME $ 25,074 $ 5,125 $ 30,199
Mid Penn’s TE net interest margin for the nine months ended September 30, 2022 was 3.52% and compared to 3.35% for the nine months ended September 30, 2021. TE net interest income was $109.8 million for the nine months ended September 30, 2022, an increase of $30.2 million, or 37.9%, compared to $79.6 million of TE net interest income for the nine months ended September 30, 2021. Average interest earning assets increased $989.4 million, or 31.1%, compared to the first nine months of 2021, primarily as a result of the Riverview Acquisition. This growth contributed $28.2 million to the increase in TE net interest income and higher yields on interest-earning assets contributed $167 thousand. The 3.83% yield on interest earning assets was consistent for the first nine months of 2022 compared to the same period of 2021. Average investment securities increased $410.1 million and the yield on those investment securities increased 8 bp, contributing $6.0 million and $936 thousand, respectively, to the increase in interest income. Average loans and leases, net, increased $636.3 million, contributing $22.2 million to the increase in interest income, partially offset by a 9 bp decrease in the yield, or a $2.1 million decrease to interest income. The growth in the average loans and leases, net, balances was primarily due to the Riverview Acquisition. The lower yields on loans and leases, net, were the result of a decrease of $11.6 million in the recognition of PPP loan processing fees generated as a result of Mid Penn’s participation in the PPP for the first nine months of 2022 compared to the same period of 2021.
Interest expense decreased $1.8 million during the first nine months of 2022 compared to the same period of 2021. The rate of interest-bearing liabilities decreased to 0.41% for the first nine months of 2022 from 0.64% for the first nine months of 2021. 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 $3.1 million in interest expense due to the $714.4 million, or 29.9%, increase in interest-bearing liabilities during the first nine months of 2022 compared to the same period of 2021.
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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 FOMC.
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 nine months of 2022, economic and external factor changes, and shifting collateral values from December 31, 2021 to September 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 $1.6 million and $425 thousand was recorded for the three months ended September 30, 2022 and 2021, respectively. During the nine months ended September 30, 2022, the provision for the loan and lease losses was $3.8 million compared to $2.6 million for the nine months ended September 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 $14.6 million at December 31, 2021 to $18.5 million at September 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 nine months ended September 30, 2022.
Noninterest Income
For the three months ended September 30, 2022, noninterest income totaled $6.0 million, an increase of $454 thousand or 8.2%, compared to noninterest income of $5.5 million for the same period in 2021. For the nine months ended September 30, 2022, noninterest income totaled $16.9 million, an increase of $1.1 million or 6.74%, compared to noninterest income of $15.9 million 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 for the three months ended September 30, 2022 as compared to the same period in 2021:
Three Months Ended September 30,
(Dollars in Thousands) 2022 2021 $ Variance % Variance
Income from fiduciary and wealth management activities $ 1,729 $ 618 $ 1,111 179.8 %
ATM debit card interchange income 1,078 630 448 71.1
Service charges on deposits 483 223 260 116.6
Mortgage banking income 536 3,162 (2,626) (83.0)
Mortgage hedging income 217 22 195 N/M
Net gain on sales of SBA loans 152 105 47 44.8
Earnings from cash surrender value of life insurance 250 74 176 N/M
Net gain on sales of investment activities — 79 (79) (100.0)
Other income 1,518 596 922 154.7
Total $ 5,963 $ 5,509 $ 454 8.2 %
N/M - Not Meaningful
Income from fiduciary and wealth management activities was $1.7 million for the three months ended September 30, 2022, an increase of $1.1 million compared to the three months ended September 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.
ATM debit card interchange income was $1.1 million for the three months ended September 30, 2022, an increase of $448 thousand compared to the three months ended September 30, 2021. The additional income is a result of an increased volume of checking accounts
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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.
Service charges on deposits were $483 thousand for the three months ended September 30, 2022, an increase of $260 thousand, compared to 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.
Mortgage banking income decreased $2.6 million for the three months ended September 30, 2022 to $536 thousand compared to the same period in 2021. Mortgage loan originations and secondary-market loan sales and gains slowed during the first nine months of 2022 as a result of increases in interest rates. 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 nine months of 2021.
Mortgage hedging income was $217 thousand for the three months ended September 30, 2022 compared to $22 thousand for the same period in 2021. The increase was the result of a hedging program related to mortgage derivative activities that Mid Penn did not participate in during the third quarter of 2021.
