# MID Penn Bancorp Inc: Form 10-Q for the period ended Mar 31, 2020

- Company: [MID Penn Bancorp Inc](/companies/mpb.md) (CIK 879635)
- Form: 10-Q
- Filed: 2020-05-11
- Accepted by EDGAR: May 11, 2020, 12:28 ET
- Period: 2020-03-31
- Accession: 0001564590-20-023969
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/879635/000156459020023969/mpb-10q_20200331.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/879635/000156459020023969/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2020-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Interest expense | 3 months, 2020-01-01 to 2020-03-31 | $6.0m | us-gaap:InterestExpense |
| Income tax | 3 months, 2020-01-01 to 2020-03-31 | $650.0k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2020-01-01 to 2020-03-31 | $3.8m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2020-01-01 to 2020-03-31 | $0.45 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2020-01-01 to 2020-03-31 | $0.45 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2020-01-01 to 2020-03-31 | 8,485,831 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2020-01-01 to 2020-03-31 | −$902.0k | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2020-01-01 to 2020-03-31 | $2.1m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 3 months, 2020-01-01 to 2020-03-31 | $1.9m | us-gaap:PaymentsOfDividendsCommonStock |
| Total assets | at 2020-03-31 | $2.30bn | us-gaap:Assets |
| Total liabilities | at 2020-03-31 | $2.06bn | us-gaap:Liabilities |
| Shareholders' equity | at 2020-03-31 | $239.5m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 67,747 characters.

The following is Management’s Discussion and Analysis of Consolidated Financial Condition as of March 31, 2020, compared to year-end 2019, and the Results of Operations for the three months ended March 31, 2020, compared to the same periods in 2019. For comparative purposes, the March 31, 2020 and December 31, 2019 balances have been reclassified when, and if necessary, to conform to the 2020 presentation. Such reclassifications had no impact on net income. 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, 2019 (the “2019 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 2019 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 states government, including a failure to increase the government debt limit or a prolonged shutdown of the federal government, or a federal or state government-mandated shutdowns 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;
- 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;
- impacts of the capital and liquidity requirements imposed by the Basel III standards and other 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 and including our acquisition strategy;
- our ability to implement organic branch, product and service expansion strategies;
- our current and future acquisition strategies may not be successful in locating or acquiring advantageous targets at favorable prices;
- our ability to successfully integrate any banks, companies, assets, liabilities, customers, systems and management personnel we acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames;
- potential goodwill impairment charges, future impairment charges and fluctuations in the fair values of reporting units or of assets in the event projected financial results are not achieved within expected time frames;
- our ability to attract and retain qualified management and personnel;
- our ability to maintain the value and image of our brand and protect our intellectual property rights;
- results of regulatory examination and supervision processes;
- our ability to maintain compliance with the exchange rules of The NASDAQ Stock Market LLC;
- the failure of assumptions underlying the establishment of reserves for loan and lease losses and estimations of values of collateral and various financial assets and liabilities;
- acts of war or terrorism; disruptions due to flooding, severe weather, or other natural disasters or Acts of God; and
- volatility in the securities markets.

The above list of factors that may affect future performance is illustrative, but by no means exhaustive. Accordingly, all forward-looking statements should be evaluated with this understanding of inherent uncertainty.

### Critical Accounting Estimates

Mid Penn’s consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and conform to general practices within the banking industry. Application of these principles involves significant judgments and estimates by management that have a material impact on the carrying value of certain assets and liabilities. The judgments and estimates that we used are also based on historical experiences and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and estimates that we have made, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities and the results of our operations. Management of the Corporation considers the accounting judgments relating to the allowance, the evaluation of the Corporation’s investment securities for other-than-temporary impairment, the valuation of the Corporation’s goodwill and other merger-related intangible assets for impairment, and the valuation of assets acquired and liabilities assumed in business combinations, to be the accounting areas that require the most subjective and complex judgments.

The allowance represents management’s estimate of probable incurred credit losses inherent in the loan and lease portfolio. Determining the amount of the allowance is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan and lease portfolio also represents the largest asset type on the consolidated balance sheet. Throughout the remainder of this report, the terms “loan” or “loans” refers to both loans and leases.

Valuations for the investment portfolio are determined using quoted market prices, where available. If quoted market prices are not available, investment valuation is based on pricing models, quotes for similar investment securities, and observable yield curves and spreads. In addition to securities valuation, management must assess whether there are any declines in value below the carrying value of the investments that should be considered other than temporary or otherwise require an adjustment in carrying value and recognition of the loss in the consolidated statement of income.

Certain intangible assets generated in connection with acquisitions are periodically assessed for impairment. Goodwill is tested annually for impairment, and if certain events occur which indicate goodwill might be impaired between annual tests, goodwill must be tested when such events occur. In making this assessment, Mid Penn considers a number of factors including operating results, business plans, economic projections, anticipated future cash flows, current market data, stock price, etc. Similarly, the amortized basis of the core deposit intangible asset and trade name intangible are periodically assessed for impairment. There are inherent uncertainties related to these factors and Mid Penn’s judgment in applying them to the analysis of core deposit intangible, trade name intangible, and goodwill impairment. Changes in economic and operating conditions could result in goodwill or core deposit intangible or trade name intangible impairment in future periods.

Valuations of assets acquired and liabilities assumed in business combinations are measured at fair value as of the acquisition date. In many cases, determining the fair value of the assets acquired and liabilities assumed requires Mid Penn to estimate cash flows expected to result from these assets and liabilities and to discount these cash flows at appropriate rates of interest, which require the utilization of significant estimates and judgment in accounting for the acquisition.

### Results of Operations

### Overview

Net income available to common shareholders was $3,818,000 or $0.45 per common share, for the quarter ended March 31, 2020, compared to net income of $4,077,000 or $0.48 per common share for the quarter ended March 31, 2019.

Net income as a percent 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 March 31, 2020 | 2019 |
| --- | ---: | ---: |
| Return on average assets | 0.68% | 0.79% |
| Return on average equity | 6.43% | 7.35% |

### Net Interest Income/Funding Sources

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. 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 percent for the three months ended March 31, 2020 and 2019.

The following tables include average balances, amounts, and rates of interest income and expense, interest rate spread, and net interest margin for the three months ended March 31, 2020 and 2019.

