Loans and Allowance for Credit Losses - Loans | Loans and Allowance for Credit Losses - Loans Mid Penn adopted the amendments of FASB ASU 2016-13, on January 1, 2023. The amendments of ASU 2016-13 created FASB ASC Topic 326, "Financial Instruments – Credit Losses," which, among other things, replace much of the guidance and disclosures previously provided in FASB ASC Topic 310, "Receivables." The guidance in FASB ASC Topic 326 replaces the incurred loss methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to determine credit losses. In accordance with FASB ASC Subtopic 326-20, "Financial Instruments – Credit Losses – Measured at Amortized Cost," Mid Penn has developed an ACL methodology effective January 1, 2023, which replaces its previous allowance for loan losses methodology. See the section captioned "Allowance for Credit Losses, effective January 1, 2023" within this note for additional information regarding Mid Penn’s ACL. Mid Penn adopted FASB ASC Topic 326 using the modified retrospective approach prescribed by the amendments of ASU 2016-13; therefore, prior period balances are presented under legacy GAAP and may not be comparable to current period presentation. Loans, net of unearned income, are summarized as follows by portfolio segment: (In thousands) September 30, 2023 December 31, 2022 Commercial real estate (1) $ 2,288,396 $ 2,052,934 Commercial and industrial 648,439 596,042 Construction 462,215 441,246 Residential mortgage (1) 743,533 416,221 Consumer 3,074 7,676 Total loans $ 4,145,657 $ 3,514,119 (1) In accordance with the guidance in FASB ASC Topic 326, Mid Penn redefined its loan portfolio segments and related loan classes based on the level at which risk is monitored within the ACL methodology. As such, $181.9 million of loans were reclassified from Commercial real estate to Residential mortgage upon adoption of CECL on January 1, 2023. Prior periods were not reclassified. Total loans are stated at the amount of unpaid principal, adjusted for net deferred fees and costs. Net deferred loan fees of $3.9 million reduced the carrying value of loans as of September 30, 2023 and December 31, 2022, respectively. Accrued interest receivable is not included in the amortized cost basis of Mid Penn's loans. At September 30, 2023, accrued interest receivable for loans totaled $20.4 million with no related ACL and was reported in other assets on the accompanying Consolidated Balance Sheet. Past Due and Nonaccrual Loans 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 September 30, 2023 and December 31, 2022, are summarized as follows: (In thousands) 30-59 60-89 Greater Total Past Current Total Loans Loans September 30, 2023 Commercial real estate $ 8,355 $ — $ 3,006 $ 11,361 $ 2,277,035 $ 2,288,396 $ — Commercial and industrial 232 — 1,533 1,765 646,674 648,439 — Construction 472 — 2,256 2,728 459,487 462,215 — Residential mortgage 4,068 233 1,675 5,976 737,557 743,533 9 Consumer — — 3 3 3,071 3,074 3 Total $ 13,127 $ 233 $ 8,473 $ 21,833 $ 4,123,824 $ 4,145,657 $ 12 (In thousands) 30-59 60-89 Greater Total Past Current Total Loans Loans December 31, 2022 Commercial real estate $ 1,792 $ — $ 1,438 $ 3,230 $ 2,047,167 $ 2,050,397 $ — Commercial and industrial 1,808 3 1,854 3,665 592,377 596,042 654 Construction 2,258 — — 2,258 438,988 441,246 — Residential mortgage 3,826 955 670 5,451 409,630 415,081 — Consumer 44 19 — 63 7,613 7,676 — Loans acquired with credit deterioration: Commercial real estate 78 — 826 904 1,633 2,537 — Commercial and industrial — — — — — — — Construction — — — — — — — Residential mortgage 223 228 241 692 448 1,140 — Consumer — — — — — — — Total $ 10,029 $ 1,205 $ 5,029 $ 16,263 $ 3,497,856 $ 3,514,119 $ 654 Loans are placed on nonaccrual status when management determines that the full repayment of principal and collection of interest according to contractual terms is no longer likely, generally when the loan becomes 90 days or more past due. Nonaccrual loans by loan portfolio class, including loans acquired with credit deterioration, as of September 30, 2023 and December 31, 2022 are summarized as follows: September 30, 2023 December 31, 2022 Non-accrual Loans Total non-accrual Loans (In thousands) With a Related Allowance Without a Related Allowance Total Commercial real estate $ 461 $ 6,228 $ 6,689 $ 4,864 Commercial and industrial 1,375 181 1,556 1,222 Construction — 2,256 2,256 — Residential mortgage 95 2,862 2,957 1,698 Consumer — — — 411 $ 1,931 $ 11,527 $ 13,458 $ 8,195 The amount of interest income recognized on nonaccrual loans was approximately $551 thousand and $221 thousand during the three months ended September 30, 2023 and 2022, respectively. During the nine months ended September 30, 2023 and 2022, the amount of interest income recognized on nonaccrual loans was approximately $1.0 million and $605 thousand, respectively. Credit Quality Indicators Mid Penn categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, such as current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. On a minimum of a quarterly basis, Mid Penn analyzes loans individually to classify the loans as to their credit risk. The following table presents risk ratings by loan portfolio segment and origination year, which is the year of origination or renewal. September 30, 2023 Term Loans Amortized Cost Basis by Origination Year Revolving Loans Amortized (In thousands) 2023 2022 2021 2020 2019 Prior Total Commercial real estate Pass $ 230,714 $ 555,982 $ 391,929 $ 303,897 $ 188,508 $ 545,699 $ 35,339 $ 2,252,068 Special mention 200 — 210 — — 16,825 190 17,425 Substandard or lower — 5,241 — 3,176 230 10,208 48 18,903 Total commercial real estate 230,914 561,223 392,139 307,073 188,738 572,732 35,577 2,288,396 Gross charge offs — — — — — (16) — (16) Net charge offs — — — — — (16) — (16) Commercial and industrial Pass 110,268 111,429 75,748 31,053 52,412 62,133 192,538 635,581 Special mention — 141 786 — — 2,652 5,055 8,634 Substandard or lower — 150 — — — 1,587 2,487 4,224 Total commercial and industrial 110,268 111,720 76,534 31,053 52,412 66,372 200,080 648,439 Gross charge offs — (100) — (111) — (9) — (220) Net charge offs — (100) — (111) — (9) — (220) Construction Pass 104,753 214,316 84,231 22,267 10,282 6,395 15,441 457,685 Special mention — 573 — 1,700 — — — 2,273 Substandard or lower — — — — — 2,257 — 2,257 Total construction 104,753 214,889 84,231 23,967 10,282 8,652 15,441 462,215 Residential mortgage Performing 129,139 132,888 87,794 93,336 28,454 184,398 84,569 740,578 Non-performing — — 37 226 — 2,692 — 2,955 Total residential mortgage 129,139 132,888 87,831 93,562 28,454 187,090 84,569 743,533 Gross charge offs — — — — — (4) — (4) Current period recoveries — — — — — 37 — 37 Net recoveries — — — — — 33 — 33 Consumer Performing 1,497 810 — — 98 380 289 3,074 Non-performing — — — — — — — — Total consumer 1,497 810 — — 98 380 289 3,074 Gross charge offs (70) — (8) (9) — (30) — (117) Current period recoveries 26 — — — — — — 26 Net charge offs (44) — (8) (9) — (30) — (91) Total Pass $ 445,735 $ 881,727 $ 551,908 $ 357,217 $ 251,202 $ 614,227 $ 243,318 $ 3,345,334 Special mention 200 714 996 1,700 — 19,477 5,245 28,332 Substandard or lower — 5,391 — 3,176 230 14,052 2,535 25,384 Performing 130,636 133,698 87,794 93,336 28,552 184,778 84,858 743,652 Nonperforming — — 37 226 — 2,692 — 2,955 Total $ 576,571 $ 1,021,530 $ 640,735 $ 455,655 $ 279,984 $ 835,226 $ 335,956 $ 4,145,657 Mid Penn had no loans classified as "doubtful" as of September 30, 2023 and December 31, 2022. Collateral-Dependent Loans A financial asset is considered to be collateral-dependent when the debtor is experiencing financial difficulty and repayment is expected to be provided substantially through the sale or operation of the collateral. For all classes of financial assets deemed collateral-dependent, Mid Penn elected the practical expedient to estimate expected credit losses based on the collateral’s fair value less cost to sell. In most cases, Mid Penn records a partial charge-off to reduce the loan’s carrying value to the collateral’s fair value less cost to sell. Substantially all of the collateral supporting collateral-dependent financial assets consists of various types of real estate, including residential properties; commercial properties such as retail centers, office buildings, and lodging; agriculture land; and vacant land. Allowance for Credit Losses, effective January 1, 2023 Mid Penn’s ACL - loans methodology is based upon guidance within FASB ASC Subtopic 326-20, as well as regulatory guidance from the FDIC, its primary federal regulator. The ACL - loans is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Credit quality within the loan portfolio is continuously monitored by management and is reflected within the ACL - loans. The ACL - loans is an estimate of expected losses inherent within Mid Penn’s existing loan portfolio. The ACL - loans is adjusted through the PCL and reduced by the charge off of loan amounts, net of recoveries. The loan loss estimation process involves procedures to appropriately consider the unique characteristics of Mid Penn’s loan portfolio segments. When computing allowance levels, credit loss assumptions are estimated using a model that categorizes loan pools based on loss history and other credit trends and risk characteristics, including current conditions and reasonable and supportable forecasts about the future. Evaluations of the portfolio and individual credits are inherently subjective, as they require estimates, assumptions and judgments as to the facts and circumstances of particular situations. Determining the appropriateness of the allowance is complex and requires judgement by management about the effect of matters that are inherently uncertain. In future periods, evaluations of the overall loan portfolio, in light