Mid Penn Bancorp Inc.
Annual Report 2002

Plain-text annual report

Mid Penn Bancorp, Inc. Shareholder Letter Dear Shareholder: The year 2002 was another challenging year in terms of the economy, interest rates, corporate governance issues, a sputter- ing stock market and global unrest. In spite of all these chal- lenges, I am pleased to present a very favorable 2002 financial report for Mid Penn Bancorp, Inc. Net income for the year 2002 totaled $4,495,000, an increase of 6.3% over the net income of $4,230,000 for the year 2001. Earnings per share for 2002 were $1.48 compared to $1.39 for the year 2001. Primary contributors to increased profits were higher net interest income resulting from an increase in earning assets and improved noninterest income, particularly service charges on deposits. Your Bank continues to manage costs and overhead resulting in an efficiency ratio of 54% which is very strong when compared to peer banks. The appreciation in your stock price of $3.80 or 20.9% in 2002, combined with an annual dividend of $.80 per share provided a very favorable return in 2002, considering the S&P 500 declined by 22.1% during this same period. Now that divi- dends are again a consideration in the market, our dividend yield of 3.64% as of December 31, 2002, provides a very favorable return. I would like to recognize Warren Miller, who will be retiring from our Board of Directors in April 2003. Warren began his career in banking in August of 1951 as an employee of Tower City National Bank and joined Mid Penn Bank in January of 1985, when Tower City National Bank joined Mid Penn Bank. Warren has been a dedicated employee and Board member who has made a substantial contribution to our organization. I remain optimistic about our future growth and opportuni- ties. Mergers and changes in the banking community continue to create opportunities for community banks like your Bank that provide local service, local decision making and support for the communities they serve. Thank you for your support and confidence. Please contact me at (717) 692-2133 or e-mail me at adakey@midpennbank.com if you have any questions, sugges- tions or concerns. Sincerely, Alan W. Dakey President and CEO Total assets of $363,284,000 increased by 9.9% over the prior year. A significant contributor to growth in assets was growth in the loan portfolio, which ended the year at $223,203,000, an increase of $18,102,000, or 8.8%. We also experienced growth in the investment portfolio, particularly interest-bearing balances with financial institutions. Our asset growth was primarily funded by growth in deposits. Total deposits at year end were $274,703,000 com- pared to $254,105,000 the prior year, an increase of 8.1%. The primary deposit growth category was money market accounts where growth has been fueled by an uncertain economy, poor performance in the stock market and uncertainty about interest rates. Your Bank remains very strongly capitalized with stockhold- er equity of $35,204,000 at year end, an increase of $3,488,000, or 11%. The increase in equity is due to strong earnings and appreciation in the bank's investment portfolio. Return on average equity (ROE) was 13.60% in 2002 com- pared to 13.68% the prior year. The decline in ROE was pri- marily attributable to the growth in average equity, which increased at a faster pace than earnings. Return on average assets (ROA) of 1.32% for 2002 increased from 1.31% the prior year. Mid Penn Bancorp, Inc. (AMEX - MBP) share price as of December 31, 2002, was $22.00 compared to $18.20 as of December 31, 2001, and $15.00 as of December 31, 2000. 1 Mid Penn Bancorp, Inc. Financial Highlights AS OF AND FOR YEARS ENDED DECEMBER 31, 2002 AND 2001 (Dollars in thousands, except per share data.) 2002 2001 Total Assets ..................................................................... $ 363,284 274,703 Total Deposits ................................................................. 218,302 Net Loans ........................................................................ 124,346 Total Investments and Interest Bearing Balances........... 35,204 Stockholders' Equity ....................................................... 4,495 Net Income...................................................................... Earnings Per Share.......................................................... 1.48 Cash Dividend Per Share Based on Weighted Average Number of Shares Outstanding ...................... Book Value Per Share ..................................................... .80 11.59 330,635 254,105 199,980 108,390 31,716 4,230 1.39 .80 10.44 Percent Change + 9.9 + 8.1 +9.2 +14.7 +11.0 + 6.3 + 6.5 0 +11.0 Mid Penn Bancorp, Inc. Stockholders' Information Market Value Per Share ........................................ $ 2002 2001 High 19.00 18.55 19.00 23.70 Low 18.01 17.75 17.75 18.50 High 16.55 19.04 19.25 18.65 Low 14.88 16.50 17.75 18.05 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, 2002, there were 968 stockholders. Dividends: A dividend of $.20 per share was paid during each quarter of 2002 and 2001. 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 22, 2003, at 349 Union Street, Millersburg, Pennsylvania. 2 Mid Penn Bancorp, Inc. Graphs (unaudited) 363.3 330.6 315.6 287.5 277.8 Total Assets 370 340 320 290 260 230 200 170 140 110 80 50 s n o i l l i M n I 274.7 254.1 231.4 217.8 216.8 Total Deposits 280 260 240 220 200 180 160 140 120 100 80 60 1998 1999 2000 Year 2001 2002 1998 1999 2000 Year 2001 2002 Net Income 3.87 3.88 3.95 4.50 4.23 s n o i l l i M n I 4.5 4.0 3.5 3.0 2.5 2.0 Total Stockholders’ Equity 1998 1999 2000 Year 2001 2002 35.2 Book Value Per Share s n o i l l i M n I 35 30 25 20 15 10 31.5 29.6 26.6 31.7 10.38 10.44 9.76 8.74 11.59 s r a l l o D n I 12 11 10 9 8 7 6 5 4 3 1998 1999 2000 Year 2001 2002 1998 1999 2000 Year 2001 2002 3 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, 2002 and 2001, and the related consolidated statements of income, changes in stockholders' equi- ty and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibili- ty 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, 2002 and 2001, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. PARENTE RANDOLPH, PC Williamsport, Pennsylvania January 16, 2003 4 Mid Penn Bancorp, Inc. Consolidated Balance Sheet DECEMBER 31, 2002 AND 2001 (Dollars in thousands, except share data) 2002 2001 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 income (loss) ......................... Treasury stock at cost (18,622 and 19,065 shares in 2002 ........... and 2001, respectively) ............................................................. Stockholders' Equity, Net Total Liabilities and Stockholders' Equity $ $ $ 8,095 65,487 58,859 223,203 (1,850) (3,051) 218,302 3,317 781 2,007 456 4,743 1,237 363,284 28,011 33,645 40,515 26,705 145,827 274,703 18,156 1,187 1,651 32,383 328,080 3,057 20,368 10,944 1,357 (522) 35,204 363,284 $ The accompanying notes are an integral part of these consolidated financial statements. 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 5 Mid Penn Bancorp, Inc. Consolidated Statement of Income FOR YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (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 gains (losses), 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 real estate expense ........................................................ Other expenses ........................................................................ Total Noninterest Expense $ 2002 15,863 2,703 659 2,001 79 47 21,352 7,807 50 2,069 9,926 11,426 425 11,001 188 1,053 60 51 239 431 2,022 3,978 384 514 259 46 115 79 294 1,589 7,258 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 43 1,560 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 11 1,531 6,656 INCOME BEFORE PROVISION FOR INCOME TAXES ........ Provision for income taxes ..................................................... Net Income Earnings Per Share Weighted Average Number of Shares Outstanding 5,765 1,270 4,495 1.48 3,036,508 $ $ 5,448 1,218 4,230 1.39 3,038,859 5,173 1,225 3,948 1.30 3,036,007 The accompanying notes are an integral part of these consolidated financial statements. 6 Mid Penn Bancorp, Inc. Consolidated Statement of Changes in Stockholders' Equity FOR YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (Dollars in thousands, except share data) Additional Common Paid-in Capital Stock Accumulated Other Retained Comprehensive Treasury Stock Earnings Income (Loss) Total Balance, December 31, 1999 ................................................ $ 3,057 20,368 5,557 (1,861) (556) 26,565 Comprehensive income: Net income ..................................................................... Change in net unrealized gain (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 gain (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 Comprehensive income: Net income ..................................................................... Change in net unrealized gain (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 (443 shares) ................................... 0 0 0 0 0 0 0 0 4,495 0 0 1,413 (2,431) 0 0 0 0 0 0 11 4,495 1,413 5,908 (2,431) 11 Balance, December 31, 2002 ................................................ $ 3,057 20,368 10,944 1,357 (522) 35,204 The accompanying notes are an integral part of these consolidated financial statements. 7 Mid Penn Bancorp, Inc. Consolidated Statement of Cash Flows FOR YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (Dollars in thousands) Operating Activities: Net income............................................................................... $ Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses .................................................. Depreciation ..................................................................... Increase in cash surrender value of life insurance ........... Investment securities (gains) losses, net .......................... Loss (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 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 in deposits .......................................................... Net increase (decrease) in short-term borrowings ................ Cash dividends paid................................................................ Long-term debt repayment ..................................................... Sale of treasury stock.............................................................. Long-term borrowings ............................................................ Net Cash Provided By Financing Activities Net (decrease) increase in cash and due from banks...................... Cash and due from banks at January 1........................................... Cash and due from banks at December 31..................................... $ 2002 4,495 425 340 (239) (60) 54 (51) (147) 84 (712) (105) 307 4,391 (12,445) 8,163 3,176 (12,657) 983 (19,969) (262) 1,311 (163) (31,863) 20,598 8,546 (2,431) (185) 11 0 26,539 (933) 9,028 8,095 Supplemental Disclosures of Cash Flow Information: Interest paid ............................................................................. $ Income taxes paid .................................................................... $ 10,031 1,427 Supplemental Noncash Disclosures: Loan charge-offs ...................................................................... $ Transfers to foreclosed assets held for sale............................. $ 302 290 The accompanying notes are an integral part of these consolidated financial statements. 2001 4,230 500 336 (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) 22,697 (13,128) (2,428) (1,673) 0 5,000 10,468 3,042 5,986 9,028 11,989 1,250 489 1,688 8 2000 3,948 325 369 (198) 4 (40) (31) (176) (382) (77) 344 126 4,212 (7,806) 4,042 3,515 (15,047) 3,622 (15,558) (643) 68 0 (27,807) 13,568 (1,898) (2,427) (2,159) 23 15,000 22,107 (1,488) 7,474 5,986 11,111 1,355 74 35 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements for 2002 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, (collective- ly, “MPB”). All significant intercompany balances and transactions have been eliminated in consolidation. (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 with accounting principles generally accepted in the United States of America and to general practice within the financial industry. The following is a description of the more significant accounting policies. (a) Use of Estimates The preparation of financial statements requires management to make estimates and assumptions that affect the report- ed amounts of assets and liabilities and disclosure of contingent 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: Available-for-Sale Securities - includes debt and equity 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 com- ponent of other accumulated income (loss) within 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 9 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 a specific and a general com- ponent. The specific 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 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 general portion of the allowance for loan losses represents the results of measuring potential losses inherent in the portfolio that are not identified in the specific allowance analysis. This general 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 and changes in economic conditions. 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 auditors 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 straight-line 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 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 value less costs of disposal, based upon periodic evaluations that consider changes in market conditions and develop- ment 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 noninter- est 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 $115,000 in 2002, $127,000 in 2001 and $144,000 in 2000. 10 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 board membership. (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 consolidated 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 diluted earnings per share are the same since there are no potentially dilutive securities outstanding. (l) Statement of Cash Flows For purposes 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 on available-for-sale securities.................................... $ Less reclassification adjustment for (gains) losses realized in income................ Net unrealized gains ............................................................................................. Income tax expense .............................................................................................. Net ....................................................................................................................... $ Years Ended December 31, 2002 2,193 (60) 2,133 (720) 1,413 2001 422 14 436 (148) 288 2000 2,296 4 2,300 (783) 1,517 (5) Restrictions on Cash and Due from Bank Accounts The Bank is required to maintain reserve balances with the Federal Reserve Bank of Philadelphia. The amount of those required reserve balances were $500,000 at December 31, 2002 and $2,554,000 at December 31, 2001. (6) Investment Securities At December 31, 2002 and 2001, amortized cost, fair value, and unrealized gains and losses on investment securities are as follows: (Dollars in Thousands) December 31, 2002 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............................. $ Amortized Cost Unrealized Gains Unrealized Losses Fair Value 291 134 1,647 0 2,072 0 9 14 0 23 9,829 5,637 41,021 2,372 58,859 9,538 5,512 39,388 2,372 56,810 11 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (Dollars in Thousands) December 31, 2001 Available-for-sale securities: U.S. Treasury and U.S. Amortized Cost Unrealized Unrealized Gains Losses Fair Value government agencies ................................. $ Mortgage-backed U.S. government agencies .................................. State and political subdivision obligations ............................... Restricted equity securities............................. $ 9,028 4,674 39,760 1,970 55,432 102 59 439 0 600 96 0 588 0 684 9,034 4,733 39,611 1,970 55,348 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 $26,909,000 at December 31, 2002 and $31,381,000 at December 31, 2001, were pledged to secure public deposits and other borrowings. Net gains (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 $60,000 in 2002, ($14,000) in 2001 and ($4,000) in 2000. The proceeds from sales of investment securities were $3,176,000 in 2002, $11,284,000 in 2001 and $3,515,000 in 2000. The following is a schedule of the maturity distribution of investment securities at amortized cost and fair value at December 31, 2002 and 2001: (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, 2002 Fair Amortized Value Cost 3,280 3,264 10,269 9,802 10,453 9,978 26,848 25,882 50,850 48,926 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 Mortgage-backed securities............................................................. Restricted equity securities.............................................................. 5,512 2,372 $ 56,810 5,637 2,372 58,859 4,674 1,970 55,432 4,733 1,970 55,348 (7) Loans A summary of loans at December 31, 2002 and 2001 is as follows: (Dollars in thousands) Commercial real estate, construction and land development.......... Commercial, industrial and agricultural.......................................... Real estate - residential ................................................................... Consumer......................................................................................... 2002 $ 146,325 22,398 41,502 12,978 $ 223,203 2001 130,913 23,107 38,349 12,732 205,101 Net unamortized loan fees of $443,000 in 2002 and $398,000 in 2001 were deducted from loans. 12 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 $1,935,000 at December 31, 2002 and $1,580,000 at December 31, 2001. New loans extended were $177,000 in 2002 and $497,000 in 2001. Net draws on these loans exceeded repayments by $178,000 in 2002 and $335,000 in 2001. 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 2002, 2001, and 2000 are summarized as follows: (Dollars in thousands) Balance, January 1........................................................................... Provision for loan losses ................................................................. Loans charged off ............................................................................ Recoveries on loans charged off ..................................................... Balance, December 31..................................................................... 2002 2,856 425 (302) 72 3,051 $ $ 2001 2,815 500 (489) 30 2,856 2000 2,505 325 (74) 59 2,815 The recorded investment in loans that are considered impaired amounted to $1,077,000 and $1,686,000 (all in nonaccrual) on December 31, 2002 and December 31, 2001, 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 $425,000 at December 31, 2002 and $125,000 at December 31, 2001. Impaired loans of approximately $743,000 at December 31, 2001 have no related allowance. The average balances of these loans amounted to approximately $1,361,000, $1,293,000 and $752,000 for the years 2002, 2001 and 2000, 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 2002, 2001 and 2000. (Dollars in thousands) Cash receipts applied to reduce principal balance .......................... Cash receipts recognized as interest income................................... Total cash receipts ........................................................................... 2002 122 1 123 $ $ 2001 238 31 269 2000 520 36 556 Loans which were past due 90 days or more for which interest continued to be accrued amounted to approximately $350,000 at December 31, 2002 and $828,000 at December 31, 2001. The Bank has no commitments to loan additional funds to borrowers with impaired or nonaccrual loans. (9) Bank Premises and Equipment At December 31, 2002 and 2001, bank premises and equipment are as follows: (Dollars in thousands) Land................................................................................................. Buildings.......................................................................................... Furniture and fixtures ...................................................................... Less accumulated depreciation........................................................ 2002 838 3,976 3,716 8,530 5,213 3,317 $ $ 2001 822 3,938 3,517 8,277 4,882 3,395 Depreciation expense was $340,000 in 2002, $336,000 in 2001 and $369,000 in 2000. (10) Deposits At December 31, 2002 and 2001, time deposits in denominations of $100,000 or more amounted to $24,831,000 and $24,341,000 respectively. Interest expense on such certificates of deposit amounted to approximately $1,112,000, $1,454,000 and $1,211,000 for the years ended December 31, 2002, 2001 and 2000, respectively. Time deposits at December 31, 2002, mature as follows: (in thousands) 2003, $62,026; 2004, $32,484; 2005, $25,288; 2006, $6,106; 2007, $3,537; thereafter, $16,386. Deposits and other funds from related parties held by MPB at December 31, 2002 and 2001 amounted to approxi- mately $5,807,000 and $4,307,000, respectively. 13 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (11) Short-term Borrowings Short-term borrowings as of December 31, 2002 and 2001 consisted of: (Dollars in thousands) Federal funds purchased.................................................................. $ Repurchase agreements .................................................................. Treasury, tax and loan note ............................................................ Due to broker .................................................................................. $ 2002 14,200 2,550 1,058 348 18,156 2001 5,800 2,666 196 948 9,610 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 repre- sents 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, 2002. (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, 2002, the Bank had long-term debt in the amount of $32,383,000 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 6.55% which will mature on November 24, 2003; a $283,000 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, 2002 are $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) 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 was $353,000 for 2002, $362,000 for 2001 and $361,000 for 2000. (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 Bank-paid benefits cease; however, the retiree may continue coverage through the Bank at his/her own expense. (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 three times the participant's annual salary at retirement or $50,000, whichever is less. After age 65, the life insurance coverage amount will decrease by 10% per year, subject to a minimum amount of $2,000. 14 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) 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, 2002 and 2001 and a statement of the funded status at December 31, 2002 and 2001: (Dollars in thousands) Change in benefit obligations: Benefit obligations, January 1..................................................................... $ Service cost.............................................................................................. Interest cost.............................................................................................. Actuarial loss (gain) ................................................................................ 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 ...................................................... $ 2002 377 24 28 45 (24) 450 0 24 (24) 0 2001 354 20 24 (3) (18) 377 0 18 (18) 0 Funded status: Excess of the benefit obligation over the value of plan assets ............... $ Unrecognized transition obligation ......................................................... Unrecognized gain................................................................................... Net amount recognized............................................................................ $ December 31, 2002 (450) 147 (101) (404) 2001 (377) 162 (150) (365) Amount recognized in the consolidated balance sheet at December 31, 2002 and 2001 is as follows: (Dollars in thousands) Accrued benefit liability.......................................................................... $ 2002 (404) 2001 (365) The components of net periodic postretirement benefit cost for 2002, 2001 and 2000 are as follows: (Dollars in thousands) Service cost.............................................................................................. $ Interest cost.............................................................................................. Amortization of transition obligation...................................................... Amortization of net gain ......................................................................... Net periodic postretirement benefit cost ................................................. $ 2002 24 28 15 (4) 63 2001 20 24 15 (7) 52 2000 18 22 15 (8) 47 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................................. $ $ One-Percentage Point Increase 7 50 6 42 Decrease Assumptions used in the measurement of MPB’s benefit obligations at December 31, 2002 and 2001 are as follows: Weighted-average assumptions: Discount rate............................................................................ Rate of compensation increase................................................ 6.75% 5.00% 15 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) For measurement purposes, no change in the per capita cost of covered health care benefits was assumed for 2003. The rate was assumed to be 6 percent for 2003 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 directors. 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, 2002 and 2001 and a statement of the funded status at December 31, 2002 and 2001: (Dollars in thousands) Change in benefit obligations: December 31, 2002 2001 Benefit obligations, January 1 ................................................................ Service cost......................................................................................... Interest cost......................................................................................... Actuarial (gain) loss ........................................................................... Change in assumptions ....................................................................... 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 loss (gain) ........................................................................ Net amount recognized........................................................................... $ $ $ $ $ $ 502 23 35 (1) 13 (9) 563 0 9 (9) 0 (563) 79 1 (483) 455 21 32 3 0 (9) 502 0 9 (9) 0 (502) 104 (11) (409) Amounts recognized in the consolidated balance sheet at December 31, 2002 and 2001 are as follows: (Dollars in thousands) Accrued benefit liability ......................................................................... Intangible asset ....................................................................................... Net amount recognized........................................................................... $ $ 2002 (489) 6 (483) The components of net periodic pension cost for 2002, 2001 and 2000 are as follows: (Dollars in thousands) Service cost............................................................................................. Interest cost............................................................................................. Amortization of prior-service cost.......................................................... Net periodic pension cost ....................................................................... $ $ 2002 23 35 26 84 2001 (426) 17 (409) 2001 21 32 26 79 2000 20 28 26 74 Assumptions used in the measurement of MPB’s benefit obligations at December 31, 2002 and 2001 are as follows: Weighted-average assumptions: Discount rate............................................................................ Change in consumer price index ............................................. 6.75% 4.00% 16 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) 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 $1,670,000 and $1,585,000 at December 31, 2002 and 2001, respectively. (e) Deferred Compensation Plans The Bank has 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, 2002 and 2001, the Bank has accrued a liability of approximately $56,000 and $33,000, respectively, for this plan. The Bank also has a directors’ 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, 2002 and 2001, the Bank has accrued a liability of approximately $117,000 and $92,000, 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 approx- imately $1,362,000 and $1,296,000 at December 31, 2002 and 2001, respectively. (f) Salary Continuation Agreement The Bank maintains a Salary Continuation Agreement (Agreement) for an executive officer. The 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 reasons 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, 2002 and 2001, the Bank has accrued a liability of approximately $100,000 and $72,000, respectively, for the Agreement. The expense related to the Agreement was $28,000 for 2002, $26,000 for 2001 and $24,000 for 2000. 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 $802,000 and $760,000 at December 31, 2002 and 2001, respectively. (g) Employee Stock Ownership Plan The Bank has an Employee Stock Ownership Plan (ESOP) covering substantially all employees. Contributions to the ESOP are made at the discretion of the Board of Directors. Total expense related to the Bank’s contribution to the ESOP for 2002, 2001 and 2000 was $118,000, $121,000 and $118,000, respectively. The ESOP held 21,496 and 15,889 shares of MPB stock as of December 31, 2002 and December 31, 2001, 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. Dividends paid on shares held by the ESOP are charged to retained earnings. (h) Other At December 31, 2002 and 2001, the Bank had a Split Dollar Life Insurance arrangement with two executives for which the aggregate cash surrender value is approximately $909,000 and $863,000, respectively. (14) Federal Income Taxes The following temporary differences gave rise to the deferred tax asset at December 31, 2002 and 2001: (Dollars in thousands) Deferred tax assets: Allowance for loan losses ....................................................... Benefit plans............................................................................ Nonaccrual interest.................................................................. Other items .............................................................................. Unrealized losses on securities................................................ Total $ $ 2002 883 390 75 63 - 1,411 2001 817 328 42 61 29 1,277 17 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (Dollars in thousands) 2002 2001 Deferred tax liabilities: Depreciation ............................................................................ Loan fees ................................................................................. Bond accretion......................................................................... Unrealized gain on securities .................................................. 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.......................................................... $ $ $ $ $ (93) (132) (31) (699) (955) 456 2002 1,417 (147) 1,270 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.......................................................... 2002 1,960 (824) 73 61 1,270 $ $ (90) (128) (22) - (240) 1,037 2001 1,334 (116) 1,218 2001 1,852 (753) 83 36 1,218 2000 1,401 (176) 1,225 2000 1,759 (633) 69 30 1,225 (15) 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, 2002: Capital Adequacy Tier I Capital (to Average Assets) .................... $ 25,235 25,235 Tier I Capital (to Risk Weighted Assets).......... 28,283 Total Capital (to Risk Weighted Assets)........... Actual Amount Ratio 7.4% 10.4% 11.6% Required Amount Ratio 4.0% 13,712 4.0% 9,754 8.0% 19,507 To Be Well Capitalized Under Prompt Corrective Action Provisions: Amount Ratio 5.0% 6.0% 10.0% 17,140 14,630 24,384 As of December 31, 2001: Tier I Capital (to Average Assets) .................... $ 23,246 23,246 Tier I Capital (to Risk Weighted Assets).......... 26,050 Total Capital (to Risk Weighted Assets)........... 7.4% 10.4% 11.6% 12,650 8,971 17,942 4.0% 4.0% 8.0% 15,812 13,457 22,428 5.0% 6.0% 10.0% As of December 31, 2002, the Bank’s capital ratios are well in excess of the minimum and well-capitalized guide lines and MPB’s capital ratios are in excess of the Bank’s capital ratios. 18 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (16) 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 financial standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recog- nized 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 properties. 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 financial standby letters of credit written is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for direct, funded loans. 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. Financial standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a cus- tomer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The term of these financial standby letters of credit is generally one year or less. As of December 31, 2002, commitments to extend credit amounted to $42,261,000 and financial standby letters of credit amounted to $4,579,000. 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, 2002, 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 commercial real estate office financings and mobile home park land. Outstanding credit to these sectors amounted to $23,985,000 or 11.0% and $17,368,000 or 7.9% of net loans out- standing as of December 31, 2002. (17) Commitments and Contingencies Capital Purchases The Bank has committed to the purchase of equipment in the amount of approximately $755,000. Deposits of approximate- ly $443,000, which are included in other assets in the consolidated balance sheet, have been made at December 31, 2002. The balance of approximately $312,000 is expected to be funded through operating cash flows. Litigation 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 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (18) 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 December 31, 2002 and 2001 (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 Years Ended December 31, 2002, 2001 and 2000 (Dollars in thousands) Dividends from Subsidiaries ....................................................... Other Income from Subsidiaries ................................................. Undistributed Earnings of Subsidiaries....................................... Other Expenses............................................................................ Net Income CONDENSED STATEMENT OF CASH FLOWS For Years Ended December 31, 2002, 2001 and 2002 (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 of Treasury Stock ................................................................ Net Cash Used By Financing Activities Net Increase (Decrease) in Cash ................................................. Cash at Beginning of Period ....................................................... Cash at End of Period.................................................................. 2002 277 34,927 35,204 35,726 (522) 35,204 2002 2,496 27 2,051 (79) 4,495 2001 253 31,463 31,716 32,249 (533) 31,716 2001 1,544 25 2,733 (72) 4,230 2000 2,795 30 1,212 (89) 3,948 2002 2001 2000 4,495 (2,051) 2,444 4,230 (2,733) 1,497 3,948 (1,212) 2,736 0 (15) 0 (2,431) 11 (2,420) 24 253 277 (2,428) 0 (2,428) (946) 1,199 253 (2,427) 23 (2,404) 332 867 1,199 $ $ $ $ $ $ $ (19) 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 consolidated 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 techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and esti- mates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to indepen- dent markets, 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. 20 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) 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 borrowings: 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 value and fair value of financial instruments at December 31, 2002 and 2001. (Dollars in thousands) Financial assets: Cash and due from banks ............................................................ Interest-bearing balances ............................................................. Investment securities ................................................................... Net loans...................................................................................... $ December 31, 2002 Fair Value 8,095 65,487 58,859 234,783 Book Value 8,095 65,487 58,859 218,302 December 31, 2001 Fair Value 9,028 53,042 55,348 211,170 Book Value 9,028 53,042 55,348 199,980 21 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (Dollars in thousands) Financial liabilities: Deposits ....................................................................................... Short-term borrowings ................................................................ Long-term debt ............................................................................ Off-balance sheet financial instruments: December 31, 2002 December 31, 2001 Book Value $ 274,703 18,156 32,383 Fair Value 280,514 18,156 35,724 Book Value 254,105 9,610 32,568 Fair Value 258,305 9,610 34,673 Commitments to extend credit .................................................... Financial standby letters of credit ............................................... $ 42,261 4,579 42,261 4,579 37,674 4,009 37,674 4,009 (20) 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. Under MPB’s amended and restated dividend reinvestment plan, (DRIP), two hundred thousand shares of MPB’s autho- rized but unissued common stock are reserved for issuance. The DRIP also allows for voluntary cash payments within speci- fied limits, for the purchase of additional shares. (21) Summary of Quarterly Consolidated Financial Data (Unaudited): The following table presents summarized quarterly financial data for 2002, 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............................................................................... Gain on Sale of Loans ..................................................................... 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 5,420 2,511 2,909 100 2,809 462 5 0 1,843 1,433 327 1,106 .36 Mar. 31 5,783 3,147 2,636 75 2,561 449 (11) 1,737 1,262 291 971 0.32 $ $ $ $ 2002 Quarter Ended Sept. 30 June 30 5,379 5,274 2,550 2,483 2,829 2,791 100 100 2,729 2,691 498 454 55 0 0 0 1,807 1,910 1,475 1,235 330 259 1,145 976 .38 .32 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 Dec. 31 5,279 2,382 2,897 125 2,772 497 0 51 1,698 1,622 354 1,268 .42 Dec. 31 5,570 2,682 2,888 250 2,638 491 0 1,639 1,490 312 1,178 0.39 22 Mid Penn Bancorp, Inc. Notes to Consolidated Financial Statements (cont'd) (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 Losses ............................................................................. Other Expenses................................................................................ Income Before Income Tax Provision............................................. Income Tax Provision...................................................................... Net Income ...................................................................................... Earnings Per Share .......................................................................... $ $ Mar. 31 5,230 2,652 2,578 75 2,503 414 0 1,653 1,264 316 948 0.31 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 5,852 3,130 2,722 75 2,647 371 0 1,613 1,405 321 1,084 0.36 (22) Recent Accounting Pronouncements: In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 143, "Accounting for Asset Retirement Obligations." It is effective for financial statements issued for fiscal years beginning after June 15, 2002. Earlier application is encouraged. The adoption of this SFAS on January 1, 2003 is not expected to have an impact on MPB's earnings, financial condition or equity. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The provisions of this SFAS are effective for financial statements issued for fiscal years beginning after December 15, 2001, inter- im periods within those fiscal years, with earlier application encouraged. The provisions of this SFAS generally are to be applied prospectively. The adoption of this SFAS on January 1, 2002 did not have an impact on MPB's earnings, financial condition or equity. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." The provisions of this SFAS related to the rescission of SFAS No. 4 are to be applied in fiscal years beginning after May 15, 2002. Early application of the provisions of this SFAS related to SFAS No. 13 shall be effective for transactions occurring after May 15, 2002. All other provisions of the SFAS shall be effective for finan- cial statements issued on or after May 15, 2002. Early application of the SFAS is encouraged. The adoption of the effective portions of the SFAS did not have an impact on MPB's earnings, financial condition or equity. The adoption of the remaining portions of this SFAS is not expected to have an impact on MPB's earnings, financial condition or equity. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The provisions of this SFAS are effective for exit or disposal activities that are initiated after December 31, 2002, with early appli- cation encouraged. MPB does not expect the adoption of this Statement to have an impact on its earnings, financial condition or equity. On October 1, 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions," effective for all busi- ness combinations initiated after October 1, 2002. This Statement addresses the financial accounting and reporting for the acquisition of all or part of a financial institution, except for a transaction between two or more mutual enterprises. Under this SFAS, acquisition of all or part of a financial institution that meets the definition of a business combination shall be accounted for by the purchase method in accordance with SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." This SFAS also provides guidance on the accounting for the impairment or disposal of acquired long-term customer-relationship intangible assets (such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets), including those acquired in transactions between two or more mutual enterprises. The adoption of this SFAS did not have an impact on MPB's earnings, financial condition or equity. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of the Indebtedness of Others." This Interpretation clarifies the requirements for a guarantor's accounting for and disclosures of certain guarantees issued and outstanding. This Interpretation requires a guaran- tor to recognize a liability for the fair value of the obligation it assumes under that guarantee. The initial recognition and ini- tial measurement provisions of the Interpretation are applied on a prospective basis to guarantees issued or modified after December 31, 2002. The Interpretation's disclosure requirements were implemented during the year ended December 31, 2002. The adoption of the recognition and measurement provisions of this Interpretation are not expected to have a significant impact on MPB's earnings, financial condition or equity. 23 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 regulato- ry authorities which, if they were to be implemented, would have a material effect on MPB’s liquidity, capital resources or operations. This discussion should be read along with the consolidated financial statements also appearing in this report. 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 $4,495,000 for the year 2002, compared to $4,230,000 in 2001, which was an increase of $265,000 or 6.3%. This represents net income in 2002 of $1.48 per share compared to $1.39 per share in 2001 and $1.30 per share in 2000. Total assets of MPB continued to grow in 2002, reaching the level of $363,284,000, an increase of $32,649,000 or 9.9% over $330,635,000 at year end 2001. The majority of growth came from increases in commercial real estate loans, and an increase in our portfolio of investment certificates of deposit. These increases were funded primarily through retained earnings of the Bank as well as short-term borrowings. MPB continued to achieve an excellent return on average shareholders’ equity, (ROE), a widely recognized performance indicator in the financial industry. The ROE was 13.60% in 2002, 13.68% in 2001 and 14.64% in 2000. Return on average assets (ROA), another performance indicator, was 1.32% in 2002, 1.31% in 2001 and 1.34% in 2000. Tier one capital (to risk weighted assets) of $25,235,000 or 10.4% and total capital (to risk weighted assets) of $28,283,000 or 11.6% at December 31, 2002, are well above the December 31, 2002 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 2002 net interest income increased $297,000 or 2.7% as compared to an increase of $531,000 or 5.0% in 2001. The average balances, effective interest differential and interest yields for the years ended December 31, 2002, 2001 and 2000 and the components of net interest rate growth, are presented in Table 1. A comparative presentation of the changes in net interest income for 2002 compared to 2001, and 2001 compared to 2000, 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. 24 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) The yield on earning assets decreased to 7.00% in 2002 from 7.93% in 2001. The yield on earning assets for 2000 was 8.33%. 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 2002 was 4.67% as compared to 6.91% for 2001 and 9.23% for 2000. Interest expense decreased by $1,809,000 or 15.4% in 2002 as compared to an increase of $280,000 or 2.44% in 2001. In order to maintain the spread between interest earning assets and interest bearing liabilities, management was forced to aggres- sively decrease the expense on deposits. Primarily resulting from the fluctuations in interest rates, the net interest margin, on a tax equivalent basis, in 2002 was 3.91% compared to 4.04% in 2001 and 4.25% in 2000. 