*(Dollars in thousands)*

| ASSETS: | Average Balances, Income and Interest Rates on a Taxable Equivalent Basis For the Three Months Ended March 31, 2020 Average Balance | Interest |  | Average Rates | March 31, 2019 Average Balance | Interest |  | Average Rates |
| --- | ---: | ---: | --- | ---: | ---: | ---: | --- | ---: |
| Interest Bearing Balances | $4,488 | $15 |  | 1.34% | $6,162 | $30 |  | 1.97% |
| Investment Securities: |  |  |  |  |  |  |  |  |
| Taxable | 133,502 | 740 |  | 2.23% | 165,461 | 989 |  | 2.42% |
| Tax-Exempt | 42,765 | 280 | (a) | 2.63% | 107,718 | 784 | (a) | 2.95% |
| Total Securities | 176,267 | 1,020 |  | 2.33% | 273,179 | 1,773 |  | 2.63% |
| Federal Funds Sold | 122,635 | 390 |  | 1.28% | 11,294 | 68 |  | 2.44% |
| Loans and Leases, Net | 1,771,444 | 22,341 | (b) | 5.07% | 1,629,480 | 21,162 | (b) | 5.27% |
| Restricted Investment in Bank Stocks | 4,660 | 84 |  | 7.25% | 5,987 | 82 |  | 5.55% |
| Total Earning Assets | 2,079,494 | 23,850 |  | 4.61% | 1,926,102 | 23,115 |  | 4.87% |
| Cash and Due from Banks | 30,580 |  |  |  | 28,178 |  |  |  |
| Other Assets | 147,924 |  |  |  | 138,249 |  |  |  |
| Total Assets | $2,257,998 |  |  |  | $2,092,529 |  |  |  |
| LIABILITIES & SHAREHOLDERS' EQUITY: |  |  |  |  |  |  |  |  |
| Interest-bearing Demand | $455,685 | 1,172 |  | 1.03% | $382,478 | 853 |  | 0.90% |
| Money Market | 502,925 | 1,597 |  | 1.28% | 387,525 | 1,463 |  | 1.53% |
| Savings | 175,924 | 120 |  | 0.27% | 200,714 | 176 |  | 0.36% |
| Time | 480,316 | 2,491 |  | 2.09% | 487,567 | 2,094 |  | 1.74% |
| Total Interest-bearing Deposits | 1,614,850 | 5,380 |  | 1.34% | 1,458,284 | 4,586 |  | 1.28% |
| Short-term Borrowings | — | — |  | 0.00% | 34,491 | 232 |  | 2.73% |
| Long-term Debt | 28,780 | 252 |  | 3.52% | 48,125 | 354 |  | 2.98% |
| Subordinated Debt | 29,048 | 402 |  | 5.57% | 27,079 | 388 |  | 5.81% |
| Total Interest-bearing Liabilities | 1,672,678 | 6,034 |  | 1.45% | 1,567,979 | 5,560 |  | 1.44% |
| Noninterest-bearing Demand | 320,524 |  |  |  | 276,673 |  |  |  |
| Other Liabilities | 25,927 |  |  |  | 22,970 |  |  |  |
| Shareholders' Equity | 238,869 |  |  |  | 224,907 |  |  |  |
| Total Liabilities & Shareholders' Equity | $2,257,998 |  |  |  | $2,092,529 |  |  |  |
| Net Interest Income (taxable equivalent basis) |  | $17,816 |  |  |  | $17,555 |  |  |
| Taxable Equivalent Adjustment |  | (151) |  |  |  | (249) |  |  |
| Net Interest Income |  | $17,665 |  |  |  | $17,306 |  |  |
| Total Yield on Earning Assets |  |  |  | 4.61% |  |  |  | 4.87% |
| Rate on Supporting Liabilities |  |  |  | 1.45% |  |  |  | 1.44% |
| Average Interest Spread |  |  |  | 3.16% |  |  |  | 3.43% |
| Net Interest Margin |  |  |  | 3.45% |  |  |  | 3.70% |

(a) Includes tax-equivalent adjustments on interest from tax-free municipal securities of $59,000 and $165,000 for the three months ended March 31, 2020 and 2019, respectively. Tax-equivalent adjustments were calculated using statutory tax rate of 21% at March 31, 2020 and 2019.

(b) Includes tax-equivalent adjustments on interest from tax-free municipal loans of $92,000 and $84,000 for the three months ended March 31, 2020 and 2019, respectively. Tax-equivalent adjustments were calculated using statutory tax rate of 21% at March 31, 2020 and 2019.

42

### MID PENN BANCORP, INC.

*(Dollars in thousands on a Taxable Equivalent Basis)*

| INTEREST INCOME: | Three months ended March 31, 2020 vs. 2019 Increase (decrease) Volume | Rate | Net |
| --- | ---: | ---: | ---: |
| Interest Bearing Balances | $(8) | $(7) | $(15) |
| Investment Securities: |  |  |  |
| Taxable | (193) | (56) | (249) |
| Tax-Exempt | (477) | (27) | (504) |
| Total Securities | (670) | (83) | (753) |
| Federal Funds Sold | 676 | (354) | 322 |
| Loans and Leases, Net | 1,859 | (680) | 1,179 |
| Restricted Investment Bank Stocks | (18) | 20 | 2 |
| Total Interest Income | 1,839 | (1,104) | 735 |
| INTEREST EXPENSE: |  |  |  |
| Interest Bearing Deposits: |  |  |  |
| Interest Bearing Demand | 165 | 154 | 319 |
| Money Market | 439 | (305) | 134 |
| Savings | (22) | (34) | (56) |
| Time | (31) | 428 | 397 |
| Total Interest Bearing Deposits | 551 | 243 | 794 |
| Short-term Borrowings | (234) | 2 | (232) |
| Long-term Debt | (143) | 41 | (102) |
| Subordinated Debt | 28 | (14) | 14 |
| Total Interest Expense | 202 | 272 | 474 |
| NET INTEREST INCOME | $1,637 | $(1,376) | $261 |

Taxable-equivalent net interest income was $17,816,000 for the three months ended March 31, 2020, an increase of $261,000 or 1 percent compared to the three months ended March 31, 2019.

For the three months ended March 31, 2020, Mid Penn’s tax-equivalent net interest margin was 3.45% for the first quarter of 2020 compared to 3.70% for the first quarter of 2019. Though the quarterly average balance of interest-earning assets increased year over year, the yields on interest earning assets declined consistent with reductions in the yield curve during the first quarter of 2020, including the impact of the two rate decreases approved by the Federal Open Market Committee (“FOMC”), for 1.50% combined, during March 2020 in response to the COVID-19 pandemic. The total cost of deposits for the first quarter of 2020 favorably decreased compared to the first quarter of 2019 as a result of the same yield curve reductions and FOMC rate cuts.

Although the effective interest rate impact on 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 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 three months of 2020, and shifting collateral values from December 31, 2019 to March 31, 2020.

