8. ALLOWANCE FOR LOAN AND LEASE LOSSES AND CREDIT QUALITY INFORMATION

Allowance for Loan Losses

We maintain an allowance for loan losses which represents our best estimate of probable losses in our loan portfolio. As losses are realized, they are charged to this allowance. We established our allowance in accordance with guidance provided in the SEC’s Staff Accounting Bulletin 102 (SAB 102), Selected Loan Loss Allowance Methodology and Documentation Issues, ASC 450, Contingencies and ASC 310, Receivables. When we have reason to believe it is probable that we will not be able to collect all contractually due amounts of principal and interest, loans are evaluated for impairment on an individual basis and a specific allocation of the allowance is assigned in accordance with ASC 310-10. We also maintain an allowance for loan losses on acquired loans when: (i) for loans accounted for under ASC 310-30, there is deterioration in credit quality subsequent to acquisition and (ii) for loans accounted for under ASC 310-20, the inherent losses in the loans exceed the remaining credit discount recorded at the time of acquisition. The determination of the allowance for loan losses requires significant judgment reflecting our best estimate of impairment related to specifically identified impaired loans as well as probable loan losses in the remaining loan portfolio. Our evaluation is based on a continuing review of these portfolios. The following are included in our allowance for loan losses:


•	Specific reserves for impaired loans


•	An allowance for each pool of homogeneous loans based on historical loss experience


•	Adjustments for qualitative and environmental factors allocated to pools of homogeneous loans

When it is probable that the Bank will be unable to collect all amounts due (interest and principal) in accordance with the contractual terms of the loan agreement, it assigns a specific reserve to that loan, as necessary. Unless loans are well-secured and collection is imminent, loans greater than 90 days past due are deemed impaired and their respective reserves are generally charged off once the loss has been confirmed. Estimated specific reserves are based on collateral values, estimates of future cash flows or market valuations. We charge loans off when they are deemed to be uncollectible. During the three months ended March 31, 2019 and 2018, net charge-offs totaled $0.9 million, or 0.06%, of average loans annualized, and $3.4 million, or 0.29%, of average loans annualized, respectively.

Allowances for pooled homogeneous loans, that are not deemed impaired, are based on historical net loss experience. Estimated losses for pooled portfolios are determined differently for commercial loan pools and retail loan pools. Commercial loans are pooled as follows: commercial, owner-occupied commercial, commercial mortgages and construction. Each pool is further segmented by internally assessed risk ratings. Loan losses for commercial loans are estimated by determining the probability of default and expected loss severity upon default. The probability of default is calculated based on the historical rate of migration to impaired status during the last 33 quarters. During the first quarter of 2019, we increased the look-back period to 33 quarters from the 32 quarters used at December 31, 2018. This increase in the look-back period allows us to continue to anchor to the fourth quarter of 2010 to ensure that the quantitative reserves calculated by the allowance for loan loss model are adequately considering the losses within a full credit cycle.

Loss severity upon default is calculated as the actual loan losses (net of recoveries) on impaired loans in their respective pool during the same time frame. Retail loans are pooled into the following segments: residential mortgage, consumer secured and consumer unsecured loans. Pooled reserves for retail loans are calculated based solely on average net loss rates over the same 33 quarter look-back period.

Qualitative adjustment factors consider various current internal and external conditions which are allocated among loan types and take into consideration:


•	Current underwriting policies, staff, and portfolio mix,


•	Internal trends of delinquency, nonaccrual and criticized loans by segment,


•	Risk rating accuracy, control and regulatory assessments/environment,


•	General economic conditions - locally and nationally,


•	Market trends impacting collateral values, and


•	The competitive environment, as it could impact loan structure and underwriting.

The above factors are based on their relative standing compared to the period in which historic losses are used in quantitative reserve estimates and current directional trends. Qualitative factors in our model can add to or subtract from quantitative reserves.

The allowance methodology uses a loss emergence period (LEP), which is the period of time between an event that triggers the probability of a loss and the confirmation of the loss. We estimate the commercial LEP to be approximately nine quarters as of March 31, 2019. Our residential mortgage and consumer LEP estimate remains at four quarters as of March 31, 2019. We evaluate LEP quarterly for reasonableness and complete a detailed historical analysis of our LEP annually for our commercial portfolio and review the current four quarter LEP for the retail portfolio to determine the continued reasonableness of this assumption.

