Mid Penn Bancorp Inc.
Annual Report 2001

Plain-text annual report

Mid Penn Bancorp, Inc. A Salute to Our Community of Everyday Heroes With respect for all the people who perished during the September 11, 2001, terrorist attacks against the United States, Mid Penn Bank would like to recognize the everyday heroes of our community. Mid Penn Bank, headquartered in Dauphin County, central Pennsylvania salutes all of our local volunteer fire com- pany and ambulance personnel. While most of us are taught to flee a burning structure, trained fire and rescue personnel are taught to run into a burning structure. Putting aside their own safety, risking their own lives, our local fire and rescue personnel respond to the call of duty, without ever giving as much as a second thought to their own security. Perhaps more astonishing than the fact that these men and women risk their own safe- ty, is that these fire and rescue departments are staffed by volunteer men and women. This is not their prima- ry job. They leave their regular jobs when the siren sounds. They leave their spouses and children, mothers and fathers, and other loved ones to save someone else’s loved ones or the property of a stranger. They aid the sick and injured, while they may be caring for a sick or injured family member of their own at home. Mid Penn Bank is very proud, as a local community bank, to support the local fire company and ambulance associations within our branch network with annual donations. Mid Penn Bank has been supporting these volunteer associations with annual donations for more than fifteen years. We give annual donations to more than forty fire company and ambulance associations, with donations totaling approximately $75,000 over the past three years alone. Apart from volunteer organizations, such as the fire companies and ambulance organizations, Mid Penn Bank supports local community growth. We support small business, (approximately 70% of our loans are to small businesses), local enterprise and growth in the areas in which we serve. We are very proud of the suc- cess of our local business owners and thriving commu- nities. Mid Penn Bank is happy to employ more than 125 dedicated, professional, local members of the commu- nities in which we serve. Our team of local, communi- ty business bankers are proud parents, grandparents, rel- atives and friends who choose to provide our neighbors with a true community bank atmosphere. We wouldn’t have it any other way. Mid Penn Bank is very proud to be a part of our local communities and we are even prouder of the fine men and women who comprise the very foundation of those communities. Mid Penn Bank could not have prospered over the past 130 years without the support and confi- dence of the local communities in which we chose to serve. Mid Penn Bank salutes all of our everyday heroes; firefighters, military personnel, ambulance personnel, police officers, rescuers, and all those men and women who bravely rush in while everyone else is running out. Thank you. Mid Penn Bancorp, Inc. Shareholder Letter Dear Shareholder: The year 2001 was certainly a year with more than its share of historic and economic events. A year in which we experienced the “tech wreck,” plummeting interest rates, a significant decline in the stock market, a reces- sion and the effects of September 11th. In spite of all these events, your Bank experienced record profits and an increase in share price of 21% from the prior year-end. I am pleased to present Mid Penn Bancorp’s financial report for the year 2001. Net income for the year 2001 totaled $4,230,000, an increase of 7.1% over the net income of $3,948,000 for the year 2000 and net income on a per share basis of $1.39 for 2001 compared to $1.30 for 2000. The growth in earnings was primarily attributable to higher levels of earning assets, increased loan origination fees, particularly in the residential mortgage area, and increased service charges on deposits. We continue to control expenses and are proud of our efficiency ratio of 54%, which is very strong compared to peer banks. Net loans of $199,980,000 at year-end increased by $18,584,000, growing by 10.2% over the prior year. Total deposits of $254,105,000 grew by $22,697,000, an increase of 9.8%. The majority of deposit growth was in demand deposits and money market accounts as depositors sought shorter-term investments in light of the rate environment and uncertainties in the equity markets. Loan and deposit growth is primarily being achieved in the Capital Region, where we anticipate new branch openings in the coming years. As I write this letter, we are experiencing the Enron debacle. Let me assure you that Mid Penn Bancorp does not rely on aggressive accounting to provide results, but instead, provides value to shareholders over the long term through consistent earnings and a strong balance sheet. Mid Penn Bank will be adding an extensive Investor Relations page to our website. Look for this on our website at midpennbank.com sometime in late March or early April, 2002. From the Investor Relations page, you will be able to download the most recent quarterly earnings reports and other press releases, annual report copies, investor presentations, shareholder forms and more. Once the Investor Relations page is finished, we would appreciate your feedback. During 2002, Mid Penn Bank mourned the passing of Bruce C. Adams, who had served as a director of our bank from 1985 until his retirement in 1995. Prior to being elected to the Mid Penn Bank Board of Directors, Adams served on the former Tower City National Bank Board of Directors until its merger by Mid Penn Bank. We convey our sympathies to his family. We appreciate your support and confidence. I encour- age you to contact me at (717) 692-2133 or e-mail: adakey@midpennbank.com should you have any ques- tions, comments or suggestions. Sincerely, Total equity at year-end of $31,716,000 increased by 7.1% over the prior year. Your Bank continues to main- tain a strong equity position with average equity to aver- age assets of 9.7%. Alan W. Dakey President and CEO Mid Penn Bancorp, Inc. (AMEX: MBP) share price as of December 31, 2001 was $18.20 compared to a share price of $15.00 as of December 31, 2000, with a divi- dend of $ .80 per share. The annualized dividend yield was 4.4% as of December 31, 2001, a dividend yield higher than the yield available on most long-term cer- tificates of deposit. 2 Mid Penn Bancorp, Inc. Financial Highlights AS OF AND FOR YEARS ENDED DECEMBER 31, 2001 AND 2000 (Dollars in thousands, except per share data.) 2001 2000 Total Assets ............................................................... Total Deposits............................................................ Net Loans .................................................................. Total Investments and Interest Bearing Balances...... Stockholders' Equity.................................................. Net Income ................................................................ Earnings Per Share .................................................... Cash Dividend Per Share based on Weighted Average Number of Shares Outstanding ............... Book Value Per Share................................................ $ 330,635 254,105 199,980 108,390 31,716 4,230 1.39 .80 10.44 315,584 231,408 181,396 116,261 29,626 3,948 1.30 .80 9.76 Mid Penn Bancorp, Inc. Stockholders' Information Market Value Per Share ........................................ $ 2001 2000 High 16.55 19.04 19.25 18.65 Low 14.88 16.50 17.75 18.05 High 22.00 19.25 18.50 15.88 Low 13.25 15.38 15.25 14.75 Percent Change +4.8 +9.8 +10.2 -6.8 +7.1 +7.1 +6.9 0 +7.0 Quarter 1st 2nd 3rd 4th Market Value Information: The market share information was provided by the American Stock Exchange, New York, NY. Mid Penn Bancorp, Inc. common stock trades on the American Stock Exchange under the symbol: MBP. Transfer Agent: Wells Fargo Shareholder Services, P.O. Box 64854, St. Paul, MN 55164-0854. Phone: 1-800-468-9716. Number of Stockholders: At December 31, 2001, there were 969 stockholders. Dividends: A dividend of $.20 per share was paid during each quarter of 2001 and 2000. Mid Penn Bancorp, Inc. plans to continue a quarterly dividend payable in February, May, August and November. Dividend Reinvestment and Stock Purchases: Stockholders of Mid Penn Bancorp, Inc. may acquire additional shares of common stock by reinvesting their cash dividends under the Dividend Reinvestment Plan without paying a brokerage fee. Voluntary cash contribu- tions may also be made under the Plan. For additional information about the Plan, contact the Transfer Agent. Form 10-K: A Copy of Mid Penn Bancorp, Inc.'s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission, will be provided to stockholders without charge upon written request to: Secretary, Mid Penn Bancorp, Inc., 349 Union Street, Millersburg, PA 17061. Annual Meeting: The Annual Meeting of the Stockholders of Mid Penn Bancorp, Inc. will be held at 10:00 a.m. on Tuesday, April 23, 2002, at 349 Union Street, Millersburg, Pennsylvania. 3 Mid Penn Bancorp, Inc. Graphs (unaudited) 330.6 315.6 277.8 287.5 256.7 Total Assets 340 320 290 260 230 200 170 140 110 80 50 20 s n o i l l i M n I 254.1 231.4 216.8 217.8 217.1 Total Deposits 260 240 220 200 180 160 140 120 100 80 60 40 1997 1998 1999 Year 2000 2001 1997 1998 1999 Year 2000 2001 Net Income 4.17 3.87 3.88 3.95 4.23 s n o i l l i M n I 4.5 4.0 3.5 3.0 2.5 2.0 1997 1998 1999 Year 2000 2001 Total Equity Book Value Per Share s n o i l l i M n I 35 30 25 20 15 10 31.5 29.7 31.7 29.6 26.6 10.38 9.78 10.44 9.76 8.74 s r a l l o D n I 11 10 9 8 7 6 5 4 3 2 1997 1998 1999 Year 2000 2001 1997 1998 1999 Year 2000 2001 4 Independent Auditors’ Report The Board of Directors and Stockholders Mid Penn Bancorp, Inc. Millersburg, Pennsylvania: We have audited the accompanying consolidated balance sheet of Mid Penn Bancorp, Inc. and subsidiaries (collectively, “Corporation”) as of December 31, 2001 and 2000, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial state- ments. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as eval- uating 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 Mid Penn Bancorp, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. PARENTE RANDOLPH, PC Williamsport, Pennsylvania January 18, 2002 5 Mid Penn Bancorp, Inc. Consolidated Balance Sheet DECEMBER 31, 2001 AND 2000 (Dollars in thousands, except share data) 2001 2000 ASSETS Cash and due from banks ...................................................................... Interest-bearing balances with other financial institutions ................... Available-for-sale investment securities................................................ Loans ..................................................................................................... Less:............................................................................................ Unearned income....................................................................... Allowance for loan losses.......................................................... Net loans ................................................................................ Bank premises and equipment, net ...................................................... Foreclosed assets held for sale .............................................................. Accrued interest receivable ................................................................... Deferred income taxes........................................................................... Cash surrender value of life insurance .................................................. Other assets............................................................................................ Total Assets LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Noninterest-bearing demand .......................................................... Interest-bearing demand................................................................. Money market ................................................................................ Savings ........................................................................................... Time................................................................................................ Total Deposits Short-term borrowings........................................................................... Accrued interest payable ....................................................................... Other liabilities ...................................................................................... Long-term debt ...................................................................................... Total Liabilities Stockholders' Equity: Common stock, par value $1 per share; authorized 10,000,000 shares; 3,056,501 shares issued ......................................................................................... Additional paid-in capital............................................................... Retained earnings ........................................................................... Accumulated other comprehensive loss......................................... Treasury stock at cost (19,065 and 19,057 shares in 2001 and 2000, respectively).............................................................. Stockholders' Equity, Net Total Liabilities and Stockholders' Equity $ $ $ 9,028 53,042 55,348 205,101 (2,265) (2,856) 199,980 3,395 1,693 2,091 1,037 4,504 517 330,635 29,226 30,795 27,734 26,398 139,952 254,105 9,610 1,292 1,344 32,568 298,919 3,057 20,368 8,880 (56) (533) 31,716 330,635 $ The accompanying notes are an integral part of these consolidated financial statements. 5,986 42,376 73,885 186,941 (2,730) (2,815) 181,396 3,581 70 2,502 1,069 4,288 431 315,584 23,274 28,293 17,494 25,912 136,435 231,408 22,738 1,546 1,025 29,241 285,958 3,057 20,368 7,078 (344) (533) 29,626 315,584 6 Mid Penn Bancorp, Inc. Consolidated Statement of Income FOR YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999 (Dollars in thousands, except share data) INTEREST INCOME Interest and fees on loans........................................................ Interest on interest-bearing balances....................................... Interest and dividends on investment securities: U.S. Treasury and government agencies ......................... State and political subdivision obligations, tax-exempt .. Other securities ................................................................ Interest on federal funds sold and securities purchased under agreement to resell .................................................... Total Interest Income INTEREST EXPENSE Interest on deposits ................................................................. Interest on short-term borrowings........................................... Interest on long-term debt....................................................... Total Interest Expense Net Interest Income PROVISION FOR LOAN LOSSES .............................................. Net Interest Income After Provision for Loan Losses NONINTEREST INCOME Trust department income ........................................................ Service charges on deposits .................................................... Investment securities (losses) gains, net ................................. Gain on sale of loans............................................................... Income on cash surrender value of life insurance .................. Other income........................................................................... Total Noninterest Income NONINTEREST EXPENSE Salaries and employee benefits............................................... Occupancy expense, net.......................................................... Equipment expense ................................................................. Pennsylvania bank shares tax expense .................................. FDIC insurance premium........................................................ Marketing and advertising ...................................................... Loss on mortgage loan sales ................................................... Other expenses ........................................................................ Total Noninterest Expense $ 2001 16,340 3,092 1,349 1,806 193 84 22,864 9,192 441 2,102 11,735 11,129 500 10,629 158 921 (14) 16 216 548 1,845 4,012 392 461 262 44 127 125 1,603 7,026 2000 15,769 2,306 2,284 1,475 219 0 22,053 8,958 879 1,618 11,455 10,598 325 10,273 203 590 (4) 31 198 538 1,556 3,790 364 481 271 45 144 19 1,542 6,656 1999 13,829 2,409 2,426 1,311 136 1 20,112 8,302 516 856 9,674 10,438 325 10,113 127 554 50 0 189 769 1,689 3,741 318 510 279 26 121 47 1,623 6,665 INCOME BEFORE PROVISION FOR INCOME TAXES.......... Provision for income taxes...................................................... Net Income Earnings Per Share Weighted Average Number of Shares Outstanding 5,448 1,218 4,230 1.39 3,038,859 $ $ 5,173 1,225 3,948 1.30 3,036,007 5,137 1,253 3,884 1.28 3,037,976 The accompanying notes are an integral part of these consolidated financial statements. 7 Mid Penn Bancorp, Inc. Consolidated Statement of Changes in Stockholders' Equity FOR YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999 (Dollars in thousands, except share data) Additional Common Paid-in Capital Stock Accumulated Other Retained Comprehensive Treasury Earnings (Loss) Income Stock Total Balance, December 31, 1998 ................................................ $ 2,912 17,181 11,640 344 (541) 31,536 Comprehensive income: Net income ..................................................................... Change in net unrealized loss on securities available for sale, net of reclassification adjustment and tax effects............................................................. Total comprehensive income Cash dividends ($2.29 per share, historical)..................... 5% stock dividend (additional 144,234 shares) ................ Purchase of treasury stock (659 shares)............................ 0 0 0 145 0 0 0 3,884 0 0 (2,205) 0 3,187 0 (6,635) (3,332) 0 0 0 0 0 0 0 0 (15) 3,884 (2,205) 1,679 (6,635) 0 (15) Balance, December 31, 1999 ................................................ 3,057 20,368 5,557 (1,861) (556) 26,565 Comprehensive income: Net income ..................................................................... Change in net unrealized loss on securities available for sale, net of reclassification adjustment and tax effects............................................................. Total comprehensive income Cash dividends ($ .80 per share, historical)...................... Sale of treasury stock (939 shares) ................................... 0 0 0 0 0 0 0 0 3,948 0 0 1,517 (2,427) 0 0 0 0 0 0 23 3,948 1,517 5,465 (2,427) 23 Balance, December 31, 2000 ................................................ 3,057 20,368 7,078 (344) (533) 29,626 Comprehensive income: Net income ..................................................................... Change in net unrealized loss on securities available for sale, net of reclassification adjustment and tax effects............................................................. Total comprehensive income Cash dividends ($ .80 per share, historical)...................... Sale of treasury stock (8 shares) ....................................... 0 0 0 0 0 0 0 0 4,230 0 0 288 (2,428) 0 0 0 0 0 0 0 4,230 288 4,518 (2,428) 0 Balance, December 31, 2001 ................................................ $ 3,057 20,368 8,880 (56) (533) 31,716 The accompanying notes are an integral part of these consolidated financial statements. 8 Mid Penn Bancorp, Inc. Consolidated Statement of Cash Flows FOR YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999 (Dollars in thousands) Operating Activities: Net income .......................................................................... Adjustments to reconcile net income to net cash provided by operating activities: 2001 $ 4,230 Provision for loan losses .............................................. Depreciation ................................................................. Increase in cash surrender value of life insurance ....... Investment securities losses (gains), net ...................... Gain on sale of foreclosed assets ................................. Gain on sale of loans.................................................... Deferred income taxes.................................................. Change in accrued interest receivable.......................... Change in other assets.................................................. Change in accrued interest payable.............................. Change in other liabilities ............................................ Net Cash Provided By Operating Activities Investing Activities: Net (increase) decrease in interest-bearing balances .......... Proceeds from the maturity of investment securities .......... Proceeds from the sale of investment securities ................. Purchases of investment securities ...................................... Proceeds from sale of loans ................................................ Net increase in loans ........................................................... Net purchases of bank premises and equipment ................. Proceeds from the sale of foreclosed assets........................ Capitalized additions - foreclosed assets............................. Net Cash Used In Investing Activities Financing Activities: Net increase (decrease) in demand and savings deposits.... Net increase (decrease) in time deposits ............................. Net (decrease) increase in short-term borrowings .............. Long-term borrowings......................................................... Long-term debt repayment .................................................. Cash dividends paid............................................................. Sale (purchase) of treasury stock ........................................ Net Cash Provided By Financing Activities Net increase (decrease) in cash and due from banks ................................................................................. Cash and due from banks at January 1....................................... Cash and due from banks at December 31................................. Supplemental Disclosures of Cash Flow Information: Cash payments of interest expense ..................................... Cash payments of income taxes .......................................... Supplemental Noncash Disclosures: Loan charge-offs.................................................................. Transfers to foreclosed assets held for sale......................... $ $ $ $ $ 500 336 (216) 14 (16) (16) (116) 411 (86) (254) 319 5,106 (10,666) 23,455 11,284 (15,780) 1,128 (21,884) (150) 81 0 (12,532) 19,180 3,517 (13,128) 5,000 (1,673) (2,428) 0 10,468 3,042 5,986 9,028 11,989 1,250 489 1,688 The accompanying notes are an integral part of these consolidated financial statements. 9 2000 3,948 325 369 (198) 4 (40) (31) (177) (382) (76) 344 126 4,212 (7,806) 4,042 3,515 (15,047) 3,622 (15,558) (643) 68 0 (27,807) (3,034) 16,602 (1,898) 15,000 (2,159) (2,427) 23 22,107 (1,488) 7,474 5,986 11,111 1,355 74 35 1999 3,884 325 404 (189) (50) (229) 0 (105) (213) 238 (38) 359 4,386 8,313 9,663 3,811 (12,931) 0 (19,434) (213) 523 (10) (10,278) 6,339 (5,301) 12,477 12,000 (11,150) (6,635 (15) 7,715 1,823 5,651 7,474 9,636 1,149 224 0 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements for 2001 Report (1) Basis of Presentation The accompanying consolidated financial statements include the accounts of Mid Penn Bancorp, Inc. and its wholly-owned subsidiaries Mid Penn Bank (“Bank”), Mid Penn Investment Corporation and Mid Penn Insurance Services, LLC, (collectively, “MPB”). All significant intercompany balances and transactions have been eliminated. (2) Nature of Business The Bank engages in a 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, mortgage and home equity loans, secured and unsecured commercial and consumer loans, lines of credit, construction financing, farm loans, community development loans, loans to non-profit entities and local government loans and various types of time and demand deposits, including but not limited to, checking accounts, savings accounts, clubs, money market deposit accounts, certificates of deposit and IRAs. In addition, the Bank provides a full range of trust services through its Trust Department. Deposits are insured by the Federal Deposit Insurance Corporation (FDIC) to the extent provided by law. The financial services are provided to individuals, partnerships, non-profit organizations and corporations through its eleven offices located in the northern portion of Dauphin County, Swatara Township in the lower portion of Dauphin County, the southern portion of Northumberland County, the western portion of Schuylkill County and Hampden Township in Cumberland County. Mid Penn Investment Corporation is engaged in investing activities. Mid Penn Insurance Services, LLC provides a range of personal and investment insurance products. (3) Summary of Significant Accounting Policies The accounting and reporting policies of MPB conform to generally accepted accounting principles and to general practice within the banking industry. The following is a description of the more significant accounting policies. (a) Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires manage- ment to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contin- gent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired through, or in lieu of, foreclosure in settlement of debt. While management uses available information to recognize losses on loans and foreclosed assets, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the bank’s allowances for loan losses and foreclosed assets. Such agencies may require the bank to recognize changes to the allowances based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the allowance for loan losses may change materially in the near term. (b) Investment Securities Investments are accounted for as follows: Held-to-Maturity Securities - includes debt securities that MPB has the positive intent and ability to hold to maturi- ty. These securities are reported at amortized cost. Available-for-Sale Securities - includes debt and equity securities not classified as held-to-maturity securities. Such securities are reported at fair value, with unrealized holding gains and losses excluded from earnings and reported, net of deferred income taxes, as a separate component of stockholders’ equity. (c) Loans Interest on loans is recognized on a method which approximates a level yield basis over the life of the loans. The accrual of interest on loans, including impaired loans, is discontinued when principal or interest has consistently been in default for a period of 90 days or more, or because of a deterioration in the financial condition of the borrower, payment in full of principal or interest is not expected. Interest income is subsequently recognized only to the extent cash pay- ments are received. The placement of a loan on the nonaccrual basis for revenue recognition does not necessarily imply a 10 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont’d) potential charge-off of loan principal. Loan origination fees and certain direct origination costs are capitalized and recog- nized as an adjustment of the yield of the related loan. (d) Allowance for Loan Losses The Bank's methodology for determining the allowance for loan losses establishes both an allocated and an unallocated component. The allocated portion of the allowance represents the results of analysis of individual "watch list" loans (com- mercial, residential and consumer loans) as well as pools of consumer loans within the portfolio. The individual commer- cial loans are risk rated with specific attention to estimated loss exposure. Historical loan loss rates are applied to "prob- lem" consumer credits, adjusted to reflect current conditions. Specific regular reviews of credits exceeding $500,000 are performed to monitor the major portfolio risk. The Bank analyzes all commercial loans in excess of $10,000 that are rated as watch list credits. Potential credit problems are moni- tored to determine whether specific loans are impaired, with impairment normally measured by reference to borrowers' collateral values and cash flows. The unallocated portion of the allowance for loan losses represents the results of measuring potential losses inherent in the portfolio that are not specifically identified in the allocated allowance analysis. This unallocated portion is analyzed by assessing changes in the Bank's underwriting criteria, growth and/or changes in the mix of loans originated, industry concentrations and evaluations, lending management changes, comparisons of certain factors to peer group banks, changes in economic conditions and assessment of off balance sheet risk. Management believes the allowance for loan losses is adequate. Identification of specific losses is an ongoing process using available information. Specifically, quarterly management meetings to review "problem" loans are utilized to deter- mine a plan for collection and, if necessary, a recommendation to the Board for loss. Future additions to the loan loss reserve via loan loss provisions will be made based on identified changes in the above factors coupled with loss experi- ence. Various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. These agencies may require the Bank to recognize changes to the allowance based on their judgment about information available to them at the time of their examinations. In addition, the Bank's Audit Committee and exter- nal accountants also review the Bank's methodology utilized in determining the adequacy of the loan loss reserve. (e) Bank Premises and Equipment Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is provided on the straightline basis. Maintenance and repairs are charged to expense when incurred. Gains and losses on dispositions are reflected in current operations. (f) Foreclosed Assets Held for Sale Foreclosed assets held for sale consist of real estate acquired through, or in lieu of, foreclosure in settlement of debt and are recorded at fair market value at the date of transfer. Any valuation adjustments required at the date of transfer are charged to the allowance for loan losses. Subsequent to acquisition, foreclosed assets are carried at the lower of cost or fair market value less costs of disposal, based upon periodic evaluations that consider changes in market conditions and development and disposition costs. Operating results from assets acquired in satisfaction of debt, including rental income less operating costs and gains or losses on the sale of or the periodic evaluation of foreclosed assets, are recorded in non- interest expense. (g) Income Taxes Certain items of income and expense are recognized in different accounting periods for financial reporting purposes than for income tax purposes. Deferred income tax assets and liabilities are provided in recognition of these timing dif- ferences at currently enacted income tax rates. As changes in tax laws or rates are enacted, deferred income tax assets and liabilities are adjusted through the provision for income taxes. (h) Marketing and Advertising Costs Marketing and advertising costs are expensed as incurred and were $127,000, $144,000 and $121,000 in 2001, 2000 and 1999, respectively. 