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MPB > SEC Filings for MPB > Form 10-Q on 15-May-2013All Recent SEC Filings

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Form 10-Q for MID PENN BANCORP INC


15-May-2013

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 March 31, 2013, compared to year-end 2012, and the Results of Operations for the three months ended March 31, 2013, compared to the same period in 2012.

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, 2012. 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 and the prolonged economic malaise 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;

Possible impacts of the capital and liquidity requirements proposed by the Basel III standards and other regulatory pronouncements, regulations and rules;

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

Slow 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, 2012.

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 Mid Penn 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, the assessment of goodwill for impairment, and the valuation of deferred tax assets to be the accounting areas that require the most subjective and complex judgments.


MID PENN BANCORP, INC.

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.

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.

Mid Penn recognizes deferred tax assets and liabilities for the future effects of temporary differences and tax credits. Enacted tax rates are applied to cumulative temporary differences based on expected taxable income in the periods in which the deferred tax asset or liability is anticipated to be realized. Future tax rate changes could occur that would require the recognition of income or expense in the consolidated statements of income in the period in which they are enacted. Deferred tax assets must be reduced by a valuation allowance if in management's judgment, it is "more likely than not" that some portion of the asset will not be realized. Management may need to modify their judgment in this regard from one period to another should a material change occur in the business environment, tax legislation, or in any other business factor that could impair Mid Penn's ability to benefit from the asset in the future.

Results of Operations

Overview

Net income available to common shareholders was $624,000, $0.18 per common share, for the quarter ended March 31, 2013, as compared to net income available to common shareholders of $1,006,000, or $0.29 per common share, for the quarter ended March 31, 2012, a 38.0% decrease.

Net interest income declined $218,000, or 3.8%, to $5,459,000 for the quarter ended March 31, 2013 from $5,677,000 during the quarter ended March 31, 2012. This decline is a combination of lower yields on our earning assets and a reduction in the level of average earning assets, which decreased from $679,381,000 at March 31, 2012 to $664,083,000 at March 31, 2013.

The provision for loan and lease losses in the first quarter of 2013 was $495,000, compared to $300,000 in the first quarter of 2012.

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 March 31,
                             2013              2012
Return on average assets     0.40%             0.64%
Return on average equity     5.26%             8.42%

Total assets increased $21,230,000 to $726,430,000 at March 31, 2013, from $705,200,000 at December 31, 2012. This increase is attributable to growth in net loans, increasing $10,615,000 from $478,711,000 at December 31, 2012 to $489,326,000 at March 31, 2013, as well as an increase in cash and cash equivalents due to the influx of public and non-profit entity deposits. Those deposits are a result of Mid Penn's decision to expand its Cash Management offerings and attract a larger share of public and non-profit deposit dollars. Total deposits increased $14,724,000 from $625,461,000 at December 31, 2012 to $640,185,000 at March 31, 2013. Other liabilities increased $6,824,000 from $4,389,000 at December 31, 2012. This increase was the result of $7,166,000 in pending purchases of available for sale investment securities included on the consolidated balance sheet but not yet reaching their settlement date. Growth in available for sale investment securities has declined in the first quarter of 2013 mainly due to the rapid amortization of our CMO portfolio, as well as the lack of quality investment securities available that meet our needs. In order to continue improving net interest margin within the current environment, Mid Penn has chosen to manage the consolidated balance sheet in such a way that loan and deposit growth in 2013 remain closely matched.


MID PENN BANCORP, INC.

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%.

For the three months ended March 31, 2013, Mid Penn's taxable-equivalent net interest margin decreased slightly to 3.53%, from 3.54%, as compared to the three months ended March 31, 2012. Net interest income, on a taxable-equivalent basis, in the three months ended March 31, 2013, decreased to $5,785,000 from $5,980,000 during the same three months of 2012. This decline is attributable to the increasing level of investment securities relative to loans in the composition of interest earning assets and the reduction in average earning assets, which decreased 2.3% from the three months ended March 31, 2012 to the three months ended March 31, 2013.

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.

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 three months of 2013, Mid Penn continued to experience a challenging economic and operating environment both on a national and local level. 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, 2012 to March 31, 2013.