Our loan officers and risk managers meet at least quarterly to discuss and review the conditions and risks associated with individual problem loans. In addition, various regulatory agencies periodically review our loan ratings and allowance for loan losses and the Bank’s internal loan review department performs loan reviews.

The following tables provide the activity of our allowance for loan losses and loan balances for the three months ended March 31, 2019:



(Dollars in thousands)	Commercial and Industrial⁽¹⁾			Owner-occupied Commercial			Commercial Mortgages			Construction		Residential⁽²⁾			Consumer			Total
Three months ended March 31, 2019
Allowance for loan losses
Beginning balance	$	14,211		$	5,057		$	6,806		$	3,712	$	1,428		$	8,325		$	39,539
Charge-offs	(742		)	—			(2		)	—		(122		)	(684		)	(1,550		)
Recoveries	358			3			29			1		(14		)	301			678
Provision (credit)	7,123			(111		)	(156		)	331		51			257			7,495
Provision (credit) for acquired loans	66			—			2			—		58			33			159
Ending balance	$	21,016		$	4,949		$	6,679		$	4,044	$	1,401		$	8,232		$	46,321
Period-end allowance allocated to:
Loans individually evaluated for impairment	$	4,588		$	—		$	—		$	367	$	533		$	166		$	5,654
Loans collectively evaluated for impairment	16,427			4,856			6,600			3,663		830			8,064			40,440
Acquired loans evaluated for impairment	1			93			79			14		38			2			227
Ending balance	$	21,016		$	4,949		$	6,679		$	4,044	$	1,401		$	8,232		$	46,321
Period-end loan balances:
Loans individually evaluated for impairment⁽³⁾	$	16,109		$	5,384		$	3,999		$	2,781	$	10,590		$	8,169		$	47,032
Loans collectively evaluated for impairment	1,415,689			1,198,337			753,911			347,035		130,499			824,684			4,670,155
Acquired nonimpaired loans	782,160			105,154			1,575,527			225,245		949,804			295,450			3,933,340
Acquired impaired loans	6,130			4,070			19,715			636		8,483			3,456			42,490
Ending balance⁽⁴⁾	$	2,220,088		$	1,312,945		$	2,353,152		$	575,697	$	1,099,376		$	1,131,759		$	8,693,017


⁽¹⁾	Includes commercial small business leases.


⁽²⁾	Period-end loan balance excludes reverse mortgages at fair value of $16.2 million.


⁽³⁾	The difference between this amount and nonaccruing loans represents accruing troubled debt restructured loans of $15.0 million for the period ending March 31, 2019. Accruing troubled debt restructured loans are considered impaired loans.


⁽⁴⁾	Ending loan balances do not include net deferred fees.

The following table provides the activity of the allowance for loan losses and loan balances for the three months ended March 31, 2018:



(Dollars in thousands)	Commercial and Industrial			Owner - occupied Commercial			Commercial Mortgages			Construction			Residential⁽¹⁾			Consumer			Total
Three months ended March 31, 2018
Allowance for loan losses
Beginning balance	$	16,732		$	5,422		$	5,891		$	2,861		$	1,798		$	7,895		$	40,599
Charge-offs	(3,360		)	(10		)	(48		)	—			—			(462		)	(3,880		)
Recoveries	80			5			134			1			14			207			441
Provision (credit)	2,650			(58		)	617			27			(129		)	548			3,655
Provision for acquired loans	—			—			23			(25		)	(3		)	—			(5		)
Ending balance	$	16,102		$	5,359		$	6,617		$	2,864		$	1,680		$	8,188		$	40,810
Period-end allowance allocated to:
Loans individually evaluated for impairment	$	2,632		$	—		$	—		$	—		$	643		$	186		$	3,461
Loans collectively evaluated for impairment	13,296			5,347			6,528			2,857			1,001			7,994			37,023
Acquired loans evaluated for impairment	174			12			89			7			35			9			326
Ending balance	$	16,102		$	5,359		$	6,617		$	2,864		$	1,679		$	8,189		$	40,810
Period-end loan balances:
Loans individually evaluated for impairment⁽²⁾	$	16,993		$	4,342		$	5,946		$	6,490		$	12,861		$	7,677		$	54,309
Loans collectively evaluated for impairment	1,361,517			938,166			970,750			267,293			145,753			541,644			4,225,123
Acquired nonimpaired loans	107,183			133,007			178,518			15,259			67,722			33,152			534,841
Acquired impaired loans	3,870			5,147			9,210			901			777			249			20,154
Ending balance⁽³⁾	$	1,489,563		$	1,080,662		$	1,164,424		$	289,943		$	227,113		$	582,722		$	4,834,427


⁽¹⁾	Period-end loan balance excludes reverse mortgages at fair value of $20.0 million.


