The disclosures set forth in this
Item are qualified by the section captioned Special Cautionary Notice Regarding Forward-Looking Statements contained in Part II, Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations of
this report and other cautionary statements set forth elsewhere in this report.
Mid Penn Bancorp, Inc.
Mid Penn Bancorp, Inc. is a one-bank holding company, incorporated in the Commonwealth of Pennsylvania in August 1991. On December 31, 1991, MPB
acquired, as part of the holding company formation, all of the outstanding common stock of Mid Penn Bank, and the Bank became a wholly owned subsidiary of MPB. MPBs other wholly owned subsidiaries are Mid Penn Insurance Services, LLC, which
provides a range of personal and investment insurance products and Mid Penn Investment Corporation, which is engaged in investing activities. Mid Penn Bancorp, Inc. and its wholly owned subsidiaries are collectively referred to herein as
MPB or the Company. MPBs primary business is to supervise and coordinate the business of its subsidiaries and to provide them with capital and resources.
MPBs consolidated financial condition and results of operations consist almost entirely of that of Mid Penn Bank, which is managed as a single
business segment. At December 31, 2007, MPB had total consolidated assets of $509,757,000 total deposits of $372,817,000 and total shareholders equity of $40,444,000.
As of December 31, 2007, Mid Penn Bancorp, Inc. did not own or lease any properties. Mid Penn Bank owns the banking offices identified in
Item 2. All MPB employees are employed by Mid Penn Bank, Mid Penn Insurance Services, LLC or Mid Penn Investment Corporation.
Mid Penn Bank
Millersburg Bank, the predecessor to Mid Penn Bank (the Bank), was organized in 1868, and became a state chartered bank in
1931, obtaining trust powers in 1935, at which time its name was changed to Millersburg Trust Company. In 1962, the Lykens Valley Bank merged with and into Millersburg Trust Company. In 1971, Farmers State Bank of Dalmatia merged with
Millersburg Trust Company and the resulting entity adopted the name Mid Penn Bank. In 1985, the Bank acquired Tower City National Bank. In 1998, MPB acquired Miners Bank of Lykens, which was merged into Mid Penn Bank. The Bank is
supervised by the Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation. MPBs and the Banks legal headquarters are located at 349 Union Street, Millersburg, Pennsylvania 17061. The Bank presently has 15 offices
located throughout Dauphin, Northumberland, Schuylkill, and Cumberland Counties, Pennsylvania.
MPBs primary business consists of
attracting deposits from its network of community banking offices operated by the Bank. The Bank engages in 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, personal loans, mortgage and home equity loans, secured and unsecured commercial and consumer loans, lines of credit, construction financing, farm loans, community development and local government loans and various
types of time and demand deposits. Deposits of the Bank are insured by the Bank Insurance Fund of the FDIC to the
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maximum extent provided by law. In addition, the Bank provides a full range of trust services through its Trust Department. The Bank also offers other
services such as Internet banking, telephone banking, cash management services, automated teller services and safe deposit boxes.
Business Strategy
The Bank provides an array of sophisticated products typically found only in major regional banks. These services are provided to
small to middle market businesses, high net worth individuals, and retail consumers through 15 full service banking facilities. Several banking locations have seasoned management with significant lending experience who are responsible for credit and
pricing decisions, subject to loan committee approval for larger credits. This decentralized relationship management approach, coupled with the continuity of service by its banking officers, enables the Bank to develop long-term customer
relationships, maintain high quality service and provide quick responses to customer needs. MPB believes that its emphasis on local relationship banking, together with its conservative approach to lending and resultant strong asset quality, are
important factors in the success and the growth of MPB.
The Bank seeks credit opportunities of good quality within its target market that
exhibit positive historical trends, stable cash flows and secondary sources of repayment from tangible collateral. The Bank extends credit for the purpose of obtaining and continuing long-term relationships. Lenders are provided with detailed
underwriting policies for all types of credit risks accepted by the Bank and must obtain appropriate approvals for credit extensions in excess of conservatively assigned individual lending limits. The Bank also maintains strict documentation
requirements and extensive credit quality assurance practices in order to identify credit portfolio weaknesses as early as possible so any exposures that are discovered might be reduced.
At December 31, 2007, the Bank had 134 full-time and 20 part-time employees. A collective bargaining agent represents none of the employees, and the
Bank believes it enjoys good relations with its personnel.
Lending Activities
The Bank offers a variety of loan products to its customers, including loans secured by real estate, commercial and consumer loans. The Banks
lending objectives are as follows:
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to establish a diversified commercial loan portfolio; and
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to provide a satisfactory return to MPBs shareholders by properly pricing loans to include the cost of funds, administrative costs, bad debts, local economic
conditions, competition, customer relationships, the term of the loan, credit risk, collateral quality and a reasonable profit margin.
