# MID Penn Bancorp Inc: Form 10-K for the period ended Dec 31, 2018 - Company: [MID Penn Bancorp Inc](/companies/mpb.md) (CIK 879635) - Form: 10-K - Filed: 2019-03-19 - Accepted by EDGAR: Mar 18, 2019, 17:46 ET - Period: 2018-12-31 - Accession: 0001564590-19-008349 - Inline XBRL: yes - Main document: https://www.sec.gov/Archives/edgar/data/879635/000156459019008349/mpb-10k_20181231.htm - All documents and exhibits: https://www.sec.gov/Archives/edgar/data/879635/000156459019008349/ ## Figures reported in this filing Standardized XBRL line items for the period ended 2018-12-31. | Line item | Period | Value | XBRL concept | | --- | --- | ---: | --- | | Interest expense | 3 months, 2018-10-01 to 2018-12-31 | $4.6m | us-gaap:InterestExpense | | Interest expense | 12 months, 2018-01-01 to 2018-12-31 | $12.7m | us-gaap:InterestExpense | | Income tax | 3 months, 2018-10-01 to 2018-12-31 | $916.0k | us-gaap:IncomeTaxExpenseBenefit | | Income tax | 12 months, 2018-01-01 to 2018-12-31 | $2.1m | us-gaap:IncomeTaxExpenseBenefit | | Net income | 3 months, 2018-10-01 to 2018-12-31 | $4.6m | us-gaap:NetIncomeLoss | | Net income | 12 months, 2018-01-01 to 2018-12-31 | $10.6m | us-gaap:NetIncomeLoss | | Basic EPS | 3 months, 2018-10-01 to 2018-12-31 | $0.54 | us-gaap:EarningsPerShareBasic | | Basic EPS | 12 months, 2018-01-01 to 2018-12-31 | $1.48 | us-gaap:EarningsPerShareBasic | | Operating cash flow | 12 months, 2018-01-01 to 2018-12-31 | $11.0m | us-gaap:NetCashProvidedByUsedInOperatingActivities | | Capital expenditure | 12 months, 2018-01-01 to 2018-12-31 | $9.0m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment | | Dividends paid | 12 months, 2018-01-01 to 2018-12-31 | $4.5m | us-gaap:PaymentsOfDividendsCommonStock | | Total assets | at 2018-12-31 | $2.08bn | us-gaap:Assets | | Total liabilities | at 2018-12-31 | $1.85bn | us-gaap:Liabilities | | Short-term borrowings | at 2018-12-31 | $43.1m | us-gaap:ShortTermBorrowings | | Shareholders' equity | at 2018-12-31 | $223.2m | us-gaap:StockholdersEquity | ## Business As filed, 48,104 characters. 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., Management’s Discussion and Analysis of Financial Condition and Results of Operations, 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. Mid Penn Bancorp, Inc. and its wholly owned subsidiaries are collectively referred to herein as “Mid Penn” or the “Corporation.” On December 31, 1991, Mid Penn acquired, as part of the holding company formation, all of the outstanding common stock of Mid Penn Bank (the “Bank”), and the Bank became a wholly-owned subsidiary of Mid Penn. Mid Penn’s primary business is to supervise and coordinate the business of its Bank subsidiary and its divisions, and to provide them with capital and resources. Mid Penn’s consolidated financial condition and results of operations consist almost entirely of that of the Bank, which is managed as a single business segment. At December 31, 2018, Mid Penn had total consolidated assets of $2,077,981,000 with total deposits of $1,726,026,000 and total shareholders’ equity of $223,209,000. Mid Penn currently does not own or lease any real property. Mid Penn Bank owns or leases the banking offices as identified in Part I, Item 2. All Mid Penn employees are employed by the Bank, with a shared services agreement to support the operation of the holding company. At December 31, 2018, the Bank had 372 full-time and 34 part-time employees. The Bank and its employees are not subject to a collective bargaining agreement, and the Bank believes it enjoys good relations with its personnel. Mid Penn Insurance Services, LLC, a wholly-owned subsidiary of Mid Penn Bank that provided a wide range of personal and commercial insurance products, ceased operations effective March 1, 2016 due to a lack of activity within this subsidiary. ### Mid Penn Bank Mid Penn Bank was organized in 1868 under a predecessor name, Millersburg Bank, and became a state chartered bank in 1931 and obtained trust powers in 1935, at which time its name was changed to Millersburg Trust Company. In 1971, Millersburg Trust Company adopted the name “Mid Penn Bank”. Mid Penn’s and the Bank’s legal headquarters are located at 349 Union Street, Millersburg, Pennsylvania 17061. On March 1, 2015, in connection with the acquisition of Phoenix Bancorp, Inc. (“Phoenix”) by Mid Penn, Phoenix’s wholly-owned banking subsidiary, Miners Bank, was merged with and into the Bank. The Bank was the surviving charter, and Miners Bank’s five branches in Schuylkill and Luzerne Counties, Pennsylvania operate as “Miners Bank, a Division of Mid Penn Bank”. On January 8, 2018, Mid Penn completed its acquisition of The Scottdale Bank and Trust Company (“Scottdale”) through the merger of Scottdale with and into Mid Penn Bank (the “Scottdale Merger”). The Scottdale Merger resulted in the addition of five branches in Western Pennsylvania operating as “Scottdale Bank & Trust, a Division of Mid Penn Bank”. On July 31, 2018, Mid Penn completed its acquisition of First Priority Financial Corp. (“First Priority”) pursuant to which First Priority was merged with and into Mid Penn (the “First Priority Merger”), with Mid Penn being the surviving corporation in the First Priority Merger. As part of this acquisition, First Priority’s banking subsidiary, First Priority Bank, was merged with and into Mid Penn Bank. The First Priority Merger resulted in the addition of eight offices in Southeastern Pennsylvania operating as “First Priority Bank, a Division of Mid Penn Bank”. Additional information related to the Scottdale and First Priority Mergers can be found in Notes 4 and 5 to the Consolidated Financial Statements contained in Item 8 of this report. Also, in January 2018, Mid Penn opened a new full-service office in Halifax, PA, and in September 2018, opened a new full-service office in Pillow, PA. After the opening of these two branches and adding thirteen from the two acquisitions that occurred during 2018, the Bank now has thirty-eight full service retail banking properties located in Berks, Bucks, Chester, Cumberland, Dauphin, Fayette, Lancaster, Luzerne, Montgomery, Northumberland, Schuylkill and Westmoreland Counties within Pennsylvania. Mid Penn’s primary business consists of attracting deposits and loans from the Bank’s network of community banking offices. 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, 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. The Pennsylvania Department of Banking and Securities and the Federal Deposit Insurance Corporation (the “FDIC”) supervise the Bank. Deposits of the Bank are insured by the FDIC’s Deposit Insurance Fund (the “DIF”) to the maximum extent provided by law. In addition, the Bank provides a full range of trust and retail investment services. The Bank also offers other services such as online banking, telephone banking, cash management services, automated teller services and safe deposit boxes. #### Business Strategy The Bank provides services to commercial businesses and real estate investors, consumers, nonprofit organizations, and municipalities through thirty-eight full service retail banking properties, one loan production office, a corporate administration office, and one operations facility which are all based in Pennsylvania. Mid Penn’s primary markets reflect a diversified manufacturing and services base across twelve Pennsylvania counties, including having several offices in and around the state capital region of Harrisburg. The Bank emphasizes developing long-term customer relationships, maintaining high quality service, and providing quick responses to customer needs. Mid Penn believes that local relationship building and its conservative approach to lending are important factors in the success and growth of Mid Penn. ### Lending Activities The Bank offers a variety of loan products to its customers, including loans secured by real estate, and commercial and consumer loans. The Bank’s primary lending objectives are as follows: - to establish relationships with creditworthy customers who exhibit positive historical repayment trends, stable cash flows and secondary sources of repayment from tangible collateral; - to establish a diversified loan portfolio; and - to provide a satisfactory return to Mid Penn’s 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. Credit risk is managed through portfolio diversification, underwriting policies and procedures, and loan monitoring practices. 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. 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 mitigated or potential losses reduced. 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, 2018, the Bank’s highest concentration of credit is in commercial real estate. ### Investment Activities Mid Penn’s securities portfolio is a source for both liquidity and interest earnings, and serves to support pledging requirements on public funds deposits through investments in primarily higher-quality fixed-income debt securities. Mid Penn does not have any significant non-governmental concentrations within its investment securities portfolio. In addition to an available-for-sale portfolio, during the first quarter of 2017, Mid Penn established a held-to-maturity investment portfolio comprised primarily of lower-risk and lower-yielding U.S. Treasury notes, U.S. agency mortgage-backed securities, and investment-grade municipal securities. The held-to-maturity portfolio was established to support the Bank’s growth in public fund deposits which require pledging. The investments in the held-to-maturity portfolio are recorded on the balance sheet at book value (amortized cost), while the available-for-sale securities are recorded on the balance sheet at fair value. Mid Penn’s available-for-sale investments include agency notes, agency mortgage-backed securities, and municipal securities. These debt securities derive fair values relative to investments of the same type and credit profile with similar maturity dates. As the interest rate environment changes, Mid Penn’s fair value of securities will change. This difference between the amortized cost and fair value of available-for-sale investment securities, or unrealized loss, amounted to $4,103,000 as of December 31, 2018. On an after-tax basis, this unrealized loss on available-for-sale securities resulted in a reduction to shareholders’ equity, through the accumulated other comprehensive loss component, of $3,242,000. A majority of the investments are high quality United States and municipal securities that, if held to maturity, are expected to result in no realized loss to the Bank. ### Deposits and Other Sources of Funds The Bank primarily uses retail deposits and, to a lesser extent, wholesale borrowings to finance lending and investment activities. Wholesale borrowing sources include advances from the Federal Home Loan Bank of Pittsburgh (the “FHLB”) and overnight borrowings from the Bank’s other correspondent banking relationships. All borrowings, except for lines of credit with the Bank’s correspondent banks, require collateral in the form of loans or securities. Collateral levels, therefore, limit the extent of borrowings and the available lines of credit extended by the Bank’s creditors. As a result, generating and retaining retail deposits remains critical to the future funding and growth of the business. Deposit growth within the banking industry has been subject to strong competition from a variety of financial services companies. This competition may require financial institutions to adjust their product offerings and pricing to maintain and grow deposits. Additionally, the safety of traditional bank deposit products has remained an attractive option during periods of market volatility. Mid Penn’s ability to attract retail funds in the future will continue to be impacted by the public’s appetite for the safety of insured or local investments versus the returns offered by alternative choices as part of their personal investment mix. ### Competition The banking business is highly competitive, and the profitability of Mid Penn depends principally upon the Bank’s ability to successfully compete in its market area. The Bank actively competes with other financial services companies for deposit, loan, and trust business. Competitors include other commercial banks, credit unions, savings banks, savings and loan associations, insurance companies, securities brokerage firms, finance companies, mutual funds, and service alternatives via the Internet. 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 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. For more information, see the “Supervision and Regulation” section below and Item 1A., “Risk Factors”. Mid Penn has been able to compete effectively with other financial institutions by emphasizing customer service, convenient hours, efficient and friendly employees, local decision making, and quality products. ### Supervision and Regulation #### General Bank holding companies and banks are extensively regulated under both federal and state laws. The regulation and supervision of Mid Penn and the Bank are primarily focused on the protection of depositors, the DIF, and the monetary system, and do not prioritize shareholder interests. Enforcement actions that may be imposed by federal and state banking regulators 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 a banking regulator takes any enforcement action, the value of an equity investment in Mid Penn could be substantially reduced or eliminated. As of December 31, 2018, the Bank was not subject to any supervisory enforcement actions. Federal and state banking laws contain numerous provisions affecting various aspects of the business and operations of Mid Penn and the Bank. Mid Penn is subject to, among others, the regulations of the Securities and Exchange Commission (“SEC”) and the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Bank is subject to, among others, the regulations of the Pennsylvania Department of Banking and Securities, and the FDIC. The descriptions below of, and references to, applicable statutes and regulations are not intended to be complete lists or reflective of all applicable provisions or their effects on Mid Penn or the Bank. They are summaries of the more significant laws and regulations and are qualified in their entirety by reference to the complete provisions of such statutes and regulations. #### Holding Company Regulation Mid Penn is a registered bank holding company subject to supervision and regulation by the Federal Reserve. As such, it is subject to the Bank Holding Company Act of 1956 (“BHCA”) and many of the Federal Reserve’s regulations promulgated thereunder. The Federal Reserve has broad enforcement powers over bank holding companies, including the power to impose substantial fines and civil penalties. The BHCA requires Mid Penn 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 actions would constitute an unsafe or unsound practice or violation of law. The Federal Reserve Board also makes policy that applies to the declaration and distribution of dividends by bank holding companies. The BHCA restricts a bank holding company’s 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 Under the Gramm-Leach-Bliley Financial Modernization Act (“GLB”), bank holding companies, such as Mid Penn, that meet certain management, capital, and Community Reinvestment Act standards, are permitted to become financial holding companies. 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 certain financial activities permitted under GLB. Activities cited by GLB as being financial in nature include: - securities underwriting, dealing and market making; - sponsoring mutual funds and investment companies; - insurance underwriting and agency; - merchant banking activities; and - activities that the Federal Reserve has determined by regulation to be closely related to banking. In addition to permitting financial holding companies entry into new lines of business, the law allows companies the freedom to streamline existing operations and to potentially reduce costs. The GLB may increase both opportunity and competition. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized under the FDIC Improvement Act’s 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. Many community banks are less able to devote the capital and management resources needed to facilitate broad expansion of financial services, such as insurance and brokerage services. Mid Penn has not elected to become a financial holding company at this time. #### Bank Regulation The Bank, a Pennsylvania-chartered institution, is subject to supervision, regulation and examination by both the Pennsylvania Department of Banking and Securities and the FDIC. The deposits of the Bank are insured by the FDIC to the maximum extent provided by law. The FDIC assesses deposit insurance premiums, the amount of which depends in part on both the asset size and the condition of the Bank. Moreover, the FDIC may terminate deposit insurance of the Bank under certain circumstances. The federal and state banking regulatory agencies have broad enforcement powers over depository institutions under their jurisdiction, including the power to terminate deposit insurance, to impose fines and other 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 affect a wide range of the Bank’s activities and operations, including, but snot limited to, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans, compensation standards, payment of dividends, various bank account and bank service disclosures, and the safety and soundness of banking practices. #### Capital Requirements Under risk-based capital requirements for bank holding companies, Mid Penn 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”). The remainder may consist of subordinated debt, non-qualifying preferred stock and a limited amount of the loan loss allowance (“Tier 2 Capital”). Combined, the Tier 1 Capital and Tier 2 Capital comprise regulatory “Total Capital”. As of December 31, 2018, Mid Penn complied with these risk-based capital requirements. In addition, the Federal Reserve 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 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 will continue to consider a “Tangible Tier 1 Leverage Ratio” (deducting all intangibles) in evaluating proposals for expansion or new activity. As of December 31, 2018, Mid Penn has met these leverage requirements, and the Federal Reserve has not advised Mid Penn of any specific minimum Tier 1 leverage ratio requirement. The Bank is subject to similar capital requirements adopted by the FDIC, and as of December 31, 2018, the Bank’s capital levels were sufficient to be considered “well-capitalized”. The FDIC has not advised the Bank of any specific minimum leverage ratios. The capital ratios of Mid Penn and the Bank are described in Note 19 to Mid Penn’s Consolidated Financial Statements, which are included herein. Banking regulators may further refine capital requirements applicable to banking organizations, including those discussed in the “Regulatory Capital Changes” section below. Changes to capital requirements could materially affect the profitability of Mid Penn or the fair value of Mid Penn stock. #### 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” 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 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 institution’s 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 “critically undercapitalized” and continues in that category for four quarters, the statute requires, with certain limited exceptions, that the institution be placed in receivership. #### 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 Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The final rules established a common equity tier 1 capital conservation buffer with a multi-year phase in to an eventual buffer of 2.5% of risk-weighted assets applicable to all banking organizations. If a banking organization fails to hold capital above the minimum capital ratios and the applicable capital conservation buffer for a given year, the bank could be subject to certain restrictions on capital distributions and discretionary bonus payments. The phase-in period for the capital conservation and countercyclical capital buffers for all banking organizations began on January 1, 2016 and were phased-in over a three-year period. The final rules called for the following minimum capital requirements, including the capital conservation buffer, effective at both January 1, 2018 and 2019). | | Effective January 1, 2018 | 2019 | | --- | ---: | ---: | | Common equity tier 1 capital to risk-weighted assets | 6.375% | 7.0% | | Tier 1 