⁽²⁾	The difference between this amount and nonaccruing loans represents accruing troubled debt restructured loans of $20.2 million for the period ending March 31, 2018. Accruing troubled debt restructured loans are considered impaired loans.


⁽³⁾	Ending loan balances do not include net deferred fees.

Nonaccrual and Past Due Loans

Nonaccruing loans are those on which the accrual of interest has ceased. Typically, we discontinue accrual of interest on originated loans after payments become more than 90 days past due or earlier if we do not expect the full collection of principal or interest in accordance with the terms of the loan agreement. Interest accrued but not collected at the date a loan is placed on nonaccrual status is reversed and charged against interest income. In addition, the accretion of net deferred loan fees and amortization of net deferred loan costs is suspended when a loan is placed on nonaccrual status. Subsequent cash receipts are applied either to the outstanding principal balance or recorded as interest income, depending on our assessment of the ultimate collectability of principal and interest. Loans greater than 90 days past due and still accruing are defined as loans contractually past due 90 days or more as to principal or interest payments, but which remain in accrual status because they are considered well secured and are in the process of collection.

The following tables show our nonaccrual and past due loans at the dates indicated:



	March 31, 2019
(Dollars in thousands)	30–59 Days Past Due and Still Accruing			60–89 Days Past Due and Still Accruing			Greater Than 90 Days Past Due and Still Accruing			Total Past Due And Still Accruing			Accruing Current Balances			Acquired Impaired Loans			Nonaccrual Loans			Total Loans
Commercial and industrial⁽¹⁾	$	2,941		$	833		$	—		$	3,774		$	2,194,854		$	6,130		$	15,330		$	2,220,088
Owner-occupied commercial	3,109			—			—			3,109			1,300,383			4,070			5,383			1,312,945
Commercial mortgages	5,848			114			—			5,962			2,323,606			19,715			3,869			2,353,152
Construction	638			1,309			—			1,947			570,333			636			2,781			575,697
Residential⁽²⁾	11,404			1,751			739			13,894			1,074,517			8,483			2,482			1,099,376
Consumer	10,470			6,017			12,237			28,724			1,097,386			3,456			2,193			1,131,759
Total⁽³⁾	$	34,410		$	10,024		$	12,976		$	57,410		$	8,561,079		$	42,490		$	32,038		$	8,693,017
% of Total Loans	0.40		%	0.11		%	0.15		%	0.66		%	98.48		%	0.49		%	0.37		%	100		%


⁽¹⁾	Includes commercial small business leases.


⁽²⁾	Residential accruing current balances excludes reverse mortgages at fair value of $16.2 million.


⁽³⁾	The balances above include a total of $3.9 billion acquired non-impaired loans.



	December 31, 2018
(Dollars in thousands)	30–59 Days Past Due and Still Accruing			60–89 Days Past Due and Still Accruing			Greater Than 90 Days Past Due and Still Accruing			Total Past Due And Still Accruing			Accruing Current Balances			Acquired Impaired Loans			Nonaccrual Loans			Total Loans
Commercial and industrial	$	3,653		$	993		$	71		$	4,717		$	1,452,185		$	1,531		$	14,056		$	1,472,489
Owner-occupied commercial	733			865			—			1,598			1,049,722			4,248			4,406			1,059,974
Commercial mortgages	1,388			908			—			2,296			1,148,988			7,504			3,951			1,162,739
Construction	157			—			—			157			312,879			749			2,781			316,566
Residential⁽¹⁾	1,970			345			660			2,975			194,960			761			2,854			201,550
Consumer	525			971			104			1,600			677,182			151			2,006			680,939
Total⁽²⁾	$	8,426		$	4,082		$	835		$	13,343		$	4,835,916		$	14,944		$	30,054		$	4,894,257
% of Total Loans	0.17		%	0.08		%	0.02		%	0.27		%	98.81		%	0.31		%	0.61		%	100		%


⁽¹⁾	Residential accruing current balances excludes reverse mortgages, at fair value of $16.5 million.