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, 2002 Average Balance Interest Income/Expense Average Rates Earned/Paid $ 57,454 (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............................... $ $ $ 14,460 39,937 54,397 2,786 207,028 321,665 6,350 13,745 341,760 32,480 36,390 26,662 144,353 4,821 32,469 277,175 28,069 3,475 33,041 341,760 25 2,703 738 3,032 47 15,983 22,503 168 801 355 6,483 50 2,069 9,926 12,577 4.70% 5.10% 7.59% 1.69% 7.72% 7.00% 0.52% 2.20% 1.33% 4.49% 1.04% 6.37% 3.58% 7.00% 3.09% 3.91% 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, 2001 (Dollars in thousands) Average Balance Interest Income/Expense Average Rates Earned/Paid 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% ASSETS: Interest Bearing Balances ..................... Investment Securities: Taxable.............................................. Tax-Exempt....................................... Total Investment Securities $ 49,013 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 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 ASSETS: Interest Bearing Balances ..................... Investment Securities: Taxable.............................................. Tax-Exempt....................................... Total Investment Securities $ 36,234 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 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............................... $ $ $ 2,306 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% 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 $550,000, $387,000 and $203,000 are included with interest income in Table 1 for the years 2002, 2001 and 2000, respectively. 27 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) TABLE 2: VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME (Dollars in thousands) 2002 Compared to 2001 Increase (Decrease) Due to Change In: 2001 Compared to 2000 Increase (Decrease) Due to Change In: Taxable Equivalent Basis INTEREST INCOME: Interest Bearing Balances.................. $ Investment Securities: Taxable .............................................. Tax-Exempt ....................................... Total Investment Securities (601) 305 (296) (203) (9) (212) (804) 296 (508) Volume Rate Net Volume Rate Net 533 (922) (389) 813 (27) 786 Federal Funds Sold ........................... Loans, Net ......................................... Total Interest Income 12 1,423 1,672 (49) (1,900) (3,083) (37) (477) (1,411) INTEREST EXPENSE: Interest Bearing Deposits: NOW ............................................ Money Market............................... Savings .......................................... Time .............................................. Total Interest Bearing Deposits Short-term Borrowings ..................... Long-term Debt................................. Total Interest Expense 256 414 18 245 933 (225) (15) 693 (334) (352) (119) (1,513) (2,318) (166) (18) (2,502) (78) 62 (101) (1,268) (1,385) (391) (33) (1,809) (990) 510 (480) 146 1,369 1,848 12 169 (2) 540 719 (278) 553 994 29 (9) 20 (62) (1,219) (1,288) (157) (89) (112) (127) (485) (160) (69) (714) (961) 501 (460) 84 150 560 (145) 80 (114) 413 234 (438) 484 280 NET INTEREST INCOME .................. $ 979 (581) 398 854 (574) 280 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 $425,000 allocation in 2002 as well as a provision of $500,000 in 2001 and $325,000 in 2000. The allowance for loan losses as a percentage of average total loans was 1.45% at December 31, 2002, compared to 1.48% at December 31, 2001 and 1.58% at December 31, 2000, 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 present- ed in Table 3. 28 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) TABLE 3: ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES 2002 2,856 $ Years ended December 31, 2000 2001 2,505 2,815 1999 2,313 (Dollars in thousands) Balance, beginning of year ........................... 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 41 113 0 148 302 17 0 0 55 72 249 118 0 122 489 0 1 0 29 30 1 12 0 61 74 28 5 0 26 59 1998 2,281 40 200 40 37 317 10 56 0 29 95 222 254 2,313 0 146 0 78 224 55 1 0 35 91 133 325 2,505 Net charge-offs.............................................. Provision for loan losses .............................. Balance, end of year...................................... 230 425 3,051 $ 459 500 2,856 15 325 2,815 Ratio of net charge-offs during the year to average loans outstanding during the year, net of unearned discount .................. Allowance for loan losses as a percentage .11% .24 .01 .08 .14 of average total loans ................................ 1.45% 1.48 1.58 1.58 1.47 Noninterest Income During 2002, MPB earned $2,022,000 in noninterest income, compared to $1,845,000 earned in 2001, and $1,556,000 earned in 2000. Service charges on deposit accounts amounted to $1,053,000 for 2002, an increase of $132,000 or 14.33% over $921,000 for 2001, which showed an increase of $331,000 over 2000. The majority of this increase resulted from the increasing rev- enues 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 controllable level of associated loss. MPB owns cash surrender value life insurance policies that provide funding for director retirement and salary continuation plans. The income on these policies amounted to $239,000 during the year 2002. Trust department income for 2002 was $188,000, a $30,000 or 19.0% increase from the $158,000 in 2001, which was $45,000 or 22.2% decrease from the $203,000 earned in 2000. The Trust Department adopted a new fee schedule during 2000, which has resulted in increased trust fees earned. Trust Department income fluctuates from year to year, due to the number of estates being settled during the year. MPB also earned $64,000 in 2002 and $75,000 in 2001 in fees from Invest, the third-party provider of investments whose services the Bank has contracted. Other income amounted to $431,000 in 2002, $612,000 in 2001 and $496,000 in 2000, net of gains on other real estate. 29 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) Noninterest Expense A summary of the major components of noninterest expense for the years ended December 31, 2002, 2001 and 2000 is reflected in Table 4. Noninterest expense increased to $7,258,000 in 2002 from $7,026,000 in 2001 and $6,656,000 in 2000. The major component of noninterest expense is salaries and employee benefits. The number of full-time equivalent employees increased from 109 to 110 during 2002. Increases in the 2002 workforce also included the addition of two experienced com- mercial loan officers. A major increase in noninterest expense was the increase in expenses associated with maintaining other real estate and moving these parcels toward sale. Most of the 2002 increase dealt with one commercial parcel, over $1 million in value, that was completed for sale and sold during the year. TABLE 4: NONINTEREST EXPENSE (Dollars in thousands) Years ended December 31, Salaries and employee benefits ........................................ Occupancy, net ................................................................. Equipment ........................................................................ Postage and supplies ........................................................ FDIC insurance premium ................................................. Marketing and advertising ............................................... Other real estate, net......................................................... Pennsylvania bank shares tax........................................... Professional services ........................................................ Telephone ......................................................................... Loss on mortgage sales .................................................... Other................................................................................. Total Noninterest Expense 2002 3,978 384 514 278 46 115 294 259 160 78 79 1,073 7,258 $ $ Investments 2001 4,012 392 461 280 44 127 43 262 213 78 125 989 7,026 2000 3,790 364 481 291 45 144 11 271 104 72 19 1,064 6,656 MPB’s 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 at fair 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 gain, amounted to $1,357,000, net of tax, as of the end of the year. At December 31, 2002, SFAS No. 115 resulted in an increase of shareholders’ equity of $1,357,000 (unrealized gain on securities of $2,049,000 less estimated income tax expense of $692,000). As of December 31, 2001, SFAS No. 115 resulted in a decrease in shareholders’ equity of $56,000 (unrealized loss on securities of $84,000, less estimated income tax benefit of $28,000), compared to a decrease in stockholders’ equity of $344,000 (unrealized loss on securities of $522,000, less estimated income tax benefit of $178,000) as of December 31, 2000. MPB does not have any significant concentrations of investment securities. Table 5 provides a history of the amortized cost of investment securities at December 31, for each of the past three years. The unrealized gains and losses on investment securities are outlined in Note 6 to the Consolidated Financial Statements. 