Dear Shareholders: I am pleased to present the 2006 Annual Report for Mid Penn Bancorp, Inc. The year was one of strong growth in assets and favorable growth in earnings when taking into consideration the challenging interest rate environment for financial institutions. Net income for the year of $4,888,000 increased from $4,603,000 the prior year. On a per share basis, net income increased by 7% to $1.46 for 2006 compared to $1.37 for 2005. The increase in income was primarily attributable to a strong improvement in net interest income, which increased $1,745,000 or 12.7% from the prior year. Total assets at year end of $491 million increased by $53 million, a 12.2% growth rate. Asset growth was attributable to strong loan growth, with net loans increasing by 15% over the prior year. The acquisition of the Steelton and Middletown offices from Omega Bank, which were acquired in December of 2006, added $27 million in deposits and $16 million in loan balances. The growth in loans had a positive impact on the improvement in net interest income resulting from the higher earnings rate on loans compared to other investment alternatives. Your Bank continues to maintain strong capital ratios, well above regulatory requirements. Total capital of $39,085,000 at year end was 8% of total assets. Return on equity, a widely recognized performance indicator, was 12.93% in 2006, compared to 12.87% in 2005. 2006 ANNUAL REPORT LETTER TO OUR SHAREHOLDERS The past and future success of your Bank is dependent upon the quality of people managing and directing the Bank. Our positive performance in 2006 was the result of dedicated directors, managers and employees. I would like to recognize individuals who have been significant contributors to the success of Mid Penn Bancorp, Inc. Eugene F. Shaffer joined the Bank in 1969 and served as President and CEO until 1993 and as Chairman of the Board until his retirement in April of 2006. Mr. Shaffer contributed substantially to the growth and success of the bank during his 38 years of service to the Bank. William G. Nelson joined the Board of Directors in 1970 and served as a dedicated director and Vice Chairman of the Board until his retirement from the Board in April 2006, having provided 36 years of dedicated service. The contributions of these individuals were significant and appreciated by all those associated with the Bank. I would also like to pay tribute to Guy F. Bucher who passed away in July 2006, who served as a director from 1951 to 1980 with the former Farmers State Bank of Dalmatia, which merged with Mid Penn Bank in 1971. Looking forward to 2007, we are excited about the opening of our newly relocated Elizabethville office. This office bears the prototype design we plan to use for future new offices. We are looking to further branch expansion through the construction of an additional office in the Capital Region, as well as continuing to seek branch purchases that would allow us to grow our franchise and contribute to earnings. Thank you for your continuing support of Mid Penn Bancorp, Inc. Please consider Mid Penn Bank for all your banking needs. Why not bank with the Bank that you have invested in? 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. Sincerely, Alan W. Dakey Chairman, President and CEO NORTHERN REGION LOCATIONS Millersburg - 349 Union Street / Millersburg, PA 17061 • 717.692.2133 Elizabethville - 4642 State Route 209 / 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 Middletown - 1100 Spring Garden Drive / Middletown, PA 17057 • 717.985.0100 Steelton - 51 South Front Street / Steelton, PA 17113 • 717.939.1966 Member FDIC 2006 ANNUAL REPORTFINANCIAL HIGHLIGHTS 2006 ANNUAL REPORT COMMUNITY IS THE KEY TO A BRIGHT FUTURE G I V I N G B A C K T O O U R C O M M U N I T Y Mid Penn Bank knows that a strong community is the key to a bright future. A strong community stimulates small business growth, provides for home ownership possibilities, presents savings and investment options, creates new employment opportunities and enhances the quality of life for it’s members. Most importantly, a strong community reciprocates its successes. Because Mid Penn Bank’s investments flow back into the communities in which we serve, we are ensuring growth and enhancement of these communities and also growth for other businesses. Being able to give back to the community that has allowed Mid Penn Bank to prosper for more than 135 years is Mid Penn Bank’s reciprocal gift to the community that has embraced us for so many years. In July of 2006, Mid Penn Bank announced that it would be donating its historic Elizabethville building located at the square in Elizabethville to the Northern Dauphin County Revitalization Project (NDCRP). Mid Penn Bank is relocating the Elizabethville office in 2007 to a new building being constructed at 4642 State Route 209. While the new office will provide customers with much needed conveniences, the gift of our existing building will provide a new home and serve as central headquarters for the NDCRP. The NDCRP is very involved in new initiatives that will bring economic development, downtown revitalization, tourism and job training to the communities of the Northern Dauphin County region. Mid Penn Bank also partnered with the Federal Home Loan Bank of Pittsburgh (FHLBank) to provide $4.4 million in innovative financing to Cole Crest Rehab in Steelton, Dauphin County. The Housing and Redevelopment Authorities of Dauphin County (HACD) broke ground on the largest rehabilitation project in its history. The ground-breaking ceremony, held at Cole Crest apartments in the Borough of Steelton, provides affordable housing with low-cost funding provided to Mid Penn Bank by the FHLBank. Mid Penn Bank’s support of much-needed renovations is part of the Bank’s growing commitment to businesses and non-profits across Central Pennsylvania, as several communities are involved in major revitalization projects. Mid Penn Bank is one of four area banks participating in HACD’s Family Savings Account Program, which encourages lower-income families to save money and achieve financial self-sufficiency through regular deposits that are matched by the Commonwealth of PA. Mid Penn Bank donates to our local volunteer fire company and ambulance associations on an annual basis. The donations program has been in place for approximately 20 years, and over the years, the Bank has donated hundreds of thousands of dollars to these well-deserving organizations. The donation program is based on the relationship of the associations with the bank and the Bank’s earnings, which again allows the Bank’s successes to flow back into the community as a whole. Through these, and many other initiatives, Mid Penn Bank is extremely fortunate to be able to give back to the communities that have given us so much. While a strong community is the key to a bright future, we all have an obligation to do our part. B R A N C H L O C A T I O N S S E R V I N G C E N T R A L P E N N S Y L V A N I A M I L E S T O N E S R E A C H E D EUGENE F. SHAFFER Congratulations to Eugene F. Shaffer, retired Chairman of Mid Penn Bancorp, Inc., who in 2006 was recognized by the Pennsylvania Bankers Association (PBA) for his fifty years in banking. Shaffer joined Mid Penn Bank in 1969 and served as President and CEO until 1993, then serving as Chairman of the Board until his retirement in April of 2006, with 38 years of valuable service to Mid Penn Bank. TA K I N G A L O O K AT O U R N E W E S T B R A N C H E S ELIZABETHVILLE BRANCH Our relocated Elizabethville office will open for business on February 26, 2007 at 4642 State Route 209, Elizabethville. The new office will provide increased convenience, security and parking for our customers. This new, functional office design will serve as the prototype for new offices as Mid Penn Bank pursues future expansion plans and site development opportunities. STEELTON BRANCH On December 4, 2006, Mid Penn Bank acquired the former Steelton office of Omega Bank. Mid Penn Bank is pleased to provide community banking to the residents of Steelton and the surrounding communities. We look forward to working with the community and the leaders of the “New Steelton,” as the borough continues its revitalization efforts. “An exciting future is just around the corner.” MIDDLETOWN BRANCH On December 4, 2006, Mid Penn Bank acquired the former Middletown office of Omega Bank. Mid Penn Bank is looking forward to providing the residents of Middletown and surrounding communities with the services of our local, independent bank, which has been serving neighbors and friends since 1868. With the acquisition of the two former Omega branches, Mid Penn Bank has reached a new milestone as well, with 14 offices throughout central Pennsylvania to serve our customers. G I V I N G B A C K T O O U R C O M M U N I T Y Mid Penn Bank knows that a strong community is the key to a bright future. A strong community stimulates small business growth, provides for home ownership possibilities, presents savings and investment options, creates new employment opportunities and enhances the quality of life for it’s members. Most importantly, a strong community reciprocates its successes. Because Mid Penn Bank’s investments flow back into the communities in which we serve, we are ensuring growth and enhancement of these communities and also growth for other businesses. Being able to give back to the community that has allowed Mid Penn Bank to prosper for more than 135 years is Mid Penn Bank’s reciprocal gift to the community that has embraced us for so many years. In July of 2006, Mid Penn Bank announced that it would be donating its historic Elizabethville building located at the square in Elizabethville to the Northern Dauphin County Revitalization Project (NDCRP). Mid Penn Bank is relocating the Elizabethville office in 2007 to a new building being constructed at 4642 State Route 209. While the new office will provide customers with much needed conveniences, the gift of our existing building will provide a new home and serve as central headquarters for the NDCRP. The NDCRP is very involved in new initiatives that will bring economic development, downtown revitalization, tourism and job training to the communities of the Northern Dauphin County region. Mid Penn Bank also partnered with the Federal Home Loan Bank of Pittsburgh (FHLBank) to provide $4.4 million in innovative financing to Cole Crest Rehab in Steelton, Dauphin County. The Housing and Redevelopment Authorities of Dauphin County (HACD) broke ground on the largest rehabilitation project in its history. The ground-breaking ceremony, held at Cole Crest apartments in the Borough of Steelton, provides affordable housing with low-cost funding provided to Mid Penn Bank by the FHLBank. Mid Penn Bank’s support of much-needed renovations is part of the Bank’s growing commitment to businesses and non-profits across Central Pennsylvania, as several communities are involved in major revitalization projects. Mid Penn Bank is one of four area banks participating in HACD’s Family Savings Account Program, which encourages lower-income families to save money and achieve financial self-sufficiency through regular deposits that are matched by the Commonwealth of PA. Mid Penn Bank donates to our local volunteer fire company and ambulance associations on an annual basis. The donations program has been in place for approximately 20 years, and over the years, the Bank has donated hundreds of thousands of dollars to these well-deserving organizations. The donation program is based on the relationship of the associations with the bank and the Bank’s earnings, which again allows the Bank’s successes to flow back into the community as a whole. Through these, and many other initiatives, Mid Penn Bank is extremely fortunate to be able to give back to the communities that have given us so much. While a strong community is the key to a bright future, we all have an obligation to do our part. B R A N C H L O C A T I O N S S E R V I N G C E N T R A L P E N N S Y L V A N I A M I L E S T O N E S R E A C H E D EUGENE F. SHAFFER Congratulations to Eugene F. Shaffer, retired Chairman of Mid Penn Bancorp, Inc., who in 2006 was recognized by the Pennsylvania Bankers Association (PBA) for his fifty years in banking. Shaffer joined Mid Penn Bank in 1969 and served as President and CEO until 1993, then serving as Chairman of the Board until his retirement in April of 2006, with 38 years of valuable service to Mid Penn Bank. TA K I N G A L O O K AT O U R N E W E S T B R A N C H E S ELIZABETHVILLE BRANCH Our relocated Elizabethville office will open for business on February 26, 2007 at 4642 State Route 209, Elizabethville. The new office will provide increased convenience, security and parking for our customers. This new, functional office design will serve as the prototype for new offices as Mid Penn Bank pursues future expansion plans and site development opportunities. STEELTON BRANCH On December 4, 2006, Mid Penn Bank acquired the former Steelton office of Omega Bank. Mid Penn Bank is pleased to provide community banking to the residents of Steelton and the surrounding communities. We look forward to working with the community and the leaders of the “New Steelton,” as the borough continues its revitalization efforts. “An exciting future is just around the corner.” MIDDLETOWN BRANCH On December 4, 2006, Mid Penn Bank acquired the former Middletown office of Omega Bank. Mid Penn Bank is looking forward to providing the residents of Middletown and surrounding communities with the services of our local, independent bank, which has been serving neighbors and friends since 1868. With the acquisition of the two former Omega branches, Mid Penn Bank has reached a new milestone as well, with 14 offices throughout central Pennsylvania to serve our customers. Dear Shareholders: I am pleased to present the 2006 Annual Report for Mid Penn Bancorp, Inc. The year was one of strong growth in assets and favorable growth in earnings when taking into consideration the challenging interest rate environment for financial institutions. Net income for the year of $4,888,000 increased from $4,603,000 the prior year. On a per share basis, net income increased by 7% to $1.46 for 2006 compared to $1.37 for 2005. The increase in income was primarily attributable to a strong improvement in net interest income, which increased $1,745,000 or 12.7% from the prior year. Total assets at year end of $491 million increased by $53 million, a 12.2% growth rate. Asset growth was attributable to strong loan growth, with net loans increasing by 15% over the prior year. The acquisition of the Steelton and Middletown offices from Omega Bank, which were acquired in December of 2006, added $27 million in deposits and $16 million in loan balances. The growth in loans had a positive impact on the improvement in net interest income resulting from the higher earnings rate on loans compared to other investment alternatives. Your Bank continues to maintain strong capital ratios, well above regulatory requirements. Total capital of $39,085,000 at year end was 8% of total assets. Return on equity, a widely recognized performance indicator, was 12.93% in 2006, compared to 12.87% in 2005. 