capital to risk-weighted assets | 7.875% | 8.5% | | Total capital to risk-weighted assets | 9.875% | 10.5% | | Leverage ratio | 4.0% | 4.0% | The final rules also 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 grandfather 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 replace 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 former 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 and the Bank have complied throughout the phase-in period, and currently remain in compliance, with all the regulatory capital requirements. Accordingly, the new rules did not have a material negative effect on Mid Penn’s financial condition or capital management activities for any period since the changes were implemented. #### Safety and Soundness Standards 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 management practices, internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, liquidity, capital, earnings, 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 an institution is not satisfying certain safety and soundness standards and fails to submit to the banking regulatory agency an acceptable compliance plan or fails to implement an accepted plan, the agency may 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, restricting dividend payments to shareholders, and requiring an increase in the institution’s ratio of tangible equity to assets. For the periods reported in this Form 10-K and in the period subsequent to December 31, 2018, up to the date of the filing of this Form 10-K, Mid Penn was not subject to any such bank regulatory orders. #### Payment of Dividends and Other Restrictions Mid Penn 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, Mid Penn. Specifically, dividends from the Bank are the principal source of Mid Penn’s 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 Mid Penn and the Bank from engaging in what, in the opinion of such regulatory body, constitutes an unsafe or unsound banking practice. Depending upon the financial condition of Mid Penn and the Bank, the payment of dividends could be deemed by a regulatory agency to constitute such an unsafe or unsound practice. Mid Penn and the Bank were not subject to any such dividend prohibitions during the years ended December 31, 2018, 2017, and 2016. #### Deposit Insurance The FDIC insures deposits of the Bank through the DIF. The FDIC maintains the DIF by assessing depository institutions an insurance premium. The amount each institution is assessed is based upon a variety of factors that include the level of assets and tangible equity, and the condition of the Bank (the degree of risk the institution poses to the insurance fund). The FDIC insures deposits up to $250,000. The Bank pays an insurance premium into the DIF based on a regulatory defined assessment calculation. The FDIC uses a risk-based premium system that assesses higher rates on those institutions that pose greater risks to the DIF. The FDIC places each institution in one of four risk categories using a two-step process based first on capital ratios (the capital group assignment) and then on other relevant information (the supervisory group assignment). Subsequently, the rate for each institution within a risk category may be adjusted depending upon different factors that either enhance or reduce the risk the institution poses to the DIF, including the unsecured debt, secured liabilities and brokered deposits related to each institution. Finally, certain risk multipliers may be applied to the adjusted assessment. Beginning with the second quarter of 2011 and as applicable continuously through to the current period, as mandated by the Dodd-Frank Act, the assessment base that the FDIC uses to calculate assessment premiums is a bank’s average assets minus average tangible equity. As the asset base of the banking industry is larger than the deposit base, the range of assessment rates is a low of 2.5 basis points and a high of 45 basis points, per $100 of assets. The FDIC is required under the Dodd-Frank Act to establish assessment rates that will allow the DIF to achieve a reserve ratio of 1.35% of Insurance Fund insured deposits by September 2020. In addition, the FDIC has established a “designated reserve ratio” of 2.0%, a target ratio that, until it is achieved, will not likely result in the FDIC reducing assessment rates. In attempting to achieve the mandated 1.35% ratio, the FDIC is required to implement assessment formulas that charge banks over $10 billion in asset size more than banks under that size. These new formulas did not affect the Bank as it was less than $10 billion in total assets size. #### Consumer Protection Laws A number of laws govern the relationship between the Bank and its customers. For example, the Community Reinvestment Act is designed to encourage services, investments, and lending activities 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 conditioning the availability or terms of credit on the purchase of another banking product) further restrict the Bank’s relationships with its customers. The Bank maintains a comprehensive compliance management program to promote its compliance with these and other applicable consumer protection laws and regulations. #### Privacy Laws The federal banking regulators have issued a number of regulations governing the privacy of consumer financial and customer information. The regulations limit the disclosure by financial institutions, such as Mid Penn 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 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; - annual notices of their privacy policies to their current customers; and - a reasonable method for consumers to “opt out” of disclosures to nonaffiliated third parties. #### Affiliate Transactions Transactions between Mid Penn 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. #### The USA Patriot Act, Anti-Money Laundering and Anti-Terrorism Financing The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“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. 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 Mid Penn 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. The principal provisions of Title III of the USA Patriot Act require that regulated financial institutions, including state-chartered banks: - establish an anti-money laundering program that includes training and audit components; - comply with regulations regarding the verification of the identity of any person seeking to open an account; - take additional required precautions with non-U.S. owned accounts; and - perform certain verification and certification of money laundering risk for their foreign correspondent banking relationships. Additional information-sharing among financial institutions, regulators, and law enforcement authorities is encouraged 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 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 Act’s requirements could have serious legal and reputational consequences for the institution. 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. 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. #### Tax Cuts and Jobs Act On December 22, 2017, President Donald J. Trump signed into law the Tax Cuts and Jobs Act (the “TCJA”), a tax reform law that included a significant provision reducing the corporate tax rate applicable to Mid Penn, for tax years beginning after 2017, to a flat 21 percent rate. The reduction resulted in a one-time $1,169,000 write-down of Mid Penn’s deferred tax asset in December 2017, because the deferred tax asset was previously valued based upon the projection of Mid Penn realizing a 34 percent future corporate tax rate benefit. This write-down was included in Mid Penn’s income tax provision for the year ended December 31, 2017, as further discussed in Note 18 (Federal Income Taxes) to the consolidated financial statements. Other significant provisions of the TCJA include (i) for tax years beginning after Dec. 31, 2017, the corporate AMT is repealed, and (ii) for property placed in service in tax years beginning after Dec. 31, 2017, the maximum amount Mid Penn may expense under Internal Revenue Code Sec. 179 is increased to $1 million, and the deduction phase-out threshold amount for all qualifying purchases in a year is increased to $2.5 million (with these amounts being indexed for inflation beginning for tax years after 2018). #### JOBS Act In 2012, the Jumpstart Our Business Startups Act (the “JOBS Act”) became law. The JOBS Act is aimed at facilitating capital raising by smaller companies, banks, and bank holding companies. Certain changes implemented by the JOBS Act that impacted Mid Penn included (i) raising the threshold requiring registration under the Securities Exchange Act of 1934 (the "Exchange Act") for banks and bank holdings companies from 500 to 2,000 holders of record, and (ii) raising the threshold for triggering deregistration under the Exchange Act for banks and bank holding companies from 300 to 1,200 holders of record. #### Dodd-Frank Act The Dodd-Frank Act, which became law in July 2010, significantly changed regulation of financial institutions and the financial services industry. Dodd-Frank created a Financial Services Oversight Council to identify emerging systemic risks and improve interagency cooperation, and centralized responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, which is responsible for implementing, examining and enforcing compliance with federal consumer financial laws. Dodd-Frank also permanently raised the current standard maximum deposit insurance amount to $250,000, established strengthened capital standards for banks, disallowed certain trust preferred securities from qualifying as Tier 1 Capital (subject to certain grandfather provisions for existing trust preferred securities), established new minimum mortgage underwriting standards, granted the Federal Reserve the power to regulate debit card interchange fees, and implemented corporate governance changes. #### Effects of Government Policy and Potential Changes in Regulation Changes in regulations applicable to Mid Penn or the Bank, or shifts in monetary or other government policies, could have a material effect on our business. Mid Penn’s and the Bank’s business is also affected by the state of the financial services industry in general. As a result of legal, economic, and competitive changes, management believes that the Bank and the financial services industry will continue to experience an increased rate of change from both the opportunities and competitive challenges resulting from greater product and service offerings, technological advancements, and business combinations. From time to time, legislation is enacted that has the effect of increasing the compliance and operations requirements and the cost of doing business, changing the tax structure applicable to Mid Penn, 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. Mid Penn cannot predict the likelihood of any major changes or the impact such changes might have on Mid Penn and/or the Bank. Congressional bills and other proposals could result in additional significant changes to the banking system, including but not limited to 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, changing the regulation of bank derivatives activities, and allowing commercial enterprises to own banks. As a consequence of the extensive regulation of commercial banking activities in the United States, the Bank’s business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business or change Mid Penn’s and the Bank’s competitive landscape. Whether any future legislation will be enacted or additional regulations will be adopted, and how they might impact Mid Penn, cannot be determined at this time. Mid Penn’s 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 Reserve’s power to implement national monetary policy to, among other things, promote employment, control inflation or combat recession. The Federal Reserve has a major impact on the loan and deposit rates offered by the Bank and its competitors, and 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 reasonably predict the nature, amount, frequency, and impact of future changes in monetary and fiscal policies. #### Environmental Laws Management does not anticipate that compliance with environmental laws and regulations will have any material effect on Mid Penn’s capital, expenditures, earnings, or competitive position. However, environmentally-related hazards have become a source of high risk and liability for some financial institutions. Additionally, the Pennsylvania Economic Development Agency, Fiduciary and Lender Environmental Liability Protection Act provides, among other things, 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 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 knew and willfully compelled the borrower to commit an action which caused such release or to violate an environmental act. The Pennsylvania Economic Development Agency, Fiduciary and Lender Environmental Liability Protection Act does not limit federal liability which still exists under certain circumstances. #### Corporate Governance The Sarbanes-Oxley Act of 2002 (“SOX”) and related regulations adopted by the SEC and NASDAQ addressed the following issues: corporate governance, auditor independence and accounting standards, executive compensation, insider loans, whistleblower protection, and enhanced and timely disclosure of corporate information. Mid Penn has established policies, procedures, and systems designed to promote compliance with these regulations. Section 404 of SOX requires publicly held companies to document, test and certify that their internal control systems over financial reporting are effective. Effective for year-end financial reports beginning with December 31, 2017, Mid Penn is subject to the independent attestation requirement under Section 404 of the SOX. The Bank remains subject to independent auditor attestation under FDIC regulation 363.3(b), which is a similar independent attestation requirement at the Bank level. ### Available Information Mid Penn’s common stock is registered under Section 12(b) of the Exchange Act and is traded on NASDAQ under the trading symbol MPB. Mid Penn is subject to the informational requirements of the Exchange Act, and, accordingly, files reports, proxy statements and other information with the SEC. Mid Penn 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 SEC’s Internet site address is www.sec.gov. Mid Penn’s headquarters are located at 349 Union Street, Millersburg, Pennsylvania 17061, and its telephone number is 1-866-642-7736. Mid Penn’s website is *midpennbank.com* and Mid Penn 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 possible after filing with the SEC. Mid Penn has adopted a Code of Ethics that applies to all employees. This document is also available on Mid Penn’s website. The information included on our website is not considered a part of this document. ## Risk factors As filed, 42,586 characters. Before investing in Mid Penn common stock, an investor should carefully read and consider the risk factors described below, which are not intended to be all inclusive, and to review other information contained in this report and in our other filings with the SEC. The risks and uncertainties described below are not the only ones facing Mid Penn and the Bank. Additional risks and uncertainties that we are not aware of, or that we currently deem less significant, or that we are otherwise not specifically focused on, may also impact our business, results of operations, and our common stock. If any of these known or unknown risks or uncertainties actually occurs, our business, financial condition and results of operations could be materially and adversely affected. If this were to happen, the market price of our common stock could decline significantly, and an investor could lose all or part of his or her investment in Mid Penn. Unless the context otherwise requires, references to “we,” “us,” “our,” “Mid Penn,” or “Mid Penn Bancorp, Inc.,” collectively refer to Mid Penn Bancorp, Inc. and its banking subsidiary, and specific references to the “Bank” refer to Mid Penn Bank, the wholly-owned banking subsidiary of Mid Penn Bancorp, Inc. ### Risks Related to Our Primary Business and Industry #### Mid Penn is subject to interest rate risk Mid Penn’s earnings and cash flows are largely dependent upon the Bank’s 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 Mid Penn’s 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 income the Bank receives on loans and securities and the amount of interest expense it pays on deposits and borrowings, but such changes could also affect (i) the Bank’s ability to originate loans and obtain deposits, (ii) the fair value of financial assets and liabilities, and (iii) the average duration of mortgage-backed securities in the Bank’s investment 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, Mid Penn’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and investments fall more quickly than the interest rates paid on deposits and borrowings. Management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on Mid Penn’s results of operations. Any substantial, unexpected, prolonged, or rapid change in market interest rates could have a material adverse effect on the Bank’s net interest income and Mid Penn’s financial condition and results of operations. #### Mid Penn is subject to credit risk As of December 31, 2018, approximately 79 percent of the Bank’s loan portfolio in Table 8 of Management’s Discussion and Analysis consisted of commercial, industrial, and agricultural loans. These types of loans are generally viewed as having more risk of default than residential real estate loans or secured consumer loans. These types of loans are also typically larger than residential real estate loans and consumer loans. Because the 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. In addition, Mid Penn’s credit risk may be exacerbated when the collateral held by Mid Penn cannot be readily realized or liquidated at prices sufficient to recover the full amount of the credit or derivative exposure due to Mid Penn. An increase in non-performing loans or collateral value deficiencies 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 Mid Penn’s financial condition and results of operations. #### The allowance for loan and lease losses may be insufficient Mid Penn maintains an allowance for loan and lease losses, which is a reserve established that represents management’s 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 management’s 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 Mid Penn to make significant estimates of current credit risks and 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 Mid Penn’s control, may require an increase in the allowance. In addition, bank regulatory agencies periodically review Mid Penn’s allowance for possible loan and lease losses 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, Mid Penn may need additional provisions to increase the allowance for possible loan and lease losses. Any increases in the allowance resulting from loan loss provisions will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on Mid Penn’s financial condition and results of operations. #### Competition from other financial institutions may adversely affect Mid Penn’s profitability Mid Penn’s banking subsidiary faces substantial competition in originating both commercial and consumer loans. This competition comes principally from other banks, credit unions, savings institutions, mortgage banking companies and other lenders. Many of its larger competitors who offer loans enjoy advantages over the Bank, 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 Mid Penn’s net income by decreasing the number and size of loans that its banking subsidiary originates and the interest rates it may charge on these loans. In attracting business and consumer deposits, the Bank faces substantial competition from other insured depository institutions such as other commercial banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many of Mid Penn’s larger competitors who accept deposits also enjoy advantages over the Bank, including greater financial resources, more aggressive marketing campaigns, better brand recognition, and more convenient branch locations. These competitors may offer higher interest rates than Mid Penn, which could decrease the deposits that the Bank attracts or require an increase in rates and interest expense to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect Mid Penn’s ability to generate the funds necessary for lending operations. As a result, Mid Penn may