30 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) 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 $ 2002 9,538 5,512 39,388 2,372 $ 56,810 December 31, 2001 9,028 4,674 39,760 1,970 55,432 2000 34,750 2,402 33,972 3,281 74,405 Loans At December 31, 2002, net loans totaled $218,302,000, an $18,584,000 or 9.2% increase from December 31, 2001. During 2002, MPB experienced a net increase in commercial real estate and commercial/industrial loans of approximately $14,703,000, 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, 2002, loans, net of unearned income, represented 64.4% of earning assets as compared to 64.6% on December 31, 2001 and 62.7% on December 31, 2000. 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, industrial 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) 2002 December 31, 2000 2001 1999 1998 Commercial real estate, construction Commercial, industrial and agricultural ....... Real estate-residential ................................... Consumer ...................................................... Lease financing ............................................. Total Loans Unearned income .......................................... Loans net of unearned discount .................... Allowance for loan losses ............................. and land development ............................... $ 146,325 22,398 41,502 12,978 0 223,203 (1,850) 221,353 (3,051) Net Loans $ 218,302 130,913 23,107 38,349 12,732 0 205,101 (2,265) 202,836 (2,856) 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 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 experience, current economic conditions and other factors. For installment and real estate mortgages, specific allocations are based on past loss experience adjusted for recent portfolio growth and economic trends. The total of reserves resulting from this analysis are "specific" reserves. The amounts not specifically provided for individual classes of loans are considered "general." This amount is determined and based on judgments regarding economic conditions, trends and other factors. 31 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) 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, 2002, was $3,051,000 or 1.38% of total loans less unearned discount as compared to $2,856,000 or 1.41% at December 31, 2001, and $2,815,000 or 1.53% at December 31, 2000. TABLE 7: ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES (Dollars in thousands) 2002 2001 December 31, 2000 1999 1998 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 ........................ $ 1,898 Commercial, industrial and agricultural .......................... Real estate-residential ............. Consumer ................................ General .................................... 922 56 147 28 Total loans $ 3,051 65.6% 1,584 63.8% 1,318 59.3% 927 60.3% 861 56.8% 10.0% 18.6% 5.8% - 987 73 166 46 11.3% 1,008 209 18.7% 93 6.2% 187 - 2,815 14.1% 782 19.0% 198 7.6% 114 484 - 100% 2,505 11.5% 18.6% 9.6% - 100% 693 219 127 413 2,313 13.5% 19.4% 10.3% - 100.0% 100% 2,856 100% 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 $350,000, $87,000 and $222,000 in 2002, 2001, and 2000, 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, 2002, totaled $2,753,000 or 0.76% of total assets compared to $4,744,000 or 1.44% of total assets in 2001, and $2,312,000 or 0.73% of total assets in 2000. The foreclosed assets held for sale at December 31, 2002, consist of two pieces of commercial real estate and residential building lots that MPB has available for sale. 32 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 $ 2002 1,164 808 0 1,972 781 2,753 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 Percent of loans outstanding ......................... Percent of total assets.................................... 1.23% 0.76% 2.31% 1.44% 1.24% 0.73% 1.27% 0.77% 2.00% 1.10% 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, 2002, increased by $20,598,000 or 8.1% over December 31, 2001, which also increased by $22,697,000 or 9.8% from December 31, 2000. Average balances and average interest rates applicable to the major classifications of deposits for the years ended December 31, 2002, 2001, and 2000 are presented in Table 9. Average short-term borrowings for 2002 were $4,821,000 as compared to $9,822,000 in 2001. 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) 2002 Years ended December 31, 2001 2000 Average Balance Noninterest-bearing demand deposits ......... $ Interest-bearing demand deposits ................ Money market.............................................. Savings......................................................... Time ............................................................. 28,069 32,480 36,390 26,662 144,353 Total $ 267,954 Average Rate 0.00% 0.52% 2.20% 1.33% 4.49% 2.91% 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% 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 stockholders and the buildup makes it difficult for a company to offer a competitive return on the stockholders’ capital going forward. For these reasons capital ade- quacy has been, and will continue to be, of paramount importance. In 2002, capital was increased by $3,488,000 or 11.0%. In 2001, capital was increased by $2,090,000 or 7.05%. In 2000, capital was increased by $3,061,000 or 11.52%. Capital growth is achieved by retaining more in earnings than we pay out to our stockholders. MPB’s normal dividend payout allows for quarterly cash returns to its stockholders and provides earnings retention at a level sufficient to finance future growth. The dividend payout ratio, which represents the percentage of annual net income returned to the stockholders in the form of cash dividends, was 54% for 2002 compared to 58% for 2001 and 62% for 2000. 33 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) At December 31, 2002, 18,622 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 2002 was $1,270,000 compared to $1,218,000 and $1,225,000 in 2001 and 2000, respec- tively. The effective tax rate was 22% for 2002 and 2001, and 24% for 2000. 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 2002 came from operations and the influx of deposit dollars during the year. Demand and savings balances posted a net increase of $14,723,000 and time deposits increased by a net amount of $5,875,000 as bank cus- tomers returned to the safety of bank deposits during this time of uncertainty in the equity markets. The Bank used this cash to fund loans which increased by a net $18,322,000 during the year, as well as investing in short- term interest-bearing (certificate of deposit) balances in other banks. These jumbo certificates offer a competitive rate of return with no credit risk and little interest-rate risk due to their short terms. 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 2001 sources of cash were used primarily to fund loan growth and to pay down short-term borrowings. Net loan fund- ing used $18,584,000 of cash. While loan growth was very sluggish during the first half of 2001, MPB experienced substan- tial loan growth with the portfolio growing more than 10% by the end of 2001. The majority of the loan growth was in loans to fund commercial real estate in the Greater Harrisburg area. 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 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 earning assets by 34 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) 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) December 31, 2002 U.S. Treasury and U.S.government agencies ............ $ State and political subdivision obligations................ Mortgage-backed U.S. government agencies............ Equity securities ........................................................ One Year and Less 2,994 270 61 0 3,325 Total $ After One Year thru Five Years 6,544 3,258 1,808 0 11,610 After Five Years thru Ten Years 0 9,978 2,105 0 12,083 One Year and Less After One Year thru Five Years After Five Years thru Ten Years 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 1.91% 7.39 6.10 0 2.43% 3.92 7.38 6.09 0 5.23 TABLE 11: LOAN MATURITY AND INTEREST SENSITIVITY 0 7.18 5.92 0 6.96 (Dollars in thousands) December 31, 2002 After Ten Years 0 25,882 1,538 2,372 29,792 After Ten Years 0 7.07 3.93 3.23 6.60 Total 9,538 39,388 5,512 2,372 56,810 Total 3.29 7.13 5.42 3.23 6.16 One Year and Less After One Year thru Five Years After Five Years Total Commercial, real estate, construction and land development............................. $ 48,755 90,305 7,265 146,325 Commercial, industrial and agricultural.............................................. Real estate-residential mortgages ............... Consumer.................................................... Total Loans Rate Sensitivity Predetermined rate...................................... Floating or adjustable rate .......................... Total 12,960 13,165 3,169 78,049 9,104 68,945 78,049 $ $ $ 8,281 19,112 7,462 125,160 36,589 88,571 125,160 1,157 9,225 497 18,144 17,660 484 18,144 22,398 41,502 11,128 221,353 63,353 158,000 221,353 35 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) TABLE 12: INTEREST RATE SENSITIVITY GAP (Dollars in thousands) (As of December 31, 2002) Assets: Expected Maturity Year Ended December 31, 2003 2004 2005 2006 2007 Thereafter Total Fair Value Interest bearing balances .................. $ 55,189 3.66 3,325 2.43 68,945 5.47 9,104 7.72 Total $136,563 Average interest rate..................... Debt securities .................................. Average interest rate..................... Adjustable rate loans ........................ Average interest rate..................... Fixed rate loans ................................ Average interest rate..................... Interest liabilities: Variable rate savings and transaction accounts ....................... $ 55,602 1.44 Average interest rate..................... 62,026 Certificates of deposit and IRAs ...... 3.81 Average interest rate..................... 18,156 Short term borrowings ..................... 1.40 Average interest rate..................... 5,197 Long term fixed rate borrowings ..... 6.61 Average interest rate .................... Total $140,981 8,615 4.19 1,007 6.95 33,371 7.82 7,710 8.37 50,703 0 - 32,484 4.08 0 - 5,086 5.24 37,570 1,287 7.21 5,368 4.57 22,966 7.40 9,988 8.32 39,609 0 - 25,288 4.51 0 - 0 - 25,288 297 6.68 3,976 5.26 14,242 7.84 8,949 6.38 27,464 0 - 6,106 4.78 0 - 5,000 6.21 11,106 99 5.05 1,261 5.57 17,992 6.94 9,942 7.11 29,294 0 - 16,386 4.53 0 - 0 - 16,386 0 - 39,500 6.91 484 7.76 17,660 7.72 57,644 73,274 .39 2,853 4.73 0 - 17,100 6.55 93,227 65,487 3.82 54,437 6.27 158,000 6.64 63,353 7.64 341,277 65,487 56,486 158,000 79,834 359,807 128,876 .84 145,143 4.13 18,156 1.40 32,383 6.30 324,558 128,876 151,638 18,156 34,673 333,343 Rate sensitive gap: Periodic gap...................................... $ (4,418) Cumulative gap ................................ $ (4,418) 13,133 8,715 14,321 23,036 16,358 39,394 12,908 52,302 (35,583) 16,719 Cumulative gap as a percentage of total assets .................................... -1.2% +2.4% +6.3% +10.8% +14.4% +4.6% (Dollars in thousands) (As of December 31, 2001) Assets: Expected Maturity Year Ended December 31, 2002 2003 2004 2005 2006 Thereafter Total Fair Value Interest bearing balances .................. $ 35,642 5.45 521 7.63 52,655 6.27 8,952 8.09 Total $ 97,770 Average interest rate..................... Debt securities .................................. Average interest rate..................... Adjustable rate loans ........................ Average interest rate..................... Fixed rate loans ................................ 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 - 42,585 6.91 1,015 8.08 18,625 8.29 62,225 53,042 5.67 53,463 6.77 141,151 7.39 61,685 8.49 309,341 53,042 53,377 141,151 72,875 320,445 36 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) TABLE 12: INTEREST RATE SENSITIVITY GAP (cont’d) (Dollars in thousands) (As of December 31, 2001) Interest liabilities: Variable rate savings and Expected Maturity Year Ended December 31, 2002 2003 2004 2005 2006 Thereafter Total Fair Value transaction accounts ....................... $ 42,012 1.88 Average interest rate..................... 79,798 Certificates of deposit and IRAs ...... 4.60 Average interest rate..................... 8,662 Short term borrowings ..................... 1.50 Average interest rate..................... 184 Long term fixed rate borrowings ..... 7.30 Average interest rate..................... Total $130,656 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 72,141 0.61 2,977 5.35 0 - 17,100 6.55 92,218 114,153 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% Duing 2002, Management analyzed interest rate risk using the Profit Star 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, 2002, all interest rate risk levels according to our model were within the tolerance guidelines set by Management. 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 $ 2002 5,757 6,179 12,895 $ 24,831 December 31, 2001 3,925 12,773 7,643 24,341 2000 5,431 8,534 9,377 23,342 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. 37 Mid Penn Bancorp, Inc. Management's Discussion and Analysis (cont'd) 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, 2002, commitments to extend credit amounted to $42,261,000 as compared to $37,674,000 as of December 31, 2001. MPB also issues financial standby letters of credit to its customers. The risk associated with financial standby letters of credit is essentially the same as the credit risk involved in loan extensions to customers. Financial standby letters of credit increased to $4,579,000 at December 31, 2002, from $4,009,000 at December 31, 2001. 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 for the years ended December 31, 2002, 2001 and 2000 was $1,413,000, $288,000 and $1,517,000, respectively. Critical Accounting Policies The Bank's methodology for determining the allowance for loan losses establishes both a specific and a general component. The specific portion of the allowance represents the results of analysis of individual "watch list" loans (commercial, 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, adjust- ed 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 general portion of the allowance for loan losses represents the results of measuring potential losses inherent in the port- folio that are not identified in the specific allowance analysis. This general 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, and changes in economic conditions. 38 Mid Penn Bancorp, Inc. Summary of Selected Financial Data (Dollars in thousands, except per share data) 2002 2001 2000 1999 1998 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 ................... Provision for Income Taxes ...................... Net Income................................................ 21,352 9,926 11,426 425 2,022 7,258 5,765 1,270 4,495 COMMON STOCK DATA PER SHARE: Earnings Per Share.................................... Cash Dividends Declared.......................... Stockholders' Equity ................................. $ 1.48 .80 11.59 22,864 11,735 11,129 500 1,845 7,026 5,448 1,218 4,230 1.39 .80 10.44 22,053 11,455 10,598 325 1,556 6,656 5,203 1,255 3,948 1.30 .80 9.76 20,112 9,674 10,438 325 1,689 6,665 5,137 1,253 3,884 1.28 2.18 8.74 20,436 9,593 10,843 254 1,398 6,606 5,381 1,516 3,865 1.27 .69 10.90 AVERAGE SHARES OUTSTANDING ...... 3,036,508 3,038,859 3,036,007 3,037,976 2,892,416 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 ................................. $ $ 58,859 221,353 3,051 363,284 274,703 18,156 32,383 35,204 55,348 202,836 2,856 330,635 254,105 9,610 32,568 31,716 RATIOS: Return on Average Assets ......................... Return on Average Stockholders' Equity .. Cash Dividend Payout Ratio..................... Allowance for Loan Losses to Loans ....... Average Stockholders' Equity to 1.32 13.60 54.05 1.38 1.31 13.68 57.55 1.41 73,885 184,211 2,815 315,584 231,408 22,738 29,241 29,626 1.34 14.64 61.54 1.53 64,099 172,294 2,505 287,542 217,840 24,636 16,400 26,565 1.40 14.68 170.91 1.45 Average Assets ...................................... 9.67 9.67 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 39 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 E. 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 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 46 Years Banking Experience Alan W. Dakey President and CEO 29 Years Banking Experience Randall L. Klinger Senior Vice President and Senior Credit Officer 29 Years Banking Experience Allen J. Trawitz Executive Vice President 34 Years Banking Experience Michael T. Lehmer Vice President and Senior Trust Officer 12 Years Banking Experience Steven S. Shuey Vice President and Loan Review Officer 29 Years Banking Experience Linda M. Sitlinger Vice President and Sales Manager/Branch Administrator 23 Years Banking Experience Dennis E. Spotts Vice President and Operations Officer 30 Years Banking Experience Cindy L. Wetzel Vice President and Corporate Secretary 24 Years Banking Experience Eric S. Williams Vice President and Senior Commercial Loan Officer 24 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 Kathy I. Bordner Vice President and Marketing Director 18 Years Banking Experience 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 Nelson E. Carr Vice President and Business Development Officer 42 Years Banking Experience Roberta A. Hoffman Vice President, Human Resources Officer and Asst. Secretary 27 Years Banking Experience Kevin W. Laudenslager Vice President and Chief Financial Officer 18 Years Banking Experience 40 Mid Penn Bancorp, Inc. Office Locations Millersburg 349 Union Street Millersburg, PA 17061 (717) 692-2133 Harrisburg 4098 Derry Street Harrisburg, PA 17111 (717) 558-2144 Tower City 545 East Grand Avenue Tower City, PA 17980 (717) 647-2157 Dauphin 1001 Peters Mountain Road Dauphin, PA 17018 (717) 921-8899 Elizabethville 2 East Main Street Elizabethville, PA 17023 (717) 362-8147 Tremont 7-9 East Main Street Tremont, PA 17981 (570) 695-3358 Halifax Halifax Shopping Center 3763 Peters Mountain Road Halifax, PA 17032 (717) 896-8258 Miners-Lykens 550 Main Street Lykens, PA 17048 (717) 453-7185 Carlisle Pike 4622 Carlisle Pike Mechanicsburg, PA 17050 (717) 761-2480 Dalmatia School Road, PO Box 205 Dalmatia, PA 17017 (570) 758-2711 Harrisburg 2615 North Front Street Harrisburg, PA 17110 (717) 233-7380 www.midpennbank.com 

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