2006 ANNUAL REPORT LETTER TO OUR SHAREHOLDERS The past and future success of your Bank is dependent upon the quality of people managing and directing the Bank. Our positive performance in 2006 was the result of dedicated directors, managers and employees. I would like to recognize individuals who have been significant contributors to the success of Mid Penn Bancorp, Inc. Eugene F. Shaffer joined the Bank in 1969 and served as President and CEO until 1993 and as Chairman of the Board until his retirement in April of 2006. Mr. Shaffer contributed substantially to the growth and success of the bank during his 38 years of service to the Bank. William G. Nelson joined the Board of Directors in 1970 and served as a dedicated director and Vice Chairman of the Board until his retirement from the Board in April 2006, having provided 36 years of dedicated service. The contributions of these individuals were significant and appreciated by all those associated with the Bank. I would also like to pay tribute to Guy F. Bucher who passed away in July 2006, who served as a director from 1951 to 1980 with the former Farmers State Bank of Dalmatia, which merged with Mid Penn Bank in 1971. Looking forward to 2007, we are excited about the opening of our newly relocated Elizabethville office. This office bears the prototype design we plan to use for future new offices. We are looking to further branch expansion through the construction of an additional office in the Capital Region, as well as continuing to seek branch purchases that would allow us to grow our franchise and contribute to earnings. Thank you for your continuing support of Mid Penn Bancorp, Inc. Please consider Mid Penn Bank for all your banking needs. Why not bank with the Bank that you have invested in? 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. Sincerely, Alan W. Dakey Chairman, President and CEO NORTHERN REGION LOCATIONS Millersburg - 349 Union Street / Millersburg, PA 17061 • 717.692.2133 Elizabethville - 4642 State Route 209 / 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 Middletown - 1100 Spring Garden Drive / Middletown, PA 17057 • 717.985.0100 Steelton - 51 South Front Street / Steelton, PA 17113 • 717.939.1966 Member FDIC 2006 ANNUAL REPORTFINANCIAL HIGHLIGHTS 2006 ANNUAL REPORT COMMUNITY IS THE KEY TO A BRIGHT FUTURE G I V I N G B A C K T O O U R C O M M U N I T Y Mid Penn Bank knows that a strong community is the key to a bright future. A strong community stimulates small business growth, provides for home ownership possibilities, presents savings and investment options, creates new employment opportunities and enhances the quality of life for it’s members. Most importantly, a strong community reciprocates its successes. Because Mid Penn Bank’s investments flow back into the communities in which we serve, we are ensuring growth and enhancement of these communities and also growth for other businesses. Being able to give back to the community that has allowed Mid Penn Bank to prosper for more than 135 years is Mid Penn Bank’s reciprocal gift to the community that has embraced us for so many years. In July of 2006, Mid Penn Bank announced that it would be donating its historic Elizabethville building located at the square in Elizabethville to the Northern Dauphin County Revitalization Project (NDCRP). Mid Penn Bank is relocating the Elizabethville office in 2007 to a new building being constructed at 4642 State Route 209. While the new office will provide customers with much needed conveniences, the gift of our existing building will provide a new home and serve as central headquarters for the NDCRP. The NDCRP is very involved in new initiatives that will bring economic development, downtown revitalization, tourism and job training to the communities of the Northern Dauphin County region. Mid Penn Bank also partnered with the Federal Home Loan Bank of Pittsburgh (FHLBank) to provide $4.4 million in innovative financing to Cole Crest Rehab in Steelton, Dauphin County. The Housing and Redevelopment Authorities of Dauphin County (HACD) broke ground on the largest rehabilitation project in its history. The ground-breaking ceremony, held at Cole Crest apartments in the Borough of Steelton, provides affordable housing with low-cost funding provided to Mid Penn Bank by the FHLBank. Mid Penn Bank’s support of much-needed renovations is part of the Bank’s growing commitment to businesses and non-profits across Central Pennsylvania, as several communities are involved in major revitalization projects. Mid Penn Bank is one of four area banks participating in HACD’s Family Savings Account Program, which encourages lower-income families to save money and achieve financial self-sufficiency through regular deposits that are matched by the Commonwealth of PA. Mid Penn Bank donates to our local volunteer fire company and ambulance associations on an annual basis. The donations program has been in place for approximately 20 years, and over the years, the Bank has donated hundreds of thousands of dollars to these well-deserving organizations. The donation program is based on the relationship of the associations with the bank and the Bank’s earnings, which again allows the Bank’s successes to flow back into the community as a whole. Through these, and many other initiatives, Mid Penn Bank is extremely fortunate to be able to give back to the communities that have given us so much. While a strong community is the key to a bright future, we all have an obligation to do our part. B R A N C H L O C A T I O N S S E R V I N G C E N T R A L P E N N S Y L V A N I A M I L E S T O N E S R E A C H E D EUGENE F. SHAFFER Congratulations to Eugene F. Shaffer, retired Chairman of Mid Penn Bancorp, Inc., who in 2006 was recognized by the Pennsylvania Bankers Association (PBA) for his fifty years in banking. Shaffer joined Mid Penn Bank in 1969 and served as President and CEO until 1993, then serving as Chairman of the Board until his retirement in April of 2006, with 38 years of valuable service to Mid Penn Bank. TA K I N G A L O O K AT O U R N E W E S T B R A N C H E S ELIZABETHVILLE BRANCH Our relocated Elizabethville office will open for business on February 26, 2007 at 4642 State Route 209, Elizabethville. The new office will provide increased convenience, security and parking for our customers. This new, functional office design will serve as the prototype for new offices as Mid Penn Bank pursues future expansion plans and site development opportunities. STEELTON BRANCH On December 4, 2006, Mid Penn Bank acquired the former Steelton office of Omega Bank. Mid Penn Bank is pleased to provide community banking to the residents of Steelton and the surrounding communities. We look forward to working with the community and the leaders of the “New Steelton,” as the borough continues its revitalization efforts. “An exciting future is just around the corner.” MIDDLETOWN BRANCH On December 4, 2006, Mid Penn Bank acquired the former Middletown office of Omega Bank. Mid Penn Bank is looking forward to providing the residents of Middletown and surrounding communities with the services of our local, independent bank, which has been serving neighbors and friends since 1868. With the acquisition of the two former Omega branches, Mid Penn Bank has reached a new milestone as well, with 14 offices throughout central Pennsylvania to serve our customers. Dear Shareholders: I am pleased to present the 2006 Annual Report for Mid Penn Bancorp, Inc. The year was one of strong growth in assets and favorable growth in earnings when taking into consideration the challenging interest rate environment for financial institutions. Net income for the year of $4,888,000 increased from $4,603,000 the prior year. On a per share basis, net income increased by 7% to $1.46 for 2006 compared to $1.37 for 2005. The increase in income was primarily attributable to a strong improvement in net interest income, which increased $1,745,000 or 12.7% from the prior year. Total assets at year end of $491 million increased by $53 million, a 12.2% growth rate. Asset growth was attributable to strong loan growth, with net loans increasing by 15% over the prior year. The acquisition of the Steelton and Middletown offices from Omega Bank, which were acquired in December of 2006, added $27 million in deposits and $16 million in loan balances. The growth in loans had a positive impact on the improvement in net interest income resulting from the higher earnings rate on loans compared to other investment alternatives. Your Bank continues to maintain strong capital ratios, well above regulatory requirements. Total capital of $39,085,000 at year end was 8% of total assets. Return on equity, a widely recognized performance indicator, was 12.93% in 2006, compared to 12.87% in 2005. 2006 ANNUAL REPORT LETTER TO OUR SHAREHOLDERS The past and future success of your Bank is dependent upon the quality of people managing and directing the Bank. Our positive performance in 2006 was the result of dedicated directors, managers and employees. I would like to recognize individuals who have been significant contributors to the success of Mid Penn Bancorp, Inc. Eugene F. Shaffer joined the Bank in 1969 and served as President and CEO until 1993 and as Chairman of the Board until his retirement in April of 2006. Mr. Shaffer contributed substantially to the growth and success of the bank during his 38 years of service to the Bank. William G. Nelson joined the Board of Directors in 1970 and served as a dedicated director and Vice Chairman of the Board until his retirement from the Board in April 2006, having provided 36 years of dedicated service. The contributions of these individuals were significant and appreciated by all those associated with the Bank. I would also like to pay tribute to Guy F. Bucher who passed away in July 2006, who served as a director from 1951 to 1980 with the former Farmers State Bank of Dalmatia, which merged with Mid Penn Bank in 1971. Looking forward to 2007, we are excited about the opening of our newly relocated Elizabethville office. This office bears the prototype design we plan to use for future new offices. We are looking to further branch expansion through the construction of an additional office in the Capital Region, as well as continuing to seek branch purchases that would allow us to grow our franchise and contribute to earnings. Thank you for your continuing support of Mid Penn Bancorp, Inc. Please consider Mid Penn Bank for all your banking needs. Why not bank with the Bank that you have invested in? 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. Sincerely, Alan W. Dakey Chairman, President and CEO NORTHERN REGION LOCATIONS Millersburg - 349 Union Street / Millersburg, PA 17061 • 717.692.2133 Elizabethville - 4642 State Route 209 / 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 Middletown - 1100 Spring Garden Drive / Middletown, PA 17057 • 717.985.0100 Steelton - 51 South Front Street / Steelton, PA 17113 • 717.939.1966 Member FDIC 2006 ANNUAL REPORTFINANCIAL HIGHLIGHTS 2006 ANNUAL REPORT COMMUNITY IS THE KEY TO A BRIGHT FUTURE MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS 2 0 0 6 A N N U A L R E P O RT F I N A N C I A L H I G H L I G H T S 2 0 0 6 A N N U A L R E P O RT F I N A N C I A L H I G H L I G H T S 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 10-26 27-41 42-43 MID PENN BANCORP, INC. FFIINNAANNCCIIAALL HHIIGGHHLLIIGGHHTTSS AS OF AND FOR YEARS ENDED DECEMBER 31, 2006 AND 2005 (Dollars in thousands, except per share data.) Total Assets................................................................................................ Total Deposits............................................................................................. Net Loans and Leases................................................................................. 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 Assets to Total Assets............................................................. Mid Penn Bancorp, Inc. Stockholders' Information Market Value Per Share ................................................................. $ $ 2006 491,694 364,226 354,386 104,182 39,085 4,888 1.46 .80 11.68 12.93% 1.08% 3.82% 0.50% 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% Percent Change +12.23% +11.98% +15.01% -1.18% +6.03% +6.19% +6.57% 0.00% +6.09% +0.47% -1.82% +4.09% -34.21% 2006 2005 High 27.20 26.60 25.50 26.08 Low 25.00 24.30 23.00 23.90 High 27.70 25.40 27.00 25.85 Low 25.10 24.60 25.35 24.20 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, 2006, there were 1,068 registered stockholders. Dividends: A dividend of $.20 per share was paid during each quarter of 2006. Mid Penn Bancorp, Inc. plans to continue a quarterly dividend payable in February, May, August and November. Additionally, a 5% stock dividend was paid in February of 2006. 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 24, 2007, at 349 Union Street, Millersburg, Pennsylvania. Accounting, Auditing and Internal Control Complaints: able 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 avail- 2 MID PENN BANCORP, INC. UUNNAAUUDDIITTEEDD GGRRAAPPHHSS OOFF FFIINNAANNCCIIAALL DDAATTAA 490 480 470 460 450 440 430 420 410 400 390 380 370 360 5.2 5.1 5.0 4.9 4.8 4.7 4.6 4.5 4.4 4.3 4.2 4.1 12.0 11.5 11.0 10.5 10.0 9.5 9.0 8.5 8.0 7.5 7.0 6.5 491.7 438.1 403.3 373.5 363.3 02 03 04 05 06 4.89 4.62 4.60 4.50 4.37 02 03 04 05 06 11.68 11.16 11.01 10.51 10.53 ) S N O I L L I M N I ( S T E S S A L A T O T ) S N O I L L I M N I ( E M O C N I T E N ) S R A L L O D N I ( E R A H S R E P E U L A V K O O B 370 360 350 340 330 320 310 300 290 280 270 260 40.0 39.5 39.0 38.5 38.0 37.5 37.0 36.5 36.0 35.5 35.0 34.5 1.50 1.45 1.40 1.35 1.30 1.25 1.20 1.15 1.10 1.05 1.00 0.95 364.2 325.3 301.1 288.3 274.4 02 03 04 05 06 39.1 37.4 36.9 35.2 35.3 02 03 04 05 06 1.46 1.38 1.37 1.34 1.30 ) S N O I L L I M N I ( I S T S O P E D L A T O T ) S N O I L L I M N I ( I Y T U Q E R E D L O H K C O T S L A T O T ) S R A L L O D N I ( E R A H S R E P S G N N R A E I 02 03 04 05 06 02 03 04 05 06 3 MID PENN BANCORP, INC. RREEPPOORRTT OOFF IINNDDEEPPEENNDDEENNTT RREEGGIISSTTEERREEDD PPUUBBLLIICC AACCCCOOUUNNTTIINNGG FFIIRRMM 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, 2006 and 2005, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2006. 