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MPB > SEC Filings for MPB > Form 10-Q on 14-Nov-2011All Recent SEC Filings

Show all filings for MID PENN BANCORP INC

Form 10-Q for MID PENN BANCORP INC


14-Nov-2011

Quarterly Report


ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is Management's Discussion of Consolidated Financial Condition as of September 30, 2011, compared to year-end 2010, and the Results of Operations for the three and nine months ended September 30, 2011, compared to the same period in 2010.

This discussion should be read in conjunction with the financial tables, statistics, and the audited financial statements and notes thereto included in Mid Penn's Annual Report on Form 10-K for the year ended December 31, 2010. The results of operations for interim periods are not necessarily indicative of operating results expected for the full year.

Certain of the matters discussed in this document and in documents incorporated by reference herein, including matters discussed under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," may constitute forward-looking statements for purposes of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and as such may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of Mid Penn to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. The words "expect", "anticipates", "intend", "plan", "believe", "estimate", and similar expressions are intended to identify such forward-looking statements.

Mid Penn's actual results may differ materially from the results anticipated in these forward-looking statements due to a variety of factors, including, without limitation:

The effects of 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 recently enacted 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.

Mid Penn undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report. Readers should carefully review the risk factors described in the documents that we periodically file with the SEC, including Mid Penn's Annual Report on Form 10-K for the year ended December 31, 2010.

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, 2010. If certain events occur which might indicate goodwill has been impaired, the goodwill is tested when such events occur.

Results of Operations

Overview

Net income available to common shareholders was $1,004,000, $0.29 per common share, for the quarter ended September 30, 2011, as compared to net income available to common shareholders of $352,000, or $0.11 per common share, for the quarter ended September 30, 2010. During the nine months ended September 30, 2011, net income available to common shareholders was $2,806,000, or $0.81 per common share, versus $1,621,000, or $0.47 per common share for the same period in 2010.

Net interest income increased $632,000, or 12.7%, to $5,619,000 for the quarter ended September 30, 2011 from $4,987,000 during the quarter ended September 30, 2010. Through the first nine months of 2011, net interest income increased $1,679,000, or 11.6%, to $16,192,000 from $14,513,000 during the same period in 2010. This increase has been spurred by a moderating cost of funds and increasing levels of average earning assets.

The provision for loan and lease losses in the third quarter of 2011 was $405,000, compared to $975,000 in the third quarter of 2010. During the nine months ended September 30, 2011, the provision for loan and lease losses was $1,155,000 compared to $2,060,000 for the nine months ended September 30, 2010.

Net income as a percent of average assets (return on average assets or "ROA") and shareholders' equity (return on average equity or "ROE") were as follows on an annualized basis:

                                    Three Months Ended           Nine Months Ended
                                       September 30,               September 30,
                                    2011            2010         2011           2010
       Return on average assets        0.64 %        0.30 %         0.63 %       0.43 %
       Return on average equity        8.69 %        3.93 %         8.53 %       5.61 %

Total assets increased to $720,817,000 at September 30, 2011, from $637,457,000 at December 31, 2010. This asset increase was driven by strong core deposit growth through the first nine months of 2011 with total deposits of $635,780,000 at September 30, 2011, compared to $554,982,000 at December 31, 2010, an increase of approximately $81,000,000. This growth in core deposits led to an increase in federal funds sold, and is being deployed to replace maturing long-term borrowings, and principally into investments and loans to maximize the return on these new funds.

The funding side of Mid Penn has continued the transformation begun in 2009. Deposit growth remained strong, as noted above, during the first nine months of 2011. This increase in deposits was primarily the result of an attractive money market rate, and the building of relationship-based core deposit accounts from the extensive portfolio of commercial real estate borrowers. In addition to the ongoing efforts to place these funds into loans and investments, during the first nine months of 2011, $5,000,000 of long-term FHLB debt has matured and been replaced with core deposits at a more advantageous rate structure. These strategies have improved the cost of funds and overall net interest margin despite continued downward pressure on asset yields.

