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MPB > SEC Filings for MPB > Form 10-K on 25-Mar-2013All Recent SEC Filings

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Form 10-K for MID PENN BANCORP INC


25-Mar-2013

Annual Report


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 effects of the failure of the federal government to reach a deal to raise the debt ceiling or avoid sequester, and the negative results on economic or business conditions resulting therefrom;

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.

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


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

may be susceptible to significant change. The loan and lease portfolio also represents the largest asset type on the consolidated balance sheet. Throughout the remainder of this report, the terms "loan" or "loans" refers to both loans and leases.

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

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, 2012. If certain events occur which might indicate goodwill has been impaired, the goodwill is tested when such events occur.

Financial Summary

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

2012 versus 2011

Mid Penn recorded net income available to common shareholders of $4,437,000 for the year 2012, compared to $4,029,000 in 2011, which was an increase of $408,000 or 10.1%. This represents net income in 2012 of $1.27 per common share compared to $1.16 per common share in 2011.

Total assets of Mid Penn contracted in 2012, falling to $705,200,000, a decrease of $10,183,000, or 1.4% from $715,383,000 at year-end 2011. The majority of asset contraction came from a decrease in investments, which fell to $154,295,000 or 3.0% from $159,043,000 at the end of 2011. Federal funds sold also decreased, falling $3,439,000 or 53.4% from $6,439,000 at the end of 2011. These asset reductions were used to offset a reduction in deposits, which decreased 1.4% to $625,461,000 from $634,055,000 at year-end 2011. This deposit decrease was the result of the maturity of a $10,000,000 brokered certificate of deposit early in 2012.

The continued soft economy was the major contributor to modest loan growth during 2012. Loan balances increased 0.3% to $484,220,000 from $482,717,000 in 2011. Mid Penn experienced weak loan demand during 2012 despite a desire to sensibly lend to support creditworthy existing and new customers in the marketplace. Adding additional strain to weakened demand was the increase in unscheduled payoffs of large loans within the portfolio. The continued low interest rate environment and weak economy has increased the competitive pressure from other lending institutions to attract borrowers from other institutions as well as incenting borrowers to use surplus cash reserves to pay down debt rather than expand their operations.

Mid Penn's return on average shareholders' equity, (ROE), a widely recognized performance indicator in the financial industry, was 8.78% in 2012 and 8.96% in 2011. Return on average assets (ROA), another performance indicator, was 0.69% in 2012 and 0.66% in 2011.

Mid Penn's performance during 2012 was a solid improvement over the results reported in 2011. This improvement was the result of reduced provision for loan and lease losses, improving cost of funds, consistent management of controllable expenses, and growth in noninterest income sources throughout 2012.

Net charge-offs increased from $1,494,000 in 2011 to $2,299,000 during 2012. Despite the increase in net charge-offs from 2011, Mid Penn was able to reduce provision for loan and lease losses from $1,205,000 in 2011 to $1,036,000 in 2012. This stemmed from the fact that $1,499,000 of the net charge-offs during 2012 had a previously recorded balance included in the allowance for loan and lease losses. As Mid Penn continues to work to resolve the elevated levels of nonperforming loans, the relationship between net charge-offs and provision for loan and lease losses may continue to have a more tenuous link. Further discussion of these issues can be found in the Provision for Loan and Lease Losses section below.

Net interest margin improved to 3.63% in 2012 from 3.52% in 2011. This improvement was driven by a 48 basis point improvement in the rate on supporting liabilities from 1.68% in 2011 to 1.20% in 2012. This improvement allowed average interest spread to increase to 3.49% from 3.29% in 2011 and net interest income on a tax equivalent basis to increase from $23,094,000 in 2011 to $24,494,000 in 2012. 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 2012 amounted to $2,974,000. Further discussion of net interest margin can be found in the Net Interest Income section below.

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 2012, the expenses associated with the increased collection and management efforts on troubled


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

assets were $369,000 as compared to $299,000 in 2011. 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 2012 was sound despite these issues and the general economic conditions experienced by the banking industry as a whole.

The Bank's tier one capital (to risk weighted assets) of $48,764,000, or 10.0%, and total capital (to risk weighted assets) of $54,363,000, or 11.1%, at December 31, 2012, are above the regulatory requirements. Tier one capital consists primarily of the Bank's shareholders' equity and any qualifying preferred stock. Total capital also 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.

2011 versus 2010

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.

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.

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

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 $1,942,000. 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 $435,000 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.


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

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 and any qualifying preferred stock. Total capital also 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.

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.


