# MID Penn Bancorp Inc: Form 10-Q for the period ended Sep 30, 2017

- Company: [MID Penn Bancorp Inc](/companies/mpb.md) (CIK 879635)
- Form: 10-Q
- Filed: 2017-11-08
- Accepted by EDGAR: Nov 8, 2017, 19:44 ET
- Period: 2017-09-30
- Accession: 0001564590-17-022644
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/879635/000156459017022644/mpb-10q_20170930.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/879635/000156459017022644/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2017-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Interest expense | 3 months, 2017-07-01 to 2017-09-30 | $1.6m | us-gaap:InterestExpense |
| Interest expense | 9 months, 2017-01-01 to 2017-09-30 | $4.5m | us-gaap:InterestExpense |
| Income tax | 3 months, 2017-07-01 to 2017-09-30 | $871.0k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2017-01-01 to 2017-09-30 | $2.3m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2017-07-01 to 2017-09-30 | $2.2m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2017-01-01 to 2017-09-30 | $6.6m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2017-07-01 to 2017-09-30 | $0.53 | us-gaap:EarningsPerShareBasicAndDiluted |
| Diluted EPS | 9 months, 2017-01-01 to 2017-09-30 | $1.56 | us-gaap:EarningsPerShareBasicAndDiluted |
| Basic EPS | 3 months, 2017-07-01 to 2017-09-30 | $0.53 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2017-01-01 to 2017-09-30 | $1.56 | us-gaap:EarningsPerShareBasic |
| Capital expenditure | 9 months, 2017-01-01 to 2017-09-30 | $4.6m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 9 months, 2017-01-01 to 2017-09-30 | $1.7m | us-gaap:PaymentsOfDividendsCommonStock |
| Total assets | at 2017-09-30 | $1.15bn | us-gaap:Assets |
| Total liabilities | at 2017-09-30 | $1.08bn | us-gaap:Liabilities |
| Short-term borrowings | at 2017-09-30 | $20.0m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2017-09-30 | $77.4m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 67,448 characters.

The following is Management’s Discussion of Consolidated Financial Condition as of September 30, 2017, compared to year-end 2016, and the Results of Operations for the three and nine months ended September 30, 2017, compared to the same periods in 2016. For comparative purposes, the September 30, 2016 and December 31, 2016 balances have been reclassified, when, and if necessary, to conform to the 2017 presentation. Such reclassifications had no impact on net income. This discussion should be read in conjunction with the financial tables, statistics, and the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 (the “2016 Annual Report”). The results of operations for interim periods are not necessarily indicative of operating results expected for the full year.

Forward-looking statements involve risks, uncertainties and assumptions. Although Mid Penn generally does not make forward-looking statements unless Mid Penn’s management believes its management has a reasonable basis for doing so, Mid Penn cannot guarantee the accuracy of any forward-looking statements. Actual results may differ materially from those expressed in any forward-looking statements due to a number of uncertainties and risks, including the risks described in the 2016 Annual Report, and other unforeseen risks. You should not put undue reliance on any forward-looking statements. These statements speak only as of the date of this Quarterly Report on Form 10-Q, even if subsequently made available by us on Mid Penn’s website or otherwise, and Mid Penn undertakes no obligation to update or revise these statements to reflect events or circumstances occurring after the date of this Quarterly Report on Form 10-Q.

Certain of the matters discussed in this document and in documents incorporated by reference herein, including matters discussed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, may constitute forward-looking statements for purposes of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and as such may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of Mid Penn to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. The words “expect”, “anticipates”, “intend”, “plan”, “believe”, “estimate”, and similar expressions are intended to identify such forward-looking statements.

Mid Penn’s actual results may differ materially from the results anticipated in these forward-looking statements due to a variety of factors, including, without limitation:

- the effects of potentially slowing or volatile future economic conditions on Mid Penn and its customers;
- governmental monetary and fiscal policies, as well as legislative and regulatory changes;
- future actions or inactions of the United States government, including a failure to increase the government debt limit or a prolonged shutdown of the federal government;
- an increase in the Pennsylvania Bank Shares Tax to which Mid Penn Bank’s capital stock is currently subject, or imposition of any additional taxes on Mid Penn or Mid Penn Bank;
- impacts of the capital and liquidity requirements imposed by the Basel III standards and other regulatory pronouncements and rules;
- the effect of changes in accounting policies and practices, as may be adopted by the supervisory agencies, as well as the Public Company Accounting Oversight Board, Financial Accounting Standards Board, and other accounting standard setters;
- the risks of changes in interest rates on the level and composition of deposits and other funding sources, loan demand and yields, values of loan collateral, securities and yields, and interest rate protection agreements;
- the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in Mid Penn’s market area and elsewhere, including institutions operating locally, regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the internet;
- the costs and effects of litigation and of unexpected or adverse outcomes in such litigation;
- technological changes;
- our ability to implement business strategies, including our proposed acquisition of The Scottdale Bank and Trust Co. (Scottdale), and other business acquisition activities and organic branch, product and service expansion strategies;
- our current and future acquisition strategies may not be successful in locating or acquiring advantageous targets at favorable prices;
- our ability to successfully integrate any banks, companies, assets, liabilities, customers, systems and management personnel we acquire into our operations, including those related to our proposed acquisition of Scottdale, and our ability to realize related revenue synergies and cost savings within expected time frames;
- potential goodwill impairment charges, future impairment charges and fluctuations in the fair values of reporting units or of assets in the event projected financial results are not achieved within expected time frames;
- our ability to attract and retain qualified management and personnel;
- our ability to maintain the value and image of our brand and protect our intellectual property rights;
- results of regulatory examination and supervision processes;
- our ability to maintain compliance with the exchange rules of The NASDAQ Stock Market LLC;
- the failure of assumptions underlying the establishment of reserves for loan and lease losses and estimations of values of collateral and various financial assets and liabilities;
- acts of war or terrorism;
- disruptions due to flooding, severe weather, or other natural disasters or Acts of God; and
- volatilities in the securities markets.

The above list of factors that may affect future performance is illustrative, but by no means exhaustive. Accordingly, all forward-looking statements should be evaluated with this understanding of inherent uncertainty.

### Important Additional Information and Where to Find It

In connection with the Merger, Mid Penn has filed with the SEC a Registration Statement on Form S-4 (SEC File No. 333-220020) that includes a Joint Proxy Statement of Mid Penn and Scottdale and a Prospectus of Mid Penn (the “Joint Proxy Statement/Prospectus”), as well as other relevant documents concerning the proposed transaction. The S-4 has been declared effective and the Joint Proxy Statement/Prospectus has been mailed to shareholders of Mid Penn and Scottdale. SHAREHOLDERS OF MID PENN AND SCOTTDALE ARE URGED TO READ THE REGISTRATION STATEMENT AND THE JOINT PROXY STATEMENT/PROSPECTUS REGARDING THE MERGER AND ANY OTHER RELEVANT DOCUMENTS FILED WITH THE SEC, AS WELL AS ANY AMENDMENTS OR SUPPLEMENTS TO THOSE DOCUMENTS, BECAUSE THEY CONTAIN IMPORTANT INFORMATION.

A free copy of the Joint Proxy Statement/Prospectus, as well as other filings containing information about Mid Penn, may be obtained at the SEC’s Internet site (http://www.sec.gov). You may also obtain these documents, free of charge, from Mid Penn at www.midpennbank.com under the heading “Investors” and then under the heading “SEC Filings”. Copies of the Joint Proxy Statement/Prospectus can also be obtained, free of charge, by directing a request to Mid Penn Bank, 349 Union Street, Millersburg, Pennsylvania 17061, Attention: Chief Financial Officer, Telephone: (866)-642-7736, or to The Scottdale Bank & Trust Company, 150 Pittsburgh Street, Scottdale, Pennsylvania 15683, Attention: Corporate Secretary, Telephone: (724) 887-8330.

