SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-17706
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QNB Corp.
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(Exact Name of Registrant as Specified in Its Charter)
Pennsylvania 23-2318082
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
10 North Third Street, Quakertown, PA 18951-9005
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(Address of Principal Executive Offices (Zip Code)
Registrant's Telephone Number, Including Area Code (215)538-5600
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Not Applicable
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Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report
Indicate by check x/ whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x/ No
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Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at November 10,1996
Common Stock, par value $1.25 1,424,232
<PAGE>
QNB CORP. AND SUBSIDIARY
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 1996
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS PAGE
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Consolidated Statements of Income for Three and
Nine Months Ended September 30, 1996 and 1995 .............1
Consolidated Balance Sheets at September 30, 1996
and December 31, 1995 .....................................2
Consolidated Statements of Cash Flows for Nine
Months Ended September 30, 1996 and 1995 ..................3
Notes to Consolidated Financial Statements .........................4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION ............................5
PART II - OTHER INFORMATION
OTHER INFORMATION .................................................17
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
QNB Corp. and Subsidiary
<TABLE>
<CAPTION>
(in thousands, except per share data)
(unaudited)
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Three Months Nine Months
Ended September 30, Ended September 30,
1996 1995 1996 1995
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<S> <C> <C> <C> <C>
Interest Income
Interest and fees on loans........................................................ $ 3,363 $ 3,368 $ 10,047 $10,120
Interest and dividends on investment securities available-for-sale................ 916 981 2,546 2,546
Interest and dividends on investment securities held-to-maturity:
Taxable...................................................................... 555 492 1,623 1,431
Tax-exempt................................................................... 129 111 381 293
Interest on Federal funds sold.................................................... 68 109 170 277
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Total interest income.................................................... 5,031 5,061 14,767 14,667
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Interest Expense
Interest on deposits:
NOW accounts................................................................. 224 220 518 564
Money market accounts........................................................ 255 278 768 856
Savings...................................................................... 197 199 583 606
Time......................................................................... 1,212 1,151 3,515 3,217
Time over $100,000........................................................... 216 251 647 742
Interest on short-term borrowings................................................. 70 76 198 180
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Total interest expense................................................... 2,174 2,175 6,229 6,165
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Net interest income...................................................... 2,857 2,886 8,538 8,502
Provision for possible loan losses................................................ 100 100 300 910
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Net interest income after provision for possible loan losses............. 2,757 2,786 8,238 7,592
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Non-Interest Income
Fees for services to customers.................................................... 280 224 783 658
Mortgage servicing fees........................................................... 52 50 159 172
Net gain (loss) on investment securities.......................................... 1 __ 94 (8)
Net gain on sale of loans......................................................... 21 7 60 97
Other operating income............................................................ 73 51 207 160
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Total non-interest income................................................ 427 332 1,303 1,079
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Non-Interest Expense
Salaries and employee benefits.................................................... 1,294 1,265 3,823 4,128
Net occupancy expense............................................................. 173 169 507 493
Furniture and equipment expense................................................... 179 173 497 543
Marketing expense................................................................. 63 68 233 197
Supplies expense.................................................................. 61 53 158 161
Professional fees................................................................. 54 61 137 190
Insurance expense................................................................. 22 8 67 355
Other real estate owned expense................................................... 50 78 140 365
Other expense..................................................................... 375 312 1,049 946
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Total non-interest expense............................................... 2,271 2,187 6,611 7,378
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Income before income taxes ................................................. 913 931 2,930 1,293
Provision for income taxes........................................................ 245 214 801 279
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Net Income................................................................... $ 668 $ 717 $ 2,129 $ 1,014
====================================================================================================================================
Net Income Per Share......................................................... $ .48 $ .50 $ 1.50 $ .71
====================================================================================================================================
Cash Dividends Per Share..................................................... $ .14 $ .125 $ .42 $ .375
====================================================================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
Page 1
<PAGE>
CONSOLIDATED BALANCE SHEETS
QNB Corp. and Subsidiary
<TABLE>
<CAPTION>
(in thousands)
(unaudited)
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September 30, December 31,
1996 1995
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<S> <C> <C>
Assets
Cash and due from banks................................................................................. $ 14,268 $ 12,950
Federal funds sold...................................................................................... 9,812 2,907
Investment securities
available-for-sale................................................................................. 53,849 55,380
held-to-maturity (market value $43,259 and $42,861)................................................ 43,428 42,515
Total loans, net of unearned income of $466 and $382.................................................... 158,234 155,957
Allowance for possible loan losses................................................................. (2,576) (2,384)
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Net loans...................................................................................... 155,658 153,573
Premises and equipment, net............................................................................. 4,403 4,536
Other real estate owned................................................................................. 1,423 775
Accrued interest receivable ............................................................................ 1,880 1,943
Other assets............................................................................................ 1,996 1,470
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Total assets............................................................................................ $ 286,717 $ 276,049
====================================================================================================================================
Liabilities
Deposits