need to seek other sources of funds that may be more expensive to obtain and could increase its cost of funds. Mid Penn’s 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 and costly regulations that govern its banking operations. As a result, such non-bank competitors may have advantages over Mid Penn’s banking subsidiary in providing certain products and services. This competition may reduce or limit Mid Penn’s margins on banking services, reduce its market share and adversely affect its earnings and financial condition. *The expected discontinuance of LIBOR presents risks to the financial instruments originated, issued or held by Mid Penn that use LIBOR as a reference rate* LIBOR is used as a reference rate for many of Mid Penn’s transactions, which means it is the base on which relevant interest rates are determined. Transactions include those in which Mid Penn lends and borrows money; issues, purchases and sells securities; and enters into derivatives to manage Mid Penn’s and its customers’ risk. LIBOR is the subject of recent national and international regulatory guidance and proposals for reform. The United Kingdom Financial Conduct Authority, which regulates the process for setting LIBOR, announced in July 2017 that it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR to the administrator of LIBOR after 2021. While there are ongoing efforts to establish an alternative reference rate to LIBOR, as of the date of this report, no such rate has been accepted or is considered ready to be implemented. If another rate does not achieve wide acceptance as the alternative to LIBOR, there likely will be disruption to all of the markets relying on the availability of a broadly accepted reference rate. Even if another reference rate ultimately replaces LIBOR, risks will remain for Mid Penn with respect to outstanding loans, derivatives or other instruments using LIBOR. Those risks arise in connection with transitioning those instruments to a new reference rate and the corresponding value transfer that may occur in connection with that transition. Risks related to transitioning instruments to a new reference rate or to how LIBOR is calculated and its availability include impacts on the yield on loans or securities held by Mid Penn, amounts paid on securities Mid Penn has issued, or amounts received and paid on derivative instruments Mid Penn has entered into. The value of loans, securities, or derivative instruments tied to LIBOR and the trading market for LIBOR-based securities could also be impacted upon its discontinuance or if it is limited. Further, it is possible that LIBOR quotes will become unavailable prior to 2021 if sufficient banks decline to make submissions to the LIBOR administrator. In that case, the risks associated with the transition to an alternative reference rate will be accelerated and magnified. These risks may also be increased due to the shorter timeframe for preparing for the transition. #### The Basel III capital requirements require us to maintain higher levels of capital, which could reduce our profitability Basel III established higher levels of base capital, certain capital buffers, and a migration toward common equity as the key source of regulatory capital. Although these capital requirements have been phased in and met by Mid Penn, the Basel III requirements signal a growing effort by domestic and international bank regulatory agencies to require financial institutions, including depository institutions, to maintain higher levels of capital. The Basel III implementation activities and related regulatory capital targets required additional capital to support our business risk profile. Maintaining higher levels of capital potentially reduces opportunities to leverage interest-earning assets, which could limit the net interest income and profitability of Mid Penn, and adversely impact our financial condition and results of operations. *If Mid Penn’s information systems are interrupted or sustain a breach in security, those events may negatively affect Mid Penn’s financial performance and reputation* In conducting its business, Mid Penn relies heavily on its information systems. Maintaining and protecting those systems and data is difficult and expensive, as is dealing with any failure, interruption, or breach in security of these systems, whether due to acts or omissions by Mid Penn or by a third party, and whether intentional or not. Any such failure, interruption, or breach could result in failures or disruptions in Mid Penn’s customer relationship management, general ledger, deposit, loan, and other systems. A breach of Mid Penn’s information security may result from fraudulent activity committed against Mid Penn or its clients, resulting in financial loss to Mid Penn or its clients, or privacy breaches against Mid Penn’s clients. Such fraudulent activity may consist of check fraud, electronic fraud, wire fraud, “phishing”, social engineering, identity theft, or other deceptive acts. The policies, procedures, and technical safeguards put in place by Mid Penn to prevent or limit the effect of any failure, interruption, or security breach of its information systems and data may be insufficient to prevent or remedy the effects of any such occurrences. The occurrence of any failures, interruptions, or security breaches of Mid Penn’s information systems and data could damage Mid Penn’s reputation, cause Mid Penn to incur additional expenses, result in online services or other businesses becoming inoperable, subject Mid Penn to regulatory sanctions or additional regulatory scrutiny, or expose Mid Penn to civil litigation and possible financial liability, any of which could have a material adverse effect on Mid Penn’s financial condition and results of operations. *Mid Penn’s business operations and interaction with customers are increasingly done via technology and electronic delivery channels, and this has increased risks related to cyber security* Mid Penn is exposed to the risk of cyber-attacks in the normal course of business. In general, cyber incidents can result from deliberate attacks or unintentional events. An increased level of attention in the industry is focused on cyber-attacks that include, but are not limited to, gaining unauthorized access to digital systems for purposes of misappropriating assets or sensitive information, corrupting data, or causing operational disruption. To combat against these attacks, Mid Penn has certain security systems and policies and procedures in place to prevent or limit the effect of the possible security breach of its information systems and it has insurance against some cyber-risks and attacks. While Mid Penn has not incurred any material losses related to cyber-attacks, nor is it aware of any specific or threatened cyber-incidents as of the date of this report, it may incur substantial costs and suffer other negative consequences if it falls victim to successful cyber-attacks. Such negative consequences could include remediation costs that may include liability for stolen assets or information and repairing system damage that cyber-attacks may have caused; deploying additional personnel and protection technologies, training employees, and engaging third party experts and consultants; lost revenues resulting from unauthorized use of proprietary information or the failure to retain or attract customers following an attack; litigation; and reputational damage adversely affecting customer or investor confidence. #### Mid Penn’s controls and procedures may fail or be circumvented Management periodically reviews and updates Mid Penn’s 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 performance by personnel or certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of Mid Penn’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on Mid Penn’s business, results of operations, and financial condition. *We are required to make a number of judgments in applying generally accepted accounting standards, and different estimates and assumptions in the application of these accounting standards could result in a decrease in capital and/or other material changes to our reports of financial condition and results of operations* Generally accepted accounting principles involve certain estimates and processes that are particularly susceptible to significant change, including those related to the determination of the allowance for loan losses and reserve for unfunded lending commitments, the fair value of certain financial instruments including investment securities, income tax assets or liabilities (including deferred tax assets and any related valuation allowance), and share-based compensation. While we have identified critical accounting policies and have procedures and processes in place to support making the related judgments and estimates, changes to the processes, assumptions, or models in the application of these generally accepted accounting principles, and the impact to the related judgments and estimates could result in a decrease to net income and, possibly, capital and may have a material adverse effect on our financial condition and results of operations. From time to time, the Financial Accounting Standards Board and the SEC issues changes to or updated interpretations of the financial accounting and reporting guidance that governs the preparation of Mid Penn’s financial statements. These changes are beyond our control, can be difficult to predict, and could materially impact how we report our financial condition and results of operations. We could be required to apply new or revised guidance retrospectively, which may result in the revision of prior financial statements by material amounts. The implementation of new or revised guidance could also result in material adverse effects to our reported capital. #### Mid Penn’s profitability depends significantly on economic conditions in Pennsylvania Unlike larger or regional financial institutions that are more geographically diversified, Mid Penn’s success is dependent to a significant degree on economic conditions in Pennsylvania, especially in the twelve counties and markets primarily served by Mid Penn. The banking industry is affected by general economic conditions, including the effects of inflation, recession, unemployment, real estate values, trends in national and global economics, and other factors beyond our control. An economic recession or a delayed recovery over a prolonged period of time in Pennsylvania, or more specific to the communities in the Pennsylvania served by Mid Penn, could cause an increase in the level of the Bank’s non-performing assets and loan and lease losses, thereby causing operating losses, impairing liquidity, and eroding capital. Mid Penn cannot assure that adverse changes in the local and state economy supporting its market area would not have a material adverse effect on Mid Penn’s consolidated financial condition, results of operations, and cash flows. #### Mid Penn may not be able to attract and retain skilled personnel Mid Penn’s success depends, in large part, on its ability to attract and retain qualified, key personnel. Competition for the best personnel in most activities engaged in by Mid Penn can be intense, and Mid Penn may not be able to hire or retain them. The unexpected loss of services of one or more of Mid Penn’s key personnel could have a material adverse impact on Mid Penn’s business because of their skills, knowledge of Mid Penn’s market, years of industry experience, and the difficulty of promptly finding qualified replacement personnel. #### Mid Penn is subject to claims and litigation pertaining to fiduciary responsibility From time to time, customers may make claims and take legal action pertaining to Mid Penn’s performance of its fiduciary responsibilities. Whether customer claims and legal action related to Mid Penn’s performance of its fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to Mid Penn, the claims or related litigation processes may result in significant financial expense and liability, and/or adversely affect the market perception of Mid Penn 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 Mid Penn’s business, which, in turn, could have a material adverse effect on Mid Penn’s financial condition and results of operations. #### Mid Penn operates in a highly regulated environment and may be adversely affected by changes in federal, state and local laws and regulations Mid Penn and the Bank are subject to extensive regulation, supervision and examination by federal and state banking authorities. The potential exists for additional or amended federal or state laws and regulations, or changes in supervisory policies or activities, to materially affect many aspects of Mid Penn’s operations, including capital levels, lending and funding practices, and liquidity standards. New laws and regulations may increase costs of regulatory compliance and of doing business and otherwise affect operations, and may significantly affect the markets in which Mid Penn does business, the markets for and value of Mid Penn’s loans and investments, the ability to attract deposits at a reasonable cost, the fees charged, and ongoing operations, costs and profitability. Further, additional legislation and regulations that could significantly affect Mid Penn’s 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. Also, 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. Any changes in applicable regulations or federal, state or local legislation, or the exercise of bank regulatory authority, may have a negative impact on Mid Penn’s results of operations, financial condition, and its ability to pay dividends on common stock. #### The soundness of other financial institutions may adversely affect Mid Penn Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. Mid Penn has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose Mid Penn to credit risk and losses in the event of a default by a counterparty or client. Any such losses could have a material adverse effect on Mid Penn’s financial condition and results of operations. #### Volatility in financial markets and the economy may have materially adverse effects on our liquidity and financial condition In the recent past, the capital and credit markets experienced extreme volatility and economic disruption. Adverse financial market and economic conditions can exert downward pressure on stock prices, security prices, and credit availability for certain issuers without regard to their underlying financial strength. If such levels of financial market and economic disruption and volatility return, there can be no assurance that Mid Penn will not experience adverse effects, which may materially affect its liquidity, financial condition, and profitability. #### Mid Penn’s banking subsidiary may be required to pay higher FDIC insurance premiums or special assessments which may adversely affect its earnings Poor economic conditions and the resulting bank failures from the most recent recession stressed the DIF and increased the costs of the Bank’s FDIC insurance assessments. Future bank failures may prompt the FDIC to increase its premiums above the recently increased levels or to issue special assessments. Mid Penn generally is unable to control the amount of premiums or special assessments that its banking subsidiary is required to pay for FDIC insurance. Any future changes in the calculation or assessment of FDIC insurance premiums may have a material adverse effect on the results of Mid Penn’s operations and financial condition. *If we conclude that the decline in the value of any of our investment securities is other than temporary, we are required to write down the value of that security through a charge to earnings* Mid Penn reviews its investment securities portfolio at each quarter-end reporting period to determine whether the fair value of individual securities or the portfolio as a whole is below the current carrying value. When the fair value of any of its investment securities has declined below its carrying value, Mid Penn is required to assess whether the decline is other than temporary. If Mid Penn concludes that the decline is other than temporary, it is required to write down the value of that security through a charge to earnings. Changes in the expected cash flows of these securities and/or prolonged price declines may result in Mid Penn concluding that impairment of these securities is other than temporary, which would require a charge to earnings to write down these securities to their fair value. Due to the complexity of the process, inputs, calculations and assumptions used in determining whether an investment is impaired, Mid Penn’s assessment of or disclosure of the impairment status of investments may not accurately reflect the actual impairment in the future. #### Mid Penn is subject to environmental liability risk associated with lending activities A significant portion of Mid Penn’s loan portfolio is secured by real property. During the ordinary course of business, Mid Penn may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, Mid Penn may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require Mid Penn to incur substantial expenses and may materially reduce the affected property’s value or limit Mid Penn’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase Mid Penn’s exposure to environmental liability. Although Mid Penn has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on Mid Penn’s financial condition and results of operations. #### Mid Penn’s financial performance may suffer if its information technology is unable to keep pace with its growth or industry developments Effective and competitive delivery of Mid Penn’s products and services is increasingly dependent upon information technology resources and processes provided both internally and through third party vendors. In addition to better serving customers, the effective use of technology increases efficiency and enables Mid Penn to reduce costs. Mid Penn’s future success will depend, in part, upon its ability to address the needs of its customers by using technology to provide products and services to enhance customer convenience, attract customers who prefer technological delivery channels, and to create additional efficiencies in its operations. Many of Mid Penn’s competitors have greater resources to invest in technological improvements. Additionally, as technology in the financial services industry changes and evolves, keeping pace becomes increasingly complex and expensive for Mid Penn. There can be no assurance that Mid Penn will be able to effectively keep pace with these technological advancements or the related substantial costs and investments required, which could adversely affect its financial condition and results of operations. #### Growing by acquisition entails certain risks, and difficulties in integrating past or future acquisitions could adversely affect our business During 2018, Mid Penn completed acquisitions of both The Scottdale Bank & Trust Company and First Priority Financial Corp. Growth by acquisition involves substantial risks, as the ultimate success of such acquisitions may depend on, among other things, the ability to realize anticipated cost savings and to integrate the acquired companies and operation in a manner that does not result in decreased revenues resulting from excessive acquisition costs, conversion costs, or disruption of existing customer relationships in both the acquired companies and legacy markets. If we are not able to successfully achieve the financial efficiencies or integration and growth objectives of acquisitions, the anticipated benefits of an acquisition may not be realized fully, or at all, or may take longer to realize than planned. Further, the asset quality or other financial characteristics of an acquired company may deteriorate from the date a merger or other acquisition agreement is entered into and when the transaction is completed or the post-merger period. Mid Penn has spent and may continue to spend significant resources identifying companies and businesses to acquire. The efficient and effective integration of any companies and businesses we acquire and integrate into our organization is critical to our growth. The Scottdale Merger, the First Priority Merger, and any future mergers or acquisitions, involve numerous risks including difficulties in integrating the culture, operations, technologies and personnel of the acquired companies, the diversion of management’s attention from other business concerns and the potential loss of customers. Failure to successfully integrate the operations of Scottdale and First Priority, or those of future