Mid Penn and certain of its directors and executive officers may be deemed to be participants in the solicitation of proxies from the shareholders of Mid Penn and Scottdale in connection with the proposed merger. Information about the directors and executive officers of Mid Penn and their ownership of Mid Penn common stock is set forth in the Joint Proxy Statement/Prospectus. Additional information regarding the interests of those participants and other persons who may be deemed participants in the transaction may be obtained by reading the Joint Proxy Statement/Prospectus regarding the Merger. Free copies of this document may be obtained as described in the preceding paragraph.

### Critical Accounting Estimates

Mid Penn’s consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and conform to general practices within the banking industry. Application of these principles involves significant judgments and estimates by management that have a material impact on the carrying value of certain assets and liabilities. The judgments and estimates that we used are also based on historical experiences and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and estimates that we have made, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities and the results of our operations. Management of the Company considers the accounting judgments relating to the allowance, the evaluation of the Company’s investment securities for other-than-temporary impairment, the valuation of the Company’s goodwill for impairment, and the valuation of assets acquired and liabilities assumed in business combinations, to be the accounting areas that require the most subjective and complex judgments.

The allowance represents management’s estimate of probable incurred credit losses inherent in the loan and lease portfolio. Determining the amount of the allowance is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan and lease portfolio also represents the largest asset type on the consolidated balance sheet. Throughout the remainder of this report, the terms “loan” or “loans” refers to both loans and leases.

Valuations for the investment portfolio are determined using quoted market prices, where available. If quoted market prices are not available, investment valuation is based on pricing models, quotes for similar investment securities, and observable yield curves and spreads. In addition to securities valuation, management must assess whether there are any declines in value below the carrying value of the investments that should be considered other than temporary or otherwise require an adjustment in carrying value and recognition of the loss in the consolidated statement of income.

Goodwill recorded in connection with acquisitions is tested annually for impairment. If certain events occur, which indicate goodwill might be impaired between annual tests, goodwill must be tested when such events occur. In making this assessment, Mid Penn considers a number of factors including operating results, business plans, economic projections, anticipated future cash flows, current market data, stock price, etc. There are inherent uncertainties related to these factors and Mid Penn’s judgment in applying them to the analysis of goodwill impairment. Changes in economic and operating conditions could result in goodwill impairment in future periods.

Valuations of assets acquired and liabilities assumed in business combinations are measured at fair value as of the acquisition date. In many cases, determining the fair value of the assets acquired and liabilities assumed requires Mid Penn to estimate cash flows expected to result from these assets and liabilities and to discount these cash flows at appropriate rates of interest, which require the utilization of significant estimates and judgment in accounting for the acquisition.

### Results of Operations

### Overview

Net income was $2,249,000 or $0.53 per common share, for the quarter ended September 30, 2017, compared to net income of $1,901,000 or $0.45 per common share, for the quarter ended September 30, 2016. During the nine months ended September 30, 2017, net income was $6,588,000 or $1.56 per common share, versus $5,728,000 or $1.35 per common share, for the nine months ended September 30, 2016.

Net income as a percent of (i) average assets (return on average assets, or “ROA”) and (ii) shareholders' equity (return on average equity, or “ROE”) were as follows (calculated and reported on an annualized basis):

|  | Three Months Ended September 30, 2017 | 2016 | Nine Months Ended September 30, 2017 | 2016 |
| --- | ---: | ---: | ---: | ---: |
| Return on average assets | 0.81% | 0.73% | 0.81% | 0.77% |
| Return on average equity | 11.75% | 10.12% | 11.94% | 10.54% |

### Net Interest Income/Funding Sources

Net interest income, Mid Penn’s primary source of revenue, is the amount by which interest income on loans and investments exceeds interest incurred on deposits and borrowings. The amount of net interest income is affected by changes in interest rates and changes in the volume and mix of interest-sensitive assets and liabilities. Net interest income and corresponding yields are presented in the analysis below on a taxable-equivalent basis. Income from tax-exempt assets, primarily loans to or securities issued by state and local governments, is adjusted by an amount equivalent to the federal income taxes which would have been paid if the income received on these assets was taxable at the statutory rate of 34%.

The following tables include average balances, amounts, and rates of interest income and expense, interest rate spread, and net interest margin for the three and nine months ended September 30, 2017 and 2016.

*(Dollars in thousands)*

| ASSETS: | Average Balances, Income and Interest Rates on a Taxable Equivalent Basis For the Three Months Ended September 30, 2017 Average Balance | Interest |  | Average Rates | September 30, 2016 Average Balance | Interest |  | Average Rates |
| --- | ---: | ---: | --- | ---: | ---: | ---: | --- | ---: |
| Interest Bearing Balances | $2,751 | $5 |  | 0.72% | $1,813 | $2 |  | 0.44% |
| Investment Securities: |  |  |  |  |  |  |  |  |
| Taxable | 132,926 | 639 |  | 1.91% | 77,960 | 379 |  | 1.93% |
| Tax-Exempt | 46,903 | 363 | (a) | 3.07% | 89,582 | 834 | (a) | 3.70% |
| Total Securities | 179,829 | 1,002 |  | 2.21% | 167,542 | 1,213 |  | 2.88% |
| Federal Funds Sold | 7,998 | 23 |  | 1.14% | 27,064 | 36 |  | 0.53% |
| Loans and Leases, Net | 866,972 | 10,314 | (b) | 4.72% | 784,669 | 9,277 | (b) | 4.70% |
| Restricted Investment in Bank Stocks | 3,173 | 31 |  | 3.88% | 2,648 | 24 |  | 3.61% |
| Total Earning Assets | 1,060,723 | 11,375 |  | 4.25% | 983,736 | 10,552 |  | 4.27% |
| Cash and Due from Banks | 24,227 |  |  |  | 13,472 |  |  |  |
| Other Assets | 35,241 |  |  |  | 31,861 |  |  |  |
| Total Assets | $1,120,191 |  |  |  | $1,029,069 |  |  |  |
| LIABILITIES & SHAREHOLDERS' EQUITY: |  |  |  |  |  |  |  |  |
| Interest-bearing Demand | $337,379 | 370 |  | 0.44% | $305,490 | 262 |  | 0.34% |
| Money Market | 242,485 | 364 |  | 0.60% | 240,913 | 338 |  | 0.56% |
| Savings | 63,159 | 9 |  | 0.06% | 60,922 | 9 |  | 0.06% |
| Time | 206,483 | 682 |  | 1.31% | 175,849 | 553 |  | 1.25% |
| Total Interest-bearing Deposits | 849,506 | 1,425 |  | 0.67% | 783,174 | 1,162 |  | 0.59% |
| Short-term Borrowings | 9,378 | 30 |  | 1.27% | - | - |  | - |
| Long-term Debt | 13,439 | 80 |  | 2.36% | 24,607 | 106 |  | 1.71% |
| Subordinated Debt | 7,420 | 99 |  | 5.29% | 7,410 | 99 |  | 5.32% |
| Total Interest-bearing Liabilities | 879,743 | 1,634 |  | 0.74% | 815,191 | 1,367 |  | 0.67% |
| Noninterest-bearing Demand | 156,274 |  |  |  | 131,217 |  |  |  |
| Other Liabilities | 7,348 |  |  |  | 7,950 |  |  |  |
| Shareholders' Equity | 76,826 |  |  |  | 74,711 |  |  |  |
| Total Liabilities & Shareholders' Equity | $1,120,191 |  |  |  | $1,029,069 |  |  |  |
| Net Interest Income (taxable equivalent basis) |  | $9,741 |  |  |  | $9,185 |  |  |
| Taxable Equivalent Adjustment |  | (225) |  |  |  | (427) |  |  |
| Net Interest Income |  | $9,516 |  |  |  | $8,758 |  |  |
| Total Yield on Earning Assets |  |  |  | 4.25% |  |  |  | 4.27% |
| Rate on Supporting Liabilities |  |  |  | 0.74% |  |  |  | 0.67% |
| Average Interest Spread |  |  |  | 3.51% |  |  |  | 3.60% |
| Net Interest Margin |  |  |  | 3.64% |  |  |  | 3.71% |

(a) Includes tax-equivalent adjustments on interest from tax-free municipal securities of $124,000 and $283,000 for the three months ended September 30, 2017 and 2016, respectively.