Management performed a current evaluation of the adequacy of the loan and lease loss allowance and based on this evaluation, a loan loss provision of $550,000 and $125,000 was recorded for the three months ended March 31, 2020 and 2019, respectively. The allowance for loan losses and the related provision reflect Mid Penn’s continued application of the incurred loss method for estimating credit losses as the Mid Penn is not required to adopt the current expected credit loss (“CECL”) accounting standard until January 1, 2023. The increase in the loan loss reserves and the quarterly provision were primarily the result of an increase in the allowance balance related to general allocations, driven by increases in qualitative factors reserves, particularly in the commercial real estate pool, when compared to prior periods. Mid Penn’s allowance and other asset quality measures did not reflect any new impaired assets or specific reserve allocations related to the early impact of the COVID-19 pandemic, though Bank management is continuously and closely monitoring and evaluating the impact of the COVID-19 situation on the portfolio. See Note 13 for additional subsequent events information related to Mid Penn’s response to the COVID-19 pandemic.

### Noninterest Income

During the three months ended March 31, 2020, noninterest income totaled $2,934,000, an increase of $885,000 or 43 percent, compared to noninterest income of $2,049,000 for the three months ended March 31, 2019.

The following components of noninterest income showed significant changes:

*(Dollars in Thousands)*

|  | Three Months Ended March 31, 2020 | 2019 | $ Variance | % Variance |
| --- | ---: | ---: | ---: | ---: |
| ATM debit card interchange income | $416 | $334 | $82 | 25% |
| Mortgage banking income | 1,182 | 437 | 745 | 170% |
| Net gain on sales of SBA loans | 84 | 202 | (118) | -58% |
| Net gain on sales of investment securities | 132 | 7 | 125 | 1786% |
| Other income | 372 | 330 | 42 | 13% |

Mortgage banking income was $1,182,000 for the three months ended March 31, 2020, an increase of $745,000 or 170 percent compared to mortgage banking income of $437,000 for the three months ended March 31, 2019. Longer-term mortgage interest rates have declined significantly over the past twelve months, resulting in a higher level of mortgage originations (both purchase and refinance activity) and secondary-market loan sales when comparing the first quarter of 2020 to the same period in 2019. Additionally, the first three months of 2020 reflected a full quarter of production and loan sales from Mid Penn’s Southeastern Pennsylvania mortgage origination team, while the same group was not fully operational for the entire first quarter of 2019.

ATM debit card interchange income was $416,000 for the three months ended March 31, 2020, an increase of $82,000 or 25 percent compared to interchange income of $334,000 for the three months ended March 31, 2019. The increase resulted from increasing card-based transaction usage across our expanding transactional account customer base.

Net gains on sales of securities were $132,000 for the three months ended March 31, 2020, an increase of $125,000 compared to net gains on sales of securities of $7,000 for the three months ended March 31, 2019. Sale volume and gains were driven by the implementation of asset/liability management strategies, which vary from quarter to quarter based upon market conditions and related yield curve and valuation changes.

Net gains on sales of SBA loans were $84,000 for the three months ended March 31, 2020, a decrease of $118,000 or 58 percent compared to net gains on sales of SBA loans of $202,000 during the same quarter of 2019. None of the SBA loan production or sales activity in the first quarter of 2020 related to the Treasury’s and SBA’s Payroll Protection Program (“PPP”) loans under the CARES Act, as the PPP loans did not begin to be disbursed by Mid Penn until April 2020.

Other income was $372,000 for the three months ended March 31, 2020, an increase of $42,000 compared to other income of $330,000 for the three months ended March 31, 2019. The increase in other income was primarily driven by higher volumes of fee-based income, including wire transfer fees, letter of credit fees, and credit card program referrals and royalties.

### Noninterest Expense

Noninterest expense for the three months ended March 31, 2020 totaled $15,581,000, an increase of $1,278,000 or 9 percent, compared to noninterest expense of $14,303,000 for the three months ended March 31, 2019. The year-over-year increase in quarterly noninterest expense was attributable to both (i) growth-related business development and retail staff additions since March 31, 2019, and (ii) increases across other expense categories reflective of the overall growth of the organization, including software licensing and utilization, Pennsylvania bank shares tax, and occupancy and equipment expenses. Also, other expenses for the first quarter of 2020 included approximately $63,000 of non-recurring FHLB prepayment costs resulting from Mid Penn’s early redemption of $9,500,000 of higher-cost term advances. No FHLB borrowing prepayments occurred during the first quarter of 2019.

The changes were primarily a result of the following components of noninterest expense, which had significant variances when comparing results for periods ending in 2020 versus the corresponding period in 2019:

*(Dollars in Thousands)*

|  | Three Months Ended March 31, 2020 | 2019 | $ Variance | % Variance |
| --- | ---: | ---: | ---: | ---: |
| Salaries and employee benefits | $8,281 | $7,759 | $522 | 7% |
| Equipment expense | $713 | $627 | $86 | 14% |
| Pennsylvania bank shares tax expense | 405 | 136 | 269 | 198% |
| FDIC Assessment | 312 | 359 | (47) | -13% |
| Legal and professional fees | 352 | 422 | (70) | -17% |
| Software licensing and utilization | 1,221 | 1,021 | 200 | 20% |
| Intangible amortization | 323 | 363 | (40) | -11% |

Salaries and employee benefits were $8,281,000 for the three months ended March 31, 2020, an increase of $522,000 or 7 percent, versus the same period in 2019, with the increase primarily attributable to (i) retail staff added as part of the new Hazle Township branch location opened during the fourth quarter of 2019, (ii) the addition of private banking business development professionals to enhance our wealth management activities, and (iii) increases in medical expenses and other employee benefits costs when compared to the same period of 2019.

Equipment expense increased $86,000 or 14 percent during the three months ended March 31, 2020 compared to the same period in 2019, related to the expansion of the corporate administrative facilities and further centralization of back-office functions to enhance operations and efficiencies across the Mid Penn footprint.

Pennsylvania bank shares tax expense was $405,000 for the three months ended March 31, 2020, an increase of $269,000 or 198 percent compared to $136,000 for the three months ended March 31, 2019. The first quarter of 2019 reflected the application of $122,500 of shares tax credits that were earned based upon the timing of certain carryover donations made that quarter that had been committed by First Priority Bank (which Mid Penn acquired in 2018). Similar donations and credits did not occur in the first quarter 2020. The increase in shares tax expense also reflects the organic growth in the past year of the total shareholder equity balance upon which the tax is based.

Software licensing and utilization costs were $1,221,000 for the three months ended March 31, 2020, an increase of $200,000 or 20 percent compared to $1,021,000 for the three months ended March 31, 2019. This increase reflects the additional costs from both transaction volume based charges, and licensing fees related to the addition of new staff and locations added since the first quarter of 2019. Additionally, Mid Penn continued to invest in upgrades to internal systems, networks, storage capabilities, and data security mechanisms to enhance data management and security capabilities responsive to both the larger company profile and increasing complexity of information technology management.