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Credit risk is managed through portfolio diversification, underwriting policies and procedures and loan monitoring practices. The Bank generally secures its loans with real estate with such collateral values dependent
and subject to change based on real estate market conditions within its market area. As of December 31, 2007, the Banks highest concentrations of credit were in hotel/motel and multiple-family housing financings and most of the
Banks business activity with customers was located in Central Pennsylvania, specifically in Dauphin, lower Northumberland, Western Schuylkill, and Cumberland Counties.
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Investment Activities
MPBs investment portfolio is used to improve earnings through investments of funds in higher-yielding assets, while maintaining asset quality, which provide the necessary balance sheet liquidity for MPB. MPB
does not have any significant concentrations within investment securities.
MPBs entire portfolio of investment securities is
considered available for sale. As such, the investments are recorded on the balance sheet at market value. MPBs investments include US Treasury, agency and municipal securities that are given a market price relative to investments of the same
type with similar maturity dates. As the interest rate environment of these securities changes, MPBs existing securities are valued differently in comparison. This difference in value, or unrealized gain, amounted to $434,000, net of tax, as
of December 31, 2007. A majority of the investments are high quality United States and municipal securities that if held to maturity are expected to yield no loss to the Bank.
For additional information with respect to MPBs business activities, see Part II, Item 7 of this report.
Sources of Funds
The Bank primarily uses deposits
and borrowings to finance lending and investment activities. Borrowing sources include advances from the Federal Home Loan Bank of Pittsburgh, reverse repurchase agreements with investment banks and overnight borrowings from the Banks
customers and correspondent bank. All borrowings, except for the line of credit with the Banks correspondent bank, require collateral in the form of loans or securities. Borrowings are, therefore, limited by collateral levels and the available
lines of credit extended by the Banks creditors. As a result, deposits remain key to the future funding and growth of the business. Deposit growth within the banking industry has been generally slow due to strong competition from a variety of
financial services companies. This competition may require financial institutions to adjust their product offerings and pricing to adequately grow deposits.
Competition
The banking business is highly competitive, and the profitability of MPB depends principally upon the
Banks ability to compete in its market area. The Bank actively competes with other financial services companies for deposit and loan business. Competitors include other commercial banks, savings banks, savings and loan associations, insurance
companies, securities brokerage firms, credit unions, finance companies, mutual funds, and money market funds. Financial institutions compete primarily on the quality of services rendered, interest rates on loans and deposits, service charges, the
convenience of banking facilities, location and hours of operation and, in the case of loans to larger commercial borrowers, relative lending limits.
Many competitors are significantly larger than the Bank and have significantly greater financial resources, personnel and locations from which to conduct business. In addition, the Bank is subject to banking
regulations while certain competitors may not be. There are relatively few barriers for companies wanting to enter into the financial services industry. For more information, see the Supervision and Regulation section below.
MPB has been able to compete effectively with other financial institutions by emphasizing technology and customer service, including local branch
decision making on loans, establishing long-term customer relationships and building customer loyalty, and providing
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products and services designed to address the specific needs of its customers. The Gramm-Leach-Bliley Act (see discussion below), which breaks down many
barriers between the banking, securities and insurance industries, may significantly affect the competitive environment in which MPB operates.
The growth of mutual funds over the past decade has made it increasingly difficult for financial institutions to attract deposits. The continued flow of cash into mutual funds, much of which is made through tax deferred investment vehicles
such as 401(k) plans, and a generally strong economy, have, until recently, fueled high returns for these investments, in particular, certain equity funds. These returns perpetuated the flow of additional investment dollars into mutual funds and
other products not traditionally offered by banks. In addition, insurance companies recently have become more significant competitors for deposits through their thrift subsidiaries.
Further, MPBs success is dependent to a significant degree on economic conditions in Central Pennsylvania, especially in Dauphin, lower
Northumberland, Western Schuylkill and eastern Cumberland Counties, which we define as our primary market. The banking industry is affected by general economic conditions including the effects of inflation, recession, unemployment, real estate
values, trends in the national and global economics, and other factors beyond our control. An economic recession or a delayed recovery over a prolonged period of time in the Central Pennsylvania area could cause an increase in the level of the
Banks non-performing assets and loan and lease losses, thereby causing operating losses, impairing liquidity and eroding capital. We cannot assure you that further adverse changes in the local economy would not have a material adverse effect
on MPBs consolidated financial condition, results of operations, and cash flows.
Supervision and Regulation
General
Bank holding companies and
banks are extensively regulated under both Federal and state laws. The regulation and supervision of MPB and the Bank are designed primarily for the protection of depositors, the FDIC, and the monetary system, and not MPB or its shareholders.