(b) Includes tax-equivalent adjustments on interest from tax-free municipal loans of $101,000 and $144,000 for the three months ended September 30, 2017 and 2016, respectively.

39

### MID PENN BANCORP, INC.

*(Dollars in thousands)*

| ASSETS: | Average Balances, Income and Interest Rates on a Taxable Equivalent Basis For the Nine Months Ended September 30, 2017 Average Balance | Interest |  | Average Rates | September 30, 2016 Average Balance | Interest |  | Average Rates |
| --- | ---: | ---: | --- | ---: | ---: | ---: | --- | ---: |
| Interest Bearing Balances | $2,559 | $12 |  | 0.63% | $2,873 | $11 |  | 0.51% |
| Investment Securities: |  |  |  |  |  |  |  |  |
| Taxable | 117,507 | 1,709 |  | 1.94% | 77,822 | 1,103 |  | 1.89% |
| Tax-Exempt | 50,621 | 1,242 | (a) | 3.28% | 80,289 | 2,367 | (a) | 3.94% |
| Total Securities | 168,128 | 2,951 |  | 2.35% | 158,111 | 3,470 |  | 2.93% |
| Federal Funds Sold | 13,288 | 97 |  | 0.98% | 14,450 | 54 |  | 0.50% |
| Loans and Leases, Net | 846,903 | 30,199 | (b) | 4.77% | 762,796 | 27,277 | (b) | 4.78% |
| Restricted Investment in Bank Stocks | 2,738 | 87 |  | 4.25% | 2,893 | 105 |  | 4.85% |
| Total Earning Assets | 1,033,616 | 33,346 |  | 4.31% | 941,123 | 30,917 |  | 4.39% |
| Cash and Due from Banks | 20,528 |  |  |  | 12,548 |  |  |  |
| Other Assets | 34,596 |  |  |  | 33,770 |  |  |  |
| Total Assets | $1,088,740 |  |  |  | $987,441 |  |  |  |
| LIABILITIES & SHAREHOLDERS' EQUITY: |  |  |  |  |  |  |  |  |
| Interest-bearing Demand | $332,233 | 940 |  | 0.38% | $285,701 | 730 |  | 0.34% |
| Money Market | 247,730 | 1,069 |  | 0.58% | 230,642 | 961 |  | 0.56% |
| Savings | 62,693 | 27 |  | 0.06% | 59,701 | 26 |  | 0.06% |
| Time | 194,884 | 1,870 |  | 1.28% | 169,514 | 1,576 |  | 1.24% |
| Total Interest-bearing Deposits | 837,540 | 3,906 |  | 0.62% | 745,558 | 3,293 |  | 0.59% |
| Short-term Borrowings | 4,656 | 43 |  | 1.23% | 3,166 | 15 |  | 0.63% |
| Long-term Debt | 13,496 | 241 |  | 2.39% | 33,465 | 360 |  | 1.44% |
| Subordinated Debt | 7,417 | 297 |  | 5.35% | 7,438 | 297 |  | 5.33% |
| Total Interest-bearing Liabilities | 863,109 | 4,487 |  | 0.70% | 789,627 | 3,965 |  | 0.67% |
| Noninterest-bearing Demand | 141,506 |  |  |  | 116,782 |  |  |  |
| Other Liabilities | 10,095 |  |  |  | 8,441 |  |  |  |
| Shareholders' Equity | 74,030 |  |  |  | 72,591 |  |  |  |
| Total Liabilities & Shareholders' Equity | $1,088,740 |  |  |  | $987,441 |  |  |  |
| Net Interest Income (taxable equivalent basis) |  | $28,859 |  |  |  | $26,952 |  |  |
| Taxable Equivalent Adjustment |  | (758) |  |  |  | (1,236) |  |  |
| Net Interest Income |  | $28,101 |  |  |  | $25,716 |  |  |
| Total Yield on Earning Assets |  |  |  | 4.31% |  |  |  | 4.39% |
| Rate on Supporting Liabilities |  |  |  | 0.70% |  |  |  | 0.67% |
| Average Interest Spread |  |  |  | 3.61% |  |  |  | 3.72% |
| Net Interest Margin |  |  |  | 3.73% |  |  |  | 3.83% |

(a) Includes tax-equivalent adjustments on interest from tax-free municipal securities of $423,000 and $805,000 for the nine months ended September 30, 2017 and 2016, respectively.

(b) Includes tax-equivalent adjustments on interest from tax-free municipal loans of $335,000 and $431,000 for the nine months ended September 30, 2017 and 2016, respectively.

Taxable-equivalent net interest income was $9,741,000 for the three months ended September 30, 2017, an increase of $556,000 or 6 percent compared to the three months ended September 30, 2016. During the nine months ended September 30, 2017, taxable-equivalent net interest income increased $1,907,000 or 7 percent to $28,859,000 as compared to $26,952,000 for the nine months ended September 30, 2016. Net interest income in the first nine months of 2017 was positively impacted by core loan growth funded by lower-cost deposits, as well as the recognition of $279,000 of loan income from the successful workout of a loan relationship that included a previous charge-off in 2010.

For the three months ended September 30, 2017, Mid Penn’s tax-equivalent net interest margin was 3.64% compared to 3.71% for the three months ended September 30, 2016. For the nine months ended September 30, 2017, Mid Penn’s tax-equivalent net interest margin was 3.73% versus 3.83% for the nine months ended September 30, 2016. The decrease in the net interest margin year over year was primarily attributed to the lower yield earned on the investment portfolio. For the first nine months of 2017, the overall investment portfolio yield was 2.35%, compared to an investment portfolio yield of 2.93% for the same period in 2016. The reduction was attributed to Mid Penn establishing an $82,625,000 held-to-maturity investment portfolio including lower-risk and lower-yielding U.S. Treasury notes and U.S. agency mortgage-backed securities in the first quarter of 2017. The held-to-maturity portfolio was established to support the Bank’s growth in public fund deposit pledging requirements.

Although the effective interest rate impact on earning assets and funding sources can be reasonably estimated at current interest rate levels, the interest-bearing product and pricing options selected by customers, and the future mix of the loan, investment, and deposit products in the Bank's portfolios, may significantly change the estimates used in Mid Penn’s asset and liability management and related interest rate risk simulation models. In addition, our net interest income may be impacted by further interest rate actions of the Board of Governors of the Federal Reserve System.

### Provision for Loan Losses

The provision for loan and lease losses is the expense necessary to maintain the allowance at a level adequate to absorb management’s estimate of probable losses in the loan and lease portfolio. Mid Penn’s provision for loan and lease losses is based upon management’s monthly review of the loan portfolio. The purpose of the review is to assess loan quality, identify impaired loans and leases, analyze delinquencies, ascertain loan and lease growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets Mid Penn serves.

Mid Penn has maintained the allowance in accordance with Mid Penn’s assessment process, which takes into consideration, among other relevant factors, the risk characteristics of the loan portfolio, the growth in the loan portfolio during the first nine months of 2017, and shifting collateral values from December 31, 2016 to September 30, 2017.