acquisition targets, could harm Mid Penn’s business, financial condition, results of operations and cash flows. #### We plan to pursue a growth strategy and there are risks associated with rapid growth We intend to pursue a growth plan consistent with our prior business strategy, including growth by acquisition, as well as leveraging our existing branch network or adding new branch locations in current and adjacent markets we choose to serve. The Scottdale Merger and First Priority Merger were part of our growth strategy. Our ability to manage growth successfully will depend on our ability to attract or retain qualified personnel, maintain cost controls and efficiencies, and ensure our areas of growth continue to meet our high asset quality standards, while attracting additional loans and deposits on favorable terms, as well as on factors beyond our control, such as economic conditions and competition in existing and new markets. If we grow too quickly and are not able to attract qualified personnel, control costs and maintain asset quality, this continued rapid growth could materially adversely affect our financial performance. #### The interest rate on our subordinated notes will remain fixed until December 2020, when some will begin to float to Prime plus 0.50% The per annum interest rate on the $7.5 million of our subordinated notes issued by Mid Penn in December 2015 is fixed at 5.15%, until December 2020 when the interest rate will float at the Wall Street Journal’s Prime rate plus 0.50%, provided that the interest rate applicable will at no time be less than 4.0%. The per annum interest rate on the $10 million of our subordinated notes issued in December 2017 is fixed at 5.25% until December 2022, when it will float at the Wall Street Journal’s Prime rate plus 0.50%, provided that the interest rate applicable will at no time be less than 5.0%. The per annum interest rate on the $9.5 million of subordinated notes assumed in the First Priority acquisition is fixed at 7.00% and the notes are non-callable through November 2020. These notes include provisions for redemption pricing between 101.5% and 100.5% of the total of $9.5 million, plus accrued but unpaid interest thereon up to but excluding the redemption date, if called after five years but prior to the maturity date of November 2025. Depending on Mid Penn’s financial condition at the time of these rates changing from fixed to variable, an increase in the interest rate on our subordinated debt could have a material adverse effect on Mid Penn’s liquidity and results of operations. ### Risks Related to Mid Penn Common Stock #### The trading volume in Mid Penn’s common stock is less than that of other larger financial services companies Mid Penn’s common stock is listed for trading on NASDAQ; however, 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 Mid Penn’s common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which Mid Penn has no control. Given the generally lower trading volume of Mid Penn’s common stock, significant sales of Mid Penn’s common stock, or the expectation of these sales, could cause Mid Penn’s stock price to fall. *The market price of Mid Penn common stock may fluctuate significantly, and this may make it difficult for investors to resell shares of common stock owned by them at times or at prices they find attractive* The market price of our common stock as reported on NASDAQ is subject to constant change during business trading hours. We expect that the market price of Mid Penn common stock will continue to fluctuate and there can be no assurance about the stability or trend of market prices for Mid Penn common stock. Stock price volatility may make it difficult for investors to resell their Mid Penn common stock when they want and at times or prices that they find attractive. Mid Penn’s stock price may fluctuate significantly as a result of a variety of factors, many of which are beyond our control. These factors include those described elsewhere in this entire “Risk Factors” section, in this document, and our other filings with the SEC. *Mid Penn’s ability to pay dividends on its common stock, and principal and interest on its subordinated notes, depends primarily on dividends from its banking subsidiary, which is subject to regulatory limits* Mid Penn is a bank holding company and its operations are conducted primarily by its banking subsidiary. Mid Penn’s ability to pay dividends on its common stock, and principal and interest on its subordinated notes, depends on its receipt of dividends from the Bank. Dividend payments from its banking subsidiary are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by the respective regulatory agencies that supervise the Bank. The ability of the Bank to pay dividends is also subject to profitability, financial condition, liquidity, and capital management limits. There is no assurance that Mid Penn’s banking subsidiary or other subsidiaries established in the future will be able to pay dividends, or that Mid Penn itself will generate adequate cash flow to pay dividends in the future. Federal Reserve policy, which applies to Mid Penn as a registered bank holding company, also provides that dividends by bank holding companies should generally be paid out of earnings from both the current period and a designated look-back period. Mid Penn’s ability to pay dividends on its common stock, or the amount of any dividends paid, could have a material adverse effect on the market price of its common stock. *Mid Penn may need to, or be required to, raise additional capital in the future, and capital may not be available when needed and on terms favorable to current stockholders* Federal banking regulators require Mid Penn and its subsidiary bank to maintain adequate levels of capital to support their operations. These capital levels are determined and dictated by law, regulation, and banking regulatory agencies. In addition, capital levels are also determined by Mid Penn’s management and board of directors, based on capital levels that they believe are necessary to support Mid Penn’s business operations. If Mid Penn raises capital through merger and acquisition activities, or through the issuance of additional shares of its common stock or other securities, it would likely dilute the ownership interests of current investors and could dilute the per share book value and earnings per share of its common stock. Furthermore, a capital raise through issuance of additional shares may have an adverse impact on Mid Penn’s stock price. New investors also may have rights, preferences and privileges senior to Mid Penn’s current common stockholders, which may adversely impact its current common stockholders. Mid Penn’s ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside of its control, and on its financial performance. Accordingly, Mid Penn cannot be certain of its ability to raise additional capital on acceptable terms and acceptable time frames or to raise additional capital at all. If Mid Penn cannot raise additional capital in sufficient amounts when needed, its ability to comply with regulatory capital requirements could be materially impaired. Additionally, the inability to raise capital in sufficient amounts may adversely affect Mid Penn’s financial condition and results of operations. *Offerings of debt, which would be senior to Mid Penn’s common stock upon liquidation, and/or preferred equity securities which may be senior to our common stock for purposes of dividend distributions or upon liquidation, may adversely affect the market price of our common stock* Mid Penn may attempt to increase its capital resources or, if its or the Bank’s capital ratios fall below the required minimums, Mid Penn or the Bank could be required to raise additional capital by making additional offerings of debt or preferred equity securities, including medium-term notes, senior or subordinated notes and preferred stock. If a future liquidation of Mid Penn occurs, holders of debt securities and shares of preferred stock and lenders with respect to other borrowings are likely to receive distributions of available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of existing shareholders or reduce the market price of our common stock, or both. Holders of Mid Penn common stock are not entitled to preemptive rights or other protections against dilution. Also, Mid Penn’s board of directors is authorized to issue one or more classes or series of preferred stock from time to time without any action on the part of the shareholders. The board of directors also has the power, without shareholder approval, to set the terms of any such classes or series of preferred stock that may be issued, including voting rights, dividend rights, and preferences over common stock with respect to dividends or upon our dissolution, winding up and liquidation and other terms. If Mid Penn issues preferred stock in the future that has a preference over its common stock with respect to the payment of dividends or upon our liquidation, dissolution or winding up, or if preferred stock is issued with voting rights that dilute the voting power of common stock, the rights of holders of Mid Penn’s common stock or the market price of the common stock could be adversely affected. *Pennsylvania Business Corporation Law and various anti-takeover provisions under our articles of incorporation and bylaws could impede the takeover of Mid Penn* Various Pennsylvania laws affecting business corporations may have the effect of discouraging offers to acquire Mid Penn, even if the acquisition would be advantageous to shareholders. In addition, Mid Penn has various anti-takeover measures in place under its articles of incorporation and bylaws, including a supermajority vote requirement for mergers, the staggered election of Mid Penn’s board of directors, and the absence of cumulative voting. Any one or more of these laws or measures may impede the takeover of Mid Penn and may prevent its shareholders from taking part in a transaction in which they could realize a premium over the current market price of its common stock. #### Mid Penn’s common stock is not insured by any governmental entity Although Mid Penn and the Bank are regulated by governmental agencies, Mid Penn common stock is not a deposit account or other obligation of the Bank or any other bank and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund, any other governmental entity or by any other public or private entity. Investment in Mid Penn common stock is inherently risky for the reasons described elsewhere in this “Risk Factors” section, in this document, and our other filings with the SEC. Mid Penn common stock is also subject to the same market forces that affect the price of common stock in any other publicly traded company. As a result, investors who acquire Mid Penn common stock may lose some or all of their investment. ## Properties As filed, 1,489 characters. The Bank owns a building in Millersburg, Pennsylvania, located at 349 Union Street, which serves as its headquarters and the primary executive and administrative offices of Mid Penn and the Bank. The Bank also owns one building in Halifax, Pennsylvania that serves as an operational support facility and two buildings in Harrisburg, Pennsylvania that serve as additional administrative and operational support offices. Administrative space is also leased in Pottsville, Lancaster, and Chambersburg, Pennsylvania. The Bank’s retail office network is comprised of thirty-eight full service locations and one loan production office at December 31, 2018. Twelve retail banking locations are located in Dauphin County, five in Schuylkill County, four in Berks County, three in Westmoreland County, three in Cumberland County, three in Lancaster County, two in Fayette County, two in Chester County, and one location in each of Northumberland, Luzerne, Montgomery, and Bucks Counties. As of December 31, 2018, retail banking facilities at twenty-four locations were owned, while fourteen branch facilities and the loan production office were leased. All real estate owned is free and clear of encumbrances. Mid Penn’s operating leases expire at various dates through the year 2035 and generally include options to renew. For additional information regarding the lease commitments, refer to Part II, Item 8, Note 10 “Bank Premises and Equipment” in the Notes to Consolidated Financial Statements. ## Legal proceedings As filed, 626 characters. There has been no change to the information disclosed in Item 1, Part II of Mid Penn’s Quarterly Report or Form 10-Q for the period ended June 30, 2018, which is incorporated by reference. Management is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the Corporation. Mid Penn and the Bank have no proceedings pending other than ordinary, routine litigation occurring in the normal course of business. In addition, management does not know of any material proceedings contemplated by governmental authorities against Mid Penn, the Bank, or any of its properties. ## Management's discussion and analysis As filed, 102,476 characters. ### SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS Certain of the matters discussed in this document 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 or the Bank to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. The words “expect,” “anticipate,” “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 future economic conditions on Mid Penn, the Bank, and their markets and 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; - the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, the value of investment securities, 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; - 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 the capital stock of Mid Penn or Mid Penn Bank; - impacts of the capital and liquidity requirements imposed by bank regulatory agencies; - the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, Financial Accounting Standards Board, the SEC, and other accounting and reporting standard setters; - 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 acquisition strategy; - our ability to successfully expand our franchise, including acquiring institutions or establishing new offices at advantageous prices; - our ability to successfully integrate any banks, companies, offices, assets, labilities, customers, systems and management personnel we acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames; - potential goodwill impairment charges, or 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; - results of regulatory examination and supervision processes; - the failure of assumptions underlying the establishment of reserves for loan and lease losses, the assessment of potential impairment of investment securities, and estimations of values of collateral and various financial assets and liabilities; - our ability to maintain compliance with the listing rules of NASDAQ; - our ability to maintain the value and image of our brand and protect our intellectual property rights; - volatility in the securities markets; - disruptions due to flooding, severe weather, or other natural disasters or Acts of God; and - acts of war or terrorism. All written or oral forward-looking statements attributable to Mid Penn are expressly qualified in their entirety by these cautionary factors. This Management’s Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of Mid Penn’s consolidated financial statements and should be read in conjunction with the Consolidated Financial Statements of the Corporation and Notes thereto and other detailed information appearing elsewhere in this Annual Report on Form 10-K. The comparability of the results of operations for the year ended 2018, compared to 2017 and 2016, in general, have been materially impacted by the acquisition of The Scottdale Bank and Trust Company, which closed on January 8, 2018, and the acquisition of First Priority Financial Corp., which closed on July 31, 2018. For comparative purposes, some 2017 and 2016 balances have been reclassified to conform to the 2018 presentation. Such reclassifications had no impact on net income available to common shareholders or shareholders’ equity. Mid Penn is not aware of any current trends, events, uncertainties or any current recommendations by the regulatory authorities which, if they were to be implemented, would have a material effect on Mid Penn’s or the Bank’s liquidity, capital resources, or operations. #### Critical Accounting Estimates Mid Penn’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and conform to general practices within the banking industry for smaller reporting public companies. 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 used in applying these principles are 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 have been 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 reported results of operations. Management of the Corporation considers the accounting judgments relating to the allowance for loan and lease losses, the evaluation of the Corporation’s investment securities for other-than-temporary impairment, the valuation of the Corporation’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 for loan and lease losses represents management’s estimate of probable incurred credit losses inherent in the loan and lease portfolio. Determining the amount of the allowance for loan and lease losses 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 adjusted for qualitative factors, 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 values based upon yield curves and spreads. In addition to valuation of securities, management must assess whether there are any declines where the fair value is below the carrying value of any investments such that the decline should be considered other than temporary or otherwise require an adjustment in carrying value and recognition of a loss in the consolidated statement of income. Certain intangible assets generated in connection with acquisitions are periodically assessed for impairment. Goodwill is tested annually for impairment, and 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. Similarly, the amortized basis of the core deposit intangible asset and trade name intangible are periodically assessed for impairment. There are inherent uncertainties related to these factors and Mid Penn’s judgment in applying them to the analysis of core deposit intangible, trade name intangible, and goodwill impairment. Future changes in economic and operating conditions could result in goodwill or core deposit intangible or trade name intangible impairment in subsequent 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 the timing and amount of 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. #### Financial Summary As noted above, the comparability of the results of operations for the years ended 2018 and 2017, in general, have been materially impacted by the acquisitions of Scottdale, which closed on January 8, 2018, and First Priority, which closed on July 31, 2018. Mid Penn’s net income available to common shareholders (“earnings”) was $10,494,000 or $1.48 per common share basic and diluted for the year ended December 31,2018, compared to earnings of $7,089,000 or $1.67 per common share basic and diluted for the year ended December 31, 2017. The results for the year ended December 31, 2018 included merger and acquisition expenses resulting from Mid Penn’s acquisitions of First Priority and Scottdale. Earnings for the year ended December 31, 2017 included certain merger-related costs for the Scottdale acquisition, and were also impacted by a one-time non-cash reduction in the value of Mid Penn’s deferred tax asset, which resulted in a charge of $1,169,000 included in the provision for income taxes. This income tax adjustment was a result of the TCJA, which lowered Mid Penn’s maximum corporate tax rate from 34 percent in 2017 and prior periods to 21 percent in 2018 and future periods. Total assets of Mid Penn grew $907,627,000 or 78 percent, in 2018 to close the year at $2,077,981,000, compared to total assets of $1,170,354,000 at the end of 2017. Asset growth during the year ended December 31, 2018 includes the acquired loans, investments, cash, facilities, goodwill and core deposit intangibles recorded from the legal closing of the Scottdale and First Priority transactions, as well as organic growth from our legacy markets. Increases in short-term debt, long-term debt and subordinated debt during the year ended December 31, 2018 were a result of both (i) $50 million of shorter-term FHLB fixed-rate borrowings obtained in late November 2018, and (ii) $15.5 million of combined long-term FHLB borrowings and subordinated debt assumed in the