2 0 0 5 A N N U A L R E P O R T Dear Shareholder: It is my pleasure to present the 2005 Annual Report for Mid Penn Bancorp, Inc. The year was one of solid growth, branch expansion and positive trends in earnings. I believe we lived up to our brand promise, “Making things happen for you,” and we fully expect to build on this success in 2006 and beyond. Net income of $4,603,000 for the year increased from $4,369,000 the prior year, a gain of 5.4%. Earnings per share of $1.37 increased from $1.30 the prior year. Your Bank’s return on average equity was 12.87%, compared to 12.73% the prior year. The increase in income was primarily attributable to a strong improvement in net interest income, which increased $1,665,000 or 13.8% from the prior year. We also experienced a favorable reduction in the loan loss provision from $725,000 in 2004 to $225,000 in 2005, primarily as the result of an upgrade in the risk rating of a significant credit. During 2005, we opened two new offices in the Capital Region, which contributed $26.5 million in new deposits for the year and $13.8 million in new loans. We are pleased with the results of the new offices. Total deposits of $325,274,000 increased by 8.01% in 2005 with the majority of deposit growth resulting from the new Allentown Boulevard and Market Square Offices. In 2006, we will be relocating our Elizabethville Office, which will allow us to take advantage of the growth we anticipate in connection with the opening of a new Wal-Mart store adjacent to the new branch site. Total assets of $437,937,000 as of year end 2005 increased by $34,681,000 or 8.60% from the prior year. We had a solid year for loan growth with net loans increasing by 11.68% over the prior year. The majority of the loan growth was in commercial loans, an area of strong growth for a number of years. Our equipment leasing division, which we launched in 2005, has been well received in the market and has created synergies for our commercial loan business. Effective January 1, 2006, the Board of Directors appointed two new board members, Robert C. Grubic and William A. Specht, III, both of whom are shareholders and successful business owners and are active in the community. I feel they will represent the shareholders well and will contribute to our continued success. I would also like to recognize Charles R. Phillips, a director of the Bank from 1979 to 1997, who passed away in June 2005. Thank you for your continuing support of Mid Penn Bancorp, Inc. Please consider Mid Penn Bank for all your banking needs. We have a full range of banking services, a friendly and helpful staff and a community bank philosophy. We want to continue “Making things happen for you.” Please call me at (717) 692-2133, or e-mail me at adakey@midpennbank.com, should you have any questions, concerns, suggestions or financial needs. Northern Region Locations Millersburg | 349 Union Street • Millersburg, PA 17061 | 717.692.2133 Elizabethville | 2 East Main Street • Elizabethville, PA 17023 | 717.362.8147 Dalmatia | PO Box 205, School Road • Dalmatia, PA 17017 | 570.758.2711 Tower City | 545 East Grand Avenue • Tower City, PA 17980 | 717.647.2157 Lykens | 550 Main Street • Lykens, PA 17048 | 717.453.7185 Halifax | 3763 Peters Mountain Road • Halifax, PA 17032 | 717.896.8258 Dauphin | 1001 Peters Mountain Road • Dauphin, PA 17018 | 717.921.8899 Capital Region Locations Harrisburg | 4098 Derry Street • Harrisburg, PA 17111 | 717.558.2144 Harrisburg | 2615 North Front Street • Harrisburg, PA 17110 | 717.233.7380 Harrisburg | 5500 Allentown Boulevard • Harrisburg, PA 17112 | 717.920.1772 Harrisburg | 17 North Second Street • Harrisburg, PA 17101 | 717.920.1980 Mechanicsburg | 4622 Carlisle Pike • Mechanicsburg, PA 17050 | 717.761.2480 Mission Statement: Mid Penn Bank and our employees promise to work hard to meet the expectations of our brand promise - Making things happen for you. Through hard work and dedication, we continue to make things happen for our customers and our shareholders today, as we have since 1868. Sincerely, To the best of our ability, each employee will identify and meet the financial needs of our customers and support the financial expectations of our shareholders. Highly satisfied customers are the key to superior results, which bring rewards for our shareholders and our employees, as well as satisfaction in a job well done. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K 4622 Carlisle Pike • Mechanicsburg, PA 17050 |717.761.2480 Mechanicsburg 12 3763 Peters Mountain Road • Halifax, PA 17032 |717.896.8258 Halifax 17 North Second Street • Harrisburg, PA 17101 |717.920.1980 Harrisburg 11 550 Main Street • Lykens, PA 17048 |717.453.7185 Lykens 5500 Allentown Boulevard • Harrisburg, PA 17112 |717.920.1772 Harrisburg 10 545 East Grand Avenue • Tower City, PA 17980 | 717.647.2157 Tower City 2615 North Front Street • Harrisburg, PA 17110 |717.233.7380 Harrisburg 4098 Derry Street • Harrisburg, PA 17111 |717.558.2144 Harrisburg 1001 Peters Mountain Road • Dauphin, PA 17018 |717.921.8899 Dauphin 9 8 7 PO Box 205, School Road • Dalmatia, PA 17017 |570.758.2711 Dalmatia 2 East Main Street • Elizabethville, PA 17023 |717.362.8147 Elizabethville 349 Union Street • Millersburg, PA 17061 |717.692.2133 Millersburg 6 5 4 3 2 1 John DeSanto, Jr. and Michael Lehmer, Trust Division 17th North Second Street Office Elizabethville Office Staff The year 2005 has been a busy year for Mid Penn Bank. Looking back at the year in review, it was definitely a year of “Making things happen,” which included new branching initiatives, new product lines and services, new commitments and new challenges. In early 2005, Mid Penn Bank converted our existing Check Card portfolio from MasterCard® to Visa® in an effort to be able to offer our customers the increased purchasing power of the Visa brand as well as to provide increased fraud monitoring and fraud protection services. In addition to improving service to our customers, Annual Report 2005 existing ATMs to offer the newest state-of-the-art functionality, security and operation. we were also able to lower our costs with this provider. During this conversion, Mid Penn Bank also upgraded all Mid Penn Bank also introduced our newest product line, equipment leasing, through our newest division, Mid Penn Bank Leasing Services. Leasing has become a practical means for businesses, municipalities, school districts and other organizations to maintain capital, increase buying power by spreading payments out over time, making purchases upfront while waiting for budgetary approvals, etc. Equipment leases may generate energy savings, reduce labor expenses and/or produce additional income for businesses. Mid Penn Bank Leasing Services operates out of Mid Penn Bank’s new regional headquarters located at 5500 Allentown Boulevard, Harrisburg. Capital Region Headquarters, 5500 Allentown Boulevard, Harrisburg While proudly maintaining the Bank’s corporate headquarters in our original office located in Millersburg, Dauphin County, Pennsylvania since 1868, the Bank realized the need to have a regional presence where the Bank’s Commercial Lending Division would be able to establish a base to service the growing commercial loan demand from the Capital Region and surrounding areas. As part of Mid Penn Bank’s commitment to the Capital Region, in April 2005, Mid Penn Bank opened our eleventh office at 5500 Allentown Boulevard. This office serves as Mid Penn Bank’s Regional Headquarters. In July 2005, Mid Penn Bank opened our twelfth office at Continued Growth Square Plaza building next to the Hilton. This new office presence 17 N. Second Street, Harrisburg, in the first floor of the Market allows us to service our downtown market of existing professional and business customers, as well as the many consumer financial relationships established by customers who commute to the Capital Region’s downtown area for employment. Operating out of our new Market Square Office, Mid Penn Bank is pleased to provide the expertise of our Trust Department’s new Investment Officer, John DeSanto. John has extensive experience, with nearly twenty years related to the financial services industry. Mid Penn Bank’s Trust Department, established in 1931, provides estate, investment and asset management services, led by our Senior Trust Officer, Michael Lehmer, who has more than twenty years of financial services, trust and asset management experience. Also in 2005, Mid Penn Bank purchased a site in Washington Township, where we will re-locate our Elizabethville Office. This new office will provide an efficient, new facility for existing customers, will allow for handicapped access and be compliant with the Americans with Disabilities Act, offer better parking and more security for customers, as well as a state-of-the-art design. This will be Mid Penn Bank’s first office designed with the Bank’s new office prototype. The existing staff will be relocated to the new office. The office is expected to be completed by the Summer of 2006. John DeSanto, Jr. and Michael Lehmer, Trust Division 17th North Second Street Office Elizabethville Office Staff The year 2005 has been a busy year for Mid Penn Bank. Looking back at the year in review, it was definitely a year of “Making things happen,” which included new branching initiatives, new product lines and services, new commitments and new challenges. In early 2005, Mid Penn Bank converted our existing Check Card portfolio from MasterCard® to Visa® in an effort to be able to offer our customers the increased purchasing power of the Visa brand as well as to provide increased fraud monitoring and fraud protection services. In addition to improving service to our customers, Annual Report 2005 existing ATMs to offer the newest state-of-the-art functionality, security and operation. we were also able to lower our costs with this provider. During this conversion, Mid Penn Bank also upgraded all Mid Penn Bank also introduced our newest product line, equipment leasing, through our newest division, Mid Penn Bank Leasing Services. Leasing has become a practical means for businesses, municipalities, school districts and other organizations to maintain capital, increase buying power by spreading payments out over time, making purchases upfront while waiting for budgetary approvals, etc. Equipment leases may generate energy savings, reduce labor expenses and/or produce additional income for businesses. Mid Penn Bank Leasing Services operates out of Mid Penn Bank’s new regional headquarters located at 5500 Allentown Boulevard, Harrisburg. Capital Region Headquarters, 5500 Allentown Boulevard, Harrisburg While proudly maintaining the Bank’s corporate headquarters in our original office located in Millersburg, Dauphin County, Pennsylvania since 1868, the Bank realized the need to have a regional presence where the Bank’s Commercial Lending Division would be able to establish a base to service the growing commercial loan demand from the Capital Region and surrounding areas. As part of Mid Penn Bank’s commitment to the Capital Region, in April 2005, Mid Penn Bank opened our eleventh office at 5500 Allentown Boulevard. This office serves as Mid Penn Bank’s Regional Headquarters. In July 2005, Mid Penn Bank opened our twelfth office at Continued Growth Square Plaza building next to the Hilton. This new office presence 17 N. Second Street, Harrisburg, in the first floor of the Market allows us to service our downtown market of existing professional and business customers, as well as the many consumer financial relationships established by customers who commute to the Capital Region’s downtown area for employment. Operating out of our new Market Square Office, Mid Penn Bank is pleased to provide the expertise of our Trust Department’s new Investment Officer, John DeSanto. John has extensive experience, with nearly twenty years related to the financial services industry. Mid Penn Bank’s Trust Department, established in 1931, provides estate, investment and asset management services, led by our Senior Trust Officer, Michael Lehmer, who has more than twenty years of financial services, trust and asset management experience. Also in 2005, Mid Penn Bank purchased a site in Washington Township, where we will re-locate our Elizabethville Office. This new office will provide an efficient, new facility for existing customers, will allow for handicapped access and be compliant with the Americans with Disabilities Act, offer better parking and more security for customers, as well as a state-of-the-art design. This will be Mid Penn Bank’s first office designed with the Bank’s new office prototype. The existing staff will be relocated to the new office. The office is expected to be completed by the Summer of 2006. 2 0 0 5 A N N U A L R E P O R T Dear Shareholder: It is my pleasure to present the 2005 Annual Report for Mid Penn Bancorp, Inc. The year was one of solid growth, branch expansion and positive trends in earnings. I believe we lived up to our brand promise, “Making things happen for you,” and we fully expect to build on this success in 2006 and beyond. Net income of $4,603,000 for the year increased from $4,369,000 the prior year, a gain of 5.4%. Earnings per share of $1.37 increased from $1.30 the prior year. Your Bank’s return on average equity was 12.87%, compared to 12.73% the prior year. The increase in income was primarily attributable to a strong improvement in net interest income, which increased $1,665,000 or 13.8% from the prior year. We also experienced a favorable reduction in the loan loss provision from $725,000 in 2004 to $225,000 in 2005, primarily as the result of an upgrade in the risk rating of a significant credit. During 2005, we opened two new offices in the Capital Region, which contributed $26.5 million in new deposits for the year and $13.8 million in new loans. We are pleased with the results of the new offices. Total deposits of $325,274,000 increased by 8.01% in 2005 with the majority of deposit growth resulting from the new Allentown Boulevard and Market Square Offices. In 2006, we will be relocating our Elizabethville Office, which will allow us to take advantage of the growth we anticipate in connection with the opening of a new Wal-Mart store adjacent to the new branch site. Total assets of $437,937,000 as of year end 2005 increased by $34,681,000 or 8.60% from the prior year. We had a solid year for loan growth with net loans increasing by 11.68% over the prior year. The majority of the loan growth was in commercial loans, an area of strong growth for a number of years. Our equipment leasing division, which we launched in 2005, has been well received in the market and has created synergies for our commercial loan business. Effective January 1, 2006, the Board of Directors appointed two new board members, Robert C. Grubic and William A. Specht, III, both of whom are shareholders and successful business owners and are active in the community. I feel they will represent the shareholders well and will contribute to our continued success. I would also like to recognize Charles R. Phillips, a director of the Bank from 1979 to 1997, who passed away in June 2005. Thank you for your continuing support of Mid Penn Bancorp, Inc. Please consider Mid Penn Bank for all your banking needs. We have a full range of banking services, a friendly and helpful staff and a community bank philosophy. We want to continue “Making things happen for you.” Please call me at (717) 692-2133, or e-mail me at adakey@midpennbank.com, should you have any questions, concerns, suggestions or financial needs. Northern Region Locations Millersburg | 349 Union Street • Millersburg, PA 17061 | 717.692.2133 Elizabethville | 2 East Main Street • Elizabethville, PA 17023 | 717.362.8147 Dalmatia | PO Box 205, School Road • Dalmatia, PA 17017 | 570.758.2711 Tower City | 545 East Grand Avenue • Tower City, PA 17980 | 717.647.2157 Lykens | 550 Main Street • Lykens, PA 17048 | 717.453.7185 Halifax | 3763 Peters Mountain Road • Halifax, PA 17032 | 717.896.8258 Dauphin | 1001 Peters Mountain Road • Dauphin, PA 17018 | 717.921.8899 Capital Region Locations Harrisburg | 4098 Derry Street • Harrisburg, PA 17111 | 717.558.2144 Harrisburg | 2615 North Front Street • Harrisburg, PA 17110 | 717.233.7380 Harrisburg | 5500 Allentown Boulevard • Harrisburg, PA 17112 | 717.920.1772 Harrisburg | 17 North Second Street • Harrisburg, PA 17101 | 717.920.1980 Mechanicsburg | 4622 Carlisle Pike • Mechanicsburg, PA 17050 | 717.761.2480 Mission Statement: Mid Penn Bank and our employees promise to work hard to meet the expectations of our brand promise - Making things happen for you. Through hard work and dedication, we continue to make things happen for our customers and our shareholders today, as we have since 1868. Sincerely, To the best of our ability, each employee will identify and meet the financial needs of our customers and support the financial expectations of our shareholders. Highly satisfied customers are the key to superior results, which bring rewards for our shareholders and our employees, as well as satisfaction in a job well done. