10-K 1 d321007d10k.htm MID PENN BANCORP INC--FORM 10-K Mid Penn Bancorp Inc--Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-K

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 1-13677

 

 

MID PENN BANCORP, INC.

(Exact Name of Registrant as Specified in its Charter)

Pennsylvania   25-1666413

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification Number)

349 Union Street

Millersburg, Pennsylvania

  17061
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code 717.692.2133

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, $1.00   The NASDAQ Stock Market, Inc.

Securities registered pursuant to Section 12(g) of the Act: None.

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One).

 

Large accelerated filer   ¨    Accelerated Filer   ¨
Non-accelerated Filer   ¨    Smaller Reporting Company   x

Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates computed by reference to the closing price of the common equity of $8.20 per share, as reported by NASDAQ, on June 30, 2011, the last business day of the registrant’s most recently completed second fiscal quarter was approximately $28,551,777.

As of February 15, 2012, the registrant had 3,484,509 shares of common stock outstanding.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement to be used in connection with the 2012 Annual Meeting of Shareholders is incorporated herein by reference in partial response to Part III, hereof.

 

 

 


Table of Contents

MID PENN BANCORP, INC.

FORM 10-K

TABLE OF CONTENTS

 

            PAGE  

PART I

       

Item 1 -

    

Business

     3   

Item 1A -

    

Risk Factors

     11   

Item 1B -

    

Unresolved Staff Comments

     15   

Item 2 -

    

Properties

     16   

Item 3 -

    

Legal Proceedings

     16   

Item 4 -

    

Mine Safety Disclosures

     16   

PART II

       

Item 5 -

    

Market for Registrant’s Common Equity, Related Shareholder Matters And Issuer Purchases of Equity Securities

     17   

Item 6 -

    

Selected Financial Data

     19   

Item 7 -

    

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     20   

Item 7A -

    

Quantitative and Qualitative Disclosure About Market Risk

     40   

Item 8 -

    

Financial Statements and Supplementary Data

     41   

Item 9 -

    

Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

     84   

Item 9A -

    

Controls and Procedures

     84   

Item 9B -

    

Other Information

     84   

PART III

       

Item 10 -

    

Directors, Executive Officers and Corporate Governance

     85   

Item 11 -

    

Executive Compensation

     85   

Item 12 -

    

Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

     85   

Item 13 -

    

Certain Relationships and Related Transactions, and Director Independence

     85   

Item 14 -

    

Principal Accountant Fees and Services

     85   

PART IV

       

Item 15 -

    

Exhibits and Financial Statement Schedules

     86   
    

Signatures

     88   

EXHIBITS

  

 

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PART I

 

ITEM 1. BUSINESS

The disclosures set forth in this Item are qualified by the section captioned “Special Cautionary Notice Regarding Forward-Looking Statements” contained in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this report and other cautionary statements set forth elsewhere in this report.

Mid Penn Bancorp, Inc.

Mid Penn Bancorp, Inc. is a one-bank holding company, incorporated in the Commonwealth of Pennsylvania in August 1991. Mid Penn Bancorp, Inc. and its wholly owned subsidiaries are collectively referred to herein as “Mid Penn” or the “Corporation.” On December 31, 1991, Mid Penn acquired, as part of the holding company formation, all of the outstanding common stock of Mid Penn Bank, and the Bank became a wholly owned subsidiary of Mid Penn. Mid Penn’s other wholly owned subsidiaries are Mid Penn Insurance Services, LLC and Mid Penn Investment Corporation. Mid Penn’s primary business is to supervise and coordinate the business of its subsidiaries and to provide them with capital and resources.

Mid Penn Investment Corporation engaged in investing activities. A decision was made to close the Mid Penn Investment Corporation, effective August 31, 2010 due to lack of activity within the subsidiary.

Mid Penn Insurance Services, LLC provided title insurance. Due to the lack of activity within this subsidiary, the decision was made to exit this line of business effective December 31, 2009. In August of 2010, Mid Penn Insurance Services, LLC was revived as a wholly-owned subsidiary of Mid Penn Bank to provide a wide range of personal and commercial insurance products.

Mid Penn’s consolidated financial condition and results of operations consist almost entirely of that of Mid Penn Bank, which is managed as a single business segment. At December 31, 2011, Mid Penn had total consolidated assets of $715,383,000, total deposits of $634,055,000, and total shareholders’ equity of $53,452,000.

As of December 31, 2011, Mid Penn Bancorp, Inc. did not own or lease any properties. Mid Penn Bank owns or leases the banking offices as identified in Part I, Item 2.

All Mid Penn employees are employed by Mid Penn Bank. At December 31, 2011, the Bank had 175 full-time and 26 part-time employees. The Bank and its employees are not subject to a collective bargaining agreement, and the Bank believes it enjoys good relations with its personnel.

Mid Penn Bank

Millersburg Bank, the predecessor to Mid Penn Bank (the “Bank”), was organized in 1868, and became a state chartered bank in 1931, obtaining trust powers in 1935, at which time its name was changed to Millersburg Trust Company. In 1962, the Lykens Valley Bank merged with and into Millersburg Trust Company. In 1971, Farmer’s State Bank of Dalmatia merged with Millersburg Trust Company and the resulting entity adopted the name “Mid Penn Bank.” In 1985, the Bank acquired Tower City National Bank. In 1998, Mid Penn acquired Miners Bank of Lykens, which was merged into Mid Penn Bank. The Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation supervise the Bank. Mid Penn’s and the Bank’s legal headquarters are located at 349 Union Street, Millersburg, Pennsylvania 17061. The Bank presently has 14 offices located in Dauphin, Northumberland, Schuylkill, and Cumberland Counties, Pennsylvania.

Mid Penn’s primary business consists of attracting deposits and loans from its network of community banking offices operated by the Bank. The Bank engages in full-service commercial banking and trust business, making available to the community a wide range of financial services, including, but not limited to, installment loans, personal loans, mortgage and home equity loans, secured and unsecured commercial and consumer loans, lines of credit, construction financing, farm loans, community development and local government loans and various types of time and demand deposits. Deposits of the Bank are insured by the Bank Insurance Fund of the FDIC to the maximum extent provided by law. In addition, the Bank provides a full range of trust services through its Trust Department. The Bank also offers other services such as Internet banking, telephone banking, cash management services, automated teller services and safe deposit boxes.

In addition, the Bank has a wholly-owned subsidiary, Mid Penn Insurance Services, LLC, which provides a wide range of personal and commercial insurance products.

Business Strategy

The Bank engages in a full-service commercial banking and trust business, making available to the community a wide range of financial services. These services are provided to small and middle-market businesses, high net worth individuals, and retail consumers through 14 full service banking facilities. The Bank seeks to develop long-term customer relationships, maintain high quality service and provide quick responses to customer needs. Mid Penn believes that an emphasis on local relationship building and its conservative approach to lending, are important factors in the success and growth of Mid Penn.

 

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The Bank seeks credit opportunities of good quality within its target market that exhibit positive historical trends, stable cash flows and secondary sources of repayment from tangible collateral. The Bank extends credit for the purpose of obtaining and continuing long-term relationships. Lenders are provided with detailed underwriting policies for all types of credit risks accepted by the Bank and must obtain appropriate approvals for credit extensions in excess of conservatively assigned lending limits. The Bank also maintains strict documentation requirements and extensive credit quality assurance practices in order to identify credit portfolio weaknesses as early as possible so any exposures that are discovered might be reduced.

Lending Activities

The Bank offers a variety of loan products to its customers, including loans secured by real estate, commercial and consumer loans. The Bank’s lending objectives are as follows:

 

   

to establish a diversified commercial loan portfolio; and

 

   

to provide a satisfactory return to Mid Penn’s shareholders by properly pricing loans to include the cost of funds, administrative costs, bad debts, local economic conditions, competition, customer relationships, the term of the loan, credit risk, collateral quality and a reasonable profit margin.

Credit risk is managed through portfolio diversification, underwriting policies and procedures and loan monitoring practices. The Bank generally secures its loans with real estate with such collateral values dependent and subject to change based on real estate market conditions within its market area. As of December 31, 2011, the Bank’s highest concentration of credit is in Commercial Real Estate. Most of the Bank’s business activity with customers was located in Central Pennsylvania, specifically in Dauphin, lower Northumberland, western Schuylkill, and eastern Cumberland Counties.

Investment Activities

Mid Penn’s investment portfolio is used to improve earnings through investments of funds in higher-yielding assets than overnight funding alternatives, while maintaining asset quality, which provides the necessary balance sheet liquidity for Mid Penn. Mid Penn does not have any significant concentrations within investment securities.

Mid Penn’s entire portfolio of investment securities is considered available for sale. As such, the investments are recorded on the balance sheet at fair value. Mid Penn’s investments include US Treasury, agency and municipal securities that are given a market price relative to investments of the same type with similar maturity dates. As the interest rate environment changes, Mid Penn’s fair value of existing securities will change. This difference in value, or unrealized gain, amounted to $3,096,000, as of December 31, 2011. A majority of the investments are high quality United States and municipal securities that, if held to maturity, are expected to result in no loss to the Bank.

For additional information with respect to Mid Penn’s business activities, see Part II, Item 7 of this report, which is incorporated herein by reference.

Sources of Funds

The Bank primarily uses deposits and borrowings to finance lending and investment activities. Borrowing sources include advances from the Federal Home Loan Bank of Pittsburgh and overnight borrowings from the Bank’s customers and correspondent bank. All borrowings, except for the line of credit with the Bank’s correspondent bank, require collateral in the form of loans or securities. Collateral levels, therefore, limit borrowings and the available lines of credit extended by the Bank’s creditors. As a result, deposits remain critical to the future funding and growth of the business. Deposit growth within the banking industry has been subject to strong competition from a variety of financial services companies. This competition may require financial institutions to adjust their product offerings and pricing to adequately grow deposits.

Competition

The banking business is highly competitive, and the profitability of Mid Penn depends principally upon the Bank’s ability to compete in its market area. The Bank actively competes with other financial services companies for deposit, loan, and trust business. Competitors include other commercial banks, credit unions, savings banks, savings and loan associations, insurance companies, securities brokerage firms, finance companies, mutual funds, and service alternatives via the Internet. Financial institutions compete primarily on the quality of services rendered, interest rates on loans and deposits, service charges, the convenience of banking facilities, location and hours of operation and, in the case of loans to larger commercial borrowers, relative lending limits.

Many competitors are significantly larger than the Bank and have significantly greater financial resources, personnel and locations from which to conduct business. In addition, the Bank is subject to banking regulations while certain competitors may not be. There are relatively few barriers for companies wanting to enter into the financial services industry. For more information, see the “Supervision and Regulation” section below.

 

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Mid Penn has been able to compete effectively with other financial institutions by emphasizing customer service. Mid Penn’s customer service model is based on convenient hours, efficient and friendly employees, local decision making, and quality products. The Gramm-Leach-Bliley Act (see discussion below), which breaks down many barriers between the banking, securities and insurance industries, may significantly affect the competitive environment in which Mid Penn operates.

The flow of cash into mutual funds, much of which is made through tax deferred investment vehicles such as 401(k) plans, and a generally strong economy, have, until recently, fueled high returns for these investments, in particular, certain equity funds. The recent economic turmoil has negatively impacted the returns on many of these investments and impacted the manner in which investors distribute their funds across investment alternatives. The safety of traditional bank products has again become an attractive option during this period of market volatility. Mid Penn’s ability to attract funds in the future will be impacted by the public’s appetite for the safety of insured or local investments versus the returns offered by alternative choices as part of their personal investment mix.

Supervision and Regulation

General

Bank holding companies and banks are extensively regulated under both Federal and state laws. The regulation and supervision of Mid Penn and the Bank are designed primarily for the protection of depositors, the Deposit Insurance Fund, and the monetary system, and not Mid Penn or its shareholders. Enforcement actions may include the imposition of a conservator or receiver, cease-and-desist orders and written agreements, the termination of insurance on deposits, the imposition of civil money penalties and removal and prohibition orders. If a banking regulator takes any enforcement action, the value of an equity investment in Mid Penn could be substantially reduced or eliminated.

Federal and state banking laws contain numerous provisions affecting various aspects of the business and operations of Mid Penn and the Bank. Mid Penn is subject to, among others, the regulations of the Securities and Exchange Commission and the Federal Reserve Board, and the Bank is subject to, among others, the regulations of the Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation (“FDIC”). The following descriptions of and references to applicable statutes and regulations are not intended to be complete descriptions of these provisions or their effects on Mid Penn or the Bank. They are summaries only and are qualified in their entirety by reference to such statutes and regulations.

Holding Company Regulation

Mid Penn is a registered bank holding company subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). As such, it is subject to the Bank Holding Company Act of 1956 (“BHCA”) and many of the Federal Reserve’s regulations promulgated thereunder. The Federal Reserve has broad enforcement powers over bank holding companies, including the power to impose substantial fines and civil penalties.

The BHCA requires Mid Penn to file an annual report with the Federal Reserve regarding the holding company and its subsidiary bank. The Federal Reserve Board also makes examinations of the holding company. The Bank is not a member of the Federal Reserve System; however, the Federal Reserve possesses cease-and-desist powers over bank holding companies and their subsidiaries where their actions would constitute an unsafe or unsound practice or violation of law. The Federal Reserve Board also makes policy that guides the declaration and distribution of dividends by bank holding companies.

The BHCA restricts a bank holding company’s ability to acquire control of additional banks. In addition, the BHCA restricts the activities in which bank holding companies may engage directly or through non-bank subsidiaries.

Gramm-Leach-Bliley Financial Modernization Act

The Gramm-Leach-Bliley Act (“GLB”) became effective on March 11, 2000. The primary purpose of GLB was to eliminate barriers between investment banking and commercial banking and to permit, within certain limitations, the affiliation of financial service providers. Generally, GLB:

 

   

repealed the historical restrictions against, and eliminated many federal and state law barriers to affiliations among banks, securities firms, insurance companies and other financial service providers;

 

   

provided a uniform framework for the activities of banks, savings institutions and their holding companies;

 

   

broadened the activities that may be conducted by and through national banks and other banking subsidiaries of bank holding companies;

 

   

provided an enhanced framework for protecting the privacy of consumers’ information;

 

   

adopted a number of provisions related to the capitalization, membership, corporate governance and other measures designed to modernize the Federal Home Loan Bank System;

 

   

modified the laws governing the implementation of the Community Reinvestment Act; and

 

   

addressed a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions.

 

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More specifically, under GLB, bank holding companies, such as Mid Penn, that meet certain management, capital, and Community Reinvestment Act standards, are permitted to become financial holding companies and, by doing so, to affiliate with securities firms and insurance companies and to engage in other activities that are financial in nature, incidental to such financial activities, or complementary to such activities. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized under the FDIC Improvement Act’s prompt corrective action provisions, is well managed and has at least a satisfactory rating under the Community Reinvestment Act. The required filing is a declaration that the bank holding company wishes to become a financial holding company and meets all applicable requirements. Mid Penn has not elected to become a financial holding company at this time.

No prior regulatory approval will be required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities permitted under GLB. Activities cited by GLB as being financial in nature include:

 

   

securities underwriting, dealing and market making;

 

   

sponsoring mutual funds and investment companies;

 

   

insurance underwriting and agency;

 

   

merchant banking activities; and

 

   

activities that the Federal Reserve has determined to be closely related to banking.

In addition to permitting financial services providers to enter into new lines of business, the law allows firms the freedom to streamline existing operations and to potentially reduce costs. The Act may increase both opportunity as well as competition. Many community banks are less able to devote the capital and management resources needed to facilitate broad expansion of financial services including insurance and brokerage services.

Corporate Governance

On July 30, 2002, the Sarbanes-Oxley Act of 2002 was enacted. The Sarbanes-Oxley Act represents a comprehensive revision of laws affecting corporate governance, auditor independence and accounting standards, executive compensation, insider loans, whistleblower protection, and enhanced and timely disclosure of corporate information. The Sarbanes-Oxley Act is applicable to all companies with equity securities registered or that file reports under the Securities Exchange Act of 1934. In particular, the Sarbanes-Oxley Act established:

 

   

new requirements for audit committees, including independence, expertise and responsibilities;

 

   

additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company;

 

   

new standards for auditors and regulation of audits;

 

   

increased disclosure and reporting obligations for the reporting company and its directors and executive officers; and

 

   

new and increased civil and criminal penalties for violations of the securities laws.