Enforcement actions may include the imposition of a conservator or receiver, cease-and-desist orders and written agreements, the termination of insurance on deposits, the imposition of civil money penalties and removal and prohibition orders. If any
enforcement action is taken by a banking regulator, the value of an equity investment in MPB could be substantially reduced or eliminated.
Federal and state banking laws contain numerous provisions affecting various aspects of the business and operations of MPB and the Bank. MPB is subject to, among others, the regulations of the Securities and Exchange Commission and the
Federal Reserve Board and the Bank is subject to, among others, the regulations of the Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation. The following descriptions of and references to applicable statutes and
regulations are not intended to be complete descriptions of these provisions or their effects on MPB or the Bank. They are summaries only and are qualified in their entirety by reference to such statutes and regulations.
Holding Company Regulation
MPB is a
registered bank holding company subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the Federal Reserve). As such, it is subject to the Bank Holding Company Act of 1956 (BHCA) and
many of the Federal Reserves regulations promulgated thereunder. The Federal Reserve has broad enforcement powers over bank holding companies, including the power to impose substantial fines and civil penalties.
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The BHCA requires MPB to file an annual report with the Federal Reserve regarding the holding company and
its subsidiary bank. The Federal Reserve Board also makes examinations of the holding company. The Bank is not a member of the Federal Reserve System; however, the Federal Reserve possesses cease-and-desist powers over bank holding companies and
their subsidiaries where their actions would constitute an unsafe or unsound practice or violation of law.
The BHCA restricts a bank
holding companys ability to acquire control of additional banks. In addition, the BHCA restricts the activities in which bank holding companies may engage directly or through non-bank subsidiaries.
Gramm-Leach-Bliley Financial Modernization Act
The Gramm-Leach Bliley Act (GLB) became effective on March 11, 2000. The primary purpose of GLB was to eliminate barriers between investment banking and commercial banking and to permit, within
certain limitations, the affiliation of financial service providers. Generally, GLB:
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repealed the historical restrictions against, and eliminated many federal and state law barriers to affiliations among banks, securities firms, insurance companies
and other financial service providers,
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provided a uniform framework for the activities of banks, savings institutions and their holding companies,
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broadened the activities that may be conducted by and through national banks and other banking subsidiaries of bank holding companies,
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provided an enhanced framework for protecting the privacy of consumers information,
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adopted a number of provisions related to the capitalization, membership, corporate governance and other measures designed to modernize the Federal Home Loan Bank
System,
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modified the laws governing the implementation of the Community Reinvestment Act, and
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addressed a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions.
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More specifically, under GLB, bank holding companies, such as MPB, that meet certain management, capital, and Community
Reinvestment Act standards, are permitted to become financial holding companies and, by doing so, to affiliate with securities firms and insurance companies and to engage in other activities that are financial in nature, incidental to such financial
activities, or complementary to such activities. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized under the FDIC Improvement Acts prompt corrective action provisions, is well managed
and has at least a satisfactory rating under the Community Reinvestment Act. The required filing is a declaration that the bank holding company wishes to become a financial holding company and meets all applicable requirements.
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No prior regulatory approval will be required for a financial holding company to acquire a company, other
than a bank or savings association, engaged in activities permitted under GLB. Activities cited by GLB as being financial in nature include:
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securities underwriting, dealing and market making;
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sponsoring mutual funds and investment companies;
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insurance underwriting and agency;
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merchant banking activities; and
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activities that the Federal Reserve has determined to be closely related to banking.
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In addition to permitting financial services providers to enter into new lines of business, the law allows firms the freedom to streamline existing
operations and to potentially reduce costs. The Act may increase both opportunity as well as competition. Many community banks are less able to devote the capital and management resources needed to facilitate broad expansion of financial services
including insurance and brokerage services.
Corporate Governance
On July 30, 2002, the Sarbanes-Oxley Act of 2002 was enacted. The Sarbanes-Oxley Act represents a comprehensive revision of laws affecting corporate
governance, auditor independence and accounting standards, executive compensation, insider loans, whistleblower protection, and enhanced and timely disclosure of corporate information. The Sarbanes-Oxley Act is applicable to all companies with
equity securities registered or that file reports under the Securities Exchange Act of 1934. In particular, the Sarbanes-Oxley Act established:
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new requirements for audit committees, including independence, expertise and responsibilities;
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additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company;
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new standards for auditors and regulation of audits;
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increased disclosure and reporting obligations for the reporting company and its directors and executive officers; and
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new and increased civil and criminal penalties for violations of the securities laws.
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The SEC and AMEX have adopted numerous rules implementing the provisions of the Sarbanes-Oxley Act that affect MPB. The changes are intended to allow
shareholders to monitor more effectively the performance of companies and management. Increased costs have been approximately $200,000 annually related to MPBs compliance with the Sarbanes-Oxley Act.