FDIC assessment expense was $312,000 for the three months ended March 31, 2020, a decrease of $47,000 or 13 percent compared to $359,000 for the three months ended March 31, 2019 due to the Bank having a favorably lower FDIC Assessment rate during the first quarter of 2020.

Legal and professional fees for the three months ended March 31, 2020 decreased by $70,000 or 17 percent compared to the same period in 2019, due primarily to the first quarter of 2019 including additional services supporting a new third-party loan review service, as well costs associated with supporting both trust and wealth management activities, and the update and revision of Mid Penn’s corporate governance and Board structure.

Intangible amortization decreased from $363,000 during the three months ended March 31, 2019 to $323,000 during the three months ended March 31, 2020, as the core deposit intangible (“CDI”) amortization from the 2018 acquisitions of both (i) Scottdale on January 8, 2018, and (ii) First Priority on July 31, 2018 continues to decrease as it is amortized using the sum-of-the-years digits method over a ten year term (which results in decreasing expense recognized in each year following the respective acquisition).

### Income Taxes

The provision for income taxes was $650,000 during the three months ended March 31, 2020, a decrease of $200,000 or 24 percent compared to $850,000 for the same period in 2019. The provision for income taxes for the three months ended March 31, 2020 reflects an effective federal tax rate of 14.5%, compared to an effective federal tax rate of 17.3% for the three months ended March 31, 2019. The reduction in the effective federal tax rate for 2020 reflects tax credits recognized related to Mid Penn’s investment in a low-income housing project in Dauphin County, Pennsylvania. The units were substantially completed and met the occupancy requirements necessary to begin recognizing the related amortization and tax credits during the fourth quarter of 2019. Similar credits were not recognized during the three months ended March 31, 2019.

Generally, Mid Penn’s effective tax rate is below the 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 tax credits. 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 $2,299,751,000 as of March 31, 2020, reflecting an increase of $68,576,000 or 3 percent compared to total assets of $2,231,175,00 as of December 31, 2019, and an increase of $151,934,000 or 7 percent compared to total assets of $2,147,817,000 as of March 31, 2019. Asset growth during the quarter ended March 31, 2020 included an increase of $21,897,000 in investment securities, and an increase in total loans outstanding of $35,393,000 since year-end, representing an 8 percent annualized loan growth rate. The asset growth was funded by $60,887,000 of deposit growth, representing an annualized deposit growth rate of 13 percent, with more than half of such growth favorably being in noninterest-bearing deposits.

### Loans

Total loans at March 31, 2020 were $1,798,149,000 compared to $1,762,756,000 at December 31, 2019, an increase of $35,393,000 or 2.0 percent since year-end 2019 (annualized growth rate of 8 percent). The increase in total loans was primarily comprised of growth in both commercial real estate credits, and commercial and industrial financing loans.

*(Dollars in thousands)*

|  | March 31, 2020 Amount% |  | December 31, 2019 Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| Commercial and industrial | $351,339 | 19.5% | $339,147 | 19.2% |
| Commercial real estate | 939,995 | 52.3% | 929,138 | 52.7% |
| Commercial real estate - construction | 205,248 | 11.4% | 181,690 | 10.3% |
| Residential mortgage | 230,047 | 12.8% | 236,724 | 13.4% |
| Home equity | 64,610 | 3.6% | 68,271 | 3.9% |
| Consumer | 6,910 | 0.4% | 7,786 | 0.5% |
|  | $1,798,149 | 100.0% | $1,762,756 | 100.0% |

### Credit Quality, Credit Risk, and Allowance for Loan and Lease Losses

The allowance for loan 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 required to adopt the current expected credit loss (“CECL”) accounting standard until January 1, 2023. Mid Penn’s allowance and other asset quality measures did not reflect any new impaired assets or specific reserve allocations related to the early impact of the COVID-19 pandemic, though Bank management is continuously and closely monitoring and evaluating the impact of the COVID-19 situation on the portfolio.

For the three months ended March 31, 2020, Mid Penn had net loan charge-offs of $51,000 compared to net charge-offs of $20,000 during the same period in 2019. None of the charge offs in the first quarter of 2020 were a result of the COVID-19 pandemic. Loans charged off during the first three months of 2019 totaled $58,000 and included two commercial and industrial loans for $43,000, one consumer loan for $5,000, and $10,000 in deposit account charge-offs. 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 losses as compared to the balance of outstanding loans.

Changes in the allowance for the three months ended March 31, 2020 and 2019 are summarized as follows:

*(Dollars in thousands)*

|  | Three Months Ended March 31, 2020 | 2019 |
| --- | ---: | ---: |
| Balance, beginning of period | $9,515 | $8,397 |
| Loans charged off during period | (58) | (41) |
| Recoveries of loans previously charged off | 7 | 21 |
| Net charge-offs | (51) | (20) |
| Provision for loan and lease losses | 550 | 125 |
| Balance, end of period | $10,014 | $8,502 |
| Ratio of net loan charge-offs to average loans outstanding, annualized | 0.01% | 0.01% |
| Ratio of allowance for loan losses to net loans at end of period | 0.56% | 0.52% |

46

Other than as described herein, including the disclosures in previous sections and in Note 13 of the consolidated financial statements regarding subsequent events regarding the continued impact of the COVID-19 pandemic, 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, including those related to COVID-19, may influence certain borrowers’ abilities to comply with their repayment terms. Mid Penn continues to monitor closely the financial strength of these borrowers and the economic conditions impacting them, including the impacts from the COVID-19 pandemic. Mid Penn does not ordinarily engage in practices which may be used to artificially shield certain borrowers from the negative economic or business cycle effects that may compromise their ability to repay. Mid Penn does not normally structure construction loans with interest reserve components. Mid Penn has not in the past performed any commercial real estate or other type of loan workouts whereby an existing loan was restructured into multiple new loans. Also, Mid Penn does not extend loans at maturity solely due to the existence of guarantees, without recognizing the credit as impaired. While the existence of a guarantee may be a mitigating factor in determining the proper level of allowance once impairment has been identified, the guarantee does not affect the impairment analysis.

The following table presents the change in nonperforming asset categories as of March 31, 2020, December 31, 2019, and March 31, 2019.