The SEC and NASDAQ have adopted numerous rules implementing the provisions of the Sarbanes-Oxley Act that affect Mid Penn. The changes are intended to allow shareholders to monitor more effectively the performance of companies and management.

Bank Regulation

The Bank, a Pennsylvania-chartered institution, is subject to supervision, regulation and examination by the Pennsylvania Department of Banking and the FDIC. The deposits of the Bank are insured by the FDIC to the extent provided by law. The FDIC assesses deposit insurance premiums the amount of which may, in the future, depend in part on the condition of the Bank. Moreover, the FDIC may terminate deposit insurance of the Bank under certain circumstances. The Bank regulatory agencies have broad enforcement powers over depository institutions under their jurisdiction, including the power to terminate deposit insurance, to impose fines and other civil and criminal penalties, and to appoint a conservator or receiver if any of a number of conditions is met. In addition, the Bank is subject to a variety of local, state and federal laws that affect its operations.

Banking regulations include, but are not limited to, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and the safety and soundness of banking practices.

Capital Requirements

Under risk-based capital requirements for bank holding companies, Mid Penn is required to maintain a minimum ratio of total capital to risk-weighted assets (including certain off-balance-sheet activities, such as standby letters of credit) of eight percent. At least half of the total capital is to be composed of common equity, retained earnings and qualifying perpetual preferred stock, less goodwill (“Tier 1 Capital” and together with Tier 2 Capital, Total Capital”). The remainder may consist of subordinated debt, non-qualifying preferred stock and a limited amount of the loan loss allowance (“Tier 2 Capital”).

In addition, the Federal Reserve Board has established minimum leverage ratio requirements for bank holding companies. These requirements provide for a minimum leverage ratio of Tier 1 Capital to adjusted average quarterly assets (“leverage ratio”) equal to 3% for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies will generally

 

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be required to maintain a leverage ratio of at least 4-5%. The requirements also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the requirements indicate that the Federal Reserve Board will continue to consider a “Tangible Tier 1 Leverage Ratio” (deducting all intangibles) in evaluating proposals for expansion or new activity. The Federal Reserve Board has not advised Mid Penn of any specific minimum Tier 1 leverage ratio.

The Bank is subject to similar capital requirements adopted by the FDIC. The FDIC has not advised the Bank of any specific minimum leverage ratios.

The capital ratios of Mid Penn and the Bank are described in Note 17 to Mid Penn’s Consolidated Financial Statements, which are incorporated herein by reference.

Banking regulators continue to indicate their desire to further develop capital requirements applicable to banking organizations. Changes to capital requirements could materially affect the profitability of Mid Penn or the fair value of Mid Penn stock.

FDIC Improvement Act

As a result of the FDIC Improvement Act of 1991, banks are subject to increased reporting requirements and more frequent examinations by the bank regulatory agencies. The agencies also have the authority to dictate certain key decisions that formerly were left to management, including compensation standards, loan underwriting standards, asset growth, and payment of dividends. Failure to comply with these standards, or failure to maintain capital above specified levels set by the regulators, could lead to the imposition of penalties or the forced resignation of management. If a bank becomes critically undercapitalized, the banking agencies have the authority to place an institution into receivership.

Safety and Soundness Standards

Pursuant to FDICIA, the federal banking regulatory agencies have adopted a set of guidelines prescribing safety and soundness standards for depository institutions such as the Bank. The guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal shareholder. In addition, the agencies adopted regulations that authorize an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If the institution fails to submit an acceptable compliance plan or fails to implement an accepted plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions be taken, including restricting asset growth, restricting interest rates paid on deposits, and requiring an increase in the institution’s ratio of tangible equity to assets.

Payment of Dividends and Other Restrictions

Mid Penn is a legal entity separate and distinct from its subsidiary, the Bank. There are various legal and regulatory limitations on the extent to which the Bank can, among other things, finance, or otherwise supply funds to, Mid Penn. Specifically, dividends from the Bank are the principal source of Mid Penn’s cash funds and there are certain legal restrictions under Pennsylvania law and Pennsylvania banking regulations on the payment of dividends by state-chartered banks. The relevant regulatory agencies also have authority to prohibit Mid Penn and the Bank from engaging in what, in the opinion of such regulatory body, constitutes an unsafe or unsound banking practice. The payment of dividends could, depending upon the financial condition of Mid Penn and the Bank, be deemed to constitute such an unsafe or unsound practice. Further, under the terms of the Capital Purchase Program (“CPP”), Mid Penn is restricted from increasing its dividends on its common stock above the last per share quarterly dividend declared prior to October 14, 2008 ($0.20 per share) without permission as long as the CPP preferred stock is outstanding.

Prompt Corrective Action

In addition to the required minimum capital levels described above, federal law establishes a system of “prompt corrective actions” which Federal banking agencies are required to take, and certain actions which they have discretion to take, based upon the capital category into which a federally regulated depository institution falls. Regulations set forth detailed procedures and criteria for implementing prompt corrective action in the case of any institution, which is not adequately capitalized. Under the rules, an institution will be deemed to be “adequately capitalized” if it exceeds the minimum Federal regulatory capital requirements. However, it will be deemed “undercapitalized” if it fails to meet the minimum capital requirements, “significantly undercapitalized” if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0%, or a leverage ratio that is less than 3.0%, and “critically undercapitalized” if the institution has a ratio of tangible equity to total assets that is equal to or less than 2.0%.

The prompt corrective action rules require an undercapitalized institution to file a written capital restoration plan, along with a performance guaranty by its holding company or a third party. In addition, an undercapitalized institution becomes subject to certain automatic restrictions

 

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including a prohibition on payment of dividends, a limitation on asset growth and expansion, in certain cases, a limitation on the payment of bonuses or raises to senior executive officers, and a prohibition on the payment of certain “management fees” to any “controlling person”. Institutions that are classified as undercapitalized are also subject to certain additional supervisory actions, including increased reporting burdens and regulatory monitoring, a limitation on the institution’s ability to make acquisitions, open new branch offices, or engage in new lines of business, obligations to raise additional capital, restrictions on transactions with affiliates, and restrictions on interest rates paid by the institution on deposits. In certain cases, bank regulatory agencies may require replacement of senior executive officers or directors, or sale of the institution to a willing purchaser. If an institution is deemed “critically undercapitalized” and continues in that category for four quarters, the statute requires, with certain narrowly limited exceptions, that the institution be placed in receivership.

Deposit Insurance

The FDIC insures deposits of the Bank through the Deposit Insurance Fund (“DIF”). The FDIC maintains the DIF by assessing depository institutions an insurance premium. The amount each institution is assessed is based upon a variety of factors that include the balance of insured deposits as well as the degree of risk the institution poses to the insurance fund. The FDIC recently increased the amount of deposits it insures from $100,000 to $250,000. The Bank pays an insurance premium into the DIF based on the quarterly average daily deposit liabilities net of certain exclusions. The FDIC uses a risk-based premium system that assesses higher rates on those institutions that pose greater risks to the DIF. The FDIC places each institution in one of four risk categories using a two-step process based first on capital ratios (the capital group assignment) and then on other relevant information (the supervisory group assignment). Subsequently, the rate for each institution within a risk category may be adjusted depending upon different factors that either enhance or reduce the risk the institution poses to the DIF, including the unsecured debt, secured liabilities and brokered deposits related to each institution. Finally, certain risk multipliers may be applied to the adjusted assessment. In 2009, the FDIC increased the amount assessed from financial institutions by increasing its risk-based deposit insurance assessment scale. The quarterly annualized assessment scale for 2009 ranged from twelve basis points of assessable deposits for the strongest institutions to 77.5 basis points for the weakest. In 2009, the FDIC also adopted a uniform special assessment rate for all institutions not to exceed 10 basis points on the individual bank’s assessment base. The total amount paid by the Bank for FDIC insurance for the year ended December 31, 2009 under these provisions was $1,163,000.

On November 12, 2009, the FDIC approved a rule to require insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012. An insured institution’s risk-based deposit insurance assessments will continue to be calculated on a quarterly basis, but will be paid from the amount the institution prepaid until the later of the date that amount is exhausted or June 30, 2013, at which point any remaining funds would be returned to the insured institution. Consequently, Mid Penn’s prepayment of DIF premiums made in December 2009 resulted in a prepaid asset of $2,719,000 at December 31, 2009. At December 31, 2010 and 2011, the prepaid asset was $1,878,000 and $871,000, respectively.

Beginning with the second quarter of 2011, as mandated by the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the assessment base that the FDIC will use to calculate assessment premiums will be a bank’s average assets minus average tangible equity. As the asset base of the banking industry is larger than the deposit base, the range of assessment rates will change to a low of 2.5 basis points through a high of 45 basis points, per $100 of assets; however, the dollar amount of total actual premiums is expected to be roughly the same.

The FDIC is required under the Dodd-Frank Act to establish assessment rates that will allow the Deposit Insurance Fund to achieve a reserve ratio of 1.35% of Insurance Fund insured deposits by September 2020. In addition, the FDIC has established a “designated reserve ratio” of 2.0%, a target ratio that, until it is achieved, will not likely result in the FDIC reducing assessment rates. In attempting to achieve the mandated 1.35% ratio, the FDIC is required to implement assessment formulas that charge banks over $10 billion in asset size more than banks under that size. Those new formulas began in the second quarter of 2011, but did not affect the Bank. Under the Dodd-Frank Act, the FDIC is authorized to make reimbursements from the insurance fund to banks if the reserve ratio exceeds 1.50%, but the FDIC has adopted the “designated reserve ratio” of 2.0% and has announced that any reimbursements from the fund are indefinitely suspended.

Environmental Laws

Management does not anticipate that compliance with environmental laws and regulations will have any material effect on Mid Penn’s capital, expenditures, earnings, or competitive position. However, environmentally related hazards have become a source of high risk and potentially unlimited liability for financial institutions.

In 1995, the Pennsylvania General Assembly enacted the Economic Development Agency, Fiduciary and Lender Environmental Liability Protection Act, which among other things, provides protection to lenders from environmental liability and remediation costs under the environmental laws for releases and contamination caused by others. A lender who engages in activities involved in the routine practices of commercial lending, including, but not limited to, the providing of financial services, holding of security interests, workout practices, foreclosure or the recovery of funds from the sale of property shall not be liable under the environmental acts or common law equivalents to the Pennsylvania Department of Environmental Resources or to any other person by virtue of the fact that the lender engages in such commercial lending practice. A lender, however, will be liable if it, its employees or agents, directly cause an immediate release or directly exacerbate a release of regulated substance on or from the property, or known and willfully compelled the borrower to commit an action which caused such release or violate an environmental act. The Economic Development Agency, Fiduciary and Lender Environmental Liability Protection Act does not limit federal liability which still exists under certain circumstances.

 

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Consumer Protection Laws

A number of laws govern the relationship between the Bank and its customers. For example, the Community Reinvestment Act is designed to encourage lending by banks to persons in low and moderate income areas. The Home Mortgage Disclosure Act and the Equal Credit Opportunity Act attempt to minimize lending decisions based on impermissible criteria, such as race or gender. The Truth-in-Lending Act and the Truth-in-Savings Act require banks to provide certain disclosure of relevant terms related to loans and savings accounts, respectively. Anti-tying restrictions (which prohibit conditioning the availability or terms of credit on the purchase of another banking product) further restrict the Bank’s relationships with its customers.

Privacy Laws

In 2000, the federal banking regulators issued final regulations implementing certain provisions of GLB governing the privacy of consumer financial information. The regulations limit the disclosure by financial institutions, such as Mid Penn and the Bank, of nonpublic personal information about individuals who obtain financial products or services for personal, family, or household purposes. Subject to certain exceptions allowed by law, the regulations cover information sharing between financial institutions and nonaffiliated third parties. More specifically, the regulations require financial institutions to:

 

   

provide initial notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal financial information to nonaffiliated third parties and affiliates;

 

   

provide annual notices of their privacy policies to their current customers; and

 

   

provide a reasonable method for consumers to “opt out” of disclosures to nonaffiliated third parties.

Protection of Customer Information

In 2001, the federal banking regulators issued final regulations implementing the provisions of GLB relating to the protection of customer information. The regulations, applicable to Mid Penn and the Bank, relate to administrative, technical, and physical safeguards for customer records and information. These safeguards are intended to:

 

   

insure the security and confidentiality of customer records and information;

 

   

protect against any anticipated threats or hazards to the security or integrity of such records; and

 

   

protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer.

Affiliate Transactions

Transactions between Mid Penn and the Bank and its affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. An “affiliate” of a bank or savings institution is any company or entity that controls, is controlled by, or is under common control with the bank or savings institution. Generally, a subsidiary of a depository institution that is not also a depository institution is not treated as an affiliate of the bank for purposes of Sections 23A and 23B. Sections 23A and 23B are intended to protect insured depository institutions from suffering losses arising from transactions with non-insured affiliates, by limiting the extent to which a bank or its subsidiaries may engage in covered transactions with any one affiliate and with all affiliates of the bank in the aggregate, and requiring that such transactions be on terms that are consistent with safe and sound banking practices.

Effective April 1, 2003, Regulation W of the Federal Reserve comprehensively amended Sections 23A and 23B. The regulation unifies and updates staff interpretations issued over the years, incorporates several new interpretative proposals (such as to clarify when transactions with an unrelated third party will be attributed to an affiliate), and addresses new issues arising as a result of the expanded scope of non-banking activities engaged in by bank and bank holding companies in recent years and authorized for financial holding companies under the GLB.

The USA Patriot Act

In 2001, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA Patriot Act) was signed into law. The USA Patriot Act broadened the application of anti-money laundering regulations to apply to additional types of financial institutions, such as broker-dealers, and strengthened the ability of the U.S. government to detect and prosecute international money laundering and the financing of terrorism. The principal provisions of Title III of the USA Patriot Act require that regulated financial institutions, including state-chartered banks:

 

   

establish an anti-money laundering program that includes training and audit components;

 

   

comply with regulations regarding the verification of the identity of any person seeking to open an account;

 

   

take additional required precautions with non-U.S. owned accounts; and

 

   

perform certain verification and certification of money laundering risk for their foreign correspondent banking relationships.

 

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The USA Patriot Act also expanded the conditions under which funds in a U.S. interbank account may be subject to forfeiture and increased the penalties for violation of anti-money laundering regulations. Failure of a financial institution to comply with the USA Patriot Act’s requirements could have serious legal and reputational consequences for the institution. The Bank has adopted policies, procedures and controls to address compliance with the requirements of the USA Patriot Act under the existing regulations and will continue to revise and update its policies, procedures and controls to reflect changes required by the USA Patriot Act and implementing regulations.

Anti-Money Laundering and Anti-Terrorism Financing

Under Title III of the USA PATRIOT Act, also known as the International Money Laundering Abatement and Anti-Terrorism Financing Act of 2001, all financial institutions, including Mid Penn and the Bank, are required in general to identify their customers, adopt formal and comprehensive anti-money laundering programs, scrutinize or prohibit altogether certain transactions of special concern, and be prepared to respond to inquiries from U.S. law enforcement agencies concerning their customers and their transactions. Additional information-sharing among financial institutions, regulators, and law enforcement authorities is encouraged by the presence of an exemption from the privacy provisions of the GLB Act for financial institutions that comply with this provision and the authorization of the Secretary of the Treasury to adopt rules to further encourage cooperation and information-sharing. The effectiveness of a financial institution in combating money-laundering activities is a factor to be considered in any application submitted by the financial institution under the Bank Merger Act, which applies to the Bank.