Bank Regulation
The Bank, a
Pennsylvania-chartered institution, is subject to supervision, regulation and examination by the Pennsylvania Department of Banking and the FDIC. The deposits of the Bank are insured by the FDIC to the extent provided by law. The FDIC assesses
deposit insurance premiums the amount of which may, in the future, depend in part on the condition of the Bank. Moreover, the FDIC may terminate deposit insurance of the Bank under certain circumstances. The Bank regulatory agencies have broad
enforcement powers over depository institutions under their jurisdiction, including the power to terminate deposit insurance, to impose fines and other
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civil and criminal penalties, and to appoint a conservator or receiver if any of a number of conditions is met. In addition, the Bank is subject to a variety
of local, state and federal laws that affect its operations.
Banking regulations include, but are not limited to, permissible types and
amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and the safety and soundness of banking practices.
Capital Requirements
Under risk-based capital requirements for bank holding companies, MPB is
required to maintain a minimum ratio of total capital to risk-weighted assets (including certain off-balance-sheet activities, such as standby letters of credit) of eight percent. At least half of the total capital is to be composed of common
equity, retained earnings and qualifying perpetual preferred stock, less goodwill (Tier 1 Capital and together with Tier 2 Capital, Total Capital). The remainder may consist of subordinated debt, non-qualifying preferred stock and
a limited amount of the loan loss allowance (Tier 2 Capital).
In addition, the Federal Reserve Board has established minimum
leverage ratio requirements for bank holding companies. These requirements provide for a minimum leverage ratio of Tier 1 Capital to adjusted average quarterly assets (leverage ratio) equal to 3% for bank holding companies that meet
certain specified criteria, including having the highest regulatory rating. All other bank holding companies will generally be required to maintain a leverage ratio of from at least 4-5%. The requirements also provide that bank holding companies
experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the requirements indicate
that the Federal Reserve Board will continue to consider a Tangible Tier 1 Leverage Ratio (deducting all intangibles) in evaluating proposals for expansion or new activity. The Federal Reserve Board has not advised MPB of any specific
minimum Tier 1 leverage ratio applicable to it.
The Bank is subject to similar capital requirements adopted by the FDIC. The FDIC has not
advised the Bank of any specific minimum leverage ratios applicable to it.
The capital ratios of MPB and the Bank are described in Note 18
to MPBs Consolidated Financial Statements.
Banking regulators continue to indicate their desire to further develop capital
requirements applicable to banking organizations. Changes to capital requirements could materially affect the profitability of MPB or the market value of MPB stock.
FDIC Improvement Act
As a result of the FDIC Improvement Act of 1991, banks are subject to increased
reporting requirements and more frequent examinations by the bank regulatory agencies. The agencies also have the authority to dictate certain key decisions that formerly were left to management, including compensation standards, loan underwriting
standards, asset growth, and payment of dividends. Failure to comply with these standards, or failure to maintain capital above specified levels set by the regulators, could lead to the imposition of penalties or the forced resignation of
management. If a bank becomes critically undercapitalized, the banking agencies have the authority to place an institution into receivership.
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Safety and Soundness Standards
Pursuant to FDICIA, the federal banking regulatory agencies have adopted a set of guidelines prescribing safety and soundness standards for depository
institutions such as the Bank. The guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality,
earnings and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive
compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal shareholder. In
addition, the agencies adopted regulations that authorize an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If the institution
fails to submit an acceptable compliance plan or fails to implement an accepted plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions be taken, including restricting asset
growth, restricting interest rates paid on deposits, and requiring an increase in the institutions ratio of tangible equity to assets.
Payment of Dividends and Other Restrictions
MPB is a legal entity separate and distinct from its subsidiary, the Bank.
There are various legal and regulatory limitations on the extent to which the Bank can, among other things, finance, or otherwise supply funds to, MPB. Specifically, dividends from the Bank are the principal source of MPBs cash funds and there
are certain legal restrictions under Pennsylvania law and Pennsylvania banking regulations on the payment of dividends by state-chartered banks. The relevant regulatory agencies also have authority to prohibit MPB and the Bank from engaging in what,
in the opinion of such regulatory body, constitutes an unsafe or unsound banking practice. The payment of dividends could, depending upon the financial condition of MPB and the Bank, be deemed to constitute such an unsafe or unsound practice.