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 subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 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, 2006, based on criteria established in Internal Control - Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 26, 2007 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 26, 2007 4 MID PENN BANCORP, INC. CCOONNSSOOLLIIDDAATTEEDD BBAALLAANNCCEE SSHHEEEETT DECEMBER 31, 2006 AND 2005 (Dollars in thousands, except share data) 2006 2005 $ $ $ 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 and leases ........................................................................................... 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; 3,367,119 shares and 3,207,912 shares issued in 2006 and 2005, respectively ...................................................................... Additional paid-in capital ................................................................................................. Retained earnings .......................................................................................................... Accumulated other comprehensive income........................................................................ Treasury stock, at cost (23,038 and 19,056 shares at December 31, 2006 and 2005, respectively).................................................................. Stockholders' Equity, Net Total Liabilities and Stockholders' Equity $ The accompanying notes are an integral part of these consolidated financial statements. 9,498 46,921 57,261 360,336 (1,763) (4,187) 354,386 9,562 146 2,822 1,610 1,016 428 7,154 890 491,694 44,097 32,978 59,640 25,397 202,114 364,226 24,275 1,912 2,483 59,713 452,609 3,367 27,452 8,583 317 (634) 39,085 491,694 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 5 MID PENN BANCORP, INC. CCOONNSSOOLLIIDDAATTEEDD SSTTAATTEEMMEENNTT OOFF IINNCCOOMMEE FOR YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004 (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 .......................................................... Gain on sale of other real estate...................................................................... 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 ...................................................................... Early withdrawal penalty on investment CDs ...................................................... Marketing and advertising............................................................................... Debit card processing expense ....................................................................... Director fees and benefits expense.................................................................. Other expenses ............................................................................................ Total Noninterest Expense 2006 2005 2004 $ 23,455 2,225 1,032 1,287 186 29 28,214 8,868 686 3,178 12,732 15,482 735 14,747 258 1,376 33 0 219 112 271 104 655 3,028 6,023 622 838 286 733 191 255 129 241 1,945 11,263 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 56 702 2,953 5,662 594 734 259 540 0 298 154 221 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 0 725 3,457 4,918 456 631 265 457 0 185 214 196 1,708 9,030 INCOME BEFORE PROVISION FOR INCOME TAXES .................................................... Provision for income taxes ............................................................................. NET INCOME EARNINGS PER SHARE Weighted Average Number of Shares Outstanding 6,512 1,624 4,888 1.46 3,347,448 $ $ 6,203 1,600 4,603 1.37 3,348,299 5,774 1,405 4,369 1.30 3,348,310 Earnings per share information has been restated to reflect the retroactive effect of a five percent stock dividend issued in the first quarter of 2006. The accompanying notes are an integral part of these consolidated financial statements. 6 MID PENN BANCORP, INC. CCOONNSSOOLLIIDDAATTEEDD SSTTAATTEEMMEENNTT OOFF SSTTOOCCKKHHOOLLDDEERRSS’’ EEQQUUIITTYY FOR YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004 (Dollars in thousands, except share data) Balance, December 31, 2003 .................................................................. 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 ($1.80 per share)......................................................... Sale of treasury stock (322 shares) ...................................................... Common Stock 3,208 Additional Paid-in Capital 23,472 Accumulated Other Retained Earnings 9,805 Comprehensive Treasury Income (Loss) 1,415 Stock (539) 0 0 0 0 0 0 0 0 4,369 0 0 (722) (5,739) 0 0 0 0 0 0 3 Total 37,361 4,369 (722) 3,647 (5,739) 3 Balance, December 31, 2004................................................................... 3,208 23,472 8,435 693 (536) 35,272 Comprehensive income: Net income ................................................................................... Change in net unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax effects .......................................................... Total comprehensive income Cash dividends ($ .80 per share) ......................................................... 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................................................................... Comprehensive income: Net income ................................................................................... Change in net unrealized gain (loss) on securities available for sale, net of reclassification adjustment and tax effects .......................................................... Adjustments to initially apply FASB Statement No. 158, net of tax Net transition obligation ......................................................... Net gain .............................................................................. Total comprehensive income Cash dividends ($ .80 per share) ......................................................... Stock dividend 5% issued February 2006 ............................................. Purchase of treasury stock (3,982 shares)............................................. 3,208 23,472 10,486 231 (536) 36,861 0 0 0 0 0 0 0 0 4,888 0 0 0 0 159 0 0 3,980 0 (2,652) (4,139) 0 0 60 (58) 84 0 0 0 0 0 0 0 0 0 (98) 4,888 60 (58) 84 4,974 (2,652) 0 (98) Balance, December 31, 2006................................................................... $ 3,367 27,452 8,583 317 (634) 39,085 The accompanying notes are an integral part of these consolidated financial statements. 7 MID PENN BANCORP, INC. CCOONNSSOOLLIIDDAATTEEDD SSTTAATTEEMMEENNTT OOFF CCAASSHH FFLLOOWWSS FOR YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004 (Dollars in thousands) Operating Activities: 2006 Net income ....................................................................................................... Adjustments to reconcile net income to net cash $ 4,888 provided by operating activities: 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 ............................................................................... (Gain) 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 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 increase (decrease) in short-term borrowings.................................................... Cash dividends paid ............................................................................................ Long-term debt repayment .................................................................................. (Purchase) sale of treasury stock........................................................................... Long-term borrowings......................................................................................... Net Cash Provided By Financing Activities Net increase (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 ............................................................ $ $ $ $ $ 735 638 39 (219) (33) (104) 0 (9) (262) (464) (25) 266 241 5,691 7,628 5,546 1,923 (13,728) (533) 7,100 0 (31,011) 13 (1,044) 746 0 (23,360) 11,759 11,933 (2,652) (10,125) (98) 10,000 20,817 3,148 6,350 9,498 12,355 1,910 309 330 8 2005 4,603 225 579 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 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 MID PENN BANCORP, INC. CCOONNSSOOLLIIDDAATTEEDD SSTTAATTEEMMEENNTT OOFF CCAASSHH FFLLOOWWSS Business Combination: (Dollars in thousands) Investing Activities: 2006 2005 2004 Cash received from business combination ............................................................. $ 7,100 $ Supplemental Noncash Disclosures: Noncash Assets Received and Liabilities Assumed from Acquisition of Branches Assets received: Loans ..................................................................................................... Accrued Interest receivable ......................................................................... Bank premises and equipment .................................................................... Intangible asset - core deposit intangible ...................................................... Intangible asset - goodwill .......................................................................... Other assets ............................................................................................. Total noncash assets received.......................................................................... Liabilities assumed: Deposits................................................................................................... Accrued interest payable ............................................................................ Other liabilities........................................................................................... Total noncash liabilities assumed ...................................................................... $ $ $ 16,307 89 2,826 232 757 14 20,225 27,193 111 21 27,325 $ The accompanying notes are an integral part of these consolidated financial statements. - - - - - - - - - - - - $ 4,139 2,483 - - 291 259 21 3,054 7,193 - - 7,193 $ $ 9 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS (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. 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 provides a full range of trust The financial services are provided to individuals, partnerships, non-profit organizations and corporations through its fourteen offices located in 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 (b) Investment Securities Available-for-Sale Securities - includes 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 2006 or 2005. (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. 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. 10 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS 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 disposals are reflected in current operations. (f) Foreclosed Assets Held for Sale Foreclosed assets held for sale consist primarily 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 disposal 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. (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. The core deposit intangible is subject to impairment testing whenever events or changes in circumstances indicate its carrying amount may not be recoverable. (i) Goodwill Goodwill is the excess of the purchase price over the fair value of assets acquired in connection with 2004 and 2006 business acquisitions accounted for as purchases. Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” requires a two-step process for testing the impair- ment of goodwill on at least an annual basis. No impairment of goodwill was recognized in 2004, 2005 or 2006. (j) Marketing and Advertising Costs Marketing and advertising costs are expensed as incurred and were $255,000 in 2006, $298,000 in 2005, and $185,000 in 2004. (k) Pensions and Other Postretirement Benefit Plans MPB has adopted Statement of Financial Accounting Standards No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits” (“Revised SFAS No. 132”). Revised SFAS No. 132 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. (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 present- ed 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. 11 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS (4) Adoption of New Accounting Principle Effective December 31, 2006, MPB adopted Financial Accounting Standards Board (FASB), Statement of Financial Accounting Standards (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. SFAS No. 158 requires, among other things, that an employer measure the funded status of a defined benefit pension plan in its balance sheet. The funded status is measured as the difference between plan assets at fair value and the benefit obligation. For a pension plan, the benefit obligation is the projected benefit obligation; for any other postretirement benefit plan, it is the accumulated postretirement benefit obligation. Changes in the funded status will be recognized through a change in other comprehensive income in the year the change occurs. Amounts recognized in the balance sheet, including the gains or losses, prior service costs or application of SFAS No. 87, Employers’ Accounting for Pensions, are adjusted as they are subsequently rec- ognized as components of net periodic benefit costs pursuant to the recognition and measurement provisions of that statement. It also requires that an employer measure the funded status of a plan as of its balance sheet date for fiscal years ending after December 15, 2008. The adoption of SFAS No. 158 did not have a material effect on MPB’s financial statements. The incremental effect of applying SFAS No. 158 on individual line items in the consolidated balance sheet is as follows: (Dollars in thousands) Deferred income taxes........................................................................................................ Total Assets ............................................................................................................................ Other Liabilities .................................................................................................................. Total Liabilities ................................................................................................................... Accumulated other comprehensive income ............................................................................ Total stockholders’ equity .................................................................................................... $ Before application of Statement 158 Adjustments (14) $ 1,624 (14) 491,708 (40) 2,523 (40) 452,649 26 291 26 39,059 After application of Statement 158 $ 1,610 491,694 2,483 452,609 317 39,085 The estimated net gain and transition obligation expected to be recognized in net periodic benefit cost in the upcoming fiscal year for the plans are as follows: (Dollars in thousands) Defined Benefit Pension Plan ........................................................................................... Postretirement Life and Health Plan................................................................................... Total ............................................................................................................................. Net Gain $ $ - 3 3 $ $ (5) Comprehensive Income The components of other comprehensive income (loss) and related tax effects are as follows: (Dollars in thousands) Years Ended December 31, 2006 2005 Change in unrealized holding gains (losses) on available-for-sale securities ........................................................................................................................ Less reclassification adjustment for gains realized in income........................................................ Net unrealized (losses) gains................................................................................................... Other comprehensive income related to SFAS No. 158.............................................................. Income tax benefit (expense) .................................................................................................. ................................................................................................................................. Net $ $ 123 (33) 90 40 (44) 86 (699) (1) (700) 0 238 (462) Transition obligation - (15) (15) 2004 (619) (475) (1,094) 0 372 (722) (6) 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 $512,000 at December 31, 2006 and $480,000 at December 31, 2005. Deposits with each financial institution are insured up to $100,000. (7) Investment Securities At December 31, 2006 and 2005, amortized cost, fair value, and unrealized gains and losses on investment securities are as follows: (Dollars in Thousands) December 31, 2006 Available-for-sale securities: U.S. Treasury and U.S. Amortized Cost Unrealized Gains Unrealized Losses Fair Value government agencies .......................................................... Mortgage-backed U.S. ............................................................... government agencies ........................................................... State and political subdivision obligations .......................................................... Restricted equity securities.......................................................... $ $ 15,015 9,041 29,050 3,713 56,819 15 28 711 0 754 194 95 14 9 312 14,836 8,974 29,747 3,704 57,261 12 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS (Dollars in Thousands) December 31, 2005 Available-for-sale securities: U.S. Treasury and U.S. Amortized Cost Unrealized Gains Unrealized Losses Fair Value government agencies .......................................................... $ 14,999 Mortgage-backed U.S. government agencies ........................................................... State and political subdivision obligations .......................................................... Restricted equity securities.......................................................... 8,114 24,160 3,253 50,526 $ 0 6 847 0 853 305 150 35 11 501 14,694 7,970 24,972 3,242 50,878 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 and at December 31, 2005 and December 31, 2006 is reported at fair value. Investment securities having a fair value of $44,913,000 at December 31, 2006 and $36,385,000 at December 31, 2005, were pledged to secure public deposits and other borrowings. Gains from sales of investment securities amounted to $33,000 in 2006, $1,000 in 2005 and $475,000 in 2004. The proceeds from sales of investment secu- rities were $1,923,000 in 2006, $535,000 in 2005 and $17,195,000 in 2004. 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, 2006 and 2005. (Dollars in thousands) December 31, 2006 Available-for-sale securities: U.S. Treasury and U.S. Less Than 12 Months Unrealized Fair Losses Value 12 Months or More Unrealized Fair Losses Value Total Fair Value Unrealized Losses government agencies.............................................................. $ Mortgage-backed U.S. government agencies.............................................................. 0 0 State and political subdivision obligations ............................................................ Restricted equity securities .......................................................... Total temporarily impaired available-for-sale securities ................................ $ 1,954 0 1,954 0 0 5 0 5 13,806 194 13,806 194 5,822 1,293 241 21,162 95 9 9 307 5,822 3,247 241 23,116 95 14 9 312 (Dollars in thousands) December 31, 2005 Available-for-sale securities: U.S. Treasury and U.S. Less Than 12 Months Unrealized Fair Losses Value 12 Months or More Unrealized Fair Losses Value Total Fair Value Unrealized Losses government agencies.............................................................. $ 6,935 Mortgage-backed U.S. government agencies.............................................................. 4,082 State and political subdivision obligations ............................................................ Restricted equity securities .......................................................... Total temporarily impaired available-for-sale securities ................................ $ 2,684 0 13,701 64 66 32 0 162 7,759 241 14,694 3,637 268 238 11,902 84 3 11 339 7,719 2,952 238 25,603 305 150 35 11 501 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, 2006, the 30 debt securities with unrealized losses have depreciated 0.5% from its amortized cost basis. These securities are guaranteed by either the U.S. Government or other governmental agencies. These unrealized losses relate principally to current interest rates for similar types of securities. In analyzing 13 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS an issuer's financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer's 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, 2006: (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) .................................................. Restricted equity securities.................................................................................. December 31, 2006 Fair Value 2,451 10,702 17,623 13,807 44,583 Amortized Cost 2,455 10,722 17,323 13,566 44,066 9,041 3,713 56,820 8,974 3,704 57,261 $ $ December 31, 2005 Amortized Cost 220 11,917 15,022 12,002 39,161 8,112 3,253 50,526 Fair Value 222 11,861 15,375 12,208 39,666 7,970 3,242 50,878 (8) Loans A summary of loans at December 31, 2006 and 2005 is as follows: (Dollars in thousands) Commercial real estate, construction and land development.......................................................... $ Commercial, industrial and agricultural ....................................................................................... Real estate - residential ........................................................................................................... Consumer.............................................................................................................................. $ 2006 226,663 48,785 63,141 21,747 360,336 2005 219,385 31,368 44,688 17,982 313,423 Net unamortized loan fees and costs of $346,000 in 2006 and $350,000 in 2005 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 $6,058,000 at December 31, 2006 and $2,722,000 at December 31, 2005. New loans extended were $199,000 in 2006 and $814,000 in 2005. Outstanding credit to a new director in 2006 amounted to $3,289,000. Net payments on these loans equalled $152,000 during 2006 and $1,075,000 during 2005. 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. (9) Allowance for Loan and Lease Losses Changes in the allowance for loan and lease losses for the years 2006, 2005, and 2004 are summarized as follows: (Dollars in thousands) Balance, January 1................................................................................................................ Provision for loan losses ......................................................................................................... Loans charged off ................................................................................................................. Recoveries on loans charged off.............................................................................................. Balance, December 31 .......................................................................................................... $ $ 2006 3,704 735 (309) 57 4,187 2005 3,643 225 (199) 35 3,704 2004 2,992 725 (121) 47 3,643 The recorded investment in loans that are considered impaired amounted to $1,126,000 , $1,126,000 and $1,013,000 on December 31, 2006, December 31, 2005 and December 31, 2004, 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 $163,000 at December 31, 2006 and $150,000 at December 31, 2005. All impaired loans at the end of 2006 and 2005 had related allowances. The average balances of these loans amounted to approximately $1,739,000, $1,404,000 and $945,000 for the years 2006, 2005 and 2004, 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 2006, 2005 and 2004. (Dollars in thousands) Cash receipts applied to reduce principal balance ......................................................... Cash receipts recognized as interest income ................................................................ Total cash receipts.................................................................................................... 2006 563 2 565 $ $ 2005 23 15 38 2004 36 3 39 14 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS Loans which were past due 90 days or more for which interest continued to be accrued amounted to approximately $900,000 at December 31, 2006 and $1,002,000 at December 31, 2005. Total nonaccrual loans amounted to $1,235,000 at December 31, 2006 and $1,773,000 at December 31, 2005. The Bank has no commitments to loan additional funds to borrowers with impaired or nonaccrual loans. (10) Bank Premises and Equipment At December 31, 2006 and 2005, bank premises and equipment are as follows: (Dollars in thousands) Land ................................................................................................................... Buildings ................................................................................................................. Furniture and fixtures ................................................................................................ Leasehold improvements........................................................................................... Construction in progress............................................................................................ Less accumulated depreciation .................................................................................. Depreciation expense was $638,000 in 2006, $579,000 in 2005 and $475,000 in 2004. (11) Deposits 2006 2,466 7,169 6,368 133 (739) 16,875 (7,313) 9,562 $ $ 2005 1,823 5,172 5,881 133 0 13,009 (6,675) 6,334 At December 31, 2006 and 2005, time deposits in denominations of $100,000 or more amounted to $33,985,000 and $34,219,000, respectively. Interest expense on such certificates of deposit amounted to approximately $1,549,000, $1,036,000 and $830,000 for the years ended December 31, 2006, 2005 and 2004, respectively. Time deposits at December 31, 2006, mature as follows (in thousands): 2007, $22,080; 2008, $9,969; 2009, $895; 2010, $693; 2011, $348. Brokered deposits included in the deposit totals equalled $39,849,000 at December 31, 2006 and $30,338,000 at December 31, 2005. Deposits and other funds from related parties held by MPB at December 31, 2006 and 2005 amounted to approximately $5,736,000 and $5,430,000, respectively. (12) Short-term Borrowings Short-term borrowings as of December 31, 2006 and 2005 consisted of: (Dollars in thousands) Federal funds purchased .......................................................................................... Repurchase agreements .......................................................................................... Treasury, tax and loan notes ...................................................................................... 2006 14,500 9,175 600 24,275 $ $ 2005 5,000 6,899 443 12,342 The weighted average interest rate on total short-term borrowings outstanding was 4.91% at December 31, 2006 and 4.22% at December 31, 2005. 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 Bank also has unused lines of credit with several banks amounting to $24,687,297 at December 31, 2006. (13) 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, 2006 and 2005, the Bank had long-term debt in the amount of $59,713,000 and $59,838,000, respectively, consisting of: (Dollars in thousands) Loans matured 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 2011 at a rate of 5.13% .............................................................. 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 At December 31, 2006 2005 $ $ 0 5,000 15,000 17,000 10,000 5,000 3,500 4,122 91 59,713 10,000 5,000 15,000 12,000 10,000 0 3,500 4,245 93 59,838 15 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS The aggregate amounts of maturities of long-term debt subsequent to December 31, 2006 are $5,131,000 (2007), $15,138,000 (2008), $12,145,000 (2009), $10,152,000 (2010), $5,159,000 (2011), $11,988,000 thereafter. $6,561,014 of the Bank’s investments, and the bank’s mortgage loan portfolio are pledged to secure FHLB borrowings. (14) 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. 