Emergency Economic Stabilization Act of 2008 and Related Programs

Mid Penn is subject to the rules and regulations promulgated under the Emergency Economic Stabilization Act of 2008 (“EESA”) and related legislation as a result of its sale of preferred stock to the U.S. Treasury under the U.S. Treasury’s Capital Purchase Program (“CPP”). Additional information relating to the CPP, including restrictions on dividends and redemptions of common stock, is included in the information set forth in Item 7 of this report under the caption, “Capital Purchase Program Participation.” Furthermore, under rules and regulations of EESA to which the Mid Penn is subject, no dividends may be declared or paid on Mid Penn’s common stock and Mid Penn may not repurchase or redeem any common stock unless dividends then due and payable with respect to Treasury’s preferred stock have been paid in full. Moreover, the consent of Treasury would be required for any increase in the per share dividend amount on the common stock beyond the per share dividend declared immediately prior to October 14, 2008 ($0.20 per share per quarter) until the third anniversary of the date of Treasury’s investment, unless prior to the third anniversary, Treasury’s preferred stock is redeemed in whole or Treasury has transferred all of its preferred shares to third parties. Because of Mid Penn’s participation in the CPP, Mid Penn is subject to certain restrictions on its executive compensation practices, which are discussed in Item 7 of this report under the caption, “Capital Purchase Program Participation.”

Dodd-Frank Act

The Dodd-Frank Act, which became law in July 2010, significantly changes regulation of financial institutions and the financial services industry, including: creating a Financial Services Oversight Council to identify emerging systemic risks and improve interagency cooperation; centralizing responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, which will be responsible for implementing, examining and enforcing compliance with federal consumer financial laws; permanently raising the current standard maximum deposit insurance amount to $250,000; establishing strengthened capital standards for banks, and disallowing certain trust preferred securities from qualifying as Tier 1 capital (subject to certain grandfather provisions for existing trust preferred securities); establishing new minimum mortgage underwriting standards; granting the Federal Reserve Board the power to regulate debit card interchange fees; and implementing corporate governance changes. Many aspects of the Dodd-Frank Act are subject to rulemaking that will take effect over several years, thus making it difficult to assess the impact of the statute on the financial industry, including Mid Penn, at this time.

It is difficult to predict at this time the specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on community banks. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on financial institutions’ operations is presently unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.

Effects of Government Policy and Potential Changes in Regulation

Changes in regulations applicable to Mid Penn or the Bank, or shifts in monetary or other government policies, could have a material affect on our business. Mid Penn’s and the Bank’s business is also affected by the state of the financial services industry in general. As a result of legal and industry changes, management believes that the industry will continue to experience an increased rate of change as the financial services industry strives for greater product offerings, market share and economies of scale.

From time to time, legislation is enacted that has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial institutions are frequently made in Congress, and before various

 

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bank regulatory agencies. Mid Penn cannot predict the likelihood of any major changes or the impact such changes might have on Mid Penn and/or the Bank. Various congressional bills and other proposals have proposed a sweeping overhaul of the banking system, including provisions for: limitations on deposit insurance coverage; changing the timing and method financial institutions use to pay for deposit insurance; expanding the power of banks by removing the restrictions on bank underwriting activities; and tightening the regulation of bank derivatives activities; and allowing commercial enterprises to own banks.

Mid Penn’s earnings are, and will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The monetary policies of the Federal Reserve have had, and will likely continue to have, an impact on the operating results of commercial banks because of the Federal Reserve’s power to implement national monetary policy to, among other things, curb inflation or combat recession. The Federal Reserve has a major impact on the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of, among other things, the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature and impact of future changes in monetary and fiscal policies.

From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions on, the business of Mid Penn and the Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, the Bank’s business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business. Congress is currently debating major legislation that may fundamentally change the regulatory oversight of banking institutions in the United States. Whether any legislation will be enacted or additional regulations will be adopted, and how they might impact Mid Penn cannot be determined at this time.

Available Information

Mid Penn’s common stock is registered under Section 12(b) of the Securities Exchange Act of 1934 and is traded on the NASDAQ Stock Market under the trading symbol MPB. Mid Penn is subject to the informational requirements of the Exchange Act, and, accordingly, files reports, proxy statements and other information with the Securities and Exchange Commission. The reports, proxy statements and other information filed with the SEC are available for inspection and copying at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Mid Penn is an electronic filer with the SEC. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The SEC’s Internet site address is www.sec.gov.

Mid Penn’s headquarters are located at 349 Union Street, Millersburg, Pennsylvania 17061, and its telephone number is (717) 692-2133. Mid Penn’s Internet address is www.midpennbank.com. Mid Penn makes available through its website, free of charge, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after filing with the Securities and Exchange Commission. Mid Penn has adopted a Code of Ethics that applies to all employees. This document is also available on Mid Penn’s website. The information included on our website is not a part of this document.

 

ITEM 1A. RISK FACTORS

Future dividend payments and common stock repurchases are restricted by the terms of the U.S. Treasury’s equity investment in Mid Penn

Under the terms of the CPP, for so long as any preferred stock issued under the CPP remains outstanding, Mid Penn is prohibited from increasing dividends to holders of its common stock above the last per share quarterly amount in effect immediately prior to October 14, 2008 ($0.20 per share), and from making certain repurchases of equity securities, including our common stock, without the U.S. Treasury’s consent until the third anniversary of the U.S. Treasury’s investment or until the U.S. Treasury has transferred all of the preferred stock it purchased under the CPP to third parties. As long as the preferred stock issued to the U.S. Treasury is outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including Mid Penn’s common stock, are prohibited until all accrued and unpaid dividends are paid on such preferred stock, subject to certain limited exceptions.

Mid Penn is subject to interest rate risk

Mid Penn’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond Mid Penn’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in interest rates, could influence not only the interest Mid Penn receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) Mid Penn’s ability to originate loans and obtain deposits, (ii) the fair value of Mid Penn’s financial assets and liabilities, and (iii) the average duration of Mid Penn’s mortgage-backed securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, Mid Penn’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

 

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Management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on Mid Penn’s results of operations. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on Mid Penn’s financial condition and results of operations.

Mid Penn is subject to lending risk

As of December 31, 2011, approximately 68.0% of Mid Penn’s loan portfolio consisted of commercial and industrial, construction and commercial real estate loans. These types of loans are generally viewed as having more risk of default than residential real estate loans or consumer loans. These types of loans are also typically larger than residential real estate loans and consumer loans. Because Mid Penn’s loan portfolio contains a significant number of commercial and industrial, construction and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans. An increase in non-performing loans could result in a net loss of earnings from these loans, an increase in the provision for possible loan and lease losses and an increase in loan charge-offs, all of which could have a material adverse effect on Mid Penn’s financial condition and results of operations.

Mid Penn’s allowance for possible loan and lease losses may be insufficient

Mid Penn maintains an allowance for possible loan and lease losses, which is a reserve established through provisions for possible losses charged to expense, that represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan and lease losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for possible loan and lease losses inherently involves a high degree of subjectivity and requires Mid Penn to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem credits and other factors, both within and outside of Mid Penn’s control, may require an increase in the allowance. In addition, bank regulatory agencies periodically review Mid Penn’s allowance for possible loan and lease losses and may require an increase in the provision for possible loan and lease losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance, Mid Penn will need additional provisions to increase the allowance for possible loan and lease losses. Any increases in the allowance will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on Mid Penn’s financial condition and results of operations.

Competition from other financial institutions may adversely affect Mid Penn’s profitability

Mid Penn’s banking subsidiary faces substantial competition in originating both commercial and consumer loans. This competition comes principally from other banks, credit unions, savings institutions, mortgage banking companies and other lenders. Many of its competitors enjoy advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce the Corporation’s net income by decreasing the number and size of loans that its banking subsidiary originates and the interest rates it may charge on these loans.

In attracting business and consumer deposits, its banking subsidiary faces substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many of Mid Penn’s competitors enjoy advantages, including greater financial resources, more aggressive marketing campaigns, better brand recognition, and more convenient branch locations. These competitors may offer higher interest rates than Mid Penn, which could decrease the deposits that Mid Penn attracts or require Mid Penn to increase its rates to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect Mid Penn’s ability to generate the funds necessary for lending operations. As a result, Mid Penn may need to seek other sources of funds that may be more expensive to obtain and could increase its cost of funds.

Mid Penn’s banking subsidiary also competes with non-bank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance agencies and governmental organizations, which may offer more favorable terms. Some of its non-bank competitors are not subject to the same extensive regulations that govern its banking operations. As a result, such non-bank competitors may have advantages over Mid Penn’s banking subsidiary in providing certain products and services. This competition may reduce or limit Mid Penn’s margins on banking services, reduce its market share and adversely affect its earnings and financial condition.

Mid Penn’s controls and procedures may fail or be circumvented

Management periodically reviews and updates Mid Penn’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of Mid Penn’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on Mid Penn’s business, results of operations, and financial condition.

 

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Mid Penn’s ability to pay dividends depends primarily on dividends from its banking subsidiary, which is subject to regulatory limits

Mid Penn is a bank holding company and its operations are conducted by its subsidiaries. Its ability to pay dividends depends on its receipt of dividends from its subsidiaries. Dividend payments from its banking subsidiary are subject to legal and regulatory limitations, generally based on net profits, and retained earnings, imposed by the various banking regulatory agencies. The ability of Mid Penn’s subsidiaries to pay dividends is also subject to their profitability, financial condition, capital expenditures and other cash flow requirements. There is no assurance that Mid Penn’s subsidiaries will be able to pay dividends in the future or that Mid Penn will generate adequate cash flow to pay dividends in the future. Federal Reserve Board policy, which applies to Mid Penn as a registered bank holding company, also provides that dividends by bank holding companies should generally be paid out of current earnings looking back over a one-year period. Mid Penn’s failure to pay dividends on its common stock could have a material adverse effect on the market price of its common stock.

Mid Penn’s profitability depends significantly on economic conditions in the central Pennsylvania

Mid Penn’s success is dependent to a significant degree on economic conditions in central Pennsylvania, especially in Dauphin, lower Northumberland, western Schuylkill and eastern Cumberland Counties, which Mid Penn defines as our primary market. The banking industry is affected by general economic conditions including the effects of inflation, recession, unemployment, real estate values, trends in the national and global economics, and other factors beyond our control. An economic recession or a delayed recovery over a prolonged period of time in the Central Pennsylvania area could cause an increase in the level of the Bank’s non-performing assets and loan and lease losses, thereby causing operating losses, impairing liquidity, and eroding capital. Mid Penn cannot assure you that adverse changes in the local economy would not have a material adverse effect on Mid Penn’s consolidated financial condition, results of operations, and cash flows.

Mid Penn may not be able to attract and retain skilled people

Mid Penn’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities engaged in by Mid Penn can be intense and Mid Penn may not be able to hire people or to retain them. The unexpected loss of services of one or more of Mid Penn’s key personnel could have a material adverse impact on Mid Penn’s business because of their skills, knowledge of Mid Penn’s market, years of industry experience, and the difficulty of promptly finding qualified replacement personnel.

Mid Penn is subject to claims and litigation pertaining to fiduciary responsibility

From time to time, customers make claims and take legal action pertaining to Mid Penn’s performance of its fiduciary responsibilities. Whether customer claims and legal action related to Mid Penn’s performance of its fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to Mid Penn they may result in significant financial liability and/or adversely affect the market perception of Mid Penn and its products and services as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on Mid Penn’s business, which, in turn, could have a material adverse effect on Mid Penn’s financial condition and results of operations.

The trading volume in Mid Penn’s common stock is less than that of other larger financial services companies

Mid Penn’s common stock is listed for trading on NASDAQ; the trading volume in its common stock, however, is less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of Mid Penn’s common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which Mid Penn has no control. Given the lower trading volume of Mid Penn’s common stock, significant sales of Mid Penn’s common stock, or the expectation of these sales, could cause Mid Penn’s stock price to fall.

Mid Penn operates in a highly regulated environment and may be adversely affected by changes in federal, state and local laws and regulations

Mid Penn is subject to extensive regulation, supervision and examination by federal and state banking authorities. Any change in applicable regulations or federal, state or local legislation could have a substantial impact on Mid Penn and its operations. Additional legislation and regulations that could significantly affect Mid Penn’s powers, authority and operations may be enacted or adopted in the future, which could have a material adverse effect on its financial condition and results of operations. Further, regulators have significant discretion and authority to prevent or remedy unsafe or unsound practices or violations of laws by banks and bank holding companies in the performance of their supervisory and enforcement duties. The exercise of regulatory authority may have a negative impact on Mid Penn’s results of operations and financial condition.

In response to the financial crisis that commenced in 2008, Congress has taken actions that are intended to strengthen confidence and encourage liquidity in financial institutions, and the Federal Deposit Insurance Corporation has taken actions to increase insurance coverage on deposit accounts. The recently enacted Dodd-Frank Act provides for the creation of a consumer protection division at the Board of Governors of the

 

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Federal Reserve System that will have broad authority to issue regulations governing the services and products we provide consumers. This additional regulation could increase our compliance costs and otherwise adversely impact our operations. That legislation also contains provisions that, over time, could result in higher regulatory capital requirements and loan loss provisions for the Bank, and may increase interest expense due to the ability in July 2011 to pay interest on all demand deposits. In addition, there have been proposals made by members of Congress and others that would reduce the amount delinquent borrowers are otherwise contractually obligated to pay under their mortgage loans and limit an institution’s ability to foreclose on mortgage collateral. These proposals could result in credit losses or increased expense in pursuing our remedies as a creditor. Recent regulatory changes impose limits on our ability to charge overdraft fees, which may decrease our non-interest income as compared to more recent prior periods.

The potential exists for additional federal or state laws and regulations, or changes in policy, affecting many aspects of our operations, including capital levels, lending and funding practices, and liquidity standards. New laws and regulations may increase our costs of regulatory compliance and of doing business and otherwise affect our operations, and may significantly affect the markets in which we do business, the markets for and value of our loans and investments, the fees we can charge and our ongoing operations, costs and profitability.

The soundness of other financial institutions may adversely affect Mid Penn

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. Mid Penn has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose Mid Penn to credit risk in the event of a default by a counterparty or client. In addition, Mid Penn’s credit risk may be exacerbated when the collateral held by Mid Penn cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to Mid Penn. Any such losses could have a material adverse affect on the Mid Penn’s financial condition and results of operations.

Current levels of market volatility are unprecedented and may have materially adverse effects on our liquidity and financial condition

The capital and credit markets have been experiencing extreme volatility and disruption for more than two years. In some cases, the markets have exerted downward pressure on stock prices, security prices, and credit availability for certain issuers without regard to their underlying financial strength. If the current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience adverse effects, which may be material, on our liquidity, financial condition, and profitability.

Mid Penn’s banking subsidiary may be required to pay higher FDIC insurance premiums or special assessments which may adversely affect its earnings.

Poor economic conditions and the resulting bank failures have increased the costs of the FDIC and depleted its deposit insurance fund. Additional bank failures may prompt the FDIC to increase its premiums above the recently increased levels or to issue special assessments. Mid Penn generally is unable to control the amount of premiums or special assessments that its subsidiary is required to pay for FDIC insurance. Any future changes in the calculation or assessment of FDIC insurance premiums may have a material adverse effect on our results of operations, financial condition, and our ability to continue to pay dividends on our common stock at the current rate or at all.

Pennsylvania Business Corporation Law and various anti-takeover provisions under our articles and bylaws could impede the takeover of Mid Penn.

Various Pennsylvania laws affecting business corporations may have the effect of discouraging offers to acquire Mid Penn, even if the acquisition would be advantageous to shareholders. In addition, we have various anti-takeover measures in place under our articles of incorporation and bylaws, including a supermajority vote requirement for mergers, a staggered board of directors, and the absence of cumulative voting. Any one or more of these measures may impede the takeover of Mid Penn without the approval of our board of directors and may prevent our shareholders from taking part in a transaction in which they could realize a premium over the current market price of our common stock.

Mid Penn may need to or be required to raise additional capital in the future, and capital may not be available when needed and on terms favorable to current shareholders.

Federal banking regulators require Mid Penn and its subsidiary bank to maintain adequate levels of capital to support their operations. These capital levels are determined and dictated by law, regulation, and banking regulatory agencies. In addition, capital levels are also determined by Mid Penn’s management and board of directors based on capital levels that they believe are necessary to support Mid Penn’s business operations.