The following components of noninterest income showed significant changes for the nine months ended September 30, 2022 as compared to the same period in 2021:
Nine Months Ended September 30,
(Dollars in Thousands) 2022 2021 $ Variance % Variance
Income from fiduciary and wealth management activities $ 3,986 $ 1,716 $ 2,270 132.3 %
ATM debit card interchange income 3,263 1,854 1,409 76.0
Service charges on deposits 1,617 552 1,065 192.9
Mortgage banking income 1,370 8,382 (7,012) (83.7)
Mortgage hedging income 1,321 22 1,299 N/M
Net gain on sales of SBA loans 262 560 (298) (53.2)
Earnings from cash surrender value of life insurance 758 223 535 N/M
Net gain on sales of investment activities — 79 (79) (100.0)
Other income 4,366 2,485 1,881 75.7
Total $ 16,943 $ 15,873 $ 1,070 6.7 %
N/M - Not Meaningful
Income from fiduciary and wealth management activities was $4.0 million for the nine months ended September 30, 2022, an increase of $2.3 million compared to $1.7 million during the nine months ended September 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.
ATM debit card interchange income was $3.3 million for the nine months ended September 30, 2022, an increase of $1.4 million compared to the the nine months ended September 30, 2021. The additional income is a result of 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.
Service charges on deposits were $1.6 million for the nine months ended September 30, 2022, an increase of $1.1 million, compared to $552 thousand 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.
Mortgage banking income was $1.4 million for the nine months ended September 30, 2022, a decrease of $7.0 million, compared to the $8.4 million of mortgage banking income for the nine months ended September 30, 2021. Mortgage loan originations and secondary-market loan sales and gains slowed during the first nine months of 2022 as a result of increases in interest rates. As a result of 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 nine months of 2021.
Mortgage hedging income was $1.3 million for the nine months ended September 30, 2022 compared to $22 thousand for the same period in 2021. The increase was the result of a hedging program related to mortgage derivative activities that Mid Penn did not participate in during the first nine months of 2021.
Earnings from cash surrender value of life insurance was $758 thousand for the nine months ended September 30, 2022, an increase of $535 thousand, compared to $223 thousand for the same period of 2021. The increase is a result of additional policies assumed in the Riverview Acquisition.
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Other income was $4.4 million for the nine months ended September 30, 2022, an increase of $1.9 million, compared to $2.5 million during the same period of 2021. Mid Penn experienced increases in other miscellaneous income amounts as a result of the Riverview Acquisition.
Noninterest Expense
For the three months ended September 30, 2022, noninterest expense totaled $24.7 million, an increase of $4.7 million, or 23.46%, compared to noninterest expense of $20.0 million for the same period in 2021. For the nine months ended September 30, 2022, noninterest expense totaled $74.4 million, an increase of $17.3 million, or 30.41%, compared to noninterest expense of $57.0 million 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.:
Three Months Ended September 30,
(Dollars in Thousands) 2022 2021 $ Variance % Variance
Salaries and employee benefits $ 13,583 $ 10,342 $ 3,241 31.3 %
Software licensing and utilization 1,804 1,551 253 16.3
Occupancy expense, net 1,634 1,318 316 24.0
Equipment expense 1,121 745 376 50.5
Shares tax 920 498 422 84.8
ATM/card processing 518 249 269 108.0
Intangible amortization 514 266 248 93.2
Mortgage banking profit-sharing expense — 1,140 (1,140) (100.0)
Merger and acquisition expense — 198 (198) (100.0)
Other expenses 3,896 2,648 1,248 47.1
Salaries and employee benefits were $13.6 million for the three months ended September 30, 2022, an increase of $3.2 million versus the same period in 2021, with the increase attributable to the retail staff additions at the seven retail locations added through the Riverview Acquisition and the addition of wealth management professionals, commercial lending professionals, and other staff additions in alignment with Mid Penn’s core banking and non-banking growth initiatives.
Software licensing and utilization costs were $1.8 million for the three months ended September 30, 2022, an increase of $253 thousand compared to $1.6 million for the three months ended September 30, 2021. The increase is a result of additional costs to license the additional Riverview branches and increases in certain core processing fees as our customer base and transaction volume continue to grow.
Occupancy expenses increased $316 thousand during the three months ended September 30, 2022 compared to the same period in 2021. Similarly, equipment expense increased $376 thousand during the three months ended September 30, 2022, compared to the three months ended September 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.