First Priority acquisition. Scottdale had no borrowings that were assumed by Mid Penn in that acquisition. Mid Penn’s return on average shareholders’ equity (“ROE”), a widely recognized performance indicator in the financial industry, was 5.98% in 2018 and 9.48% in 2017. The reduction in this indicator was significantly impacted by the material costs incurred in 2018 with the two acquisitions, and from the impact of additional common equity issued in conjunction with both transactions. Return on average assets (“ROA”), another performance indicator, was 0.63% in 2018 and 0.64% in 2017. Net interest margin was 3.67% in 2018 versus 3.68% in 2017. Net interest income on a tax equivalent basis increased to $56,824,000 in 2018 from $38,597,000 in 2017. Increases in yields on earning assets and increases in noninterest-bearing deposits during 2018 were offset by the impact of both (i) the rising cost of both deposit and borrowed funds as a result of market pricing in response to recent Federal Open Market Committee (“FOMC”) rate increases, and (ii) the increase in wholesale funding and related interest costs, including the assumption of some higher-cost brokered time deposits, FHLB borrowings, and subordinated debt in the First Priority transaction. Further discussion of net interest margin can be found in the Net Interest Income section below. Mid Penn’s allowance for loan and lease losses at December 31, 2018 was $8,397,000 or 0.52% of total loans (less unearned discount), as compared to $7,606,000 or 0.84% at December 31, 2017. During 2018, Mid Penn had net loan recoveries of $291,000 compared to net recoveries of $98,000 during the same period of 2017. The primary reason for the favorable net recovery amount during 2018 was Mid Penn’s workout and recovery of $777,000 of principal from a commercial real estate relationship that was subject to a restructuring and partial charge-off in 2009. Mid Penn’s net recovery position for the year ended December 31, 2017 was primarily attributed to the recovery of $318,000 of principal from the successful workout of a different commercial real estate relationship that was partially charged-off in 2010. Further discussion of these items can be found in the Provision for Loan and Lease Losses section below. Total nonperforming assets increased $975,000 from $11,308,000 at the end of 2017 to $12,283,000 at the end of 2018. Further discussion of the components of nonperforming assets can be found in the Credit Quality, Credit Risk, and Allowance for Loan and Lease Losses section below. Mid Penn’s regulatory capital measures of Tier 1 Capital (to risk weighted assets) of $155,662,000 or 10.0%, and Total Capital (to risk weighted assets) of $191,300,000 or 12.3%, at December 31, 2018, are above the regulatory “well capitalized” requirements. Tier 1 Capital consists primarily of Mid Penn’s shareholders' equity less the value of goodwill and other intangible assets, and excluding the impact of the accumulated other comprehensive income/loss component. Total Capital includes the Tier 1 Capital, as well as Mid Penn’s qualifying subordinated debt and the allowance for loan and lease losses, within permitted regulatory limits. Risk-weighted assets are determined by assigning various levels of risk, in accordance with regulatory risk-weighting definitions, to different categories of assets and off-balance sheet activities. Mid Penn’s net income available to common shareholders (“earnings”) of $7,089,000 for the year 2017 reflects a decrease of $715,000 or 9 percent, as compared to earnings of $7,804,000 for the year 2016. This represents earnings in 2017 of $1.67 per common share, basic and diluted, compared to $1.85 per common share basic and diluted in 2016. Earnings for the year 2017 were negatively impacted by a non-cash reduction in the value of Mid Penn’s deferred tax asset under the TCJA, which resulted in a charge of $1,169,000 included in the provision for income taxes. Total assets of Mid Penn grew $137,755,000 or 13 percent, in 2017 to close the year at $1,170,354,000 compared to total assets of $1,032,599,000 at the end of 2016. Mid Penn realized favorable loan growth, primarily in commercial relationships, of $96,480,000 or over 11 percent since December 31, 2016. This asset and loan growth was principally funded by an increase in deposits of $88,195,000 or over 9 percent since year-end 2016, with $40,903,000 of the deposit growth being in noninterest-bearing accounts. Mid Penn was in a short-term borrowing position of $34,611,000 at December 31, 2017, while it was in a Federal Funds Sold position of $30,477,000 at December 31, 2016. During the year ended December 31, 2017, long-term debt decreased by $1,229,000 or 9 percent, to $12,352,000 by the end of the year as previous higher-cost borrowings matured and Mid Penn was able to replace them with lower-cost funding sources. Mid Penn’s ROE was 9.48% in 2017 and 10.71% in 2016. ROA was 0.64% in 2017 and 0.78% in 2016. Net interest margin was 3.68% in 2017 versus 3.82% in 2016. Net interest income on a tax equivalent basis increased to $38,597,000 in 2017 from $36,470,000 in 2016. The decrease in the net interest margin for 2017 compared to 2016 was primarily the result of a lower realized yield on the relatively shorter-term and lower-risk securities in the held-to-maturity investment portfolio established in 2017. Included in net interest income for the year ended December 31, 2016 was $167,000 in income from the successful resolution of two legacy Phoenix loans acquired with credit deterioration. The income was the result of recognizing the remaining accretable and nonaccretable discounts on these loans. Further discussion of net interest margin can be found in the Net Interest Income section below. Total nonperforming assets increased $5,549,000 from $5,759,000 at the end of 2016 to $11,308,000 at the end of 2017. The increase in nonperforming assets is primarily due to two loan relationships totaling $7.3 million, with a combined $136,000 specific allowance allocation, being placed on nonaccrual status during the latter six months of 2017. Further discussion of these components can be found in the Credit Quality, Credit Risk, and Allowance for Loan and Lease Losses section below. Mid Penn had net loan recoveries of $98,000 for the twelve months ended December 31, 2017, compared to net loan charge-offs of $855,000 during the same period of 2016. The net recoveries were a result of Mid Penn’s successful collection and workout efforts on previously impaired loan relationships. Gross charge-offs decreased $610,000 from $1,107,000 in 2016 to $497,000 in 2017. Mid Penn decreased the provision for loan and lease losses from $1,870,000 in 2016 to $325,000 in 2017. The significant net principal recoveries during the twelve months ended December 31, 2017 added $98,000 to the allowance for loan loss balance. Also, as a result of favorable workout activities of certain impaired credits, the amount of required specific allocations in the allowance was reduced as of December 31, 2017 as compared to the prior year end. Further discussion of these issues can be found in the Provision for Loan and Lease Losses section below. Mid Penn’s regulatory capital measures of Tier 1 Capital (to risk weighted assets) of $74,417,000 or 8.4%, and Total Capital (to risk weighted assets) of $99,466,000 or 11.3%, at December 31, 2017, are above the regulatory “well capitalized” requirements. Tier 1 Capital consists primarily of Mid Penn’s shareholders' equity net of the accumulated other comprehensive income/loss component. Total Capital includes the Tier 1 Capital, as well as Mid Penn’s qualifying subordinated debt and the allowance for loan and lease losses, within permitted regulatory limits. Risk-weighted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet activities. ### TABLE 1: AVERAGE BALANCES, EFFECTIVE INTEREST DIFFERENTIAL AND INTEREST YIELDS *(Dollars in thousands)* | ASSETS: | Income and Rates on a Taxable Equivalent Basis for Years Ended December 31, 2018 Average Balance | Interest | | Average Rates | December 31, 2017 Average Balance | Interest | | Average Rates | December 31, 2016 Average Balance | Interest | | Average Rates | | --- | ---: | ---: | --- | ---: | ---: | ---: | --- | ---: | ---: | ---: | --- | ---: | | Interest Bearing Balances | $4,983 | $75 | | 1.51% | $2,621 | $18 | | 0.69% | $2,559 | $12 | | 0.47% | | Investment Securities: | | | | | | | | | | | | | | Taxable | 165,422 | 3,838 | | 2.32% | 121,050 | 2,376 | | 1.96% | 79,277 | 1,515 | | 1.91% | | Tax-Exempt | 102,656 | 2,940 | (a) | 2.86% | 52,919 | 1,687 | (a) | 3.19% | 80,451 | 3,130 | (a) | 3.89% | | Total Securities | 268,078 | 6,778 | | 2.53% | 173,969 | 4,063 | | 2.34% | 159,728 | 4,645 | | 2.91% | | Federal Funds Sold | 25,745 | 451 | | 1.75% | 11,220 | 115 | | 1.02% | 16,848 | 82 | | 0.49% | | Loans and Leases, Net | 1,243,987 | 61,965 | (b) | 4.98% | 857,259 | 40,591 | (b) | 4.73% | 772,877 | 36,963 | (b) | 4.78% | | Restricted Investment in Bank Stocks | 3,567 | 275 | | 7.71% | 2,955 | 114 | | 3.86% | 2,751 | 135 | | 4.91% | | Total Earning Assets | 1,546,360 | 69,544 | | 4.50% | 1,048,024 | 44,901 | | 4.28% | 954,763 | 41,837 | | 4.38% | | Cash and Due from Banks | 29,408 | | | | 20,323 | | | | 12,791 | | | | | Other Assets | 89,953 | | | | 35,092 | | | | 33,898 | | | | | Total Assets | $1,665,721 | | | | $1,103,439 | | | | $1,001,452 | | | | | LIABILITIES & SHAREHOLDERS' EQUITY: | | | | | | | | | | | | | | Interest-bearing Demand | $371,873 | 2,447 | | 0.66% | $335,859 | 1,410 | | 0.42% | $293,745 | 1,009 | | 0.34% | | Money Market | 309,705 | 2,990 | | 0.97% | 247,337 | 1,448 | | 0.59% | 235,561 | 1,315 | | 0.56% | | Savings | 191,686 | 540 | | 0.28% | 62,500 | 35 | | 0.06% | 59,615 | 34 | | 0.06% | | Time | 324,853 | 4,907 | | 1.51% | 197,154 | 2,570 | | 1.30% | 172,657 | 2,156 | | 1.25% | | Total Interest-bearing Deposits | 1,198,117 | 10,884 | | 0.91% | 842,850 | 5,463 | | 0.65% | 761,578 | 4,514 | | 0.59% | | Short-term Borrowings | 8,833 | 207 | | 2.34% | 7,961 | 111 | | 1.39% | 2,370 | 15 | | 0.63% | | Long-term Debt | 17,292 | 462 | | 2.67% | 13,321 | 318 | | 2.39% | 28,474 | 442 | | 1.55% | | Subordinated Debt | 21,324 | 1,167 | | 5.47% | 7,746 | 412 | | 5.32% | 7,431 | 396 | | 5.33% | | Total Interest-bearing Liabilities | 1,245,566 | 12,720 | | 1.02% | 871,878 | 6,304 | | 0.72% | 799,853 | 5,367 | | 0.67% | | Noninterest-bearing Demand | 232,562 | | | | 146,683 | | | | 120,244 | | | | | Other Liabilities | 12,030 | | | | 10,094 | | | | 8,462 | | | | | Shareholders' Equity | 175,563 | | | | 74,784 | | | | 72,893 | | | | | Total Liabilities & Shareholders' Equity | $1,665,721 | | | | $1,103,439 | | | | $1,001,452 | | | | | Net Interest Income (taxable equivalent basis) | | $56,824 | | | | $38,597 | | | | $36,470 | | | | Taxable Equivalent Adjustment | | (890) | | | | (1,009) | | | | (1,625) | | | | Net Interest Income | | $55,934 | | | | $37,588 | | | | $34,845 | | | | Total Yield on Earning Assets | | | | 4.50% | | | | 4.28% | | | | 4.38% | | Rate on Supporting Liabilities | | | | 1.02% | | | | 0.72% | | | | 0.67% | | Average Interest Spread | | | | 3.48% | | | | 3.56% | | | | 3.71% | | Net Interest Margin | | | | 3.67% | | | | 3.68% | | | | 3.82% | (a) Includes tax equivalent adjustments (calculated using statutory rates of 21% for 2018 and 34% for 2017 and 2016) of $617,000, $574,000, and $1,064,000 for the years 2018, 2017, and 2016, respectively, resulting from tax-free municipal securities in the investment portfolio. (b) Includes tax equivalent adjustments (calculated using statutory rates of 21% for 2018 and 34% for 2017 and 2016) of $273,000, $435,000, and $561,000 for the years 2018, 2017, and 2016, respectively, resulting from tax-free municipal loans in the commercial loan portfolio. #### Net Interest Income Net interest income, Mid Penn's primary source of earnings, represents the difference between interest income received on loans, investments, and overnight funds, and interest expense paid on deposits and short- and long-term borrowings. Net interest income is affected by changes in interest rates and changes in average balances (volume) in the various interest-sensitive assets and liabilities. Interest and average rates in Table 1 above are presented on a fully taxable-equivalent basis. Tax-equivalent adjustments were calculated using statutory corporate tax rates of 21 percent for the year ended December 31, 2018, and 34 percent for the years ended December 31, 2017 and 2016. For purposes of calculating loan yields, average loan balances include nonaccrual loans. Loan fees of $1,038,000, $921,000 and $1,097,000 are included with loan interest income in Table 1 above for the years ended December 31, 2018, 2017, and 2016, respectively. ### TABLE 2: VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME *(Dollars in thousands on a Taxable Equivalent Basis)* | INTEREST INCOME: | 2018 Compared to 2017 Increase (Decrease) Due to Change In: Volume | Rate | Net | 2017 Compared to 2016 Increase (Decrease) Due to Change In: Volume | Rate | Net | | --- | ---: | ---: | ---: | ---: | ---: | ---: | | Interest Bearing Balances | $16 | $41 | $57 | $1 | $5 | $6 | | Investment Securities: | | | | | | | | Taxable | 871 | 591 | 1,462 | 798 | 63 | 861 | | Tax-Exempt | 1,586 | (333) | 1,253 | (1,071) | (372) | (1,443) | | Total Securities | 2,457 | 258 | 2,715 | (273) | (309) | (582) | | Federal Funds Sold | 149 | 187 | 336 | (27) | 60 | 33 | | Loans and Leases, Net | 18,311 | 3,063 | 21,374 | 4,036 | (408) | 3,628 | | Restricted Investment Bank Stocks | 24 | 137 | 161 | 10 | (31) | (21) | | Total Interest Income | 20,957 | 3,686 | 24,643 | 3,747 | (683) | 3,064 | | INTEREST EXPENSE: | | | | | | | | Interest Bearing Deposits: | | | | | | | | Interest Bearing Demand | 151 | 886 | 1,037 | 145 | 256 | 401 | | Money Market | 365 | 1,177 | 1,542 | 66 | 67 | 133 | | Savings | 72 | 433 | 505 | — | 1 | 1 | | Time | 1,665 | 672 | 2,337 | 306 | 108 | 414 | | Total Interest Bearing Deposits | 2,253 | 3,168 | 5,421 | 517 | 432 | 949 | | Short-term Borrowings | 12 | 84 | 96 | 35 | 61 | 96 | | Long-term Debt | 95 | 49 | 144 | (235) | 111 | (124) | | Subordinated Debt | 722 | 33 | 755 | 17 | (1) | 16 | | Total Interest Expense | 3,082 | 3,334 | 6,416 | 334 | 603 | 937 | | NET INTEREST INCOME | $17,875 | $352 | $18,227 | $3,413 | $(1,286) | $2,127 | The effect of changing volume and rate, which cannot be segregated, has been allocated entirely to the rate column. Tax-exempt income is shown on a tax equivalent basis using statutory corporate tax rates of 21 percent for the year ended December 31, 2018, and 34 percent for the years ended December 31, 2017 and 2016. During 2018, taxable equivalent net interest income increased $18,227,000 or 47 percent compared to 2017. During 2017, taxable equivalent net interest income increased $2,127,000 or 6 percent compared to 2016. The average balances, effective interest differential, and interest yields for the years ended December 31, 2018, 2017, and 2016 and the components of net interest income are presented in Table 1. Table 2 provides a comparative presentation of the changes in net interest income for 2018 compared to 2017, and 2017 compared to 2016, by reflecting changes in interest income and interest expense caused by the volume and rate components of interest earning assets and interest bearing liabilities. The yield on earning assets increased to 4.50% in 2018 from 4.28% in 2017. The yield on earning assets for 2016 was 4.38%. The increase in the yield on earning assets in 2018 was largely due to increases in both rate and volume of loan and investments. The average rate on loans increased to 4.98% in 2018 from 4.73% in 2017. The average rates on investment securities also increased from 2017 to 2018 as a decrease in the yield on tax-exempt investments from 3.19% to 2.86% was more than offset by the impact of an increase in the yield on taxable investments from 1.96% to 2.32%. The increase in investment yields in 2018 was affected by both yields on purchases, and from yields on securities added to the investment portfolio as a result of the two 2018 acquisitions. Interest expense increased by $6,416,000 or 102 percent in 2018, as compared to 2017. For the year ending December 31, 2017, interest expense increased $937,000 or 17 percent, compared to 2016. The cost of interest bearing liabilities increased to 1.02% in 2018 from 0.72% in 2017. The cost of interest bearing liabilities for 2016 was 0.67%. The increase in the cost of interest bearing liabilities was due to both (i) the rising cost of both deposit and borrowed funds as a result of market pricing in response to recent FOMC rate increases, and (ii) the increase in wholesale funding, including the assumption of some higher-cost brokered time deposits, FHLB borrowings, and subordinated debt in the First Priority transaction. Net interest margin, on a tax equivalent basis, was 3.67% in 2018 compared to 3.68% in 2017 and 3.82% in 2016. Increases in yields on earning assets and increases in noninterest-bearing deposits were offset by the higher cost of interest bearing liabilities when comparing 2018 to 2017. The decrease in the net interest margin for 2017 compared to 2016 was primarily the result of a lower realized yield on the investment portfolio, including the impact of purchases of lower-risk and lower-yielding held-to-maturity portfolio securities in 2017. Further changes to the future mix of the loan, investment, and deposit products in the Bank's portfolios, and the volume of variable rate and fixed rate instruments based upon new loan originations and investment purchases, may significantly change the net interest margin and the yields on earning-assets and the costs of interest-bearing liabilities. In addition, net interest income may be impacted by further interest rate actions of the Federal Reserve. Management continues to monitor the net interest margin closely. #### Provision for Loan and Lease Losses The provision for loan and lease losses is the expense necessary to maintain the allowance for loan and lease losses 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 actual and potential charge-offs and recoveries, and assess general economic conditions in the markets we serve. Mid Penn has maintained the allowance for loan and lease losses in accordance with Mid Penn’s portfolio credit risk and potential loss assessment process, which took into consideration the risk characteristics of the loan and lease portfolio, shifting collateral values, and the assessment of other relevant qualitative factors from December 31, 2017 to December 31, 2018. For the year ended December 31, 2018, the provision for loan and lease losses was $500,000 compared to $325,000 for the year ended December 31, 2017. The increase in loan loss provision expense year-over-year was necessary to support the allowance for loan loss given the organic loan growth within Mid Penn’s loan portfolio since December 31, 2017, though the required provision for both years was favorably impacted by the net recoveries for the respective year. The allowance for loan and lease losses as a percentage of total loans was 0.52% at December 31, 2018, compared to 0.84% at December 31, 2017 and 0.88% at December 31, 2016. For the year ended December 31, 2018, Mid Penn favorably had net recoveries of $291,000 compared to net recoveries of $98,000 during the same period of 2017. Loans charged off during 2018 were comprised of two commercial and industrial loans for $142,000, four commercial real estate loans among two relationships totaling $64,000 and one commercial real estate – construction loan of $40,000. In addition, there were charge-offs for three home equity loans for $185,000, three residential real estate loans totaling $60,000, and four consumer loans to unrelated borrowers totaling $14,000. The remaining $23,000 was comprised of deposit account charge-offs. These charge-offs were more than offset by total recoveries of $819,000 realized during 2017, primarily comprised of one commercial real estate loan totaling $777,000. 