If Mid Penn raises capital through the issuance of additional shares of its common stock or other securities, it would likely dilute the ownership interests of current investors and could dilute the per share book value and earnings per share of its common stock. Furthermore, a capital raise through issuance of additional shares may have an adverse impact on Mid Penn’s stock price. New investors also may have rights, preferences and privileges senior to Mid Penn’s current shareholders, which may adversely impact its current shareholders.

 

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Mid Penn’s ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside of its control, and on its financial performance. Accordingly, Mid Penn cannot be certain of its ability to raise additional capital on acceptable terms and acceptable time frames or to raise additional capital at all. If Mid Penn cannot raise additional capital in sufficient amounts when needed, its ability to comply with regulatory capital requirements could be materially impaired. Additionally, the inability to raise capital in sufficient amounts may adversely affect Mid Penn’s financial condition and results of operations and its ability to repurchase the preferred stock and the warrant to purchase shares of Mid Penn’s common stock issued under the CPP (see Item 7 of this report under the caption, “Capital Purchase Program Participation.”).

Mid Penn’s profitability depends significantly on the economic conditions in the Commonwealth of Pennsylvania and the local region in which it does business.

Mid Penn’s profitability depends primarily on the general economic conditions of the Commonwealth of Pennsylvania and the specific markets in which Mid Penn operates. Unlike larger national or other regional banks that are more geographically diversified, Mid Penn provides banking and financial services to customers primarily in south central Pennsylvania. The local economic conditions in this area has a significant impact on the demand for Mid Penn’s products and services, as well as the ability of Mid Penn’s customers to repay loans, the value of collateral securing loans, and the stability of Mid Penn’s deposit funding sources. A significant decline in general economic conditions caused by inflation, recession, unemployment, changes in securities markets, or other factors could impact these local economic conditions and, consequently, have a material adverse effect on Mid Penn’s financial condition and results of operation.

If we conclude that the decline in the value of any of our investment securities is other than temporary, we are required to write down the value of that security through a charge to earnings.

We review our investment securities portfolio at each quarter-end reporting period to determine whether the fair value is below the current carrying value. When the fair value of any of our investment securities has declined below its carrying value, we are required to assess whether the decline is other than temporary. If we conclude that the decline is other than temporary, we are required to write down the value of that security through a charge to earnings. Changes in the expected cash flows of these securities and/or prolonged price declines have resulted and may result in our concluding in future periods that there is additional impairment of these securities that is other than temporary, which would require a charge to earnings to write down these securities to their fair value. Due to the complexity of the calculations and assumptions used in determining whether an asset is impaired, the impairment disclosed may not accurately reflect the actual impairment in the future.

Mid Penn’s financial performance may suffer if its information technology is unable to keep pace with its growth or industry developments.

Effective and competitive delivery of Mid Penn’s products and services is increasingly dependent upon information technology resources and processes, both those provided internally as well as those provided through third party vendors. In addition to better serving customers, the effective use of technology increases efficiency and enables Mid Penn to reduce costs. Mid Penn’s future success will depend, in part, upon its ability to address the needs of its customers by using technology to provide products and services to enhance customer convenience, as well as to create additional efficiencies in its operations. Many of Mid Penn’s competitors have greater resources to invest in technological improvements. Additionally, as technology in the financial services industry changes and evolves, keeping pace becomes increasingly complex and expensive for Mid Penn. There can be no assurance that Mid Penn will be able to effectively implement new technology-driven products and services, which could reduce its ability to compete effectively.

There can be no assurance that Mid Penn will repurchase the preferred stock and warrant issued under the CPP or that its regulators would approve such repurchase.

To repurchase the preferred stock and the warrant to purchase shares of Mid Penn’s common stock issued under the CPP (see Item 7 of this report under the caption, “Capital Purchase Program Participation.”), Mid Penn must raise sufficient capital and obtain regulatory approval. There can be no assurance when or if the preferred stock or the warrant can be repurchased or what the redemption price for the warrant will be. Until such time as the preferred stock and the warrant are repurchased, Mid Penn will remain subject to the terms and conditions set forth in the purchase agreement with the U.S. Treasury, the preferred stock and the warrant, which, among other things impose restrictions on quarterly cash dividends on its common stock and, with some exceptions, on repurchases of its common stock. Further, Mid Penn’s continued participation in the CPP subjects it to increased regulatory and legislative oversight.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None

 

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MID PENN BANCORP, INC.

 

ITEM 2. PROPERTIES

With the exception of the Market Square Office and Derry Street Loan Operations Center in Harrisburg, PA, the Bank owns its main office, branch offices and certain parking facilities related to its banking offices, all of which are free and clear of any lien. The Bank’s main office and all branch offices are located in Pennsylvania. All of these properties are in good condition and are deemed by management to be adequate for the Bank’s purposes. The table below sets forth the location of each of the Bank’s properties.

 

Property Location

 

Description of Property

 

Property Location

 

Description of Property

Millersburg     Lykens Office  
349 Union Street   Branch Office   550 Main Street   Branch Office
Millersburg, PA 17061     Lykens, PA 17048  
Elizabethville Office     Allentown Boulevard Office  
4642 State Route 209   Branch Office   5500 Allentown Boulevard   Branch Office
Elizabethville, PA 17023     Harrisburg, PA 17112  
Dalmatia Office     Market Square Office  
132 School House Road   Branch Office   17 N. Second Street   Branch Office
Dalmatia, PA 17017     Harrisburg, PA 17101  
Carlisle Pike Office     Steelton Office  
4622 Carlisle Pike   Branch Office   51 South Front Street   Branch Office
Mechanicsburg, PA 17050     Steelton, PA 17113  
Derry Street Office     Middletown Office  
4509 Derry Street   Branch Office   1100 Spring Garden Drive   Branch Office
Harrisburg, PA 17111     Middletown, PA 17057  
Front Street Office     Camp Hill Office  
2615 North Front Street   Branch Office   2101 Market Street   Branch Office
Harrisburg, PA 17110     Camp Hill, PA 17011  
Tower City Office     Operations Center  
545 East Grand Avenue   Branch Office   894 N. River Road   Operations Center
Tower City, PA 17980     Halifax, PA 17032  

Dauphin Office

1001 Peters Mountain Road

  Branch Office  

Derry Street

Administrative Office

  Administrative Office
Dauphin, PA 17018     4098 Derry Street  
    Harrisburg, PA 17111  

Derry Street Loan

Operations Center

  Operations Center    
4099 Derry Street      
Harrisburg, PA 17111      

 

ITEM 3. LEGAL PROCEEDINGS

Management is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the Corporation. Mid Penn and the Bank have no proceedings pending other than ordinary routine litigation occurring in the normal course of business. In addition, management does not know of any material proceedings contemplated by governmental authorities against Mid Penn or the Bank or any of its properties.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not Applicable

 

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MID PENN BANCORP, INC.

 

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Corporation’s common stock is traded on the NASDAQ Stock Market under the symbol MPB. The following table shows the range of high and low sale prices for the Corporation’s stock and cash dividends paid for the quarters indicated.

 

     High      Low      Cash
Dividends
Paid
 

Quarter Ended:

        

March 31, 2011

   $ 12.33       $ 7.10       $ 0.05   

June 30, 2011

     9.75         8.10         0.05   

September 30, 2011

     8.97         7.20         0.05   

December 31, 2011

     8.50         6.60         0.05   

March 31, 2010

   $ 10.60       $ 9.05       $ —     

June 30, 2010

     10.60         9.10         —     

September 30, 2010

     9.81         5.93         —     

December 31, 2010

     8.00         6.35         —     

Transfer Agent: Registrar and Transfer Company, 10 Commerce Drive, Cranford, NJ 07016. Phone: 1-800-368-5948.

Number of Shareholders: As of February 15, 2012, there were approximately 1,486 shareholders of record of Mid Penn’s common stock.

Dividends: Cash dividends of $0.20 per share were paid during 2011. There were no cash dividends paid during 2010. Cash dividends of $0.52 per share were paid during 2009. The quarterly dividend payment was suspended during the fourth quarter of 2009 consistent with the Federal Reserve Board policy that dividend payouts should not exceed net income for the previous four quarters, net of dividends previously paid during that period. Furthermore, Mid Penn is restricted from increasing its dividends on its common stock above the last per share quarterly dividend declared prior to October 14, 2008 ($0.20 per share) without prior regulatory approval as long as the Capital Purchase Plan preferred stock is outstanding. On January 25, 2012, Mid Penn declared a cash dividend of $0.05 per common share, payable on February 27, 2012 to shareholders of record as of February 8, 2012.

Dividend Reinvestment and Stock Purchases: Shareholders of Mid Penn may acquire additional shares of common stock by reinvesting their cash dividends under the Dividend Reinvestment Plan without paying a brokerage fee. Voluntary cash contributions may also be made under the Plan. For additional information about the Plan, contact the Transfer Agent.

Annual Meeting: The Annual Meeting of the Shareholders of Mid Penn will be held at 10:00 a.m. on Tuesday, May 1, 2012, at 349 Union Street, Millersburg, Pennsylvania.

Accounting, Auditing and Internal Control Complaints: Information on how to report a complaint regarding accounting, internal accounting controls or auditing matters is available at Mid Penn’s website: www.midpennbank.com.

 

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MID PENN BANCORP, INC.

 

Stock Performance Graph

 

LOGO

 

     Period Ending  

Index

   12/31/2006      12/31/2007      12/31/2008      12/31/2009      12/31/2010      12/31/2011  

Mid Penn Bancorp, Inc.

     100.00         114.28         92.16         46.62         33.98         34.98   

Russell 3000

     100.00         105.14         65.92         84.60         98.92         99.93   

Mid-Atlantic Custom Peer Group*

     100.00         91.11         72.66         67.78         73.57         73.91   

 

* Mid-Atlantic Custom Peer Group consists of Mid-Atlantic commercial banks with assets less than $1B.

Source: SNL Financial LC, Charlottesville, VA

© 2011

www.snl.com

A detailed list of the Banks comprising the Mid-Atlantic Custom Peer Group is incorporated herein by reference to Exhibit 99.1, which is attached to this Annual Report on Form 10-K.

 

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MID PENN BANCORP, INC.

 

ITEM 6. SELECTED FINANCIAL DATA

Summary of Selected Financial Data

 

(Dollars in thousands, except per share data)                               
      2011     2010     2009     2008     2007  

INCOME:

          

Total Interest Income

   $ 31,545      $ 30,148      $ 31,336      $ 31,856      $ 31,444   

Total Interest Expense

     9,522        10,642        13,304        14,890        15,339   

Net Interest Income

     22,023        19,506        18,032        16,966        16,105   

Provision for Loan and Lease Losses

     1,205        2,635        9,520        1,230        925   

Noninterest Income

     2,996        3,414        3,656        3,682        3,481   

Noninterest Expense

     18,048        17,121        16,671        14,726        12,596   

Income (Loss) Before Provision for (Benefit from) Income Taxes

     5,766        3,164        (4,503     4,692        6,065   

Provision for (Benefit from) Income Taxes

     1,223        416        (2,208     1,104        1,394   

Net Income (Loss)

     4,543        2,748        (2,295     3,588        4,671   

Preferred Stock Dividends and Discount Accretion

     514        514        514        16        —     

Net Income (Loss) Available to Common Shareholders

     4,029        2,234        (2,809     3,572        4,671   

COMMON STOCK DATA PER SHARE:

          

Earnings (Loss) Per Common Share (Basic)

   $ 1.16      $ 0.64      $ (0.81   $ 1.03      $ 1.34   

Earnings (Loss) Per Common Share (Fully Diluted)

     1.16        0.64        (0.81     1.03        1.34   

Cash Dividends

     0.20        —          0.52        0.80        0.80   

Book Value Per Common Share

     12.47        10.98        10.55        11.75        11.56   

Tangible Book Value Per Common Share

     12.10        10.58        10.15        11.34        11.03   

AVERAGE SHARES OUTSTANDING (BASIC)

     3,481,414        3,479,780        3,479,780        3,483,097        3,497,806   

AVERAGE SHARES OUTSTANDING (FULLY DILUTED)

     3,481,414        3,479,780        3,479,780        3,483,153        3,497,806   

AT YEAR-END:

          

Investments

   $ 159,043      $ 70,702      $ 47,345      $ 52,739      $ 50,250   

Loans and Leases, Net of Unearned Discount

     482,717        467,735        480,385        434,643        377,128   

Allowance for Loan and Lease Losses

     6,772        7,061        7,686        5,505        4,790   

Total Assets

     715,383        637,457        606,010        572,999        509,757   

Total Deposits

     634,055        554,982        500,015        436,824        372,817   

Short-term Borrowings

     —          1,561        16,044        23,977        37,349   

Long-term Debt

     22,701        27,883        38,057        55,223        54,581   

Shareholders’ Equity

     53,452        48,201        46,704        50,890        40,444   

RATIOS:

          

Return on Average Assets

     0.66     0.44     -0.39     0.67     0.94

Return on Average Shareholders’ Equity

     8.96     5.71     -4.43     8.87     11.84

Cash Dividend Payout Ratio

     15.32     0.00     -64.40     77.67     59.70

Allowance for Loan and Lease Losses to Loans and Leases

     1.40     1.51     1.60     1.27     1.27

Average Shareholders’ Equity to Average Assets

     7.37     7.73     8.88     7.55     7.82

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

Certain of the matters discussed in this document 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,” “anticipate,” “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 economic deterioration on current customers, specifically the effect of the economy on loan customers’ ability to repay loans;

 

   

Governmental monetary and fiscal policies, as well as legislative and regulatory changes, including the effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act;

 

   

The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Financial Accounting Standards Board and other accounting standard setters;

 

   

The risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities and interest rate protection agreements, as well as interest rate risks;

 

   

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;

 

   

Acquisitions and integration of acquired businesses;

 

   

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;

 

   

Volatilities in the securities markets; and

 

   

Deteriorating economic conditions.

All written or oral forward-looking statements attributable to Mid Penn are expressly qualified in their entirety by these cautionary statements.

Management’s Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of Mid Penn’s consolidated financial statements and should be read in conjunction with the Consolidated Financial Statements of the Corporation and Notes thereto and other detailed information appearing elsewhere in this Annual Report. Mid Penn is not aware of any known trends, events, uncertainties or of any current recommendations by the regulatory authorities which, if they were to be implemented, would have a material effect on Mid Penn’s liquidity, capital resources or operations.

Financial Summary

The consolidated earnings of Mid Penn are derived primarily from the operations of its wholly owned subsidiary, Mid Penn Bank.

Mid Penn recorded net income available to common shareholders of $4,029,000 for the year 2011, compared to $2,234,000 in 2010, which was an increase of $1,795,000 or 80.3%. This represents net income in 2011 of $1.16 per common share compared to $0.64 per common share in 2010, and a net loss of ($0.81) per common share in 2009.

Total assets of Mid Penn continued to grow in 2011, reaching $715,383,000, an increase of $77,926,000, or 12.2% over $637,457,000 at year-end 2010. The majority of growth in assets came from increases in investments, which increased to $159,043,000 or 124.9% over $70,702,000 at the end of 2010. This growth was funded primarily through growth in deposits, which increased 14.2% to $634,055,000 from $554,982,000 at year-end 2010.

The continued soft economy was the major contributor to modest loan growth during 2011. Loan balances increased 3.2% to $482,717,000 from $467,735,000 in 2010. The modest growth numbers were a welcome improvement over the loan balance contraction experienced in 2010 from the end of 2009. Mid Penn experienced weak loan demand during 2011 despite a desire to sensibly lend to support creditworthy existing and new customers in the marketplace.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

Mid Penn’s return on average shareholders’ equity, (ROE), a widely recognized performance indicator in the financial industry, was 8.96% in 2011, 5.71% in 2010, and (4.43%) in 2009. Return on average assets (ROA), another performance indicator, was 0.66% in 2011, 0.44% in 2010, and (0.39%) in 2009.

Mid Penn’s performance during 2011 was a dramatic improvement over the results reported in 2010. This improvement was the result of reduced loan charge-offs and provision for loan and lease losses, improving cost of funds, consistent management of controllable expenses, and positive loan growth throughout 2011.