⁽²⁾	The balances above include a total of $430.0 million acquired non-impaired loans.

Impaired Loans

Loans for which it is probable we will not collect all principal and interest due according to their contractual terms, which is assessed based on the credit characteristics of the loan and/or payment status, are measured for impairment in accordance with the provisions of SAB 102 and ASC 310. The amount of impairment is required to be measured using one of three methods: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the fair value of collateral, if the loan is collateral dependent or (3) the loan’s observable market price. If the measure of the impaired loan is less than the recorded investment in the loan, a related allowance is allocated for the impairment.

The following tables provide an analysis of our impaired loans at March 31, 2019 and December 31, 2018:



	March 31, 2019
(Dollars in thousands)	Ending Loan Balances		Loans with No Related Reserve⁽¹⁾		Loans with Related Reserve⁽²⁾		Related Reserve		Contractual Principal Balances⁽²⁾		Average Loan Balances
Commercial and industrial	$	16,114	$	10,200	$	5,914	$	4,590	$	22,775	$	17,539
Owner-occupied commercial	6,988		5,384		1,604		92		7,316		5,701
Commercial mortgages	5,579		3,999		1,580		79		15,321		7,034
Construction	3,432		—		3,432		382		4,970		4,519
Residential	10,892		6,877		4,015		571		13,136		11,932
Consumer	8,201		7,212		989		168		9,171		8,032
Total	$	51,206	$	33,672	$	17,534	$	5,882	$	72,689	$	54,757


⁽¹⁾	Reflects loan balances at or written down to their remaining book balance.


⁽²⁾	The above includes acquired impaired loans totaling $4.2 million in the ending loan balance and $4.6 million in the contractual principal balance.



	December 31, 2018
(Dollars in thousands)	Ending Loan Balances		Loans with No Related Reserve⁽¹⁾		Loans with Related Reserve⁽²⁾		Related Reserve		Contractual Principal Balances⁽²⁾		Average Loan Balances
Commercial and industrial	$	14,841	$	8,625	$	6,216	$	878	$	22,365	$	18,484
Owner-occupied commercial	6,065		4,406		1,659		92		6,337		5,378
Commercial mortgages	5,679		4,083		1,596		79		15,372		7,438
Construction	3,530		—		3,530		458		5,082		5,091
Residential	11,321		6,442		4,879		581		13,771		12,589
Consumer	7,916		6,899		1,017		170		8,573		7,956
Total	$	49,352	$	30,455	$	18,897	$	2,258	$	71,500	$	56,936


⁽¹⁾	Reflects loan balances at or written down to their remaining book balance.


⁽²⁾	The above includes acquired impaired loans totaling $4.3 million in the ending loan balance and $4.8 million in the contractual principal balance.

Interest income of $0.2 million and $0.3 million was recognized on impaired loans during the three months ended March 31, 2019 and March 31, 2018, respectively.

As of March 31, 2019, there were 17 residential loans and 13 commercial loans in the process of foreclosure. The total outstanding balance on these loans was $1.2 million and $5.6 million, respectively. As of December 31, 2018, there were 26 residential loans and 11 commercial loans in the process of foreclosure. The total outstanding balance on the loans was $1.9 million and $5.3 million, respectively.

Reserves on Acquired Nonimpaired Loans

In accordance with ASC 310, loans acquired by the Bank through its mergers with First National Bank of Wyoming, Alliance Bancorp, Inc. (Alliance), Penn Liberty Bank (Penn Liberty) and Beneficial are reflected on the balance sheet at their fair values on the date of acquisition as opposed to their contractual values. Therefore, on the date of acquisition establishing an allowance for acquired loans is prohibited. After the acquisition date, the Bank performs a separate allowance analysis on a quarterly basis to determine if an allowance for loan loss is necessary. Should the credit risk calculated exceed the purchased loan portfolio’s remaining credit mark, additional reserves will be added to the Bank’s allowance. When a purchased loan becomes impaired after its acquisition, it is evaluated as part of the Bank’s reserve analysis and a specific reserve is established to be included in the Bank’s allowance.