Shares tax totaled $920 thousand for the three months ended September 30, 2022, a $422 thousand increase compared to the same period in 2021 due to the increase in shareholders' equity, primarily a result of the Riverview Acquisition.
ATM/card processing increased from $249 thousand during the three months ended September 30, 2021 to $518 thousand during the three months ended September 30, 2022 as a result of an increase in transaction volume resulting from the accounts assumed in the Riverview Acquisition.
Intangible amortization increased to $514 thousand during the three months ended September 30, 2022 from $266 thousand during the same period of 2021 as a result of the customer list and core deposit intangible assets added from the Riverview Acquisition.
Mortgage banking profit-sharing was $1.1 million during the three months ended September 30, 2021 compared to zero in the current period and is reflective of the decrease in mortgage banking income between the two periods.
Merger and acquisition expenses were $198 thousand during the three months ended September 30, 2021 and consisted of legal and professional fees associated withe the Riverview Acquisition.
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Other expenses increased $1.2 million from $2.6 million during the three months ended September 30, 2021, to $3.9 million for the same period in 2022. Several categories within other expense experienced increases as a result of the Riverview Acquisition and organic growth, including marketing, telephone, postage, courier, payroll processing, employee travel costs, and director fees.
Nine Months Ended September 30,
(Dollars in Thousands) 2022 2021 $ Variance % Variance
Salaries and employee benefits $ 39,167 $ 29,873 $ 9,294 31.1 %
Software licensing and utilization 5,731 4,493 1,238 27.6
Occupancy expense, net 5,088 4,115 973 23.6
Equipment expense 3,244 2,237 1,007 45.0
Shares tax 2,626 1,022 1,604 156.9
ATM/card processing 1,605 696 909 130.6
Intangible amortization 1,516 823 693 84.2
Mortgage banking profit-sharing expense 178 2,005 (1,827) (91.1)
Merger and acquisition expense — 720 (720) (100.0)
Post-acquisition restructuring expense 329 — 329 —
Other expenses 11,577 7,485 4,092 54.7
Salaries and employee benefits were $39.2 million for the nine months ended September 30, 2022, an increase of $9.3 million versus the same period in 2021, with the increase attributable to the retail staff additions at the seven retail locations added through the Riverview Acquisition, the retention of various Riverview team members through the completion of the systems integration, which occurred on March 4, 2022, and the addition of wealth management professionals, commercial lending professionals, and other staff additions in alignment with Mid Penn’s core banking and non-banking growth initiatives.
Software licensing and utilization costs were $5.7 million for the nine months ended September 30, 2022, an increase of $1.2 million compared to $4.5 million for the nine months ended September 30, 2021. The increase is a result of additional costs to license the additional Riverview branches, 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 increases in certain core processing fees as our customer base and transaction volume continue to grow.
Occupancy expenses increased $1.0 million during the first nine months of 2022 compared to the same period in 2021. Similarly, equipment expense increased $1.0 million during the nine months ended September 30, 2022, compared to the nine months ended September 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.
Shares tax totaled $2.6 million for nine months ended September 30, 2022, a $1.6 million increase compared to the same period in 2021 due to the increase in shareholders' equity, primarily a result of a stock offering completed in 2021 and the Riverview Acquisition.
ATM/card processing expenses were $1.6 million for the nine months ended September 30, 2022, an increase of $909 thousand as a result of an increase in transaction volume resulting from the accounts assumed in the Riverview Acquisition.
Intangible amortization increased from $823 thousand during the first nine months of 2021 to $1.5 million during the same period of 2022 as a result of the customer list and core deposit intangible assets added from the Riverview Acquisition.
Merger and acquisition expenses were $720 thousand during the first nine months of 2021 prior to the completion of the Riverview Acquisition. During the first nine months of 2022, post-acquisition restructuring expenses were $329 thousand and primarily consisted of contract termination fees related to the Riverview Acquisition.
Other expenses increased $4.1 million from $7.5 million during the nine months ended September 30, 2021, to $11.6 million for the same period in 2022. Several categories within other expense experienced increases as a result of the Riverview Acquisition and organic growth, including marketing, telephone, postage, courier, payroll processing, employee travel costs, and director fees. In addition, the nine months ended September 30, 2022 contained an impaired asset write-off of $664 thousand, representing the disposal of certain fixed assets and leasehold improvements from Riverview offices not being retained.