Following its model for loan and lease loss allowance adequacy, management recorded a $495,000 provision for the three months ended March 31, 2013, as compared to a provision of $300,000 for the three months ended March 31, 2012. The allowance for loan and lease losses as a percentage of total loans was 1.19% at March 31, 2013, compared to 1.14% at December 31, 2012. 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 increased $112,000, or 15.2%, during the first quarter of 2013 versus the first quarter of 2012. The following components of noninterest income showed significant changes:

(Dollars in Thousands)                            Three Months Ended March 31,
                                            2013     2012    $ Variance    % Variance
Income from fiduciary activities           $ 139    $ 112    $       27        24.1%
Net gain on sales of investment securities      -      16           (16)      -100.0%
Mortgage banking income                      110      122           (12)        -9.8%
Other income                                 290      177           113        63.8%

Income from fiduciary activities increased during the three months ended March 31, 2013 versus the same periods in 2012. This variance is the result of an increase in estate settlement fees and sales of third party mutual funds during 2013 versus 2012.

Mid Penn recognized investment security gains in the three months ended March 31, 2012, while there were no sales of investment securities in the first quarter of 2013. Mortgage banking income was off slightly during the three months ended March 31, 2013. Refinancing activity has begun to subside while purchase activity has increased, but is still weak versus pre-recession levels in spite of low financing rates and reduced home prices.


MID PENN BANCORP, INC.

Other income also increased during the three months ended March 31, 2013 versus the three months ended March 31, 2012 due to the growth in merchant services revenue, as well as the reimbursement of loan collection costs by a commercial borrower and the reimbursement of unclaimed funds from the flexible spending and dental reimbursement Plans from the 2011-2012 plan year.

Noninterest Expenses

Noninterest expenses increased $299,000 or 6.3% during the first quarter of 2013, versus the same period in 2012. The changes were primarily a result of the following components of noninterest expense:

(Dollars in Thousands)                  Three Months Ended March 31,
                                 2013       2012     $ Variance    % Variance
Salaries and employee benefits $ 2,857    $ 2,596    $      261        10.1%
FDIC Assessment                    202        301           (99)       -32.9%
Legal and professional fees        154        107            47        43.9%
Other expenses                     610        513            97        18.9%

Salaries and employee benefits increased during the three months ended March 31, 2013, primarily due to the increase in actual medical claims experienced from Mid Penn's self-funded medical insurance plan. Also contributing to the increase were the merit increases for existing team members and the hiring of new, experienced team members to add depth to the sales and support areas. FDIC assessments consist of premiums paid by FDIC-insured institutions. The assessments are based on statutory and risk classification factors. FDIC assessments decreased during the three months ended March 31, 2013 mainly due to a reduction in the Bank's risk rating over that period, as well as the contraction in the asset base used in the computation. Legal and professional fees increased during the three months ended March 31, 2013, comprised primarily of increased fees associated with a change in the firm used for outsourced internal audit and a fee paid to a recruiter for the hiring of an additional commercial lender. Other expenses increased during the three months ended March 31, 2013, due to the use of temporary staff to complete Mid Penn's transition to electronic retention of loan documents, higher costs of managing the pool of other real estate owned and a general increase in overall cost of services utilized.

Income Taxes

The provision for income taxes was $92,000 for the three months ended March 31, 2013, as compared to the provision for income taxes of $243,000 in the same period last year. The effective tax rate for the three months ended March 31, 2013, was 11.8% compared to 17.6% for the three months ended March 31, 2012. This decline was the result of lower taxable income in the first quarter of 2013 versus the same period in 2012. 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 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 three months of 2013, Mid Penn experienced an increase in loans outstanding. Commercial real estate, as well as commercial, industrial, and agricultural balances showed modest increases as requests from creditworthy borrowers began to increase, while balances in the residential real estate 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 improvement, Mid Penn continues to experience weaker than normal loan demand during the first three months of 2013 despite a desire to sensibly lend to support creditworthy existing and new customers in our marketplace.

(Dollars in thousands)                   March 31, 2013           December 31, 2012
                                        Amount         %           Amount         %
Commercial real estate, construction
and land development                 $   264,806     53.5%      $   255,231     52.7%
Commercial, industrial and
agricultural                              85,238     17.2%           79,228     16.4%
Residential mortgage                     138,504     28.0%          143,243     29.6%
Consumer                                   6,648      1.3%            6,518      1.3%
                                     $   495,196    100.0%      $   484,220    100.0%


MID PENN BANCORP, INC.