Management performs a monthly evaluation of the adequacy of the loan and lease loss allowance and based on this evaluation, no loan loss provision was recorded for the three months ended September 30, 2017, compared to a loan loss provision of $585,000 for the three months ended September 30, 2016. For the nine months ended September 30, 2017, the recorded loan loss provision was $225,000 compared to a loan loss provision of $1,320,000 for the nine months ended September 30, 2016. The significant net principal recoveries during the nine months ended September 30, 2017 added $94,000 to the allowance for loan loss balance. Additionally, during the nine months ended September 30, 2017, Mid Penn had favorable workouts of certain impaired credits which reduced the amount of required specific allocations in the allowance. The allowance for loan and lease losses as a percentage of total loans was 0.86% at September 30, 2017, compared to 0.88% at December 31, 2016, and 0.95% at September 30, 2016. For further discussion of factors affecting the provision for loan and lease losses please see *Credit Quality, Credit Risk, and Allowance for Loan and Lease Losses* in the Financial Condition section of this Management’s Discussion and Analysis.

### Noninterest Income

During the three months ended September 30, 2017, noninterest income was $1,564,000 reflecting an increase of $145,000 or 10 percent compared to noninterest income of $1,419,000 for the three months ended September 30, 2016. For the nine months ended September 30, 2017, noninterest income totaled $4,362,000, an increase of $313,000 or 8 percent, compared to noninterest income of $4,049,000 for the same period in 2016.

The following components of noninterest income showed significant changes:

*(Dollars in Thousands)*

|  | Three Months Ended September 30, 2017 | 2016 | $ Variance | % Variance |
| --- | ---: | ---: | ---: | ---: |
| Income from fiduciary activities | $217 | $104 | $113 | 109% |
| Service charges on deposits | 175 | 171 | 4 | 2% |
| Net gain on sales of investment securities | 22 | 200 | (178) | -89% |
| Mortgage banking income | 230 | 266 | (36) | -14% |
| ATM debit card interchange income | 233 | 214 | 19 | 9% |
| Net gain on sales of SBA loans | 262 | 89 | 173 | 194% |
| Other income | 276 | 221 | 55 | 25% |

41

### MID PENN BANCORP, INC.

*(Dollars in Thousands)*

|  | Nine Months Ended September 30, 2017 | 2016 | $ Variance | % Variance |
| --- | ---: | ---: | ---: | ---: |
| Income from fiduciary activities | $613 | $349 | $264 | 76% |
| Service charges on deposits | 554 | 484 | 70 | 14% |
| Net gain on sales of investment securities | 42 | 413 | (371) | -90% |
| Mortgage banking income | 646 | 698 | (52) | -7% |
| ATM debit card interchange income | 689 | 623 | 66 | 11% |
| Net gain on sales of SBA loans | 703 | 354 | 349 | 99% |
| Other income | 669 | 687 | (18) | -3% |

Mid Penn increased its origination and sales activities related to Small Business Administration (“SBA”) loans, resulting in gains of $703,000 from related loan sales during the first nine months of 2017, an increase of $349,000 or 99 percent compared to SBA loan sales gains of $354,000 for the first nine months of 2016. More qualified small business borrowers continue to take advantage of Mid Penn’s Preferred Lender status with the SBA.

Income from fiduciary activities was $613,000 for the first nine months of 2017, an increase of $264,000 or 76 percent compared to fiduciary income of $349,000 during the same period in 2016. These additional revenues were attributed to trust assets under management significantly increasing over the past twelve months as a result successful business development efforts by Mid Penn’s expanded team of trust and retail investment officers.

For the nine months ended September 30, 2017, service charges on deposits were $554,000, an increase of $70,000 or 14 percent, compared to service charges of $484,000 for the nine months ended September 30, 2016. This upturn was driven by an increase in the volume of transactional deposit accounts, and by an increase in charges collected, including overdraft fees.

ATM debit card interchange income was $689,000 for the nine months ended September 30, 2017, an increase of $66,000 or 11 percent compared to interchange income of $623,000 for the same period in 2016. The additional income is a result of an increased volume of transactional checking accounts and an increase in Mid Penn Bank ATM debit card transactions across our market area.

Other noninterest income increased $55,000 for the three months ended September 30, 2017 compared to the three months ended September 30, 2016, primarily due to the recognition of certain incentive fees for check book purchases, which vary in timing and amount each year, and from gains on sales of fixed assets.

Net gains on sales of securities were $42,000 for the first nine months of 2017, a decrease of $371,000 or 90 percent compared to net gains on sales of securities of $413,000 during the same period ended September 30, 2016. During the first nine months of 2016, Mid Penn took advantage of favorable fixed income investment market conditions and increased fair values on several securities to reposition some of its investment portfolio, including selling a large volume of longer-term and rate-sensitive CMOs, as well as certain municipal bonds and agency notes.

### Noninterest Expense

During the three months ended September 30, 2017, noninterest expenses totaled $7,960,000, an increase of $795,000 or 11 percent compared to noninterest expenses of $7,165,000 for the three months ended September 30, 2016. For the nine months ended September 30, 2017, noninterest expenses totaled $23,320,000, an increase of $2,242,000 or 11 percent compared to noninterest expenses of $21,078,000 for the first nine months in 2016.

The changes were primarily a result of the following components of noninterest expense, which had notable variances when comparing results for periods ending in 2017 versus the similar periods in 2016:

*(Dollars in Thousands)*

|  | Three Months Ended September 30, 2017 | 2016 | $ Variance | % Variance |
| --- | ---: | ---: | ---: | ---: |
| Salaries and employee benefits | $4,277 | $3,982 | $295 | 7% |
| Occupancy expense, net | 631 | 496 | 135 | 27% |
| Pennsylvania bank shares tax expense | 170 | 197 | (27) | -14% |
| FDIC Assessment | 197 | 134 | 63 | 47% |
| Legal and professional fees | 218 | 130 | 88 | 68% |
| Software licensing | 397 | 350 | 47 | 13% |
| Telephone expense | 120 | 135 | (15) | -11% |

42

### MID PENN BANCORP, INC.

*(Dollars in Thousands)*

|  | Nine Months Ended September 30, 2017 | 2016 | $ Variance | % Variance |
| --- | ---: | ---: | ---: | ---: |
| Salaries and employee benefits | $12,666 | $11,428 | $1,238 | 11% |
| Occupancy expense, net | 1,872 | 1,542 | 330 | 21% |
| Pennsylvania bank shares tax expense | 500 | 606 | (106) | -17% |
| FDIC Assessment | 585 | 434 | 151 | 35% |
| Legal and professional fees | 584 | 515 | 69 | 13% |
| Software licensing | 1,096 | 1,015 | 81 | 8% |
| Telephone expense | 379 | 420 | (41) | -10% |

Salaries and employee benefits expense increased $1,238,000 or 11 percent during the first nine months of 2017 versus the same period in 2016, with the increase attributable to (i) the addition of lending personnel, credit support staff, and executive management in alignment with Mid Penn’s core banking growth, (ii) added retail staff for three new branch offices at Oregon Pike, New Holland, and Orwigsburg, all of which opened after September 30, 2016, and (iii) increased healthcare costs from Mid Penn’s self-funded medical plan during the first nine months of 2017.

Occupancy expenses for the nine months ended September 30, 2017 increased $330,000 or 21 percent compared to the same period in 2016. In the twelve months since September 30, 2016, Mid Penn added facility operating costs associated with opening the above-noted three new branch offices, as well as loan production offices in Lancaster and Franklin Counties in Pennsylvania.

Mid Penn’s FDIC assessment increased by $151,000 or 35 percent from $434,000 during the nine months ended September 30, 2016, to $585,000 during the nine months ended September 30, 2017, due to the Company’s growing deposits and assets, which increased the base amount used to determine the FDIC insurance assessment.