Prompt Corrective Action
In addition to the required minimum capital levels described above, federal law establishes a system of prompt corrective actions which Federal banking agencies are required to take, and certain actions which they have
discretion to take, based upon the capital category into which a federally regulated depository institution falls. Regulations set forth detailed procedures and criteria for implementing prompt corrective action in the case of any institution, which
is not adequately capitalized. Under the rules, an institution will be deemed to be adequately capitalized or better if it exceeds the minimum Federal regulatory capital requirements. However, it will be deemed
undercapitalized if it fails to meet the minimum capital requirements, significantly undercapitalized if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than
3.0%, or a leverage ratio that is less than 3.0%, and critically undercapitalized if the institution has a ratio of tangible equity to total assets that is equal to or less than 2.0%.
The prompt corrective action rules require an undercapitalized institution to file a written capital restoration plan, along with a performance guaranty
by its holding company or a third party. In addition, an undercapitalized institution becomes subject to certain automatic restrictions including a prohibition on payment of dividends, a limitation on asset growth and expansion, in
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certain cases, a limitation on the payment of bonuses or raises to senior executive officers, and a prohibition on the payment of certain management
fees to any controlling person. Institutions that are classified as undercapitalized are also subject to certain additional supervisory actions, including increased reporting burdens and regulatory monitoring, a limitation on the
institutions ability to make acquisitions, open new branch offices, or engage in new lines of business, obligations to raise additional capital, restrictions on transactions with affiliates, and restrictions on interest rates paid by the
institution on deposits. In certain cases, bank regulatory agencies may require replacement of senior executive officers or directors, or sale of the institution to a willing purchaser. If an institution is deemed to be critically
undercapitalized and continues in that category for four quarters, the statute requires, with certain narrowly limited exceptions, that the institution be placed in receivership.
Deposit Insurance
Deposits of the
Bank are insured by the FDIC through the Bank Insurance Fund (BIF). The insurance assessments paid by an institution are to be based on the probability that the fund will incur a loss with respect to the institution. The FDIC has adopted
deposit insurance regulations under which insured institutions are assigned to one of the following three capital groups based on their capital levels: well-capitalized, adequately capitalized and
undercapitalized. Banks in each of these three groups are further classified into three subgroups based upon the level of supervisory concern with respect to each bank. The resulting matrix creates nine assessment risk classifications to
which are assigned deposit insurance premiums ranging from 0.00% for the best-capitalized, healthiest institutions, to 0.27% for undercapitalized institutions with substantial supervisory concerns.
The FDIC sets deposit insurance assessment rates on a semiannual basis and will increase deposit insurance assessments whenever the ratio of reserves to
insured deposits in a fund is less than 1.25. While under the current assessment matrix, the Bank does not pay any assessments for deposit insurance, because of past bank failures there is a possibility that the FDIC will adjust the assessment
matrix in the future and that as a result the Bank may have to start paying insurance assessments.
The Bank is also subject to quarterly
assessments relating to interest payments on Financing Corporation (FICO) bonds issued in connection with the resolution of the thrift industry crisis. The FICO assessment rate is adjusted quarterly to reflect changes in the assessment bases of the
BIF and SAIF. The FICO assessments on BIF-insured deposits are set at an annual rate of .0168% of assessable deposits.
Environmental
Laws
Management does not anticipate that compliance with environmental laws and regulations will have any material effect on MPBs
capital, expenditures, earnings, or competitive position. However, environmentally related hazards have become a source of high risk and potentially unlimited liability for financial institutions.
In 1995, the Pennsylvania General Assembly enacted the Economic Development Agency, Fiduciary and Lender Environmental Liability Protection Act, which
among other things, provides protection to lenders from environmental liability and remediation costs under the environmental laws for releases and contamination caused by others. A lender who engages in activities involved in the routine practices
of commercial lending, including, but not limited to, the providing of financial services, holding of security interests, workout practices, foreclosure or
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the recovery of funds from the sale of property shall not be liable under the environmental acts or common law equivalents to the Pennsylvania Department of
Environmental Resources or to any other person by virtue of the fact that the lender engages in such commercial lending practice. A lender, however, will be liable if it, its employees or agents, directly cause an immediate release or directly
exacerbate a release of regulated substance on or from the property, or known and willfully compelled the borrower to commit an action which caused such release or violate an environmental act. The Economic Development Agency, Fiduciary and Lender
Environmental Liability Protection Act does not limit federal liability which still exists under certain circumstances.
Consumer
Protection Laws
There are a number of laws that govern the relationship between the Bank and its customers. For example, the Community
Reinvestment Act is designed to encourage lending by banks to persons in low and moderate income areas. The Home Mortgage Disclosure Act and the Equal Credit Opportunity Act attempt to minimize lending decisions based on impermissible criteria, such
as race or gender. The Truth-in-Lending Act and the Truth-in-Savings Act require banks to provide certain disclosure of relevant terms related to loans and savings accounts, respectively. Anti-tying restrictions (which prohibit, for instance,
conditioning the availability or terms of credit on the purchase of another banking product) further restrict the Banks relationships with its customers.