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 Medicare within the five year (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, 2006 and 2005 and a statement of the funded status at December 31, 2006 and 2005: (Dollars in thousands) Change in benefit obligations: Benefit obligations, January 1 .......................................................................................................... Service cost............................................................................................................................. Interest cost............................................................................................................................. Actuarial loss (gain)................................................................................................................... Benefit payments...................................................................................................................... Benefit obligations, December 31..................................................................................................... Change in fair value of plan assets: Fair value of plan assets, January 1.................................................................................................. Employer contributions .............................................................................................................. Benefit payments...................................................................................................................... Fair value of plan assets, December 31 ............................................................................................ (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, 2006 and 2005 is as follows: $ $ $ $ $ $ (Dollars in thousands) Accrued benefit liability.............................................................................................................. $ December 31, 2006 720 39 30 (146) (19) 624 0 19 (19) 0 December 31, 2006 (624) 0 0 (624) 2006 (624) 2005 646 43 36 16 (21) 720 0 21 (21) 0 2005 (720) 103 20 (597) 2005 (597) The accumulated benefit obligation for health and life insurance plans was $624,000 and $720,000 at December 31, 2006 and 2005, respectively. 16 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS The components of net periodic postretirement benefit cost for 2006, 2005 and 2004 are as follows: (Dollars in thousands) Service cost ............................................................................................................................. Interest cost ............................................................................................................................. Amortization of transition obligation.............................................................................................. Amortization of net (gain) ........................................................................................................... Net periodic postretirement benefit cost ....................................................................................... 2006 39 30 15 (4) 80 $ $ 2005 43 36 15 0 94 2004 38 31 15 0 84 Assumptions used in the measurement of MPB’s benefit obligations at December 31, 2006 and 2005 are as follows: Weighted-average assumptions: Discount rate.................................................................................................................. Rate of compensation increase ......................................................................................... 2006 5.75% 5.00% 2005 5.50% 5.00% Assumptions used in the measurement of MPB’s net periodic benefit cost for the years ended December 31, 2006, 2005 and 2004 are as follows: Weighted-average assumptions: Discount rate ........................................................................................................................... Rate of compensation increase................................................................................................... 5.50% 5.00% 5.75% 5.00% 6.00% 5.00% 2006 2005 2004 Assumed health care cost trend rates at December 31, 2006, 2005 and 2004 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 .......................................................................... 2006 9.00% 5.00% 2010 2005 9.00% 5.00% 2009 2004 10.00% 5.00% 2009 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 $19,725 to its postretirement benefit plans in 2007. Estimated Future Benefit Payments 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 12/31/2011 ...................................................................................................... 1/1/2012 to 12/31/2016 ...................................................................................................... $ $ Plan assets and benefit obligations were measured as of December 31, 2006 for the postretirement benefit plan. One-Percentage Point Increase 11 76 Decrease 9 64 19,725 19,444 24,967 20,316 21,772 218,231 A net gain of $122,698 and a net transition obligation of $88,363 represent the unrecognized components of accumulated other comprehensive income for the postretirement benefit plan at December 31, 2006. 17 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS 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, 2006 and 2005 and a statement of the funded status at December 31, 2006 and 2005: (Dollars in thousands) Change in benefit obligations: 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 ........................................................................................ (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, 2006 and 2005 are as follows: (Dollars in thousands) Accrued benefit liability ............................................................................................................. Intangible asset........................................................................................................................ Net amount recognized............................................................................................................. December 31, 2006 2005 716 19 37 (10) (11) (35) 716 2006 0 35 (35) 0 712 26 41 17 (57) (23) 716 2005 0 23 (23) 0 December 31, (716) 0 0 (716) (716) 0 17 (699) 2006 2005 (716) 0 (716) (716) 17 (699) $ $ $ $ $ $ $ $ The accumulated benefit obligation for the retirement plan was $716,000 at both December 31, 2006 and 2005. The components of net periodic retirement cost for 2006, 2005 and 2004 are as follows: (Dollars in thousands) Service cost ........................................................................................................................... Interest cost............................................................................................................................ Amortization of prior-service cost ............................................................................................... Net periodic retirement cost ...................................................................................................... 2006 20 37 0 57 $ $ 2005 26 41 26 93 2004 22 39 26 87 Assumptions used in the measurement of MPB’s benefit obligations at December 31, 2006 and 2005 are as follows: Weighted-average assumptions: Discount rate .......................................................................................................................... Change in consumer price index ............................................................................................... 2006 5.75% 3.25% 2005 5.50% 3.00% Assumptions used in the measurement of MPB’s net periodic benefit cost for the years ended December 31, 2006, 2005 and 2004 are as follows: Weighted-average assumptions: Discount rate .......................................................................................................................... Rate of compensation increase.................................................................................................. 5.50% 3.25% 5.75% 3.00% 6.00% 4.00% 2006 2005 2004 18 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS MPB expects to contribute $53,277 to its retirement plan in 2007. Estimated Future Benefit Payments 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 12/31/2011 ...................................................................................................... 1/1/2012 to 12/31/2016 ...................................................................................................... $ 53,277 59,752 59,232 58,497 57,531 323,969 Plan assets and benefit obligations were measured as of December 31, 2006 for the directors’ defined benefit plan. A net gain of $4,964 represents the unrecognized component of accumulated other comprehensive income for the director’s defined benefit plan at December 31, 2006. The Bank is the owner and beneficiary of insurance policies on the lives of certain officers and directors whichinformally fund the retirement plan obligation. The aggregate cash surrender value of these policies was $2,942,000 and $2,326,000 at December 31, 2006 and 2005, respectively. (15) 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 $251,000 for 2006, $277,000 for 2005 and $307,000 for 2004. (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 both December 31, 2006 and 2005, the Bank had accrued a liability of approximately $140,000 for this plan. The Bank also has a directors’ deferred compensation plan which allows directors to defer receipt of fees for a specified period in order to provide future retirement income. At December 31, 2006 and 2005, the Bank had accrued a liability of approximately $274,000 and $237,000, 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 $1,923,000 and $1,683,000 at December 31, 2006 and 2005, 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. 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, 2006 and 2005, the Bank has accrued a liability of approximately $232,000 and $195,000, respectively, for the Agreement. The expense related to the Agreement was $37,000 for 2006, $34,000 for 2005 and $32,000 for 2004. If the executive officer terminates employment before the normal retirement 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 $930,000 and $897,000 at December 31, 2006 and 2005, 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 2006, 2005 and 2004 was $94,000, $139,000 and $155,000, respectively. The ESOP held 40,461 and 36,160 shares of MPB stock as of December 31, 2006 and December 31, 2005, 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, 2006 and 2005, the Bank had Split Dollar Life Insurance arrangements with one existing and one former executive for which the aggregate collateral assignment and cash surrender values are approximately $1,550,000 and $1,496,000, respectively. 19 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS (16) Federal Income Taxes The following temporary differences gave rise to the net deferred tax asset at December 31, 2006 and 2005: (Dollars in thousands) Deferred tax assets: 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 ........................................................................................................ 2006 2005 $ $ $ $ $ $ 1,270 703 110 15 2,098 (149) (117) (42) (30) (150) (488) 1,610 2006 1,886 (262) 1,624 2006 2,214 (643) 66 (13) 1,624 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 2004 1,712 (307) 1,405 2004 1,963 (583) 34 (9) 1,405 (17) Business Combination On December 4, 2006, MPB consummated the purchase of assets and assumption of liabilities of the Middletown and Steelton offices of Omega Bank (“Omega Branches”). MPB approved this deal in order to increase market share in the Central Pennsylvania Area. The net receipt of cash from the Omega Branches was $7,100,000. The results of operations of these former Omega Branches 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 ................................................................................................................................... Accrued interest receivable ....................................................................................................... Property, plant and equipment ................................................................................................... Goodwill................................................................................................................................. Core deposit intangible............................................................................................................. Other assets ........................................................................................................................... Total Assets Acquired................................................................................................................ Deposits ................................................................................................................................. Accrued interest payable........................................................................................................... Other liabilities ......................................................................................................................... Total Liabilities Assumed ........................................................................................................... Net Liabilities Assumed ............................................................................................................. $ 2006 445 16,307 89 2,826 757 232 14 $ 20,670 $ 27,193 111 21 27,325 $ 6,655 20 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS Presented herein is certain unaudited pro forma information for 2006 as if the Omega Branches had been acquired on January 1, 2006 and for 2005 as if these former Omega Branches had been acquired on January 1, 2005. These results combine historical results of these former Omega Branches into MPB’s consoli- dated 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) Net interest income .................................................................................................................. Noninterest income .................................................................................................................. Noninterest expense ................................................................................................................. Net income ............................................................................................................................. Earnings per share ................................................................................................................... (18) Core Deposit Intangible A summary of core deposit intangible is as follows at December 31, 2006. Unaudited Pro forma for Year Ended December 31 2006 $ 15,852 3,220 11,505 5,208 1.55 2005 14,107 3,145 10,504 4,923 1.47 2004 12,442 3,649 9,272 4,689 1.40 (Dollars in thousands) Gross carrying amount.............................................................................................................. Less accumulated amortization................................................................. ................................ Net carrying amount ................................................................................................................ 2004 Acquisition 291 (93) 198 $ $ 2006 Acquisition 232 (2) 230 Total 523 (95) 428 The core deposit intangibles for the acquisitions are being amortized over the weighted average useful life of 8 years, with no estimated residual value. Amortization expense amounted to $39,000 in 2006 and $36,000 in 2005. The estimated amortization expense of intangible assets for each of the five succeeding fiscal years is $65,000 per year. (19) Regulatory Matters The Bank is subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. The regulations require the Bank to meet specific capital adequacy guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital classification is also subject to qualitative judgments by the regulators about compo- nents, 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, 2006: Tier I Capital (to Average Assets) ........................................... Tier I Capital (to Risk Weighted Assets) .................................. Total Capital (to Risk Weighted Assets) ................................... Actual: Amount Ratio $ 36,833 36,833 41,020 7.9% 9.4 10.5 As of December 31, 2005: 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 Capital Adequacy Minimum Capital Required: Amount 18,677 15,610 31,219 17,172 13,487 26,974 Ratio 4.0% 4.0 8.0 4.0% 4.0 8.0 To Be Well Capitalized Under Prompt Corrective Action Provisions: Ratio Amount 23,346 23,414 39,024 5.0% 6.0 10.0 21,465 20,231 33,718 5.0% 6.0 10.0 As of December 31, 2006, 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. 21 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS (20) 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 exten- sion 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, 2006, commitments to extend credit amounted to $70,630,000 and financial standby letters of credit amounted to $11,163,000. 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. As of December 31, 2006, 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 sec- tors amounted to $30,234,000 or 8.5% and $25,507,000 or 7.2%, respectively, of net loans outstanding as of December 31, 2006. (21) 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, 2006 for each of the next 4 years and in the aggregate are: 2007 .......................................................................................................................... 2008 .......................................................................................................................... 2009 .......................................................................................................................... 2010 .......................................................................................................................... $ $ 69,636 71,725 73,877 18,605 233,843 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. 22 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS (22) 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, 2006 and 2005 (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, 2006, 2005 and 2004 (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, 2006, 2005 and 2004 (Dollars in thousands) CASH FLOWS FROM OPERATING ACTIVITIES 2006 2005 277 38,808 39,085 39,719 (634) 39,085 273 36,588 36,861 37,397 (536) 36,861 2006 2005 2004 2,864 61 2,134 (171) 4,888 2,643 47 2,051 (138) 4,603 5,774 23 (1,361) (67) 4,369 2006 2005 2004 Net Income ............................................................................................................................. Undistributed Earnings of Subsidiaries ......................................................................................... Net Cash Provided By Operating Activities $ 4,888 (2,134) 2,754 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............................................................................................................... (2,652) (98) (2,750) 4 273 277 $ 4,603 (2,051) 2,552 (2,552) 0 (2,552) 0 273 273 4,369 1,361 5,730 (5,739) 3 (5,736) (6) 279 273 (23) 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. 23 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS Investment securities: As indicated in Note 7, estimated fair values of investment securities are based on quoted market prices, where If quoted market prices are not available, fair values are based on quoted market prices for comparable instruments, adjusted for differences between the applicable. 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. The following table summarizes the book value and fair value of financial instruments at December 31, 2006 and 2005. (Dollars in thousands) Financial assets: Cash and due from banks........................................................................................ Interest-bearing balances ......................................................................................... Investment securities ............................................................................................... Net loans............................................................................................................... $ December 31, 2006 Fair Book Value Value 9,498 9,498 46,921 46,921 57,261 57,261 355,155 354,386 (Dollars in thousands) Financial liabilities: Deposits................................................................................................................ Short-term borrowings............................................................................................. Accrued interest ..................................................................................................... Long-term debt...................................................................................................... Off-balance sheet financial instruments: December 31, 2006 Book Value $ 364,226 24,275 1,912 59,713 Fair Value 364,110 24,275 1,912 60,042 December 31, 2005 Book Value 6,350 54,549 50,878 308,133 Fair Value 6,350 54,549 50,878 306,157 December 31, 2005 Fair Book Value Value 324,461 325,274 12,342 12,342 1,535 1,535 59,829 59,838 Commitments to extend credit .................................................................................. Financial standby letters of credit............................................................................... $ 75,051 11,163 75,051 11,163 64,795 10,102 64,795 10,102 (24) 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. In September of 2005, Mid Penn Bancorp’s Board of Directors approved a Stock Repurchase Program under which the Corporation could buy back up to 250,000 shares of Mid Penn Bancorp Common Stock. Through December 31, 2006, 3,982 shares have been repurchased at an average price of $24.55 per share. 24 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS (25) Summary of Quarterly Consolidated Financial Data (Unaudited) The following table presents summarized quarterly financial data for 2006, 2005 and 2004. (Dollars in Thousands, Except Per Share Data) 2006 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 (Loss) on Sale of Other Real Estate.......................................................................... 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 (Credit) for Loan Losses................................................................................... Net Interest Income After Provision (Credit) 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 6,580 2,807 3,773 135 3,638 673 0 152 2,914 1,549 394 1,155 .34 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 June 30 6,962 3,071 3,891 225 3,666 741 0 0 2,895 1,512 395 1,117 .33 Sept. 30 7,104 3,290 3,814 75 3,739 723 33 (21) 2,785 1,689 447 1,242 .37 2005 Quarter Ended 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 Dec. 31 7,568 3,564 4,004 300 3,704 754 0 (27) 2,669 1,762 388 1,374 .42 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 25 MID PENN BANCORP, INC. NNOOTTEESS TTOO CCOONNSSOOLLIIDDAATTEEDD FFIINNAANNCCIIAALL SSTTAATTEEMMEENNTTSS (26) Subsequent Event On February 15, 2007, the Bank settled on a parcel of real estate for approximately $350,000 which the Bank has purchased for possible future use. (27) Recent Accounting Pronouncements In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), “Share-Based Payment” (“SFAS 123(R)”). SFAS 123(R) establishes standards for accounting for transactions in which an entity exchanges its equity instruments for goods or services. SFAS 123(R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS 123(R) requires that the fair value of such equity instruments be recognized as expense in the financial statements as services are performed. Prior to SFAS 123(R), only the pro forma disclosures of fair value were required. MPB did not have any share-based payment transactions therefore the adoption of SFAS 123(R) at the beginning of 2006 had no effect on MPB’s consolidated financial statements. In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), to establish a consistent framework for measuring fair value and expand disclosures on fair value measurements. The provisions of SFAS No. 157 are effective for fiscal year beginning after December 17, 2007 and are not expected to have a material effect on MPB’s consolidated financial statements. In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“Interpretation 48”). Interpretation 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement 109, “Accounting for Income Taxes.” Interpretation 48 is effective for fiscal years beginning after December 17, 2007. MPB does not expect the adoption of this pronouncement to have a material effect on its consolidated financial statements. In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments.” SFAS No. 155 permits fair value remeasurement for any hybrid financial instruments that contain an embedded derivative that otherwise would require bifurcation. As of December 31, 2006, MPB did not have any hybrid financial instruments subject to the fair value election under SFAS No. 155. This statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 2006. SFAS No. 156, Accounting for Servicing of Financial Assets - an amendment of SFAS No. 140 requires that all separately recognized servicing assets and liabilities be initially measured at fair value and permits (but does not require) subsequent measurement of servicing assets and liabilities at fair value. This statement is effective for fiscal years beginning after September 15, 2006. MPB has evaluated this statement and does not believe it will have a material effect on MPB’s consolidated financial statements. 26 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS 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 $4,888,000 for the year 2006, compared to $4,603,000 in 2005, which was an increase of $285,000 or 6.2%. This represents net income in 2006 of $1.46 per share compared to $1.37 per share in 2005 and $1.30 per share in 2004. Total assets of MPB continued to grow in 2006, reaching the level of $491,694,000, an increase of $53,584,000 or 12.2% over $438,110,000 at year end 2005. 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 12.93% in 2006, 12.87% in 2005 and 12.73% in 2004. Return on average assets (ROA), another performance indicator, was 1.08% in 2006, 1.10% in 2005 and 1.12% in 2004. The Bank’s tier one capital (to risk weighted assets) of $36,833,000 or 9.4% and total capital (to risk weighted assets) of $41,020,000 or 10.5% at December 31, 2006, 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. In early December, MPB completed the purchase of two Dauphin County branches of Omega Bank located at 51 South Front Street in Steelton and 1100 Spring Garden Drive in Middletown. This acquisition includes approximately $27 million in deposits and $16 million in loans and is expected to contribute positively to earnings in 2007. Steelton and Middletown are an excellent geographic fit for Mid Penn and for expanding our presence in Dauphin County, including further south into a market with attractive growth characteristics. Critical Accounting Policies 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 uncer- tainty in evaluating the level of the allowance required to cover credit losses inherent in the loan and lease portfolio and the material effect that such judgments 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 assump- tions, 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. In addition, the assumptions and estimates used in the internal 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. 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 2006 net interest income increased $1,745,000 or 12.7% as compared to an increase of $1,665,000 or 13.8% in 2005. The average balances, effective interest differential and interest yields for the years ended December 31, 2006, 2005 and 2004 and the components of net interest income, are presented in Table 1. A comparative presentation of the changes in net interest income for 2006 compared to 2005, and 2005 compared to 2004, 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 6.80% in 2006 from 6.10% in 2005. The yield on earning assets for 2004 was 5.66%. The change in the yield on earn- ing assets was due primarily to the upward movement of rates on new and maturing assets. The average “prime rate” for 2006 was 7.96% as compared to 6.19% for 2005 and 4.34% for 2004. Interest expense increased by $3,175,000 or 33.22% in 2006 as compared to $1,552,000 or 19.39% in 2005. Primarily resulting from the fluctuations in interest rates, the net interest margin, on a tax equivalent basis, in 2006 was 3.82% compared to 3.67% in 2005 and 3.48% in 2004. Management continues to closely monitor the net interest margin. 27 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS TABLE 1: AVERAGE BALANCES, EFFECTIVE INTEREST DIFFERENTIAL AND INTEREST YIELDS INCOME AND RATES ON A TAXABLE EQUIVALENT BASIS FOR YEAR ENDED DECEMBER 31, 2006 (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 $ 46,038 $ 2,225 $ $ 27,343 28,402 55,745 564 324,720 427,067 7,000 19,100 453,167 31,877 60,968 24,772 172,792 14,937 63,329 368,675 43,161 3,527 37,804 1,218 1,950 29 23,598 29,020 90 1,898 61 6,819 686 3,178 12,732 $ 453,167 $ 16,288 4.83% 4.45% 6.87% 5.14% 7.27% 6.80% 0.28% 3.11% 0.25% 3.95% 4.59% 5.02% 3.45% 6.80% 2.98% 3.82% 3.35% 28 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS 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, 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 $ 2,067 $ $ 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 35,779 893 1,561 53 19,427 24,001 58 1,073 69 5,321 203 2,833 9,557 $ 418,648 $ 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% 29 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS 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) 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: NOW Time Interest Bearing Deposits:.............................................. ............................................................................ Money Market ............................................................. Savings....................................................................... ............................................................................ 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 $ 66,750 $ 1,809 $ $ 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 33,527 599 1,948 7 16,449 20,812 61 442 77 5,044 137 2,244 8,005 $ 390,338 $ 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% 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 bal- ances include nonaccrual loans. Loan fees of $748,000, $492,000 and $448,000 are included with interest income in Table 1 for the years 2006, 2005 and 2004, respectively. 30 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS TABLE 2: VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME (Dollars in thousands) Taxable Equivalent Basis INTEREST INCOME: 2006 Compared to 2005 Increase (Decrease) Due to Change In: 2005 Compared to 2004 Increase (Decrease) Due to Change In: Volume Rate Net Volume 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 (447) 165 378 543 (35) 2,537 2,598 (1) 212 (8) 464 667 202 207 1,076 605 160 11 171 11 1,634 2,421 33 613 0 1,034 1,680 281 138 2,099 158 325 389 714 (24) 4,171 5,019 32 825 (8) 1,498 2,347 483 345 3,175 (217) 190 (271) (81) 26 1,959 1,687 (3) 56 (2) 192 243 (47) 782 978 Rate 475 104 (116) (12) 20 1,019 1,502 0 575 (6) 85 654 113 (193) 574 Net 258 294 (387) (93) 46 2,978 3,189 (3) 631 (8) 277 897 66 589 1,552 NET INTEREST INCOME ....................................................... $ 1,522 322 1,844 709 928 1,637 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 $735,000 provision in 2006 as well as a provision of $225,000 in 2005 and $725,000 in 2004. The allowance for loan and lease losses as a percentage of total loans was 1.17% at December 31, 2006, compared to 1.18% at December 31, 2005 and 1.30% at December 31, 2004, 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 2005 allowed the Bank to reduce its 2005 provision to $225,000. The loans purchased through the Omega merger approximately $16 million in total, were recorded in December 2006 at fair value with no related allowance for loan losses. Thus, these loans were not included in the adequacy model in December of 2006. A summary of charge-offs and recoveries of loans and leases is presented in Table 3. 31 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS 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 2006 3,704 17 158 0 134 309 0 3 0 54 57 Years ended December 31, 2004 2,992 2005 3,643 2003 3,051 32 29 0 138 199 0 12 0 23 35 25 10 8 78 121 0 8 0 39 47 171 140 0 98 409 0 14 0 46 60 Net charge-offs...................................................................................... Provision for loan and lease losses ........................................................... Balance, end of year............................................................................... $ 252 735 4,187 164 225 3,704 74 725 3,643 349 290 2,992 2002 2,856 41 113 0 148 302 17 0 0 55 72 230 425 3,051 Ratio of net charge-offs during the year to average loans outstanding during the year, net of unearned discount....................................................... Allowance for loan losses as a percentage .08% .06% .03% .14% .11% of total loans .................................................................................... 1.17% 1.18% 1.30% 1.28% 1.37% Noninterest Income During 2006, MPB earned $3,028,000 in noninterest income, compared to $2,953,000 earned in 2005 and $3,457,000 earned in 2004. Service charges on deposit accounts amounted to $1,376,000 for 2006, an increase of $28,000 or 2.1% compared to $1,348,000 for 2005, which was a decrease of $119,000 or 8.1% under 2004. 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. Investment security gains of $33,000 were realized in 2006. 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 of life insurance policies that informally provide funding for director retirement and salary continuation and deferred compensation plans. The income on these policies amounted to $219,000 during the year 2006, $222,000 in 2005 and $211,000 in 2004. Trust department income for 2006 was $258,000, a $54,000 or 17.3% decrease from $312,000 in 2005, which was a $64,000 or 25.8% increase from the $248,000 in 2004. Trust Department income can fluctuate from year to year, due to the number of estates being settled during the year. MPB also earned $112,000 in 2006, $70,000 in 2005 and $162,000 in 2004 in fees from the third-party seller of investments whose services the Bank has contracted. The decrease in investment services income during 2005 resulted from a vacancy in the investment representative position for more than six months. Other income amounted to $655,000 in 2006, $702,000 in 2005 and $725,000 in 2004. 32 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS Noninterest Expense A summary of the major components of noninterest expense for the years ended December 31, 2006, 2005 and 2004 is reflected in Table 4. Noninterest expense increased to $11,263,000 in 2006 from $10,262,000 in 2005 and $9,030,000 in 2004. The major component of noninterest expense is salaries and employee benefits. The number of full-time equivalent employees increased from 124 to 133 during 2006. Increases in the 2006 workforce included the purchase and addition of two Omega Bank branches. Early withdrawal penalties on investment CDs of $191,000 and recruiter fees of $94,000 contributed to the increase in noninterest expense. Another significant expense in 2006 was the continuing 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. 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............................................................................. Telephone ....................................................................................................... Loss on mortgage sales.................................................................................... Legal and professional services.......................................................................... Debit card processing ....................................................................................... Director fees and benefits.................................................................................. Computer software licensing and maintenance ..................................................... Early withdrawal penalty on investment CD’s......................................................... Other.............................................................................................................. Total Noninterest Expense Investments 2006 6,023 622 838 370 255 146 286 85 51 733 129 241 208 191 1,085 11,263 $ $ Years ended December 31, 2005 5,662 594 734 370 298 91 259 91 51 590 154 221 179 0 968 10,262 2004 4,918 456 631 308 185 0 265 86 66 505 214 196 170 0 1,030 9,030 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, 2006, SFAS No. 115 resulted in a contribution to shareholders’ equity of $291,000 (unrealized gain on securities of $441,000 less esti- mated income tax expense of $150,000). At December 31, 2005, SFAS No. 115 resulted in an increase in the unrealized gain included in other comprehensive income of $231,000 (unrealized gain on securities of $352,000 less estimated income tax expense of $121,000) compared to a December 31, 2004 increase in the unrealized gain included in other comprehensive income of $693,000 (unrealized gain on securities of $1,051,000, less estimated income tax expense of $357,000). MPB does not have any significant concentrations of investment securities. 33 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS 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 Loans 2006 15,015 9,041 29,050 3,713 56,819 $ $ December 31, 2005 14,999 8,112 24,162 3,253 50,526 2004 11,998 5,508 22,620 3,435 43,561 At December 31, 2006, net loans totaled $354,386,000, a $46,253,000 or 15.0% increase from December 31, 2005. During 2006, MPB experienced a net increase in commercial real estate and commercial/industrial loans of approximately $24,695,000, the majority of which was generated in the greater Capital (Harrisburg) Region. Approximately $16 million of this growth came from the purchase of the Omega Branches. The current environment in lending remains extremely competitive with financial institutions aggressively pursuing potential borrowers. At December 31, 2006, loans, net of unearned income, represented 76.1% of earning assets as compared to 73.7% on December 31, 2005 and 71.5% on December 31, 2004. 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 Hampden Township in 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. 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 2006 2005 December 31, 2004 2003 2002 Amount Percent of Loans Amount Percent of Loans Percent of Loans Amount Percent of Loans Percent of Loans Amount Amount $ 226,663 63.0% 219,385 70.0% 195,549 69.6% 154,296 66.5% 146,325 65.6% 48,785 63,141 21,747 360,336 (1,763) 13.5 17.5 6.0 100 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 discount..................... 358,573 311,837 279,547 232,078 221,353 Allowance for loan and lease losses ............... .............Net Loans (4,187) 354,386 $ (3,704) 308,133 (3,643) 275,904 (2,992) 229,086 (3,051) 218,302 34 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS 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 evaluated to estimate potential loss- In addition, loss estimates for each category of credit are provided based on Management's judgment which considers past experience, current economic conditions and es. other factors. For installment, real estate mortgages and other consumer loans, specific reserve allocations are based on past loss experience adjusted for recent port- folio 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 lending conditions, management trends and other factors. The 2006 provision of $735,000 reflects both an increase in net loan losses in 2006 and loan growth. It is comparable to the 2004 provision. The 2005 provision of $225,000 reflected the removal from the “watch list” of a significant loan relationship, thus reducing overall provisions in 2005. 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, 2006 was $4,187,000 or 1.17% of total loans less unearned discount as compared to $3,704,000 or 1.19% at December 31, 2005 and $3,643,000 or 1.30% at December 31, 2004. TABLE 7: ALLOCATION OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES (Dollars in thousands) Commercial real estate, construction and land development.................................................................... Commercial, industrial and agricultural .................................................. Real estate-residential ........................................................................ Consumer ........................................................................................ General ............................................................................................ Total Loans $ $ 2006 2005 2004 2003 2002 December 31, 2,462 1,515 54 124 32 4,187 2,037 1,481 52 110 24 3,704 2,368 1,093 65 83 34 3,643 1,938 954 20 65 15 2,992 1,898 922 56 147 28 3,051 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 deterioration in the financial condition of the borrower, payment in full of principal or interest is not expected. Loans past due 90 days or more and still accruing interest are loans that are generally well-secured and in the process of collection or repayment. Restructured loans are those loans whose terms have been modified to lower interest or principal pay- ments 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 residential mortgage loans past due 90 days or more at year-end was $586,000, $892,000 and $397,000 in 2006, 2005 and 2004, 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, 2006, totaled $2,434,000 or 0.50% of total assets compared to $3,317,000 or 0.76% of total assets in 2005 and $1,775,000 or 0.44% of total assets in 2004. The foreclosed assets held for sale at December 31, 2006, consist of two parcels of commercial real estate and one residential property. 35 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS TABLE 8: NONPERFORMING ASSETS (Dollars in thousands) December 31, Nonaccrual loans..................................................................... Past due 90 days or more ....................................................... Restructured loans................................................................... Total nonperforming loans Foreclosed assets held for sale ................................................. Total nonperforming assets $ $ Percent of loans outstanding..................................................... Percent of total assets.............................................................. 2006 1,293 995 0 2,288 146 2,434 0.68% 0.50% 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% 2003 984 666 0 1,650 1,117 2,767 1.18% 0.74% 2002 1,164 808 0 1,972 781 2,753 1.23% 0.76% 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, 2006 increased by $38,952,000 or 12.0% over December 31, 2005, which increased by $24,130,000 or 8.0% over December 31, 2004. Average balances and average interest rates applicable to the major classifications of deposits for the years ended December 31, 2006, 2005, and 2004 are presented in Table 9. Approximately $27 million of 2006 deposit growth was related to the purchase of two Omega Bank offices in Steelton and Middletown. Average short-term borrowings for 2006 were $14,937,000 as compared to $7,498,000 in 2005. These borrowings included customer repurchase agreements, treasury tax and loan option borrowings and federal funds purchased. Two five-million dollar borrowings, maturing March 2009 and February 2011, were entered into during 2006 with the FHLB. TABLE 9: DEPOSITS BY MAJOR CLASSIFICATION (Dollars in thousands) Noninterest-bearing demand deposits....................................... $ Interest-bearing demand deposits ............................................ Money market....................................................................... Savings................................................................................ ................................................................................ Time Total $ 2006 2005 2004 Years ended December 31, Average Balance 43,161 31,877 60,968 24,772 172,792 333,570 Average Rate 0.00% 0.28% 3.11% 0.25% 3.95% 2.66% 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% 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. Capital growth is achieved by retaining more in earnings than is paid out to our shareholders. Stockholders’ equity increased in 2006 by $2,224,000 or 6.0% and by $1,589,000 or 4.5% in 2005. In 2004, capital decreased by $2,089,000 or 5.6%, largely due to the $1 per share special dividend in the first quarter of 2004. MPB’s normal dividend payout allows for quarterly cash returns to its stockholders and provides earnings retention at a level sufficient to finance future growth. The dividend payout ratio, which represents the percentage of annual net income returned to the stockholders in the form of cash dividends, was 54% for 2006 compared to 55% for 2005 and 131% for 2004. At December 31, 2006, 23,038 shares of MPB’s common stock have been purchased back by MPB, held as treasury stock. 36 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS Federal Income Taxes Federal income tax expense for 2006 was $1,624,000 compared to $1,600,000 and $1,405,000 in 2005 and 2004, respectively. The effective tax rate was 25% for 2006, 26% for 2005 and 24% for 2004. 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 investments as a source of liquidity, along with deposit growth and increases in repurchase agreements and borrowings. 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 investments is provided primarily The major sources of cash in 2006 came from operations and a net increase in deposits of $11,795,000 (excluding the deposits of the purchased Omega offices), as well as an increase in short-term borrowings of $11,933,000. Other major sources of funds included a net decrease in interest-bearing balances (investment certificates of deposit of other banks), as well as the cash received of $7,100,000 through the Omega Branches purchase. The major use of cash in 2006 was funding strong loan demand. Net loans increased $46,253,000, including $16,307,000 in loans received as part of the Omega Branch acquisition. Another major use of funds was an increase in investment securities of $6,383,000, as funds were moved out of lower yielding interest-bearing balances. 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. 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. 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. 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 repricing in a 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. 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. 37 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS TABLE 10: INVESTMENT MATURITY AND YIELD (Dollars in thousands) December 31, 2006 U.S. Treasury and U.S.government agencies ............................................ State and political subdivision obligations ................................................ Mortgage-backed U.S. government agencies .......................................... Equity securities .................................................................................. Total $ $ Weighted Average Yields U.S. Treasury and U.S. government agencies ........................................... State and political subdivision obligations ................................................ Mortgage-backed U.S. government agencies........................................... Equity securities .................................................................................. Total One Year and Less 1,996 456 0 0 2,452 One Year and Less 4.54 6.03 0 0 4.82 After One Year thru Five Years 7,442 3,260 0 0 10,702 After One Year thru Five Years 4.27 7.05 0 0 5.10 After Five Years thru Ten Years 4,905 12,717 42 0 17,664 After Five Years thru Ten Years 4.18 6.89 6.51 0 6.10 After Ten Years 493 13,314 8,932 3,704 26,443 After Ten Years 5.00 6.34 4.94 4.77 5.63 Total 14,836 29,747 8,974 3,704 57,261 Total 4.28 6.66 4.95 4.77 5.64 TABLE 11: LOAN MATURITY AND INTEREST SENSITIVITY (Dollars in thousands) December 31, 2006 After One Year thru Five Years One Year and Less After Five Years Total Commercial, real estate, construction and land development .................................................................... $ 62,982 120,929 42,752 226,663 Commercial, industrial and agricultural .................................................................................... Real estate-residential mortgages .......................................................... Consumer .......................................................................................... Total Loans Rate Sensitivity Predetermined rate .............................................................................. Floating or adjustable rate..................................................................... Total TABLE 12: INTEREST RATE SENSITIVITY GAP $ $ $ 21,936 18,850 5,581 109,349 18,575 29,432 10,943 179,879 8,274 14,859 5,223 71,108 48,785 63,141 21,747 360,336 18,483 90,866 109,349 48,166 131,713 179,879 68,238 2,870 71,108 134,887 225,449 360,336 (Dollars in thousands) (As of December 31, 2006) Assets: 2007 2008 2009 2010 Expected Maturity Year Ended December 31, Thereafter 2011 Interest bearing balances......................... Average interest rate ......................... Debt securities ....................................... Average interest rate ......................... Adjustable rate loans............................... Average interest rate ......................... Fixed rate loans ..................................... Average interest rate ......................... ................................................Total $ $ 31,197 5.41 2,451 4.47 90,866 8.19 18,483 7.15 142,997 9,788 5.39 3,869 4.38 31,003 6.26 8,660 6.50 53,320 4,748 5.39 2,719 4.58 38,069 6.50 15,743 6.70 61,279 297 5.35 2,592 6.15 34,321 6.50 7,835 7.04 45,045 891 5.67 1,522 6.10 28,320 7.13 15,928 6.82 46,661 0 - 44,108 5.63 2,870 6.03 68,238 6.90 115,216 Total Fair Value 46,921 5.41 57,261 5.64 225,449 7.22 134,887 6.88 464,518 46,921 57,261 225,449 135,656 465,287 38 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS TABLE 12: INTEREST RATE SENSITIVITY GAP (cont’d) 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, 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 (Dollars in thousands) (As of December 31, 2005) 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 $ $ $ $ $ $ $ $ $ $ 74,236 2.81 102,971 4.18 24,275 4.91 5,131 3.71% 206,613 0 - 42,810 4.48 0 - 15,138 3.56 57,948 0 - 18,464 3.92 0 - 12,145 4.64 30,609 0 - 18,378 4.27 0 - 10,152 6.50 28,530 0 - 16,326 5.22 0 - 5,159 5.13 21,485 87,876 0.10 3,165 4.14 0 - 11,988 4.61 103,029 162,112 1.34 202,114 4.33 24,275 4.91 59,713 4.69 448,214 162,599 201,997 24,275 60,042 448,913 (63,616) (63,616) (4,628) (68,244) 30,670 (37,574) 16,515 (21,059) 25,176 4,117 12,187 16,304 -12.9% -13.9% -7.6% -4.3% +0.8% +3.3% 2006 2007 2008 2009 Expected Maturity Year Ended December 31, Thereafter 2010 41,178 4.04 220 7.71 92,091 7.33 11,646 6.65 145,135 396 4.50 2,550 4.90 19,688 6.65 10,183 6.46 32,817 5,843 3.76 4,895 3.90 42,182 6.25 7,578 6.75 60,498 7,033 3.92 1,725 4.03 28,758 6.22 8,054 6.59 45,570 99 4.40 2,747 6.11 34,203 6.52 6,510 6.77 43,559 0 - 38,389 5.35 5,534 5.80 46,996 6.47 90,919 Total Fair Value 54,549 4.00 50,526 5.45 222,456 6.76 90,967 6.55 418,498 54,549 50,878 222,456 88,991 416,874 2006 2007 2008 2009 Expected Maturity Year Ended December 31, Thereafter 2010 Total Fair Value 76,049 1.75 68,419 3.19 12,342 4.22 10,125 4.19 166,935 0 - 47,964 3.76 0 - 5,131 3.71 53,095 0 - 18,300 3.56 0 - 15,138 3.56 33,438 0 - 15,349 3.98 0 - 12,145 4.64 27,494 0 - 10,576 4.40 0 - 10,152 6.50 20,728 85,602 .10 3,015 3.92 0 - 7,147 4.61 95,764 161,651 .88 163,623 3.56 12,342 4.22 59,838 4.52 397,454 161,651 162,359 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 of total assets ........................................ -5.0% -9.6% -3.4% +0.7% +5.9% +4.8% 39 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS During 2006, 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, 2006, all interest rate risk levels accord- ing 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. tion, the table does not take into consideration changes which Management would make to realign its portfolio in the event of a changing rate environment. In addi- 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 2006 675 11,300 22,010 33,985 $ $ December 31, 2005 8,421 12,930 12,868 34,219 2004 7,431 6,771 13,681 27,883 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. 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, 2006, commitments to extend credit amounted to $70,630,000 as compared to $64,795,000 as of December 31, 2005. MPB also issues financial standby letters of credit to its customers. The risk associated with financial standby letters of credit is essentially the same as the credit risk involved in loan extensions to customers. Financial standby letters of credit increased to $11,163,000 at December 31, 2006, from $10,102,000 at December 31, 2005. 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 primarily of unrealized gains and losses on available-for-sale securities, net of deferred income tax. Other Comprehensive Income also includes a pension component in accordance with FASB Statement No. 158. 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 Income (Loss) for the years ended December 31, 2006, 2005 and 2004 was $86,000, $(462,000) and $(722,000), respectively. 40 MID PENN BANCORP, INC. MMAANNAAGGEEMMEENNTT’’SS DDIISSCCUUSSSSIIOONN AANNDD AANNAALLYYSSIISS (Dollars in thousands, except per share data) Summary of Selected Financial Data 2006 2005 2004 2003 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 .............................................................. 28,214 12,732 15,482 735 3,028 11,263 6,512 1,624 4,888 1.46 .80 11.68 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 2002 21,352 9,926 11,426 425 2,022 7,258 5,765 1,270 4,495 1.34 .80 10.51 AVERAGE SHARES OUTSTANDING............................................... 3,346,102 3,348,299 3,348,310 3,347,929 3,347,750 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 .............................................................. $ 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 ................................................................ 46,921 358,612 4,187 491,694 364,226 24,275 59,713 39,085 1.08 12.93 54.79 1.17 8.34 54,549 311,837 3,704 438,110 325,274 12,342 59,838 36,861 1.10 12.87 55.56 1.19 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 1.32 13.60 54.05 1.38 9.67 41 MID PENN BANCORP, INC. LLIISSTT OOFF DDIIRREECCTTOORRSS AANNDD OOFFFFIICCEERRSS AASS OOFF 1122//3311//0066 DIRECTORS EXECUTIVE OFFICERS Ernest P. Kemper, Jr. Mid Penn Bancorp, Inc. Mid Penn Bancorp, Inc. Vice President and Chief Information Officer 26 Years Banking Experience Michael T. Lehmer Vice President and Senior Trust Officer 16 Years Banking Experience John F. Lydic Vice President and Retail Division Manager 25 Years Banking Experience Robert E. McDonald Vice President and Commercial Lending Team Leader 23 Years Banking Experience Eric D. Mummau Vice President and Commercial Loan Officer 27 Years Banking Experience Brad N. Shaak Vice President, Consumer and Mortgage Lending Manager 20 Years Banking Experience Steven S. Shuey Vice President and Loan Review Officer 33 Years Banking Experience Dennis E. Spotts Vice President and Operations Officer 34 Years Banking Experience Cindy L. Wetzel Vice President and Corporate Secretary 28 Years Banking Experience Rick E. Witwer Vice President and Commercial Loan Officer 19 Years Banking Experience 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 Robert C. Grubic President & CEO Herbert, Rowland and Grubic, Inc. Gregory M. Kerwin Senior Partner Kerwin & Kerwin, Attorneys Theodore W. Mowery Partner Gunn-Mowery Insurance Group, Inc. Donald E. Sauve Consultant Don’s Food Market, Inc. Edwin D. Schlegel Retired Superintendent Millersburg Area School District Guy J. Snyder, Jr. President Snyder Fuels, Inc. William A. Specht, III President Seal Glove Mfg, Inc. DIRECTORS EMERITI Earl R. Etzweiler Harvey J. Hummel Charles F. Lebo Warren A. Miller William G. Nelson Eugene F. Shaffer Anna C. Woodside 42 Alan W. Dakey Chairman, President and CEO Edwin D. Schlegel Vice Chairman and Lead Director Kevin W. Laudenslager Treasurer Cindy L. Wetzel Secretary SENIOR MANAGEMENT Mid Penn Bank Alan W. Dakey Chairman, President and CEO 33 Years Banking Experience Kevin W. Laudenslager Executive Vice President and Chief Financial Officer 22 Years Banking Experience Eric S. Williams Executive Vice President and Senior Commercial Loan Officer 28 Years Banking Experience Randall L. Klinger Senior Vice President and Senior Credit Officer 33 Years Banking Experience Leonard K. Beasom, Jr. Vice President and Commercial Loan Officer 35 Years Banking Experience Donald J. Bonafede Vice President and Director of Equipment Leasing 24 Years Banking Experience Kathy I. Bordner Vice President and Marketing Director 22 Years Banking Experience Roberta A. Hoffman, PHR Vice President, Human Resources Officer and Asst. Secretary 31 Years Banking Experience MID PENN BANCORP, INC. LLIISSTT OOFF AADDVVIISSOORRYY BBOOAARRDD MMEEMMBBEERRSS AASS OOFF 1122//3311//0066 ADVISORY BOARD MEMBERS Mid Penn Bank Capital Region: Northern Region Stanford D. Custer, Jr. Custer Homes, Inc. Robert C. Grubic Herbert, Rowland & Grubic Norman L. Houser Retired, Mid Penn Bank Theodore W. Mowery Gun-Mowery Insurance Michael G. Musser II Steelton Borough Secretary/Treasurer Robert M. Newbury RM Newbury & Co Dale R. Schwan Environmental Interiors, Inc. Matthew G. DeSoto MI Windows and Doors James S. Facinelli Restorations Unlimited, Inc. Linda J. Faust Faust Real Estate Dane P. Harman Harman Stove Co. Robert E. Klinger Klinger Lumber Co, Inc. Dixie L. Laudenslager Mahantongo Game Farms Dr. David R. Russell Dr. David R. Russell, DMD, PC Kent S. Smeltz Advanced Scientifics, Inc. Carl E. Snyder Century 21- Carl Sndyer Thomas E. Troutman Keystone Insurers Group 43 MID PENN BANCORP, INC. LLOOCCAATTIIOONNSS 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 Steelton 717.939.1966 Middletown 717.985.0100 44 w w w. m i d p e n n b a n k . c o m