Net charge-offs decreased from $3,260,000 in 2010 to $1,494,000 during 2011. The reduction from 2010 allowed for a reduced provision for loan and lease losses from $2,635,000 in 2010 to $1,205,000 in 2011. The recession and problems in the commercial real estate sector of the economy continued to negatively impact a number of loans in the portfolio, causing continued elevation in the level of nonperforming loans from those experienced prior to 2009. Further discussion of these issues can be found in the Provision for Loan and Lease Losses section below.

Net interest margin improved to 3.52% in 2011 from 3.47% in 2010. This improvement was driven by a 40 basis point improvement in the rate on supporting liabilities from 2.08% in 2010 to 1.68% in 2011. This improvement allowed average interest spread to increase to 3.29% from 3.20% in 2010 and net interest income on a tax equivalent basis to increase from $20,468,000 in 2010 to $23,094,000 in 2011. This increase was achieved in spite of the substantial pool of nonperforming loans being carried on the balance sheet. The amount of interest income lost on this pool of troubled loans in 2011 amounted to $2,200,000. Further discussion of net interest margin can be found in the Net Interest Income section below.

FDIC insurance premiums increased in 2011 from 2010 and this expense remains at historically high levels as the FDIC continues its efforts to restore the Deposit Insurance Fund and keep it solvent to handle future bank failures should they occur. In addition to high deposit insurance premiums, the increasing regulatory and compliance burden necessitated the hiring of a dedicated compliance officer in 2010 to ensure Mid Penn’s continued compliance with current and anticipated future regulatory changes. This hiring was followed in 2011 with the addition of three additional positions dedicated to compliance with the Bank Secrecy Act, U.S. Patriot Act, and general regulatory compliance. Mid Penn was negatively impacted by recent regulatory changes governing overdraft charges, which has resulted in a reduction in NSF revenue of $425,000 during 2011.

In addition to the interest lost on nonperforming loans, this pool of troubled assets increases Mid Penn’s costs associated with the management and collection of this pool of assets. During 2011, the expenses associated with the increased collection and management efforts on troubled assets were $299,000 as compared to $307,000 in 2010. These expenses remain at historically high levels as Mid Penn resolves problems associated with the pool of troubled assets.

Mid Penn’s fundamental operating performance in 2011 was sound despite these issues and the general economic conditions and credit crisis issues experienced by the banking industry as a whole.

The Bank’s tier one capital (to risk weighted assets) of $50,265,000 or 10.4% and total capital (to risk weighted assets) of $56,327,000 or 11.6% at December 31, 2011, are above the regulatory requirements. Tier one capital consists primarily of the Bank’s shareholders’ equity. Total capital includes qualifying subordinated debt, if any, and the allowance for loan and lease losses, within permitted limits. Risk-weighted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet activities.

Critical Accounting Estimates

Mid Penn’s consolidated financial statements are prepared in accordance with accounting principles generally accepted 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 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 for loan and lease losses, the evaluation of the Corporation’s investment securities for other-than-temporary impairment, and the assessment of goodwill for impairment to be the accounting areas that require the most subjective and complex judgments.

The allowance for loan and lease losses represents management’s estimate of probable incurred credit losses inherent in the loan and lease portfolio. Determining the amount of the allowance for loan and lease losses 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.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

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 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 operations.

Accounting Standards Codification (ASC) Topic 350, Intangibles-Goodwill and Other, requires that goodwill is not amortized to expense, but rather that it be tested for impairment at least annually. Impairment write-downs are charged to results of operations in the period in which the impairment is determined. The Corporation did not identify any impairment on its outstanding goodwill from its most recent testing, which was performed as of December 31, 2011. If certain events occur which might indicate goodwill has been impaired, the goodwill is tested when such events occur.

Net Interest Income

Net interest income, Mid Penn’s primary source of revenue, represents the difference between interest income and interest expense. Net interest income is affected by changes in interest rates and changes in average balances (volume) in the various interest-sensitive assets and liabilities.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

TABLE 1: AVERAGE BALANCES, EFFECTIVE INTEREST DIFFERENTIAL AND INTEREST YIELDS

 

Income and Rates on a Taxable Equivalent Basis for Years Ended  
(Dollars in thousands)                                                             
     December 31, 2011     December 31, 2010     December 31, 2009  
     Average             Average     Average             Average     Average             Average  
     Balance      Interest      Rates     Balance      Interest      Rates     Balance      Interest      Rates  

ASSETS:

                        

Interest Earning Balances

   $ 50,458       $ 520         1.03   $ 45,244       $ 818         1.81   $ 41,925       $ 1,460         3.48

Investment Securities:

                        

Taxable

     81,017         1,632         2.01     31,981         800         2.50     18,829         665         3.53

Tax-Exempt

     35,238         2,015         5.72     26,254         1,679         6.40     25,188         1,774         7.04
  

 

 

         

 

 

         

 

 

       

Total Securities

     116,255              58,235              44,017         
  

 

 

         

 

 

         

 

 

       

Federal Funds Sold

     9,922         25         0.25     9,222         25         0.27     279         1         0.30

Loans and Leases, Net:

                        

Taxable

     458,533         27,290         5.95     455,927         26,660         5.85     446,649         27,370         6.13

Tax-Exempt

     17,144         1,134         6.61     16,655         1,128         6.77     17,504         1,013         5.79
  

 

 

         

 

 

         

 

 

       

Total Loans and Leases, Net

     475,677              472,582              464,153         

Restricted Investment in Bank Stocks

     3,441         —           0.00     3,995         —           0.00     3,929         1         0.03
  

 

 

    

 

 

      

 

 

    

 

 

      

 

 

    

 

 

    

Total Earning Assets

     655,753         32,616         4.97     589,278         31,110         5.28     554,303         32,284         5.82
     

 

 

         

 

 

         

 

 

    

Cash and Due from Banks

     7,941              7,466              6,795         

Other Assets

     24,756              26,330              22,071         
  

 

 

         

 

 

         

 

 

       

Total Assets

   $ 688,450            $ 623,074            $ 583,169         
  

 

 

         

 

 

         

 

 

       

LIABILITIES & SHAREHOLDERS’ EQUITY:

                        

Interest Bearing Deposits:

                        

NOW

   $ 57,342         144         0.25   $ 48,024         69         0.14   $ 38,198         33         0.09

Money Market

     248,615         2,992         1.20     163,415         2,357         1.44     87,427         1,383         1.58

Savings

     27,801         15         0.05     26,585         16         0.06     26,241         17         0.06

Time

     209,574         5,358         2.56     239,761         6,877         2.87     255,123         9,293         3.64

Short-term Borrowings

     803         4         0.50     3,798         18         0.47     19,715         112         0.57

Long-term Debt

     23,394         1,009         4.31     28,860         1,305         4.52     47,241         2,466         5.22
  

 

 

    

 

 

      

 

 

    

 

 

      

 

 

    

 

 

    

Total Interest Bearing Liabilities

     567,529         9,522         1.68     510,443         10,642         2.08     473,945         13,304         2.81
     

 

 

         

 

 

         

 

 

    

Demand Deposits

     63,484              58,480              51,464         

Other Liabilities

     6,722              6,010              5,985         

Shareholders’ Equity

     50,715              48,141              51,775         
  

 

 

         

 

 

         

 

 

       

Total Liabilities and Shareholders’ Equity

   $ 688,450            $ 623,074            $ 583,169         
  

 

 

         

 

 

         

 

 

       

Net Interest Income

      $ 23,094            $ 20,468            $ 18,980      
     

 

 

         

 

 

         

 

 

    

Net Yield on Interest Earning Assets:

                        

Total Yield on Earning Assets

           4.97           5.28           5.82

Rate on Supporting Liabilities

           1.68           2.08           2.81

Average Interest Spread

           3.29           3.20           3.01

Net Interest Margin

           3.52           3.47           3.42

Interest and average rates are presented on a fully taxable equivalent basis, using an effective tax rate of 34%. For purposes of calculating loan yields, average loan balances include nonaccrual loans.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

Loan fees of $701,000, $710,000, and $683,000 are included with interest income in Table 1 for the years 2011, 2010 and 2009, respectively.

TABLE 2: VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME

 

(Dollars in thousands)    2011 Compared to 2010     2010 Compared to 2009  
     Increase (Decrease) Due to Change In:     Increase (Decrease) Due to Change In:  
Taxable Equivalent Basis    Volume     Rate     Net     Volume     Rate     Net  

INTEREST INCOME:

            

Interest Bearing Balances

   $ 94      $ (392   $ (298   $ 116      $ (758   $ (642

Investment Securities:

            

Taxable

     1,227        (395     832        465        (330     135   

Tax-Exempt

     575        (239     336        75        (170     (95
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Investment Securities

     1,801        (633     1,168        540        (500     40   

Federal Funds Sold

     2        (2     —          27        (3     24   

Loans and Leases, Net

     186        450        636        519        (1,114     (595

Restricted Investment Bank Stocks

     —          —          —          —          (1     (1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Interest Income

     2,083        (577     1,506        1,202        (2,376     (1,174
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

INTEREST EXPENSE:

            

Interest Bearing Deposits:

            

NOW

     13        62        75        8        28        36   

Money Market

     1,229        (594     635        1,202        (228     974   

Savings

     1        (2     (1     —          (1     (1

Time

     (866     (653     (1,519     (560     (1,856     (2,416
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Interest Bearing Deposits

     376        (1,186     (810     650        (2,057     (1,407

Short-term Borrowings

     (14     —          (14     (90     (4     (94

Long-term Debt

     (247     (49     (296     (959     (202     (1,161
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Interest Expense

     115        (1,235     (1,120     (400     (2,262     (2,662
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET INTEREST INCOME

   $ 1,968      $ 658      $ 2,626      $ 1,601      $ (113   $ 1,488   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The effect of changing volume and rate has been allocated entirely to the rate column. Tax-exempt income is shown on a tax equivalent basis assuming a federal income tax rate of 34%.

During 2011, net interest income increased $2,626,000 or 12.8%, as compared to an increase of $1,488,000 or 7.8% in 2010. The average balances, effective interest differential, and interest yields for the years ended December 31, 2011, 2010, and 2009 and the components of net interest income, are presented in Table 1. A comparative presentation of the changes in net interest income for 2011 compared to 2010, and 2010 compared to 2009, is provided in Table 2. This analysis indicates the changes in interest income and interest expense caused by the volume and rate components of interest earning assets and interest bearing liabilities.

The yield on earning assets decreased to 4.97% in 2011 from 5.28% in 2010. The yield on earning assets for 2009 was 5.82%. The change in the yield on earning assets was due primarily to changes in market interest rates and extreme rate competition within our market. The average “prime rate” for 2011, 2010, and 2009 was 3.25%. The yield on earning assets is also negatively impacted by the loss of interest on nonperforming loans. During 2011, this loss of interest amounted to $2,200,000. Had this interest been included in Mid Penn’s earnings, the yield on earning assets would have increased by 34 basis points.

Interest expense decreased by $1,120,000, or 10.5%, in 2011 as compared to a decrease of $2,662,000, or 20.0%, in 2010. The cost of interest bearing liabilities decreased to 1.68% in 2011 from 2.08% in 2010. The cost of interest bearing liabilities for 2009 was 2.81%. The reduction in cost of interest bearing liabilities was due to changes in market interest rates and Mid Penn’s ability to reduce the rates on Money Market accounts and Certificates of Deposit.

Net interest margin, on a tax equivalent basis was 3.52% in 2011 compared to 3.47% in 2010 and 3.42% in 2009. The interest rate impact of earning assets and funding sources due to changes in interest rates can be reasonably estimated at current interest rate levels, the options selected

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

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 the simulation models. In addition, our net interest income may be impacted by further interest rate actions of the Federal Reserve Bank. Management continues to monitor the net interest margin closely.

Provision for Loan and Lease Losses

The provision for loan and lease losses is the expense necessary to maintain the allowance for loan and lease losses 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 we serve.

During 2011, Mid Penn continued to experience a challenging economic and operating environment. Given the economic pressures that impact some borrowers, Mid Penn has maintained the allowance for loan and lease losses in accordance with Mid Penn’s assessment process, which took into consideration the risk characteristics of the loan and lease portfolio and shifting collateral values from December 31, 2010 to December 31, 2011. For the year ended December 31, 2011, the provision for loan and lease losses was $1,205,000, as compared to $2,635,000 for the year ended December 31, 2010.

For the year ended December 31, 2011, Mid Penn had net charge-offs of $1,494,000 compared to net charge-offs of $3,260,000 during the year ended December 31, 2010. Loans charged off during 2011 were comprised of 12 residential real estate loans totaling $310,000, 9 commercial and industrial loans totaling $546,000, 8 commercial real estate loans totaling $545,000, and 4 leases representing $44,000 of the total charged off during 2011. The remaining $142,000 was comprised primarily of various consumer loans. 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.

Following its model for loan and lease loss allowance adequacy, management recorded a $1,205,000 provision in 2011, as well as a provision of $2,635,000 in 2010, and $9,520,000 in 2009. The allowance for loan and lease losses as a percentage of total loans was 1.40% at December 31, 2011, compared to 1.51% at December 31, 2010 and 1.60% at December 31, 2009.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

A summary of charge-offs and recoveries of loans and leases are presented in Table 3.

TABLE 3: ANALYSIS OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES

 

(Dollars in thousands)    Years ended December 31,  
     2011     2010     2009     2008     2007  

Balance, beginning of year

   $ 7,061      $ 7,686      $ 5,505      $ 4,790      $ 4,187   

Loans and leases charged off:

          

Commercial real estate, construction and land development

     545        1,413        2,841        384        —     

Commercial, industrial and agricultural

     546        787        4,158        70        100   

Real estate - residential

     310        858        115        —          —     

Consumer

     142        146        209        188        231   

Leases

     44        230        108        5        129   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans and leases charged off

     1,587        3,434        7,431        647        460   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries on loans and leases previously charged off:

          

Commercial real estate, construction and land development

     26        21        —          1        —     

Commercial, industrial and agricultural

     10        3        16        20        5   

Real estate - residential

     19        70        —          —          —     

Consumer

     32        80        76        111        49   

Leases

     6        —          —          —          84   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans and leases recovered

     93        174        92        132        138   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     1,494        3,260        7,339        515        322   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for loan and lease losses

     1,205        2,635        9,520        1,230        925   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of year

   $ 6,772      $ 7,061      $ 7,686      $ 5,505      $ 4,790   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     Years ended December 31,  
     2011     2010     2009     2008     2007  

Ratio of net charge-offs during the year to average loans and leases outstanding during the year, net of unearned discount

     0.31     0.69     1.58     0.13     0.09
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan and lease losses as a percentage of total loans and leases at December 31

     1.40     1.51     1.60     1.27     1.27
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan and lease losses as a percentage of non-performing assets at December 31

     50.91     35.05     48.33     96.92     97.68
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest Income

A summary of the major components of noninterest income for the years ended December 31, 2011, 2010, and 2009 is found in Table 4. During 2011, Mid Penn earned $2,996,000 in noninterest income, compared to $3,414,000 earned in 2010 and $3,656,000 earned in 2009.

Service charges on deposit accounts amounted to $704,000 for 2011, a decrease of $435,000 or 38.2% compared to $1,139,000 for 2010, which was a decrease of $340,000 or 23.0% below 2009. The decrease in service charges in 2011 occurred in spite of general growth in transaction accounts during 2011. During this period of economic downturn, customers seem to have become more conscientious about their account balances and avoiding unnecessary charges related to insufficient funds. In addition to this behavioral change, Mid Penn was negatively impacted by regulatory changes contained in the Dodd-Frank Act governing overdraft charges, which has resulted in a reduction in NSF revenue.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

Income from fiduciary activities for 2011 was $539,000, a $108,000 or 25.1% increase from $431,000 in 2010, which was a $14,000 or 3.4% increase from $417,000 in 2009. This revenue source is comprised of fees generated by Mid Penn’s Trust department and fees from the sale of third-party mutual funds and annuities to the Bank’s retail and commercial customers. Trust department income for 2011 was $185,000, a $15,000 or 7.5% decrease from $200,000 in 2010, which was a $43,000 or 17.7% decrease from $243,000 in 2009. Trust Department income can fluctuate from year to year, due to the number of estates settled during the year. Fees from third-party mutual fund and annuity sales were $354,000 in 2011, $231,000 in 2010, and $174,000 in 2009.