Privacy Laws
In 2000, the federal banking regulators issued final regulations implementing certain
provisions of GLB governing the privacy of consumer financial information. The regulations limit the disclosure by financial institutions, such as MPB and the Bank, of nonpublic personal information about individuals who obtain financial products or
services for personal, family, or household purposes. Subject to certain exceptions allowed by law, the regulations cover information sharing between financial institutions and nonaffiliated third parties. More specifically, the regulations require
financial institutions to:
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provide initial notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal financial information
to nonaffiliated third parties and affiliates;
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provide annual notices of their privacy policies to their current customers; and
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provide a reasonable method for consumers to opt out of disclosures to nonaffiliated third parties.
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Protection of Customer Information
In 2001, the federal banking regulators issued final regulations implementing the provisions of GLB relating to the protection of customer information. The regulations, applicable to the MPB and the Bank, relate to administrative,
technical, and physical safeguards for customer records and information. These safeguards are intended to:
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insure the security and confidentiality of customer records and information;
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protect against any anticipated threats or hazards to the security or integrity of such records; and
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protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer.
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Affiliate Transactions
Transactions between MPB and the Bank and its affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a bank or savings institution is any company or entity that
controls, is controlled by, or is under common control with the bank or savings institution. Generally, a subsidiary of a depository institution that is not also a depository institution is not treated as an affiliate of the bank for purposes of
Sections 23A and 23B. Sections 23A and 23B are intended to protect insured depository institutions from suffering losses arising from transactions with non-insured affiliates, by limiting the extent to which a bank or its subsidiaries may engage in
covered transactions with any one affiliate and with all affiliates of the bank in the aggregate, and requiring that such transactions be on terms that are consistent with safe and sound banking practices.
In 2002, the Federal Reserve adopted a new regulation, Regulation W, effective April 1, 2003, that comprehensively amends Sections 23A and 23B. The
regulation unifies and updates staff interpretations issued over the years, incorporates several new interpretative proposals (such as to clarify when transactions with an unrelated third party will be attributed to an affiliate), and addresses new
issues arising as a result of the expanded scope of non-banking activities engaged in by bank and bank holding companies in recent years and authorized for financial holding companies under the GLB.
The USA Patriot Act
In 2001, the
Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA Patriot Act) was signed into law. The USA Patriot Act broadened the application of anti-money laundering regulations to
apply to additional types of financial institutions, such as broker-dealers, and strengthened the ability of the U.S. government to detect and prosecute international money laundering and the financing of terrorism. The principal provisions of Title
III of the USA Patriot Act require that regulated financial institutions, including state-chartered banks:
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establish an anti-money laundering program that includes training and audit components;
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comply with regulations regarding the verification of the identity of any person seeking to open an account;
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take additional required precautions with non-U.S. owned accounts; and
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perform certain verification and certification of money laundering risk for their foreign correspondent banking relationships.
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The USA Patriot Act also expanded the conditions under which funds in a U.S. interbank account may be subject to forfeiture and increased the penalties
for violation of anti-money laundering regulations. Failure of a financial institution to comply with the USA Patriot Acts requirements could have serious legal and reputational consequences for the institution. The Bank has adopted policies,
procedures and controls to address compliance with the requirements of the USA Patriot Act under the existing regulations and will continue to revise and update its policies, procedures and controls to reflect changes required by the USA Patriot Act
and implementing regulations.
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Anti-Money Laundering and Anti-Terrorism Financing
Under Title III of the USA PATRIOT Act, also known as the International Money Laundering Abatement and Anti-Terrorism Financing Act of 2001, all financial
institutions, including MPB and the Bank, are required in general to identify their customers, adopt formal and comprehensive anti-money laundering programs, scrutinize or prohibit altogether certain transactions of special concern, and be prepared
to respond to inquiries from U.S. law enforcement agencies concerning their customers and their transactions. Additional information-sharing among financial institutions, regulators, and law enforcement authorities is encouraged by the presence of
an exemption from the privacy provisions of the GLB Act for financial institutions that comply with this provision and the authorization of the Secretary of the Treasury to adopt rules to further encourage cooperation and information-sharing. The
effectiveness of a financial institution in combating money laundering activities is a factor to be considered in any application submitted by the financial institution under the Bank Merger Act, which applies to the Bank.
Effects of Government Policy and Potential Changes in Regulation
Changes in regulations applicable to MPB or the Bank, or shifts in monetary or other government policies, could have a material affect on our business. MPBs and the Banks business is also affected by the
state of the financial services industry in general. As a result of legal and industry changes, management believes that the industry will continue to experience an increased rate of change as the financial services industry strives for greater
product offerings, market share and economies of scale.