Net Interest Income/Funding Sources

Net interest income, Mid Penn's primary source of revenue, is the amount by which interest income on loans and investments exceeds interest incurred on deposits and borrowings. The amount of net interest income is affected by changes in interest rates and changes in the volume and mix of interest-sensitive assets and liabilities. Net interest income and corresponding yields are presented in the analysis below on a taxable-equivalent basis. Income from tax-exempt assets, primarily loans to or securities issued by state and local governments, is adjusted by an amount equivalent to the federal income taxes which would have been paid if the income received on these assets was taxable at the statutory rate of 34%. The following table includes average balances, rates, interest income and expense, interest rate spread, and net interest margin:


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

Average Balances, Effective Interest Differential and Interest Yields

Interest rates and interest differential - taxable equivalent basis



                                                    For the Nine Months Ended                    For the Nine Months Ended
                                                       September 30, 2011                           September 30, 2010
(Dollars in thousands)                        Average       Interest       Rate (%)        Average       Interest       Rate (%)
ASSETS:
Interest Earning Balances                    $   56,747     $     442           1.04 %    $   41,668     $     622           2.00 %
Investment Securities:
Taxable                                          70,510         1,079           2.05 %        28,048           577           2.75 %
Tax-Exempt                                       31,723         1,412           5.95 %        25,504         1,228           6.44 %

Total Investment Securities                     102,233                                       53,552

Federal Funds Sold                               11,356            20           0.24 %         9,763            20           0.27 %
Loans and Leases, Net                           474,040        21,346           6.02 %       474,291        20,859           5.88 %
Restricted Investment in Bank Stocks              3,533            -            0.00 %         4,029            -            0.00 %

Total Earning Assets                            647,909        24,299           5.01 %       583,303        23,306           5.34 %
Cash and Due from Banks                           7,690                                        7,646
Other Assets                                     25,306                                       26,438

Total Assets                                 $  680,905                                   $  617,387

LIABILITIES & SHAREHOLDERS' EQUITY:
Interest Bearing Deposits:
NOW                                          $   55,994           104           0.25 %    $   48,618            50           0.14 %
Money Market                                    242,056         2,315           1.28 %       150,391         1,625           1.44 %
Savings                                          27,585            11           0.05 %        26,936            11           0.05 %
Time                                            211,892         4,133           2.61 %       246,470         5,385           2.92 %
Short-term Borrowings                               868             4           0.62 %         4,491            16           0.48 %
Long-term Debt                                   23,620           763           4.32 %        29,182           993           4.55 %

Total Interest Bearing Liabilities              562,015         7,330           1.74 %       506,088         8,080           2.13 %
Demand Deposits                                  61,624                                       57,457
Other Liabilities                                 7,229                                        6,065
Shareholders' Equity                             50,037                                       47,777

Total Liabilities and Shareholders' Equity   $  680,905                                   $  617,387

Net Interest Income                                         $  16,969                                    $  15,226


Net Yield on Interest Earning Assets:
Total Yield on Earning Assets                                                   5.01 %                                       5.34 %
Rate on Supporting Liabilities                                                  1.74 %                                       2.13 %
Average Interest Spread                                                         3.27 %                                       3.21 %
Net Interest Margin                                                             3.50 %                                       3.49 %

For the nine months ended September 30, 2011, Mid Penn's taxable-equivalent net interest margin increased to 3.50%, from 3.49%, as compared to the nine months ended September 30, 2010, driven primarily by a reduction in cost of supporting liabilities. Net interest income, on a taxable-equivalent basis, in the first nine months of 2011, increased to $16,969,000 from $15,226,000 in the first nine months of 2010, related to the changing composition of interest bearing liabilities and the growth in average earning assets, which increased 11.1% from September 30, 2010 to September 30, 2011. In spite of increasing earning assets, the positive impact on net interest margin has been dampened by the continued lack of qualified borrowers. Average loans and leases decreased $251,000 from September 30, 2010 to September 30, 2011. Earning asset growth has been concentrated primarily in the area of investment securities which carry an average yield of 3.26% during the nine months ended September 30, 2011 versus 4.51% during the nine months ended September 30, 2010.