Income Taxes
The provision for income taxes was $3.6 million for the three months ended September 30, 2022, compared to $2.3 million of income tax provision recorded for the same period in 2021. The provision for income taxes was $9.0 million during the nine months ended
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September 30, 2022, compared to $6.7 million of income tax provision recorded for the same period in 2021. The provision for income taxes for the three and nine months ended September 30, 2022, reflects a combined Federal and State effective tax rate of 19.0% and 18.7%, respectively, compared to 18.8% and 19.0% for the three and nine months ended September 30, 2021, respectively. The change in the effective tax rates reflect the mix of 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 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
Overview
Mid Penn’s total assets were $4.3 billion as of September 30, 2022, reflecting a decrease of $355.5 million, or 7.58%, compared to total assets of $4.7 billion as of December 31, 2021. Included in total assets as of September 30, 2022 are $2.8 million of PPP loans, net of deferred fees. Comparatively, as of December 31, 2021, Mid Penn had $111.3 million of PPP loans outstanding, net of deferred fees.
Total loans and leases, net of unearned interest, totaled $3.3 billion as of September 30, 2022, an increase of $218.1 million, or 7.0% 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 $3.3 billion as of September 30, 2022, an increase of $326.5 million, or 10.9% 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 September 30, 2021 through September 30, 2022.
Total deposits decreased $272.4 million or 6.81%, from $4.0 billion on December 31, 2021, to $3.7 billion at September 30, 2022. The decrease in total deposits since December 31, 2021 was primarily attributable to the maturity of certificates of deposit, which have renewed into lower rates, migrated to other retail investment products, or exited the Bank.
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Investment Securities
Total investment securities as of September 30, 2022 were $644.3 million compared to $392.1 million as of December 31, 2021.
September 30, 2022 December 31, 2022 $ Variance % Variance
(Dollars in thousands)
Available-for-sale debt securities:
U.S. Treasury and U.S. government agencies $ 37,584 $ — $ 37,584 N/M
Mortgage-backed U.S. government agencies 168,204 49,480 118,724 239.9 %
State and political subdivision obligations 3,374 3,914 (540) (13.8) %
Corporate debt securities 33,033 9,468 23,565 248.9 %
Total available-for-sale debt securities 242,195 62,862 179,333 125,724
Held-to-maturity debt securities:
U.S. Treasury and U.S. government agencies $ 245,638 $ 178,136 $ 67,502 37.9 %
Mortgage-backed U.S. government agencies 52,788 61,157 (8,369) (13.7) %
State and political subdivision obligations 87,724 75,958 11,766 15.5 %
Corporate debt securities 15,992 14,006 1,986 14.2 %
Total held-to-maturity debt securities 402,142 329,257 72,885 22.1 %
Total $ 644,337 $ 392,119 $ 252,218 64.3 %
N/M - Not Meaningful
The $252.2 million increase in the investment securities portfolio is the result of excess cash being re-deployed into higher yielding loans and investment securities during the nine months ended September 30, 2022.
Loans and Leases, net of unearned interest
Total loans and leases, net of unearned interest, as of September 30, 2022 were $3.3 billion compared to $3.1 billion 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.
September 30, 2022 December 31, 2021
(Dollars in thousands) Amount % Amount %
Commercial and industrial $ 556,796 16.8 % $ 619,562 20.0 %
Commercial real estate 1,944,802 58.6 % 1,668,142 53.5 %
Commercial real estate - construction 400,188 12.0 % 372,734 12.0 %
Residential mortgage 296,910 8.9 % 323,223 10.4 %
Home equity 115,608 3.5 % 110,306 3.6 %
Consumer 8,153 0.2 % 10,429 0.5 %
$ 3,322,457 100.0 % $ 3,104,396 100.0 %
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 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 $2.8 million balance of PPP loans outstanding, net of deferred fees, as of September 30, 2022.