From time to time, legislation is enacted that has the effect of increasing the
cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of banks,
bank holding companies and other financial institutions are frequently made in Congress, and before various bank regulatory agencies. MPB cannot predict the likelihood of any major changes or the impact such changes might have on MPB and/or the
Bank. Various congressional bills and other proposals have proposed a sweeping overhaul of the banking system, including provisions for: limitations on deposit insurance coverage; changing the timing and method financial institutions use to pay for
deposit insurance; expanding the power of banks by removing the restrictions on bank underwriting activities; and tightening the regulation of bank derivatives activities; and allowing commercial enterprises to own banks.
MPBs earnings are and will be affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its
agencies. The monetary policies of the Federal Reserve have had, and will likely continue to have, an impact on the operating results of commercial banks because of the Federal Reserves power to implement national monetary policy, to, among
other things, curb inflation or combat recession. The Federal Reserve has a major impact on the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of,
among other things, the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature and impact of future changes in monetary and fiscal policies.
From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions on,
the business of the Bank. It cannot be predicted whether any such legislation will be adopted or, if adopted, how such legislation would
12
affect the business of the Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, the Banks business
is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business.
Available
Information
Mid Penn Bancorp Inc.s common stock is registered under Section 12(b) of the Securities Exchange Act of 1934 and
is traded on the American Stock Exchange under the trading symbol MBP. Mid Penn Bancorp, Inc. is subject to the informational requirements of the Exchange Act, and, accordingly, files reports, proxy statements and other information with the
Securities and Exchange Commission. The reports, proxy statements and other information filed with the SEC are available for inspection and copying at the SECs Public Reference Room at 100 F Street, NE, Room 1580, Washington, D.C. 20549. You
may obtain information on the operation of the Public Reference Room by calling the SEC at (202) 551-8090. Mid Penn Bancorp, Inc. is an electronic filer with the SEC. The SEC maintains an Internet site that contains reports, proxy and
information statements, and other information regarding issuers that file electronically with the SEC. The SECs Internet site address is
www.sec.gov
.
MPBs headquarters are located at 349 Union Street, Millersburg, Pennsylvania 17061, and its telephone number is (717) 692-2133. MPBs Internet address is
www.midpennbank.com
. MPB makes available
through its website, free of charge, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after filing with the Securities and Exchange
Commission. MPB has adopted a Code of Ethics that applies to all employees. This document is also available on MPBs website. The information included on our website is not a part of this document.
You may also inspect materials and other information concerning Mid Penn Bancorp, Inc. at the offices of the American Stock Exchange, Inc. at 86 Trinity
Place, New York, New York 10006. Our common stock is listed on the American Stock Exchange under the trading symbol MBP. The American Stock Exchanges Internet site address is
www.amex.com
.
13
MPB Is Subject To Interest
Rate Risk
MPBs earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference
between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond
MPBs control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary policy, including changes in
interest rates, could influence not only the interest MPB receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) MPBs ability to originate loans and obtain
deposits, (ii) the fair value of MPBs financial assets and liabilities, and (iii) the average duration of MPBs mortgage-backed securities portfolio. If the interest rates paid on deposits and other borrowings increase at a
faster rate than the interest rates received on loans and other investments, MPBs net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and
other investments fall more quickly than the interest rates paid on deposits and other borrowings.
Although management believes it has
implemented effective asset and liability management strategies, to reduce the potential effects of changes in interest rates on MPBs results of operations. Any substantial, unexpected, prolonged change in market interest rates could have a
material adverse effect on MPBs financial condition and results of operations.
MPB Is Subject To Lending Risk
As of December 31, 2007, approximately 76.5% of MPBs loan portfolio consisted of commercial and industrial, construction and commercial real
estate loans. These types of loans are generally viewed as having more risk of default than residential real estate loans or consumer loans. These types of loans are also typically larger than residential real estate loans and consumer loans.
Because MPBs loan portfolio contains a significant number of commercial and industrial, construction and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant
increase in non-performing loans. An increase in non-performing loans could result in a net loss of earnings from these loans, an increase in the provision for possible loan and lease losses and an increase in loan charge-offs, all of which could
have a material adverse effect on MPBs financial condition and results of operations.
MPBs Allowance For Possible Loan and
Lease Losses May Be Insufficient
MPB maintains an allowance for possible loan and lease losses, which is a reserve established through
provisions for possible losses charged to expense, that represents managements best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to
reserve for estimated loan and lease losses and risks inherent in the loan portfolio. The level of the allowance reflects managements continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan
portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for possible loan and lease losses inherently
involves a high degree of subjectivity and requires MPB to make significant estimates of current credit risks and
14
future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans,
identification of additional problem credits and other factors, both within and outside of MPBs control, may require an increase in the allowance. In addition, bank regulatory agencies periodically review MPBs and may require an increase
in the provision for possible loan and lease losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance, MPB will need additional
provisions to increase the allowance for possible loan and lease losses. Any increases in the allowance will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on MPBs financial condition and
results of operations.