Although the effective interest rate impact on earning assets and funding sources can be reasonably estimated at current interest rate levels, the options selected by customers, and the future mix of the loan, investment, and deposit products in the Bank's portfolios, may significantly change the estimates used in the simulation models. In addition, our net interest income may be impacted by further interest rate actions of the Federal Reserve Bank.


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

Provision for Loan 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 the first nine months of 2011, Mid Penn continued to experience a challenging economic and operating environment. Given the economic pressures that impact some borrowers, Mid Penn has increased the allowance for loan and lease losses in accordance with Mid Penn's assessment process, which took into consideration the decrease in collateral values from December 31, 2010 to September 30, 2011. The provision for loan and lease losses was $405,000 for the three months ended September 30, 2011, as compared to $975,000 for the three months ended September 30, 2010. During the nine months ended September 30, 2011, the provision for loan and lease losses was $1,155,000, as compared to $2,060,000 for the nine months ended September 30, 2010. For further discussion of factors affecting the provision for loan and lease losses please see Credit Quality, Credit Risk, and Allowance for Loan and Lease Losses in the Financial Condition section of this Management's Discussion and Analysis.

Noninterest Income

Noninterest income decreased $60,000, or 7.3%, during the third quarter of 2011
versus the third quarter of 2010. During the nine months ended September 30,
2011, noninterest income decreased $313,000, or 12.3%, versus the same period in
2010. The following components of noninterest income showed significant changes:



                                               Three Months Ended September 30,
 (Dollars in Thousands)              2011          2010       $ Variance        % Variance
 Income from fiduciary activities   $   157       $   104     $        53              51.0 %
 Service charges on deposits            167           262             (95 )           -36.3 %

                                                Nine Months Ended September 30,
 (Dollars in Thousands)              2011          2010       $ Variance        % Variance
 Income from fiduciary activities   $   367       $   335     $        32               9.6 %
 Service charges on deposits            539           918            (379 )           -41.3 %
 Mortgage banking income                305           241              64              26.6 %

Income from fiduciary activities increased during the three and nine months ended September 30, 2011 versus the same period in 2010. This increase was the result of greater sales of third party mutual funds during these periods in 2011. Service charges on deposits, primarily fees from insufficient funds, have decreased during both the three and nine months ended September 30, 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 recent regulatory changes governing overdraft charges on electronic transactions, which has resulted in a reduction in NSF revenue. Helping to offset this reduction in revenue is the increase in mortgage banking income during the nine months ended September 30, 2011 versus the same period in 2010. Historically low long-term mortgage rates have triggered a wave of refinancing activity, improving fee income from this line of business. The negative variance in other income during the three and nine months ended September 30, 2011 versus the same period in 2010 is primarily the result of reduced volume in letters of credit to commercial borrowers and net expenses associated with amortization of mortgage servicing rights on the Bank's sold mortgage portfolio to Fannie Mae.


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

Noninterest Expenses

Noninterest expenses increased $182,000 or 4.2% during the third quarter of
2011, versus the same period in 2010. During the nine months ended September 30,
2011, noninterest expenses increased $569,000, or 4.5%, versus the same period
in 2010. The changes were primarily a result of the following components of
noninterest expense:



                                                          Three Months Ended September 30,
(Dollars in Thousands)                       2011           2010         $ Variance          % Variance
Salaries and employee benefits              $ 2,390        $ 2,202       $       188                 8.5 %
Occupancy expense, net                          274            243                31                12.8 %
FDIC Assessment                                 225            205                20                 9.8 %
Loss on sale/write-down of foreclosed
assets                                           27            128              (101 )             -78.9 %