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K 4622 Carlisle Pike • Mechanicsburg, PA 17050 |717.761.2480 Mechanicsburg 12 3763 Peters Mountain Road • Halifax, PA 17032 |717.896.8258 Halifax 17 North Second Street • Harrisburg, PA 17101 |717.920.1980 Harrisburg 11 550 Main Street • Lykens, PA 17048 |717.453.7185 Lykens 5500 Allentown Boulevard • Harrisburg, PA 17112 |717.920.1772 Harrisburg 10 545 East Grand Avenue • Tower City, PA 17980 | 717.647.2157 Tower City 2615 North Front Street • Harrisburg, PA 17110 |717.233.7380 Harrisburg 4098 Derry Street • Harrisburg, PA 17111 |717.558.2144 Harrisburg 1001 Peters Mountain Road • Dauphin, PA 17018 |717.921.8899 Dauphin 9 8 7 PO Box 205, School Road • Dalmatia, PA 17017 |570.758.2711 Dalmatia 2 East Main Street • Elizabethville, PA 17023 |717.362.8147 Elizabethville 349 Union Street • Millersburg, PA 17061 |717.692.2133 Millersburg 6 5 4 3 2 1 John DeSanto, Jr. and Michael Lehmer, Trust Division 17th North Second Street Office Elizabethville Office Staff The year 2005 has been a busy year for Mid Penn Bank. Looking back at the year in review, it was definitely a year of “Making things happen,” which included new branching initiatives, new product lines and services, new commitments and new challenges. In early 2005, Mid Penn Bank converted our existing Check Card portfolio from MasterCard® to Visa® in an effort to be able to offer our customers the increased purchasing power of the Visa brand as well as to provide increased fraud monitoring and fraud protection services. In addition to improving service to our customers, Annual Report 2005 existing ATMs to offer the newest state-of-the-art functionality, security and operation. we were also able to lower our costs with this provider. During this conversion, Mid Penn Bank also upgraded all Mid Penn Bank also introduced our newest product line, equipment leasing, through our newest division, Mid Penn Bank Leasing Services. Leasing has become a practical means for businesses, municipalities, school districts and other organizations to maintain capital, increase buying power by spreading payments out over time, making purchases upfront while waiting for budgetary approvals, etc. Equipment leases may generate energy savings, reduce labor expenses and/or produce additional income for businesses. Mid Penn Bank Leasing Services operates out of Mid Penn Bank’s new regional headquarters located at 5500 Allentown Boulevard, Harrisburg. Capital Region Headquarters, 5500 Allentown Boulevard, Harrisburg While proudly maintaining the Bank’s corporate headquarters in our original office located in Millersburg, Dauphin County, Pennsylvania since 1868, the Bank realized the need to have a regional presence where the Bank’s Commercial Lending Division would be able to establish a base to service the growing commercial loan demand from the Capital Region and surrounding areas. As part of Mid Penn Bank’s commitment to the Capital Region, in April 2005, Mid Penn Bank opened our eleventh office at 5500 Allentown Boulevard. This office serves as Mid Penn Bank’s Regional Headquarters. In July 2005, Mid Penn Bank opened our twelfth office at Continued Growth Square Plaza building next to the Hilton. This new office presence 17 N. Second Street, Harrisburg, in the first floor of the Market allows us to service our downtown market of existing professional and business customers, as well as the many consumer financial relationships established by customers who commute to the Capital Region’s downtown area for employment. Operating out of our new Market Square Office, Mid Penn Bank is pleased to provide the expertise of our Trust Department’s new Investment Officer, John DeSanto. John has extensive experience, with nearly twenty years related to the financial services industry. Mid Penn Bank’s Trust Department, established in 1931, provides estate, investment and asset management services, led by our Senior Trust Officer, Michael Lehmer, who has more than twenty years of financial services, trust and asset management experience. Also in 2005, Mid Penn Bank purchased a site in Washington Township, where we will re-locate our Elizabethville Office. This new office will provide an efficient, new facility for existing customers, will allow for handicapped access and be compliant with the Americans with Disabilities Act, offer better parking and more security for customers, as well as a state-of-the-art design. This will be Mid Penn Bank’s first office designed with the Bank’s new office prototype. The existing staff will be relocated to the new office. The office is expected to be completed by the Summer of 2006. 2 0 0 5 A N N U A L R E P O R T Dear Shareholder: It is my pleasure to present the 2005 Annual Report for Mid Penn Bancorp, Inc. The year was one of solid growth, branch expansion and positive trends in earnings. I believe we lived up to our brand promise, “Making things happen for you,” and we fully expect to build on this success in 2006 and beyond. Net income of $4,603,000 for the year increased from $4,369,000 the prior year, a gain of 5.4%. Earnings per share of $1.37 increased from $1.30 the prior year. Your Bank’s return on average equity was 12.87%, compared to 12.73% the prior year. The increase in income was primarily attributable to a strong improvement in net interest income, which increased $1,665,000 or 13.8% from the prior year. We also experienced a favorable reduction in the loan loss provision from $725,000 in 2004 to $225,000 in 2005, primarily as the result of an upgrade in the risk rating of a significant credit. During 2005, we opened two new offices in the Capital Region, which contributed $26.5 million in new deposits for the year and $13.8 million in new loans. We are pleased with the results of the new offices. Total deposits of $325,274,000 increased by 8.01% in 2005 with the majority of deposit growth resulting from the new Allentown Boulevard and Market Square Offices. In 2006, we will be relocating our Elizabethville Office, which will allow us to take advantage of the growth we anticipate in connection with the opening of a new Wal-Mart store adjacent to the new branch site. Total assets of $437,937,000 as of year end 2005 increased by $34,681,000 or 8.60% from the prior year. We had a solid year for loan growth with net loans increasing by 11.68% over the prior year. The majority of the loan growth was in commercial loans, an area of strong growth for a number of years. Our equipment leasing division, which we launched in 2005, has been well received in the market and has created synergies for our commercial loan business. Effective January 1, 2006, the Board of Directors appointed two new board members, Robert C. Grubic and William A. Specht, III, both of whom are shareholders and successful business owners and are active in the community. I feel they will represent the shareholders well and will contribute to our continued success. I would also like to recognize Charles R. Phillips, a director of the Bank from 1979 to 1997, who passed away in June 2005. Thank you for your continuing support of Mid Penn Bancorp, Inc. Please consider Mid Penn Bank for all your banking needs. We have a full range of banking services, a friendly and helpful staff and a community bank philosophy. We want to continue “Making things happen for you.” Please call me at (717) 692-2133, or e-mail me at adakey@midpennbank.com, should you have any questions, concerns, suggestions or financial needs. Northern Region Locations Millersburg | 349 Union Street • Millersburg, PA 17061 | 717.692.2133 Elizabethville | 2 East Main Street • Elizabethville, PA 17023 | 717.362.8147 Dalmatia | PO Box 205, School Road • Dalmatia, PA 17017 | 570.758.2711 Tower City | 545 East Grand Avenue • Tower City, PA 17980 | 717.647.2157 Lykens | 550 Main Street • Lykens, PA 17048 | 717.453.7185 Halifax | 3763 Peters Mountain Road • Halifax, PA 17032 | 717.896.8258 Dauphin | 1001 Peters Mountain Road • Dauphin, PA 17018 | 717.921.8899 Capital Region Locations Harrisburg | 4098 Derry Street • Harrisburg, PA 17111 | 717.558.2144 Harrisburg | 2615 North Front Street • Harrisburg, PA 17110 | 717.233.7380 Harrisburg | 5500 Allentown Boulevard • Harrisburg, PA 17112 | 717.920.1772 Harrisburg | 17 North Second Street • Harrisburg, PA 17101 | 717.920.1980 Mechanicsburg | 4622 Carlisle Pike • Mechanicsburg, PA 17050 | 717.761.2480 Mission Statement: Mid Penn Bank and our employees promise to work hard to meet the expectations of our brand promise - Making things happen for you. Through hard work and dedication, we continue to make things happen for our customers and our shareholders today, as we have since 1868. Sincerely, To the best of our ability, each employee will identify and meet the financial needs of our customers and support the financial expectations of our shareholders. Highly satisfied customers are the key to superior results, which bring rewards for our shareholders and our employees, as well as satisfaction in a job well done. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K 4622 Carlisle Pike • Mechanicsburg, PA 17050 |717.761.2480 Mechanicsburg 12 3763 Peters Mountain Road • Halifax, PA 17032 |717.896.8258 Halifax 17 North Second Street • Harrisburg, PA 17101 |717.920.1980 Harrisburg 11 550 Main Street • Lykens, PA 17048 |717.453.7185 Lykens 5500 Allentown Boulevard • Harrisburg, PA 17112 |717.920.1772 Harrisburg 10 545 East Grand Avenue • Tower City, PA 17980 | 717.647.2157 Tower City 2615 North Front Street • Harrisburg, PA 17110 |717.233.7380 Harrisburg 4098 Derry Street • Harrisburg, PA 17111 |717.558.2144 Harrisburg 1001 Peters Mountain Road • Dauphin, PA 17018 |717.921.8899 Dauphin 9 8 7 PO Box 205, School Road • Dalmatia, PA 17017 |570.758.2711 Dalmatia 2 East Main Street • Elizabethville, PA 17023 |717.362.8147 Elizabethville 349 Union Street • Millersburg, PA 17061 |717.692.2133 Millersburg 6 5 4 3 2 1 ANNUAL REPORT 2005 financial highlights table of contents: financial highlights unaudited graphs of financial data report of independent registered public accounting firm consolidated balance sheet consolidated statement of income consolidated statement of stockholders’ equity consolidated statement of cash flows notes to consolidated financial statements management’s discussion and analysis directors, officers and advisory board members page 2 3 4 5 6 7 8 9-25 26-40 41 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. FINANCIAL HIGHLIGHTS AS OF AND FOR YEARS ENDED DECEMBER 31, 2005 AND 2004 (Dollars in thousands, except per share data.) Total Assets................................................................................................ Total Deposits............................................................................................. Net Loans.................................................................................................. Total Investments and Interest Bearing Balances .............................................. Stockholders' Equity .................................................................................... Net Income ................................................................................................ Earnings Per Share...................................................................................... Cash Dividend Per Share, historical ............................................................... Book Value Per Share.................................................................................. Return on Average Stockholders’ Equity ......................................................... Return on Average Assets ............................................................................ Net Interest Margin...................................................................................... Nonperforming Loans to Total Loans.............................................................. Per share information has been restated to reflect the retroactive effect of a five percent stock dividend paid in the first quarter of 2006. Mid Penn Bancorp, Inc. Stockholders' Information 2 Market Value Per Share ................................................................. $ $ 2005 438,110 325,274 308,133 105,427 36,861 4,603 1.37 .80 11.01 12.87% 1.10% 3.67% 0.76% 2004 403,256 301,144 275,904 105,020 35,272 4,369 1.30 1.80 10.53 12.73% 1.12% 3.48% 0.63% Percent Change +8.64% +8.01% +11.68% +0.39% +4.50% +5.36% +5.38% -55.56% +4.56% +1.10% -1.79% +5.46% +20.63% 2005 2004 High 27.70 25.40 27.00 25.85 Low 25.10 24.60 25.35 24.20 High 31.95 28.78 31.25 28.20 Low 23.75 27.25 27.20 25.10 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: Registrar and Transfer Company, 10 Commerce Drive, Cranford, NJ 07016-3572. Phone: 1-800-368-5948. Number of Stockholders: At December 31, 2005, there were 1,049 registered stockholders. Dividends: A dividend of $.20 per share was paid during each quarter of 2005 and 2004. A special dividend of $1.00 per share was also paid in the first quarter of 2004. 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 contributions 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 25, 2006, at 349 Union Street, Millersburg, Pennsylvania. Accounting, Auditing and Internal Control Complaints: available at Mid Penn Bank's website: www.midpennbank.com Information on how to report a complaint regarding accounting, internal accounting controls or auditing matters is A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. UNAUDITED GRAPHS OF FINANCIAL DATA total assets (IN MILLIONS) total deposits (IN MILLIONS) 438.1 403.3 440 430 420 410 400 390 380 370 360 350 340 330 373.5 363.3 330.6 330 320 310 300 290 280 270 260 250 240 230 220 325.3 301.1 288.3 274.4 254.1 2001 2002 2003 2004 2005 2001 2002 2003 2004 2005 net income (IN MILLIONS) total stockholders’ equity (IN MILLIONS) 4.62 4.50 4.60 4.37 4.23 4.7 4.6 4.5 4.4 4.3 4.2 4.1 4.0 3.9 3.8 3.7 3.6 37.4 36.9 35.2 35.3 3 38 37 36 35 34 33 32 31 30 29 28 27 31.7 2001 2002 2003 2004 2005 2001 2002 2003 2004 2005 book value per share (IN DOLLARS) earnings per share (IN DOLLARS) 1.34 1.27 1.38 1.37 1.30 11.16 11.01 10.51 10.53 9.47 12.0 11.5 11.0 10.5 10.0 9.5 9.0 8.5 8.0 7.5 7.0 6.5 1.45 1.40 1.35 1.30 1.25 1.20 1.15 1.10 1.05 1.00 .95 .90 2001 2002 2003 2004 2005 2001 2002 2003 2004 2005 Per share information has been restated to reflect the retroactive effect of a five percent stock dividend paid in the first quarter of 2006. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders Mid Penn Bancorp, Inc.: We have audited the accompanying consolidated balance sheet of Mid Penn Bancorp, Inc. and subsidiaries (collectively, the “Corporation”) as of December 31, 2005 and 2004, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating 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 4 subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the Standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 1, 2006 expressed an unqualified opinion on management’s assessment of internal control over financial reporting and an unqualified opinion on the effectiveness of internal control over financial reporting. PARENTE RANDOLPH, LLC Williamsport, Pennsylvania February 1, 2006 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. CONSOLIDATED BALANCE SHEET DECEMBER 31, 2005 AND 2004 (Dollars in thousands, except share data) 2005 2004 $ $ $ ASSETS Cash and due from banks......................................................................................................... Interest-bearing balances with other financial institutions ................................................................ Available-for-sale investment securities........................................................................................ Loans and leases..................................................................................................................... Less: Unearned income .................................................................................................... Allowance for loan and lease losses ........................................................................... Net loans........................................................................................................... Bank premises and equipment, net ........................................................................................... Foreclosed assets held for sale.................................................................................................. Accrued interest receivable ....................................................................................................... Deferred income taxes ............................................................................................................. Goodwill ................................................................................................................................. Core deposit intangible, net ....................................................................................................... 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; 3,207,912 shares issued in 2005 and 2004 ........................................................................................ Additional paid-in capital ................................................................................................. Retained earnings .......................................................................................................... Accumulated other comprehensive income........................................................................ Treasury stock, at cost (19,056 and 19,086 shares at December 31, 2005 and 2004, respectively) Stockholders' Equity, Net Total Liabilities and Stockholders' Equity $ 6,350 54,549 50,878 313,423 (1,586) (3,704) 308,133 6,334 458 2,269 1,392 259 235 6,402 851 438,110 41,719 31,686 61,421 26,825 163,623 325,274 12,342 1,535 2,260 59,838 401,249 3,208 23,472 10,486 231 (536) 36,861 438,110 6,679 60,407 44,613 281,083 (1,536) (3,643) 275,904 4,874 505 1,875 982 259 271 6,180 707 403,256 37,586 35,562 43,116 28,414 156,466 301,144 13,801 1,192 1,890 49,957 367,984 3,208 23,472 8,435 693 (536) 35,272 403,256 5 The accompanying notes are an integral part of these consolidated financial statements. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. CONSOLIDATED STATEMENT OF INCOME FOR YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (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 AND LEASE LOSSES ............................................................ Net Interest Income After Provision for Loan and Lease Losses NONINTEREST INCOME Trust department income................................................................................ Service charges on deposits........................................................................... Investment securities gains, net ....................................................................... Gain on sale of loans..................................................................................... Income on cash surrender value of life insurance............................................... Fee income from investment services .............................................................. Fee income from debit card transactions .......................................................... Other income ............................................................................................... Total Noninterest Income NONINTEREST EXPENSE Salaries and employee benefits....................................................................... Occupancy expense, net ................................................................................ Equipment expense....................................................................................... Pennsylvania bank shares tax expense ............................................................ Legal and professional expense ...................................................................... Marketing and advertising............................................................................... Debit card processing expense ....................................................................... Director fees and benefits expense.................................................................. External audit/tax preparation expense ............................................................. Other expenses ............................................................................................ Total Noninterest Expense 6 2005 2004 2003 $ 19,251 2,067 801 1,030 92 53 23,294 6,521 203 2,833 9,557 13,737 225 13,512 312 1,348 1 19 222 70 223 758 2,953 5,662 594 734 259 408 298 154 221 132 1,800 10,262 16,327 1,809 599 1,286 49 7 20,077 5,624 137 2,244 8,005 12,072 725 11,347 248 1,467 475 0 211 162 169 725 3,457 4,918 456 631 265 385 185 214 196 72 1,708 9,030 15,470 2,099 559 1,783 64 9 19,984 6,117 128 2,189 8,434 11,550 290 11,260 202 1,227 261 45 210 21 149 592 2,707 4,496 423 602 266 284 100 167 201 64 1,496 8,099 INCOME BEFORE PROVISION FOR INCOME TAXES .................................................... Provision for income taxes ............................................................................. NET INCOME EARNINGS PER SHARE Weighted Average Number of Shares Outstanding 6,203 1,600 4,603 1.37 3,348,299 $ $ 5,774 1,405 4,369 1.30 3,348,310 5,868 1,253 4,615 1.38 3,347,929 Earnings per share information has been restated to reflect the retroactive effect of a five percent stock dividend paid in the first quarter of 2006. The accompanying notes are an integral part of these consolidated financial statements. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. CONSOLIDATED STATEMENT OF STOCKHOLDER’S EQUITY FOR YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (Dollars in thousands, except share data) Balance, December 31, 2002 .................................................................. $ 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) ........................................... 5% stock dividend (additional 151,411 shares) ..................................... Purchase of treasury stock (786 shares) ............................................... Common Stock 3,057 Additional Paid-in Capital 20,368 0 0 0 151 0 0 0 0 3,104 0 Retained Earnings 10,944 4,615 0 (2,499) (3,255) 0 Accumulated Other Comprehensive Income (Loss) 1,357 Treasury Stock (522) 0 58 0 0 0 0 0 0 0 (17) Total 35,204 4,615 58 4,673 (2,499) 0 (17) Balance, December 31, 2003 .................................................................. 3,208 23,472 9,805 1,415 (539) 37,361 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 ($1.80 per share, historical) ........................................... Sale of treasury stock (322 shares) ...................................................... 0 0 0 0 0 0 0 0 4,369 0 0 (722) (5,739) 0 0 0 0 0 0 3 4,369 (722) 3,647 (5,739) 3 Balance, December 31, 2004................................................................... 3,208 23,472 8,435 693 (536) 35,272 Comprehensive income: Net income ................................................................................... Change in net unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax effects ............................ Total comprehensive income Cash dividends ($ .80 per share, historical)............................................ 0 0 0 0 0 0 4,603 0 0 (462) (2,552) 0 0 0 0 4,603 (462) 4,141 (2,552) Balance, December 31, 2005................................................................... $ 3,208 23,472 10,486 231 (536) 36,861 7 The accompanying notes are an integral part of these consolidated financial statements. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. CONSOLIDATED STATEMENT OF CASH FLOWS 8 FOR YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003 (Dollars in thousands) Operating Activities: Net income ....................................................................................................... Adjustments to reconcile net income to net cash provided by operating activities: $ 4,603 2005 Provision for loan and lease losses............................................................... Depreciation ............................................................................................. Amortization of core deposit intangible ......................................................... Increase in cash surrender value of life insurance........................................... Investment securities gains, net.................................................................... (Gain) loss on sale of foreclosed assets ........................................................ Gain on sale of loans ................................................................................. Loss on disposal of bank premises and equipment ........................................ 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 decrease (increase) in interest-bearing balances................................................ Proceeds from the maturity of investment securities................................................. Proceeds from the sale of investment securities ...................................................... Purchases of investment securities ........................................................................ Purchase of life insurance .................................................................................... Cash received from business combination .............................................................. Proceeds from sale of loans................................................................................. Net increase in loans........................................................................................... Proceeds from sale of bank premises and equipment .............................................. 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 (decrease) increase in short-term borrowings.................................................... Cash dividends paid ............................................................................................ Long-term debt repayment .................................................................................. Sale (purchase) of treasury stock .......................................................................... Long-term borrowings......................................................................................... Net Cash Provided By Financing Activities Net decrease in cash and due from banks....................................................................... Cash and due from banks at beginning of year ................................................................ Cash and due from banks at end of year......................................................................... Supplemental Disclosures of Cash Flow Information: Interest paid....................................................................................................... Income taxes paid .............................................................................................. Supplemental Noncash Disclosures: Loan charge-offs................................................................................................ Transfers to foreclosed assets held for sale ............................................................ Business Combination: Fair value of assets acquired ........................................................................... Fair value of liabilities assumed ........................................................................ The accompanying notes are an integral part of these consolidated financial statements. $ $ $ $ $ $ $ 225 579 36 (222) (1) (66) (19) 2 (173) (394) (143) 343 370 5,140 5,858 4,798 535 (12,297) 0 0 348 (33,241) 40 (2,081) 571 0 (35,469) 24,130 (1,459) (2,552) (119) 0 10,000 30,000 (329) 6,679 6,350 9,214 1,876 199 458 0 0 2004 4,369 725 475 20 (211) (475) 4 0 0 (307) (112) 142 147 540 5,317 9,511 7,979 17,195 (16,305) (1,016) 4,139 0 (45,163) 0 (1,429) 879 (147) (24,357) 5,613 4,113 (5,739) (5,127) 3 19,400 18,263 (777) 7,456 6,679 7,858 1,385 74 124 3,054 7,193 2003 4,615 290 426 0 (210) (261) (20) (45) 0 123 244 380 (142) (301) 5,099 (4,431) 15,635 5,793 (16,313) 0 0 1,710 (13,530) 0 (1,029) 475 0 (11,690) 13,635 (8,468) (2,499) (5,199) (17) 8,500 5,952 (639) 8,095 7,456 8,576 1,410 349 791 0 0 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) Basis of Presentation The accompanying consolidated financial statements include the accounts of Mid Penn Bancorp, Inc. and its wholly-owned subsidiaries Mid Penn Bank (“Bank”), Mid Penn Investment Corporation and Mid Penn Insurance Services, LLC, (collectively, “MPB”). All significant intercompany balances and transactions have been eliminated 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. 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. In addition, the Bank 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 reported 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. A material estimate that is particularly susceptible to significant change relates to the determination of the allowance for loan and lease losses. While management uses available information to recognize losses on loans and leases, future additions to the allowance may be necessary based on changes in local economic conditions. allowance for loan and lease losses. Such agencies may require the Bank to recognize changes to the allowance 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 and lease losses may change materially in the near term. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank’s 9 (b) Investment Securities Available-for-Sale Securities include debt and restricted equity securities. Debt securities are reported at fair value, with unrealized holding gains and losses excluded from earnings and reported, net of deferred income taxes, as a component of accumulated other comprehensive income (loss) within stockholders’ equity. Realized gains and losses on sales of investment securities are computed on the basis of specific identification of the cost of each security. Restricted equity securities are generally carried at cost and evaluated for impairment due to the lack of available market data. Restricted equity securities for which market data is available are reported at fair value. MPB had no trading securities or held-to-maturity securities in 2005, 2004 or 2003. Declines in the fair value of individual available-for-sale securities below their cost that are other than temporary result in write-downs of the individual securities to their fair value. The related write-downs are included in earnings as realized losses. In estimating other-than-temporary impairment losses, man- agement considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Bank to retain its investment in the issuer for a periord of time sufficient to allow for any anticipated recov- ery in fair value. (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 generally 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 payments are received. The placement of a loan on the nonaccrual basis for revenue recognition does not necessarily imply a potential charge-off of loan principal. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield on the related loan. (d) Allowance for Loan and Lease Losses The Bank's methodology for determining the allowance for loan and lease losses establishes both a specific and a general component. The specific portion of the allowance represents the results of analysis of leases and individual "watch list" loans (commercial, residential and consumer loans). 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. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 monitored to determine whether specific loans are impaired, with impairment normally measured by reference to borrowers' collateral values and estimated cash flows. The general portion of the allowance for loan and lease 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 determined using historical loan and lease loss experience adjusted 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 and lease losses is adequate. Identification of specific losses is an ongoing process using available information. Specifically, quarterly management meetings to review "problem" loans and leases are utilized to determine a plan for collection and, if necessary, a recommendation to the Board for charge off. Future additions to the allowance for loan and lease losses through a provision for loan and lease losses will be made based on identified changes in the above factors coupled with loss experience. Various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan and lease 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. (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 development and disposition costs. Operating results from assets acquired in satisfaction of debt, including rental income less operating costs and gains or losses on the sale of, or the periodic evaluation of foreclosed assets, are recorded in noninterest expense. 10 (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 temporary differences 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) Core Deposit Intangible Core deposit intangible is a measure of the value of consumer demand and savings deposits acquired in business combinations accounted for as purchases. The core deposit intangible is being amortized over an 8 year life on a straight-line basis. (i) Goodwill Goodwill is the excess of the purchase price over the fair value of assets acquired in connection with a 2004 business acquisition accounted for as a purchase. The potential impairment of goodwill is tested on an annual basis. No impairment of goodwill was recognized in 2005 or 2004. (j) Marketing and Advertising Costs Marketing and advertising costs are expensed as incurred and were $298,000 in 2005, $185,000 in 2004 and $100,000 in 2003. (k) Pensions and Other Postretirement Benefit Plans Effective December 31, 2003, MPB adopted Statement of Financial Accounting Standards No. 132R (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits” (“SFAS No. 132R”). SFAS No. 132R requires additional disclosures about defined benefit pension plans and other postretirement defined benefit plans. It does not change the measurement or recognition of those plans. (l) Other Benefit Plan A funded contributory profit-sharing plan is maintained for substantially all employees. The cost of the MPB profit-sharing plan is charged to current operating expenses and is funded annually. (m) 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. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (n) Earnings Per Share Earnings per share is computed by dividing net income by the weighted average number of common shares outstanding 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. (o) Statement of Cash Flows For purposes of cash flows, MPB considers cash and due from banks to be cash equivalents. (p) 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 (losses) gains on available-for-sale securities................................................... Less reclassification adjustment for gains realized in income........................................................ Net unrealized (losses) gains................................................................................................... Income tax benefit (expense) .................................................................................................. Net .................................................................................................................................... $ $ Years Ended December 31, 2005 (699) (1) (700) 238 (462) 2004 (619) (475) (1,094) 372 (722) 2003 349 (261) 88 (30) 58 (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 amounts of those required reserve balances were $480,000 at December 31, 2005 and $575,000 at December 31, 2004. Deposits with one financial institution are insured up to $100,000. (6) Investment Securities At December 31, 2005 and 2004, amortized cost, fair value, and unrealized gains and losses on investment securities are as follows: (Dollars in Thousands) December 31, 2005 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.......................................................... (Dollars in Thousands) December 31, 2004 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 14,999 8,114 24,160 3,253 50,526 Amortized Cost 11,998 5,508 22,621 3,435 43,561 $ $ $ $ Gross Unrealized Gains Gross Unrealized Losses 0 6 847 0 853 305 150 35 11 501 Gross Unrealized Gains Gross Unrealized Losses 12 21 1,213 0 1,246 91 87 13 4 195 11 Fair Value 14,694 7,970 24,972 3,242 50,878 Fair Value 11,919 5,442 23,821 3,431 44,613 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 which do not have a readily determinable fair value because their ownership is restricted and they lack a market. Also included in restricted equity securities is an investment in Access Capital Strategies, an equity fund that invests in low to moderate income financing projects. This investment was purchased in 2004 to help fulfill the Bank’s regulatory requirement of the Community Reinvestment Act Investment and at December 31, 2005, is reported at fair value. Investment securities having a fair value of $36,385,000 at December 31, 2005 and $29,128,000 at December 31, 2004, were pledged to secure public deposits and other borrowings. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Gains from sales of investment securities amounted to $1,000 in 2005, $475,000 in 2004 and $261,000 in 2003. The proceeds from sales of investment securities were $535,000 in 2005, $17,195,000 in 2004 and $5,793,000 in 2003. The following table presents gross unrealized losses and fair value of investments aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2005 and 2004. (Dollars in thousands) December 31, 2005 Available-for-sale securities: Less Than 12 Months Unrealized Fair 12 Months or More Unrealized Fair Value Losses Value Losses Total Fair Value Unrealized Losses U.S. Treasury and U.S. government agencies .................................. $ Mortgage-backed U.S. government agencies .................................. State and political subdivision obligations........................................ Restricted equity securities .......................................................... Total temporarily impaired available-for-sale securities ................................ $ 6,935 4,082 2,684 0 13,701 64 66 32 0 162 7,759 3,637 268 238 11,902 241 84 3 11 339 14,694 7,719 2,952 238 25,603 305 150 35 11 501 (Dollars in thousands) December 31, 2004 Available-for-sale securities: Less Than 12 Months Unrealized Fair Losses Value 12 Months or More Unrealized Fair Losses Value Total Fair Value Unrealized Losses U.S. Treasury and U.S. government agencies.................................. $ Mortgage-backed U.S. government agencies .................................. State and political subdivision obligations........................................ Restricted equity securities .......................................................... Total temporarily impaired available-for-sale securities ................................ $ 0 0 0 0 0 0 0 0 0 0 7,906 4,071 716 246 12,939 91 87 13 4 195 7,906 4,071 716 246 12,939 91 87 13 4 195 12 Management evaluates securities for other-than-temporary impairment at least on a quarterly basis; and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the intent and ability of MPB to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. At December 31, 2005 the thirty-two debt securities with unrealized losses have depreciated 2% from their amortized cost basis. These securities are issued by either the U.S. Government or municipalities. These unrealized losses relate principally to current interest rates for similar types of securities. In analyzing an issuer's financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agen- cies have occurred, and the results of reviews of the issuer's prior financial condition. As management has the ability to hold debt securities until maturity, or for the foreseeable future if classified as available-for-sale, no declines are deemed to be other-than-temporary. The following is a schedule of the maturity distribution of investment securities at amortized cost and fair value at December 31, 2005: (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 ............................................................................................ ....................................................................................................... Mortgage-backed securities (avg. life 1.96 years for 2005) .................................... Restricted equity securities.................................................................................. ....................................................................................................... $ $ Amortized Cost December 31, 2005 Fair Value 222 11,861 15,375 12,208 39,666 220 11,917 15,022 12,002 39,161 8,112 3,253 50,526 7,970 3,242 50,878 December 31, 2004 Fair Value 1,252 6,857 13,709 13,922 35,740 Amortized Cost 1,240 6,832 13,240 13,306 34,618 5,508 3,435 43,561 5,442 3,431 44,613 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (7) Loans A summary of loans at December 31, 2005 and 2004 is as follows: (Dollars in thousands) Commercial real estate, construction and land development.......................................................... $ Commercial, industrial and agricultural ....................................................................................... Real estate - residential ........................................................................................................... Consumer.............................................................................................................................. $ 2005 219,385 31,368 44,688 17,982 313,423 2004 195,549 30,940 43,914 10,680 281,083 Net unamortized loan fees and costs of $350,000 in 2005 and $344,000 in 2004 were deducted from loans. Loans and available credit 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 $2,722,000 at December 31, 2005 and $2,983,000 at December 31, 2004. New loans extended were $814,000 in 2005 and $867,000 in 2004. Net payments on these loans equalled $1,075,000 during 2005 and $1,159,000 during 2004. 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 and Lease Losses Changes in the allowance for loan and lease losses for the years 2005, 2004, and 2003 are summarized as follows: Balance, January 1 .............................................................................................................. Provision for loan losses ....................................................................................................... Loans charged off ............................................................................................................... Recoveries on loans charged off............................................................................................ Balance, December 31......................................................................................................... $ $ 2005 3,643 225 (199) 35 3,704 (Dollars in thousands) 2004 2,992 725 (121) 47 3,643 2003 3,051 290 (409) 60 2,992 The recorded investment in loans that are considered impaired amounted to $1,126,000, $1,013,000 and $439,000 on December 31, 2005, December 31, 2004 and December 31, 2003, 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 and lease losses related to loans classified as impaired amounted to approximately $150,000 at December 31, 2005 and $126,000 at December 31, 2004. All impaired loans at the end of 2005 and 2004 had related allowances. The average balances of these loans amounted to approximately $1,404,000, $945,000 and $983,000 for the years 2005, 2004 and 2003, 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 2005, 2004 and 2003. 13 (Dollars in thousands) Cash receipts applied to reduce principal balance .................................................................... Cash receipts recognized as interest income ........................................................................... Total cash receipts............................................................................................................... $ $ 2005 23 15 38 2004 36 3 39 2003 4 0 4 Loans which were past due 90 days or more for which interest continued to be accrued amounted to approximately $1,002,000 at December 31, 2005 and $394,000 at December 31, 2004. Total nonaccrual loans amounted to $1,773,000 at December 31, 2005 and $873,000 at December 31, 2004. The Bank has no commitments to loan additional funds to borrowers with impaired or nonaccrual loans. (9) Bank Premises and Equipment At December 31, 2005 and 2004, bank premises and equipment are as follows: (Dollars in thousands) Land .............................................................................................................................. Buildings ............................................................................................................................ Furniture and fixtures ........................................................................................................... Leasehold improvements...................................................................................................... Less accumulated depreciation.............................................................................................. Depreciation expense was $579,000 in 2005, $475,000 in 2004 and $426,000 in 2003. 2005 1,823 5,172 5,881 133 13,009 6,675 6,334 $ $ 2004 1,288 4,732 4,966 0 10,986 6,112 4,874 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (10) Deposits At December 31, 2005 and 2004, time deposits in denominations of $100,000 or more amounted to $34,219,000 and $27,883,000, respectively. Interest expense on such certificates of deposit amounted to approximately $1,036,000, $830,000, and $873,000 for the years ended December 31, 2005, 2004 and 2003, respectively. Time deposits at December 31, 2005, mature as follows: (in thousands) 2006, $21,351; 2007, $6,297; 2008, $2,658; 2009, $962; 2010, $2,345 thereafter, $606. Deposits and other funds from related parties held by MPB at December 31, 2005 and 2004 amounted to approximately $5,430,000 and $6,133,000, respectively. (11) Short-term Borrowings Short-term borrowings as of December 31, 2005 and 2004 consisted of: (Dollars in thousands) Federal funds purchased .......................................................................................... Repurchase agreements .......................................................................................... Treasury, tax and loan notes ...................................................................................... 2005 5,000 6,899 443 12,342 $ $ 2004 10,400 2,928 473 13,801 The weighted average interest rate on total short-term borrowings outstanding was 4.22% at December 31, 2005 and 2.25% at December 31, 2004. Federal funds purchased represent overnight funds. Securities sold under repurchase agreements generally mature between one day and one year. Treasury, tax and loan notes are open-ended interest bearing notes payable to the U.S. Treasury upon call. All tax deposits accepted by the Bank are placed in the Treasury note option account. The due to broker balance represents previous day balances transferred from deposit accounts under a sweep account agreement. The Bank also has unused lines of credit with several banks amounting to $21,748,000 dollars at December 31, 2005. (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, 2005 and 2004, the Bank had long-term debt in the amount of $59,838,000 and $49,957,000, respectively, consisting of: 14 (Dollars in thousands) At December 31, 2005 2004 Loans maturing in 2006 with rates ranging from 2.17% to 6.21% ................................ Loans maturing in 2007 at a rate of 3.71% .............................................................. Loans maturing in 2008 with rates ranging from 3.08% to 3.80% ................................ Loans maturing in 2009 with rates ranging from 4.22% to 7.24% ................................ Loans maturing in 2010 with rates ranging from 6.28% to 6.71% ................................ Loans maturing in 2013 with rates ranging from 4.08% to 4.75% ................................ Loans maturing in 2026 at a rate of 4.80% .............................................................. Loans maturing in 2027 at a rate of 6.71% .............................................................. ..............................................................................................Total Long-term Debt $ $ 10,000 5,000 15,000 12,000 10,000 3,500 4,245 93 59,838 10,000 5,000 5,000 12,000 10,000 3,500 4,362 95 49,957 The aggregate amounts of maturities of long-term debt subsequent to December 31, 2005 are $10,125,000 (2006), $5,131,000 (2007), $15,138,000 (2008), $12,145,000 (2009), $10,152,000 (2010),$7,147,000 thereafter. $4,700,000 of the Bank’s investments as well as the Bank’s mortgage loan portfolio are pledged to secure FHLB borrowings. (13) Pension and Other Postretirement Benefit Plans MPB has an unfunded noncontributory defined benefit pension plan for directors. The plan provides defined benefits based on years of service. MPB also has other postretirement benefit plans covering full-time employees. These health care and life insurance plans are noncontributory. The significant aspects of each plan are as follows: (a) Health Insurance For full-time employees who retire after at least 20 years of service, MPB 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, in all cases payment of medical premiums by MPB will not exceed five years. 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 MPB paid benefits cease; however, the retiree may continue coverage through the Bank at his/her own expense. If the retiree becomes eligible for A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (b) Life Insurance For full-time employees who retire after at least 20 years of service, MPB 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. (c) Retirement Plan MPB 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 health and life insurance benefit obligations and fair value of plan assets for the years ended December 31, 2005 and 2004 and a statement of the funded status at December 31, 2005 and 2004: (Dollars in thousands) Change in benefit obligations: Benefit obligations, January 1 .......................................................................................................... Service cost............................................................................................................................. Interest cost............................................................................................................................. Actuarial loss............................................................................................................................ Benefit payments...................................................................................................................... Benefit obligations, December 31..................................................................................................... Change in fair value of plan assets: Fair value of plan assets, January 1.................................................................................................. Employer contributions .............................................................................................................. Benefit payments...................................................................................................................... Fair value of plan assets, December 31 ............................................................................................ (Dollars in thousands) Funded status: Excess of the benefit obligation over the value of plan assets.......................................................... Unrecognized transition obligation ............................................................................................... Unrecognized loss (gain) ........................................................................................................... Net amount recognized ............................................................................................................. Amount recognized in the consolidated balance sheet at December 31, 2005 and 2004 is as follows: December 31, 2005 2004 646 43 36 16 (21) 720 0 21 (21) 0 December 31, 2005 (720) 103 20 (597) 501 38 31 92 (16) 646 0 16 (16) 0 2004 (646) 117 4 (525) $ $ $ $ $ $ (Dollars in thousands) Accrued benefit liability.............................................................................................................. $ 2005 (597) 2004 (525) The accumulated benefit obligation for health and life insurance plans was $720,000 and $646,000 at December 31, 2005 and 2004, respectively. The components of net periodic postretirement benefit cost for 2005, 2004 and 2003 are as follows: (Dollars in thousands) Service cost ............................................................................................................................. Interest cost ............................................................................................................................. Amortization of transition obligation.............................................................................................. Amortization of net gain ............................................................................................................. Net periodic postretirement benefit cost ....................................................................................... 2005 43 36 15 0 94 $ $ 2004 38 31 15 0 84 2003 30 30 15 (3) 72 Assumptions used in the measurement of MPB’s benefit obligations at December 31, 2005 and 2004 are as follows: Weighted-average assumptions: Discount rate............................................................................................................................ Rate of compensation increase ................................................................................................... 2005 5.50% 5.00% 2004 5.75% 5.00% 15 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assumptions used in the measurement of MPB’s net periodic benefit cost for the years ended December 31, 2005, 2004 and 2003 are as follows: Weighted-average assumptions: Discount rate ........................................................................................................................... Rate of compensation increase................................................................................................... 5.75% 5.00% 6.00% 5.00% 6.75% 5.00% 2005 2004 2003 Assumed health care cost trend rates at at December 31, 2005, 2004 and 2003 are as follows: Health care cost trend rate assumed for next year......................................................................... Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) ............................... Year that the rate reaches the ultimate trend rate .......................................................................... 2005 9.00% 5.00% 2009 2004 10.00% 5.00% 2009 2003 5.50% 5.50% 2004 Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects: (Dollars in thousands) Effect on total of service and interest cost.................................................................................... Effect on postretirement benefit obligation.................................................................................... MPB expects to contribute $20,526 to its postretirement benefit plans in 2006. 16 Estimated Future Benefit Payments 1/1/2006 to 12/31/2006 ...................................................................................................... 1/1/2007 to 12/31/2007 ...................................................................................................... 1/1/2008 to 12/31/2008 ...................................................................................................... 1/1/2009 to 12/31/2009 ...................................................................................................... 1/1/2010 to 12/31/2010 ...................................................................................................... 1/1/2011 to 12/31/2015 ...................................................................................................... $ $ One-Percentage Point Increase 13 92 Decrease 11 78 20,526 21,769 21,188 29,043 33,120 223,626 The following tables provide a reconciliation of the changes in the directors’ defined benefit plan’s benefit obligations and fair value of plan assets for the years ended December 31, 2005 and 2004 and a statement of the funded status at December 31, 2005 and 2004: (Dollars in thousands) Change in benefit obligations: December 31, 2005 2004 Benefit obligations, January 1.................................................................................................... Service cost ...................................................................................................................... Interest cost....................................................................................................................... Actuarial (gain) loss............................................................................................................. Change in assumptions ....................................................................................................... Benefit payments ............................................................................................................... Benefit obligations, December 31 .............................................................................................. (Dollars in thousands) 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 ...................................................................................... $ $ $ $ 712 26 41 17 (57) (23) 716 2005 0 23 (23) 0 647 22 39 5 17 (18) 712 2004 0 18 (18) 0 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands) Funded status: Excess of the benefit obligation over the value of plan assets........................................................... Unrecognized prior-service cost................................................................................................... Unrecognized loss ..................................................................................................................... Net amount recognized .............................................................................................................. Amounts recognized in the consolidated balance sheet at December 31, 2005 and 2004 are as follows: (Dollars in thousands) Accrued benefit liability ............................................................................................................. Intangible asset........................................................................................................................ Net amount recognized............................................................................................................. December 31, $ $ $ $ (716) 0 17 (699) 2005 (716) 17 (699) (712) 26 57 (629) 2004 (645) 16 (629) The accumulated benefit obligation for the retirement plan was $716,000 and $645,000 at December 31, 2005 and 2004, respectively. Other plan information at December 31, 2005 and 2004 is as follows: (Dollars in thousands) Projected benefit obligation ...................................................................................................... Accumulated benefit obligation ................................................................................................. Fair value of plan assets .......................................................................................................... The components of net periodic pension cost for 2005, 2004 and 2003 are as follows: (Dollars in thousands) Service cost ........................................................................................................................... Interest cost............................................................................................................................ Amortization of prior-service cost ............................................................................................... Net periodic pension cost ......................................................................................................... 2005 716 716 0 2005 26 41 26 93 $ $ $ 2004 712 645 0 2004 22 39 26 87 Assumptions used in the measurement of MPB’s benefit obligations at December 31, 2005 and 2004 are as follows: Weighted-average assumptions: Discount rate .......................................................................................................................... Change in consumer price index ............................................................................................... 2005 5.50% 3.00% 2004 5.75% 4.00% Assumptions used in the measurement of MPB’s net periodic benefit cost for the years ended December 31, 2005, 2004 and 2003 are as follows: 2003 20 37 26 83 17 Weighted-average assumptions: Discount rate .......................................................................................................................... Rate of compensation increase.................................................................................................. 2005 5.75% 3.00% 2004 6.00% 4.00% 2003 6.75% 4.00% MPB expects to contribute $50,153 to its pension plan in 2006. The Bank is the owner and beneficiary of insurance policies on the lives of certain officers and directors which informally fund the retirement plan obligation. The aggregate cash surrender value of these policies was $2,326,000 and $2,244,000 at December 31, 2005 and 2004, respectively. Estimated Future Benefit Payments 1/1/2006 to 12/31/2006 ...................................................................................................... 1/1/2007 to 12/31/2007 ...................................................................................................... 1/1/2008 to 12/31/2008 ...................................................................................................... 1/1/2009 to 12/31/2009 ...................................................................................................... 1/1/2010 to 12/31/2010 ...................................................................................................... 1/1/2011 to 12/31/2015 ...................................................................................................... $ 50,153 55,350 61,455 60,758 59,835 323,063 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (14) Other 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 $277,000 for 2005, $307,000 for 2004 and $267,000 for 2003. (b) 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, 2005 and 2004, the Bank has accrued a liability of approximately $140,000 and $106,000, 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, 2005 and 2004, the Bank has accrued a liability of approximately $237,000 and $179,000, 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 approximately $1,683,000 and $1,626,000 at December 31, 2005 and 2004, respectively. (c) 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 benefits. At December 31, 2005 and 2004, the Bank has accrued a liability of approximately $195,000 and $161,000, respectively, for the Agreement. The expense related to the Agreement was $34,000 for 2005, $32,000 for 2004 and $30,000 for 2003. 18 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 $897,000 and $866,000 at December 31, 2005 and 2004, respectively. (d) Employee Stock Ownership Plan MPB 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 MPB’s contribution to the ESOP for 2005, 2004 and 2003 was $139,000, $155,000 and $134,000, respectively. The ESOP held 36,160 and 32,836 shares of MPB stock as of December 31, 2005 and December 31, 2004, respectively, all of which were allocated to plan participants. 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. (e) Other At December 31, 2005 and 2004, the Bank had Split Dollar Life Insurance arrangements with two executives for which the aggregate collateral assignment and cash surrender values are approximately $1,496,000 and $1,444,000, respectively. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (15) Federal Income Taxes The following temporary differences gave rise to the net deferred tax asset at December 31, 2005 and 2004: (Dollars in thousands) Deferred tax assets: 2005 2004 Allowance for loan losses ..................................................................................................... Benefit plans ...................................................................................................................... Nonaccrual interest.............................................................................................................. Core deposit intangible ........................................................................................................ ..............................................................................................................................Total Deferred tax liabilities: Depreciation ...................................................................................................................... Loan fees .......................................................................................................................... Bond accretion .................................................................................................................. Other items ........................................................................................................................ Unrealized gain on securities ................................................................................................ Total Deferred tax asset, net.............................................................................................................. The provision for income taxes consists of the following: (Dollars in thousands) Currently payable..................................................................................................................... Deferred................................................................................................................................. Total provision for income taxes................................................................................................. 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 ........................................................................................................ $ $ $ $ $ $ 1,106 669 78 8 1,861 (162) (138) (27) (22) (120) (469) 1,392 2005 1,773 (173) 1,600 2005 2,109 (533) 39 (15) 1,600 1,085 555 54 3 1,697 (198) (129) (20) (11) (357) (715) 982 2004 1,712 (307) 1,405 2004 1,963 (583) 34 (9) 1,405 2003 1,130 123 1,253 2003 1,995 (752) 53 (43) 1,253 19 (16) Business Combination On June 14, 2004, MPB consummated the purchase of assets and assumption of liabilities of the Dauphin office of Vartan National Bank (“Vartan”). MPB approved this deal in order to increase market share in the Central Pennsylvania Area. The net receipt of cash from Vartan was $4,139,000. The results of operations of Vartan from the date of acquisition have been included in the accompanying consolidated financial statements. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. (Dollars in thousands) Cash ................................................................................................................................... Loans ................................................................................................................................... Goodwill................................................................................................................................. Core deposit intangible............................................................................................................. Total Assets Acquired................................................................................................................ Deposits: Demand and savings deposits ................................................................................................... ................................................................................................................................... Time Total Liabilities Assumed ........................................................................................................... Net Liabilities Assumed........................................................................................................ $ 2004 21 2,483 259 291 $ 3,054 $ 4,297 2,896 7,193 $ 4,139 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Presented herein is certain unaudited pro forma information for 2004 as if Vartan had been acquired on January 1, 2004 and for 2003 as if Vartan had been acquired on January 1, 2003. These results combine historical results of Vartan into MPB’s consolidated statement of income and, while certain adjustments were made for the estimated impact of purchase accounting adjustments and other acquisition-related activity, they are not necessarily indicative of what would have occurred had the acquisition taken place on the indicated dates. (Dollars in thousands, except per share data) Interest income ........................................................................................................................ Noninterest income .................................................................................................................. Net income ............................................................................................................................. Earnings per share ................................................................................................................... (17) Core Deposit Intangible A summary of core deposit intangible is as follows at December 31, 2005. Unaudited Pro Forma for Year Ended December 31, 2004 $ 20,178 3,482 4,428 1.39 2003 20,186 2,757 4,733 1.48 (Dollars in thousands)................................................................................................................ Gross carrying amount.............................................................................................................. Less accumulated amortization................................................................................................... Net carrying amount $ $ 291 56 235 Amortization expense amounted to $36,000 in 2005 and $20,000 in 2004. The estimated amortization expense of intangible assets for each of the five succeeding fiscal years is $36,000 per year. (18) Regulatory Matters 20 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 capitalized (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, 2005: Actual: Amount Ratio Tier I Capital (to Average Assets) ........................................... Tier I Capital (to Risk Weighted Assets) .................................. Total Capital (to Risk Weighted Assets) ................................... $ 31,404 31,404 35,108 7.3% 9.3 10.4 As of December 31, 2004: Tier I Capital (to Average Assets) ........................................... Tier I Capital (to Risk Weighted Assets) .................................. Total Capital (to Risk Weighted Assets) ................................... $ 27,346 27,346 30,989 7.0% 9.0 10.2 Capital Adequacy Minimum Capital Required: Amount Ratio 17,172 13,487 26,974 15,604 12,147 24,294 4.0% 4.0 8.0 4.0% 4.0 8.0 To Be Well Capitalized Under Prompt Corrective Action Provisions: Ratio Amount 21,465 20,231 33,718 5.0% 6.0 10.0 19,505 18,221 30,368 5.0% 6.0 10.0 As of December 31, 2005 and 2004, the Bank’s capital ratios are in excess of the minimum and well-capitalized guidelines and MPB’s capital ratios are in excess of the Bank’s capital ratios. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (19) 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 financing 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 recognized in the consolidated balance sheets. 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 established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment 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 customer 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, 2005, commitments to extend credit amounted to $64,795,000 and financial standby letters of credit amounted to $10,102,000. 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 collateralized by the same were excluded. 21 As of December 31, 2005, 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 hotel/motel lodging financings and apartment building financing. Outstanding credit to these sectors amounted to $27,483,000 or 8.9% and $25,416,000 or 8.2%, respectively, of net loans outstanding as of December 31, 2005. (20) Commitments and Contingencies Operating Lease In April 2005, MPB entered into a non-cancelable operating lease agreement to lease approximately 2,500 square feet of office space in the downtown Harrisburg area, with the initial term extending through March 2010. MPB has the option to renew this lease for two additional five-year periods. Minimum future rental payments under this operating lease as of December 31, 2005 for each of the next 5 years and in the aggregate are: 2006 .......................................................................................................................... 