Legal and professional fees for the nine months ended September 30, 2017 increased by $69,000 or 13 percent compared to the same period in 2016 due to increased legal and professional fees for wealth management, audit, and public relations activities.

Software licensing fees increased by $81,000 or 8 percent from $1,015,000 during the nine months ended September 30, 2016, to $1,096,000 during the nine months ended September 30, 2017. The increase is a result of additional costs to upgrade internal systems to better serve our customers, as well as increases in per-transaction and per-account data processing fees as our customer base and transaction volume grow.

Pennsylvania bank shares tax expense decreased $106,000 or 17 percent during the nine months ended September 30, 2017 versus the same period in 2016, due to the additional Pennsylvania-eligible tax credits generated from Mid Penn’s donations to support education and economic development throughout the markets it serves.

Telephone expense was $379,000 for the nine months ended September 30, 2017, a $41,000 decrease from the $420,000 recognized during the nine months ended September 30, 2016. This decrease is attributable to modifications to the company-wide telephone system intended to reduce costs.

### Income Taxes

The provision for income taxes was $871,000 for the three months ended September 30, 2017 compared to $526,000 for the three months ended September 30, 2016. The effective tax rate for the three months ended September 30, 2017 was 27.9% compared to 21.7% for the three months ended September 30, 2016. The provision for income taxes for the nine months ended September 30, 2017 was $2,330,000 compared to $1,639,000 during the same period in 2016. The effective tax rate for the nine months ended September 30, 2017 was 26.1% compared to 22.2% for the nine months ended September 30, 2016. In addition to the increased pre-tax income in 2017, the higher effective tax rates for 2017 were impacted by a relatively lower volume of tax-exempt income on municipal loans and investments, and from a portion of Mid Penn’s merger-related expenses of $467,000 being nondeductible for federal income tax purposes.

Generally, Mid Penn’s effective tax rate is below the statutory rate due to earnings on tax-exempt loans, investments, and BOLI, as well as the impact of tax credits. The realization of Mid Penn’s deferred tax assets is dependent on future earnings. Mid Penn currently anticipates that future earnings will be adequate to fully realize the currently recorded deferred tax assets.

### Financial Condition

### Overview

Mid Penn’s total assets were $1,153,373,000 as of September 30, 2017, an increase of $120,774,000 or 12 percent compared to total assets of $1,032,599,000 as of December 31, 2016. In the first nine months of 2017, Mid Penn realized favorable loan growth, primarily in commercial relationships, of $63,462,000 or 8 percent since December 31, 2016. This asset and loan growth was principally funded by an increase in deposits of $91,302,000 or 10 percent since year-end 2016.

### Loans

Total loans at September 30, 2017 were $877,386,000 compared to $813,924,000 at December 31, 2016, an increase of $63,462,000 or 8 percent (or 10 percent on an annualized basis). The main driver of Mid Penn’s loan growth continues to be commercial loans, including both commercial and industrial financing, and commercial real estate credits.

*(Dollars in thousands)*

|  | September 30, 2017 Amount% |  | December 31, 2016 Amount% |  |
| --- | ---: | ---: | ---: | ---: |
| Commercial and industrial | $182,857 | 20.8% | $172,518 | 21.2% |
| Commercial real estate | 490,603 | 55.9% | 446,524 | 54.9% |
| Commercial real estate - construction | 58,074 | 6.6% | 54,376 | 6.7% |
| Lease financing | 259 | 0.0% | 425 | 0.1% |
| Residential mortgage | 101,073 | 11.5% | 99,457 | 12.2% |
| Home equity | 40,350 | 4.6% | 37,608 | 4.6% |
| Consumer | 4,170 | 0.5% | 3,016 | 0.3% |
|  | $877,386 | 100.0% | $813,924 | 100.0% |

### Credit Quality, Credit Risk, and Allowance for Loan and Lease Losses

For the nine months ended September 30, 2017, Mid Penn had net recoveries of $94,000 compared to net losses of $6,000 during the same period of 2016. The primary reason for this favorable net recoveries amount was that, during the first half of 2017, Mid Penn recovered $318,000 of principal, as well as collected $279,000 in interest income, from the successful workout of a commercial real estate relationship that was partially charged-off in 2010. Similar recoveries were not recognized during the nine months ended September 30, 2016.

Loans charged off during the first nine months of 2017 totaled $315,000 and included two residential mortgage loans from two relationships for $25,000, one commercial and industrial loan for $12,000, four commercial real estate loan relationships for $237,000, one home equity loan for $20,000, and $21,000 in deposit account charge-offs. Mid Penn may need to make future adjustments to the allowance and the provision for loan and lease losses if economic conditions or loan credit quality differs substantially from the assumptions used in making Mid Penn’s evaluation of the level of the allowance for loan losses as compared to the balance of outstanding loans.

Changes in the allowance for the nine months ended September 30, 2017 and 2016 are summarized as follows:

*(Dollars in thousands)*

|  | Nine Months Ended September 30, 2017 | 2016 |
| --- | ---: | ---: |
| Balance, beginning of period | $7,183 | $6,168 |
| Loans charged off during period | (315) | (234) |
| Recoveries of loans previously charged off | 409 | 228 |
| Net recoveries | 94 | (6) |
| Provision for loan and lease losses | 225 | 1,320 |
| Balance, end of period | $7,502 | $7,482 |
| Ratio of net loans (recovered)/charged off to average loans outstanding, annualized | -0.01% | 0.00% |
| Ratio of allowance for loan losses to net loans at end of period | 0.86% | 0.95% |

Other than as described herein, Mid Penn does not believe there are any trends or events at this time that are reasonably expected to have a material impact on future results of operations, liquidity, or capital resources. Further, based on known information, Mid Penn believes that the effects of current and past economic conditions and other unfavorable business conditions may influence certain borrowers’ abilities to comply with their repayment terms. Mid Penn continues to monitor closely the financial strength of these borrowers. Mid Penn does not engage in practices which may be used to artificially shield certain borrowers from the negative economic or business cycle effects that may compromise their ability to repay. Mid Penn does not normally structure construction loans with interest reserve components. Mid Penn has not in the past performed any commercial real estate or other type of loan workouts whereby an existing loan was restructured into multiple new loans. Also, Mid Penn does not extend loans at maturity solely due to the existence of guarantees, without recognizing the credit as impaired. While the existence of a guarantee may be a mitigating factor in determining the proper level of allowance once impairment has been identified, the guarantee does not affect the impairment analysis.

The following table presents the change in nonperforming asset categories as of September 30, 2017, December 31, 2016, and September 30, 2016.

*(Dollars in thousands)*

| Nonperforming Assets: | September 30, 2017 | December 31, 2016 | September 30, 2016 |
| --- | ---: | ---: | ---: |
| Nonaccrual loans | $7,939 | $4,658 | $4,621 |
| Accruing troubled debt restructured loans | 551 | 877 | 904 |
| Total nonperforming loans | 8,490 | 5,535 | 5,525 |
| Foreclosed real estate | 33 | 224 | 501 |
| Total non-performing assets | 8,523 | 5,759 | 6,026 |
| Accruing loans 90 days or more past due | 56 | 59 | 557 |
| Total risk elements | $8,579 | $5,818 | $6,583 |
| Nonperforming loans as a % of total |  |  |  |
| loans outstanding | 0.97% | 0.68% | 0.70% |
| Nonperforming assets as a % of total |  |  |  |
| loans outstanding and other real estate | 0.97% | 0.71% | 0.76% |
| Ratio of allowance for loan losses |  |  |  |
| to nonperforming loans | 88.36% | 129.78% | 135.42% |

In the table above, troubled debt restructured loans that are no longer accruing interest are included in nonaccrual loans. The increase in nonperforming assets is primarily due to one larger loan relationship totaling $4.5 million, with a $150,000 specific allowance allocation, being placed on nonaccrual status during the third quarter of 2017.