Demand, noninterest-bearing........................................................................ $ 32,914 $ 31,882
NOW accounts....................................................................................... 46,066 39,477
Money market accounts.............................................................................. 34,896 36,853
Savings............................................................................................ 34,549 33,841
Time............................................................................................... 93,157 86,382
Time over $100,000................................................................................. 14,160 14,452
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Total deposits................................................................................. 255,742 242,887
Short-term borrowings................................................................................... 6,718 10,099
Accrued interest payable................................................................................ 1,050 1,040
Other liabilities....................................................................................... 1,161 1,157
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Total liabilities....................................................................................... 264,671 255,183
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Commitments and contingencies
Shareholders' Equity
Common stock, par value $1.25 per share;
authorized 5,000,000 shares; issued 1,424,207 shares and 1,423,838 shares.......................... 1,780 1,780
Surplus ............................................................................................... 4,294 4,283
Retained earnings....................................................................................... 16,112 14,581
Unrealized holding (losses) gains, net of taxes, on investment securities available-for-sale............ (140) 222
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Total shareholders' equity.............................................................................. 22,046 20,866
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Total liabilities and shareholders' equity.............................................................. $ 286,717 $ 276,049
====================================================================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
Page 2
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
QNB Corp. and Subsidiary
<TABLE>
<CAPTION>
(in thousands)
(unaudited)
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Nine Months Ended September 30, 1996 1995
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<S> <C> <C>
Operating Activities
Net income............................................................................................... $ 2,129 $ 1,014
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for possible loan losses..................................................................... 300 910
Depreciation and amortization.......................................................................... 372 452
Securities (gains) losses.............................................................................. (94) 8
Net gain on sale of loans.............................................................................. (60) (97)
Proceeds from sales of residential mortgages........................................................... 2,660 2,015
Originations of residential mortgages held-for-sale.................................................... (1,995) (2,624)
Gains on disposal of premises and equipment............................................................ __ (9)
Writedowns, net of losses (gains) on sales of other real estate owned.................................. 35 183
Deferred income tax provision.......................................................................... (30) (32)
Change in income taxes payable......................................................................... (119) 140
Net decrease (increase) in interest and dividends receivable........................................... 63 (468)
Net amortization of premiums and discounts............................................................. 41 88
Net increase (decrease) in interest payable............................................................ 10 (6)
Other, net ............................................................................................ (269) (332)
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Net cash provided by operating activities.............................................................. 3,043 1,242
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Investing Activities
Proceeds from maturities and calls of investment securities
available-for-sale..................................................................................... 11,147 1,521
held-to-maturity....................................................................................... 6,794 1,911
Proceeds from sales of investment securities
available-for-sale..................................................................................... 15,526 1,003
Purchase of investment securities
available-for-sale..................................................................................... (25,656) (17,993)
held-to-maturity....................................................................................... (7,689) (5,357)
Net (increase) decrease in Federal funds sold............................................................ (6,905) 3,573
Proceeds from sale of student loans...................................................................... 1,442 2,572
Net (increase) decrease in loans......................................................................... (5,389) 528
Net purchases of premises and equipment.................................................................. (239) (202)
Proceeds from disposal of premises and equipment......................................................... __ 12
Proceeds from the sale of other real estate owned........................................................ 274 1,172
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Net cash used by investing activities.................................................................. (10,695) (11,260)
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Financing Activities
Net increase (decrease) in noninterest-bearing deposits.................................................. 1,032 (1,068)
Net increase in interest-bearing deposits................................................................ 11,823 9,137
Net (decrease) increase in short-term borrowings......................................................... (3,381) 1,667
Cash dividends paid...................................................................................... (598) (533)
Proceeds from issuance of common stock................................................................... 11 30
Other, net............................................................................................... 83 236
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Net cash provided by financing activities.............................................................. 8,970 9,469
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Increase (decrease) in cash and cash equivalents....................................................... 1,318 (549)
Cash and cash equivalents at beginning of year......................................................... 12,950 11,427
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Cash and cash equivalents at end of period............................................................. $14,268 $10,878
====================================================================================================================================
Supplemental Cash Flow Disclosures
Interest paid............................................................................................ $ 6,219 $ 6,171
Income taxes paid........................................................................................ 950 170
Non-Cash Transactions
Transfer of loans to other real estate owned........................................................... 957 224
Change in net unrealized holding gains (losses), net of taxes, on investment securities................ (362) 1,702
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
Page 3
<PAGE>
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1996 AND 1995, AND DECEMBER 31, 1995
(Unaudited)
1. REPORTING AND ACCOUNTING POLICIES
The accompanying consolidated financial statements include the accounts of QNB
Corp. and its wholly owned subsidiary, The Quakertown National Bank, (QNB). All
significant intercompany accounts and transactions are eliminated in the
consolidated statements.