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, 2012                   December 31, 2011                  December 31, 2010
                          Average                  Average    Average                 Average    Average                 Average
                          Balance      Interest     Rates     Balance     Interest     Rates     Balance     Interest     Rates
ASSETS:
 Interest Earning
Balances               $     26,092    $    236     0.90%    $  50,458    $    520     1.03%    $  45,244    $    818     1.81%
 Investment
Securities:
   Taxable                   99,906       1,154     1.16%       81,017       1,632     2.01%       31,981         800     2.50%
   Tax-Exempt                55,033       2,609     4.74%       35,238       2,015     5.72%       26,254       1,679     6.40%
    Total Securities        154,939                            116,255                             58,235
 Federal Funds Sold           6,197          16     0.26%        9,922          25     0.25%        9,222          25     0.27%
 Loans and Leases, Net      483,977      27,599     5.70%      475,677      28,424     5.98%      472,582      27,788     5.88%
 Restricted Investment
   in Bank Stocks             2,772           5     0.18%        3,441            -    0.00%        3,995            -    0.00%
 Total Earning Assets       673,977      31,619     4.69%      655,753      32,616     4.97%      589,278      31,110     5.28%
 Cash and Due from
Banks                         8,057                              7,941                              7,466
 Other Assets                24,422                             24,756                             26,330
Total Assets           $    706,456                          $ 688,450                          $ 623,074
LIABILITIES &
SHAREHOLDERS' EQUITY:
 Interest Bearing
Deposits:
   NOW                 $    126,171         458     0.36%    $  57,342         144     0.25%    $  48,024          69     0.14%
   Money Market             236,434       1,992     0.84%      248,615       2,992     1.20%      163,415       2,357     1.44%
   Savings                   28,632          14     0.05%       27,801          15     0.05%       26,585          16     0.06%
   Time                     180,356       3,683     2.04%      209,574       5,358     2.56%      239,761       6,877     2.87%
 Short-term Borrowings        1,044           3     0.29%          803           4     0.50%        3,798          18     0.47%
 Long-term Debt              22,605         975     4.31%       23,394       1,009     4.31%       28,860       1,305     4.52%
 Total Interest
   Bearing Liabilities      595,242       7,125     1.20%      567,529       9,522     1.68%      510,443      10,642     2.08%
 Demand Deposits             47,670                             63,484                             58,480
 Other Liabilities            7,184                              6,722                              6,010
 Shareholders' Equity        56,360                             50,715                             48,141
Total Liabilities and
Shareholders' Equity   $    706,456                          $ 688,450                          $ 623,074
Net Interest Income                    $ 24,494                           $ 23,094                           $ 20,468

Net Yield on Interest
Earning Assets:
Total Yield on Earning
Assets                                              4.69%                              4.97%                              5.28%
Rate on Supporting
Liabilities                                         1.20%                              1.68%                              2.08%
Average Interest
Spread                                              3.49%                              3.29%                              3.20%
Net Interest Margin                                 3.63%                              3.52%                              3.47%

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.

Loan fees of $1,148,000, $635,000, and $710,000 are included with interest income in Table 1 for the years 2012, 2011 and 2010, respectively.


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



TABLE 2: VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME







(Dollars in thousands)            2012 Compared to 2011                            2011 Compared to 2010
                          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               $      (251)    $         (33)    $    (284)     $        94     $        (392)    $    (298)
Investment Securities:
 Taxable                       380              (858)         (478)           1,227              (395)          832
 Tax-Exempt                  1,132              (538)          594              575              (239)          336
Total Investment
Securities                   1,512            (1,396)          116            1,801              (633)        1,168

Federal Funds Sold              (9)                 -           (9)               2                (2)             -
Loans and Leases, Net          496            (1,321)         (825)             186               450           636
Restricted Investment
Bank Stocks                       -                5             5                 -                 -             -
Total Interest Income        1,748            (2,745)         (997)           2,083              (577)        1,506

INTEREST EXPENSE:
Interest Bearing
Deposits:
 NOW                           173               141           314               13                62            75
 Money Market                 (147)             (853)       (1,000)           1,229              (594)          635
 Savings                          -               (1)           (1)               1                (2)           (1)
 Time                         (747)             (928)       (1,675)            (866)             (653)       (1,519)
 Total Interest
Bearing Deposits              (721)           (1,642)       (2,362)             376            (1,186)         (810)

Short-term Borrowings            1                (2)           (1)             (14)                 -          (14)
Long-term Debt                 (34)                 -          (34)            (247)              (49)         (296)
Total Interest Expense        (754)           (1,644)       (2,397)             115            (1,235)       (1,120)

NET INTEREST INCOME    $     2,502     $      (1,102)    $   1,400      $     1,968     $         658     $   2,626

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 2012, net interest income increased $1,400,000, or 6.1%, as compared to an increase of $2,626,000, or 12.8%, in 2011. The average balances, effective interest differential, and interest yields for the years ended December 31, 2012, 2011, and 2010 and the components of net interest income, are presented in Table 1. A comparative presentation of the changes in net interest income for 2012 compared to 2011, and 2011 compared to 2010, 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 4.69% in 2012 from 4.97% in 2011. The yield on earning assets for 2010 was 5.28%. 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 2012, 2011, and 2010 was 3.25%. The yield on earning assets is also negatively impacted by the loss of interest on nonperforming loans. During 2012, this loss of interest amounted to $2,974,000. Had this interest been included in Mid Penn's earnings, the yield on earning assets would have increased by 44 basis points.

Interest expense decreased by $2,397,000, or 25.2%, in 2012 as compared to a decrease of $1,120,000, or 10.5%, in 2011. The cost of interest bearing liabilities decreased to 1.20% in 2012 from 1.68% in 2011. The cost of interest bearing liabilities for 2010 was 2.08%. 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 3.63% in 2012 compared to 3.52% in 2011 and 3.47% in 2010. 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 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.


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

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 . . .

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