Mid Penn assesses a specific allocation for both commercial loans and commercial real estate loans prior to charging down or charging off the loan. Once the charge down is taken, the remaining balance remains a nonperforming loan with the original terms and interest rate intact and is not treated as a restructured credit. The following table provides additional analysis of partially charged-off loans.

*(Dollars in thousands)*

|  | September 30, 2017 | December 31, 2016 |
| --- | ---: | ---: |
| Period ending total loans outstanding | $877,386 | $813,924 |
| Allowance for loan and lease losses | 7,502 | 7,183 |
| Total Nonperforming loans | 8,490 | 5,535 |
| Nonperforming and impaired loans with partial charge-offs | 1,782 | 1,604 |
| Ratio of nonperforming loans with partial charge-offs |  |  |
| to total loans | 0.20% | 0.20% |
| Ratio of nonperforming loans with partial charge-offs |  |  |
| to total nonperforming loans | 20.99% | 28.97% |
| Coverage ratio net of nonperforming loans with |  |  |
| partial charge-offs | 111.84% | 182.71% |
| Ratio of total allowance to total loans less |  |  |
| nonperforming loans with partial charge-offs | 0.86% | 0.88% |

Mid Penn considers a commercial loan or commercial real estate loan to be impaired when it becomes 90 days or more past due and not well-secured or otherwise not probable for collection. This methodology assumes the borrower cannot or will not continue to make additional payments. At that time the loan would be considered collateral dependent as the discounted cash flow method indicates no operating income is available for evaluating the collateral position; therefore, most impaired loans are deemed to be collateral dependent.

Mid Penn evaluates loans for charge-off on a monthly basis. Policies that govern the recommendation for charge-off are unique to the type of loan being considered. Commercial loans rated as nonaccrual or lower will first have a collateral evaluation completed in accordance with the guidance on impaired loans. Once the collateral evaluation has been completed, a specific allocation of allowance is made based upon the results of the evaluation. The balance remains a nonperforming loan with the original terms and interest rate intact (not restructured). In the event the loan is unsecured, the loan would have been charged-off at the recognition of impairment. Commercial real estate loans rated as impaired will also have an initial collateral evaluation completed in accordance with the guidance on impaired loans. An updated real estate valuation is ordered and the collateral evaluation is modified to reflect any variation in value. A specific allocation of allowance is made for any anticipated collateral shortfall. The balance remains a nonperforming loan with the original terms and interest rate intact (not restructured). The process of charge-off for residential mortgage loans begins upon a loan becoming delinquent for 90 days and not in the process of collection. The existing appraisal is reviewed and a lien search is obtained to determine lien position and any instances of intervening liens. A new appraisal of the property will be ordered if deemed necessary by management and a collateral evaluation is completed. The loan will then be charged down to the value indicated in the evaluation. Consumer loans are recommended for charge-off after reaching delinquency of 90 days and the loan is not well-secured or otherwise not probable for collection. The collateral shortfall of the consumer loan is recommended for charge-off at this point.

As noted above, Mid Penn assesses a specific allocation for both commercial loans and commercial real estate loans. The balance remains a nonperforming loan with the original terms and interest rate intact (not restructured). In addition, Mid Penn takes a preemptive step when any commercial loan or commercial real estate loan becomes classified under its internal classification system. A preliminary collateral evaluation in accordance with the guidance on impaired loans is prepared using the existing collateral information in the loan file. This process allows Mid Penn to review both the credit and documentation files to determine the status of the information needed to make a collateral evaluation. This collateral evaluation is preliminary but allows Mid Penn to determine if any potential collateral shortfalls exist.

Larger groups of small-balance loans, such as residential mortgages and consumer installment loans are collectively evaluated for impairment. Accordingly, individual consumer and residential loans are not separately identified for impairment disclosures unless such loans are the subject of a restructuring agreement.

Mid Penn’s rating system assumes any loans classified as substandard nonaccrual to be impaired, and most of these loans are considered collateral dependent; therefore, most of Mid Penn’s impaired loans, whether reporting a specific allocation or not, are considered collateral dependent.

It is Mid Penn’s policy to obtain updated third party valuations on all impaired loans collateralized by real estate as soon as practically possible of the credit being classified as substandard nonaccrual. Prior to receipt of the updated real estate valuation Mid Penn will use any existing real estate valuation to determine any potential allowance issues; however, no allowance recommendation will be made until such time Mid Penn is in receipt of the updated valuation. The Asset Recovery department employs an electronic tracking system to monitor the receipt of and need for updated appraisals. To date, there have been no material time lapses noted with the above processes.

In some instances Mid Penn is not holding real estate as collateral and is relying on business assets (personal property) for repayment. In these circumstances a collateral inspection is performed by Mid Penn personnel to determine an estimated value. The value is based on net book value, as provided by the financial statements, and discounted accordingly based on determinations made by management. Occasionally, Mid Penn will employ an outside service to provide a fair estimate of value based on auction or private sales. Management reviews the estimates of these third parties and discounts them accordingly based on management’s judgment, if deemed necessary.

For impaired loans with no valuation allowance required, Mid Penn’s practice of obtaining independent third party market valuations on the subject property as soon as practically possible of being placed on nonaccrual status sometimes indicates that the loan to value ratio is sufficient to obviate the need for a specific allocation in spite of significant deterioration in real estate values in Mid Penn’s primary market area. These circumstances are determined on a case by case analysis of the impaired loans.

Mid Penn actively monitors the values of collateral on impaired loans. This monitoring may require the modification of collateral values over time or changing circumstances by some factor, either positive or negative, from the original values. All collateral values will be assessed by management at least every 12 months for possible revaluation by an independent third party.

Mid Penn had $9,096,000 loans deemed impaired at September 30, 2017. Excluding $884,000 in loans acquired with credit deterioration from the Phoenix Bancorp, Inc. (“Phoenix”) acquisition, Mid Penn had several loan relationships deemed impaired with an aggregate carrying balance of $8,212,000. This pool of loans was further broken down into a group of loans with an aggregate carrying balance of $6,558,000 for which specific allocations totaling $691,000 were included within the loan loss reserve for these loans. The remaining $1,654,000 of loans required no specific allocation within the loan loss reserve. Of the $8,212,000 of impaired loan relationships, excluding the loans acquired with credit deterioration from the Phoenix acquisition, $4,460,000 were commercial and industrial relationships, $2,148,000 were commercial real estate relationships, $856,000 were residential relationships, $487,000 were commercial real estate – construction relationships, and $261,000 were home equity relationships. There were specific loan loss reserve allocations of $150,000 against the commercial and industrial relationships, $375,000 against the commercial real estate relationships, $66,000 against the residential real estate relationships, and $100,000 against the commercial real estate – construction relationships. Management currently believes that the specific reserves are adequate to cover probable future losses related to these relationships.

The allowance is a reserve established in the form of a provision expense for loan and lease losses and is reduced by loan charge-offs net of recoveries. In conjunction with an internal loan review function that operates independently of the lending function, management monitors the loan portfolio to identify risk on a monthly basis so that an appropriate allowance is maintained. Based on an evaluation of the loan portfolio, management presents a monthly review of the allowance to the Board of Directors, indicating any changes in the allowance since the last review. In making the evaluation, management considers the results of recent regulatory examinations, which typically include a review of the allowance an integral part of the examination process. As part of the examination process, federal or state regulatory agencies may require Mid Penn to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management.

In establishing the allowance, management evaluates on a quantitative basis individual classified loans and nonaccrual loans, and determines an aggregate reserve for those loans based on that review. In addition, an allowance for the remainder of the loan and lease portfolio is determined based on historical loss experience within certain components of the portfolio. These allocations may be modified if current conditions indicate that loan and lease losses may differ from historical experience.