Most of Mid Penn's lending activities are with customers located within the trading area of Dauphin County, lower Northumberland County, western Schuylkill County and eastern Cumberland County, Pennsylvania. This region currently, and historically, has lower unemployment than the U.S. as a whole. This is due in part to a diversified manufacturing and services base and the presence of state government offices which help shield the local area from national trends. At March 31, 2013, the unadjusted unemployment rate for the Harrisburg/Carlisle area was 7.5% versus the seasonally adjusted national unemployment rate of 7.6%.

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

During the first three months of 2013, Mid Penn had net charge-offs of $134,000 compared to net charge-offs of $495,000 during the same period of 2012. Loans charged off during the first three months of 2013 were comprised of five residential real estate loans totaling $104,000, three commercial and industrial loans totaling $21,000, two consumer loans totaling $3,000, and one commercial real estate loan totaling $25,000. The remaining $2,000 was comprised of deposit account charge-offs. All loans charged off during the first quarter were to unrelated borrowers. Mid Penn may need to make future adjustments to the allowance and the provision for loan and lease losses if economic conditions or loan credit quality differs substantially from the assumptions used in making Mid Penn's evaluation of the level of the allowance for loan losses as compared to the balance of outstanding loans.

Changes in the allowance for loan and lease losses for the three months ended March 31, 2013 and 2012 are summarized as follows:

(Dollars in thousands)                               Three Months Ended March 31,
                                                       2013               2012
Average total loans outstanding (net of unearned
income)                                           $      479,507     $      484,415
Period ending total loans outstanding (net of
unearned income)                                         495,196            488,670

Balance, beginning of period                               5,509              6,772

  Loans charged off during period                           (155)              (522)
  Recoveries of loans previously charged off                  21                 27
Net chargeoffs                                              (134)              (495)

Provision for loan and lease losses                          495                300
Balance, end of period                            $        5,870     $        6,577


Ratio of net loans charged off to average loans
outstanding (annualized)                                   0.11%              0.41%

Ratio of allowance for loan losses to net loans
at end of period                                           1.19%              1.35%

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 normally 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 solely due to the existence of guarantees, without recognizing the credit as impaired. While the existence of a guarantee may be a mitigating factor in determining the proper level of allowance once impairment has been identified, the guarantee does not affect the impairment analysis.


MID PENN BANCORP, INC.

At March 31, 2013, total nonperforming loans amounted to $12,149,000, or 2.45% of loans and leases net of unearned income, as compared to levels of $12,257,000, or 2.53%, at December 31, 2012 and $12,192,000, or 2.49%, at March 31, 2012.

(Dollars in thousands)
                                 March 31, 2013      December 31, 2012      March 31, 2012
Nonperforming Assets:
  Nonaccrual loans              $        11,802      $          11,831     $        11,756
  Loans renegotiated with
borrowers                                   347                    426                 436
    Total nonperforming loans            12,149                 12,257              12,192

  Foreclosed real estate                    772                    843                 889
    Total non-performing assets          12,921                 13,100              13,081

  Accruing loans 90 days or
more past due                                  -                      -                   -
    Total risk elements         $        12,921      $          13,100     $        13,081

Nonperforming loans as a % of
total
  loans outstanding                       2.45%                  2.53%               2.49%
Nonperforming assets as a % of
total
  loans outstanding and other
real estate                               2.61%                  2.71%               2.67%
Ratio of allowance for loan
losses
  to nonperforming loans                 48.32%                 44.95%              53.95%

In the above table, loans renegotiated with borrowers represent Mid Penn's accruing troubled debt restructured loans. Troubled debt restructured loans that are no longer accruing interest are included in nonaccrual loans.

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

(Dollars in thousands)
                                              March 31, 2013       December 31, 2012
Period ending total loans outstanding (net
of unearned income)                         $         495,196     $          484,220
Allowance for loan and lease losses                     5,870                  5,509
Total Nonperforming loans                              12,149                 12,257
Nonperforming and impaired loans with
partial charge-offs                                     3,588                  3,744

Ratio of nonperforming loans with partial
charge-offs
  to total loans                                        0.72%                  0.77%

Ratio of nonperforming loans with partial
. . .
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