Mortgage banking income remained robust during the year ended December 31, 2011. Historically low long-term mortgage rates triggered a wave of refinancing activity, generating robust fee income from this line of business. During 2011, Mid Penn decided to add approximately $1,960,000 in secondary market qualified loans to the loan portfolio. This resulted in a slight decline in mortgage banking income to $390,000 in 2011 from $423,000 in 2010.

Mid Penn owns cash surrender value of life insurance policies on its directors. The income on these policies amounted to $258,000 during the year 2011, $270,000 in 2010, and $280,000 in 2009. In addition to the income on these life insurance policies, Mid Penn recognized a gain on life insurance proceeds in 2009 of $158,000 from the death of a retired director in February 2009.

Other income amounted to $1,105,000 in 2011, $1,151,000 in 2010, and $1,198,000 in 2009.

TABLE 4: NONINTEREST INCOME

 

(Dollars in thousands)    Years ended December 31,  
     2011      2010      2009  

Income from fiduciary activities

   $ 539       $ 431       $ 417   

Service charges on deposits

     704         1,139         1,479   

Investment securities gains, net

     —           —           —     

Earnings from cash surrender value of life insurance

     258         270         280   

Gain on life insurance proceeds

     —           —           158   

Mortgage banking income

     390         423         124   

Merchant services revenue

     165         141         128   

ATM debit card interchange income

     452         408         341   

Other income

     488         602         729   
  

 

 

    

 

 

    

 

 

 

Total Noninterest Income

   $ 2,996       $ 3,414       $ 3,656   
  

 

 

    

 

 

    

 

 

 

Noninterest Expense

A summary of the major components of noninterest expense for the years ended December 31, 2011, 2010, and 2009 is reflected in Table 5. Noninterest expense increased to $18,048,000 in 2011 from $17,121,000 in 2010 and $16,671,000 in 2009.

The major component of noninterest expense is salaries and employee benefits. Increases in the 2011 workforce primarily included additions to compliance and operations support functions within Mid Penn, in order to provide enhanced controls and procedures to support a more sophisticated product line and customer base. The escalating compliance and regulatory burden experienced by banks throughout the industry necessitated the hiring of dedicated compliance staff as well as dedicating resources from support areas throughout Mid Penn to complying with the expanding regulatory changes. Mid Penn also recognized in 2011 a full year of salary and employee benefits expense from the 2010 additions within the support functions throughout the Corporation to enhance controls and support future growth. During 2011, medical benefits increased $126,000 from 2010 levels. In addition, commission-based compensation paid to mortgage originators and retail investment representatives increased $107,000 from 2010 levels.

Occupancy and equipment expenses also increased in 2011 primarily in connection with utility and snow removal costs from the harsh winter months early in the year.

FDIC insurance expense increased in 2011, closing the year at $1,057,000 as compared to $897,000 during 2010. The historically high levels of FDIC insurance expense during 2009, 2010, and 2011 stem from the escalation in Deposit Insurance premiums assessed by the FDIC on all its member banks to restore the Deposit Insurance Fund and keep it solvent to handle future bank failures should they occur. Mid Penn’s premium level was also negatively impacted by the increase in assets used in the calculation of Deposit Insurance premiums.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

Computer expense increased from $578,000 in 2010 to $697,000 in 2011. Mid Penn has been making significant enhancements to technology platforms to enhance efficiencies within the support departments and enable updated products and services to customers. These charges reflect the ongoing service contracts for these enhancements.

Internet banking expense increased to $195,000 in 2011 from $138,000 in 2010. A major focus throughout 2010 was the implementation of an enhanced website and internet banking platform. The cost of providing enhanced functionality is reflected in this line item and is part of Mid Penn’s efforts to provide a robust suite of technology-related products and services to the marketplace.

The final significant item was the loss on sale or write-down on foreclosed assets of ($20,000) in 2011 and $283,000 in 2010. During 2010, this item increased as a result of Mid Penn’s ongoing analysis of the carrying values of repossessed properties and the adjustment of their values to current market rates in the face of the overall decline in real estate values plaguing the real estate market. In 2011, the carrying values on repossessed properties have stabilized and some small gains have been realized from the ongoing liquidation of these properties.

TABLE 5: NONINTEREST EXPENSE

 

(Dollars in thousands)    Years ended December 31,  
     2011     2010      2009  

Salaries and employee benefits

   $ 9,519      $ 8,760       $ 8,173   

Occupancy expense, net

     1,075        916         844   

Equipment expense

     1,292        1,361         1,170   

Pennsylvania Bank Shares tax expense

     449        443         366   

FDIC Assessment

     1,057        897         1,163   

Legal and Professional fees

     444        529         814   

Director fees and benefits expense

     304        303         291   

Marketing and advertising expense

     354        308         679   

Computer expense

     697        578         393   

Telephone expense

     377        362         344   

(Gain) loss / write-down on sale of foreclosed assets

     (20     283         110   

Core deposit intangible amortization

     65        65         65   

Stationery and supplies expense

     166        156         151   

Postage expense

     167        172         156   

Courier expense

     30        60         96   

Meals, travel, and lodging expense

     228        211         200   

Correspondent service charge expense

     79        87         95   

Contributions expense

     77        35         77   

ATM debit card processing expense

     152        122         126   

Internet banking expense

     195        138         88   

Other expenses

     1,341        1,335         1,270   
  

 

 

   

 

 

    

 

 

 

Total Noninterest Expense

   $ 18,048      $ 17,121       $ 16,671   
  

 

 

   

 

 

    

 

 

 

Investments

Mid Penn’s investment portfolio is utilized to provide liquidity and managed to maximize return within reasonable risk parameters.

Mid Penn’s entire portfolio of investment securities is considered available for sale. As such, the investments are recorded at fair value. Our investments are valued at a market price relative to investments of the same type with similar maturity dates. As the interest rate environment of these securities changes, the value of securities changes accordingly.

As of December 31, 2011, the unrealized gain on investment securities resulted in an increase in shareholders’ equity of $2,044,000 (unrealized gain on securities of $3,096,000 less estimated income tax expense of $1,052,000). At December 31, 2010, the unrealized gain on investment securities resulted in an increase in shareholders’ equity of $176,000 (unrealized gain on securities of $266,000 less estimated income tax expense of $90,000) compared to a December 31, 2009 increase in the unrealized gain included in other comprehensive income of $817,000 (unrealized gain on securities of $1,238,000 less estimated income tax expense of $421,000). Mid Penn does not have any significant concentrations within its portfolio of investment securities. Table 6 provides a summary of our available for sale investment securities.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

TABLE 6: FAIR VALUE OF INVESTMENT SECURITIES

 

(Dollars in thousands)    December 31,  
     2011      2010      2009  

U.S. Treasury and U.S. government agencies

   $ 27,617       $ 17,394       $ 15,700   

Mortgage-backed U.S. government agencies

     82,668         25,387         4,619   

State and political subdivision obligations

     48,366         27,678         26,781   

Equity securities

     392         243         245   
  

 

 

    

 

 

    

 

 

 
   $ 159,043       $ 70,702       $ 47,345   
  

 

 

    

 

 

    

 

 

 

Maturity and yield information relating to the investment portfolio is shown in Table 7.

TABLE 7: INVESTMENT MATURITY AND YIELD

 

(Dollars in thousands)          After One     After Five              
As of December 31, 2011    One Year     Year thru     Years thru     After Ten        
     and Less     Five Years     Ten Years     Years     Total  

U.S. Treasury and U.S. government agencies

   $ 2,011      $ 19,726      $ 5,880      $ —        $ 27,617   

Mortgage-backed U.S. government agencies

     1        —          9,961        72,706        82,668   

State and political subdivision obligations

     565        5,130        13,099        29,572        48,366   

Equity securities

     —          —          —          392        392   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 2,577      $ 24,856      $ 28,940      $ 102,670      $ 159,043   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
           After One     After Five              
     One Year     Year thru     Years thru     After Ten        
     and Less     Five Years     Ten Years     Years     Total  

Weighted Average Yields

          

U.S. Treasury and U.S. government agencies

     0.99     2.62     4.77     —          2.96

Mortgage-backed U.S. government agencies

     5.51     —          4.36     4.64     4.61

State and political subdivision obligations

     7.38     6.62     5.67     5.39     5.62

Equity securities

     —          —          —          3.46     3.46
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     2.39     3.45     5.04     4.85     4.63
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans

At December 31, 2011, loans and leases totaled $482,717,000; a $14,982,000 or 3.2% increase from December 31, 2010. During 2011, Mid Penn experienced a net increase in commercial real estate and commercial/industrial loans of approximately $4,650,000. This increase was the result of an increase in business lending opportunities to credit-worthy borrowers within the markets Mid Penn serves during the latter portion of 2011. Mid Penn also experienced an increase in residential real estate loans of approximately $10,798,000 during 2011 as real estate values stabilized and borrowers felt more comfortable refinancing higher-priced debt. Mid Penn added $7,143,000 in conventional residential mortgages within the loan portfolio as an alternative to purchasing lower-yielding investment securities as part of this increase.

At December 31, 2011, loans, net of unearned income, represented 71.0% of earning assets as compared to 78.3% on December 31, 2010, and 84.8% on December 31, 2009.

The Bank’s loan portfolio is diversified among individuals and small and medium-sized businesses generally located within the Bank’s trading area of Dauphin County, lower Northumberland County, western Schuylkill County and eastern Cumberland County. Commercial real estate, construction and land development loans are collateralized mainly by mortgages on the income-producing real estate or land involved. Commercial, industrial and agricultural loans are made to business entities and may be secured by business assets, including commercial real estate, or may be unsecured. Residential real estate loans are secured by liens on the residential property. Consumer loans include installment loans, lines of credit and home equity loans. The Bank has no concentration of credit to any one borrower. The Bank’s highest concentration of credit is in Commercial Real Estate financings.

 

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A distribution of the Bank’s loan portfolio according to major loan classification is shown in Table 8.

TABLE 8: LOAN PORTFOLIO

 

(Dollars in thousands)    December 31,  
     2011      2010      2009            2008            2007        
     Amount     %      Amount     %      Amount     %      Amount     %      Amount     %  

Commercial real estate, construction and land development

   $ 249,204        51.6       $ 252,915        54.0       $ 253,878        52.8       $ 234,762        53.9       $ 197,192        52.1   

Commercial, industrial and agricultural

     78,656        16.3         70,295        15.0         85,795        17.8         71,385        16.4         65,421        17.3   

Real estate - residential

     146,846        30.4         136,048        29.1         128,522        26.7         118,547        27.2         106,141        28.0   

Consumer

     8,327        1.7         8,922        1.9         12,884        2.7         11,103        2.5         9,987        2.6   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total Loans

     483,033        100.0         468,180        100.0         481,079        100.0         435,797        100.0         378,741        100.0   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Unearned income

     (316        (445        (694        (1,154        (1,613  
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

   

Loans net of unearned discount

     482,717           467,735           480,385           434,643           377,128     

Allowance for loan and lease losses

     (6,772        (7,061        (7,686        (5,505        (4,790  
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

   

Net loans

   $ 475,945         $ 460,674         $ 472,699         $ 429,138         $ 372,338     
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

   

Mid Penn’s maturity and rate sensitivity information related to the loan portfolio is reflected in Table 9.

TABLE 9: LOAN MATURITY AND INTEREST SENSITIVITY

 

(Dollars in thousands)           After One                
As of December 31, 2011    One Year      Year thru      After Five         
     and Less      Five Years      Years      Total  

Commercial real estate, construction and land development

   $ 20,911       $ 26,303       $ 201,990       $ 249,204   

Commercial, industrial and agricultural

   $ 8,725         50,565         19,366         78,656   

Real estate - residential mortgages

     13,830         35,070         97,946         146,846   

Consumer

     2,785         3,543         1,683         8,011   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 46,251       $ 115,481       $ 320,985       $ 482,717   
  

 

 

    

 

 

    

 

 

    

 

 

 

Rate Sensitivity

           

Predetermined rate

   $ 45,820       $ 109,446       $ 114,543       $ 269,809   

Floating or adjustable rate

     431         6,035         206,442         212,908   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 46,251       $ 115,481       $ 320,985       $ 482,717   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

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

Other than as described herein, we do not believe there are any trends, events or uncertainties that are reasonably expected to have a material impact on future results of operations, liquidity, or capital resources. Further, based on known information, we believe that the effects of current and past economic conditions and other unfavorable business conditions may influence certain borrowers’ abilities to comply with their repayment terms. Mid Penn continues to monitor closely the financial strength of these borrowers. Mid Penn does not 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 structure construction loans with interest reserve components. Mid Penn has not in the past performed any commercial real estate or other type loan workouts whereby an existing loan was restructured into multiple new loans. Also, Mid Penn does not extend loans at maturity 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.

TABLE 10: NONPERFORMING ASSETS

 

(Dollars in thousands)    December 31,  
     2011     2010     2009     2008     2007  

Nonperforming Assets:

          

Nonaccrual loans

   $ 11,800      $ 17,228      $ 14,933      $ 4,113      $ 4,317   

Loans renegotiated with borrowers

     571        2,323        308        51        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     12,371        19,551        15,241        4,164        4,317   

Foreclosed real estate

     931        596        663        1,516        528   

Other repossessed property

     —          —          —          —          59   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-performing assets

     13,302        20,147        15,904        5,680        4,904   

Accruing loans 90 days or more past due

     —          19        661        1,860        2,439   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total risk elements

   $ 13,302      $ 20,166      $ 16,565      $ 7,540      $ 7,343   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nonperforming loans as a % of total loans outstanding

     2.56     4.18     3.17     0.96     1.14

Nonperforming assets as a % of total loans outstanding and other real estate

     2.76     4.31     3.31     1.30     1.30

Ratio of allowance for loan losses to nonperforming loans

     54.74     36.12     50.43     132.20     110.96

Mid Penn assesses a specific allocation for both commercial loans and commercial real estate loans prior to charging down or charging off the loan. Once the charge 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. During 2011, nonperforming loans declined $7,180,000 from $19,551,000 at December 31, 2010. This improvement has been the result of slight improvement in some sectors of the general economy and maintaining a close relationship with troubled borrowers as they navigate their plan toward a resolution of credit issues.

Mid Penn’s troubled debt restructured loans at December 31, 2011 totaled $4,602,000, of which, $571,000 are accruing residential mortgages in compliance with the terms of the modification. As a result of the evaluation, a specific allocation and, subsequently, charge offs have been taken as appropriate. Further discussion of troubled debt restructured loans can be found in Note 7 to Mid Penn’s Consolidated Financial Statements, which are incorporated herein by reference. As of December 31, 2011, there were no defaulted troubled debt restructured loans as all troubled debt restructured loans were current with respect to their associated forbearance agreements.

Mid Penn entered into forbearance agreements on all loans currently classified as troubled debt restructures and all of these agreements have resulted in additional principal repayment. The terms of these forbearance agreements vary whereby principal payments have been decreased, interest rates have been reduced and/or the loan will be repaid as collateral is sold.

As a result of adopting the amendments in ASU No. 2011-02, Mid Penn reassessed all restructurings that occurred on or after the beginning of the current fiscal year (January 1, 2011) for identification as troubled debt restructurings. Mid Penn identified no loans for which the allowance for loan losses had previously been measured under a general allowance for credit losses methodology that are now considered troubled debt restructurings in accordance with ASU No. 2011-02.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

The following table provides additional analysis of partially charged-off loans:

TABLE 11: PARTIALLY CHARGED OFF LOANS

 

(Dollars in thousands)             
     December 31, 2011     December 31, 2010  

Period ending total loans outstanding (net of unearned income)

   $ 482,717      $ 467,735   

Allowance for loan and lease losses

     6,772        7,061   

Total Nonperforming loans

     12,371        19,551   

Nonperforming and impaired loans with partial charge-offs

     4,505        7,487   

Ratio of nonperforming loans with partial charge-offs to total loans

     0.93     1.60

Ratio of nonperforming loans with partial charge-offs to total nonperforming loans

     36.42     38.29

Coverage ratio net of nonperforming loans with partial charge-offs

     86.09     58.53

Ratio of total allowance to total loans less nonperforming loans with partial charge-offs

     1.42     1.53

Mid Penn has not experienced any additional charge-offs on loans for which a partial charge-off had originally been taken.