In addition, a portion of the allowance is established for losses inherent in the loan and lease portfolio which have not been identified by the quantitative processes described above. This determination inherently involves a higher degree of subjectivity, and considers risk factors that may not have yet manifested themselves in historical loss experience. These factors include:

- changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;
- changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans;
- changes in the value of underlying collateral for collateral-dependent loans;
- changes in the experience, ability, and depth of lending management and other relevant staff;
- changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses;
- changes in the quality of the institution's loan review system;
- changes in the nature and volume of the portfolio and in the terms of loans;
- the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the institution's existing portfolio; and
- the existence and effect of any concentrations of credit and changes in the level of such concentrations.

While the allowance is maintained at a level believed to be adequate by management to provide for probable losses inherent in the loan and lease portfolio, determination of the allowance is inherently subjective, as it requires estimates, all of which may be susceptible to significant change. The unallocated component of the allowance for loan and lease losses covers several considerations that are not specifically measurable through either the specific and general components. For example, we believe that we could face increasing credit risks and uncertainties, not yet reflected in recent historical losses or qualitative factor assessments, associated with unpredictable changes in economic growth or business conditions in our markets or for certain industries in which we have commercial loan borrowers, or unanticipated stresses to the values of real estate held as collateral. Any or all of these additional issues can adversely affect our borrowers’ ability to timely repay their loans. Additionally, we have experienced continued strong commercial loan growth, including growth in newer markets where we have less of a loss history. Also, the unallocated component allocation recognizes the inherent imprecision in our allowance for loan and lease loss methodology, or any alternative methodology, for estimating specific and general loan losses, including the unpredictable timing and amounts of charge-offs, the fact that historical loss averages don’t necessarily correlate to future loss trends, and unexpected changes to specific-credit or general portfolio future cash flows and collateral values which could negatively impact unimpaired portfolio loss factors. Changes from these various other uncertainties and considerations may impact the provisions charged to expense in future periods.

Management believes, based on information currently available, that the allowance of $7,502,000 is adequate as of September 30, 2017 to cover specifically identifiable loan losses, as well as estimated losses inherent in our portfolio for which certain losses are probable but not specifically identifiable.

### Liquidity

Mid Penn’s objective is to maintain adequate liquidity to meet funding needs at a reasonable cost and to provide contingency plans to meet unanticipated funding needs or a loss of funding sources, while minimizing interest rate risk. Adequate liquidity provides resources for credit needs of borrowers, for depositor withdrawals, and for funding corporate operations. Sources of liquidity are as follows:

- a growing core deposit base;
- proceeds from the sale or maturity of investment securities;
- proceeds from interest-bearing time deposits with other financial institutions;
- payments received on loans and mortgage-backed securities;
- overnight correspondent bank borrowings on various credit lines; and
- borrowing capacity available from the FHLB, the Federal Reserve Discount Window, and other lines of credit currently available to Mid Penn.

The major sources of cash received in the first nine months of 2017 came from the $91,302,000 net increase in deposits and $52,314,000 in proceeds from the sales of available-for-sale investment securities.

Major uses of cash in the first nine months of 2017 were $101,288,000 for investment purchases and $63,400,000 for funding the increase in net loans and leases.

Mid Penn believes its core deposits are generally stable even in periods of changing interest rates. Liquidity is measured and monitored daily, allowing management to better understand and react to balance sheet trends. These measurements indicate that liquidity generally remains stable and exceeds our minimum defined levels of adequacy. Other than the trends of continued competitive pressures and volatile interest rates, there are no known demands, commitments, events, or uncertainties that will result in, or that are reasonably likely to result in, liquidity increasing or decreasing in any material way.

On a quarterly basis, a comprehensive liquidity analysis is reviewed by the Asset Liability Committee and Board of Directors. The analysis provides a summary of the current liquidity measurements, projections, and future liquidity positions given various levels of liquidity stress. Management also maintains a detailed Contingency Funding Plan designed to respond to an overall decline in the financial condition of the banking industry or a problem specific to Mid Penn.

### Subordinated Debt

On November 9, 2015, Mid Penn entered into agreements with investors to purchase $7,500,000 aggregate principal amount of its Notes due 2025. The Notes are treated as Tier 2 capital for regulatory capital purposes. The offering closed in December 2015.

The Notes bear interest at a rate of 5.15% per year for the first five years and then float at the Wall Street Journal’s Prime Rate plus 0.50%, provided that the interest rate applicable to the outstanding principal balance will at no time be less than 4.0%. Interest is paid quarterly in arrears on January 1, April 1, July 1 and October 1 of each year, beginning on January 1, 2016. The Notes will mature on December 9, 2025 and are redeemable in whole or in part, without premium or penalty, at any time on or after December 9, 2020, and prior to December 9, 2025. Additionally, Mid Penn may redeem the Notes in whole at any time, or in part from time to time, upon at least 30 days’ notice if: (i) a change or prospective change in law occurs that could prevent Mid Penn from deducting interest payable on the Notes for U.S. federal income tax purposes; (ii) an event occurs that precludes the Notes from being recognized as Tier 2 capital for regulatory capital purposes; or (iii) Mid Penn becomes required to register as an investment company under the Investment Company Act of 1940, as amended, in each case at 100% of the principal amount of the subordinated notes, plus accrued and unpaid interest thereon to but excluding the date of redemption. The unamortized debt issuance costs associated with the Notes were $79,000 at September 30, 2017 and $86,000 at December 31, 2016.

Holders of the Notes may not accelerate the maturity of the Notes, except upon Mid Penn’s or Mid Penn Bank’s bankruptcy, insolvency, liquidation, receivership, or similar event.

### Regulatory Capital Changes

In July 2013, the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for community banking organizations began January 1, 2016. The final rules implemented higher minimum capital requirements, added a new common equity Tier 1 capital requirement, and established criteria that instruments must meet to be considered common equity Tier 1 capital, additional Tier 1 capital or Tier 2 capital. Under the new rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity Tier 1 capital above its minimum risk-based capital requirements, which amount (when fully phased in) must be greater than 2.5% of total risk-weighted assets at January 1, 2019. The phase-in period for the capital conservation and countercyclical capital buffers for all banking organizations began on January 1, 2016 at the initial rate of 0.625%. A summary of the payout restrictions based on the capital conservation buffer is as follows:

| Capital Conservation Buffer (as a % of risk-weighted assets) \> 2.5% | Maximum Payout (as a % of eligible retained income) No payout limitation applies |
| --- | ---: |
| ≤2.5% and \>1.875% | 60% |
| ≤1.875% and \>1.25% | 40% |
| ≤1.25% and \>0.625% | 20% |
| ≤0.625% | 0% |

48

Implementation of the deductions and other adjustments to common equity Tier 1 capital began on January 1, 2016 and will be phased-in over a three-year period. The final rules called for the following minimum capital requirements to be considered “well-capitalized” (which include the impact of the capital conservation buffer that was effective January 1, 2016):

|  | As of January 1, 2016 | 2017 | 2018 | 2019 |
| --- | ---: | ---: | ---: | ---: |
| Minimum common equity Tier 1 capital ratio | 4.5% | 4.5% | 4.5% | 4.5% |
| Common equity Tier 1 capital conservation buffer | 0.625% | 1.25% | 1.875% | 2.5% |
| Minimum common equity Tier 1 capital ratio plus capital conservation buffer | 5.125% | 5.75% | 6.375% | 7.0% |
| Phase-in of most deductions from common equity Tier 1 capital | 60% | 80% | 100% | 100% |
| Minimum Tier 1 capital ratio | 6.0% | 6.0% | 6.0% | 6.0% |
| Minimum Tier 1 capital ratio plus capital conservation buffer | 6.625% | 7.25% | 7.875% | 8.5% |
| Minimum total capital ratio | 8.0% | 8.0% | 8.0% | 8.0% |
| Minimum total capital ratio plus capital conservation buffer | 8.625% | 9.25% | 9.875% | 10.5% |

The final rules allowed community banks to make a one-time election not to include the additional components of accumulated other comprehensive income (“AOCI”) in regulatory capital and instead use the existing treatment under the general risk-based capital rules that excludes most AOCI components from regulatory capital. Mid Penn made the election not to include the additional components of AOCI in regulatory capital.