of the factors and forecasts then prevailing, may result in significant changes in the ACL and credit loss expense. Mid Penn estimates the ACL using relevant available information, from internal and external sources, relating to past events, current conditions and reasonable and supportable forecasts. Mid Penn uses a third-party software application to calculate the quantitative portion of the ACL using a methodology and assumptions specific to each loan pool. The qualitative portion of the allowance is based on general economic conditions and other internal and external factors affecting Mid Penn as a whole, as well as specific loans. Factors considered include the following: lending process, concentrations of credit, and credit quality. The quantitative and qualitative portions of the allowance are added together to determine the total ACL, which reflects management’s expectations of future conditions based on reasonable and supportable forecasts. The methodology for estimating the amount of expected credit losses reported in the ACL has two basic components: a collective, or pooled, component for estimated expected credit losses for pools of loans that share similar risk characteristics, and an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans. In estimating the ACL for the collective component, loans are segregated into loan pools based on loan purpose codes and similar risk characteristics. The commercial real estate and residential mortgage loan portfolio segments include loans for both commercial and residential properties that are secured by real estate. The underwriting process for these loans includes analysis of the financial position and strength of both the borrower and, if applicable, guarantor, experience with similar projects in the past, market demand and prospects for successful completion of the proposed project within the established budget and schedule, values of underlying collateral, availability of permanent financing, maximum loan-to-value ratios, minimum equity requirements, acceptable amortization periods and minimum debt service coverage requirements, based on property type. The borrower’s financial strength and capacity to repay their obligations remain the primary focus of underwriting. Financial strength is evaluated based upon analytical tools that consider historical and projected cash flows and performance, in addition to analysis of the proposed project for income-producing properties. Additional support offered by guarantors is also considered when applicable. Ultimate repayment of these loans is sensitive to interest rate changes, general economic conditions, liquidity and availability of long-term financing. The commercial and industrial loan portfolio segment includes commercial loans made to many types of businesses for various purposes, such as short-term working capital loans that are usually secured by accounts receivable and inventory, equipment and fixed asset purchases that are secured by those assets, and term financing for those within Mid Penn’s geographic markets. Mid Penn’s credit underwriting process for commercial and industrial loans includes analysis of historical and projected cash flows and performance, evaluation of financial strength of both borrowers and guarantors as reflected in current and detailed financial information, and evaluation of underlying collateral to support the credit. The consumer loan portfolio segment is comprised of loans which are underwritten after evaluating a borrower’s capacity, credit and collateral. Several factors are considered when assessing a borrower’s capacity, including the borrower’s employment, income, current debt, assets and level of equity in the property. Credit is assessed using a credit report that provides credit scores and the borrower’s current and past information about their credit history. Loan-to-value and debt-to-income ratios, loan amount and lien position are also considered in assessing whether to originate a loan. These borrowers are particularly susceptible to downturns in economic trends, such as conditions that negatively affect housing prices and demand and levels of unemployment. Mid Penn utilizes a DCF method to estimate the quantitative portion of the allowance for credit losses for loan pools. The DCF is based off of historical losses, including peer data, which is correlated to national unemployment and GDP. The PD and LGD measures are used in conjunction with prepayment data as inputs into the DCF model to calculate the cash flows at the individual loan level. Contractual cash flows based on loan terms are adjusted for PD, LGD and prepayments to derive loss cash flows. These loss cash flows are discounted by the loan’s coupon rate to arrive at the discounted cash flow based quantitative loss. The prepayment studies are updated quarterly by a third-party for each applicable pool. Mid Penn determined that