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Changes in the allowance for the three and nine months ended September 30, 2022 and 2021 are summarized as follows:
Three Months Ended September 30, Nine Months Ended September 30,
(Dollars in thousands) 2022 2021 2022 2021
Balance, beginning of period $ 16,876 $ 14,716 $ 14,597 $ 13,382
Loans charged off during period (15) (1,057) (81) (1,961)
Recoveries of loans previously charged off 69 149 189 237
Net recoveries (charge-offs) 54 (908) 108 (1,724)
Provision for loan and lease losses 1,550 425 3,775 2,575
Balance, end of period $ 18,480 $ 14,233 $ 18,480 $ 14,233
Ratio of net loan (recoveries) charge-offs to average loans outstanding (annualized) -0.007 % 0.149 % -0.005 % 0.091 %
Ratio of allowance for loan losses to net loans at end of period 0.56 % 0.60 % 0.56 % 0.60 %
For the three and nine months ended September 30, 2022, Mid Penn had net recoveries of $54 thousand and $108 thousand, respectively, compared to net loan charge-offs of $908 thousand and $1.7 million, respectively during the same periods 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.
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 closely monitor 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.
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The following table presents the change in nonperforming asset categories as of September 30, 2022, December 31, 2021, and September 30, 2021.
(Dollars in thousands) September 30, 2022 December 31, 2021 September 30, 2021
Nonperforming Assets:
Nonaccrual loans $ 7,233 $ 9,547 $ 6,339
Accruing troubled debt restructured loans 396 435 442
Total nonperforming loans 7,629 9,982 6,781
Foreclosed real estate 49 — 11
Total non-performing assets 7,678 9,982 6,792
Accruing loans 90 days or more past due 633 515 —
Total risk elements $ 8,311 $ 10,497 $ 6,792
Nonperforming loans as a % of total
loans outstanding 0.23 % 0.32 % 0.29 %
Nonperforming assets as a % of total
loans outstanding and other real estate 0.23 % 0.32 % 0.29 %
Ratio of allowance for loan losses
to nonperforming loans 242.23 % 146.23 % 209.90 %
In the table above, troubled debt restructured loans that are no longer accruing interest are included in nonaccrual loans.
Total nonperforming assets were $7.7 million at September 30, 2022, a decrease compared to nonperforming assets of $10.0 million at December 31, 2021. 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 $2.3 million during the first quarter of 2022. The nonperforming assets included acquired impaired loans assumed in the Riverview Acquisition of $3.3 million 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 $2.3 million. As of September 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 0.23% of the total of loans plus other real estate assets as of September 30, 2022, a favorable reduction compared to 0.32% and 0.29% at December 31, 2021 and September 30, 2021, respectively. Loan loss reserves as a percentage of nonperforming loans increased to 242.23% at September 30, 2022, compared to 146.23% and 209.90% at December 31, 2021 and September 30, 2021, respectively.
The contractual outstanding principal balance of one commercial real estate-construction loan relationship accounts for $1.2 million of the nonperforming loan balance as of September 30, 2022. This loan was acquired in the Riverview Acquisition 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 currently been 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.
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The following table provides additional analysis of partially charged-off loans.
(Dollars in thousands) September 30, 2022 December 31, 2021
Period ending total loans outstanding $ 3,322,457 $ 3,104,396
Allowance for loan and lease losses 18,480 14,597
Total nonperforming loans 7,629 9,982
Nonperforming and impaired loans with partial charge-offs 102 107
Ratio of nonperforming loans with partial charge-offs to total loans 0.003 % 0.003 %
Ratio of nonperforming loans with partial charge-offs to total nonperforming loans 1.34 % 1.07 %
Coverage ratio net of nonperforming loans with partial charge-offs 245.52 % 147.82 %
Ratio of total allowance to total loans less nonperforming loans with partial charge-offs 0.56 % 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.
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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 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.
Mid Penn had loans with an aggregate balance of $7.5 million which were deemed by management to be impaired at September 30, 2022, including $3.8 million 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 $3.7 million of impaired loan relationships excluding the loans acquired with credit deterioration, $1.3 million were commercial and industrial relationships, $713 thousand were commercial real estate relationships, $1.4 million were residential relationships and $283 thousand were home equity relationships. There were specific loan loss reserve allocations of $831 thousand against $1.3 million of commercial and industrial loan relationships and $28 thousand against $112 thousand of commercial real estate 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
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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 may not 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 $18.5 million is adequate as of September 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 nine months ended September 30, 2022 provided $41.6 million of cash, mainly due to net income. Cash used in investing activities during the first nine months ended September 30, 2022 was $492.5 million, mainly the result of purchases of investment securities and the net increase in loans and leases. Cash used in financing activities during the first nine months ended September 30, 2022 totaled $368.2 million, primarily the result of a decrease in net deposits and long-term debt repayment and subordinated debt redemption.