The consolidated balance sheet as of September 30, 1996, as well as the
respective statements of income and cash flows for the three and nine month
periods ended September 30, 1996 and 1995, are unaudited. These financial
statements should be read in conjunction with the audited financial statements
and notes thereto included in QNB's 1995 Annual Report incorporated in the
Form 10-K.
The financial statements reflect all adjustments, which in the opinion of
management are necessary for a fair presentation of the results of the interim
periods and are of a normal and recurring nature. The results for the periods
presented are not necessarily indicative of the full year. Certain accounts in
last years financial statements have been reclassified to conform to the current
year's presentation. These reclassifications had no effect on net income.
2. ADOPTION OF FINANCIAL ACCOUNTING STANDARDS
Beginning January 1, 1996 QNB adopted Statement of Financial Accounting
Standards No. 122 (SFAS No. 122), "Accounting for Mortgage Servicing Rights."
SFAS No. 122 requires the recognition of separate assets relating to the rights
to service mortgage loans based on their fair value if it is practicable to
estimate the value. Additionally, the fair value of servicing assets will be
required to be measured at each reporting date to determine any potential
impairment. The statement applies prospectively to transactions entered into in
1996, therefore, there was no cumulative effect upon adoption of this statement.
This statement did not have a significant effect on the financial position or
results of operations of QNB.
QNB adopted Statement of Financial Accounting Standards No. 114 (SFAS No. 114),
"Accounting by Creditors for Impairment of a Loan" as amended by Statement of
Financial Accounting Standards No. 118 (SFAS No. 118), "Accounting by Creditors
for Impairment of a Loan - Income Recognition and Disclosures" on January 1,
1995. Under the new standard, a loan is considered impaired, based on current
information and events, if it is probable that QNB will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement.
The measurement of impaired loans is generally based on the present value of
expected future cash flows discounted at the historical effective interest rate,
except that all collateral-dependent loans are measured for impairment based on
the fair value of the collateral. The adoption of SFAS No. 114 did not have a
material impact on the financial position or results of operations of QNB.
At September 30, 1996 and 1995, the recorded investment in loans for which
impairment has been recognized in accordance with SFAS No. 114 totaled
$4,331,000 and $3,834,000, respectively, of which $2,232,000 and $3,455,000
related to loans with no valuation allowance and $2,099,000 and $379,000 related
to loans with a corresponding valuation allowance of approximately $576,000 and
$185,000, respectively. Most of the loans identified as impaired are
collateral-dependent.
FORM 10-Q
Page 4
<PAGE>
QNB CORP. AND SUBSIDIARY
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
QNB Corp. (the "Corporation") is a bank holding company headquartered in
Quakertown, Pennsylvania which provides a full range of commercial and retail
banking services through its banking subsidiary, The Quakertown National Bank
(the "Bank"), a 119 year old community bank with locations in Upper Bucks,
Northern Montgomery and Southern Lehigh Counties. The results of operations and
financial condition discussed herein are presented on a consolidated basis
and the consolidated entity is referred to herein as "QNB."