reasonable and supportable forecasts could be made for a twelve-month period for all of its loan pools. To the extent the lives of the loans in the LHFI portfolio extend beyond this forecast period, Mid Penn uses a reversion period of four quarters and reverts to the historical mean on a straight-line basis over the remaining life of the loans. Qualitative factors used in the ACL methodology include the following: • Lending process • Concentrations of credit The ACL for individual loans, such as non-accrual and PCD, that do not share risk characteristics with other loans is measured as the difference between the discounted value of expected future cash flows, based on the effective interest rate at origination, and the amortized cost basis of the loan, or the net realizable value. The ACL is the difference between the loan’s net realizable value and its amortized cost basis (net of previous charge-offs and deferred loan fees and costs), except for collateral-dependent loans. A loan is collateral dependent when the borrower is experiencing financial difficulty and repayment of the loan is expected to be provided substantially through the sale of the collateral. The expected credit loss for collateral-dependent loans is measured as the difference between the amortized cost basis of the loan and the fair value of the collateral, adjusted for the estimated cost to sell. Fair value estimates for collateral-dependent loans are derived from appraised values based on the current market value or the "as is" value of the collateral, normally from recently received and reviewed appraisals. Current appraisals are ordered on a regular basis based on the inspection date or more often if market conditions necessitate. Appraisals are obtained from state-certified appraisers and are based on certain assumptions, which may include construction or development status and the highest and best use of the property. These appraisals are reviewed by Mid Penn’s Appraisal Review Department to ensure they are acceptable, and values are adjusted down for costs associated with asset disposal. If the calculated expected credit loss is determined to be permanent or not recoverable, the amount of the expected credit loss is charged off. Mid Penn may also purchase loans or acquire loans through a business combination. At the purchase or acquisition date, loans are evaluated to determine whether there has been more than insignificant credit deterioration since origination. Loans that have experienced more than insignificant credit deterioration since origination are referred to as PCD loans. In its evaluation of whether a loan has experienced more than insignificant deterioration in credit quality since origination, Mid Penn takes into consideration loan grades, past due and nonaccrual status. Mid Penn may also consider external credit rating agency ratings for borrowers and for non-commercial loans, FICO score or band, probability of default levels, and number of times past due. At the purchase or acquisition date, the amortized cost basis of PCD loans is equal to the purchase price and an initial estimate of credit losses. The initial recognition of expected credit losses on PCD loans has no impact on net income. When the initial measurement of expected credit losses on PCD loans is calculated on a pooled loan basis, the expected credit losses are allocated to each loan within the pool. Any difference between the initial amortized cost basis and the unpaid principal balance of the loan represents a noncredit discount or premium, which is accreted (or amortized) into interest income over the life of the loan. Subsequent changes to the ACL on PCD loans are recorded through the PCL. For purchased loans that are not deemed to have experienced more than insignificant credit deterioration since origination and are therefore not deemed PCD, any discounts or premiums included in the purchase price are accreted (or amortized) over the contractual life of the individual loan. Loans are charged off against the ACL, with any subsequent recoveries credited back to the ACL account. Expected recoveries may not exceed the aggregate of amounts previously charged off and expected to be charged off. The following table presents the activity in the ACL - loans by portfolio segment for the three and nine months ended September 30, 2023: (In thousands) Commercial real estate Commercial and industrial Construction Residential mortgage Consumer Total Balance at June 30, 2023 $ 14,197 $ 11,403 $ 3,667 $ 3,145 $ 176 $ 32,588 Purchase credit deteriorated loans — — — — — — Loans charged off — — — — (33) (33) Recoveries — — — 7 15 22 Net loans (charged off) recovered — — — 7 (18) (11) Provision for credit losses (1) 4,483 (4,072) 2,211 (1,060) (135) 1,427 Balance at September 30, 2023 $ 18,680 $ 7,331 $ 5,878 $ 2,092 $ 23 $ 34,004 (In thousands) Commercial real estate Commercial and industrial Construction