Subordinated Debt Redemption
On August 8, 2022, Mid Penn redeemed the $7.5 million aggregate principal amount of subordinated notes (the "2015 Notes") that were due in 2025. Given that the 2015 Notes were in the seventh year since issuance, only sixty percent of the principal balance of the notes would have been treated as Tier 2 capital for regulatory capital purposes as of the date of redemption. See "Note 11 - Subordinated Debt and Trust Preferred Securities," in the Notes to Consolidated Financial Statements for additional information.
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.
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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, these 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 these 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.
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 $9.0 million, or 1.8%, from $490.1 million as of December 31, 2021 to $499.1 million as of September 30, 2022, primarily due to earnings of $39.1 million partially offset by a decrease in the carrying value of the available-for-sale investment portfolio of $19.3 million, dividends declared of $9.6 million and stock repurchases of $3.0 million. 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 nine months ended September 30, 2022 compared to the nine months ended September 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 September 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.
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Mid Penn and Mid Penn Bank maintained the following regulatory capital levels, leverage ratios, and risk-based capital ratios as of September 30, 2022 and December 31, 2021:
Capital Adequacy
(Dollars in thousands) Actual Minimum for
Basel III Capital
Adequacy (1)
To Be Well-Capitalized
Under Prompt
Corrective
Action Provisions
Amount Ratio Amount Ratio Amount Ratio
Mid Penn Bancorp, Inc.
As of September 30, 2022
Tier 1 Capital (to Average Assets) $ 406,114 9.6 % $ 169,240 4.0 % N/A N/A
Common Equity Tier 1 Capital (to Risk Weighted Assets) 396,835 11.4 % 243,964 7.0 % N/A N/A
Tier 1 Capital (to Risk Weighted Assets) 406,114 11.7 % 296,242 8.5 % N/A N/A
Total Capital (to Risk Weighted Assets) 481,748 13.8 % 365,946 10.5 % N/A N/A
Mid Penn Bank
As of September 30, 2022
Tier 1 Capital (to Average Assets) $ 444,871 10.5 % $ 169,095 4.0 % $ 211,369 5.0 %
Common Equity Tier 1 Capital (to Risk Weighted Assets) 444,871 13.3 % 234,361 7.0 % 217,621 6.5 %
Tier 1 Capital (to Risk Weighted Assets) 444,871 13.3 % 284,581 8.5 % 267,841 8.0 %
Total Capital (to Risk Weighted Assets) 463,427 13.8 % 351,542 10.5 % 334,802 10.0 %
Mid Penn Bancorp, Inc.
As of December 31, 2021
Tier 1 Capital (to Average Assets) $ 374,368 8.1 % $ 185,764 4.0 % N/A N/A
Common Equity Tier 1 Capital (to Risk Weighted Assets) 365,084 11.7 % 217,579 7.0 % N/A N/A
Tier 1 Capital (to Risk Weighted Assets) 374,368 12.0 % 264,203 8.5 % N/A N/A
Total Capital (to Risk Weighted Assets) 452,527 14.6 % 326,369 10.5 % N/A N/A
Mid Penn Bank
As of December 31, 2021
Tier 1 Capital (to Average Assets) $ 398,773 8.6 % $ 185,721 4.0 % $ 232,151 5.0 %
Common Equity Tier 1 Capital (to Risk Weighted Assets) 398,773 12.8 % 217,446 7.0 % 201,914 6.5 %
Tier 1 Capital (to Risk Weighted Assets) 398,773 12.8 % 264,041 8.5 % 248,510 8.0 %
Total Capital (to Risk Weighted Assets) 413,442 13.3 % 326,169 10.5 % 310,637 10.0 %
(1) 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%
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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
(Dollars in thousands) September 30,
2022 December 31,
2021 September 30,
2021
Loans and leases, net of unearned interest $ 3,322,457 $ 3,104,396 $ 2,370,429
Less: PPP loans, net of deferred fees 2,800 111,286 229,679
Core banking loans $ 3,319,657 $ 2,993,110 $ 2,140,750
Allowance for loan and lease losses $ 18,480 $ 14,597 $ 14,233
Ratio of allowance for loan and lease losses to net loans at end of period 0.56 % 0.47 % 0.60 %
Ratio of allowance for loan and lease losses to non-PPP core banking loans at end of period 0.56 % 0.49 % 0.66 %
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.