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 or other relevant qualitative factors differ 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. A summary of charge-offs and recoveries of loans and leases are presented in Table 3. ### TABLE 3: ANALYSIS OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES *(Dollars in thousands)* | | Years ended December 31, 2018 | 2017 | 2016 | 2015 | 2014 | | --- | ---: | ---: | ---: | ---: | ---: | | Balance, beginning of year | $7,606 | $7,183 | $6,168 | $6,716 | $6,317 | | Loans and leases charged off: | | | | | | | Commercial real estate, construction and land development | 104 | 322 | 216 | 1,569 | 1,057 | | Commercial, industrial and agricultural | 142 | 25 | 820 | 130 | 62 | | Real estate - residential | 60 | 102 | 4 | 35 | 133 | | Consumer | 222 | 48 | 67 | 50 | 76 | | Total loans and leases charged off | 528 | 497 | 1,107 | 1,784 | 1,328 | | Recoveries on loans and leases previously charged off: | | | | | | | Commercial real estate, construction and land development | 808 | 553 | 211 | 75 | 13 | | Commercial, industrial and agricultural | 1 | 26 | 4 | 12 | 13 | | Real estate - residential | - | 4 | 26 | 44 | 20 | | Consumer | 10 | 12 | 11 | 40 | 64 | | Total loans and leases recovered | 819 | 595 | 252 | 171 | 110 | | Net (recoveries) charge-offs | (291) | (98) | 855 | 1,613 | 1,218 | | Provision for loan and lease losses | 500 | 325 | 1,870 | 1,065 | 1,617 | | Balance, end of year | $8,397 | $7,606 | $7,183 | $6,168 | $6,716 | | | Years ended December 31, 2018 | 2017 | 2016 | 2015 | 2014 | | --- | ---: | ---: | ---: | ---: | ---: | | Ratio of net (recoveries) charge-offs during the year to average loans and leases outstanding during the year, net of unearned discount | -0.02% | -0.01% | 0.11% | 0.23% | 0.22% | | Allowance for loan and lease losses as a percentage of total loans and leases at December 31 | 0.52% | 0.84% | 0.88% | 0.83% | 1.18% | | Allowance for loan and lease losses as a percentage of non-performing assets at December 31 | 68.37% | 67.26% | 124.73% | 101.75% | 58.36% | 32 ### TABLE 4: NONINTEREST INCOME *(Dollars in thousands)* | | Years ended December 31, 2018 | 2017 | 2016 | | --- | ---: | ---: | ---: | | Income from fiduciary activities | $1,155 | $845 | $481 | | Service charges on deposits | 933 | 721 | 684 | | Net gain on sales of investment securities | 137 | 42 | 1,046 | | Earnings from cash surrender value of life insurance | 286 | 262 | 264 | | Mortgage banking income | 751 | 872 | 922 | | ATM debit card interchange income | 1,253 | 937 | 844 | | Merchant services income | 347 | 335 | 317 | | Net gain on sales of SBA loans | 561 | 800 | 470 | | Other income | 2,039 | 893 | 918 | | Total Noninterest Income | $7,462 | $5,707 | $5,946 | #### Noninterest Income For the year ended December 31, 2018, noninterest income totaled $7,462,000, an increase of $1,755,000 or 31 percent, compared to noninterest income of $5,707,000 for the year ended December 31, 2017. Several components of noninterest income were affected by higher account and transaction volume, when comparing 2018 to the prior year, due to both the First Priority and Scottdale acquisitions that closed during 2018. Income from fiduciary activities was $1,155,000 for the year ended December 31, 2018, an increase of $310,000 or 37 percent compared to fiduciary income of $845,000 for the year ended December 31, 2017. These additional revenues were attributed to continued growth in trust assets under management, and increased sales of retail investment products, as a result of successful business development efforts by Mid Penn’s trust and wealth management team. Service charges on deposits were $933,000 for the year ended December 31, 2018, an increase of $212,000 or 29 percent, compared to service charges of $721,000 for the year ended December 31, 2017. This increase was driven by an increase in collected charges on a higher volume of transactional deposit accounts, including deposit accounts assumed in both the Scottdale and First Priority acquisitions. Net gains on sales of securities were $137,000 for the year ended December 31, 2018, an increase of $95,000 compared to net gains on sales of securities of $42,000 for the year ended December 31, 2017. Some investment securities acquired from Scottdale and First Priority were sold to ensure that the overall portfolio, after the acquisitions, was in alignment with Mid Penn’s investment management objectives. ATM debit card interchange income was $1,253,000 for the year ended December 31, 2018, an increase of $316,000 or over 33 percent compared to interchange income of $937,000 for the year ended December 31, 2017. The increase in Mid Penn Bank ATM and debit card activity resulted from both increasing card-based transaction volume, as well as new demand deposit accounts, including those acquired in the Scottdale and First Priority transactions. Other income was $2,039,000 for the year ended December 31, 2018, an increase of $1,146,000 compared to other income of $893,000 for the year ended December 31, 2017. The increase in other income was primarily driven by $737,000 of settlement gains recognized during 2018 as a result of certain lump sum payouts reducing pension liabilities to participants of the Scottdale defined benefit retirement, with such pension liabilities being assumed as a result of the Scottdale acquisition in 2018. Also, increases in letter of credit renewal fees and other service fees and commissions also contributed to the year-over-year growth in other income. Mortgage banking income was $751,000 for the year ended December 31, 2018, a decrease of $121,000 or 14 percent compared to the year ended December 31, 2017. Higher longer-term mortgage interest rates for much of 2018 resulted in a lower volume of mortgage refinance activity during 2018 when compared to 2017. Net gains on sales of SBA loans was $561,000 for the year ended December 31, 2018, a decrease of $239,000 when compared to the same period in 2017. Increased interest rates on SBA loans, and tighter market pricing on secondary market sales yields, resulted in lower levels of loan sales and related gains in 2018 versus the prior year. During the twelve months ended December 31, 2017, noninterest income (excluding net securities gains of $42,000) increased $765,000 or 16 percent, versus the twelve months ended December 31, 2016 (excluding net security gains of $1,046,000). Items of particular note are detailed below. Mid Penn increased its origination and sales activities related to SBA loans, resulting in gains of $800,000 from related loan sales during the year ended December 31, 2017, an increase of $330,000 or 70 percent compared to SBA loan sales gains of $470,000 for the twelve months ended December 31, 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 $845,000 for the twelve months ended December 31, 2017, an increase of $364,000 or 76 percent compared to fiduciary income of $481,000 for the year ended December 31, 2016. These additional revenues were attributed to trust assets under management significantly increasing over the past twelve months as a result of successful business development efforts by Mid Penn’s expanded team of trust and retail investment officers. ATM debit card interchange income was $937,000 for the twelve months ended December 31, 2017, an increase of $93,000 or 11 percent compared to interchange income of $844,000 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. Net gains on sales of securities were $42,000 for the twelve months ended December 31, 2017, a decrease of $1,004,000 or 96 percent compared to net gains on sales of securities of $1,046,000 during the year ended December 31, 2016. During 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. Other noninterest income decreased $25,000 for the twelve months ended December 31, 2017 compared to the twelve months ended December 31, 2016. Included in 2016 other income was $86,000 from the gain on the sale of insurance policies upon the dissolution of Mid Penn Insurance Services, LLC, a then wholly-owned subsidiary of Mid Penn Bank, effective March 1, 2016. The decision was made to liquidate the subsidiary due to the lack of consistent profitability and growth. ### TABLE 5: NONINTEREST EXPENSE *(Dollars in thousands)* | | Years ended December 31, 2018 | 2017 | 2016 | | --- | ---: | ---: | ---: | | Salaries and employee benefits | $23,862 | $16,929 | $15,564 | | Occupancy expense, net | 4,019 | 2,512 | 2,064 | | Equipment expense | 2,186 | 1,536 | 1,689 | | Pennsylvania Bank Shares tax expense | 225 | 451 | 648 | | FDIC Assessment | 772 | 792 | 688 | | Legal and professional fees | 1,117 | 802 | 711 | | Marketing and advertising expense | 1,025 | 516 | 500 | | Software licensing and utilization | 3,036 | 2,051 | 1,908 | | Telephone expense | 621 | 497 | 548 | | Loss on sale/write-down of foreclosed assets | 4 | 88 | 217 | | Intangible amortization | 1,224 | 104 | 126 | | Merger and acquisition expense | 4,790 | 619 | — | | ATM debit card processing expense | 631 | 448 | 440 | | Director fees and benefits expense | 792 | 465 | 340 | | Loan collection costs | 271 | 148 | 178 | | Meals, travel, and lodging expense | 945 | 544 | 428 | | Data processing | 573 | 420 | 341 | | Insurance | 278 | 216 | 178 | | OREO expense | 275 | 79 | 248 | | Investor services | 159 | 115 | 85 | | Other expenses | 3,366 | 2,049 | 1,939 | | Total Noninterest Expense | $50,171 | $31,381 | $28,840 | 34 #### Noninterest Expense Noninterest expense for the year ended December 31, 2018 totaled $50,171,000, an increase of $18,790,000 or 60 percent compared to noninterest expenses of $31,381,000 for the twelve months ended December 31, 2017. The primary source of the increase in noninterest expense were the merger expenses and other costs supporting Mid Penn’s acquisition of both First Priority and Scottdale, and from the opening of new retail branches and new corporate administrative offices in 2018. For the year ended December 31, 2018, Mid Penn incurred merger and acquisition expenses totaling $4,790,000 in connection with the First Priority and Scottdale acquisitions, with such expenses including investment banking fees, merger-related legal expenses, professional fees related to the preparation and filing of merger documents, severance costs, and information technology conversion/termination costs. Merger and acquisition expenses of $619,000 were recorded for the year ended December 31, 2017, and consisted primarily of investment banking fees, legal fees, and professional fees related to the preparation and filing of merger documents, related to the Scottdale acquisition. Salaries and employee benefits expense increased $6,933,000 or 41 percent during the twelve months ended December 31, 2018 versus the same period in 2017, with the increase attributable to (i) the retail staff additions at the five retail locations added through the Scottdale acquisition and the opening of the Halifax, PA branch, all effective January 8, 2018, (ii) the retail staff additions at the eight retail locations and loan production office added through the First Priority acquisition, effective July 31, 2018, (iii) the retail staff additions as a result of the opening of two additional retail offices in upper Dauphin County, Pennsylvania (Halifax and Pillow), and (iv) the addition of commercial lenders, credit administration personnel, and other staff additions in Mid Penn’s legacy markets, in alignment with Mid Penn’s core banking growth objectives. Occupancy expenses increased $1,507,000 or 60 percent during the year ended December 31, 2018 compared to the same period in 2017. Similarly, equipment expense increased $650,000 or 42 percent during the year ended December 31, 2018 compared to the year ended December 31, 2017. These increases were driven by (i) the facility operating costs and increased depreciation expense for building, furniture, and equipment associated with the addition of the above-noted acquired and new branch offices, and (ii) depreciation and occupancy costs related to Mid Penn’s addition of larger corporate administrative office facilities to increase the effectiveness and efficiency of administrative and operations support services for the growing franchise. FDIC assessment expense was $772,000 for the year ended December 31, 2018, a decrease of $20,000 or 3 percent compared to $792,000 for the year ended December 31, 2017. As a result of several factors, including the 2018 acquisitions, the favorable asset quality of both legacy portfolio loan assets and acquired portfolios, and successful workouts of non-performing assets, Mid Penn had more favorable capital and asset quality ratios, resulting in a lower overall FDIC assessment rate for 2018. Legal and professional fees for the year ended December 31, 2018 increased by $315,000 or 39 percent compared to the year ended December 31, 2017, due to increased third-party services for wealth management, audit, information technology consulting, and public relations activities given the expanded franchise operating profile. Marketing and advertising expense increased 99 percent, from $516,000 for the year ended December 31, 2017 to $1,025,000 for the year ended December 31, 2018. The increased costs were a result of marketing and branding initiatives implemented at the recently acquired Scottdale and First Priority locations, and market-specific business development promotions across Mid Penn’s footprint. Software licensing and utilization costs were $3,036,000 during the year ended December 31, 2018, an increase of $985,000 or 48 percent compared to $2,051,000 for the year ended December 31, 2017. The increase is a result of additional costs to license (i) all of the Scottdale and First Priority locations and the new retail branches, (ii) upgrades to internal systems to enhance data management and storage capabilities given the larger company profile, and (iii) increases in certain core processing fees as our customer base and account/transaction volumes continue to grow. Intangible amortization increased from $104,000 during the year ended December 31, 2017 to $1,224,000 during the same period in 2018. In the first quarter of 2018, Mid Penn recorded a core deposit intangible (CDI) asset related to the Scottdale acquisition of $4,940,000. On July 31, 2018, Mid Penn recorded an additional CDI asset of $2,832,000 as a result of the First Priority acquisition. These CDI assets will be amortized using the sum of the years’ digit method over a ten-year period from the respective acquisition date. During the year ended December 31, 2018, the CDI amortization recorded related to the Scottdale and First Priority acquisitions totaled $1,113,000, of which $898,000 was related to the amortization of the Scottdale CDI and $215,000 was related to the amortization of the First Priority CDI. The remaining intangible amortization expense in 2018, and the prior year’s amortization expense, was attributable to CDI recorded as a result of Mid Penn’s acquisition of Phoenix Bancorp in 2015. Other expense was $7,290,000 during the year ended December 31, 2018, an increase of $2,806,000 or 63 percent compared to other expense of $4,484,000 for the year ended December 31, 2017. As both organic growth and the Scottdale and First Priority acquisitions have increased Mid Penn’s geographic profile and employee base, several categories within other expenses experienced year-over-year increases, including insurance costs, stationary and supplies, printing, postage, employee travel costs, and directors fees. During the year ended December 31, 2017, noninterest expenses totaled $31,381,000, an increase of $2,541,000 or 9 percent compared to $28,840,000 for the year ended December 31, 2016. Salaries and employee benefits expense increased $1,365,000 or 9 percent during the twelve months ended December 31, 2017, versus the same period in 2016, with the increase attributable to (i) the addition of commercial lending personnel and credit support staff in alignment with Mid Penn’s core banking growth and expanding markets, (ii) retail staff additions at the New Holland and Orwigsburg locations, which opened in 2017, and the Oregon Pike location, which opened in late 2016, and (iii) an increased volume of covered employees and healthcare claims as Mid Penn maintains a self-funded medical plan as part of a consortium. In connection with the acquisition of Scottdale, Mid Penn incurred $619,000 of merger related expenses during 2017, while no merger related expenses were incurred in 2016. Occupancy expenses increased $448,000 or 22 percent during the year ended December 31, 2017 compared to the same period in 2016. In the twelve months since December 31, 2016, Mid Penn added facility operating costs associated with opening the above-noted three new branch offices, as well as incurring full-year costs for loan production offices opened during 2016 in Lancaster and Franklin Counties in Pennsylvania. Mid Penn’s FDIC assessment costs were $792,000 during the twelve months ended December 31, 2017, an increase of $104,000 or 15 percent compared to the FDIC assessment of $688,000 for the twelve months ended December 31, 2016. The increase is due to Mid Penn’s growth in deposits and assets, which increased the base amount used to determine the FDIC insurance assessment. Legal and professional fees for the twelve months ended December 31, 2017 increased by $91,000 or 13 percent compared to the same period in 2016 due to increased third-party services for wealth management, audit, and public relations activities. Pennsylvania bank shares tax expense decreased $197,000 or 30 percent during the twelve months ended December 31, 2017 versus the same period in 2016, due to the additional Pennsylvania-eligible tax credits generated from Mid Penn’s increased level of charitable donations to support education and community development organizations throughout the markets it serves. The increased amount of charitable contributions supported part of the increase in Other Expenses. #### Investments Mid Penn’s investment portfolio is utilized primarily to support overall liquidity management, to provide collateral supporting pledging requirements over public funds deposit), and to generate additional interest income within reasonable risk parameters. Mid Penn’s investment portfolio includes both held-to-maturity securities and available-for-sale securities. During the year ended December 31, 2018, the portfolio of held-to-maturity securities increased over 66 percent to $168,370,000 as of December 31, 2018, as compared to $101,356,000 as of December 31, 2017 (held-to-maturity investments are recorded at amortized cost). Mid Penn’s total available-for-sale securities portfolio increased $18,458,000 or 20 percent, from $93,465,000 at December 31, 2017 to $111,923,000 at December 31, 2018. The increase to the investment securities during 2018 was primarily due to investments acquired from Scottdale and First Priority. Some acquired available-for-sale securities were sold after the mergers and the proceeds reinvested in held-to-maturity securities, both to support pledging requirements, and to ensure greater portfolio alignment with Mid Penn’s investment management objectives. Mid Penn’s available-for-sale portfolio is recorded at fair value, meaning the investments are valued at a market price relative to investments of the same type with similar maturity dates. As the interest rate environment and overall market yield curve changes, the fair value of securities changes accordingly. The fair values of securities can also be impacted by changing market supply and demand for certain types of securities. At December 31, 2018, the unrealized loss on available-for-sale investment securities resulted in a decrease in shareholders’ equity of $3,242,000 (comprised of a gross unrealized loss on securities of $4,103,000 net of a deferred income tax benefit of $861,000). At December 31, 2017, the unrealized loss on available-for-sale investment securities resulted in a decrease in shareholders’ equity of $2,159,000 (gross unrealized loss on securities of $2,733,000 net of a deferred income tax benefit of $574,000). Mid Penn does not have any significant concentrations of non-governmental securities within its investment portfolio. Table 6 provides a summary of our investment securities, and maturity and yield information relating to debt securities is shown in Table 7. ### TABLE 6: FAIR VALUE OF INVESTMENT SECURITIES *(Dollars in thousands)* | Available-for-sale securities: | December 31, 2018 | 2017 | 2016 | | --- | ---: | ---: | ---: | | U.S. Treasury and U.S. government agencies | $41,572 | $38,730 | $47,012 | | Mortgage-backed U.S. government agencies | 38,849 | 25,831 | 25,619 | | State and political subdivision obligations | 29,256 | 27,043 | 58,838 | | Corporate debt securities | 2,246 | 1,355 | 1,099 | | Total available-for-sale debt securities | 111,923 | 92,959 | 132,568 | | Available-for-sale equity securities: | | | | | Equity securities | $492 | $506 | $1,057 | | Total available-for-sale equity securities | 492 | 506 | 1,057 | | Held-to-maturity securities: | | | | | U.S. Treasury and U.S. government agencies | $16,856 | $10,894 | $— | | Mortgage-backed U.S. government agencies | 64,548 | 52,949 | — | | State and political