Competition from other financial institutions may adversely affect MPBs profitability
MPBs banking subsidiary faces substantial competition in originating, both commercial and consumer loans. This competition comes principally from
other banks, savings institutions, mortgage banking companies and other lenders. Many of its competitors enjoy advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office
locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce the Corporations net income by decreasing the number and size of
loans that its banking subsidiary originates and the interest rates they may charge on these loans.
In attracting business and consumer
deposits, its banking subsidiary faces substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money
market funds. Many of MPBs competitors enjoy advantages, including greater financial resources, more aggressive marketing campaigns, better brand recognition and more convenient branch locations. These competitors may offer higher interest
rates than MPB, which could decrease the deposits that it attracts or require it to increase its rates to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect MPBs ability to generate the funds
necessary for lending operations. As a result, it may need to seek other sources of funds that may be more expensive to obtain and could increase its cost of funds.
MPBs banking subsidiary also competes with non-bank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance agencies and governmental organizations, which
may offer more favorable terms. Some of its non-bank competitors are not subject to the same extensive regulations that govern its banking operations. As a result, such non-bank competitors may have advantages over MPBs banking subsidiary in
providing certain products and services. This competition may reduce or limit its margins on banking services, reduce its market share and adversely affect its earnings and financial condition.
MPBs Controls and Procedures May Fail or Be Circumvented
Management regularly reviews and updates MPBs internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated,
is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of MPBs controls and procedures or failure to comply with regulations
related to controls and procedures could have a material adverse effect on MPBs business, results of operations and financial condition.
15
MPBs ability to pay dividends depends primarily on dividends from its banking subsidiary, which
is subject to regulatory limits
MPB is a bank holding company and its operations are conducted by its subsidiaries. Its ability to pay
dividends depends on its receipt of dividends from its subsidiaries. Dividend payments from its banking subsidiary are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by the various banking
regulatory agencies. The ability of its subsidiaries to pay dividends is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. There is no assurance that its subsidiaries will be able to pay
dividends in the future or that MPB will generate adequate cash flow to pay dividends in the future. MPBs failure to pay dividends on its common stock could have a material adverse effect on the market price of its common stock.
MPB May Not Be Able To Attract and Retain Skilled People
MPBs success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities engaged in by MPB can be intense and MPB may not be able to hire people or
to retain them. The unexpected loss of services of one or more of MPBs key personnel could have a material adverse impact on MPBs business because of their skills, knowledge of MPBs market, years of industry experience and the
difficulty of promptly finding qualified replacement personnel. Other than Mr. Dakeys Employment Agreement, MPB does not currently have employment agreements or non-competition agreements with any of its other senior officers.
MPB Is Subject To Claims and Litigation Pertaining To Fiduciary Responsibility
From time to time, customers make claims and take legal action pertaining to MPBs performance of its fiduciary responsibilities. Whether customer
claims and legal action related to MPBs performance of its fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to MPB they may result in significant financial liability
and/or adversely affect the market perception of MPB and its products and services as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on MPBs
business, which, in turn, could have a material adverse effect on MPBs financial condition and results of operations.
The Trading
Volume In MPBs Common Stock Is Less Than That Of Other Larger Financial Services Companies
MPBs common stock is listed for
trading on AMEX, the trading volume in its common stock is less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the
marketplace of willing buyers and sellers of MPBs common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which MPB has no control. Given the lower trading
volume of MPBs common stock, significant sales of MPBs common stock, or the expectation of these sales, could cause MPBs stock price to fall.
16
MPB operates in a highly regulated environment and may be adversely affected by changes in federal,
state and local laws and regulations.
MPB is subject to extensive regulation, supervision and examination by federal and state banking
authorities. Any change in applicable regulations or federal, state or local legislation could have a substantial impact on MPB and its operations. Additional legislation and regulations that could significantly affect MPBs powers, authority
and operations may be enacted or adopted in the future, which could have a material adverse effect on its financial condition and results of operations. Further, regulators have significant discretion and authority to prevent or remedy unsafe or
unsound practices or violations of laws by banks and bank holding companies in the performance of their supervisory and enforcement duties. The exercise of regulatory authority may have a negative impact on MPBs results of operations and
financial condition.
Like other bank holding companies and financial institutions, MPB must comply with significant anti-money laundering
and anti-terrorism laws. Under these laws, MPB is required, among other things, to enforce a customer identification program and file currency transaction and suspicious activity reports with the federal government. Government agencies have
substantial discretion to impose significant monetary penalties on institutions, which fail to comply with these laws or make required reports.