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 in the process of 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 (“DCF”) method indicates no operating income is available for evaluating the collateral position; therefore, all 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. In the event the loan is unsecured, the loan would have been charged-off at the recognition of impairment. If the loan is secured, it will undergo a 90 day waiting period to ensure the collateral shortfall identified in the evaluation is accurate and then charged down by the specific allocation. Once the charge down is taken, the remaining balance remains a nonperforming loan with the original terms and interest rate intact (not restructured). 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 variations in value. A specific allocation of allowance is made for any anticipated collateral shortfall and a 90-day waiting period begins to ensure the accuracy of the collateral shortfall. The loan is then charged down by the specific allocation. Once the charge down is taken, the remaining 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 in the process of collection. The entire balance 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 prior to charging down or charging off the loan. Once the charge down is taken, the remaining balance remains a nonperforming loan with the original terms and interest rate intact (not restructured). In addition, Mid Penn takes a preemptive step when any commercial loan 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.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

Mid Penn’s rating system assumes any loans classified as sub-standard non-accrual to be impaired, and all of these loans are considered collateral dependent; therefore, all 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 within 30 days of the credit being classified as sub-standard non-accrual. 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 which time Mid Penn is in receipt of the updated valuation. The credit department employs an electronic tracking system to monitor the receipt of and need for updated appraisals. To date, there have been no significant time lapses noted with the above processes.

In some instances Mid Penn is not holding real estate as collateral and is relying on business assets (personal property) for repayment. In these circumstances a collateral inspection is performed by Mid Penn personnel to determine an estimated value. The value is based on net book value, as provided by the financial statements, and discounted accordingly based on determinations made by management. Occasionally, Mid Penn will employ an outside service to provide a fair estimate of value based on auction sales or private sales. Management reviews the estimates of these third parties and discounts them accordingly based on management’s judgment, if deemed necessary.

For impaired loans with no valuation allowance required, Mid Penn’s practice of obtaining independent third party market valuations on the subject property within 30 days of being placed on non-accrual 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 18 months for possible revaluation by an independent third party.

Mid Penn does not currently, or plan in the future to, use automated valuation methodologies as a method of valuing real estate collateral.

As of December 31, 2011, Mid Penn had several unrelated loan relationships, with an aggregate carrying balance of $10,926,000, deemed impaired. This pool of loans is further broken down into a group of loans with an aggregate carrying balance of $5,155,000 for which specific allocations totaling $1,846,000 have been included within the loan loss reserve for these loans. The remaining $5,771,000 of loans requires no specific allocation within the loan loss reserve. The $10,926,000 pool of impaired loan relationships is comprised of $7,834,000 in real estate secured commercial relationships and $3,092,000 in business relationships. There are specific allocations against the real estate secured pool totaling $523,000, spread among seventeen relationships composed primarily of customers engaged in real estate investment activities. The group of impaired business relationships with specific allocations is made up of eight relationships and a specific allocation of $1,323,000 has been set aside against these credits. Seven small business relationships account for $451,000 of the specific allocations due to the negative effects of the economy on their businesses. One additional large commercial participation loan in this pool has shown exceptional collateral devaluation and is responsible for a specific allocation of $872,000 of the total pool attributable to this segment. Management currently believes that the specific reserves are adequate to cover probable future losses related to these relationships.

The allowance for loan losses 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 for loan and lease losses 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 for loan and lease losses an integral part of the examination process.

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 local, regional, and national economic and business conditions affecting the collectability of the portfolio, the values of underlying collateral, and 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 loans.

 

   

Changes in the experience, ability, and depth of lending management and other relevant staff as well as the quality of the institution’s loan review system.

 

   

Changes in the nature and volume of the portfolio and the terms of loans generally offered.

 

   

The existence and effect of any concentrations of credit and changes in the level of such concentrations.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

While the allowance for loan and lease losses is maintained at a level believed to be adequate by management for covering estimated losses 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. Changes in these estimates may impact the provisions charged to expense in future periods.

Management believes, based on information currently available, that the allowance for loan and lease losses of $6,772,000 is adequate as of December 31, 2011.

The allocation of the allowance for loan and lease losses among the major classifications is shown in Table 12 as of December 31 of each of the past five years.

TABLE 12: ALLOCATION OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES

 

(Dollars in thousands)    December 31,  
     2011      2010      2009      2008      2007  

Commercial real estate, construction and land development

   $ 2,988       $ 3,002       $ 3,334       $ 3,326       $ 2,908   

Commercial, industrial and agricultural

     2,874         3,246         3,545         1,860         1,607   

Real estate - residential

     332         206         175         87         75   

Consumer

     435         412         467         172         148   

Unallocated

     143         195         165         60         52   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 6,772       $ 7,061       $ 7,686       $ 5,505       $ 4,790   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The 2011 provision of $1,205,000 is a decrease of $1,430,000 from the $2,635,000 provision in 2010. The smaller provision is reflective of the aggressive loan charge-offs taken at the end of 2009 and in 2010, resulting from the deterioration in the overall quality of our loan portfolio caused by the recession and problems in the commercial real estate sector. The continued slowness in the economy and continuing credit quality concerns of Mid Penn’s loan portfolio during 2011 necessitated larger than pre-2009 provision levels, even though the amount was a reduction from 2010.

The allowance for loan and lease losses at December 31, 2011 was $6,772,000, or 1.40% of total loans less unearned discount as compared to $7,061,000, or 1.51% at December 31, 2010 and $7,686,000, or 1.60% at December 31, 2009.

Deposits and Other Funding Sources

Mid Penn’s primary source of funds are deposits. Total deposits at December 31, 2011, increased by $79,073,000 or 14.2% over December 31, 2010, which increased by $54,967,000 or 11.0% over December 31, 2009. Average balances and average interest rates applicable to the major classifications of deposits for the years ended December 31, 2011, 2010, and 2009 are presented in Table 13.

Average short-term borrowings for 2011 were $803,000 as compared to $3,798,000 in 2010. These borrowings included customer repurchase agreements, treasury tax and loan note option borrowings and federal funds purchased. One $5,000,000 long-term borrowing matured in 2011, while no new long-term borrowing arrangements were entered into during the year.

At December 31, 2011, the Bank had $13,354,000 in brokered deposits. With additional success in the local deposit environment, the Bank reduced its brokered deposit funding by $3,140,000 in 2011, after having reduced such funding by $11,395,000 in 2010.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

TABLE 13: DEPOSITS BY MAJOR CLASSIFICATION

 

(Dollars in thousands)    December 31,  
     2011     2010     2009  
     Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
    Average
Balance
     Average
Rate
 

Noninterest-bearing demand deposits

   $ 63,484         0.00   $ 58,480         0.00   $ 51,464         0.00

Interest-bearing demand deposits

     57,342         0.25     48,024         0.14     38,198         0.09

Money market

     248,615         1.20     163,415         1.44     87,427         1.58

Savings

     27,801         0.05     26,585         0.06     26,241         0.06

Time

     209,574         2.56     239,761         2.87     255,123         3.64
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 606,816         1.40   $ 536,265         1.74   $ 458,453         2.34
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The maturity distribution of time deposits of $100,000 or more is reflected in Table 14.

TABLE 14: MATURITY OF TIME DEPOSITS $100,000 OR MORE

 

(Dollars in thousands)    December 31,  
     2011      2010      2009  

Three months or less

   $ 7,824       $ 7,322       $ 22,712   

Over three months to twelve months

     21,979         21,031         37,443   

Over twelve months

     36,807         37,870         25,682   
  

 

 

    

 

 

    

 

 

 
   $ 66,610       $ 66,223       $ 85,837   
  

 

 

    

 

 

    

 

 

 

Capital Resources

Shareholders’ equity, or capital, is evaluated in relation to total assets and the risk associated with those assets. The detailed computation of the Bank’s regulatory capital ratios can be found in Note 17 of Item 8, Notes to Consolidated Financial Statements. 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. The buildup makes it difficult for a corporation to offer a competitive return on the shareholders’ capital going forward. For these reasons capital adequacy has been, and will continue to be, of paramount importance.

Shareholders’ equity increased in 2011 by $5,251,000 or 10.9%, following an increase in 2010 of $1,497,000 or 3.2% and a decrease in 2009 of $4,186,000 or 8.2%. Capital was positively impacted in 2011 by the net income of $4,029,000 and the increase in other comprehensive income from the increase in value of the assets in the available for sale investment portfolio. Capital was positively impacted in 2010 by the net income of $2,234,000 and the continued suspension of the common dividend to shareholders. Capital was negatively impacted in 2009 by the net loss of $2,809,000 and the payment of cash dividends to common shareholders of $1,809,000.

Mid Penn’s normal intent for dividend payout is to provide quarterly cash returns to shareholders and earnings retention at a level sufficient to finance future growth. During the fourth quarter of 2009, Mid Penn suspended the quarterly cash dividend consistent with Federal Reserve Board policy that dividend payouts should not exceed net income for the previous four quarters, net of dividends paid during that period. Mid Penn continued the suspension of the quarterly cash dividend to shareholders throughout 2010, consistent with Federal Reserve Board policy. Mid Penn reinstated a dividend payout of $0.05 per common share during each of the calendar quarters in 2011. The dividends paid on common shares totaled $0.20 for the year ended December 31, 2011. On January 25, 2012, Mid Penn declared a cash dividend of $0.05 per common share, payable on February 27, 2012 to shareholders of record as of February 8, 2012.

The dividend payout ratio, which represents the percentage of annual net income returned to shareholders in the form of cash dividends, was 15.3% for 2011 and 0.0% for 2010.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

Mid Penn maintained the following regulatory capital levels, leverage ratios, and risk-based capital ratios as of December 31, 2011, and 2010, as follows:

 

(Dollars in thousands)                 Capital Adequacy  
                               To Be Well-Capitalized  
                               Under Prompt  
                  Minimum Capital     Corrective  
     Actual:     Required:     Action Provisions:  
     Amount      Ratio     Amount      Ratio     Amount      Ratio  

Corporation

               

As of December 31, 2011:

               

Tier 1 Capital (to Average Assets)

   $ 50,451         7.0   $ 28,679         4.0     N/A         N/A   

Tier 1 Capital (to Risk Weighted Assets)

     50,451         10.3     19,566         4.0     N/A         N/A   

Total Capital (to Risk Weighted Assets)

     56,513         11.6     39,132         8.0     N/A         N/A   

Bank

               

As of December 31, 2011:

               

Tier 1 Capital (to Average Assets)

   $ 50,265         7.1   $ 28,326         4.0   $ 35,408         5.0

Tier 1 Capital (to Risk Weighted Assets)

     50,265         10.4     19,367         4.0     29,051         6.0

Total Capital (to Risk Weighted Assets)

     56,327         11.6     38,735         8.0     48,419         10.0

Corporation

               

As of December 31, 2010:

               

Tier 1 Capital (to Average Assets)

   $ 46,957         7.4   $ 25,352         4.0     N/A         N/A   

Tier 1 Capital (to Risk Weighted Assets)

     46,957         10.2     18,501         4.0     N/A         N/A   

Total Capital (to Risk Weighted Assets)

     52,711         11.4     37,002         8.0     N/A         N/A   

Bank

               

As of December 31, 2010:

               

Tier 1 Capital (to Average Assets)

   $ 46,799         7.4   $ 25,388         4.0   $ 31,735         5.0

Tier 1 Capital (to Risk Weighted Assets)

     46,799         10.2     18,357         4.0     27,536         6.0

Total Capital (to Risk Weighted Assets)

     52,553         11.5     36,714         8.0     45,893         10.0

Capital Purchase Program Participation

On December 19, 2008, Mid Penn Bancorp, Inc. (the “Corporation”) entered into an agreement (including the Securities Purchase Agreement – Standard Terms) (the “Purchase Agreement”) with the United States Department of the Treasury (the “Treasury”) pursuant to which the Treasury invested $10,000,000 in the Corporation under the Treasury’s Capital Purchase Program (the “CPP”).

Under the Purchase Agreement, the Treasury received (1) 10,000 shares of Series A Fixed Rate Cumulative Perpetual Preferred Stock, $1,000 liquidation preference, and (2) Warrants to purchase up to 73,099 shares of the Corporation’s common stock at an exercise price of $20.52 per share.

The preferred shares pay cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter. The preferred shares are non-voting, other than class voting rights on certain matters that could adversely affect the preferred shares. If dividends on the preferred shares have not been paid for an aggregate of six quarterly dividend periods or more, whether consecutive or not, the Corporation’s authorized number of directors will automatically be increased by two, and holders of the preferred stock, voting together with holders of any then outstanding parity stock, will have the right to elect those directors at the Corporation’s next annual meeting of shareholders or special meeting of shareholders called for that purpose. These preferred share directors would be elected annually and serve until all accrued and unpaid dividends on the preferred shares have been paid.

Pursuant to the American Recovery and Reinvestment Act of 2009 (“ARRA”), the Secretary of the Treasury shall permit, subject to consultation with the appropriate Federal banking agency, the Corporation to redeem the Series A Preferred Stock. The Corporation may do so without regard to the source of the funds to be used to redeem the Series A Preferred Stock or any minimum waiting period. If the Corporation elects to redeem the Series A Preferred Stock prior to February 15, 2012, and receives approval from the Treasury and the Board of Governors of the Federal Reserve System, it must redeem at least $2,500,000 of the Series A Preferred Stock. Upon redemption of the Series A Preferred Stock,

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

the Secretary of the Treasury is required to liquidate the warrants associated with the Corporation’s participation in the CPP at the current market price. Any redemption is subject to the consent of the Board of Governors of the Federal Reserve System. Until December 19, 2011, or such earlier time as all preferred shares have been redeemed by the Corporation or transferred by Treasury to third parties that are not affiliated with Treasury, the Corporation may not, without Treasury’s consent, increase its dividend rate per share of common stock above the per share quarterly amount in effect immediately prior to October 14, 2008 ($0.20 per share) or, with certain limited exceptions, repurchase its common stock.

The warrants are immediately exercisable and have a 10-year term. The exercise price and number of shares subject to the warrants are both subject to anti-dilution adjustments. Treasury has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the warrants; however, this agreement not to vote the shares does not apply to any person who may acquire such shares.

The preferred shares and the warrants were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. The Corporation has filed a shelf registration statement covering the preferred shares, the warrants, and the common stock underlying the warrants. Treasury and other future holders of the preferred shares, the warrants, or the common stock issued pursuant to the warrants also have piggyback and demand registration rights with respect to these securities. None of the preferred shares, the warrants, or the shares issuable upon exercise of the warrants are subject to any contractual restrictions on transfer.

In the Purchase Agreement, the Corporation agreed that, until such time as the Treasury ceases to own any securities acquired from Mid Penn pursuant to the Purchase Agreement, the Corporation will take all necessary action to ensure that benefit plans with respect to our senior executive officers comply with Section 111(b) of the Emergency Economic Stability Act of 2008 (the “EESA”) and applicable guidance or regulations issued by the Secretary of the Treasury. The applicable executive compensation requirements apply to the compensation of the Corporation’s Chief Executive Officer, Chief Financial Officer, and certain other highly compensated executive officers.

These requirements, the compliance of which must be annually certified by Mid Penn’s chief executive officer and chief financial officer, include:

 

  1. limits on compensation that exclude incentives for senior executive officers of Mid Penn to take unnecessary and excessive risks that threaten the value of Mid Penn during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding;

 

  2. a provision for the recovery by Mid Penn of any bonus, retention award, or incentive compensation paid to a senior executive officer and any of the next 20 most highly-compensated employees of Mid Penn based on statements of earnings, revenues, gains, or other criteria that are later found to be materially inaccurate;

 

  3. a prohibition on Mid Penn making any golden parachute payment to a senior executive officer or any of the next five most highly-compensated employees of Mid Penn during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding;

 

  4. a prohibition on Mid Penn paying or accruing any bonus, retention award, or incentive compensation to the most highly compensated employees of Mid Penn during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding, except that any prohibition shall not apply to the payment of long-term restricted stock by Mid Penn, provided that such long-term restricted stock –

 

  i. Does not fully vest during the period in which any obligation arising from financial assistance provided to Mid Penn remains outstanding;

 

  ii. Has a value in an amount that is not greater than one-third of the total amount of annual compensation of the employee receiving the stock; and

 

  iii. Is subject to such other terms and conditions as the Secretary of the Treasury may determine is in the public interest;

 

  5. a prohibition on any compensation plan that would encourage manipulation of the reported earnings of Mid Penn to enhance the compensation of any of its employees; and

 

  6. a requirement that Mid Penn’s compensation committee remains entirely independent and meets at least semiannually to discuss and evaluate employee compensation plans in light of an assessment of any risk posed to Mid Penn from such plans.