Credit Quality Indicators

Below is a description of each of our risk ratings for all commercial loans:


•	Pass. These borrowers currently show no indication of deterioration or potential problems and their loans are considered fully collectible.

•

Special Mention. Borrowers have potential weaknesses that deserve management’s close attention. Borrowers in this category may be experiencing adverse operating trends, for example, declining revenues or margins, high leverage, tight liquidity, or increasing inventory without increasing sales. These adverse trends can have a potential negative effect on the borrower’s repayment capacity. These assets are not adversely classified and do not expose the Bank to significant risk that would warrant a more severe rating. Borrowers in this category may also be experiencing significant management problems, pending litigation, or other structural credit weaknesses.

•

Substandard. Borrowers have well-defined weaknesses that require extensive oversight by management. Borrowers in this category may exhibit one or more of the following: inadequate debt service coverage, unprofitable operations, insufficient liquidity, high leverage, and weak or inadequate capitalization. Relationships in this category are not adequately protected by the sound financial worth and paying capacity of the obligor or the collateral pledged on the loan, if any. A distinct possibility exists that the Bank will sustain some loss if the deficiencies are not corrected.

•

Doubtful. Borrowers have well-defined weaknesses inherent in the Substandard category with the added characteristic that the possibility of loss is extremely high. Current circumstances in the credit relationship make collection or liquidation in full highly questionable. A doubtful asset has some pending event that may strengthen the asset that defers the loss classification. Such impending events include: perfecting liens on additional collateral, obtaining collateral valuations, an acquisition or liquidation preceding, proposed merger, or refinancing plan.


•	Loss. Loans are uncollectible or of such negligible value that continuance as a bankable asset is not supportable. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical to defer writing off this asset even though partial recovery may be recognized sometime in the future.

Residential and Consumer Loans

The residential and consumer loan portfolios are monitored on an ongoing basis using delinquency information and loan type as credit quality indicators. These credit quality indicators are assessed in the aggregate in these relatively homogeneous portfolios. Loans that are greater than 90 days past due are generally considered nonperforming and placed on nonaccrual status.

The following tables provide an analysis of loans by portfolio segment based on the credit quality indicators used to determine the Allowance for Loan Loss.

Commercial Credit Exposure



	March 31, 2019
	Commercial and Industrial⁽¹⁾		Owner-occupied Commercial		Commercial Mortgages		Construction		Total Commercial⁽²⁾
(Dollars in thousands)									Amount		%
Risk Rating:
Special mention	$	8,127	$	27,030	$	—	$	—	$	35,157
Substandard:
Accrual	54,890		23,671		10,422		1,309		90,292
Nonaccrual	10,741		5,384		3,869		2,414		22,408
Doubtful	4,588		—		—		367		4,955
Total Special Mention and Substandard	78,346		56,085		14,291		4,090		152,812		2	%
Acquired impaired	6,130		4,070		19,715		636		30,551		—	%
Pass	2,135,612		1,252,790		2,319,146		570,971		6,278,519		98	%
Total	$	2,220,088	$	1,312,945	$	2,353,152	$	575,697	$	6,461,882	100	%


⁽¹⁾	Includes commercial small business leases.


⁽²⁾	Table includes $2.7 billion of acquired non-impaired loans as of March 31, 2019.



	December 31, 2018
	Commercial and Industrial		Owner-occupied Commercial		Commercial Mortgages		Construction		Total Commercial⁽¹⁾
(Dollars in thousands)									Amount		%
Risk Rating:
Special mention	$	8,710	$	21,230	$	—	$	—	$	29,940
Substandard:
Accrual	37,424		21,081		9,767		168		68,440
Nonaccrual	13,180		4,406		3,951		2,337		23,874
Doubtful	876		—		—		444		1,320
Total Special Mention and Substandard	60,190		46,717		13,718		2,949		123,574		3	%
Acquired impaired	1,531		4,248		7,504		749		14,032		—	%
Pass	1,410,768		1,009,009		1,141,517		312,868		3,874,162		97	%
Total	$	1,472,489	$	1,059,974	$	1,162,739	$	316,566	$	4,011,768	100	%


⁽¹⁾	Table includes $350.5 million of acquired non-impaired loans as of December 31, 2018.