*(Dollars in thousands)*

| Nonperforming Assets: | March 31, 2020 | December 31, 2019 | March 31, 2019 |
| --- | ---: | ---: | ---: |
| Nonaccrual loans | $10,670 | $11,471 | $6,655 |
| Accruing troubled debt restructured loans | 484 | 490 | 510 |
| Total nonperforming loans | 11,154 | 11,961 | 7,165 |
| Foreclosed real estate | 1,718 | 196 | 350 |
| Total non-performing assets | 12,872 | 12,157 | 7,515 |
| Accruing loans 90 days or more past due | — | — | 2 |
| Total risk elements | $12,872 | $12,157 | $7,517 |
| Nonperforming loans as a % of total |  |  |  |
| loans outstanding | 0.62% | 0.68% | 0.44% |
| Nonperforming assets as a % of total |  |  |  |
| loans outstanding and other real estate | 0.72% | 0.69% | 0.46% |
| Ratio of allowance for loan losses |  |  |  |
| to nonperforming loans | 89.78% | 79.55% | 118.66% |

In the table above, troubled debt restructured loans that are no longer accruing interest are included in nonaccrual loans.

Nonperforming loans decreased from $11,961,000 at December 31, 2019 to $11,154,000 at March 31, 2020 primarily due to the transfer of one loan relationship from nonaccrual to foreclosed real estate during the first quarter of 2020. One loan relationship which accounts for $7,385,000 of the nonperforming loan balance is discussed in more detail below.

Loan relationship no. 1 – At March 31, 2020, the contractual outstanding principal balance of this loan relationship was $7,385,000 and was comprised of two commercial and industrial loans and one commercial real estate credit acquired in 2018. Given that the fair value of the collateral, primarily comprised of a significant amount of commercial real estate, exceeds the outstanding principal balance, no specific allowance allocation has been assigned to this relationship. Management is diligently pursuing its full rights given its priority liens to the collateral under the loan agreements to collect the remaining outstanding balance.

The increase in foreclosed real estate from $196,000 at December 31, 2019 to $1,718,000 at March 31, 2020 was driven by the above noted transfer of one loan relationship from nonaccrual status to foreclosed real estate during the first quarter of 2020.

Foreclosed real estate no. 1 – At March 31, 2020, this property consisted of a commercial property and was carried at a net realizable value of $1,465,000. Management has actively listed the property for sale and expects to recover its full investment in this property at the time of sale.

Mid Penn assesses a specific allocation for both commercial loans and commercial real estate loans prior to writing down or charging off the loan. Once the write down is taken, the remaining balance remains a nonperforming loan with the original terms and interest rate intact and is not treated as a restructured credit. The following table provides additional analysis of partially charged-off loans.

### MID PENN BANCORP, INC.

*(Dollars in thousands)*

|  | March 31, 2020 | December 31, 2019 |
| --- | ---: | ---: |
| Period ending total loans outstanding | $1,798,149 | $1,762,756 |
| Allowance for loan and lease losses | 10,014 | 9,515 |
| Total Nonperforming loans | 11,154 | 11,961 |
| Nonperforming and impaired loans with partial charge-offs | 322 | 332 |
| Ratio of nonperforming loans with partial charge-offs |  |  |
| to total loans | 0.02% | 0.02% |
| Ratio of nonperforming loans with partial charge-offs |  |  |
| to total nonperforming loans | 2.89% | 2.78% |
| Coverage ratio net of nonperforming loans with |  |  |
| partial charge-offs | 92.45% | 81.82% |
| Ratio of total allowance to total loans less |  |  |
| nonperforming loans with partial charge-offs | 0.56% | 0.54% |

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.

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 $11,149,000 which were deemed by management to be impaired at March 31, 2020, including $1,792,000 in loans acquired with credit deterioration in connection with the closing of the Phoenix acquisition in 2015 and the Scottdale and First Priority acquisitions in 2018. Of the $9,357,000 of impaired loan relationships excluding the loans acquired with credit deterioration, $897,000 were commercial and industrial relationships, $7,649,000 were commercial real estate relationships, $749,000 were residential relationships, $39,000 were commercial real estate – construction relationships, and $24,000 were home equity relationships. There were specific loan loss reserve allocations of $190,000 against $816,000 of commercial real estate loan relationships and $3,000 of specific loan loss reserve allocations against $7,000 of commercial and industrial loan relationships. Management currently believes that the specific reserves are adequate to cover probable future losses related to these relationships.

The allowance is a reserve established in the form of a provision expense for loan and lease losses and is reduced by loan charge-offs net of recoveries. In conjunction with an internal loan review function that operates independently of the lending function, management monitors the loan portfolio to identify risk on a monthly basis so that an appropriate allowance is maintained. Based on an evaluation of the loan portfolio, management presents a monthly review of the allowance to the Board of Directors, indicating any changes in the allowance since the last review. In making the evaluation, management considers the results of recent regulatory examinations, which typically include a review of the allowance as an integral part of the examination process. As part of the examination process, federal or state regulatory agencies may require Mid Penn to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management.

In establishing the allowance, management evaluates on a quantitative basis individual classified loans and nonaccrual loans, and determines an aggregate reserve for those loans based on that review. In addition, an allowance for the remainder of the loan and lease portfolio is determined based on historical loss experience within certain components of the portfolio. These allocations may be modified if current conditions indicate that loan and lease losses may differ from historical experience.

In addition, a portion of the allowance is established for losses inherent in the loan and lease portfolio which have not been identified by the quantitative processes described above. This determination inherently involves a higher degree of subjectivity, and considers risk factors that may not have yet manifested themselves in historical loss experience. These factors include:

- changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;
- 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 and legal and regulatory requirements on 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, associated with unpredictable changes in economic growth or business conditions in our markets or for certain industries in which we have commercial loan borrowers, or unanticipated stresses to the values of real estate held as collateral, including the prospective unknown impacts of the COVID-19 pandemic. Any or all of these additional issues can adversely affect our borrowers’ ability to timely repay their loans. Additionally, we have experienced continued strong commercial loan growth, including growth in newer markets where we have less of a loss history. Also, the unallocated component allocation recognizes the inherent imprecision in our allowance for loan and lease loss methodology, or any alternative methodology, for estimating specific and general loan losses, including the unpredictable timing and amounts of charge-offs, the fact that historical loss averages don’t necessarily correlate to future loss trends, and unexpected changes to specific-credit or general portfolio future cash flows and collateral values which could negatively impact unimpaired portfolio loss factors. Changes from these various other uncertainties and considerations may impact the provisions charged to expense in future periods.

Management believes, based on information currently available, that the allowance for loan losses of $10,014,000 is adequate as of March 31, 2020 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;
- proceeds from interest-bearing time deposits with other financial institutions;
- payments received on loans and mortgage-backed securities;
- overnight correspondent bank borrowings on various credit lines; and
- borrowing capacity available from the FHLB, the Federal Reserve Discount Window, and other lines of credit currently available to Mid Penn.

The major sources of cash received in the first three months of 2020 were from the $60,887,000 net increase in deposits, $35,964,000 of proceeds from the sale of available-for-sale securities, and $31,190,000 of proceeds from sales of mortgage loans originated for sale.