In compliance with the EESA and ARRA, on February 27, 2009, Rory G. Ritrievi entered into a Capital Purchase Plan Executive Compensation Restriction Agreement with Mid Penn Bancorp, Inc. and Mid Penn Bank (the “Agreement”). The Agreement prohibits, during the period which any obligation to the Federal Government remains outstanding, any payment to Mr. Ritrievi (including bonus payments and payments upon a termination) which would violate the EESA and ARRA.

In addition to these requirements, Mid Penn must have in place a company-wide policy regarding excessive or luxury expenditures and must permit a separate nonbinding shareholder vote to approve the compensation of executives as disclosed pursuant to the compensation disclosure rules of the Securities and Exchange Commission. Mid Penn has adopted such a luxury and expense policy and it appears on the Corporation’s website at www.midpennbank.com.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

Federal Income Taxes

Federal income tax expense for 2011 was $1,223,000 compared to $416,000 in 2010 and a federal income tax benefit of $2,208,000 in 2009. The effective tax rate was 21% for 2011, 13% for 2010, and 49% for 2009.

The tax expense in 2011 and 2010 resulted from net income generated in the normal course of business. The tax benefit recorded in 2009 was related to a loss stemming from the increased provision for loan losses and increased noninterest expenses during 2009. Generally, our effective tax rate is below the statutory rate due to earnings on tax-exempt loans, investments, and bank-owned life insurance, and the impact of tax credits. The realization of deferred tax assets is dependent on future earnings. As a result of Mid Penn’s adoption of ASC Topic 740, Income Taxes, no significant income tax uncertainties were identified; therefore, Mid Penn recognized no adjustment for unrealized income tax benefits for the periods ended December 31, 2011 and December 31, 2010. We currently anticipate that future earnings will be adequate to fully utilize deferred tax assets.

Liquidity

Mid Penn’s asset-liability management policy addresses the management of Mid Penn’s liquidity position and its ability to raise sufficient funds to meet deposit withdrawals, fund loan growth and meet other operational needs. Mid Penn utilizes its investments as a source of liquidity, along with deposit growth and increases in repurchase agreements and borrowings. (See Deposits and Other Funding Sources which appears earlier in this discussion.) Liquidity from investments is provided primarily through investments and interest-bearing balances with maturities of one year or less. Funds are available to Mid Penn through loans from the Federal Home Loan Bank and established federal funds (overnight) lines of credit. Mid Penn’s major source of funds is its core deposit base.

Major sources of cash in 2011 came from the net increase in deposits of $79,073,000, as well as the decrease in interest-bearing balances of $27,564,000.

The major uses of cash in 2011 were the net purchase of investment securities of $84,744,000 and the increase in loans and leases of $17,774,000.

Major sources of cash in 2010 came from the net increase in deposits of $54,967,000, as well as the proceeds from the maturity of investment securities of $8,982,000 and the decrease in loans and leases of $8,690,000.

The major uses of cash in 2010 were the purchase of investment securities of $33,472,000 and the reduction in short-term borrowings and long-term debt of $14,483,000 and $10,174,000, respectively. Another major use of cash in 2010 was the increase in interest-bearing balances of $16,437,000.

Aggregate Contractual Obligations

Table 15 represents Mid Penn’s on-and-off balance sheet aggregate contractual obligations to make future payments as of December 31, 2011:

TABLE 15: AGGREGATE CONTRACTUAL OBLIGATIONS

 

(Dollars in thousands)                Payments Due by Period  
     Note
Reference
   Total      One Year or
Less
     One to
Three Years
     Three to
Five Years
     More than
Five Years
 

Certificates of deposit

   9    $ 201,892       $ 94,171       $ 76,938       $ 29,153       $ 1,630   

Long-term debt

   11      22,701         —           14,213         5,000         3,488   

Operating lease obligations

   19      341         109         211         21         —     

Payments under benefit plans

   13      1,574         103         245         316         910   
     

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
      $ 226,508       $ 94,383       $ 91,607       $ 34,490       $ 6,028   
     

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

We are not aware of any other commitments or contingent liabilities which may have a material adverse impact on Mid Penn’s liquidity or capital resources.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

Effects of Inflation

A bank’s asset and liability structure is substantially different from that of an industrial company in that virtually all assets and liabilities of a bank are monetary in nature. Management believes the impact of inflation on its financial results depends principally upon Mid Penn’s ability to manage the balance sheet sensitivity to changes in interest rates and, by such reaction, mitigate the inflationary impact on performance. Interest rates do not necessarily move in the same direction or at the same magnitude as the prices of other goods and services. As discussed previously, Management seeks to manage the relationship between interest sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation.

Information shown elsewhere in this Annual Report will assist in the understanding of how Mid Penn is positioned to react to changing interest rates and inflationary trends. In particular, the summary of net liabilities, as well as the composition of loans, investments and deposits should be considered.

Off-Balance Sheet Items

Mid Penn makes contractual commitments to extend credit and extends lines of credit, which are subject to Mid Penn’s credit approval and monitoring procedures.

As of December 31, 2011, commitments to extend credit amounted to $91,619,000 as compared to $86,141,000 as of December 31, 2010.

Mid Penn also issues standby letters of credit to its customers. The risk associated with standby letters of credit is essentially the same as the credit risk involved in loan extensions to customers. Standby letters of credit decreased to $7,320,000 at December 31, 2011, from $10,048,000 at December 31, 2010.

Comprehensive Income (Loss)

Comprehensive Income (Loss) is a measure of all changes in equity of a corporation, excluding transactions with owners in their capacity as owners (such as proceeds from issuances of stock and dividends). The difference between Net Income (Loss) and Comprehensive Income (Loss) is termed “Other Comprehensive Income (Loss).” For Mid Penn, Other Comprehensive Income (Loss) consists primarily of unrealized gains and losses on available for sale securities, net of deferred income tax. Other Comprehensive Income (Loss) also includes a pension component in accordance with ASC Topic 715. Comprehensive Income (Loss) should not be construed to be a measure of Net Income (Loss). The amount of unrealized gains or losses reflected in Comprehensive Income (Loss) may vary widely at statement dates depending on the markets as a whole and how interest rate movements affect the market value of the portfolio of available for sale securities. Other Comprehensive Income (Loss) for the years ended December 31, 2011, 2010 and 2009 was $1,880,000, ($737,000), and $369,000, respectively.

 

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MID PENN BANCORP, INC.   Management’s Discussion and Analysis

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

Mid Penn utilizes an asset-liability management model to measure the impact of interest rate movements on its interest rate sensitivity position. Mid Penn’s management also reviews the traditional maturity gap analysis regularly. Mid Penn does not always attempt to achieve an exact match between interest sensitive assets and liabilities because it believes that an actively managed amount of interest rate risk is inherent and appropriate in the management of the Corporation’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 Table 16, indicate that there would not be a significant variance in net interest income over a one-year time frame due to interest rate changes; however, actual results could vary significantly from the calculations prepared by Management. At December 31, 2011, all interest rate risk levels according to the model were within the tolerance limits of Board approved policy. In addition, the table does not take into consideration changes, which Management would make to realign its portfolio in the event of a changing rate environment.

TABLE 16: EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES

 

December 31, 2011

    December 31, 2010  

Change in

Basis Points

   % Change in
Net Interest
Income
    Risk Limit     Change in
Basis Points
  % Change in
Net Interest
Income
    Risk Limit  

300

     6.29     +/- 25   300     4.84     +/- 25

200

     4.19     +/- 15   200     3.32     +/- 15

100

     2.01     +/- 10   100     1.72     +/- 10

0

       0    

(100)

     -3.36     +/- 10   (100)     -1.87     +/- 10

(200)

     -4.73     +/- 15   (200)     -3.89     +/- 15

(300)

     -7.02     +/- 25   (300)     -5.88     +/- 25

 

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MID PENN BANCORP, INC.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following audited financial statements are set forth in this Annual Report of Form 10-K on the following pages:

Index to Financial Statements and Supplementary Data

 

Report of Independent Registered Public Accounting Firm

     42   

Consolidated Balance Sheets

     43   

Consolidated Statements of Operations

     44   

Consolidated Statements of Changes in Shareholders’ Equity

     45   

Consolidated Statements of Cash Flows

     46   

Notes to Consolidated Financial Statements

     47   

 

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders

Mid Penn Bancorp, Inc.

We have audited the accompanying consolidated balance sheets of Mid Penn Bancorp, Inc. and subsidiaries (the “Corporation”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2011. The Corporation’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Corporation is not required to have, nor were we engaged to perform, an audit of their internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for expressing an opinion on the effectiveness of the Corporation’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Corporation as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.

ParenteBeard LLC

Harrisburg, Pennsylvania

March 26, 2012

 

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MID PENN BANCORP, INC.    Consolidated Balance Sheets

 

(Dollars in thousands, except per share data)             
     December 31,2011     December 31,2010  

ASSETS

    

Cash and due from banks

   $ 9,847      $ 6,779   

Interest-bearing balances with other financial institutions

     1,555        884   

Federal funds sold

     6,439        5,238   
  

 

 

   

 

 

 

Total cash and cash equivalents

     17,841        12,901   
  

 

 

   

 

 

 

Interest-bearing time deposits with other financial institutions

     27,477        55,041   

Available for sale investment securities

     159,043        70,702   

Loans and leases, net of unearned interest

     482,717        467,735   

Less: Allowance for loan and lease losses

     (6,772     (7,061
  

 

 

   

 

 

 

Net loans and leases

     475,945        460,674   
  

 

 

   

 

 

 

Bank premises and equipment, net

     13,324        13,185   

Restricted investment in bank stocks

     3,120        3,828   

Foreclosed assets held for sale

     931        596   

Accrued interest receivable

     3,067        2,632   

Deferred income taxes

     2,439        2,875   

Goodwill

     1,016        1,016   

Core deposit and other intangibles, net

     274        351   

Cash surrender value of life insurance

     7,896        7,638   

Other assets

     3,010        6,018   
  

 

 

   

 

 

 

Total Assets

   $ 715,383      $ 637,457   
  

 

 

   

 

 

 

LIABILITIES & SHAREHOLDERS’ EQUITY

    

Deposits:

    

Noninterest bearing demand

   $ 73,261      $ 60,228   

Interest bearing demand

     59,403        44,578   

Money Market

     271,521        209,936   

Savings

     27,978        26,466   

Time

     201,892        213,774   
  

 

 

   

 

 

 

Total Deposits

     634,055        554,982   

Short-term borrowings

     —          1,561   

Long-term debt

     22,701        27,883   

Accrued interest payable

     1,064        1,111   

Other liabilities

     4,111        3,719   
  

 

 

   

 

 

 

Total Liabilities

     661,931        589,256   

Shareholders’ Equity:

    

Preferred stock, par value $1,000; authorized 10,000,000 shares; 5% cumulative dividend; 10,000 shares issued and outstanding at December 31, 2011 and December 31, 2010

     10,000        10,000   

Common stock, par value $1 per share; 10,000,000 shares authorized; 3,484,509 shares issued and outstanding at December 31, 2011 and 3,479,780 at December 31, 2010

     3,484        3,480   

Additional paid-in capital

     29,830        29,810   

Retained earnings

     8,222        4,875   

Accumulated other comprehensive income

     1,916        36   
  

 

 

   

 

 

 

Total Shareholders’ Equity

     53,452        48,201   
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 715,383      $ 637,457   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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MID PENN BANCORP, INC.    Consolidated Statements of Operations

 

(Dollars in thousands, except per share data)    Years Ended December 31,  
     2011     2010      2009  

INTEREST INCOME

       

Interest & fees on loans and leases

   $ 28,038      $ 27,397       $ 28,039   

Interest on interest-bearing balances

     520        818         1,460   

Interest and dividends on investment securities:

       

U.S. Treasury and government agencies

     1,619        788         652   

State and political subdivision obligations, tax-exempt

     1,329        1,108         1,171   

Other securities

     14        12         13   

Interest on federal funds sold and securities purchased under agreements to resell

     25        25         1   
  

 

 

   

 

 

    

 

 

 

Total Interest Income

     31,545        30,148         31,336   
  

 

 

   

 

 

    

 

 

 

INTEREST EXPENSE

       

Interest on deposits

     8,509        9,319         10,726   

Interest on short-term borrowings

     4        18         112   

Interest on long-term debt

     1,009        1,305         2,466   
  

 

 

   

 

 

    

 

 

 

Total Interest Expense

     9,522        10,642         13,304   
  

 

 

   

 

 

    

 

 

 

Net Interest Income

     22,023        19,506         18,032   

PROVISION FOR LOAN AND LEASE LOSSES

     1,205        2,635         9,520   
  

 

 

   

 

 

    

 

 

 

Net Interest Income After Provision for Loan and Lease Losses

     20,818        16,871         8,512   
  

 

 

   

 

 

    

 

 

 

NONINTEREST INCOME

       

Income from fiduciary activities

     539        431         417   

Service charges on deposits

     704        1,139         1,479   

Earnings from cash surrender value of life insurance

     258        270         280   

Gain on life insurance proceeds

     —          —           158   

Mortgage banking income

     390        423         124   

Other income

     1,105        1,151         1,198   
  

 

 

   

 

 

    

 

 

 

Total Noninterest Income

     2,996        3,414         3,656   
  

 

 

   

 

 

    

 

 

 

NONINTEREST EXPENSE

       

Salaries and employee benefits

     9,519        8,760         8,173   

Occupancy expense, net

     1,075        916         844   

Equipment expense

     1,292        1,361         1,170   

Pennsylvania Bank Shares tax expense

     449        443         366   

FDIC Assessment

     1,057        897         1,163   

Legal and professional fees

     444        529         814   

Director fees and benefits expense

     304        303         291   

Marketing and advertising expense

     354        308         679   

Computer expense

     697        578         393   

Telephone expense

     377        362         344   

(Gain) loss on sale/write-down of foreclosed assets

     (20     283         110   

Core deposit intangible amortization

     65        65         65   

Other expenses

     2,435        2,316         2,259   
  

 

 

   

 

 

    

 

 

 

Total Noninterest Expense

     18,048        17,121         16,671   
  

 

 

   

 

 

    

 

 

 

INCOME (LOSS) BEFORE PROVISION FOR (BENEFIT FROM)

       

INCOME TAXES

     5,766        3,164         (4,503

Provision for (benefit from) income taxes

     1,223        416         (2,208
  

 

 

   

 

 

    

 

 

 

NET INCOME (LOSS)

     4,543        2,748         (2,295

Preferred stock dividends and discount accretion

     514        514         514   
  

 

 

   

 

 

    

 

 

 

NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS

   $ 4,029      $ 2,234       $ (2,809
  

 

 

   

 

 

    

 

 

 

PER COMMON SHARE DATA:

       

Basic Earnings (Loss) Per Common Share

   $ 1.16      $ 0.64       $ (0.81

Diluted Earnings (Loss) Per Common Share

     1.16        0.64         (0.81

Cash Dividends

     0.20        0.00         0.52   
       

The accompanying notes are an integral part of these consolidated financial statements.

 

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MID PENN BANCORP, INC.    Consolidated Statements of Changes in Shareholders’ Equity

FOR YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009

 

(Dollars in thousands, except share data)    Preferred
Stock
     Common
Stock
     Additional
Paid-in
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income
    Treasury
Stock
     Total
Shareholders’
Equity
 

Balance, December 31, 2008

   $ 10,000       $ 3,480       $ 29,838      $ 7,168      $ 404      $ —         $ 50,890   

Comprehensive loss:

                 

Net loss

     —           —           —          (2,295