subdivision obligations | 83,649 | 36,640 | — | | Corporate debt securities | 1,539 | — | — | | Total held-to-maturity securities | 166,592 | 100,483 | — | | Total | $279,007 | $193,948 | $133,625 | ### TABLE 7: INVESTMENT MATURITY AND YIELD *(Dollars in thousands)* | As of December 31, 2018 Available for sale securities: | One Year and Less | After One Year thru Five Years | After Five Years thru Ten Years | After Ten Years | Total | | --- | ---: | ---: | ---: | ---: | ---: | | U.S. Treasury and U.S. government agencies | $— | $20,934 | $20,638 | $— | $41,572 | | Mortgage-backed U.S. government agencies | 14 | 7,858 | 23,256 | 7,721 | 38,849 | | State and political subdivision obligations | — | 3,548 | 19,389 | 6,319 | 29,256 | | Corporate debt securities | — | 250 | 1,000 | 996 | 2,246 | | | $14 | $32,590 | $64,283 | $15,036 | $111,923 | | Held to maturity securities: | | | | | | | U.S. Treasury and U.S. government agencies | $991 | $12,463 | $3,531 | $— | $16,985 | | Mortgage-backed U.S. government agencies | — | — | 23,670 | 42,142 | 65,812 | | State and political subdivision obligations | 95 | 6,282 | 77,657 | — | 84,034 | | Corporate debt securities | — | — | 1,539 | — | 1,539 | | | $1,086 | $18,745 | $106,397 | $42,142 | $168,370 | 37 ### MID PENN BANCORP, INC. Management’s Discussion and Analysis | Weighted Average Yields Available for sale securities: | One Year and Less | After One Year thru Five Years | After Five Years thru Ten Years | After Ten Years | Total | | --- | ---: | ---: | ---: | ---: | ---: | | U.S. Treasury and U.S. government agencies | — | 2.05% | 2.18% | — | 2.11% | | Mortgage-backed U.S. government agencies | 4.08% | 3.15% | 2.71% | 2.72% | 2.80% | | State and political subdivision obligations | — | 2.77% | 3.28% | 3.22% | 3.21% | | Corporate debt securities | — | 1.50% | 4.75% | 6.50% | 5.16% | | | 4.08% | 2.38% | 2.74% | 2.75% | 2.64% | | Held to maturity securities: | | | | | | | U.S. Treasury and U.S. government agencies | 1.41% | 1.93% | 3.42% | — | 2.21% | | Mortgage-backed U.S. government agencies | — | — | 2.91% | 2.72% | 2.79% | | State and political subdivision obligations | 6.93% | 3.15% | 3.47% | — | 3.45% | | Corporate debt securities | — | — | 5.36% | — | 5.36% | | | 1.89% | 2.34% | 3.37% | 2.72% | 3.08% | #### Loans Total loans at December 31, 2018 were $1,624,067,000 compared to $910,404,000 at December 31, 2017, an increase of $713,663,000 or over 78 percent since year-end 2017. A large portion of the year-over-year increase was a result of the loans acquired from First Priority and Scottdale totaling $543,272,000 as of December 31, 2018. The majority of Mid Penn’s $170,391,000 of organic loan growth during 2018 was attributable to commercial loans, including both commercial and industrial financing, and commercial real estate credits. At December 31, 2018, loans (net of unearned income) represented 85 percent of earning assets, compared to 83 percent at both December 31, 2017 and 2016. The Bank's loan portfolio is diversified among individuals and businesses generally located within the Bank's primary market area of Berks, Bucks, Chester, Cumberland, Dauphin, Fayette, Lancaster, Luzerne, Montgomery, Northumberland, Schuylkill and Westmoreland counties in Pennsylvania. Commercial real estate, construction, and land development loans are collateralized mainly by mortgages on the income-producing real estate or land involved. Commercial, industrial, and agricultural loans are primarily made to business entities and may be secured by business assets, including commercial real estate, or may be unsecured. Residential real estate loans are secured by liens on the residential property. Consumer loans include installment loans, lines of credit and home equity loans. The Bank has no significant concentration of credit to any one borrower. The Bank’s highest concentration of credit by loan type is in commercial real estate financings. A distribution of the Bank's loan portfolio according to major loan classification is shown in Table 8, and the maturity and rate sensitivity information related to the loan portfolio is reflected in Table 9. ### TABLE 8: LOAN PORTFOLIO *(Dollars in thousands)* | | December 31, 2018 Amount% | | 2017 Amount% | | 2016 Amount% | | 2015 Amount% | | 2014 Amount% | | | --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: | | Commercial real estate, construction and land development | $1,003,542 | 61.8 | $465,122 | 51.1 | $397,547 | 48.8 | $355,339 | 48.1 | $289,378 | 50.6 | | Commercial, industrial and agricultural | 286,583 | 17.6 | 188,262 | 20.7 | 171,985 | 21.1 | 160,988 | 21.8 | 120,326 | 21.0 | | Real estate - residential | 323,639 | 19.9 | 253,152 | 27.8 | 240,418 | 29.5 | 216,269 | 29.6 | 159,004 | 27.8 | | Consumer | 10,351 | 0.6 | 3,954 | 0.4 | 4,132 | 0.6 | 4,204 | 0.5 | 3,018 | 0.6 | | Total Loans | 1,624,115 | 100.0 | 910,490 | 100.0 | 814,082 | 100.0 | 736,800 | 100.0 | 571,726 | 100.0 | | Unearned income | (48) | | (86) | | (158) | | (287) | | (193) | | | Loans net of unearned discount | 1,624,067 | | 910,404 | | 813,924 | | 736,513 | | 571,533 | | | Allowance for loan and lease losses | (8,397) | | (7,606) | | (7,183) | | (6,168) | | (6,716) | | | Net loans | $1,615,670 | | $902,798 | | $806,741 | | $730,345 | | $564,817 | | 38 ### TABLE 9: LOAN MATURITY AND INTEREST SENSITIVITY *(Dollars in thousands)* | As of December 31, 2018 | One Year and Less | After One Year thru Five Years | After Five Years | Total | | --- | ---: | ---: | ---: | ---: | | Commercial real estate, construction and land development | $79,430 | $233,925 | $690,187 | $1,003,542 | | Commercial, industrial and agricultural | 17,866 | 76,253 | 192,464 | 286,583 | | Real estate - residential mortgages | 13,570 | 33,624 | 276,445 | 323,639 | | Consumer | 279 | 2,429 | 7,595 | 10,303 | | | $111,145 | $346,231 | $1,166,691 | $1,624,067 | | Rate Sensitivity | | | | | | --- | ---: | ---: | ---: | ---: | | Predetermined rate | $53,061 | $249,407 | $287,796 | $590,264 | | Floating or adjustable rate | 58,084 | 96,824 | 878,895 | 1,033,803 | | | $111,145 | $346,231 | $1,166,691 | $1,624,067 | #### Credit Quality, Credit Risk, and Allowance for Loan and Lease Losses Other than as described herein, Mid Penn does not believe there are current significant credit-related trends, events or uncertainties relating to its loan portfolio that are reasonably expected to have a material impact on future results of operations, liquidity, or capital resources. Mid Penn recognizes 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 the financial strength of borrowers constantly and 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, or perform 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. ### TABLE 10: NONPERFORMING ASSETS *(Dollars in thousands)* | Nonperforming Assets: | December 31, 2018 | 2017 | 2016 | 2015 | 2014 | | --- | ---: | ---: | ---: | ---: | ---: | | Nonaccrual loans | $10,749 | $10,575 | $4,658 | $4,418 | $8,907 | | Accruing troubled debt restructured loans | 517 | 544 | 877 | 459 | 2,035 | | Total nonperforming loans | 11,266 | 11,119 | 5,535 | 4,877 | 10,942 | | Foreclosed real estate | 1,017 | 189 | 224 | 1,185 | 565 | | Total nonperforming assets | 12,283 | 11,308 | 5,759 | 6,062 | 11,507 | | Accruing loans 90 days or more past due | — | — | 59 | 55 | — | | Total risk elements | $12,283 | $11,308 | $5,818 | $6,117 | $11,507 | | Nonperforming loans as a % of total loans outstanding | 0.69% | 1.22% | 0.68% | 0.66% | 1.91% | | Nonperforming assets as a % of total loans outstanding and other real estate | 0.76% | 1.24% | 0.71% | 0.82% | 2.01% | | Ratio of allowance for loan losses to nonperforming loans | 74.53% | 68.41% | 129.78% | 126.46% | 61.37% | Mid Penn assesses a specific allocation for both commercial loans and commercial real estate loans prior to partially or fully charging off the loan. If a partial charge off 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. During 2018, nonperforming loans increased $147,000 from $11,119,000 at December 31, 2017, to $11,266,000 at December 31, 2018, and foreclosed real estate increased $828,000 to $1,017,000 at December 31, 2018. The increase in nonperforming loans is primarily due to the addition of approximately $3,866,000 of nonaccrual loans added during the twelve months ended December 31, 2018. This increase was partially offset by favorable reductions to the nonperforming loan portfolio due to (i) the successful workout of one nonaccrual loan relationship during the second quarter of 2018, which decreased the total nonaccrual loan pool by $1,094,000 and (ii) the sale of some collateral in an existing nonaccrual loan relationship resulting in total principal pay-down of $1,393,000. Additionally, certain loans totaling $668,000 were transferred from nonaccrual loans to foreclosed real estate during 2018. Two loan relationships, which account for $5,725,000 or the majority of the nonperforming loan balance, are discussed in more detail below. Loan no. 1 – At December 31, 2018, the outstanding principal balance of this loan relationship was $4,302,000. A $275,000 specific allowance allocation was assigned to this relationship. As part of the workout process, this loan had been modified as a troubled debt restructured loan during 2017. Management is pursuing diligent workout efforts, including proceeds from the sale of pledged collateral not associated with the primary operation of the business, to collect the remaining outstanding balance. Loan no. 2 – At December 31, 2018, the contractual outstanding principal balance of this loan relationship was $1,423,000 and was comprised of four loans collateralized primarily by commercial real estate, as well as certain machinery and equipment. As part of the workout process, the loans in this relationship were modified as a troubled debt restructured loans during 2017. During the second quarter of 2018, certain commercial real estate collateral was sold, resulting in the principal payoff of three previous loans associated with this loan relationship totaling $1,393,000. Given that the fair value of the remaining collateral exceeds the outstanding principal balance, no specific allowance allocation has been assigned to this relationship. Management expects to recover the remaining outstanding balance through the sale of real estate and equipment collateral pledged in support of the loans. Mid Penn’s troubled debt restructured loans at December 31, 2017 totaled $7,020,000, of which $517,000 were accruing loans in compliance with the terms of the modification and $6,503,000 are included in nonaccrual loans. As a result of the evaluation, a specific allocation, and subsequently, charge-offs have been taken as deemed appropriate. Mid Penn entered into forbearance agreements on all loans currently classified as troubled debt restructured loans, and these agreements have resulted in additional principal repayment. The terms of these forbearance agreements vary and may include reductions in principal payments, reductions in interest rates, and/or repayment of the loan as collateral is sold. Further discussion of troubled debt restructured loans can be found in Note 9 to Mid Penn’s Consolidated Financial Statements, which are included in Item 8. As of December 31, 2018, there were no defaulted troubled debt restructured loans, as all troubled debt restructured loans were current with respect to their associated forbearance agreements. The following table provides additional analysis of partially charged off loans: ### TABLE 11: PARTIALLY CHARGED OFF LOANS *(Dollars in thousands)* | | December 31, 2018 | December 31, 2017 | | --- | ---: | ---: | | Period ending total loans outstanding (net of unearned income) | $1,624,067 | $910,404 | | Allowance for loan and lease losses | 8,397 | 7,606 | | Total Nonperforming loans | 11,266 | 11,119 | | Nonperforming and impaired loans with partial charge-offs | 333 | 1,701 | | Ratio of nonperforming loans with partial charge-offs to total loans | 0.02% | 0.19% | | Ratio of nonperforming loans with partial charge-offs to total nonperforming loans | 2.96% | 15.30% | | Coverage ratio net of nonperforming loans with partial charge-offs | 76.80% | 80.76% | | Ratio of total allowance to total loans less nonperforming loans with partial charge-offs | 0.52% | 0.84% | 40 Mid Penn has not experienced any additional charge-offs on loans for which a partial charge-off had originally been taken during the periods presented. 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 in the process of collection, or sooner when it is probable that Mid Penn will be unable to collect all contractual principal and interest due. This methodology assumes the borrower cannot or will not continue to make additional payments. At that time, the loan would likely be considered collateral dependent as the discounted cash flow (“DCF”) method would indicate 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 in the process of 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 practicable following the credit being classified as substandard non-accrual. 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 as 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 practicable following being placed on nonaccrual status sometimes indicates that the loan to value ratio is sufficient to obviate the need for a specific allocation, despite 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 loans with an aggregate balance of $11,266,000 deemed impaired at December 31, 2018. Excluding $2,803,000 in loans acquired with credit deterioration in connection with the closing of the Phoenix acquisition in 2015, and the Scottdale and First Priority acquisitions in 2018, Mid Penn had several loan relationships deemed impaired with an aggregate carrying balance of $8,463,000. This pool of impaired loans was further broken down into a group of loans with an aggregate carrying balance of $5,615,000, for which specific allocations totaling $742,000 were included within the loan loss reserve for these loans. The remaining $2,848,000 of loans required no specific allocation within the loan loss reserve. Of the $8,463,000 of impaired loan relationships, excluding the loans acquired with credit deterioration from the Phoenix, Scottdale, and First Priority acquisitions, $4,527,000 were commercial and industrial relationships, $2,728,000 were commercial real estate relationships, $811,000 were residential relationships, $367,000 were commercial real estate – construction relationships, and $30,000 were home equity relationships. There were specific loan loss reserve allocations of $500,000 against the commercial and industrial relationships, $204,000 against the commercial real estate relationships, and $38,000 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 for loan losses 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 for loan and lease losses 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 for loan and lease losses as 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 for loan and lease losses 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 and consideration of the above-noted qualitative factors which may be susceptible to significant change. Changes in these estimates may impact the provisions charged to expense in future periods. Management believes, based on information currently available, that the allowance for loan and lease losses of $8,397,000 as of December 31, 2018 is adequate 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. The allocation of the allowance for loan and lease losses among the major classifications is shown in Table 12 as of December 31 of each of the past five years. ### TABLE 12: ALLOCATION OF THE ALLOWANCE FOR LOAN AND LEASE LOSSES *(Dollars in thousands)* | | December 31, 2018 | 2017 | 2016 | 2015 | 2014 | | --- | ---: | ---: | ---: | ---: | ---: | | Commercial real estate, construction and land development | $4,778 | $4,613 | $4,467 | $3,705 | $3,958 | | Commercial, industrial and agricultural | 2,391 | 1,795 | 1,581 | 1,394 | 1,395 | | Real estate - residential | 453 | 428 | 541 | 534 | 450 | | Consumer | 535 | 426 | 382 | 329 | 688 | | Unallocated | 240 | 344 | 212 | 206 | 225 | | | $8,397 | $7,606 | $7,183 | $6,168 | $6,716 | The organic growth in the loan portfolio during 2018, as well as an increase in specific allocations on impaired loans, resulted in a larger allowance in 2018. See also the discussion in the Provision for Loan and Lease Losses section. The allowance for loan and lease losses at December 31, 2018 was $8,397,000 or 0.52% of total loans (less unearned discount), as compared to $7,606,000 or 0.84% at December 31, 2017, and $7,183,000 or 0.88% at December 31, 2016. #### Deposits and Other Funding Sources Mid Penn's primary source of funds are retail deposits from business and consumers in its market area. Total deposits at December 31, 2018 increased by $702,458,000 or 69 percent over December 31, 2017, which increased by $88,195,000 or 9 percent over December 31, 2016. Deposits assumed from the First Priority and Scottdale acquisitions accounted for $596,780,000 of the increase in total deposits since year end 2017, while organic deposit growth totaled $105,678,000. Many new customers have opened money market and time deposits to take advantage of higher deposit account yields in response to FOMC rate increases. Average balances and average interest rates applicable to the major classifications of deposits for the years ended December 31, 2018, 2017, and 2016 are presented in Table 13. Short-term borrowings, consisting of FHLB borrowings having an initial term of less than one year, totaled $43,100,000 as of December 31, 2018. Short-term borrowings totaled $34,611,000 as of December 31, 2017 and consisted entirely of federal funds purchased. At December 31, 2018, the Bank also had $56,188,000 in brokered time deposits, an increase of $53,096,000 or over 170 percent since December 31, 2017. The increase was primarily due to a portfolio of brokered certificates of deposit assumed in the First Priority acquisition. At December 31, 2017, the Bank had $3,092,000 in brokered time deposits, a decrease of $1,151,000 or 27 percent over December 31, 2016. ### TABLE 13: DEPOSITS BY MAJOR CLASSIFICATION *(Dollars in thousands)* | | Years Ended December 31, 2018 Average Balance | Average Rate | 2017 Average Balance | Average Rate | 2016 Average Balance | Average Rate | | --- | ---: | ---: | ---: | ---: | ---: | ---: | | Noninterest-bearing demand deposits | $232,562 | 0.00% | $146,683 | 0.00% | $120,244 | 0.00% | | Interest-bearing demand deposits | 371,873 | 0.66 | 335,859 | 0.42 | 293,745 | 0.34 | | Money market | 309,705 | 0.97 | 247,337 | 0.59 | 235,561 | 0.56 | | Savings | 191,686 | 0.28 | 62,500 | 0.06 | 59,615 | 0.06 | | Time | 324,853 | 1.51 | 197,154 | 1.30 | 172,657 | 1.25 | | | $1,430,679 | 0.76% | $989,533 | 0.55% | $881,822 | 0.51% | 43 The maturity distribution of time deposits of $100,000 or more is reflected in Table 14. ### TABLE 14: MATURITY OF TIME DEPOSITS $100,000 OR MORE *(Dollars in thousands)* | | December 31, 2018 | 2017 | 2016 | | --- | ---: | ---: | ---: | | Three months or less | $29,957 | $38,563 | $16,083 | | Over three months to twelve months | 201,827 | 27,295 | 28,254 | | Over twelve months | 12,952 | 39,883 | 41,822 | | | $244,736 | $105,741 | $86,159 | #### Capital Resources Shareholders' equity, or capital, is evaluated in relation to total assets and the risk associated with those assets. The detailed computation of Mid Penn’s regulatory capital ratios can be found in Note 19 of Item 8, Notes to Consolidated Financial Statements. 