                                                          Nine Months Ended September 30,
(Dollars in Thousands)                       2011           2010         $ Variance          % Variance
Salaries and employee benefits              $ 6,992        $ 6,464       $       528                 8.2 %
Occupancy expense, net                          826            693               133                19.2 %
Equipment expense                               980          1,027               (47 )              -4.6 %
FDIC Assessment                                 756            610               146                23.9 %
Legal and professional fees                     315            377               (62 )             -16.4 %
Computer expense                                500            425                75                17.6 %
(Gain) Loss on sale/write-down of
foreclosed assets                               (32 )          248              (280 )            -112.9 %

Salaries and employee benefits have shown increases during the three and nine months ended September 30, 2011, due to the hiring of experienced team members to bolster compliance functions and to add depth to the operations areas of Mid Penn. Occupancy expense for the three and nine months ended September 30, 2011 increased $31,000 and $133,000 from the same periods in 2010 respectively. This increase was attributable to an increase in utility costs and real estate taxes between the two periods. Equipment expense for the nine months ended September 30, 2011 decreased by $47,000 from the same period in 2010. During 2010, significant repairs and enhancements were made to both security and communication systems, as well as costs for items for the opening of the new banking office on Derry Street. These costs were not duplicated during 2011. The negative variance in FDIC Assessment during the three and nine months ended September 30, 2011, was driven by the growth in the assessment base used in the calculation. Legal and professional fees for the nine months ended September 30, 2011 have decreased from the same period in 2010. During 2010, employee search services were utilized to fill specialized positions within the organization. Also, Mid Penn utilized technology consultants to assist in reorganizing computer hardware assets to gain greater functionality. Computer expenses have increased during the nine months ended September 30, 2011, due to increasing annual maintenance costs on hardware and software components as well as the addition of new components to support enhanced online banking capabilities. A positive variance during the three and nine months ended September 30, 2011 was the (gain) loss on sale/write-down of foreclosed assets. Real estate values for these distressed properties have stabilized and their liquidation has been able to proceed in a more orderly manner, preventing unanticipated losses at the time of sale.

Income Taxes

The provision for income taxes was $312,000 for the three months ended September 30, 2011, as compared to the provision for income taxes of $4,000 in the same period last year. The effective tax rate for the three months ended September 30, 2011, was 21.6% compared to 0.8% for the three months ended September 30, 2010. The provision for income taxes for the nine months ended September 30, 2011 was $831,000, as compared to $314,000 during the same period of 2010. The effective tax rate for the nine months ended September 20, 2011, was 20.7% compared to 13.5% for the nine months ended September 30, 2010. Generally, our effective tax rate is below the statutory rate due to earnings on tax-exempt loans, investments, and bank-owned life insurance, as well as the impact of tax credits. The higher effective tax rate in both the three and nine months ended September 30, 2011 versus the same period in 2010 is a result of the reduced marginal impact these tax exempt elements have within the Corporation's increasing income stream. During 2011, Mid Penn has recognized higher taxable earnings from increased net interest income and reduced provisions for loan and lease losses than the comparable periods in 2010. The realization of deferred tax assets is dependent on future earnings. We currently anticipate that future earnings will be adequate to fully utilize deferred tax assets.

Financial Condition

Loans

During the first nine months of 2011, Mid Penn experienced an increase in loans outstanding. Residential real estate loans have increased during the first nine months of 2011, aided by historically low long-term mortgage rates triggering a wave of refinancing activity. Commercial, industrial, and agricultural balances showed a modest increase as requests from creditworthy borrowers have begun to increase. Balances in the


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

other components of the loan portfolio have eroded through contractual payments and the refinancing of real estate secured debt by borrowers with equity in their properties. While loan demand has shown modest improvement, Mid Penn is still experiencing weaker than normal loan demand during the first nine months of 2011 despite a desire to sensibly lend to support creditworthy existing and new customers in our marketplace.

                                                   September 30, 2011             December 31, 2010
(Dollars in thousands)                            Amount            %            Amount           %
Commercial real estate, construction and
land development                                $   250,150         51.6 %     $  252,915         54.1 %
. . .
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