The final rules permanently grandfathered non-qualifying capital instruments (such as trust preferred securities and cumulative perpetual preferred stock) issued before May 19, 2010 for inclusion in the Tier 1 capital of banking organizations with total consolidated assets less than $15 billion as of December 31, 2009 and banking organizations that were mutual holding companies as of May 19, 2010.

Consistent with the Dodd-Frank Act, the new rules replaced the ratings-based approach to securitization exposures, which is based on external credit ratings, with the simplified supervisory formula approach in order to determine the appropriate risk weights for these exposures. Alternatively, banking organizations may use the existing gross-ups approach to assign securitization exposures to a risk weight category or choose to assign such exposures a 1,250% risk weight.

Under the new rules, mortgage servicing assets (“MSAs”) and certain deferred tax assets (“DTAs”) are subject to stricter limitations than those applicable under the current general risk-based capital rule. The new rules also increase the risk weights for past-due loans, certain risk weights and credit conversion factors.

Mid Penn has implemented these changes in determining and reporting the regulatory ratios of Mid Penn and the Bank, and has concluded that the new rules did not have a material adverse effect on Mid Penn’s financial condition.

### Capital Resources

Shareholders' equity, or capital, is evaluated in relation to total assets and the risk associated with those assets. The greater a corporation’s capital resources, the more likely it is to meet its cash obligations and absorb unforeseen losses. Too much capital, however, indicates that not enough of the corporation’s earnings have been invested in the continued growth of the business or paid to shareholders. An excess capital position may make it difficult for a corporation to offer a competitive return on the shareholders’ capital going forward. For these reasons capital adequacy and capital management have been, and will continue to be, of paramount importance.

Shareholders’ equity increased by $6,924,000 or 10 percent, from $70,467,000 at December 31, 2016 to $77,391,000 at September 30, 2017. The increase during the first nine months of 2017 was attributed to both (i) growth in retained earnings through an increase in year-to-date net income and (ii) other comprehensive income, primarily due to the after-tax unrealized appreciation in the value of the available-for-sale investment portfolio since December 31, 2016. Regulatory capital ratios for both Mid Penn and the Bank exceeded regulatory “well-capitalized” levels at both September 30, 2017 and December 31, 2016.

Banks are evaluated for capital adequacy based on the ratio of capital to risk-weighted assets and total assets. The minimum capital to risk-weighted assets requirements, including the capital conservation buffers, which became effective for Mid Penn and the Bank on January 1, 2016 are illustrated below. At September 30, 2017, regulatory capital ratios for both Mid Penn and the Bank met the definition of a “well-capitalized” institution under the regulatory framework for prompt corrective action, and exceeded the minimum capital requirements under Basel III.

Mid Penn and Mid Penn Bank maintained the following regulatory capital levels, leverage ratios, and risk-based capital ratios as of September 30, 2017 and December 31, 2016:

49

### MID PENN BANCORP, INC.

*(Dollars in thousands)*

| Corporation As of September 30, 2017: | Capital Adequacy Actual: Amount | Ratio | Minimum Capital Required: Amount | Ratio | To Be Well-Capitalized Under Prompt Corrective Action Provisions: Amount | Ratio |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Tier 1 Capital (to Average Assets) | $75,637 | 6.8% | $44,760 | 4.0% | N/A | N/A |
| Common Equity Tier 1 Capital (to Risk Weighted Assets) | 75,637 | 8.9% | 48,755 | 5.75% | N/A | N/A |
| Tier 1 Capital (to Risk Weighted Assets) | 75,637 | 8.9% | 61,474 | 7.25% | N/A | N/A |
| Total Capital (to Risk Weighted Assets) | 90,687 | 10.7% | 78,432 | 9.25% | N/A | N/A |
| Bank |  |  |  |  |  |  |
| As of September 30, 2017: |  |  |  |  |  |  |
| Tier 1 Capital (to Average Assets) | $82,353 | 7.4% | $44,732 | 4.0% | $55,915 | 5.0% |
| Common Equity Tier 1 Capital (to Risk Weighted Assets) | 82,353 | 9.7% | 48,715 | 5.75% | 55,069 | 6.5% |
| Tier 1 Capital (to Risk Weighted Assets) | 82,353 | 9.7% | 61,423 | 7.25% | 67,777 | 8.0% |
| Total Capital (to Risk Weighted Assets) | 89,982 | 10.6% | 78,367 | 9.25% | 84,722 | 10.0% |
| Corporation |  |  |  |  |  |  |
| As of December 31, 2016: |  |  |  |  |  |  |
| Tier 1 Capital (to Average Assets) | $70,431 | 6.8% | $41,595 | 4.0% | N/A | N/A |
| Common Equity Tier 1 Capital (to Risk Weighted Assets) | 70,431 | 9.1% | 34,807 | 4.5% | N/A | N/A |
| Tier 1 Capital (to Risk Weighted Assets) | 70,431 | 9.1% | 46,409 | 6.0% | N/A | N/A |
| Total Capital (to Risk Weighted Assets) | 85,148 | 11.0% | 61,879 | 8.0% | N/A | N/A |
| Bank |  |  |  |  |  |  |
| As of December 31, 2016: |  |  |  |  |  |  |
| Tier 1 Capital (to Average Assets) | $77,026 | 7.4% | $41,568 | 4.0% | $51,960 | 5.0% |
| Common Equity Tier 1 Capital (to Risk Weighted Assets) | 77,026 | 10.0% | 34,781 | 4.5% | 50,239 | 6.5% |
| Tier 1 Capital (to Risk Weighted Assets) | 77,026 | 10.0% | 46,374 | 6.0% | 61,832 | 8.0% |
| Total Capital (to Risk Weighted Assets) | 84,329 | 10.9% | 61,832 | 8.0% | 77,291 | 10.0% |

## Market risk

As filed, 147 characters.

There has been no material change in market risk since December 31, 2016, as reported in Mid Penn’s Form 10-K filed with the SEC on March 23, 2017.

## Controls and procedures

As filed, 981 characters.

### Evaluation of Disclosure Controls and Procedures

Mid Penn maintains controls and procedures designed to ensure that information required to be disclosed in the reports that Mid Penn files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls and procedures as of September 30, 2017, Mid Penn’s management, with the participation of the Principal Executive Officer and Principal Financial Officer, concluded that the disclosure controls and procedures were effective as of such date.

### Changes in Internal Controls

During the three and nine months ended September 30, 2017, there were no changes in Mid Penn’s internal control over financial reporting that have materially affected, or are reasonable likely to materially affect, Mid Penn’s internal control over financial reporting.

## Risk factors

As filed, 371 characters.

Management has reviewed the risk factors that were previously disclosed in the Annual Report on Form 10-K for the fiscal year ended December 31, 2016, to determine if there were material changes applicable to the three and nine months ended September 30, 2017. There are no material changes from the risk factors as previously disclosed in the Annual Report on Form 10-K.

Filed Nov 8, 2017.
Source: SEC EDGAR, the filing index for accession 0001564590-17-022644. Last ingested by Listed: Nov 5, 2026, 18:25 ET. No prices; not investment advice.