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 a corporation’s earnings have been invested in the continued growth of the business or paid to shareholders. Excess capital makes it difficult for a corporation to offer a competitive return on the shareholders’ capital going forward. For these reasons capital management practices have been, and will continue to be, of paramount importance. Shareholders’ equity more than doubled, from $75,703,000 at December 31, 2017 to $223,209,000 at December 31, 2018, primarily due to (i) the issuance of 1,878,827 shares of Mid Penn common stock on January 8, 2018 in connection with the acquisition of Scottdale; and (ii) the issuance of 2,320,800 shares of Mid Penn common stock on July 31, 2018, in connection with the acquisition of First Priority. Additionally, shareholders’ equity reflects the growth in retained earnings through $10,494,000 of net income available to common shareholders for 2018, less dividends declared during the year of $3,453,000. These increases were partially offset by other comprehensive losses, primarily due to the after-tax impact of the unrealized reduction in market value within the available-for-sale investment portfolio since December 31, 2017. Shareholders’ equity increased in 2017 by $5,236,000 or 7 percent, following an increase in 2016 of $399,000 or 1 percent, and an increase in 2015 of $1,938,000 or 18 percent. In 2017, capital was positively impacted by the net income available to common shareholders of $7,089,000 and other comprehensive income of $1,120,000. These increases were partially offset by dividends declared during 2017 of $3,264,000. Capital was positively impacted in 2016 by the net income available to common shareholders of $7,804,000, but this increase was offset by the other comprehensive loss of $4,665,000 and dividend declarations of $2,875,000. The primary source of Mid Penn’s other comprehensive loss in 2016 was the change in unrealized losses on available-for-sale investments held primarily to support public deposit pledging requirements. These unrealized losses are not other-than-temporary-impairments, but relate to the price changes of securities from significant yield curve increases which occurred during the fourth quarter of 2016. Mid Penn’s current intent for dividend payout is to provide reasonable quarterly cash returns to shareholders while still retaining sufficient earnings to finance future growth and maintain sound capital levels. For additional information, see “Part II, Item 5, “Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Repurchases of Equity Securities – Dividends”. Dividends paid and declared on common shares totaled $0.70 and $0.45, respectively, for the year ended December 31, 2018. Dividends paid and declared totaled $0.62 and $0.77, respectively, for the year ended December 31, 2017, and $0.58 and $0.68, respectively, for the year ended December 31, 2016. The dividend payout ratio, which represents the percentage of annual net income returned to shareholders in the form of cash dividends, was 47.30% for 2018 and 37.18% for 2017. Mid Penn maintained regulatory capital levels, leverage ratios, and risk-based capital ratios as of December 31, 2018 and 2017, as follows: *(Dollars in thousands)* | Corporation As of December 31, 2018 | Capital Adequacy Actual Amount | Ratio | Minimum Capital Required (1) Amount | Ratio | To Be Well-Capitalized Under Prompt Corrective Action Provisions Amount | Ratio | | --- | ---: | ---: | ---: | ---: | ---: | ---: | | Tier 1 Capital (to Average Assets) | $155,662 | 8.0% | $77,499 | 4.000% | $N/A | N/A | | Common Equity Tier 1 Capital (to Risk Weighted Assets) | 155,662 | 10.0% | 98,977 | 6.375% | N/A | N/A | | Tier 1 Capital (to Risk Weighted Assets) | 155,662 | 10.0% | 122,265 | 7.875% | N/A | N/A | | Total Capital (to Risk Weighted Assets) | 191,300 | 12.3% | 153,317 | 9.875% | N/A | N/A | | **Bank** | | | | | | | | **As of December 31, 2018** | | | | | | | | Tier 1 Capital (to Average Assets) | $171,776 | 8.9% | $77,230 | 4.000% | $96,537 | 5.0% | | Common Equity Tier 1 Capital (to Risk Weighted Assets) | 171,776 | 11.1% | 98,963 | 6.375% | 100,903 | 6.5% | | Tier 1 Capital (to Risk Weighted Assets) | 171,776 | 11.1% | 122,248 | 7.875% | 124,189 | 8.0% | | Total Capital (to Risk Weighted Assets) | 180,332 | 11.6% | 153,295 | 9.875% | 155,236 | 10.0% | | **Corporation** | | | | | | | | **As of December 31, 2017** | | | | | | | | Tier 1 Capital (to Average Assets) | $74,417 | 6.5% | $45,857 | 4.000% | $N/A | N/A | | Common Equity Tier 1 Capital (to Risk Weighted Assets) | 74,417 | 8.4% | 50,661 | 5.750% | N/A | N/A | | Tier 1 Capital (to Risk Weighted Assets) | 74,417 | 8.4% | 63,877 | 7.250% | N/A | N/A | | Total Capital (to Risk Weighted Assets) | 99,466 | 11.3% | 81,498 | 9.250% | N/A | N/A | | **Bank** | | | | | | | | **As of December 31, 2017** | | | | | | | | Tier 1 Capital (to Average Assets) | $88,294 | 7.7% | $45,846 | 4.000% | $57,308 | 5.0% | | Common Equity Tier 1 Capital (to Risk Weighted Assets) | 88,294 | 10.0% | 50,661 | 5.750% | 57,269 | 6.5% | | Tier 1 Capital (to Risk Weighted Assets) | 88,294 | 10.0% | 63,877 | 7.250% | 70,485 | 8.0% | | Total Capital (to Risk Weighted Assets) | 96,005 | 10.9% | 81,498 | 9.250% | 88,106 | 10.0% | (1) The minimum amounts and ratios as of December 31, 2018 include the third year phase in of the capital conservation buffer of 1.875% required by the Basel III framework. At December 31, 2017, the minimum amounts and ratios included the second year phase in of the capital conservation buffer of 1.25 percent required by the Basel III framework. Effective in the third quarter of 2018, the Federal Reserve raised the consolidated asset limit to be considered a small bank holding company from $1 billion to $3 billion. A company that qualifies as a small bank holding company is not subject to the Federal Reserve’s consolidated capital rules, although a company that so qualifies may continue to file reports that include such capital amounts and ratios. The Company has elected to continue to report those amounts and ratios. #### Series D Preferred Stock In accordance with the terms and conditions of the Agreement and Plan of Merger dated January 16, 2018 between Mid Penn and First Priority (the “Merger Agreement”), each share of First Priority Fixed Rate Cumulative Perpetual Preferred Stock, Series C (the “First Priority Preferred Stock”) outstanding as of July 31, 2018 was converted into the right to receive one share of Mid Penn Fixed Rate Cumulative Perpetual Preferred Stock, Series D, having a $1,000 liquidation preference per share (the “Mid Penn Preferred Stock”). In connection with the First Priority Merger, Mid Penn issued 3,404 shares of Mid Penn Preferred Stock. The terms of the Mid Penn Preferred Stock were no less favorable than those of the First Priority Preferred Stock as in effect immediately prior to the Merger. Dividends were payable quarterly on February 15, May 15, August 15 and November 15 of each year. The dividend rate on the Mid Penn Preferred Stock was fixed at 9%. During the fourth quarter of 2018, the Federal Reserve Bank approved Mid Penn’s request to redeem all 3,404 shares of Mid Penn Preferred Stock issued in connection with the First Priority Merger, and the redemption was completed and final dividend payment made on December 14, 2018. #### Subordinated Debt #### Subordinated Debt Assumed July 2018 with the First Priority Acquisition On July 31, 2018, Mid Penn completed its acquisition of First Priority and assumed $9,500,000 of Subordinated Notes (the “First Priority Notes”). In accordance with purchase accounting principles, the First Priority Notes were assigned a fair value premium of $247,000. The notes are intended to be treated as Tier 2 capital for regulatory reporting purposes. The First Priority Notes agreements were entered into by First Priority on November 13, 2015 with five accredited investors, pursuant to which First Priority issued subordinated notes totaling $9,500,000. The First Priority Notes have a maturity date of November 30, 2025, and bear interest at a fixed rate of 7.00% per annum. The Notes are non-callable for an initial period of five years and include provisions for redemption pricing between 101.5% and 100.5% of the liquidation value, if called after five years but prior to the stated maturity date. #### Subordinated Debt Issued December 2017 On December 19, 2017, Mid Penn entered into agreements with investors to purchase $10,000,000 aggregate principal amount of its Subordinated Notes due 2028 (the “2017 Notes”). The 2017 Notes are intended to be treated as Tier 2 capital for regulatory capital purposes. The offering closed in December 2017. The 2017 Notes will bear interest at a rate of 5.25% 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 5.0%. Interest will be payable semi-annually in arrears on January 15 and July 15 of each year, beginning on July 15, 2018, for the first five years after issuance and will be payable quarterly in arrears thereafter on January 15, April 15, July 15, and October 15. The 2017 Notes will mature on January 1, 2028 and are redeemable in whole or in part, without premium or penalty, at any time on or after December 21, 2022, and prior to January 1, 2028. Additionally, Mid Penn may redeem the 2017 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 2017 Notes for U.S. federal income tax purposes; (ii) an event occurs that precludes the 2017 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 the event of a redemption described in the previous sentence, Mid Penn will redeem the 2017 Notes at 100% of the principal amount of the 2017 Notes, plus accrued and unpaid interest thereon to but excluding the date of redemption. Holders of the 2017 Notes may not accelerate the maturity of the 2017 Notes, except upon the bankruptcy, insolvency, liquidation, receivership or similar event of Mid Penn or Mid Penn Bank. #### Subordinated Debt Issued December 2015 On December 9, 2015, Mid Penn entered into agreements with investors to purchase $7,500,000 aggregate principal amount of its Subordinated Notes (the “2015 Notes”) due 2025. The 2015 Notes are treated as Tier 2 capital for regulatory capital purposes. The offering closed in December 2015. The 2015 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 2015 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 2015 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 2015 Notes for U.S. federal income tax purposes; (ii) an event occurs that precludes the 2015 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 2015 Notes, plus accrued and unpaid interest thereon to but excluding the date of redemption. Holders of the 2015 Notes may not accelerate the maturity of the 2015 Notes, except upon Mid Penn’s or Mid Penn Bank’s bankruptcy, insolvency, liquidation, receivership, or similar event. #### Federal Income Taxes Federal income tax expense for 2018 was $2,129,000, compared to $4,500,000 for 2017 and $2,277,000 in 2016. Federal income tax expense in 2018 reflects the reduction in the maximum corporate income tax rate from 34 percent to 21 percent, legislated by the TCJA in December, 2017, with the rate change effective January 1, 2018. Also, as a result of the TCJA, federal income tax expense was negatively impacted by a one-time non-cash reduction in the value of Mid Penn’s deferred tax asset, which resulted in a charge of $1,169,000 during the year ended December 31, 2017. Mid Penn’s deferred tax asset, which was previously valued based upon the projection of a 34 percent future tax benefit, was adjusted to reflect future deferred tax benefits at the new 21 percent corporate tax rate. The effective tax rate (excluding the one-time deferred tax adjustment) was 17% in 2018, 29% in 2017, and 23% in 2016. #### Liquidity Mid Penn's asset-liability management policy addresses the management of Mid Penn's liquidity position and its ability to raise sufficient funds to meet deposit withdrawals, fund loan growth and meet other operational needs. In addition to its cash and equivalents, Mid Penn utilizes its investments as a source of liquidity, along with deposit growth and increases in borrowings. For additional information, see Deposits and Other Funding Sources, which appears earlier in this discussion. Liquidity from investments is provided primarily through investment calls and sales, prepayments on mortgage-backed securities, and from investments and interest-bearing balances with maturities of one year or less. The Bank can obtain funds from overnight borrowings, short-term borrowings, and long-term borrowings from the FHLB, up to the Bank’s maximum borrowing capacity with the FHLB, which was $507,462,000 at December 31, 2018. FHLB borrowings require the Bank to make certain restricted stock purchases in accordance with FHLB requirements. Borrowings with the FHLB are collateralized by certain qualifying loans and investment securities of the Bank. The Bank also has unused lines of credit with other correspondent banks amounting to $15,000,000 at December 31, 2018. Major sources of cash in 2018 came from the $158,271,000 in proceeds from the sales of available-for-sale investments securities and the $72,616,000 in net cash received from the acquisitions of Scottdale and First Priority. Major uses of cash in 2018 were $132,097,000 to fund loan growth and $100,205,000 for investment purchases. Major sources of cash in 2017 came from the increase in deposits of $88,195,000, as well as $52,932,000 of proceeds from the sales of investments securities and $34,611,000 from the increase in short-term borrowings. Major uses of cash in 2017 were the purchases of investment securities of $124,738,000 and the increase in loans of $96,570,000. #### Aggregate Contractual Obligations Table 15 represents Mid Penn’s on-and-off balance sheet aggregate contractual obligations to make future payments as of December 31, 2018. ### TABLE 15: AGGREGATE CONTRACTUAL OBLIGATIONS *(Dollars in thousands)* | | Financial Statements Note Reference | Total | Payments Due by Period One Year or Less | One to Three Years | Three to Five Years | More than Five Years | | --- | ---: | ---: | ---: | ---: | ---: | ---: | | Operating lease obligations | 10 | $15,144 | $2,171 | $3,573 | $2,709 | $6,691 | | Certificates of deposit | 11 | 497,225 | 276,169 | 186,364 | 33,848 | 844 | | Long-term debt | 13 | 50,363 | 13,221 | 34,536 | 206 | 2,400 | | Subordinated debt | 14 | 39,005 | 1,576 | 3,152 | 3,152 | 31,125 | | Payments under benefit plans | 16 | 3,649 | 247 | 548 | 604 | 2,250 | | Executive compensation payments | 17 | 6,114 | 50 | 96 | 96 | 5,872 | | | | $596,356 | $291,263 | $224,696 | $37,906 | $42,491 | We are not aware of any other commitments or contingent liabilities which may have a material adverse impact on Mid Penn’s liquidity or capital resources. #### Effects of Inflation A bank's asset and liability structure is substantially different from that of an industrial company in that virtually all assets and liabilities of a bank are monetary in nature. Management believes the impact of inflation on its financial results depends principally upon Mid Penn's ability to measure its sensitivity to changes in interest rates and to take appropriate actions, as needed or controllable by the Bank, to mitigate the impacts of inflation on performance. Interest rates do not necessarily move in the same direction or at the same magnitude as the prices of other goods and services. As discussed previously, management seeks to manage the relationship between interest sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation. Information included elsewhere in this report will assist in the understanding of how Mid Penn is positioned to react to changing interest rates and inflationary trends. In particular, the previously discussed risk factors, the composition of and yields on loans and investments, and the composition and costs of deposits and other interest-bearing liabilities, should be considered. #### Off-Balance Sheet Items Mid Penn makes contractual commitments to extend credit and extends lines of credit, which are subject to Mid Penn's credit approval and monitoring procedures. As of December 31, 2018, commitments to extend credit amounted to $346,238,000 compared to $199,240,000 as of December 31, 2017. Mid Penn also issues standby letters of credit to its customers. The risk associated with standby letters of credit is essentially the same as the credit risk involved in loan extensions to customers. Standby letters of credit increased to $20,839,000 at December 31, 2018, from $20,496,000 at December 31, 2017. ## Market risk As filed, 3,590 characters. As a financial institution, Mid Penn’s primary source of market risk is interest rate risk. Interest rate risk is the exposure to fluctuations in Mid Penn’s future earnings (earnings at risk) resulting from changes in interest rates. This exposure or sensitivity is a function of the repricing characteristics of Mid Penn's portfolio of assets and liabilities. Each asset and liability reprices either at maturity or during the life of the instrument. Interest rate sensitivity is measured as the difference between the volume of assets and liabilities that are subject to repricing in a future period of time. The principal purpose of asset-liability management is to maximize current and future net interest income within acceptable levels of interest rate risk while satisfying liquidity and capital requirements. Net interest income is increased by increasing the net interest margin and by volume growth. Thus, the goal of interest rate risk management is to maintain a balance between risk and reward such that net interest income is maximized while risk is maintained at an acceptable level. Mid Penn utilizes an asset-liability management model to measure the impact of interest rate movements on its interest rate sensitivity position. Mid Penn’s management also reviews the traditional maturity gap analysis regularly. Mid Penn does not always attempt to achieve an exact match between interest sensitive assets and liabilities because it believes that an actively managed amount of interest rate risk is inherent and appropriate in the management of Mid Penn’s profitability. Modeling techniques and simulation analysis involve assumptions and estimates that inherently cannot be measured with complete precision. Key assumptions in the analyses include maturity and repricing characteristics of assets and liabilities, prepayments on amortizing assets, non-maturing deposit sensitivity, and loan and deposit pricing. These assumptions are inherently uncertain due to the timing, magnitude and frequency of rate changes and changes in market conditions and management strategies, among other factors. However, the analyses are useful in quantifying risk and provide a relative gauge of Mid Penn’s interest rate risk position over time. Management reviews interest rate risk on a quarterly basis. This analysis includes earnings scenarios whereby interest rates are increased and decreased by 100, 200, and 300 basis points. These scenarios, detailed in Table 16, indicate that Mid Penn would experience enhanced net interest income over a one-year time frame due to upward interest rate changes, while a reduction in interest rates would result in a decline in net interest income over a one-year time frame; however, actual results could vary significantly from the calculations prepared by management. At December 31, 2018, all interest rate risk levels according to the model were within the tolerance limits of the Board-approved policy. ### TABLE 16: EFFECT OF HYPOTHETICAL CHANGES IN INTEREST RATES | December 31, 2018 Change in Basis Points | % Change in Net Interest Income | Policy Risk Limit | December 31, 2017 Change in Basis Points | % Change in Net Interest Income | Policy Risk Limit | | ---: | ---: | --- | ---: | ---: | --- | | 300 | 8.09% | ≥ -20% | 300 | 7.83% | ≥ -20% | | 200 | 5.38% | ≥ -15% | 200 | 5.12% | ≥ -15% | | 100 | 2.66% | ≥ -10% | 100 | 2.41% | ≥ -10% | | 0 | | | 0 | | | | (100) | -2.01% | ≥ -10% | (100) | -1.49% | ≥ -10% | | (200) | -3.49% | ≥ -15% | (200) | -6.19% | ≥ -15% | | (300) | -6.43% | ≥ -20% | (300) | -11.37% | ≥ -20% | 49 ## Controls and procedures As filed, 1,613 characters. ### Evaluation of Disclosure Controls and Procedures Mid Penn carried out an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15 as of December 31, 2018. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded, as of December 31, 2018, that Mid Penn’s disclosure controls and procedures were effective in recording, processing, summarizing, and reporting information required to be disclosed by Mid Penn within the time periods specified in the SEC’s rules and forms, and such information is accumulated and communicated to management to allow timely decisions regarding required disclosures. Management’s Report on Internal Controls over Financial Reporting is located on page 49 of this report, and is incorporated herein by reference. Our independent registered public accounting firm, BDO USA, LLP, also attested to, and reported on, the effectiveness of Mid Penn’s internal control over financial reporting as of December 31, 2018. BDO USA, LLP’s attestation report appears in Part II, Item 8, “Financial Statements and Supplemental Data.” ### Changes in Internal Controls over Financial Reporting There have been no changes in Mid Penn’s internal control over financial reporting during the fourth quarter of 2018 that have materially affected, or are reasonably likely to materially affect, Mid Penn’s internal control over financial reporting. Filed Mar 19, 2019. Source: SEC EDGAR, the filing index for accession 0001564590-19-008349. Last ingested by Listed: Nov 5, 2026, 18:25 ET. No prices; not investment advice.