Major uses of cash in the first three months of 2020 were $61,945,000 to fund the purchase of held-to-maturity investment securities, $37,120,000 to fund mortgage loans originated for sale, and $36,966,000 to fund portfolio loan growth (primarily commercial loans).

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 COVID-19 event, 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 liquidity problem specific to Mid Penn.

### Subordinated Debt

#### Subordinated Debt Issued March 2020

On March 20, 2020, Mid Penn entered into agreements with accredited investors who purchased $15,000,000 aggregate principal amount of Mid Penn’s Subordinated Notes due 2030 (the “2020 Notes”), on a private placement basis, to accredited investors. The 2020 Notes are intended to be treated as Tier 2 capital for regulatory capital purposes.

The 2020 Notes bear interest at a rate of 4.0% per year for the first five years and then float at the Wall Street Journal’s Prime Rate, provided that the interest rate applicable to the outstanding principal balance during the period the 2020 Notes are floating will at no time be less than 4.25%. Interest will be payable semi-annually in arrears on June 30 and December 30 of each year, beginning on June 30, 2020, for the first five years after issuance and will be payable quarterly in arrears thereafter on March 30, June 30, September 30 and December 30. The 2020 Notes will mature on March 30, 2030 and are redeemable in whole or in part, without premium or penalty, at any time on or after March 30, 2025 and prior to March 30, 2030. Additionally, if all or any portion of the 2020 Notes cease to be deemed Tier 2 Capital, Mid Penn may redeem, on any interest payment date, all or part of the 2020 Notes. In the event of a redemption described in the previous sentence, Mid Penn will redeem the 2020 Notes at 100% of the principal amount of the 2020 Notes, plus accrued and unpaid interest thereon to but excluding the date of redemption.

Holders of the 2020 Notes may not accelerate the maturity of the 2020 Notes, except upon the bankruptcy, insolvency, liquidation, receivership or similar event of Mid Penn or Mid Penn Bank, its principal banking subsidiary.

#### Subordinated Debt Assumed July 2018 with the First Priority Acquisition

On July 31, 2018, Mid Penn completed its acquisition of First Priority and assumed $9,500,000 of Subordinated Notes (the “First Priority Notes”). In accordance with purchase accounting principles, the First Priority Notes were assigned a fair value premium of $247,000 which is being amortized through interest expense until the maturity date of November 30, 2025. The First Priority Notes are intended to be treated as Tier 2 capital for regulatory reporting purposes.

The First Priority Notes agreements were entered into by First Priority on November 13, 2015 with five accredited investors, pursuant to which First Priority issued subordinated notes totaling $9,500,000. The First Priority Notes have a maturity date of November 30, 2025, and bear interest at a fixed rate of 7.00% per annum. The First Priority Notes are non-callable for an initial period of five years and include provisions for redemption pricing between 101.5% and 100.5% of the liquidation value, if called after five years but prior to the stated maturity date.

#### Subordinated Debt Issued December 2017

On December 19, 2017, Mid Penn entered into agreements with investors to purchase $10,000,000 aggregate principal amount of its Subordinated Notes due 2028 (the “2017 Notes”). The 2017 Notes are intended to be treated as Tier 2 capital for regulatory capital purposes. The offering closed in December 2017.

The 2017 Notes bear interest at a rate of 5.25% per year for the first five years and then float at the Wall Street Journal’s Prime Rate plus 0.50%, provided that the interest rate applicable to the outstanding principal balance will at no times be less than 5.0%. Interest is payable semi-annually in arrears on January 15 and July 15 of each year, beginning on July 15, 2018, for the first five years after issuance and will be payable quarterly in arrears thereafter on January 15, April 15, July 15, and October 15. The 2017 Notes will mature on January 1, 2028 and are redeemable in whole or in part, without premium or penalty, at any time on or after December 21, 2022, and prior to January 1, 2028. Additionally, Mid Penn may redeem the 2017 Notes in whole at any time, or in part from time to time, upon at least 30 days’ notice if: (i) a change or prospective change in law occurs that could prevent Mid Penn from deducting interest payable on the 2017 Notes for U.S. federal income tax purposes; (ii) an event occurs that precludes the 2017 Notes from being recognized as Tier 2 capital for regulatory capital purposes; or (iii) Mid Penn becomes required to register as an investment company under the Investment Company Act of 1940, as amended. In the event of a redemption described in the previous sentence, Mid Penn will redeem the 2017 Notes at 100% of the principal amount of the 2017 Notes, plus accrued and unpaid interest thereon to but excluding the date of redemption.

Holders of the 2017 Notes may not accelerate the maturity of the 2017 Notes, except upon the bankruptcy, insolvency, liquidation, receivership or similar event of Mid Penn or Mid Penn Bank, its principal banking subsidiary.

#### Subordinated Debt Issued December 2015

On December 9, 2015, Mid Penn sold $7,500,000 aggregate principal amount of Subordinated Debt (the “2015 Notes”) due 2025. The 2015 Notes are treated as Tier 2 capital for regulatory capital purposes.

The 2015 Notes bear interest at a rate of 5.15% per year for the first five years and then float at the Wall Street Journal’s Prime Rate plus 0.50%, provided that the interest rate applicable to the outstanding principal balance will at no time be less than 4.0%. Interest is payable quarterly in arrears on January 1, April 1, July 1 and October 1 of each year, beginning on January 1, 2016. The 2015 Notes will mature on December 9, 2025 and are redeemable in whole or in part, without premium or penalty, at any time on or after December 9, 2020, and prior to December 9, 2025. Additionally, Mid Penn may redeem the 2015 Notes in whole at any time, or in part from time to time, upon at least 30 days’ notice if: (i) a change or prospective change in law occurs that could prevent Mid Penn from deducting interest payable on the 2015 Notes for U.S. federal income tax purposes; (ii) an event occurs that precludes the 2015 Notes from being recognized as Tier 2 capital for regulatory capital purposes; or (iii) Mid Penn becomes required to register as an investment company under the Investment Company Act of 1940, as amended, in each case at 100% of the principal amount of the 2015 Notes, plus accrued and unpaid interest thereon to but excluding the date of redemption.

Holders of the 2015 Notes may not accelerate the maturity of the 2015 Notes, except upon Mid Penn’s or Mid Penn Bank’s bankruptcy, insolvency, liquidation, receivership or similar event.

### 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 as of January 1, 2019.

A summary of the payout restrictions based on the capital conservation buffer is as follows:

| Capital Conservation Buffer (as a % of risk-weighted assets) \> 2.5% | Maximum Payout (as a % of eligible retained income) No payout limitation applies |
| --- | ---: |
| ≤2.5% and \>1.875% | 60% |
| ≤1.875% and \>1.25% | 40% |
| ≤1.25% and \>0.625% | 20% |
| ≤0.625% | 0% |

The final rules allowed community banks to make a one-time election not to include the additional components of accumulated other comprehensive income (“AOCI”) in regulatory capital and instead use the existing treatment under the general risk-based capital rules that excludes most AOCI components from regulatory capital. Mid Penn made the election not to include the additional components of AOCI in regulatory capital.