11 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (i) Benefit Plans A funded contributory profit-sharing plan is maintained for substantially all employees. The cost of the Bank's profit- sharing plan is charged to current operating expenses and is funded annually. In addition to providing a profit-sharing plan, the Bank provides under certain circumstances, postretirement health care and group life insurance coverage. Substantially all of the Bank's employees may become eligible for those benefits if they continue working for the Bank until retirement age. The Bank currently does not offer postemployment benefits. The Bank also has a defined benefit retirement bonus plan for qualified members of the Board of Directors who either voluntarily retire from service or attain mandatory retirement age (age 70). The benefit is based on years of service of active participants. (j) Trust Assets and Income Assets held by the Bank in a fiduciary or agency capacity for customers of the Trust Department are not included in the financial statements since such items are not assets of the Bank. Trust income is recognized on the cash basis which is not materially different than if it were reported on the accrual basis. (k) Earnings Per Share Earnings per share is computed by dividing net income by the weighted average number of common shares outstand- ing during each of the years presented giving retroactive effect to stock dividends and stock splits. MPB’s basic and dilut- ed earnings per share are the same since there are no dilutive shares of potential common stock outstanding. (l) Statement of Cash Flows For purposes of the statement of cash flows, MPB considers cash and due from banks to be cash equivalents. (m) Reclassifications Certain prior year amounts have been reclassified to conform to the current year's classifications. (4) Comprehensive Income The components of other comprehensive income (loss) and related tax effects are as follows: (Dollars in thousands) Unrealized holding gains (losses) on available-for-sale securities.......... Less reclassification adjustment for losses (gains) realized in income ... Net unrealized gains (losses) ................................................................... Tax effect.................................................................................................. Net-of-tax amount .................................................................................... $ $ Years Ended December 31, 2000 2,296 4 2,300 (783) 1,517 2001 422 14 436 (148) 288 1999 (3,291) (50) (3,341) 1,136 (2,205) (5) Restrictions on Cash and Due from Bank Accounts The Bank is required to maintain reserve balances. The amount of those required reserve balances at December 31, 2001 and 2000 was approximately $2,554,000 and $1,878,000, respectively. (6) Investment Securities At December 31, 2001 and 2000, amortized cost, fair value, and gross unrealized gains and losses on investment securities are as follows: (Dollars in Thousands) December 31, 2001 Available-for-sale securities: U.S. Treasury and U.S. government agencies Mortgage-backed U.S. government agencies State and political subdivision obligations Restricted equity securities Gross Amortized Cost Gross Unrealized Unrealized Gains Losses Fair Value $ $ 9,028 4,674 39,760 1,970 55,432 12 102 59 439 0 600 96 0 588 0 684 9,034 4,733 39,611 1,970 55,348 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (Dollars in Thousands) December 31, 2000 Available-for-sale securities: U.S. Treasury and U.S. Gross Amortized Unrealized Unrealized Gains Losses Gross Cost Fair Value government agencies ................................. $ 34,750 Mortgage-backed U.S. government agencies .................................. 2,402 State and political subdivision obligations ............................... Restricted equity securities............................. 33,972 3,281 $ 74,405 77 1 418 0 496 476 34,351 2 2,401 538 0 1,016 33,852 3,281 73,885 Estimated fair values of debt securities are based on quoted market prices, where applicable. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments, adjusted for differences between the quoted instruments and the instruments being valued. Restricted equity securities consist of stock in the Federal Home Loan Bank of Pittsburgh and Atlantic Central Bankers Bank and do not have a readily determinable fair value for purposes of SFAS No. 115, because their ownership is restricted and they lack a market. Therefore, these securities are classified as restricted investment securities, carried at cost, and evaluated for impairment. Investment securities having a fair value of $31,381,000 at December 31, 2001, were pledged to secure public deposits and other borrowings. Gross losses from such sales of investment securities, as determined on the basis of specific identification of the adjusted cost of each security sold, amounted to $14,000. A net loss of $4,000 and a net gain of $50,000 were realized on the sale of investment securities with proceeds of $3,515,000 and $3,811,000 in 2000 and 1999, respectively. The following is a schedule of the maturity distribution of investment securities at amortized cost and fair value as of December 31, 2001 and 2000: (Dollars in thousands) Due in 1 year or less........................................................................ Due after 1 year but within 5 years................................................. Due after 5 years but within 10 years ............................................. Due after 10 years ........................................................................... $ December 31, 2001 Fair Amortized Value Cost 415 407 8,384 8,201 9,833 9,727 30,013 30,453 48,645 48,788 December 31, 2000 Fair Amortized Cost Value 2,390 2,389 13,084 13,061 20,678 20,737 32,051 32,535 68,203 68,722 Mortgage-backed securities............................................................. Restricted equity securities.............................................................. 4,674 1,970 $ 55,432 4,733 1,970 55,348 2,402 3,281 74,405 2,401 3,281 73,885 (7) Loans A summary of loans at December 31, 2001 and 2000 is as follows: (Dollars in thousands) Commercial real estate, construction and land development.......... Commercial, industrial and agricultural.......................................... Real estate - residential ................................................................... Consumer......................................................................................... 2001 $ 130,913 23,107 38,349 12,732 $ 205,101 2000 110,947 26,274 35,610 14,110 186,941 Net unamortized loan fees of $398,000 and $417,000 were deducted from loans in 2001 and 2000, respectively. 13 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) Loans to Bank executive officers, directors, and corporations in which such executive officers and directors have beneficial interests as stockholders, executive officers, or directors aggregated approximately $1,580,000 and $1,418,000 at December 31, 2001 and 2000, respectively. New loans extended were $497,000 and $66,000 during 2001 and 2000, respectively. Net repay- ments on these loans in 2001 exceeded draws by $335,000. Net repayments in 2000 amounted to $1,000. These loans were made on substantially the same basis, including interest rates and collateral as those prevailing for comparable transactions with other borrowers at the same time. (8) Allowance for Loan Losses Changes in the allowance for loan losses for the years 2001, 2000, and 1999 are summarized as follows: (Dollars in thousands) Balance, January 1........................................................................... Provision charged to operations ...................................................... Loans charged off ............................................................................ Recoveries on loans charged off ..................................................... Balance, December 31..................................................................... 2001 2,815 500 (489) 30 2,856 $ $ 2000 2,505 325 (74) 59 2,815 1999 2,313 325 (224) 91 2,505 The recorded investment in loans that are considered impaired amounted to $1,686,000 and $1,116,000 (all in nonaccrual) on December 31, 2001 and December 31, 2000, respectively. By definition, impairment of a loan is considered when, based on current information and events, it is probable that all amounts due will not be collected according to the contractual terms of the loan agreement. The allowance for loan losses related to loans classified as impaired amounted to approximately $125,000 at December 31, 2001 and $169,000 at December 31, 2000. Impaired loans of approximately $743,000 and $668,000 have no related allowance. The average balances of these loans amounted to approximately $1,293,000, $752,000 and $873,000 for the years 2001, 2000 and 1999, respectively. The Bank recognizes interest income on impaired loans on a cash basis. The following is a summary of cash receipts on these loans and how they were applied in 2001, 2000 and 1999. (Dollars in thousands) Cash receipts applied to reduce principal balance .......................... Cash receipts recognized as interest income................................... Total cash receipts ........................................................................... 2001 238 31 269 $ $ 2000 520 36 556 1999 63 28 91 Loans which were past due 90 days or more for which interest continued to be accrued as of December 31, 2001 and 2000, amounted to approximately $828,000 and $504,000, respectively. The Bank has no commitments to loan additional funds to borrowers with impaired or nonaccrual loans. (9) Bank Premises and Equipment At December 31, 2001 and 2000, bank premises and equipment are as follows: (Dollars in thousands) Land................................................................................................. Buildings.......................................................................................... Furniture and fixtures ...................................................................... Less accumulated depreciation........................................................ 2001 822 3,938 3,517 8,277 4,882 3,395 $ $ 2000 818 3,926 3,383 8,127 4,546 3,581 (10) Deposits At December 31, 2001 and 2000, time deposits in denominations of $100,000 or more amounted to $24,341,000 and $23,342,000, respectively. Interest expense on such certificates of deposit amounted to approximately $1,454,000, $1,211,000 and $1,103,000 for the years ended December 31, 2001, 2000 and 1999, respectively. Time deposits at December 31, 2001, mature as follows: (in thousands) 2002, $87,139; 2003, $26,037; 2004, $10,852; 2005, $7,689; 2006, $5,258; thereafter, $2,977. Deposits and other funds from related parties held by the Corporation at December 31, 2001 and 2000 amounted to approximately $4,307,000 and $2,070,000, respectively. 14 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (11) Short-term Borrowings Short-term borrowings as of December 31, 2001 and 2000 consisted of: (Dollars in thousands) Discount window borrowings.......................................................... $ Federal funds purchased.................................................................. Repurchase agreements .................................................................. Treasury, tax and loan note ............................................................ Due to broker .................................................................................. $ 2001 0 5,800 2,666 196 948 9,610 2000 1,500 19,300 1,459 479 0 22,738 Discount window borrowings and federal funds purchased represent overnight funds. Securities sold under repurchase agreements generally mature between one day and one year. Treasury, tax and loan notes are open-ended interest bearing notes payable to the U.S. Treasury upon call. All tax deposits accepted by the Bank are placed in the Treasury note option account. The due to broker balance represents previous day balances transferred from deposit accounts under a sweep account agreement. The Bank also has unused lines of credit with several banks amounting to $1 million dollars at December 31, 2001. (12) Long-term Debt The Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB) and through its membership, the Bank can access a number of credit products which are utilized to provide various forms of liquidity. As of December 31, 2001, the Bank had long-term debt in the amount of $32,568,000 outstanding to the FHLB consisting of a $5,000,000 3 year fixed rate advance at 5.20% which will mature on March 12, 2004; a $5,000,000 bullet loan at 6.61% which will mature on November 24, 2003; a $468,000 10 year amortizing advance at 7.30% which will mature April 5, 2004; a $5,000,000 7 year fixed rate advance at 6.21% convertible at FHLB’s option to a LIBOR adjustable rate after 3 years which will mature November 30, 2006; a $5,000,000 10 year fixed rate advance at 6.42% convertible at FHLB’s option to a LIBOR adjustable rate after 5 years which matures December 3, 2009; a $1,000,000 10 year fixed rate advance with an interest rate of 7.06% maturing on December 9, 2009; a $1,000,000 10 year fixed rate advance with an interest rate of 7.24% which matures December 17, 2009; a $5,000,000 10 year fixed rate advance at 6.28% convertible at FHLB’s option to a LIBOR adjustable rate after 2 years which is due January 14, 2010; a $5,000,000 10 year fixed rate advance at 6.71% convertible at FHLB’s option to a LIBOR adjustable rate after 3 years which is due February 22, 2010; and a $100,000 amortizing loan at a rate of 6.71% which matures February 22, 2027. The aggregate amounts of maturities of long-term debt subsequent to December 31, 2001 are $185,000 (2002), $5,199,000 (2003), $5,088,000 (2004), $2,000 (2005), $5,002,000 (2006), $17,092,000 thereafter. Most of the Bank’s investments and mortgage loans are pledged to secure FHLB borrowings. (13) Lease Commitments The Bank leases certain premises under long-term lease agreements which are classified as operating leases. Commitments under these agreements are not material. Rental expense for 2001, 2000 and 1999 was approximately $41,000, $34,000 and $42,000, respectively. (14) Benefit Plans (a) Profit-Sharing The Bank has a funded contributory profit-sharing plan covering substantially all employees. The Bank's contribution to the plan for 2001, 2000 and 1999 was $362,000, $361,000 and $310,000, respectively. (b) Health Insurance For full-time employees who retire after at least 20 years of service, the Bank will pay premiums for major medical insurance (as provided to active employees) for a period ending on the earlier of the date the participant obtains other employment where major medical coverage is available or the date of the participant's death; however, payment of med- ical premiums by the Bank will cease after five years. If the retiree becomes eligible for Medicare within the five year period beginning on his/her retirement date, the Bank may pay, at its discretion, premiums for 65 Special coverage or a similar supplemental coverage. After the five year period has expired, all employer-paid benefits cease; however, the employee may continue coverage through the employer at his/her own expense. 15 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (c) Life Insurance For full-time employees who retire after at least 20 years of service, the Bank will provide term life insurance. The amount of coverage prior to age 65 will be the lesser of three times the participant's annual salary at retirement or $50,000. After age 65, the insurance amount will decrease by 10% of the age 65 amount per year, subject to a minimum amount of $2,000. The following tables provide a reconciliation of the changes in the plans’ health and life insurance benefit obligations and fair value of plan assets for the years ended December 31, 2001 and 2000 and a statement of the funded status at December 31, 2001 and 2000: (Dollars in thousands) Change in benefit obligations: Benefit obligations, January 1 ..................................................................... $ Service cost.............................................................................................. Interest cost.............................................................................................. Actuarial loss (gain) ................................................................................ Benefit payments ..................................................................................... Benefit obligations, December 31 ............................................................... $ 2001 354 20 24 (3) (18) 377 Change in fair value of plan assets: Fair value of plan assets, January 1............................................................. $ Employer contributions ........................................................................... Benefit payments ..................................................................................... Fair value of plan assets, December 31....................................................... $ 0 18 (18) 0 2000 329 18 22 0 (15) 354 0 15 (15) 0 December 31, Funded status: Excess of the benefit obligation over the value of plan assets................ $ Unrecognized transition obligation ......................................................... Unrecognized gain................................................................................... Net amount recognized............................................................................ $ 2001 (377) 162 (150) (365) Amount recognized in the balance sheet at December 31, 2001 and 2000 is as follows: (Dollars in thousands) 2001 Accrued benefit liability.......................................................................... $ (365) 2000 (354) 177 (154) (331) 2000 (331) The components of net periodic postretirement benefit cost for 2001, 2000 and 1999 are as follows: (Dollars in thousands) Service cost.............................................................................................. $ Interest cost.............................................................................................. Amortization of transition obligation...................................................... Amortization of net gain ......................................................................... Net periodic post-retirement benefit cost ................................................ $ 2001 20 24 15 (7) 52 2000 18 22 15 (8) 47 1999 20 23 15 (4) 54 Assumed health care cost trend rates have a significant effect on the amounts reported for the postretirement medical bene- fits plan. A one-percentage-point change in assumed health care cost trend rates would have the following effect: (Dollars in thousands) Effect on total of service and interest cost components.............. Effect on postretirement benefit obligation................................. $ $ 16 One-Percentage Point Increase 6 42 5 35 Decrease Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) Assumptions used in the measurement of MPB’s benefit obligations at December 31, 2001 and 2000 are as follows: Weighted-average assumptions: Discount rate............................................................................ Rate of compensation increase................................................ 7.0% 5.0% For measurement purposes, a one percent annual decrease in the per capita cost of covered health care benefits was assumed for 2002. The rate was assumed to be 6 percent for 2002 and remain at that level thereafter. (d) Retirement Plan The Bank has an unfunded defined benefit retirement plan for directors with benefits based on years of service. The adoption of this plan generated unrecognized prior service cost of $274,000 which is being amortized based on the expected future years of service of active participants. The following tables provide a reconciliation of the changes in the plan’s benefit obligations and fair value of plan assets for the years ended December 31, 2001 and 2000 and a statement of the funded status at December 31, 2001 and 2000: December 31, 2001 2000 (Dollars in thousands) Change in benefit obligations: Benefit obligations, January 1 ..................................................... Service cost.............................................................................. Interest cost.............................................................................. Actuarial loss........................................................................... Benefit payments ..................................................................... Benefit obligations, December 31 ............................................... Change in fair value of plan assets: Fair value of plan assets, January 1............................................. Employer contributions ........................................................... Benefit payments ..................................................................... Fair value of plan assets, December 31 Funded status: Excess of the benefit obligation over the value of plan assets.... Unrecognized prior-service cost.................................................. Unrecognized gain....................................................................... Net amount recognized................................................................ $ $ $ $ $ $ 455 21 32 3 (9) 502 0 9 (9) 0 (502) 104 (11) (409) Amounts recognized in the balance sheet at December 31, 2001 and 2000 are as follows: (Dollars in thousands) Accrued benefit liability.............................................................. Intangible asset ............................................................................ Net amount recognized................................................................ 2001 (426) 17 (409) $ $ The components of net periodic pension cost for 2001, 2000 and 1999 are as follows: (Dollars in thousands) Service cost.................................................................................. Interest cost.................................................................................. Amortization of prior-service cost .............................................. Net periodic pension cost ............................................................ 2001 21 32 26 79 $ $ 17 414 20 28 1 (8) 455 0 8 (8) 0 (455) 130 (14) (339) 2000 (376) 37 (339) 2000 20 28 26 74 1999 20 26 26 72 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) Assumptions used in the measurement of MPB’s benefit obligations at December 31, 2001 and 2000 are as follows: Weighted-average assumptions: Discount rate............................................................................ Change in consumer price index ............................................. 7.0% 4.0% The Bank is the owner and beneficiary of insurance policies on the lives of the executive officers and directors which infor- mally fund certain benefit obligations. The aggregate cash surrender value of these policies was approximately $1,585,000 and $1,512,000 at December 31, 2001 and 2000, respectively. (e) Deferred Compensation Plans During 1999, the Bank adopted an executive deferred compensation plan which allows an executive officer to defer bonus compensation for a specified period in order to provide future retirement income. At December 31, 2001 and 2000, the Bank has accrued a liability of approximately $30,000 and $20,000, respectively, for this plan. During 1999, the Bank also adopted a director’s deferred compensation plan which allows directors to defer receipt of monthly fees for a specified period in order to provide future retirement income. At December 31, 2001 and 2000, the Bank has accrued a liability of approximately $82,000 and $64,000, respectively, for this plan. The Bank is the owner and beneficiary of insurance policies on the lives of the participating executive officer and directors which informally fund the benefit obligations. The aggregate cash surrender value of these policies was approxi- mately $1,296,000 and $1,232,000 at December 31, 2001 and 2000, respectively. (f) Salary Continuation Plan During 1999, the Board of Directors adopted a Salary Continuation Agreement for an executive officer. The Salary Continuation Agreement provides the executive officer with a fixed annual benefit. The benefit is payable beginning at age 65 for a period of 15 years. If the executive officer terminates employment before the normal retirement date for rea- sons other than death, the annual benefit payable will be based on the vesting schedule as defined in the Agreement. Upon death or a change in control of the Bank, the executive officer or his beneficiary is entitled to the full fixed annual benefit. At December 31, 2001 and 2000, the Bank has accrued a liability of approximately $72,000 and $46,000, respec- tively, for this plan. The expense related to this plan was $26,000, $24,000 and $22,000 for 2001, 2000 and 1999 respec- tively. The Bank is the owner and beneficiary of an insurance policy on the life of the participating executive officer which informally funds the benefit obligation. The aggregate cash surrender value of this policy was approximately $760,000 and $723,000 at December 31, 2001 and 2000, respectively. (g) Employee Stock Ownership Plan The Bank has an Employee Stock Ownership Plan (ESOP) covering substantially all employees. Contributions to the plan are made at the discretion of the Board of Directors. Total expense related to the Bank’s contribution to the plan for 2001, 2000 and 1999 was $121,000, $118,000 and $103,000, respectively. The ESOP held 15,889 and 8,932 shares of MPB stock as of December 31, 2001 and December 31, 2000, respectively, all of which were allocated to plan partici- pants. Shares held by the ESOP are considered outstanding for purposes of calculating earnings per share. (h) Other At December 31, 2001 and 2000, the Bank had a Split Dollar Life Insurance arrangement with two executives for which the aggregate cash surrender value is approximately $863,000 and $822,000, respectively. 18 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (15) Federal Income Taxes The following temporary differences gave rise to the deferred tax asset at December 31, 2001 and 2000: (Dollars in thousands) Deferred tax assets: Allowance for loan losses........................................................ Benefit plans............................................................................ Nonaccrual interest.................................................................. Other items .............................................................................. Unrealized losses on securities................................................ Total Deferred tax liabilities: Depreciation ............................................................................ Loan fees ................................................................................. Bond accretion......................................................................... Total Deferred tax asset, net ................................................................. The provision for income taxes consists of the following: (Dollars in thousands) Current provision......................................................................... Deferred provision....................................................................... Provision for income taxes .......................................................... 2001 817 328 42 61 29 1,277 (90) (128) (22) (240) 1,037 2001 1,334 (116) 1,218 $ $ $ $ $ $ $ A reconciliation of income tax at the statutory rate to MPB's effective rate is as follows: (Dollars in thousands) Provision at the expected statutory rate ...................................... Effect of tax-exempt income ....................................................... Nondeductible interest................................................................. Other items .................................................................................. Provision for income taxes .......................................................... 2001 1,852 (753) 83 36 1,218 $ $ 2000 803 274 16 41 177 1,311 (92) (120) (30) (242) 1,069 2000 1,401 (176) 1,225 2000 1,759 (633) 69 30 1,225 1999 1,358 (105) 1,253 1999 1,747 (536) 50 (8) 1,253 (16) Regulatory Matters The Bank is subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. The regulations require the Bank to meet specific capital adequacy guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital classification is also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of Tier I capital (as defined in the regulations) to total average assets (as defined), and minimum ratios of Tier I and total capital (as defined) to risk-weighted assets (as defined). To be considered adequately capi- talized (as defined) under the regulatory framework for prompt corrective action, the Bank must maintain minimum Tier I leverage, Tier I risk-based and total risk-based ratios as set forth in the table. The Bank’s actual capital amounts and ratios are also presented in the table. (Dollars in thousands) As of December 31, 2001: Capital Adequacy Tier I Capital (to Average Assets) .................... $ 23,246 Tier I Capital (to Risk Weighted Assets).......... Total Capital (to Risk Weighted Assets) .......... Actual Amount (Ratio) (7.4%) 23,246 (10.4%) 26,050 (11.6%) Required Amount (Ratio) 12,650 (4.0%) 8,971 (4.0%) 17,942 (8.0%) To Be Well Capitalized Under Prompt Corrective Action Provisions: Amount (Ratio) (5.0%) 15,812 13,457 (6.0%) 22,428 (10.0%) 19 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (Dollars in thousands) As of December 31, 2000: Capital Adequacy Actual Amount (Ratio) (7.0%) Tier I Capital (to Average Assets) .................... $ 20,523 20,523 Tier I Capital (to Risk Weighted Assets).......... (9.9%) 23,118 (11.2%) Total Capital (to Risk Weighted Assets) .......... Required Amount (Ratio) 11,790 (4.0%) 8,296 (4.0%) 16,592 (8.0%) To Be Well Capitalized Under Prompt Corrective Action Provisions: Amount (Ratio) (5.0%) 14,737 12,444 (6.0%) 20,740 (10.0%) As of December 31, 2001, the Bank’s capital ratios are well in excess of the minimum and well-capitalized guidelines and MPB’s capital ratios are in excess of the Bank’s capital ratios. (17) Concentration of Risk and Off-Balance Sheet Risk The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financ- ing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant, and equipment, and income-producing commercial prop- erties. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit written is represented by the contractual amount of those instru- ments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance- sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition estab- lished in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require pay- ment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facili- ties to customers. The term of these standby letters of credit is generally one year or less. As of December 31, 2001, commitments to extend credit amounted to $37,674,000 and standby letters of credit amounted to $4,009,000. Significant concentration of credit risk may occur when obligations of the same parties engaged in similar activities occur and accumulate in significant amounts. In analyzing the Bank's exposure to significant concentration of credit risk, management set a parameter of 10% or more of the Bank's total net loans outstanding as the threshold in determining whether the obligations of the same or affiliated parties would be classified as significant concentration of credit risk. Concentrations by industry, product line, type of collateral, etc., are also considered. U.S. Treasury securities, obligations of U.S. government agencies and corporations, and any assets collat- eralized by the same were excluded. As of December 31, 2001, commercial real estate financing was the only similar activity that met the requirements to be classified as a significant concentration of credit risk. However, there is a geographical concentration in that most of the Bank's business activity is with customers located in Central Pennsylvania, specifically within the Bank's trading area made up of Dauphin County, lower Northumberland County, western Schuylkill County and Hampden Township in Cumberland County. The Bank's highest concentrations of credit are in the areas of mobile home park land and commercial real estate office financings. Outstanding credit to these sectors amounted to $17,385,000 or 8.7% and $25,894,000 or12.9% of net loans out- standing as of December 31, 2001. 20 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (18) Contingencies MPB is subject to lawsuits and claims arising out of its business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial condition of MPB. (19) Parent Company Statements The condensed balance sheet, statement of income and statement of cash flows for Mid Penn Bancorp, Inc., parent only, are presented below: CONDENSED BALANCE SHEET As of December 31, 2001, 2000 and 1999 (Dollars in thousands) ASSETS Cash ............................................................................................. Investment in Subsidiaries........................................................... Total Assets LIABILITIES AND STOCKHOLDERS' EQUITY Stockholders' Equity ................................................................... Less Treasury Stock .................................................................... Total Liabilities and Equity CONDENSED STATEMENT OF INCOME For the Years Ended December 31, 2001, 2000 and 1999 (Dollars in thousands) Dividends from Subsidiaries ....................................................... Other Income from Subsidiaries ................................................. Undistributed Earnings of Subsidiaries....................................... Other Expenses............................................................................ Net Income CONDENSED STATEMENT OF CASH FLOWS For the Years Ended December 31, 2001, 2000 and 1999 (Dollars in thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net Income.................................................................................. Undistributed Earnings of Subsidiaries ...................................... Net Cash Provided By Operating Activities CASH FLOWS USED BY INVESTING ACTIVITIES Funds used to capitalize Mid Penn Insurance CASH FLOWS FROM FINANCING ACTIVITIES Dividends Paid............................................................................. Sale (purchase) of Treasury Stock .............................................. Net Cash Used By Financing Activities Net (Decrease) Increase in Cash ................................................. Cash at Beginning of Period ....................................................... Cash at End of Period.................................................................. $ $ $ $ $ $ $ 2001 253 31,463 31,716 32,249 (533) 31,716 2001 1,544 25 2,733 (72) 4,230 2000 1999 1,199 28,427 29,626 30,159 (533) 29,626 867 25,698 26,565 27,121 (556) 26,565 2000 1999 2,795 30 1,212 (89) 3,948 7,080 24 (3,148) (72) 3,884 1999 3,884 3,148 7,032 2001 2000 4,230 (2,733) 1,497 3,948 (1,212) 2,736 (15) 0 0 (2,428) 0 (2,428) (946) 1,199 253 (2,427) 23 (2,404) 332 867 1,199 (6,635) (15) (6,650) 382 485 867 (20) Fair Value of Financial Instruments SFAS No. 107, “Disclosures about Fair Value of Financial Instruments” requires disclosures of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practical to estimate that value. In cases where quoted market values are not available, fair values are based on estimates using present value or other valuation tech- 21 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) niques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent mar- kets, and in many cases, could not be realized in immediate settlement of the instrument. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of MPB. The following methodologies and assumptions were used to estimate the fair value of MPB’s financial instruments: Cash and due from banks: The carrying value of cash and due from banks is considered to be a reasonable estimate of fair value. Interest-bearing balances with other financial institutions: The estimate of fair value was determined by comparing the present value of quoted interest rates on like deposits with the weighted average yield and weighted average maturity of the balances. Investment securities: As indicated in Note 6, estimated fair values of investment securities are based on quoted market prices, where applicable. If quoted market prices are not available, fair values are based on quoted market prices for comparable instruments, adjusted for differences between the quoted instruments and the instruments being valued. Loans: The loan portfolio was segregated into pools of loans with similar economic characteristics and was further segregated into fixed rate and variable rate and each pool was treated as a single loan with the estimated fair value based on the discounted value of expected future cash flows. Fair value of loans with significant collectibility concerns (that is, problem loans and potential problem loans) was determined on an individual basis using an internal rating system and appraised values of each loan. Assumptions regarding problem loans are judgmentally determined using specific borrower information. Deposits: The fair value for demand deposits (e.g., interest and noninterest checking, savings and money market deposit accounts) are by definition, equal to the amount payable on demand at the reporting date (i.e. their carrying amounts). Fair value for fixed- rate certificates of deposit was estimated using a discounted cash flow calculation by combining all fixed-rate certificates into a pool with a weighted average yield and a weighted average maturity for the pool and comparing the pool with interest rates currently being offered on a similar maturity. Short-term borrowed funds: Because of time to maturity, the estimated fair value of short-term borrowings approximates the book value. Long-term debt: The estimated fair values of long-term debt was determined using discounted cash flow analysis, based on borrowing rates for similar types of borrowing arrangements. Accrued interest: The carrying amounts of accrued interest approximates their fair values. Off-balance-sheet financial instruments: There are no unearned fees outstanding on off-balance-sheet financial instruments and the fair values are determined to be equal to the carrying values. The following table summarizes the book or notional value and fair value of financial instruments at December 31, 2001 and 2000. (Dollars in thousands) Financial assets: Cash and due from banks ............................................................ Interest-bearing balances ............................................................. Investment securities ................................................................... Net loans...................................................................................... $ 22 December 31, 2001 December 31, 2000 Book or Notional Value 9,028 53,042 55,348 199,980 Fair Value 9,028 53,042 55,348 211,170 Book or Notional Value 5,986 42,376 73,885 181,396 Fair Value 5,986 42,376 73,885 187,750 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (Dollars in thousands) Financial liabilities: December 31, 2001 December 31, 2000 Book or Notional Value Fair Value Book or Notional Value Fair Value Deposits ....................................................................................... Short-term borrowings................................................................. Long-term debt ............................................................................ $ 254,105 8,662 32,568 258,305 8,662 34,673 231,408 22,738 29,241 232,803 22,738 30,944 Off-balance sheet financial instruments: Commitments to extend credit .................................................... Standby letters of credit .............................................................. $ 37,674 4,009 37,674 4,009 30,325 2,921 30,325 2,921 (21) Common Stock: MPB has reserved 50,000 of authorized, but unissued shares of its common stock for issuance under a Stock Bonus Plan (the “Plan”). Shares issued under the Plan are at the discretion of the board of directors. In November 1997, MPB amended and restated its dividend reinvestment plan, (DRIP). Two hundred thousand shares of MPB’s authorized but unissued common stock are reserved for issuance under the DRIP. The DRIP also allows for voluntary cash payments within specified limits, for the purchase of additional shares. (22) Recent Accounting Pronouncements: In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement supersedes and replaces the guidance in Statement No. 125. It revises the stan- dards for accounting for securitization and other transfers of financial assets and collateral and requires certain disclosures, although it carries over most of Statement No. 125's provisions without reconsideration. The Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001 and for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. This Statement is to be applied prospectively with certain exceptions. Other than those exceptions, earlier or retroactive application of its accounting provisions is not permitted. The adoption of this statement had no impact on MPB's financial condition, equity, results of operations or disclosure. In June 2001, the FASB issued Statement No. 141, "Business Combinations." The Statement addresses financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, "Business Combinations," and FASB Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises." All business combinations in the scope of the Statement are to be accounted for using the purchase method. The provisions of the Statement apply to all business combina- tions initiated after June 30, 2001. In June 2001, the FASB issued Statement No. 142, "Goodwill and Other Intangible Assets." The Statement addresses finan- cial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, "Intangible Assets." It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. The Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recog- nized in the financial statements. The provisions of the Statement are required to be applied starting with fiscal years beginning after December 15, 2001, except that goodwill and intangible assets acquired after June 30, 2001 will be subject immediately to the nonamortization and amortization provisions of the Statement. Early application is permitted for entities with fiscal years beginning after March 15, 2001, provided that the first interim financial statements have not previously been issued. The Statement is required to be applied at the beginning of an entity's fiscal year and to be applied to all goodwill and other intan- gible assets recognized in its financial statement at that date. There is no expected impact on earnings, financial condition or equity upon adoption of Statement No. 142. 23 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (23) Summary of Quarterly Consolidated Financial Data (Unaudited): The following table presents summarized quarterly financial data for 2001 and 2000. (Dollars in Thousands, Except Per Share Data) Interest Income ................................................................................ Interest Expense .............................................................................. Net Interest Income ......................................................................... Provision for Loan Losses............................................................... Net Interest Income After Provision for Loan Losses .................... Other Income ................................................................................... Securities Gains (Losses) ................................................................ Other Expenses................................................................................ Income Before Income Tax Provision............................................. Income Tax Provision...................................................................... Net Income ...................................................................................... Earnings Per Share .......................................................................... Interest Income ................................................................................ Interest Expense .............................................................................. Net Interest Income ......................................................................... Provision for Loan Losses............................................................... Net Interest Income After Provision for Loan Losses .................... Other Income ................................................................................... Securities Gains (Losses) ................................................................ Other Expenses................................................................................ Income Before Income Tax Provision............................................. Income Tax Provision...................................................................... Net Income ...................................................................................... Earnings Per Share .......................................................................... Mar. 31 5,783 3,147 2,636 75 2,561 449 (11) 1,737 1,262 291 971 0.32 Mar. 31 5,230 2,652 2,578 75 2,503 414 0 1,653 1,264 316 948 0.31 $ $ $ $ 2001 Quarter Ended Sept. 30 June 30 5,671 5,840 2,885 3,021 2,786 2,819 100 75 2,686 2,744 475 444 4 (7) 1,798 1,852 1,367 1,329 303 312 1,064 1,017 0.35 0.33 2000 Quarter Ended Sept. 30 June 30 5,564 5,407 2,930 2,743 2,634 2,664 75 100 2,559 2,564 374 401 0 (4) 1,706 1,684 1,227 1,277 280 308 947 969 0.31 0.32 Dec. 31 5,570 2,682 2,888 250 2,638 491 0 1,639 1,490 312 1,178 0.39 Dec. 31 5,852 3,130 2,722 75 2,647 371 0 1,613 1,405 321 1,084 0.36 24 Mid Penn Bancorp, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations The purpose of this discussion is to further detail the financial condition and results of operations of Mid Penn Bancorp, Inc. (MPB). MPB 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 MPB’s liquidity, capital resources or opera- tions. This discussion should be read along with the financial statements also appearing in this report. Per share data has been restated to reflect the effect of stock dividends and splits. The prior financial data has been restated to reflect the 1998 merger of Miners Bank of Lykens as if the two banks had always been one. Financial Summary The consolidated earnings of MPB are derived primarily from the operations of its wholly-owned subsidiary, Mid Penn Bank. MPB earned net income of $4,230,000 for the year 2001, compared to $3,948,000 in 2000, which was an increase of $282,000 or 7.1%. This represents net income in 2001 of $1.39 per share compared to $1.30 per share in 2000 and $1.28 per share in 1999. Total assets of MPB continued to grow in 2001, reaching the level of $330,635,000, an increase of $15,051,000 or 4.8% over $315,584,000 at year end 2000. The majority of growth came from increases in commercial real estate loans, which were funded largely by the maturity and call of lower yielding investment securities . MPB continued to achieve an excellent return on average shareholders’ equity, (ROE), a widely recognized performance indicator in the financial industry. The ROE was 13.68% in 2001, 14.64% in 2000 and 14.68% in 1999. Return on average assets (ROA), another performance indicator, was 1.31% in 2001, 1.34% in 2000 and 1.40% in 1999. Tier one capital (to risk weighted assets) of $23,246,000 or 10.4% and total capital (to risk weighted assets) of $26,050,000 or 11.6% at December 31, 2001, are well above the December 31, 2001 requirement, which is 4% for tier one capital and 8% for total capital. Tier one capital consists primarily of stockholders' equity. Total capital includes qualifying subordinated debt, if any, and the allowance for loan 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, MPB'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. During 2001 net interest income increased $531,000 or 5.0% as compared to an increase of $160,000 or 1.5% in 2000. The average balances, effective interest differential and interest yields for the years ended December 31, 2001, 2000 and 1999 and the components of net interest rate growth, are presented in Table 1. A comparative presentation of the changes in net interest income for 2001 compared to 2000, and 2000 compared to 1999, is given 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. 25 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) The yield on earning assets decreased to 7.93% in 2001 from 8.33% in 2000. The yield on earning assets for 1999 was 7.91%. The change in the yield on earning assets was due primarily to the repricing of commercial loans in a very competitive rate environment and changes in the “prime rate.” The average “prime rate” for 2001 was 6.96% as compared to 9.20% for 2000 and 7.98% for 1999. Interest expense increased by $280,000 or 2.44% in 2001 as compared to an increase of $1,781,000 or 18.41% in 2000. The increase in interest expense is due primarily to the increase in the total of interest bearing liabilities including the greater reliance on borrowings from the Federal Home Loan Bank of Pittsburgh particularly in light of the short-term interest rate increases during 2000. Primarily resulting from the fluctuations in interest rates, the net interest margin, on a tax equivalent basis, in 2001 was 4.04% compared to 4.25% in 2000 and 4.24% in 1999. Management continues to closely monitor the net interest margin. TABLE 1: AVERAGE BALANCES, EFFECTIVE INTEREST DIFFERENTIAL AND INTEREST YIELDS INCOME AND RATES ON A TAXABLE EQUIVALENT BASIS FOR YEAR ENDED DECEMBER 31, 2001 Average Balance Interest Income/Expense Average Rates Earned/Paid $ 49,013 (Dollars in thousands) ASSETS: Interest Bearing Balances ..................... Investment Securities: Taxable.............................................. Tax-Exempt....................................... Total Investment Securities Federal Funds Sold ............................... Loans, Net............................................. Total Earning Assets............................. Cash and Due from Banks.................... Other Assets.......................................... Total Assets $ LIABILITIES & STOCKHOLDERS' EQUITY: Interest Bearing Deposits: NOW ................................................ Money Market .................................. Savings.............................................. Time .................................................. Short-term Borrowings ......................... Long-term Debt .................................... Total Interest Bearing Liabilities .......... Demand Deposits.................................. Other Liabilities.................................... Stockholders' Equity ............................. Total Liabilities and Stockholders' Equity Net Interest Income.................................... Net Yield on Interest Earning Assets: Total Yield on Earning Assets .............. Rate on Supporting Liabilities.............. Net Interest Margin............................... $ $ $ 23,706 35,929 59,635 2,435 190,558 301,641 6,044 12,263 319,948 29,427 23,342 25,661 139,928 9,822 32,704 260,884 25,709 2,431 30,924 319,948 26 3,092 1,542 2,736 84 16,460 23,914 246 739 456 7,751 441 2,102 11,735 12,179 6.31% 6.50% 7.62% 3.45% 8.64% 7.93% 0.84% 3.17% 1.78% 5.54% 4.49% 6.43% 4.50% 7.93% 3.89% 4.04% Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) TABLE 1: AVERAGE BALANCES, EFFECTIVE INTEREST DIFFERENTIAL AND INTEREST YIELDS (cont’d) INCOME AND RATES ON A TAXABLE EQUIVALENT BASIS FOR YEAR ENDED DECEMBER 31, 2000 (Dollars in thousands) Average Balance Interest Income/Expense Average Rates Earned/Paid 2,306 2,503 2,235 0 16,310 23,354 391 659 570 7,338 879 1,618 11,455 11,899 6.36% 6.38% 7.64% 6.00% 9.28% 8.33% 1.37% 3.55% 2.21% 5.63% 6.12% 6.64% 4.74% 8.33% 4.08% 4.25% ASSETS: Interest Bearing Balances ..................... Investment Securities: Taxable.............................................. Tax-Exempt....................................... Total Investment Securities $ 36,234 Federal Funds Sold ............................... Loans, Net............................................. Total Earning Assets............................. Cash and Due from Banks.................... Other Assets.......................................... Total Assets $ LIABILITIES & STOCKHOLDERS' EQUITY: Interest Bearing Deposits: NOW ................................................ Money Market .................................. Savings.............................................. Time .................................................. Short-term Borrowings ......................... Long-term Debt .................................... Total Interest Bearing Liabilities .......... Demand Deposits.................................. Other Liabilities.................................... Stockholders' Equity ............................. Total Liabilities and Stockholders' Equity Net Interest Income.................................... Net Yield on Interest Earning Assets: Total Yield on Earning Assets .............. Rate on Supporting Liabilities.............. Net Interest Margin............................... $ $ $ 39,224 29,251 68,475 7 175,802 280,518 5,212 9,015 294,745 28,518 18,568 25,744 130,342 14,362 24,378 241,912 23,511 2,358 26,964 294,745 27 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) TABLE 1: AVERAGE BALANCES, EFFECTIVE INTEREST DIFFERENTIAL AND INTEREST YIELDS (cont'd) INCOME AND RATES ON A TAXABLE EQUIVALENT BASIS FOR YEAR ENDED DECEMBER 31, 1999 (Dollars in thousands) Average Balance Interest Income/Expense Average Rates Earned/Paid ASSETS: Interest Bearing Balances ..................... Investment Securities: Taxable.............................................. Tax-Exempt....................................... Total Investment Securities................... $ 39,671 40,672 26,609 67,281 12 156,518 263,482 5,174 9,646 278,302 27,669 20,734 26,259 125,782 10,683 14,453 225,580 23,338 2,934 26,450 278,302 Federal Funds Sold ............................... Loans, Net............................................. Total Earning Assets............................. Cash and Due from Banks.................... Other Assets.......................................... Total Assets $ LIABILITIES & STOCKHOLDERS' EQUITY: Interest Bearing Deposits: NOW ................................................ Money Market .................................. Savings.............................................. Time .................................................. Short-term Borrowings ......................... Long-term Debt .................................... Total Interest Bearing Liabilities .......... Demand Deposits.................................. Other Liabilities.................................... Stockholders' Equity ............................. Total Liabilities and Stockholders' Equity Net Interest Income.................................... Net Yield on Interest Earning Assets: Total Yield on Earning Assets .............. Rate on Supporting Liabilities.............. Net Interest Margin............................... $ $ $ 2,409 2,562 1,988 1 13,884 20,844 380 705 586 6,631 517 855 9,674 11,170 6.07% 6.30% 7.47% 5.00% 8.87% 7.91% 1.37% 3.40% 2.23% 5.27% 4.84% 5.92% 4.29% 7.91% 3.67% 4.24% 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 $387,000, $203,000 and $258,000 are included with interest income in Table 1 for the years 2001, 2000 and 1999, respectively. 28 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) TABLE 2: VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME (Dollars in thousands) 2001 Compared to 2000 Increase (Decrease) Due to Change In: 2000 Compared to 1999 Increase (Decrease) Due to Change In: Taxable Equivalent Basis INTEREST INCOME: Volume Rate Interest Bearing Balances ............. $ Investment Securities: Taxable .......................................... Tax-Exempt ................................... Total Investment Securities 813 (990) 510 (480) (27) 29 (9) 20 Federal Funds Sold ....................... Loans, Net ..................................... 146 1,369 Total Interest Income $ 1,848 (62) (1,219) (1,288) INTEREST EXPENSE: Interest Bearing Deposits: NOW ........................................ $ Money Market........................... Savings ...................................... Time .......................................... Total Interest Bearing Deposits Short-term Borrowings ................. Long-term Debt............................. Total Interest Expense $ 12 169 (2) 540 719 (278) 553 994 (157) (89) (112) (127) (485) (160) (69) (714) Net 786 (961) 501 (460) 84 150 560 (145) 80 (114) 413 234 (438) 484 280 NET INTEREST INCOME: $ 854 (574) 280 Volume Rate Net (209) 106 (103) (91) 197 106 (1) 1,710 1,606 11 (74) (11) 240 166 178 588 932 674 32 50 82 0 716 904 0 28 (5) 467 490 184 175 849 (59) 247 188 (1) 2,426 2,510 11 (46) (16) 707 656 362 763 1,781 55 729 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%. Provision for Loan Losses The provision for loan losses charged to operating expense represents the amount deemed appropriate by management to maintain an adequate allowance for possible loan losses. Due to the cyclical nature of the economy coupled with the Bank’s substantial involvement in commercial loans and the record number of nationwide consumer bankruptcies, management thought it prudent to make a $500,000 allocation in 2001 as well as a provision of $325,000 during 2000 and 1999. The allowance for loan losses as a percentage of average total loans was 1.48% at December 31, 2001, compared to 1.58% for both the years ended December 31, 2000 and 1999, which continues to be higher than that of peer financial institutions due to MPB’s higher level of loans to finance commercial real estate. A summary of charge-offs and recoveries of loans is presented in Table 3. 29 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) TABLE 3: ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES (Dollars in thousands) Balance beginning of period ......................... Loans charged-off: Commercial real estate, construction and land development ........................... Commercial, industrial and agricultural ... Real estate-residential ............................... Consumer .................................................. Total loans charged off Recoveries on loans previously charged-off: Commercial real estate, construction and land development ........................... Commercial, industrial and agricultural ... Real estate-residential ............................... Consumer .................................................. Total recoveries Net charge-offs.............................................. Current period provision for 2001 2,815 $ Years ended December 31, 1999 2000 2,313 2,505 1998 2,281 1997 2,278 249 118 0 122 489 0 1 0 29 30 459 1 12 0 61 74 28 5 0 26 59 15 0 146 0 78 224 55 1 0 35 91 133 325 2,505 40 200 40 37 317 10 56 0 29 95 222 254 2,313 4 32 20 197 253 4 107 3 33 147 106 109 2,281 loan losses ................................................. Balance end of period ................................... 500 2,856 $ 325 2,815 Ratio of net charge-offs during the period to average loans outstanding during the period, net of unearned discount............... Allowance for loan losses as a percentage .24% .01 .08 .14 .07 of average total loans ................................ 1.48% 1.58 1.58 1.47 1.46 Noninterest Income During 2001, MPB earned $1,845,000 in noninterest income, compared to $1,556,000 earned in 2000, and $1,689,000 earned in 1999. Noninterest income in 1999 included nonrecurring gains of $336,000 from the sale of other real estate. Service charges on deposit accounts amounted to $921,000 for 2001, an increase of $331,000 or 56.10% over $590,000 for 2000, which showed an increase of $36,000 over 1999. The majority of this increase resulted from the increasing revenues from NSF charges. In 2001, MPB initiated a program which allows approved customers to overdraw their checking accounts and have the checks paid, up to an approved limit not to exceed $300. This program coupled with a more restrictive policy on fee waivers, and an increase in demand accounts, has contributed to this substantial increase in fee income with a very control- lable level of associated loss. On December 31, 1998, MPB purchased cash surrender value life insurance policies that provide funding for director retire- ment and salary continuation plans. The income on these policies amounted to $217,000 during the year 2001. Trust department income for 2001 was $158,000, a $45,000 or 22.17% decrease from the $203,000 in 2000, which was $76,000 or 59.84% more than the $127,000 earned in 1999. The Trust Department adopted a new fee schedule during 2000, which will result in increased trust fees earned. Trust Department income fluctuates from year to year, due to the number of estates being settled during the year. 30 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) MPB also earned $74,000 in fees from Invest, the third-party provider of investments whose services the Bank has contract- ed. Other operating income amounted to $612,000 in 2001, $496,000 and $481,000 in 2000 and 1999, respectively, net of gains on other real estate. Noninterest Expense A summary of the major components of noninterest expense for the years ended December 31, 2001, 2000 and 1999 is reflected in Table 4. Noninterest expense increased to $7,026,000 in 2001 from $6,656,000 in 2000 and $6,665,000 in 1999. The major component of noninterest expense is salaries and employee benefits. The number of full-time equivalent employees increased from 104 to 109 during 2001. This increase in workforce also included the addition of an experienced commercial loan officer. Despite the increase in workforce costs, noninterest expense in 2001 changed less than 6% compared to that of 2000. Noninterest expense of $6,656,000 in 2000 decreased less than 1% over that of 1999. Noninterest expense in 1999 includes approximately $126,000 of supplemental employee bonuses for the year 1998. TABLE 4: NONINTEREST EXPENSE (Dollars in thousands) Years ended December 31, Salaries and employee benefits ........................................ Occupancy, net ................................................................. Equipment ........................................................................ Postage and supplies ........................................................ FDIC assessments ............................................................ Marketing and advertising................................................ Other real estate, net......................................................... Pennsylvania bank shares tax........................................... Professional services ........................................................ Telephone ......................................................................... Loss on mortgage sales .................................................... Other................................................................................. Total Noninterest Expense 2001 4,169 392 461 280 44 127 43 262 213 78 125 832 7,026 $ $ Investments 2000 3,790 364 481 291 45 144 0 271 104 72 19 1,075 6,656 1999 3,741 318 510 275 26 121 0 279 124 74 47 1,150 6,665 MPB investment portfolio is utilized to improve earnings through investments of funds in higher-yielding assets, while maintaining asset quality, which provide the necessary balance sheet liquidity for MPB. MPB’s entire portfolio of investment securities is considered available for sale. As such, the investments are recorded on our Balance Sheet at market value. Our investments: US Treasury, Agency and Municipal securities are given a market price relative to investments of the same type with similar maturity dates. As the interest rate environment of these securities changes, our existing securities are valued differently in comparison. This difference in value, or unrealized loss, amounted to $56,000, net of tax, as of the end of the year. However, the investments are all high quality United States and municipal secu- rities that if held to maturity are expected to yield no loss to the bank. At December 31, 2001, SFAS No. 115 resulted in a decrease of shareholders’ equity of $56,000 (unrealized loss on securi- ties of $84,000 less estimated income tax effect of $28,000). As of December 31, 2000, SFAS No. 115 resulted in a decrease in shareholders’ equity of $344,000 (unrealized loss on securities of $522,000, less estimated income tax effect of $178,000), compared to a decrease in stockholders’ equity of $1,861,000 (unrealized loss on securities of $2,820,000, less estimated income tax effect of $959,000) as of December 31, 1999. MPB does not have any significant concentrations of investment securities. 