Residential and Consumer Credit Exposure



	Residential⁽²⁾				Consumer				Total Residential and Consumer⁽³⁾
	March 31,		December 31,		March 31,		December 31,		March 31, 2019				December 31, 2018
(Dollars in thousands)	2019		2018		2019		2018		Amount		Percent		Amount		Percent
Nonperforming⁽¹⁾	$	10,590	$	11,017	$	8,169	$	7,883	$	18,759	1	%	$	18,900	2	%
Acquired impaired loans	8,483		761		3,456		151		11,939		—	%	912		—	%
Performing	1,080,303		189,772		1,120,134		672,905		2,200,437		99	%	862,677		98	%
Total	$	1,099,376	$	201,550	$	1,131,759	$	680,939	$	2,231,135	100	%	$	882,489	100	%


⁽¹⁾	Includes $14.1 million as of March 31, 2019 and $14.0 million as of December 31, 2018 of troubled debt restructured mortgages and home equity installment loans that are performing in accordance with the loans’ modified terms and are accruing interest.


⁽²⁾	Residential performing loans excludes $16.2 million and $16.5 million of reverse mortgages at fair value as of March 31, 2019 and December 31, 2018, respectively.


⁽³⁾	Total includes $1.2 billion and $79.5 million in acquired non-impaired loans as of March 31, 2019 and December 31, 2018, respectively.

Troubled Debt Restructurings (TDRs)

TDRs are recorded in accordance with ASC 310-40, Troubled Debt Restructuring by Creditors.

The following table presents the balance of TDRs as of the indicated dates:



(Dollars in thousands)	March 31, 2019		December 31, 2018
Performing TDRs	$	14,995	$	14,953
Nonperforming TDRs	9,401		10,211
Total TDRs	$	24,396	$	25,164

Approximately $1.1 million and $1.2 million in related reserves have been established for these loans at March 31, 2019 and December 31, 2018, respectively.

The following table presents information regarding the types of loan modifications made for the three months ended March 31, 2019 and 2018:



	March 31, 2019					March 31, 2018
	Contractual payment reduction and term extension	Maturity Date Extension	Discharged in bankruptcy	Other⁽¹⁾	Total	Contractual payment reduction and term extension	Maturity Date Extension	Discharged in bankruptcy	Other⁽¹⁾	Total
Commercial and Industrial	—	—	—	—	—	—	—	—	—	—
Owner-occupied commercial	—	—	—	—	—	—	—	—	—	—
Commercial Mortgages	1	—	—	—	1	—	1	—	—	1
Construction	—	—	—	—	—	—	1	—	—	1
Residential	—	—	1	1	2	—	—	—	—	—
Consumer	—	—	1	3	4	1	1	—	2	4
Total	1	—	2	4	7	1	3	—	2	6


⁽¹⁾	Other includes underwriting exceptions.

Principal balances are generally not forgiven when a loan is modified as a TDR. Nonaccruing restructured loans remain in nonaccrual status until there has been a period of sustained repayment performance, which is typically six months, and payment is reasonably assured.

The following table presents loans identified as TDRs during the three months ended March 31, 2019 and 2018.



	Three Months Ended March 31,
	2019				2018
(Dollars in thousands)	Pre Modification		Post Modification		Pre Modification		Post Modification
Commercial	$	—	$	—	$	—	$	—
Owner-occupied commercial	—		—		—		—
Commercial mortgages	31		31		458		458
Construction	—		—		920		920
Residential	102		102		—		—
Consumer	868		868		262		262
Total	$	1,001	$	1,001	$	1,640	$	1,640

During the three months ended March 31, 2019, the TDRs set forth in the table above resulted in a decrease of less than $0.1 million in our allowance for loan losses and no additional charge-offs. For the same period of 2018, the TDRs set forth in the table resulted in no change in our allowance for loan losses, and resulted in no additional charge-offs. During the three months ended March 31, 2019, one TDRs defaulted that had received troubled debt modification during the past twelve months with a total loan amount of less than $0.1 million. During the three months ended March 31, 2018, two TDRs defaulted that had received troubled debt modification during the past twelve months with a total loan amount of $0.1 million.