Residential mortgage Consumer Unallocated Total Balance at December 31, 2022 $ 13,142 $ 4,593 $ — $ 1,319 $ 29 $ (126) $ 18,957 Impact of adopting CECL 288 6,600 3,201 1,562 154 126 11,931 Purchase credit deteriorated loans 314 5 13 4 — — 336 Loans charged off (16) (220) — (4) (117) — (357) Recoveries — — — 37 26 — 63 Net loans (charged off) recovered (16) (220) — 33 (91) — (294) Provision for credit losses (1) 4,952 (3,647) 2,664 (826) (69) — 3,074 Balance at September 30, 2023 $ 18,680 $ 7,331 $ 5,878 $ 2,092 $ 23 $ — $ 34,004 (1) Includes a $2.0 million initial provision for credit losses on non-PCD loans acquired in the Brunswick Acquisition. The following table presents the ACL for loans and the amortized cost basis of the loans by the measurement methodology used as of September 30, 2023: (In thousands) ACL - Loans Loans September 30, 2023 Collectively Evaluated for Credit Loss Individually Evaluated for Credit Loss Total ACL - Loans Collectively Evaluated for Credit Loss Individually Evaluated for Credit Loss Total Loans Commercial Real Estate $ 18,300 $ 380 $ 18,680 $ 2,281,707 $ 6,689 $ 2,288,396 Commercial & Industrial 6,623 708 7,331 646,883 1,556 648,439 Construction 5,878 — 5,878 459,959 2,256 462,215 Residential Mortgage 2,090 2 2,092 740,573 2,960 743,533 Consumer 23 — 23 3,074 — 3,074 Total $ 32,914 $ 1,090 $ 34,004 $ 4,132,196 $ 13,461 $ 4,145,657 Allowance for Credit Losses, prior to January 1, 2023 The following table summarizes the allowance and recorded investments in loans receivable: (In thousands) As of, and for the Commercial Real Estate Commercial and industrial Construction Residential mortgage Consumer Unallocated Total Allowance for loan and lease losses: July 1, 2022 $ 11,991 $ 3,671 $ 46 $ 1,143 $ 2 $ 23 $ 16,876 Charge-offs — (1) — (3) (11) — (15) Recoveries 63 — — — 6 — 69 Provisions 468 879 5 162 5 31 1,550 September 30, 2022 12,522 4,549 51 1,302 2 54 18,480 Individually evaluated for impairment 28 831 — 51 — — 910 Collectively evaluated for impairment $ 12,494 $ 3,718 $ 51 $ 1,251 $ 2 $ 54 $ 17,570 (In thousands) As of, and for the Commercial Real Estate Commercial and industrial Construction Residential mortgage Consumer Unallocated Total Allowance for loan and lease losses: January 1, 2022 $ 9,415 $ 3,439 $ 38 $ 1,019 $ 2 $ 684 $ 14,597 Charge-offs — (1) — (3) (77) — (81) Recoveries 128 13 24 4 20 — 189 Provisions 2,979 1,098 (11) 282 57 (630) 3,775 September 30, 2022 12,522 4,549 51 1,302 2 54 18,480 Individually evaluated for impairment 28 831 — 51 — — 910 Collectively evaluated for impairment $ 12,494 $ 3,718 $ 51 $ 1,251 $ 2 $ 54 $ 17,570 Loans Receivable Ending Balance $ 1,944,802 $ 556,796 $ 400,188 $ 412,518 $ 8,153 $ — $ 3,322,457 Individually Evaluated for impairment 713 1,309 — 1,675 — — 3,697 Acquired with credit deterioration 1,364 — 1,222 1,232 — — 3,818 $ 1,942,725 $ 555,487 $ 398,966 $ 409,611 $ 8,153 $ — $ 3,314,942 The information presented in the designated internal risk categories by portfolio segment table presented above is not required for periods prior to the adoption of CECL. The following table presents the most comparable required information for the prior period, internal credit risk ratings, for the indicated loan portfolio segments as of December 31, 2022: (In thousands) Pass Special Substandard Total December 31, 2022 Commercial real estate $ 2,018,088 $ 12,325 $ 22,521 $ 2,052,934 Commercial and industrial 582,540 4,212 9,290 596,042 Construction 438,990 2,256 — 441,246 Residential mortgage 409,259 3,104 3,858 416,221 Consumer 7,676 — — 7,676 Total loans $ 3,456,553 $ 21,897 $ 35,669 $ 3,514,119 Modifications to Borrowers Experiencing Financial Difficulty From time to time, we may modify certain loans to borrowers who are experiencing financial difficulty. In some cases, these modifications may result in new loans. Loan modifications to borrowers experiencing financial difficulty may be in the form of principal forgiveness, an interest rate reduction, an other-than-insignificant payment delay, or a term extension, or a combination thereof, among other things. There were no new modifications for the quarter ending September 30, 2023. Information related to loans modified (by type of modification), whereby the borrower was experiencing financial difficulty at the time of modification, is set forth in the following table: (In thousands) Interest Only Term Extension Combination: Total % of Total Class of Financing Receivable Nine months ended September 30, 2023 Commercial real estate $ 51 $ — $ 180 $ 231 0.01 % Commercial and industrial — 150 — 150 0.02 Total $ 51 $ 150 $ 180 $ 381 0.01 % The financial effects of the interest-only loan modifications reduced the monthly payment amounts for the borrower and the term extensions in the table above added a weighted-average of 2.0 years to the life of the loans, which also reduced the monthly payment amounts for the borrowers. |