31 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) Table 5 provides a history of the amortized cost of investment securities at December 31, for each of the past three years. The gross unrealized gains and losses on investment securities are outlined in Note 6 to the Consolidated Financial Statements. TABLE 5: AMORTIZED COST OF INVESTMENT SECURITIES (Dollars in thousands) U. S. Treasury and U.S. government agencies .................... Mortgage backed U.S. government agencies....................... State and political subdivision obligations........................... Restricted equity securities .................................................. Total $ 2001 9,028 4,674 39,760 1,970 $ 55,432 December 31, 2000 34,750 2,402 33,972 3,281 74,405 1999 33,778 1,799 28,061 3,281 66,919 Loans At December 31, 2001, net loans totaled $199,980,000, an $18,584,000 or 10.24% increase from December 31, 2000. During 2001, MPB experienced an increase in commercial real estate and commercial/industrial loans of approximately $19,966,000, the majority of which was generated in the greater Harrisburg region. The current environment in lending is extremely competitive with financial institutions aggressively pursuing potential bor- rowers. At December 31, 2001, loans, net of unearned income, represented 64.6% of earning assets as compared to 62.7% on December 31, 2000 and 63.2% on December 31, 1999. The Bank's loan portfolio is diversified among individuals, farmers, and small and medium-sized businesses generally locat- ed 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, financial and agricultural loans are made to business enti- ties 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, lines of credit and home equity loans. A distribution of the Bank's loan portfolio according to major loan classification is shown in Table 6. TABLE 6: LOAN PORTFOLIO (Dollars in thousands) 2001 December 31, 1999 2000 1998 1997 Commercial real estate, construction Commercial, industrial and agricultural ....... Real estate-residential mortgage ................... Consumer ...................................................... Lease financing ............................................. Total Loans Unearned income .......................................... Loans net of unearned discount .................... Allowance for loan losses ............................. and land development ............................... $ 130,913 23,107 38,349 12,732 0 205,101 (2,265) 202,836 (2,856) Net Loans $ 199,980 110,947 26,274 35,610 14,110 0 186,941 (2,730) 184,211 (2,815) 181,396 105,328 20,118 32,586 16,780 0 174,812 (2,518) 172,294 (2,505) 169,789 88,263 20,401 30,325 16,034 1 155,024 (2,031) 152,993 (2,313) 150,680 81,191 20,107 34,195 21,018 8 156,519 (1,943) 154,576 (2,281) 152,295 Allowance for Loan Losses The allowance for loan losses is maintained at a level believed adequate by Management to absorb potential loan losses in the loan portfolio. MPB has a loan review department that is charged with establishing a "watch list" of potential unsound loans, identifying unsound credit practices and suggesting corrective actions. A quarterly review and reporting process is in place for monitoring those loans that are on the "watch list." Each credit on the "watch list" is evaluated to estimate potential losses. In addition, estimates for each category of credit are provided based on Management's judgment which considers past experi- ence, current economic conditions and other factors. For installment and real estate mortgages, specific allocations are based 32 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) on past loss experience adjusted for recent portfolio growth and economic trends. The total of reserves resulting from this analysis are "allocated" reserves. The amounts not specifically provided for individual classes of loans are considered "unallo- cated." This unallocated amount is determined and based on judgments regarding economic conditions, trends and other fac- tors. The allocation of the allowance for loan losses among the major classifications is shown in Table 7 as of December 31 of each of the past five years. The allowance for loan losses at December 31, 2001, was $2,856,000 or 1.43% of total loans less unearned discount as compared to $2,815,000 or 1.53% at December 31, 2000, and $2,505,000 or 1.45% at December 31, 1999. TABLE 7: ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES (Dollars in thousands) December 31, 2001 2000 1999 1998 1997 Percent Amount of Loans Amount of Loans Amount of Loans Amount of Loans Amount of Loans Percent Percent Percent Percent Commercial real estate, construction and land development ........................ $ 1,584 Commercial, industrial and 63.8% 1,318 59.3% 927 60.3% 861 56.8% 596 50.6% agricultural .......................... 987 11.3% 1,008 14.1% 782 11.5% 693 13.5% 369 14.0% Real estate-residential mortgage.............................. Consumer ................................ Unallocated ............................. 73 166 46 Total loans $ 2,856 18.7% 6.2% - 209 93 187 19.0% 7.6% - 100% 2,815 100% 198 114 484 2,505 18.6% 219 9.6% 127 413 - 100% 2,313 19.4% 10.3% - 207 146 963 100.0% 2,281 21.9% 13.5% - 100.0% Nonperforming Assets Nonperforming assets, other than consumer loans and 1-4 family residential mortgages, include impaired and nonaccrual loans, loans past due 90 days or more, restructured loans and other real estate (including residential property). Nonaccrual loans are loans on which we no longer recognize daily interest income. A loan is generally classified as nonaccrual when prin- cipal or interest has consistently been in default for a period of 90 days or more, or because of a deterioration in the financial condition of the borrower, payment in full of principal or interest is not expected. Loans past due 90 days or more and still accruing interest are loans that are generally well-secured and in the process of collection or repayment. Restructured loans are those loans whose terms have been modified to lower interest or principal payments because of borrower financial difficul- ties. Foreclosed assets held for sale include those assets that have been acquired through foreclosure for debts previously con- tracted, in settlement of debt. Consumer loans are generally recommended for charge-off when they become 150 days delinquent. All 1-4 family residen- tial mortgages 90 days or more past due are reviewed quarterly by Management, and collection decisions are made in light of the analysis of each individual loan. The amount of consumer and residential mortgage loans past due 90 days or more at year-end was $87,000, $222,000 and $266,000 in 2001, 2000, and 1999, respectively. A presentation of nonperforming assets as of December 31, for each of the past five years is given in Table 8. Nonperforming assets at December 31, 2001, totaled $4,744,000 or 1.44% of total assets compared to $2,312,000 or 0.73% of total assets in 2000, and $2,217,000 or 0.77% of total assets in 1999. The foreclosed assets held for sale at December 31, 2001, consist of two pieces of commercial real estate and residential building lots that MPB has available for sale. One parcel of commercial real estate that will be marketed for sale during 2002 represents more than 30% of the total nonperforming assets at December 31, 2001. 33 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) TABLE 8: NONPERFORMING ASSETS (Dollars in thousands) December 31, Nonaccrual loans........................................... Past due 90 days or more .............................. Restructured loans......................................... Total nonperforming loans Foreclosed assets held for sale...................... $ Total nonperforming assets $ 2001 1,686 828 537 3,051 1,693 4,744 2000 1,116 504 622 2,242 70 2,312 1999 890 386 878 2,154 63 2,217 1998 376 844 1,497 2,717 347 3,064 1997 333 212 212 757 1,355 2,112 Percent of loans outstanding ......................... Percent of total assets.................................... 2.34% 1.44% 1.26% 0.73% 1.29% 0.77% 2.00% 1.10% 1.38% 0.82% There are no loans classified for regulatory purposes that have not been included in Table 8. There are no trends or uncer- tainties which management expects will materially impact future operating results, liquidity or capital resources, or no other material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with loan repayment terms. Deposits and Other Funding Sources MPB's primary source of funds is its deposits. Deposits at December 31, 2001, increased by $22,697,000 or 9.8% over December 31, 2000, which also increased by $13,568,000 or 6.23% from December 31, 1999. The majority of deposit growth in 2001 came through the promotion of a variable-rate money market account being offered at rates which are very competitive in the market. Average balances and average interest rates applicable to the major classifications of deposits for the years ended December 31, 2001, 2000, and 1999 are presented in Table 9. Average short-term borrowings for 2001 were $9,822,000 as compared to $14,362,000 in 2000. These borrowings included customer repurchase agreements, treasury tax and loan option borrowings and federal funds purchased. TABLE 9: DEPOSITS BY MAJOR CLASSIFICATION (Dollars in thousands) Noninterest-bearing demand deposits.... $ Interest-bearing demand deposits .......... Money market ........................................ Savings ................................................... Time ....................................................... Total $ 2001 Years ended December 31, 2000 1999 Average Balance 25,709 29,427 23,342 25,661 139,928 244,067 Average Rate 0.00% 0.84% 3.17% 1.78% 5.54% 3.77% Average Balance 23,511 28,518 18,568 25,744 130,342 226,683 Average Rate 0.00% 1.37% 3.55% 2.21% 5.63% 3.95% Average Balance 23,338 27,669 20,734 26,259 125,782 223,782 Average Rate 0.00% 1.37% 3.40% 2.23% 5.27% 3.71% Capital Resources Stockholders' equity, or capital, is evaluated in relation to total assets and the risk associated with those assets. The greater the capital resources, the more likely a corporation is to meet its cash obligations and absorb unforeseen losses. Too much capital, however, indicates that not enough of the company’s earnings have been paid to shareholders and the buildup makes it difficult for a company to offer a competitive return on the shareholders’ capital going forward. For these reasons capital ade- quacy has been, and will continue to be, of paramount importance. In 2001, capital was increased by $2,090,000 or 7.05%. In 2000, capital was increased by $3,061,000 or 11.52%. In 1999, capital was decreased by $4,971,000 or 15.8%. Capital growth is achieved by retaining more in earnings than we pay out to our shareholders. MPB’s normal dividend payout allows for quarterly cash returns to its stockholders and provides earnings retention at a level sufficient to finance future Corporation growth. The dividend payout ratio, which represents the percentage of annual net 34 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) income returned to the stockholders in the form of cash dividends, was 58% for 2001 compared to 62% for 2000 and 171% for 1999. The reason for the special dividend payout in 1999, as outlined in the first section of this discussion, was to increase ROE and enhance shareholder value. At December 31, 2001, 19,065 shares of MPB’s common stock have been purchased back by MPB, held as treasury stock, and are available for issuance under the dividend reinvestment plan or the stock bonus plan. The treasury stock may also be used for the employee stock ownership plan. Federal income tax expense for 2001 was $1,218,000 compared to $1,255,000 and $1,253000 in 2000 and 1999, respective- ly. The effective tax rate was 22% for 2001, and 24% for both 2000 and 1999. Federal Income Taxes Liquidity MPB's asset-liability management policy addresses the management of MPB's liquidity position and its ability to raise suffi- cient funds to meet deposit withdrawals, fund loan growth and meet other operational needs. MPB utilizes its investment port- folio as a source of liquidity, along with deposit growth and increases in repurchase agreements and other short-term borrow- ings. (See Deposits and Other Funding Sources which appears earlier in this discussion.) Liquidity from investments is pro- vided primarily through investments and interest bearing balances with maturities of one year or less. Funds are available to MPB through loans from the Federal Home Loan Bank and established federal funds (overnight) lines of credit. MPB's major source of funds is its core deposit base as well as its capital resources. The major sources of cash in 2001 came from operations and the net decrease of $18,537,000 in investment securities. Net deposits increased by $22,697,000 contributing another major source of cash. The major area of deposit increase was in a high-balance money market account known as the Prime Investment account, while certificate of deposit balances decreased during the year in the face of a very competitive price environment. The sources of cash were used primarily to fund loan growth and to pay down short-term borrowings. Net loan funding in 2001 used $18,584,000 of cash. While loan growth was very sluggish during the first half of the year, MPB experienced sub- stantial loan growth with the portfolio growing more than 10% by year end. The majority of the loan growth was in loans to fund commercial real estate in the Greater Harrisburg area. During 2000, the major sources of cash came from operations and a net increase in deposits of $13,568,000. The majority of this deposit increase came in the form of three-year certificates of deposit issued at a yield of 7%. In order to meet our funding needs over and above the funds generated by growth in deposits, MPB turned to the FHLB for borrowings. MPB bor- rowed $5,000,000 in a 10-year/2-year putable advance, $5,000,000 in a 10-year/3-year putable advance and $5,000,000 in a three year bullet borrowing. The major uses of funds during 1999 included the net increase in loans of $15,558,000, and the increase in both investments and interest-bearing balances. Short-term borrowings were used during December to purchase interest-bearing balances, which increased by $7,806,000 from year end 1999, to December 31, 2000, and to purchase other investment securities in advance of declining interest rates. Market Risk - Asset-Liability Management and Interest Rate Sensitivity Interest rate sensitivity is a function of the repricing characteristics of MPB'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 differ- ence between the volume of assets and liabilities that are subject to repricing in a future period of time. These differences are known as interest sensitivity gaps. MPB manages the interest rate sensitivity of its assets and liabilities. The principal purpose of asset-liability management is to maximize net interest income while avoiding significant fluctuations in the net interest margin and maintaining adequate liq- uidity. Net interest income is increased by increasing the net interest margin and by increasing earning assets. MPB utilizes asset-liability management models to measure the impact of interest rate movements on its interest rate sensi- tivity position. The traditional maturity gap analysis is also reviewed regularly by MPB's management. MPB does not attempt 35 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) to achieve an exact match between interest sensitive assets and liabilities because it believes that a controlled amount of inter- est rate risk is desirable. The maturity distribution and weighted average yields of investments is presented in Table 10. The maturity distribution and repricing characteristics of MPB's loan portfolio is shown in Table 11. Table 12 provides expected maturity information about MPB’s financial instruments that are sensitive to changes in interest rates. Except for the effects of prepayments on mortgage related assets, the table presents principal cash flows and related average interest rates on interest bearing assets by contractual maturity. Residential loans are assumed to have annual payment rates between 12% and 18% of the portfolio. Loan and mortgage backed securities balances are not adjusted for unearned discounts, premiums, and deferred loan fees. MPB assumes that 75% of savings and NOW accounts are core deposits and are, therefore, expected to roll-off after 5 years. Transaction accounts, excluding money market accounts, are assumed to roll-off after five years. Money market accounts are assumed to be variable accounts and are reported as maturing within the first twelve months. No roll-off is applied to certifi- cates of deposit. Fixed maturity deposits reprice at maturity. The maturity distribution of time deposits of $100,000 or more is shown in Table 13. TABLE 10: INVESTMENT MATURITY AND YIELD (Dollars in thousands) U.S. Treasury and U.S.government agencies ..... $ State and political subdivision obligations ......... Mortgage-backed U.S. government agencies ..... Equity securities.................................................. Total $ Weighted Average Yields U.S. Treasury and U.S. government agencies .... State and political subdivision obligations ......... Mortgage-backed U.S. government agencies.......................................................... Equity securities.................................................. Total One Year and Less 0 407 114 0 521 One Year and Less 0% 7.92 6.61 0 7.63% December 31, 2001 After Five Years thru Ten Years 1,000 8,726 1,913 0 11,639 After One Year thru Five Years 5,028 3,173 2,156 0 10,357 After Ten Years 3,000 27,454 491 1,970 32,915 Total 9,028 39,760 4,674 1,970 55,432 December 31, 2001 After Five Years thru Ten Years After One Year thru Five Years After Ten Years 5.36 7.44 6.10 0 6.15 6.14 7.11 5.82 0 6.81 6.27 7.03 6.56 5.71 6.87 Total 5.75 7.09 6.05 5.71 6.74 TABLE 11: LOAN MATURITY AND INTEREST SENSITIVITY (Dollars in thousands) December 31, 2001 Commercial, real estate, construction and land development ............................. Commercial, industrial and agricultural ..... Real estate-residential mortgages ............... Consumer.................................................... Total Loans One Year and Less $ 34,390 11,607 13,769 1,841 $ 61,607 After One Year thru Five Years 90,799 9,806 13,226 7,758 121,589 After Five Years 5,726 1,694 11,354 866 19,640 Total 130,915 23,107 38,349 10,465 202,836 36 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) TABLE 11: LOAN MATURITY AND INTEREST SENSITIVITY (cont’d) Rate Sensitivity Predetermined rate...................................... Floating or adjustable rate .......................... Total One Year and Less $ 8,952 52,655 $ 61,607 After One Year thru Five Years 34,108 87,481 121,589 After Five Years 18,625 1,015 19,640 Total 61,685 141,151 202,836 TABLE 12: INTEREST RATE SENSITIVITY GAP (Dollars in thousands) (As of December 31, 2001) Assets: Expected Maturity Year Ended December 31, 2002 2003 2004 2005 2006 Thereafter Total Fair Value Average interest rate..................... Debt securities .................................. $ Average interest rate..................... Interest bearing balances .................. $ 35,642 5.45 521 7.63 Adjustable rate loans ........................ $ 52,655 6.27 Fixed rate loans ................................ $ 8,952 8.09 Total $ 97,770 Average interest rate..................... Average interest rate..................... Interest liabilities: Variable rate savings and Average interest rate..................... transaction accounts ....................... $ 42,012 1.88 Average interest rate..................... Certificates of deposit and IRAs ...... $ 79,798 4.60 Short term borrowings...................... $ 8,662 1.50 184 7.30 Total $130,656 Average interest rate..................... Long term fixed rate borrowings...... $ Average interest rate 13,935 5.93 3,204 5.75 11,238 9.09 7,825 8.99 36,202 1,980 6.63 1,055 6.93 40,103 7.87 9,213 8.76 52,351 1,188 7.47 2,984 5.74 13,448 7.75 9,375 8.98 26,995 297 6.68 3,114 6.69 22,692 8.04 7,695 8.53 33,798 0 0 0 0 26,037 5.98 0 - 5,197 6.61 31,234 10,852 4.75 0 - 5,087 5.24 15,939 7,689 5.70 0 - 0 - 7,689 5,258 4.86 0 - 5,000 6.21 10,258 0 - 42,585 6.91 1,015 8.08 18,625 8.29 62,225 72,141 0.61 2,977 5.35 0 - 17,100 6.55 92,218 53,042 5.67 53,462 6.77 141,151 7.39 61,685 8.49 309,340 53,042 53,377 141,151 72,875 320,445 114,153 1.08 132,611 4.97 8,662 1.50 32,568 6.31 287,994 114,153 136,811 8,662 34,673 294,299 Rate sensitive gap: Periodic gap...................................... $(32,886) 4,968 Cumulative gap................................. $(32,886) (27,918) 36,412 8,494 19,306 27,800 23,540 51,340 (29,993) 21,347 Cumulative gap as a percentage of total assets .................................... -9.9% -8.4% +2.6% +8.4% +15.5% +6.5% 37 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) (Dollars in thousands) (As of December 31, 2000) Assets: Expected Maturity Year Ended December 31, 2001 2002 2003 2004 2005 Thereafter Total Fair Value Average interest rate..................... Average interest rate..................... Interest bearing balances .................. $ 22,479 6.45 Debt securities .................................. $ 2,389 6.32 Adjustable rate loans ........................ $ 46,093 9.18 Fixed rate loans ................................ $ 9,286 8.90 Total $ 80,247 Average interest rate..................... Average interest rate..................... Interest liabilities: Variable rate savings and Average interest rate..................... transaction accounts ....................... $ 33,276 2.97 Average interest rate..................... Certificates of deposit and IRAs ...... $ 66,186 5.69 Short term borrowings...................... $ 22,738 6.40 Long term fixed rate borrowings...... $ 1,671 6.67 $123,871 Average interest rate..................... Average interest rate Total 12,470 7.07 1,810 6.50 16,805 8.49 7,799 9.32 38,884 0 - 34,178 6.06 0 - 184 7.30 34,362 5,745 7.32 3,599 6.59 17,988 8.70 9,974 9.08 37,306 0 - 21,009 6.36 0 - 5,197 6.61 26,206 495 7.30 2,603 6.67 17,928 7.99 8,179 8.72 29,205 0 - 4,192 5.36 0 - 87 7.30 4,279 1,187 7.47 5,798 6.56 16,343 8.08 10,077 9.06 33,405 0 - 5,289 6.07 0 - 0 - 5,289 0 - 54,935 6.83 546 8.01 23,193 8.39 78,674 61,697 1.10 3,350 5.58 0 - 22,102 6.47 87,149 42,376 6.79 71,134 6.77 115,703 8.65 68,508 8.61 297,721 42,376 70,604 115,703 72,047 300,730 94,973 1.73 134,204 5.89 22,738 6.40 29,241 6.52 281,156 94,973 135,599 22,738 30,944 284,254 Rate sensitive gap: Periodic gap...................................... $(43,624) 4,522 Cumulative gap................................. $(43,624) (39,102) 11,100 (28,002) 24,926 (3,076) 28,116 25,040 (8,475) 16,565 Cumulative gap as a percentage of total assets .................................... -13.8% -12.4% -8.9% -1.0% +7.9% +5.2% In the last quarter of 2001, management analyzed interest rate risk using the Vining Sparks Asset-Liability Management Model. Using the computerized model, management reviews interest rate risk on a monthly basis. This analysis includes an earnings scenario whereby interest rates are increased by 200 basis points and another whereby they are decreased by 200 basis points. These scenarios indicate that there would not be a significant variance in net interest income at the one-year time frame due to interest rate changes; however, actual results could vary significantly from the calculations prepared by management. At December 31, 2001, all interest rate risk levels according to our model were within the tolerance guidelines set by manage- ment. The model noted above utilized by management to create the reports used for Table 12 makes various assumptions and estimates. Actual results could differ significantly from these estimates which would result in significant differences in cash flows. 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 13: MATURITY OF TIME DEPOSITS $100,000 OR MORE (Dollars in thousands) Three months or less ........................................................ Over three months to twelve months ............................... Over twelve months ......................................................... Total $ 2001 3,925 12,773 7,643 $ 24,341 December 31, 2000 5,431 8,534 9,377 23,342 1999 3,525 4,960 7,731 16,216 38 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) 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 MPB's ability to react to changes in interest rates and, by such reaction, reduce the inflationary impact on per- formance. 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 lia- bilities 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 MPB is positioned to react to changing interest rates and inflationary trends. In particular, the summary of net liabilities, the composition of loans, invest- ments and deposits should be considered. Off-Balance-Sheet Items MPB makes contractual commitments to extend credit and extends lines of credit which are subject to MPB's credit approval and monitoring procedures. As of December 31, 2001, commitments to extend credit amounted to $37,674,000 as compared to $30,325,000 as of December 31, 2000. MPB 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 increased to $4,009,000 at December 31, 2001, from $2,921,000 at December 31, 2000. Comprehensive Income Comprehensive Income 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 and Comprehensive Income is termed “Other Comprehensive Income.” For MPB, Other Comprehensive Income consists of unre- alized gains and losses on available-for-sale securities, net of deferred income tax. Comprehensive Income should not be con- strued to be a measure of net income. The effect of Other Comprehensive Income would only be reflected in the income state- ment if the entire portfolio of available-for-sale securities were sold on the statement date. The amount of unrealized gains or losses reflected in Comprehensive Income may vary widely at statement dates depending on the markets as a whole and how the portfolio of available-for-sale securities is affected by interest rate movements. Other Comprehensive Income (Loss) for the periods ended December 31, 2001, 2000 and 1999 was $288,000, $1,517,000 and ($2,205,000), respectively. Critical Accounting Policies The Bank's methodology for determining the allowance for loan losses establishes both an allocated and an unallocated component. The allocated portion of the allowance represents the results of analysis of individual "watch list" loans (commer- cial, residential and consumer loans) as well as pools of consumer loans within the portfolio. The individual commercial loans are risk rated with specific attention to estimated loss exposure. Historical loan loss rates are applied to "problem" consumer credits, adjusted to reflect current conditions. Specific regular reviews of credits exceeding $500,000 are performed to monitor the major portfolio risk. The Bank ana- lyzes all commercial loans in excess of $10,000 that are rated as watch list credits. Potential credit problems are monitored to determine whether specific loans are impaired, with impairment normally measured by reference to borrowers' collateral values and cash flows. The unallocated portion of the allowance for loan losses represents the results of measuring potential losses inherent in the portfolio that are not specifically identified in the allocated allowance analysis. This unallocated portion is analyzed by assess- ing changes in the Bank's underwriting criteria, growth and/or changes in the mix of loans originated, industry concentrations and evaluations, lending management changes, comparisons of certain factors to peer group banks, changes in economic condi- tions and assessment of off balance sheet risk. 39 Mid Penn Bancorp, Inc. Summary of Selected Financial Data (Dollars in thousands, except per share data) 2001 2000 1999 1998 1997 INCOME: Total Interest Income ................................ Total Interest Expense............................... Net Interest Income................................... Provision for Possible Loan Losses .......... Non-Interest Income ................................. Non-Interest Expense................................ Income Before Income Taxes ................... Income Tax Expense ................................. Extraordinary Income, Net of Tax ............ Net Income................................................ $ 22,864 11,735 11,129 500 1,845 7,026 5,448 1,218 0 4,230 22,053 11,455 10,598 325 1,556 6,656 5,203 1,255 0 3,948 COMMON STOCK DATA PER SHARE: Earnings Per Share.................................... Cash Dividends Declared.......................... Stockholders' Equity ................................. $ 1.39 .80 10.44 1.30 .80 9.76 20,112 9,674 10,438 325 1,689 6,665 5,137 1,253 0 3,884 1.28 2.18 8.74 20,436 9,593 10,843 254 1,398 6,606 5,381 1,516 0 3,865 1.27 .69 10.90 19,312 8,853 10,459 109 1,772 6,232 5,890 1,721 0 4,169 1.37 .66 10.27 AVERAGE SHARES OUTSTANDING ...... 3,038,859 3,036,007 3,037,976 2,892,416 2,895,417 AT YEAR-END: Investments................................................ Loans, Net of Unearned Discount ............ Allowance for Loan Losses ...................... Total Assets ............................................... Total Deposits ........................................... Short-term Borrowings ............................. Long-term Debt......................................... Stockholders' Equity ................................. $ 55,348 202,836 2,856 330,635 254,105 8,662 32,568 $ 31,716 73,885 184,211 2,815 315,584 231,408 22,738 29,241 29,626 64,099 172,294 2,505 287,542 217,840 24,636 16,400 26,565 RATIOS: Return on Average Assets......................... Return on Average Stockholders' Equity .. Cash Dividend Payout Ratio..................... Allowance for Loan Losses to Loans ....... Average Stockholders' Equity to Average Assets .......................................... 1.31 13.68 57.55 1.41 1.34 14.64 61.54 1.53 1.40 14.68 170.91 1.45 9.58 9.15 9.50 67,933 152,993 2,313 277,827 216,802 12,159 15,550 31,536 1.45 12.81 53.73 1.51 11.36 53,599 154,576 2,281 256,728 217,146 2,234 5,688 29,730 1.71 14.76 47.92 1.48 11.56 40 Mid Penn Bancorp, Inc. Directors and Officers / Mid Penn Bank Senior Management DIRECTORS Mid Penn Bancorp, Inc. Mid Penn Bank Jere M. Coxon Executive Vice President Penn Wood Products, Inc. Alan W. Dakey President and CEO Mid Penn Bank Earl R. Etzweiler Owner Etzweiler & Associates, Attorneys Gregory M. Kerwin Senior Partner Kerwin & Kerwin, Attorneys Charles F. Lebo Retired Educator PA Dept. of Education Warren A. Miller Retired Assistant Vice President Mid Penn Bank William G. Nelson President Hess Trucking Co., Inc. Donald L. Sauve Consultant Don’s Food Market, Inc. Edwin D. Schlegel Retired Superintendent Millersburg Area School District Eugene F. Shaffer Chairman Mid Penn Bank Guy J. Snyder, Jr. President Snyder Fuels, Inc. DIRECTORS EMERITI Bruce C. Adams Guy F. Bucher Harvey J. Hummel Charles R. Phillips Anna C. Woodside EXECUTIVE OFFICERS Mid Penn Bancorp, Inc. Eugene F. Shaffer Chairman Earl R. Etzweiler Vice Chairman Alan W. Dakey President and CEO Kevin W. Laudenslager Treasurer Cindy L. Wetzel Secretary SENIOR MANAGEMENT Mid Penn Bank Eugene F. Shaffer Chairman 45 Years Banking Experience Alan W. Dakey President and CEO 28 Years Banking Experience Randall L. Klinger Senior Vice President and Senior Credit Officer 28 Years Banking Experience Allen J. Trawitz Executive Vice President 33 Years Banking Experience Nelson E. Carr Vice President and Business Development Officer, Harrisburg Office 41 Years Banking Experience Kevin W. Laudenslager Vice President and Comptroller 17 Years Banking Experience Michael T. Lehmer Vice President and Senior Trust Officer 11 Years Banking Experience 41 Steven S. Shuey Vice President and Loan Review Officer 28 Years Banking Experience Linda M. Sitlinger Vice President and Sales Manager/Branch Administrator 29 Years Banking Experience Dennis E. Spotts Vice President and Operations Officer 29 Years Banking Experience Cindy L. Wetzel Corporate Secretary and Secretary to the Board 23 Years Banking Experience Eric S. Williams Vice President and Commercial Loan Officer 23 Years Banking Experience CAPITAL AREA ADVISORY BOARD Mid Penn Bank Norman K. A. Hoffer Norman L. Houser Theodore W. Mowery Robert M. Newbury David J. Remmel Ronald H. Smith MINERS-LYKENS ADVISORY BOARD Mid Penn Bank Franklin W. Ruth Jr. Raymond C. Donley Harold G. Jury Gregory M. Kerwin Terrence J. Kerwin Richard E. Klinger Donald E. Sauve Allen J. Trawitz Mid Penn Bancorp, Inc. Office Locations MILLERSBURG 349 Union Street Millersburg PA 17061 (717) 692-2133 (717) 896-3140 HARRISBURG 4098 Derry Street Harrisburg PA 17111 (717) 558-2144 CARLISLE PIKE 4622 Carlisle Pike Mechanicsburg PA 17055 (717) 761-2480 HARRISBURG 2615 North Front Street Harrisburg PA 17110 (717) 233-7380 DAUPHIN 1001 Peters Mountain Road Dauphin PA 17018 (717) 921-8899 HALIFAX Halifax Shopping Center 3763 Peters Mountain Road Halifax PA 17032 (717) 896-8258 ELIZABETHVILLE 2 East Main Street Elizabethville PA 17023 (717) 362-8147 DALMATIA School House Road Dalmatia PA 17017 (570) 758-2711 TOWER CITY 545 East Grand Avenue Tower City PA 17980 (717) 647-2157 TREMONT 7 - 9 East Main Street Tremont PA 17981 (570) 695-3358 MINERS-LYKENS 550 Main Street Lykens PA 17048 (717) 453-7185 Member FDIC w w w . m i d p e n n b a n k . c o m 7 1 7 - 6 9 2 - 4 0 0 0 

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