Consistent with the Dodd-Frank Act, the new rules replaced the ratings-based approach to securitization exposures, which is based on external credit ratings, with the simplified supervisory formula approach in order to determine the appropriate risk weights for these exposures. Alternatively, banking organizations may use the existing gross-ups approach to assign securitization exposures to a risk weight category or choose to assign such exposures a 1,250% risk weight.

Under the new rules, mortgage servicing assets (“MSAs”) and certain deferred tax assets (“DTAs”) 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.

Mid Penn has implemented these changes in determining and reporting the regulatory ratios of Mid Penn and the Bank, and has concluded that the new rules do not have a material adverse effect on Mid Penn’s financial condition.

### Capital Resources

Shareholders' equity, or capital, is evaluated in relation to total assets and the risk associated with those assets. The greater a corporation’s capital resources, the more likely it is to meet its cash obligations and absorb unforeseen losses. Too much capital, however, indicates that not enough of the corporation’s earnings have been invested in the continued growth of the business or paid to shareholders. An excess capital position may make it difficult for a corporation to offer a competitive return on the shareholders’ capital going forward. For these reasons capital adequacy and capital management have been, and will continue to be, of paramount importance.

Shareholders’ equity increased by $1,637,000 or less than 1 percent from $237,874,000 as of December 31, 2019 to $239,511,000 as of March 31, 2020. The increase in shareholders’ equity reflects the growth in retained earnings through year-to-date net income, net of dividends paid. Regulatory capital ratios for both Mid Penn and its banking subsidiary exceeded regulatory “well-capitalized” levels at both March 31, 2020 and December 31, 2019.

Banks are evaluated for capital adequacy 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 March 31, 2020, regulatory capital ratios for both Mid Penn and the Bank met the definition of a “well-capitalized” institution under the regulatory framework for prompt corrective action, and exceeded the minimum capital requirements under Basel III.

Mid Penn and Mid Penn Bank maintained the following regulatory capital levels, leverage ratios, and risk-based capital ratios as of March 31, 2020 and December 31, 2019:

*(Dollars in thousands)*

| Mid Penn Bancorp, Inc. As of March 31, 2020: | Capital Adequacy Actual: Amount | Ratio | Minimum Capital Required: Amount | Ratio | To Be Well-Capitalized Under Prompt Corrective Action Provisions: Amount | Ratio |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Tier 1 Capital (to Average Assets) | $170,597 | 7.8% | $87,547 | 4.0% | N/A | N/A |
| Common Equity Tier 1 Capital (to Risk Weighted Assets) | 170,597 | 9.6% | 124,990 | 7.0% | N/A | N/A |
| Tier 1 Capital (to Risk Weighted Assets) | 170,597 | 9.6% | 151,773 | 8.5% | N/A | N/A |
| Total Capital (to Risk Weighted Assets) | 222,750 | 12.5% | 187,484 | 10.5% | N/A | N/A |
| Mid Penn Bank |  |  |  |  |  |  |
| As of March 31, 2020: |  |  |  |  |  |  |
| Tier 1 Capital (to Average Assets) | $187,137 | 8.6% | $87,547 | 4.0% | $109,433 | 5.0% |
| Common Equity Tier 1 Capital (to Risk Weighted Assets) | 187,137 | 10.5% | 124,962 | 7.0% | 116,036 | 6.5% |
| Tier 1 Capital (to Risk Weighted Assets) | 187,137 | 10.5% | 151,740 | 8.5% | 142,814 | 8.0% |
| Total Capital (to Risk Weighted Assets) | 206,731 | 11.6% | 187,443 | 10.5% | 178,518 | 10.0% |
| Mid Penn Bancorp, Inc. |  |  |  |  |  |  |
| As of December 31, 2019: |  |  |  |  |  |  |
| Tier 1 Capital (to Average Assets) | $168,146 | 7.8% | $86,773 | 4.00% | N/A | N/A |
| Common Equity Tier 1 Capital (to Risk Weighted Assets) | 168,146 | 9.8% | 120,020 | 7.00% | N/A | N/A |
| Tier 1 Capital (to Risk Weighted Assets) | 168,146 | 9.8% | 145,738 | 8.50% | N/A | N/A |
| Total Capital (to Risk Weighted Assets) | 204,811 | 11.9% | 180,030 | 10.50% | N/A | N/A |
| Mid Penn Bank |  |  |  |  |  |  |
| As of December 31, 2019: |  |  |  |  |  |  |
| Tier 1 Capital (to Average Assets) | $185,101 | 8.5% | $86,760 | 4.00% | $108,450 | 5.0% |
| Common Equity Tier 1 Capital (to Risk Weighted Assets) | 185,101 | 10.8% | 119,995 | 7.00% | 111,424 | 6.5% |
| Tier 1 Capital (to Risk Weighted Assets) | 185,101 | 10.8% | 145,708 | 8.50% | 137,137 | 8.0% |
| Total Capital (to Risk Weighted Assets) | 204,196 | 11.9% | 179,992 | 10.50% | 171,421 | 10.0% |

53

## Market risk

As filed, 3,527 characters.

As a financial institution, Mid Penn’s primary source of market risk is interest rate risk. Interest rate risk is the exposure to fluctuations in Mid Penn’s future earnings (earnings at risk) resulting from changes in interest rates. This exposure or sensitivity is a function of the repricing characteristics of Mid Penn's portfolio of assets and liabilities. Each asset and liability reprices either at maturity or during the life of the instrument. Interest rate sensitivity is measured as the difference between the volume of assets and liabilities that are subject to repricing in a future period of time.

The principal purpose of asset-liability management is to maximize current and future net interest income within acceptable levels of interest rate risk while satisfying liquidity and capital requirements. Net interest income is increased by increasing the net interest margin and by volume growth. Thus, the goal of interest rate risk management is to maintain a balance between risk and reward such that net interest income is maximized while risk is maintained at an acceptable level.

Mid Penn utilizes an asset-liability management model to measure the impact of interest rate movements on its interest rate sensitivity position. Mid Penn’s management also reviews the traditional maturity gap analysis regularly. Mid Penn does not always attempt to achieve an exact match between interest sensitive assets and liabilities because it believes that an actively managed amount of interest rate risk is inherent and appropriate in the management of Mid Penn’s profitability.