RESULTS OF OPERATIONS
QNB recorded net income of $668,000 or $.48 per share for the three month period
ending September 30, 1996. This represents a slight decline from net income of
$717,000 or $.50 per share reported for the third quarter of 1995. For the nine
month periods ending September 30, 1996 and 1995, net income and earnings per
share were $2,129,000 and $1.50 and $1,014,000 and $.71, respectively.
The decrease in net income for the quarter can primarily be attributed to a
decline in net interest income resulting from a lower net interest margin and
increases in several expense categories including salaries, supplies, loan
workout costs, employee training and education, and postage. Higher non-interest
income for the quarter helped to offset some of the higher costs. The results
from the third quarter of 1995 also include a one time refund from the Federal
Deposit Insurance Corporation of $37,000.
The improvement in net income when comparing the results for the nine month
periods is primarily the result of actions taken by QNB during the prior two
years to reduce non-interest expense. These actions included two Corporate re-
engineering plans which resulted in approximately a 13 percent reduction in the
number of employees. Salaries and benefits expense declined $305,000 during the
nine month periods. Also positively impacting the results when comparing the
nine month periods was a $610,000 reduction in the provision for possible loan
losses, a $288,000 reduction in insurance premiums, primarily the elimination of
Federal Deposit Insurance Corporation (F.D.I.C.) insurance premiums, and a
$225,000 decline in expense related to other real estate owned. On the revenue
side, net interest income increased $36,000, fees for services to customers
increased $125,000 and net gains on the sale of investment securities increased
$102,000.
NET INTEREST INCOME
Net interest income is the primary source of operating income for QNB. Net
interest income is interest income, dividends, and fees on earning assets, less
interest expense incurred for funding sources. Earning assets primarily include
loans, investment securities and Federal funds sold. Sources used to fund these
assets include deposits, borrowed funds and shareholders' equity. Net interest
income is affected by changes in interest rates, the volume and mix of earning
assets and interest-bearing liabilities, and the amount of earning assets funded
by noninterest-bearing deposits and shareholders' equity.
Net interest income decreased slightly for the three month period ending
September 30, 1996 to $2,857,000 compared to $2,886,000 for the same period last
year. A 1.6 percent increase in average earning assets was offset by an 8 basis
point decrease in the net interest margin. The decline in the net interest
margin can primarily be attributed to a decline in the yield on earning assets,
particularly loans. The yield on loans for the third quarter of 1996 was 8.74
percent, a decline of 35 basis points from the same period in 1995. A decline in
the prime rate combined with a slight change in the mix in the loan portfolio
FORM 10-Q
Page 5
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (Continued)
and an extremely competitive marketplace contributed to the lower yield. A
significant portion of QNB's loan portfolio is indexed with the prime rate. The
average prime rate for the third quarter of 1996 was 8.25 percent compared to
8.78 percent for the third quarter of 1995. The impact of lower yields on loans
was somewhat mitigated by an increase in the yield on the investment portfolio
when comparing the two quarters. The yield on investments was 6.47 percent for
the third quarter of 1996 versus 6.35 percent for the same period in 1995. When
comparing the two quarters the cost of interest-bearing liabilities decreased
only slightly.
The yield on earning assets on a fully taxable equivalent basis was 7.79 percent
for the third quarter of 1996 versus 7.91 percent for the third quarter of 1995,
while the rate paid on interest-bearing liabilities was 3.81 percent and 3.83
percent for the same periods. The net interest margin on a fully taxable
equivalent basis for the three month period ended September 30, 1996 was 4.50
percent compared to 4.58 percent for the same period in 1995.
In the second quarter 10-Q, QNB had anticipated a decline in the net interest
margin during the second half of 1996 as a result of an increase in the rate
paid on interest-bearing liabilities. The net interest margin in the second
quarter of 1996, after adjusting for the recognition of $45,000 in interest
income on the payoff of a nonaccrual loan, was 4.67 percent. As predicted, the
cost of interest-bearing liabilities increased from 3.71 percent during the
second quarter of 1996 to 3.81 percent during the third quarter of 1996.
Seasonal deposits from a local school district that pay a rate close to Federal
funds, as well as a certificate of deposit promotion that created some movement
of existing funds from lower yielding deposits were the primary reasons for the
increase between the second and third quarters of 1996. QNB anticipates an
improvement in the net interest margin during the fourth quarter of 1996
resulting from a decline in the balances of the local school district as well as
an increase in the amount of loans outstanding.