2007 .......................................................................................................................... 2008 .......................................................................................................................... 2009 .......................................................................................................................... 2010 .......................................................................................................................... $ $ 67,608 69,636 71,725 73,877 18,605 301,451 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. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (21) 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, 2005 and 2004 (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, 2005, 2004 and 2003 (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, 2005, 2004 and 2003 (Dollars in thousands) 22 CASH FLOWS FROM OPERATING ACTIVITIES 2005 2004 $ $ $ $ $ $ 273 36,588 36,861 37,397 (536) 36,861 2005 2,643 47 2,051 (138) 4,603 273 34,999 35,272 35,808 (536) 35,272 2004 5,774 23 (1,361) (67) 4,369 2003 2,566 24 2,097 (72) 4,615 2005 2004 2003 Net Income ............................................................................................................................. Undistributed Earnings of Subsidiaries ......................................................................................... Net Cash Provided By Operating Activities $ 4,603 (2,051) 2,552 CASH FLOWS FROM FINANCING ACTIVITIES Dividends Paid......................................................................................................................... Sale (Purchase) of Treasury Stock .............................................................................................. Net Cash Used In Financing Activities Net (Decrease) Increase in Cash ................................................................................................ Cash at Beginning of Period ...................................................................................................... Cash at End of Period............................................................................................................... (2,552) 0 (2,552) 0 273 273 $ 4,369 1,361 5,730 (5,739) 3 (5,736) (6) 279 273 4,615 (2,097) 2,518 (2,499) (17) (2,516) 2 277 279 (22) 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 estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent 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. 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. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 were 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 contractual values. 23 The following table summarizes the book value and fair value of financial instruments at December 31, 2005 and 2004. (Dollars in thousands) Financial assets: Cash and due from banks........................................................................................ Interest-bearing balances ......................................................................................... Investment securities ............................................................................................... Net loans............................................................................................................... $ December 31, 2005 Fair Book Value Value 6,350 6,350 54,549 54,549 50,878 50,878 306,157 308,133 December 31, 2004 Book Value 6,679 60,407 44,613 275,904 Fair Value 6,679 60,407 44,613 283,141 (Dollars in thousands) Financial liabilities: Deposits................................................................................................................ Short-term borrowings............................................................................................. Accrued interest ..................................................................................................... Long-term debt...................................................................................................... Off-balance sheet financial instruments: December 31, 2005 Book Value $ 325,274 12,342 1,535 59,838 Fair Value 324,461 12,342 1,535 59,829 December 31, 2004 Book Value 301,144 13,801 1,192 49,957 Fair Value 302,517 13,801 1,192 53,081 Commitments to extend credit .................................................................................. Financial standby letters of credit............................................................................... $ 64,795 10,102 64,795 10,102 61,028 11,904 61,028 11,904 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K 24 Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (23) 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 authorized but unissued common stock are reserved for issuance. The DRIP also allows for voluntary cash payments within specified limits, for the purchase of additional shares. (24) Summary of Quarterly Consolidated Financial Data (Unaudited): The following table presents summarized quarterly financial data for 2005, 2004 and 2003. (Dollars in Thousands, Except Per Share Data) 2005 Quarter Ended 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 ....................................................................................................... (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........................................................................................................ (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 ....................................................................................................... $ $ $ $ $ $ $ $ $ Mar. 31 5,348 2,103 3,245 60 3,185 732 0 0 2,540 1,377 360 1,017 .30 Mar. 31 4,736 1,927 2,809 0 2,809 681 202 0 2,277 1,415 329 1,086 0.32 Mar. 31 5,139 2,281 2,858 190 2,668 598 0 0 1,948 1,318 266 1,052 0.31 June 30 5,663 2,284 3,379 110 3,269 686 1 0 2,621 1,335 333 1,002 .30 Sept. 30 5,982 2,492 3,490 280 3,210 817 0 19 2,527 1,519 387 1,132 .34 2004 Quarter Ended June 30 4,929 1,885 3,044 425 2,619 688 234 0 2,251 1,290 317 973 0.29 Sept. 30 5,177 2,021 3,156 200 2,956 742 39 0 2,331 1,406 349 1,057 0.31 2003 Quarter Ended June 30 5,089 2,108 2,981 25 2,956 570 170 0 2,025 1,671 404 1,267 0.38 Sept. 30 4,902 2,034 2,868 75 2,793 585 88 0 2,077 1,389 303 1,086 0.32 Dec. 31 6,301 2,678 3,623 (225) 3,848 698 0 0 2,574 1,972 520 1,452 .43 Dec. 31 5,235 2,172 3,063 100 2,963 871 0 0 2,171 1,663 410 1,253 0.38 Dec. 31 4,854 2,011 2,843 0 2,843 648 3 45 2,049 1,490 280 1,210 0.37 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (25) Subsequent Event Stock Dividend On January 27, 2006, the Board of Directors declared a 5% stock dividend payable on February 27, 2006 to stockholders of record on February 8, 2006. Per-share amounts in the accompanying financial statements have been restated for all periods presented to reflect the effect of this stock dividend. (26) Recent Accounting Pronouncements: In November 2005, the FASB issued Staff Position (FSP) Nos. FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. This FSP addresses the determination of when an investment is considered to be impaired, whether the impairment is other-than-temporary, and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary. The guidance in this FSP must be applied to all reporting periods beginning after December 15, 2005; however, MPB expects no material impact from this FSP. In December 2004, the FASB issued SFAS No.123R that replaces SFAS No.123, Accounting for Stock-Based Compensation, and supercedes APB Opinion 25, Accounting for Stock Issued to Employees. SFAS No. 123R requires that the cost of share-based payment transactions (including those with employees and nonemployees) be recognized in the financial statements. SFAS No. 123R applies to all share-based payment transactions in which an entity acquires goods or services by issuing (or offering to issue) its shares, share options, or other equity instruments (except for those held by an ESOP) or by incurring liabilities (1) in amounts based (even in part) on the price of the entity's shares or other equity instruments, or (2) that require (or may require) settlement by the issuance of an entity's shares or other equity instruments. MPB will implement this new standard in the first quarter of 2006 but, since MPB has no share-based payments, it will have no impact on the financial statements. In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Correctionsthat changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 replaces APB Opinion No. 20, Accounting Changesand SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS No. 154 requires retrospective application to prior periods' financial statements of changes in accounting principle, unless impracticable to determine either the period-specific effects or the cumulative effect of the change. This statement also redefines "restatement" to include the revision of previously issued financial statements to reflect the correction of an error. This statement is effective for accounting changes and error corrections made in fiscal years beginning after December 15, 2005. 25 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS The purpose of this discussion is to further detail the financial condition and results of operations of Mid Penn Bancorp, Inc. (MPB or Company). MPB is not aware of any known trends, events, uncertainties or of any current recommendations by the regulatory authorities which, if they were to be implemented, would have a material effect on MPB’s liquidity, capital resources or operations. This discussion should be read along with the consolidated financial statements also appearing in this report. The consolidated earnings of MPB are derived primarily from the operations of its wholly-owned subsidiary, Mid Penn Bank. Financial Summary MPB earned net income of $4,603,000 for the year 2005, compared to $4,369,000 in 2004, which was an increase of $234,000 or 5.4%. This represents net income in 2005 of $1.37 per share compared to $1.30 per share in 2004 and $1.38 per share in 2003. The major reason for the decrease in earnings in 2004 was the large provision for possible loan and lease losses of $725,000, compared to $225,000 in 2005 and $290,000 in 2003. The larger provision was needed because of the strong growth in the loan portfolio as well as the reclassification of a $3.5 million loan as substandard. The improved status of the same loan relationship in 2005 allowed the Bank to reduce its 2005 provision to $225,000. Total assets of MPB continued to grow in 2005, reaching the level of $438,110,000, an increase of $34,854,000 or 8.6% over $403,256,000 at year end 2004. The majority of growth came from increases in commercial real estate loans in the Capital Region. These increases were funded primarily through growth in deposits, along with increased long-term borrowings. MPB continued to achieve a solid return on average shareholders’ equity, (ROE), a widely recognized performance indicator in the financial industry. The ROE was 12.87% in 2005, 12.73% in 2004 and 12.69% in 2003. Return on average assets (ROA), another performance indicator, was 1.10% in 2005, 1.12% in 2004 and 1.25% in 2003. Tier one capital (to risk weighted assets) of $31,404,000 or 9.3% and total capital (to risk weighted assets) of $35,108,000 or 10.4% at December 31, 2005, are above the regulatory requirement, which is 4% for tier one capital and 8% for total capital. Tier one capital consists primarily of the bank’s stockholders' equity. Total capital includes qualifying subordinated debt, if any, and the allowance for loan and lease losses, within permitted limits. Risk-weighted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet activities. Critical Accounting Policies 26 Management of the Company considers the accounting policy relating to the allowance for loan and lease losses to be a critical accounting policy given the uncertainty in evaluating the level of the allowance required to cover credit losses inherent in the loan portfolio and the material effect that such judgements can have on the results of operations. While management’s current evaluation of the allowance indicates that the allowance is adequate, under adversely different conditions or assumptions, the allowance may need to be increased. For example, if historical loan loss experience significantly worsened or if current economic conditions significantly deteriorated, additional provisions for loan losses may be required to increase the allowance. reviews of the Company’s non-performing loans and potential problem loans have a significant impact on the overall analysis of the adequacy of the allowance. While management has concluded that the current evaluation of collateral values is reasonable under the circumstances, if collateral evaluations were significantly lowered, the Company’s allowance may also require additional provisions for loan and lease losses. In addition, the assumptions and estimates used in the internal 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 2005 net interest income increased $1,665,000 or 13.8% as compared to an increase of $522,000 or 4.5% in 2004. The average balances, effective interest differential and interest yields for the years ended December 31, 2005, 2004 and 2003 and the components of net interest income, are presented in Table 1. A comparative presentation of the changes in net interest income for 2005 compared to 2004, and 2004 compared to 2003, 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. The yield on earning assets increased to 6.10% in 2005 from 5.66% in 2004. The yield on earning assets for 2003 was 6.08%. The change in the yield on earning assets was due primarily to the upward movement of rates on new and maturing assets. The average “prime rate” for 2005 was 6.19% as compared to 4.34% for 2004 and 4.12% for 2003. Interest expense increased by $1,552,000 or 19.39% in 2005 as compared to a decrease of $429,000 or 5.09% in 2004. In order to maintain the spread between interest earning assets and interest bearing liabilities, management was forced to aggressively decrease the expense on deposits during 2003 and the first half of 2004. Primarily resulting from the fluctuations in interest rates, the net interest margin, on a tax equivalent basis, in 2005 was 3.67% compared to 3.48% in 2004 and 3.63% in 2003. Management continues to closely monitor the net interest margin. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS TABLE 1: AVERAGE BALANCES, EFFECTIVE INTEREST DIFFERENTIAL AND INTEREST YIELDS INCOME AND RATES ON A TAXABLE EQUIVALENT BASIS FOR YEAR ENDED DECEMBER 31, 2005 (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 ....................................................... Average Interest Spread ..................................................... Average Balance Interest Income/Expense Average Rates Earned/Paid $ 58,735 23,081 22,866 45,947 1,623 287,185 393,490 6,940 18,218 418,648 32,507 50,913 28,179 158,935 7,498 59,021 337,053 41,484 4,332 35,779 418,648 $ $ $ $ 2,067 893 1,561 53 19,427 24,001 58 1,073 69 5,321 203 2,833 9,557 14,444 3.52% 3.87% 6.83% 3.27% 6.76% 6.10% 0.18% 2.11% 0.24% 3.35% 2.71% 4.80% 2.84% 6.10% 2.43% 3.67% 3.26% 27 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS 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, 2004 (Dollars in thousands) Average Balance Interest Income/Expense Average Rates Earned/Paid 28 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 ....................................................... Average Interest Spread ..................................................... $ 66,750 17,531 26,555 44,086 346 256,627 367,809 6,527 16,002 390,338 34,750 45,202 29,027 153,100 11,415 43,780 317,274 37,586 1,951 33,527 390,338 $ $ $ $ 1,809 599 1,948 7 16,449 20,812 61 442 77 5,044 137 2,244 8,005 12,807 2.71% 3.42% 7.34% 2.02% 6.41% 5.66% 0.18% 0.98% 0.27% 3.29% 1.20% 5.13% 2.52% 5.66% 2.18% 3.48% 3.14% A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS 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, 2003 (Dollars in thousands) Average Balance Interest Income/Expense Average Rates Earned/Paid 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 ....................................................... Average Interest Spread ..................................................... $ 68,256 14,222 36,355 50,577 950 224,993 344,776 6,306 17,489 368,571 33,897 45,072 27,756 144,194 10,670 36,463 298,052 30,918 4,309 35,292 368,571 $ $ $ $ 2,099 559 2,702 9 15,598 20,967 82 638 165 5,232 128 2,189 8,434 12,533 3.08% 3.93% 7.43% 0.95% 6.93% 6.08% 0.24% 1.42% 0.59% 3.63% 1.20% 6.00% 2.83% 6.08% 2.45% 3.63% 3.25% 29 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 $492,000, $448,000 and $612,000 are included with interest income in Table 1 for the years 2005, 2004 and 2003, respectively. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS TABLE 2: VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME 2005 Compared to 2004 Increase (Decrease) Due to Change In: 2004 Compared to 2003 Increase (Decrease) Due to Change In: Volume Rate Net Volume Rate Net (217) 475 258 (46) (244) (Dollars in thousands) Taxable Equivalent Basis INTEREST INCOME: Interest Bearing Balances ................................................ $ Investment Securities: Taxable ......................................................................... Tax-Exempt ................................................................... Total Investment Securities Federal Funds Sold......................................................... Loans, Net..................................................................... Total Interest Income INTEREST EXPENSE: Interest Bearing Deposits: NOW ...................................................................... Money Market .......................................................... Savings.................................................................... Time........................................................................ Total Interest Bearing Deposits Short-term Borrowings .................................................... Long-term Debt ............................................................. Total Interest Expense 30 190 (271) (81) 26 1,959 1,687 (3) 56 (2) 192 243 (47) 782 978 104 (116) (12) 20 1,019 1,502 0 575 (6) 85 654 113 (193) 574 294 (387) (93) 46 2,978 3,189 (3) 631 (8) 277 897 66 589 1,552 (290) 40 (754) (714) (2) 851 (155) (21) (196) (88) (188) (493) 9 55 (429) (90) (35) (369) 4 (1,341) (1,706) (23) (198) (95) (511) (827) 0 (384) (1,211) 130 (719) (635) (6) 2,192 1,551 2 2 7 323 334 9 439 782 769 NET INTEREST INCOME ....................................................... $ 709 928 1,637 (495) 274 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 and Lease Losses The provision for loan and lease losses charged to operating expense represents the amount deemed appropriate by management to maintain an adequate allowance for possible loan and lease losses. Following its model for loan and lease loss allowance adequacy, management made a $225,000 provision in 2005 as well as a provision of $725,000 in 2004 and $290,000 in 2003. The allowance for loan and lease losses as a percentage of total loans was 1.18% at December 31, 2005, compared to 1.30% at December 31, 2004 and 1.28% at December 31, 2003, which continues to be higher than that of peer financial institutions due to MPB’s higher level of loans to finance commercial real estate. The higher 2004 provision was due to a more than 20% growth in loans during the year and the reclassification of a large commercial loan relationship to a substandard classification by the Bank’s regulators. The improved status of the same loan relationship in the fourth quarter of 2005 allowed the Bank to reduce its December 31, 2005 allowance for loan and lease loss, accounting for much of the decrease in the provision for loan and lease losses in 2005 . A summary of charge-offs and recoveries of loans and leases is presented in Table 3. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS TABLE 3: ANALYSIS OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES (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 2005 3,643 32 29 0 138 199 0 12 0 23 35 Years ended December 31, 2003 3,051 2004 2,992 2002 2,856 2001 2,815 25 10 8 78 121 0 8 0 39 47 171 140 0 98 409 0 14 0 46 60 41 113 0 148 302 17 0 0 55 72 249 118 0 122 489 0 1 0 29 30 Net charge-offs...................................................................................... Provision for loan and lease losses ........................................................... Balance, end of year............................................................................... $ 164 225 3,704 74 725 3,643 349 290 2,992 230 425 3,051 459 500 2,856 Ratio of net charge-offs during the year to average loans outstanding during the year, net of unearned discount....................................................... .06% .03% .14% .11% .24% Allowance for loan losses as a percentage of total loans.............................. 1.18% 1.30% 1.28% 1.37% 1.39% 31 Noninterest Income During 2005, MPB earned $2,953,000 in noninterest income, compared to $3,457,000 earned in 2004 and $2,707,000 earned in 2003. Service charges on deposit accounts amounted to $1,348,000 for 2005, a decrease of $119,000 or 8.1% compared to $1,467,000 for 2004, an increase of $240,000 or 19.6% over 2003. The majority of this decrease is attributed to reduced revenues from NSF charges, which was a result of the closure and sale of deposits of the Tremont office in early 2005 due to the expiration of a lease agreement on the office space. Gains on the sale of investment securities amounted to $475,000 in 2004 as MPB realized certain investment gains in anticipation of rising rates and diminishing gains. The same opportunities for security gains, which would not compromise future earnings, did not present themselves in 2005. 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 $222,000 during the year 2005, $211,000 in 2004 and $210,000 in 2003. Trust department income for 2005 was $312,000, a $64,000 or 25.8% increase from the $248,000 in 2004, which was a $46,000 or 22.8% increase from the $202,000 earned in 2003. Trust Department income can fluctuate from year to year, due to the number of estates being settled during the year. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS MPB also earned $70,000 in 2005, $162,000 in 2004 and $21,000 in 2003 in fees from the third-party provider of investments whose services the Bank has contracted. The decrease in investment services income resulted from a vacancy in the investment representative position for more than six months during 2005. Other income amounted to $758,000 in 2005, $725,000 in 2004 and $592,000 in 2003, including gains on other real estate. The increase in other noninterest income is due to the aggregate of several relatively small increases in other fee areas throughout the bank, as management continues to focus on generating noninterest income. Noninterest Expense A summary of the major components of noninterest expense for the years ended December 31, 2005, 2004 and 2003 is reflected in Table 4. Noninterest expense increased to $10,262,000 in 2005 from $9,030,000 in 2004 and $9,030,000 in 2003. The major component of noninterest expense is salaries and employee benefits. The number of full-time equivalent employees increased from 116 to 124 during 2005. workforce included the management and staffing for two new offices in the Capital Region. These new offices were the driving factor behind much of the increased expense in 2005. In addition to the personnel costs, there were associated increases in occupancy, equipment and marketing. Another significant expense in 2005 was the cost of complying with Section 404 of the Sarbanes-Oxley Act. The annual cost of compliance is approaching $200,000 in higher audit costs and additional personnel expense. Increases in the 2005 32 TABLE 4: NONINTEREST EXPENSE (Dollars in thousands) Salaries and employee benefits .......................................................................... Occupancy, net ................................................................................................ Equipment....................................................................................................... Postage and supplies........................................................................................ Marketing and advertising.................................................................................. Other real estate, net ........................................................................................ Pennsylvania bank shares tax............................................................................. External audit and tax preparation ....................................................................... Telephone ....................................................................................................... Loss on mortgage sales.................................................................................... Legal and professional services.......................................................................... Debit card processing ....................................................................................... Director fees and benefits.................................................................................. Computer software licensing and maintenance ..................................................... Other.............................................................................................................. Total Noninterest Expense Investments 2005 5,662 594 734 370 298 91 259 132 91 51 408 154 221 179 1,018 10,262 $ $ Years ended December 31, 2004 4,918 456 631 308 185 0 265 72 86 66 385 214 196 170 1,078 9,030 2003 4,496 423 602 320 100 135 266 64 77 146 284 167 201 91 727 8,099 MPB’s investment portfolio is utilized to provide liquidity and managed to maximize return within reasonable risk parameters. 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 valued at a market price relative to investments of the same type with similar maturity dates. As the interest rate environment of these securities changes, the value of securities changes accordingly. As of December 31, 2005, SFAS No. 115 resulted in a contribution to shareholders’ equity of $231,000 (unrealized gain on securities of $352,000 less estimated income tax expense of $121,000). At December 31, 2004, SFAS No. 115 resulted in an increase of shareholders’ equity of $693,000 (unrealized gain on securities of $1,051,000 less estimated income tax expense of $357,000) compared to a December 31, 2003 increase in shareholders’ equity of $1,415,000 (unrealized gain on securities of $2,144,000, less estimated income tax expense of $729,000). MPB does not have any significant concentrations of investment securities. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS 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 shown in Note 6 to the Consolidated Financial Statements. TABLE 5: AMORTIZED COST OF INVESTMENT SECURITIES (Dollars in thousands) U. S. Treasury and U.S. government agencies ............................................................ Mortgage-backed U.S. government agencies............................................................. State and political subdivision obligations .................................................................. Restricted equity securities...................................................................................... Total 2005 14,999 8,112 24,162 3,253 50,526 $ $ December 31, 2004 11,998 5,508 22,621 3,435 43,561 2003 10,564 4,808 34,447 2,130 51,949 Loans At December 31, 2005, net loans totaled $308,133,000, a $32,229,000 or 11.7% increase from December 31, 2004. During 2005, MPB experienced a net increase in commercial real estate and commercial/industrial loans of approximately $24,264,000, the majority of which was generated in the greater Capital (Harrisburg) Region. The current environment in lending remains extremely competitive with financial institutions aggressively pursuing potential borrowers. At December 31, 2005, loans, net of unearned income, represented 73.7% of earning assets as compared to 71.5% on December 31, 2004 and 64.3% on December 31, 2003. The Bank's loan portfolio is diversified among individuals, farmers, and small and medium-sized businesses generally located 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 entities 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 loans, lines of credit and home equity loans. 33 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) Commercial real estate, construction and land development................ Commercial, industrial and agricultural................... Real estate-residential ........ Consumer ........................ ............Total Loans Unearned income.............. Loans net of unearned 2005 Percent of Loans Amount Amount 2004 Percent of Loans December 31, 2003 2002 2001 Percent of Loans Amount Amount Percent of Loans Percent of Loans Amount $ 219,385 70.0% 195,549 69.6% 154,296 66.5% 146,325 65.6% 130,983 63.8% 31,368 44,688 17,982 313,423 (1,586) 10.0 14.3 5.7 100 30,940 43,914 10,680 281,083 (1,536) 11.0 15.6 3.8 100 25,567 43,384 10,380 233,627 (1,549) 11.0 18.7 3.8 100 22,398 41,502 12,978 233,203 (1,850) 10.0 18.6 5.8 100 23,107 38,349 12,732 205,101 (2,265) 11.3 18.7 6.2 100 discount ...................... 311,837 279,547 232,078 221,353 202,836 Allowance for loan and lease losses................. ..............Net Loans (3,704) $ 308,133 (3,643) 275,904 (2,992) 229,086 (3,051) 218,302 (2,856) 99,980 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS Allowance for Loan and Lease Losses The allowance for loan and lease losses is maintained at a level believed adequate by Management to absorb potential losses in the loan and lease 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 In addition, loss estimates for each category of credit are provided based on Management's judgment which considers past evaluated to estimate potential losses. experience, current economic conditions and other factors. For installment, real estate mortgages and other consumer loans, specific reserve allocations are based on past loss experience adjusted for recent portfolio growth and economic trends. Calculated amounts resulting from this analysis are "specific" allocations. The amounts not specifically provided for individual classes of loans are considered "general." The general portion of the allowance is determined and based on judgments regarding economic conditions, trends and other factors. The 2005 provision of $225,000 is comparable to the provisions recorded in prior years with the exception of 2004. During 2004, the provision increased to $725,000. The majority of the 2004 increase was caused by potential issues related to the status of a large commercial loan relationship. The allocation of the allowance for loan and lease 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 and lease losses at December 31, 2005 was $3,704,000 or 1.19% of total loans less unearned discount as compared to $3,643,000 or 1.30% at December 31, 2004, and $2,992,000 or 1.29% at December 31, 2003. Despite higher non-performing assets (see Table 8), reserve ratios at December 31, 2005 were considered adequate based on management’s quarterly review analysis. TABLE 7: ALLOCATION OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES (Dollars in thousands) 34 Commercial real estate, construction and land development .................... Commercial, industrial and agricultural .................................................. Real estate-residential ........................................................................ Consumer ........................................................................................ General ............................................................................................ Total Loans $ $ 2005 2,037 1,481 52 110 24 3,704 2004 2,368 1,093 65 83 34 3,643 December 31, 2003 1,938 954 20 65 15 2,992 2002 1,898 922 56 147 28 3,051 2001 1,584 987 73 166 46 2,856 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 principal or interest has consistently been in default for a period of 90 days or more, or because of a deteriora- tion 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 difficulties. Foreclosed assets held for sale include those assets that have been acquired through foreclosure for debts previously contracted, in settlement of debt. Consumer loans are generally recommended for charge-off when they become 120 days delinquent. All 1-4 family residential 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 res- idential mortgage loans past due 90 days or more at year-end was $892,000, $397,000 and $533,000 in 2005, 2004 and 2003, 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, 2005, totaled $3,317,000 or 0.76% of total assets compared to $1,775,000 or 0.44% of total assets in 2004, and $2,767,000 or 0.74% of total assets in 2003. The foreclosed assets held for sale at December 31, 2005, consist of two parcels of commercial real estate and one residential property. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS TABLE 8: NONPERFORMING ASSETS (Dollars in thousands) Nonaccrual loans..................................................................... Past due 90 days or more ....................................................... Restructured loans................................................................... Total nonperforming loans Foreclosed assets held for sale ................................................. Total nonperforming assets $ $ Percent of loans outstanding..................................................... Percent of total assets.............................................................. 2005 1,773 1,086 0 2,859 458 3,317 1.06% 0.76% 2004 873 397 0 1,270 505 1,775 0.63% 0.44% December 31, 2003 984 666 0 1,650 1,117 2,767 2002 1,164 808 0 1,972 781 2,753 2001 1,686 828 537 3,051 1,693 4,744 1.18% 0.74% 1.23% 0.76% 2.31% 1.44% There are no trends or uncertainties which Management expects will materially impact future operating results, liquidity or capital resources. There are no material credits about which Management has any information to cause 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, 2005, increased by $24,130,000 or 8.0% over December 31, 2004, which also increased by $12,806,000 or 4.4% from December 31, 2003. Average balances and average interest rates applicable to the major classifications of deposits for the years ended December 31, 2005, 2004, and 2003 are presented in Table 9. The majority of 2005 deposit growth was related to the opening of two new offices in Harrisburg, PA. Average short-term borrowings for 2005 were $7,498,000 as compared to $11,415,000 in 2004. These borrowings included customer repurchase agreements, treasury tax and loan option borrowings and federal funds purchased. A ten million dollar borrowing, maturing in February of 2008 was entered into during 2005 with the FHLB. TABLE 9: DEPOSITS BY MAJOR CLASSIFICATION 35 (Dollars in thousands) Noninterest-bearing demand deposits....................................... $ Interest-bearing demand deposits ............................................ Money market....................................................................... Savings................................................................................ ................................................................................ Time ..........................................................................Total $ 2005 Years ended December 31, 2004 2003 Average Balance 41,484 32,507 50,913 28,179 158,935 312,018 Average Rate 0.00% 0.18% 2.11% 0.24% 3.35% 2.09% Average Balance 38,884 34,750 45,202 29,027 153,100 300,963 Average Rate 0.00% 0.18% 0.98% 0.27% 3.29% 1.88% Average Balance 30,918 33,897 45,072 27,756 144,194 281,837 Average Rate 0.00% 0.24% 1.42% 0.59% 3.63% 2.17% 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 adequacy has been, and will continue to be, of paramount importance. Stockholders’ equity increased in 2005 by $1,589,000 or 4.5%. In 2004, capital decreased by $2,089,000 or 5.6%, largely due to the $1 per share In 2003, capital was increased by $2,157,000 or 6.1%. Capital growth is achieved by retaining more in earnings special dividend in the first quarter of 2004. than is paid out to our shareholders. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS 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 56% for 2005 compared to 131% for 2004 and 54% for 2003. At December 31, 2005, 19,056 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 Taxes Federal income tax expense for 2005 was $1,600,000 compared to $1,405,000 and $1,253,000 in 2004 and 2003, respectively. The effective tax rate was 26% for 2005, 24% for 2004 and 21% for 2003. The reason for the increase in effective rate was a lower mix of tax-exempt earning assets. Liquidity MPB's asset-liability management policy addresses the management of MPB's liquidity position and its ability to raise sufficient funds to meet deposit withdrawals, fund loan growth and meet other operational needs. MPB utilizes its investment portfolio as a source of liquidity, along with deposit growth and increases in repurchase agreements and borrowings. investments is provided 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. (See Deposits and Other Funding Sources which appears earlier in this discussion.) Liquidity from The major sources of cash in 2005 came from operations and a net increase in deposits of $24,130,000, particularly in the money market demand deposit category as a premium rate special was offered at the two new offices. Other major sources of funds included a $10,000,000 borrowing from the Federal Home Loan Bank, and a net decrease of interest-bearing balances, jumbo certificates of deposit, of $5,858,000. 36 Major uses of funds in 2005, included a net increase of loans of $32,783,000 as well as a net increase of investment securities of $6,265,000. The major sources of cash in 2004 came from operations, a net increase of long-term borrowings of $14,273,000, an increase in deposits of $12,806,000, a net decrease in interest-bearing balances (certificates of deposit of other banks) of $9,511,000, and a net decrease in investment securities of $9,480,000. The major use of cash during 2004 was the funding of a net increase in loans of more than $46 million. Another major use of cash during that year was the payment of $5,739,000 in cash dividends. This amount included the $1 per share special dividend, which was paid in the first quarter of 2004. 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. repricing in a future period of time. These differences are known as interest sensitivity gaps. Interest rate sensitivity is measured as the difference between the volume of assets and liabilities that are subject to 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 liquidity. Net interest income is increased by increasing the net interest margin and by volume growth. MPB utilizes an asset-liability management model to measure the impact of interest rate movements on its interest rate sensitivity 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 interest rate risk is desirable. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS 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 contractual maturity. Residential loans are assumed to have annual payment rates between 12% and 18% of the portfolio. Loans 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 reprice after 5 years. Transaction accounts, excluding money market accounts, are assumed to reprice 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 certificates of deposit. Fixed maturity deposits reprice at maturity. The maturity distribution of time deposits of $100,000 or more is shown in Table 13. TABLE 10: INVESTMENT MATURITY AND YIELD (Dollars in thousands) U.S. Treasury and U.S.government agencies ............................................ State and political subdivision obligations ................................................ Mortgage-backed U.S. government agencies .......................................... Equity securities .................................................................................. Total $ $ Weighted Average Yields U.S. Treasury and U.S. government agencies ........................................... State and political subdivision obligations ................................................ Mortgage-backed U.S. government agencies........................................... Equity securities .................................................................................. Total December 31, 2005 After Five Years thru Ten Years 3,500 11,522 0 0 15,022 After Five Years thru Ten Years 4.04 6.90 0 0 6.23 After One Year thru Five Years 8,999 2,918 0 0 11,917 After One Year thru Five Years 3.98 6.68 0 0 4.64 After Ten Years 2,500 9,502 8,112 3,253 23,367 After Ten Years 4.50 6.75 4.91 3.00 5.35 Total 14,999 24,162 8,112 3,253 50,526 Total 4.08 6.82 4.91 3.00 5.45 One Year and Less 0 220 0 0 220 One Year and Less 0 7.71 0 0 7.71 37 TABLE 11: LOAN MATURITY AND INTEREST SENSITIVITY (Dollars in thousands) Commercial, real estate, construction and land development...................... Commercial, industrial and agricultural .................................................... Real estate-residential mortgages .......................................................... Consumer .......................................................................................... Total Loans Rate Sensitivity Predetermined rate .............................................................................. Floating or adjustable rate..................................................................... Total $ $ $ $ December 31, 2005 After One Year thru Five Years 114,398 11,116 21,896 9,746 157,156 32,325 124,831 157,156 After Five Years 33,953 2,399 11,738 4,440 52,530 46,996 5,534 52,530 One Year and Less 71,034 17,853 11,054 3,796 103,737 11,646 92,091 103,737 Total 219,385 31,368 44,688 17,982 313,423 90,967 222,456 313,423 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS TABLE 12: INTEREST RATE SENSITIVITY GAP (Dollars in thousands) (As of December 31, 2005) Assets: Interest bearing balances .................... Average interest rate..................... Debt securities .................................. Average interest rate..................... Adjustable rate loans.......................... Average interest rate..................... Fixed rate loans................................. Average interest rate..................... ...........................................Total Interest liabilities: Variable rate savings and transaction accounts ........................ Average interest rate..................... Certificates of deposit and IRAs ........... Average interest rate..................... Short term borrowings........................ Average interest rate..................... Long term fixed rate borrowings .......... Average interest rate..................... ...........................................Total Rate sensitive gap:.................................. Periodic gap ..................................... Cumulative gap ................................. Cumulative gap as a percentage of total assets ................................... (Dollars in thousands) (As of December 31, 2004) Assets: Interest bearing balances .................... Average interest rate..................... Debt securities .................................. Average interest rate..................... Adjustable rate loans.......................... Average interest rate..................... Fixed rate loans................................. Average interest rate..................... ...........................................Total 2006 2007 2008 Expected Maturity Year Ended December 31, 2009 2010 Thereafter Total Fair Value 41,178 4.04 220 7.71 92,091 7.33 11,646 6.65 145,135 76,049 1.75 68,419 3.19 12,342 4.22 10,125 4.19 166,935 396 4.50 2,550 4.90 19,688 6.65 10,183 6.46 32,817 0 - 47,964 3.76 0 - 5,131 3.71 53,095 5,843 3.76 4,895 3.90 42,182 6.25 7,578 6.75 60,498 0 - 18,300 3.56 0 - 15,138 3.56 33,438 7,033 3.92 1,725 4.03 28,758 6.22 8,054 6.59 45,570 0 - 15,349 3.98 0 - 12,145 4.64 27,494 99 4.40 2,747 6.11 34,203 6.52 6,510 6.77 43,559 0 - 10,576 4.40 0 - 10,152 6.50 20,728 0 - 38,389 5.35 5,534 5.80 46,996 6.47 90,919 85,602 .10 3,015 3.92 0 - 7,147 4.61 95,764 54,549 4.00 50,526 5.45 222,456 6.76 90,967 6.55 418,498 161,651 .88 163,623 3.56 12,342 4.22 59,838 4.52 397,454 54,549 50,878 222,456 88,991 416,874 161,651 162,359 12,342 59,829 396,181 (21,800) (21,800) (20,278) (42,078) 27,060 (15,018) 18,076 3,058 22,831 25,889 (4,845) 21,044 -5.0% -9.6% -3.4% +0.7% +5.9% +4.8% 2005 2006 2007 43,967 2.73 1,240 6.08 91,696 5.91 9,371 6.68 146,274 3,663 3.32 355 7.94 20,034 6.65 4,431 7.10 28,483 99 5.05 551 6.21 22,002 6.73 10,200 6.61 32,852 Expected Maturity Year Ended December 31, 2008 2009 Thereafter Total Fair Value 5,645 3.74 4,263 3.40 30,896 6.07 6,235 6.48 47,039 6,934 3.91 1,925 4.51 27,069 6.25 6,661 6.49 42,589 99 4.40 31,741 6.19 4,960 5.55 45,993 6.24 82,793 60,407 3.00 40,075 5.79 196,657 6.14 82,891 6.42 380,030 60,407 41,129 196,657 86,484 384,677 $ $ $ $ $ $ $ $ 38 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS TABLE 12: INTEREST RATE SENSITIVITY GAP (cont’d) (Dollars in thousands) (As of December 31, 2004) Interest liabilities: Variable rate savings and transaction accounts..................... Average interest rate..................... Certificates of deposit and IRAs ........... Average interest rate..................... Short term borrowings........................ Average interest rate..................... Long term fixed rate borrowings .......... Average interest rate..................... ...........................................Total Rate sensitive gap: Periodic gap ..................................... Cumulative gap ................................. Cumulative gap as a percentage $ $ $ $ 2005 2006 2007 Expected Maturity Year Ended December 31, 2009 2008 Thereafter Total Fair Value 59,109 0.77 57,216 2.75 13,801 2.25 0 - 130,126 0 0 0 0 33,376 3.08 0 10,000 4.19 43,376 37,993 3.73 0 5,000 3.71 42,993 12,720 3.46 0 5,000 3.08 17,720 13,007 3.99 0 12,000 5.63 25,007 85,569 0.12 2,154 3.95 0 17,957 5.68 105,680 144,678 0.38 156,466 3.24 13,801 2.25 49,957 4.91 364,902 144,678 157,839 13,801 53,081 369,399 16,148 16,148 (14,893) 1,255 (10,141) (8,886) 29,319 20,433 17,582 38,015 (22,887) 15,128 of total assets ................................... +4.0% +0.3 -2.2 +5.1 +9.4 +3.8 During 2005, 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, 2005, all interest rate risk levels according to our model were within the tolerance limits of Board approved policy. 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. realign its portfolio in the event of a changing rate environment. In addition, the table does not take into consideration changes which Management would make to 39 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 Effects of Inflation 2005 8,421 12,930 12,868 34,219 $ $ December 31, 2004 7,431 6,771 13,681 27,883 2003 4,821 7,104 12,673 24,598 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 performance. 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 liabilities 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, as well as the composition of loans, investments and deposits should be considered. A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS 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, 2005, commitments to extend credit amounted to $64,795,000 as compared to $61,028,000 as of December 31, 2004. 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 decreased to $10,102,000 at December 31, 2005, from $11,904,000 at December 31, 2004. 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 unrealized gains and losses on available-for-sale securities, net of deferred income tax. Comprehensive Income should not be construed to be a measure of net income. The effect of Other Comprehensive Income would only be reflected in the income statement 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 (Loss) Income for the years ended December 31, 2005, 2004 and 2003 was $(462,000), $(722,000) and $58,000, respectively. 40 (Dollars in thousands, except per share data) Summary of Selected Financial Data 2005 2004 2003 2002 2001 INCOME: Total Interest Income ...................................................................... Total Interest Expense ..................................................................... Net Interest Income ........................................................................ Provision for Possible Loan and Lease Losses ................................... Noninterest Income ........................................................................ Noninterest Expense....................................................................... Income Before Income Taxes........................................................... Provision for Income Taxes .............................................................. Net Income ................................................................................... COMMON STOCK DATA PER SHARE: Earnings Per Share......................................................................... Cash Dividends Declared, historical................................................... Stockholders' Equity ....................................................................... $ $ 23,294 9,557 13,737 225 2,953 10,262 6,203 1,600 4,603 1.37 .80 11.01 20,077 8,005 12,072 725 3,457 9,030 5,774 1,405 4,369 1.30 1.80 10.53 19,984 8,434 11,550 290 2,707 8,099 5,868 1,253 4,615 1.38 .80 11.16 21,352 9,926 11,426 425 2,022 7,258 5,765 1,270 4,495 1.34 .80 10.51 22,864 11,735 11,129 500 1,845 7,026 5,448 1,218 4,230 1.27 .80 9.47 AVERAGE SHARES OUTSTANDING ....................................................... 3,348,299 3,348,310 3,347,929 3,347,750 3,350,342 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 ....................................................................... $ $ 54,549 311,837 3,704 438,110 325,274 12,342 59,838 36,861 RATIOS: Return on Average Assets ............................................................... Return on Average Stockholders' Equity ............................................ Cash Dividend Payout Ratio............................................................. Allowance for Loan Losses to Loans................................................. Average Stockholders' Equity to Average Assets ................................. 1.10 12.87 55.56 1.30 8.55 44,613 279,547 3,643 403,256 301,144 13,801 49,957 35,272 1.12 12.73 131.38 1.30 8.75 54,093 232,078 2,992 373,466 288,338 9,688 35,684 37,361 1.25 12.69 54.48 1.29 9.97 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 1.32 13.60 54.05 1.38 9.67 1.31 13.68 57.55 1.41 9.67 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. LIST OF DIRECTORS, OFFICERS AND ADVISORY BOARD MEMBERS AS OF DECEMBER 31, 2005 DIRECTORS EXECUTIVE OFFICERS Mid Penn Bancorp, Inc. 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 A. James Durica CPA - Consultant Gregory M. Kerwin Senior Partner Kerwin & Kerwin, Attorneys Theodore W. Mowery Partner Gunn-Mowery Insurance Group, Inc. 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 Earl R. Etzweiler Harvey J. Hummel Charles F. Lebo Warren A. Miller Anna C. Woodside Eugene F. Shaffer Chairman William G. Nelson 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 49Years Banking Experience Alan W. Dakey President and CEO 32Years Banking Experience Kevin W. Laudenslager Executive Vice President and Chief Financial Officer 21Years Banking Experience Eric S. Williams Executive Vice President and Senior Commercial Loan Officer 27Years Banking Experience Randall L. Klinger Senior Vice President and Senior Credit Officer 32Years Banking Experience Allen J. Trawitz Executive Vice President 37Years Banking Experience Leonard K. Beasom, Jr. Vice President and Commercial Loan Officer 34Years Banking Experience Donald J. Bonafede Vice President and Director of Equipment Leasing 23Years Banking Experience Kathy I. Bordner Vice President and Marketing Director 21 Years Banking Experience Roberta A. Hoffman, PHR Vice President, Human Resources Officer and Asst. Secretary 30 Years Banking Experience Michael T. Lehmer Vice President and Senior Trust Officer 15Years Banking Experience Eric D. Mummau Vice President and Commercial Loan Officer 26 Years Banking Experience 41 Brad N. Shaak Vice President, Consumer and Mortgage Lending Manager 19Years Banking Experience Steven S. Shuey Vice President and Loan Review Officer 32 Years Banking Experience Dennis E. Spotts Vice President and Operations Officer 33 Years Banking Experience Cindy L. Wetzel Vice President and Corporate Secretary 27Years Banking Experience Rick E. Witwer Vice President and Commercial Loan Officer 18Years Banking Experience CAPITAL AREA ADVISORY BOARD Mid Penn Bank Robert C. Grubic Norman K.A. Hoffer Norman L. Houser Theodore W. Mowery Robert M. Newbury David J. Remmel A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K Mid Penn Bancorp, Inc. LOCATIONS Locations Millersburg 717.692.2133 Elizabethville 717.362.8147 Dalmatia 570.758.2711 Tower City 717.647.2157 Lykens 717.453.7185 Halifax 717.896.8258 Dauphin 717.921.8899 Harrisburg 717.558.2144 Harrisburg 717.233.7380 Harrisburg 717.920.1772 Harrisburg 717.920.1980 Mechanicsburg 717.761.2480 A P R O G R E S S I V E , I N D E P E N D E N T C O M M U N I T Y B A N K