Modeling techniques and simulation analysis involve assumptions and estimates that inherently cannot be measured with complete precision. Key assumptions in the analyses include maturity and repricing characteristics of assets and liabilities, prepayments on amortizing assets, non-maturing deposit sensitivity, and loan and deposit pricing. These assumptions are inherently uncertain due to the timing, magnitude and frequency of rate changes and changes in market conditions and management strategies, among other factors. However, the analyses are useful in quantifying risk and provide a relative gauge of Mid Penn’s interest rate risk position over time.

Management reviews interest rate risk on a quarterly basis. This analysis includes earnings scenarios whereby interest rates are increased and decreased by 100, 200, and 300 basis points. These scenarios, detailed in the table below, indicate that Mid Penn would experience enhanced net interest income over a one-year time frame due to upward interest rate changes, while a reduction in interest rates would result in a decline in net interest income over a one-year time frame; however, actual results could vary significantly from the calculations prepared by management. At March 31, 2020, all interest rate risk levels according to the model were within the tolerance limits of the Board-approved policy.

| March 31, 2020 Change in Basis Points | % Change in Net Interest Income | Policy Risk Limit | December 31, 2019 Change in Basis Points | % Change in Net Interest Income | Policy Risk Limit |
| ---: | ---: | --- | ---: | ---: | --- |
| 300 | 13.32% | ≥ -20% | 300 | 10.43% | ≥ -20% |
| 200 | 9.11% | ≥ -15% | 200 | 6.84% | ≥ -15% |
| 100 | 4.24% | ≥ -10% | 100 | 3.37% | ≥ -10% |
| 0 |  |  | 0 |  |  |
| (100) | -4.30% | ≥ -10% | (100) | -2.87% | ≥ -10% |
| (200) | -9.39% | ≥ -15% | (200) | -4.99% | ≥ -15% |
| (300) | -14.46% | ≥ -20% | (300) | -8.66% | ≥ -20% |

## Controls and procedures

As filed, 963 characters.

### Evaluation of Disclosure Controls and Procedures

Mid Penn maintains controls and procedures designed to ensure that information required to be disclosed in the reports that Mid Penn files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls and procedures as of March 31, 2020, Mid Penn’s management, with the participation of the Principal Executive Officer and Principal Financial Officer, concluded that the disclosure controls and procedures were effective as of such date.

### Changes in Internal Controls

There were no changes in Mid Penn’s internal control over financial reporting that have materially affected, or are reasonable likely to materially affect, Mid Penn’s internal control over financial reporting during the three months ended March 31, 2020.

## Risk factors

As filed, 7,663 characters.

Management has reviewed the risk factors that were previously disclosed in the Annual Report on Form 10-K for the fiscal year ended December 31, 2019, to determine if there were material changes applicable to the three months ended March 31, 2020. There are no material changes to such risk factors, other than as described below.

***As a participating lender in the SBA Paycheck Protection Program (“PPP”), we are subject to additional risks of litigation from our clients or other parties regarding our processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties.***

On March 27, 2020, President Trump signed the CARES Act, which included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. We are a participating as a lender in the PPP. The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the PPP, which exposes the Corporation to risks relating to noncompliance with the PPP. On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the PPP was exhausted. Congress has approved additional funding for the PPP and President Trump signed the new legislation on April 24, 2020. Since the opening of the PPP, several other larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. We may be exposed to the risk of litigation, from both clients and non-clients that approached us regarding PPP loans, regarding our process and procedures used in processing applications for the PPP. If any such litigation is filed against us and is not resolved in a manner favorable to us, it may result in significant financial liability or adversely affect our reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have a material adverse impact on our business, financial condition and results of operations.

We also have credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by us, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by us, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from us.

***The COVID-19 pandemic has caused a significant global and national economic downturn and unprecedented levels of unemployment, which may adversely affect, our business and results of operations, and the future impact of the COVID-19 pandemic on the global, national and local economies and our business, results of operations and financial condition remain uncertain.***

The COVID-19 pandemic has caused a significant global and national economic downturn and unprecedented levels of unemployment, which has adversely affected, and is expected to continue to adversely affect, the Corporation’s business and results of operations, and the future impact of the COVID-19 pandemic on the global, national and local economies and the Corporation’s business, results of operations and financial condition remain uncertain.

The COVID-19 pandemic has resulted in authorities implementing numerous measures attempting to contain the spread and impact of COVID-19, such as travel bans and restrictions, quarantines, shelter in place orders, and limitations on business activity, including closures. These measures are, among other things, severely restricting global and national economic activity, which is disrupting supply chains, lowering asset valuations, significantly increasing unemployment and underemployment levels, decreasing liquidity in markets for certain securities and causing significant volatility and disruptions in the financial markets. These measures have negatively impacted, and could continue to negatively impact, businesses, market participants, our counterparties and clients, and the global, national and local economies for a prolonged period of time. Should current economic conditions persist or continue to deteriorate, this economic environment could have a continued adverse effect on our business and operations, including but not limited to: decreased demand for our products and services; protracted periods of lower interest rates; lower asset management fees; and increased credit losses due to deterioration in the financial condition of our consumer and commercial borrowers, including declining asset and collateral values, which may result in an increase in our provision for credit losses and net charge-offs. Additionally, our liquidity and regulatory capital could be adversely impacted by customers’ withdrawal of deposits, volatility and disruptions in the capital and credit markets, and customer draws on lines of credit. To the extent the COVID-19 pandemic continues to adversely affect the economy, and/or adversely affects our business, results of operations or financial condition, it may also have the effect of increasing the likelihood and/or magnitude of other risks described in the section captioned “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2019, including those risks related to market, credit, and business operations, or risks described in our other filings with the Securities and Exchange Commission.

In response to the economic and market conditions resulting from the COVID-19 pandemic, governments and regulatory authorities, including central banks, have acted to provide fiscal and monetary stimulus to support the global and national economy. However, there can be no assurance that these measures will stimulate the global and national economy or avert recessionary conditions in markets in which we conduct operations.

We continue to closely monitor the COVID-19 pandemic and related risks as they evolve. The magnitude, duration and likelihood of the current outbreak of COVID-19, further outbreaks of COVID-19, future actions taken by governmental authorities and/or other third parties in response to the COVID-19 pandemic, and its future direct and indirect effects on the global, national and local economies and our business and results of operation are highly uncertain. The COVID-19 pandemic may cause prolonged global, national or local recessionary economic conditions or longer lasting effects on economic conditions than currently exist, which could have a material adverse effect on our business, results of operations and financial condition.

For a more detailed description of these and other factors which would affect our results, please see Mid Penn’s filings with the SEC, including those risk factors identified in the "Risk Factors" section and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2019 and subsequent filings.

Filed May 11, 2020.
Source: SEC EDGAR, the filing index for accession 0001564590-20-023969. Last ingested by Listed: Nov 5, 2026, 18:25 ET. No prices; not investment advice.