Net interest income for the nine month period ending September 30, 1996 was
$8,538,000, an increase of $36,000 over the $8,502,000 recorded in 1995. A 2.3
percent increase in average earning assets offset a five basis point decline in
the net interest margin. While total interest income increased $100,000 to
$14,767,000 for the first nine months of 1996, interest expense increased
$64,000 to $6,229,000 over the same period. The yield on earning assets on a
fully taxable equivalent basis was 7.85 percent for the nine months ending
September 30, 1996 versus 7.95 percent for the same period of 1995, while the
rate paid on interest-bearing liabilities was 3.76 percent for both nine month
periods. The net interest margin for the nine month periods ended September 30,
1996 and 1995 was 4.62 percent and 4.67 percent, respectively.
PROVISION FOR POSSIBLE LOAN LOSSES
The provision for possible loan losses represents management's determination of
the amount necessary to be charged to operations to bring the allowance for
possible loan losses to a level considered adequate in relation to the risk of
possible losses in the loan portfolio. Actual loan losses, net of recoveries,
serve to reduce the allowance. Management uses various tools to assess the
adequacy of the allowance for possible loan losses. One tool is a methodology
recommended by the Office of the Comptroller of the Currency. This methodology
considers a number of relevant factors including: historical loan loss
experience, the assigned risk rating of the credit, current and projected credit
worthiness of the borrower, current value of the underlying collateral, levels
FORM 10-Q
Page 6
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
PROVISION FOR POSSIBLE LOAN LOSSES (Continued)
of and trends in delinquencies and nonaccrual loans, trends in volume and terms
of loans, concentrations of credit and national and local economic trends and
conditions. Other tools include ratio analysis and peer group analysis. The
implementation of SFAS No. 118, as discussed below, also impacts the
determination of the allowance for possible loan losses.
The provision for possible loan losses was $100,000 for both the third quarter
of 1996 and 1995. The provision for possible loan losses was $300,000 and
$910,000 for the nine month periods ending September 30, 1996 and 1995,
respectively. The primary reason for the higher provision for possible loan
losses in 1995 was the higher level of loans charged-off, particularly loans
secured by real estate, both residential and commercial, during 1995. The
allowance for loan loss model is heavily weighted for historical charge-offs and
since the loan portfolio is primarily comprised of loans secured by real estate,
charge-offs of these types of loans have a significant impact on the calculation
of the allowance for possible loan losses and therefore the provision for
possible loan losses.
Net charge-offs in the third quarter of 1996 were $30,000 compared to $29,000
for the same period in 1995. Net charge-offs were $108,000 and $460,000 for the
nine month periods ending September 30, 1996 and 1995, respectively. QNB's net
charge-offs as a percentage of average loans was .09 percent (annualized) for
the nine month period ended September 30, 1996, compared with .41 percent for
the same 1995 period. The partial charge-off of a group of loans to one borrower
for the purpose of low income residential investment properties and the partial
charge-off of loans to another borrower for commercial and residential
investment properties accounts for $384,000 of the $506,000 charged-off during
the first nine months of 1995.
Nonperforming assets (nonaccruing loans, loans past due 90 days or more, and
other real estate owned) amounted to 2.10 percent of total assets at September
30, 1996 compared with 1.86 percent at September 30, 1995 and 2.01 percent at
December 31, 1995. Nonperforming assets have increased 15.7 percent when
comparing the September 30, 1996 balance of $6,021,000 to the September 30, 1995
balance of $5,205,000. Nonperforming assets have also increased from the
December 31, 1995 balance of $5,535,000. Nonaccrual loans were $4,429,000 and
$3,986,000 at September 30, 1996 and 1995. Nonaccrual loans at December 31, 1995
were $4,488,000. Other real estate owned was $1,423,000 at September 30, 1996
compared to $775,000 at December 31, 1995 and $842,000 at September 30, 1995.
The increase in other real estate owned from December 31, 1995 was principally
from the acquisition of one property. This property is under agreement of sale
and should settle during the fourth quarter of 1996. During the third quarter of
1996 QNB reduced its nonperforming assets by approximately 6.8 percent or
$442,000. Management anticipates a significant reduction in nonperforming assets
during the fourth quarter through the sale of both nonaccrual loans and other
real estate owned and through payments received on nonperforming loans.
There were no restructured loans as of September 30, 1996, December 31, 1995 or
September 30, 1995 as defined in Statement of Financial Accounting Standards No.
15, "Accounting by Debtors and Creditors for Troubled Debt Restructurings," that
have not already been included in loans past due 90 days or more or nonaccrual
loans.
The allowance for possible loan losses was $2,576,000 and $2,384,000 at
September 30, 1996 and December 31, 1995, respectively. The ratio of the
allowance to total loans was 1.63 percent and 1.53 percent for the respective
periods. While QNB believes that its allowance is adequate to cover losses in
the loan portfolio, there remain inherent uncertainties regarding future
economic events and their potential impact on asset quality.
FORM 10-Q
Page 7
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME
QNB, through its core banking business, generates various fees and service
charges. Total non-interest income is composed of service charges on deposit
accounts, mortgage servicing fees, gains on the sale of investment securities,
gains on the sale of residential mortgages and student loans, and other
miscellaneous fee income. Total non-interest income increased $95,000 or 28.6
percent to $427,000 for the quarter ending September 30, 1996 when compared to
September 30, 1995. For the nine month period non-interest income increased
$224,000 or 20.8 percent to $1,303,000.
Fees for services to customers, the largest component of total non-interest
income, is primarily comprised of service charges on deposit accounts. These
fees increased 25.0 percent, from $224,000 to $280,000, when comparing the two
quarters. Charges related to a greater volume of overdrafts, as well as an
increase in the overdraft fee in November of 1995, account for approximately
$42,000 of the increase. Service charges on business deposit accounts increased
approximately $8,000 as a result of a declining earnings credit rate. An
increase in the amount of waived service charges of approximately $7,000 offset
some of these increases. Another positive factor was the increase in income
related to customer use of an out-of-network ATM, which increased approximately
$5,000 when comparing the two quarters. QNB does not charge a surcharge for non-
customer use of its own ATMs.
For the nine month period ending September 30, 1996 and 1995 fees for services
to customers was $783,000 and $658,000, respectively. As was the case for the
quarter, higher overdraft fees of approximately $97,000 and higher fees on
business deposit accounts of $20,000 accounted for the increase. The out-of-
network ATM fee contributed $6,000 to the increase.
QNB sells its conforming 30 year mortgage originations in the secondary market.
While it sells the loan it retains the servicing rights. A normal servicing fee
is retained on all mortgage loans sold and serviced. Mortgage servicing fees for
the quarter ending September 30, 1996 were $52,000 which represents a $2,000
increase from the same period in 1995. The results for the 1995 quarter include
a $5,000 reversal of fees incorrectly credited in the second quarter of 1995.
Excluding this adjustment mortgage servicing fees would have decreased by
approximately $3,000 when comparing the two quarters. This is a result of a
lower volume of mortgages sold and serviced.
For the nine month period mortgage servicing fees decreased 7.6 percent to
$159,000. The average balance of mortgages serviced was approximately
$77,075,000 for the nine month period ending September 30, 1996 compared to
$83,900,000 for the first nine months of 1995. It is anticipated that the amount
of servicing fees will continue to decline as a result of a slow down in the
origination and sale of mortgages caused by higher interest rates. However, if
interest rates were to decline and mortgage refinances would increase the amount
of mortgages sold and serviced could increase. The timing of mortgage payments
and delinquencies also impacts the amount of servicing fees recorded.
Gains on the sale of investment securities were $1,000 for the third quarter of
1996 and $94,000 for the nine month period ending September 30, 1996. This
compares to a loss of $8,000 for the nine month period ending September 30,
1995. There were no security sales during the third quarter of 1995. The small
gain recorded in the third quarter of 1996 resulted from the sale of
approximately $10,000,000 in U.S. Treasury and agency securities. The sale was
for liquidity purposes and was in direct response to the seasonality of the
local school district deposits. During the second quarter of 1996 QNB sold
approximately $5,500,000 in U.S. Treasury and agency securities. QNB took
FORM 10-Q
Page 8
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (Continued)
advantage of a steep slope in the short end of the Treasury yield curve to
"prefund" bonds that were maturing over the next year and a half and reinvested
in bonds in the three to four year range. This allowed QNB to record a profit on
the sale of $23,000 and also increase the overall book yield of the portfolio.
The remaining gain of $70,000 recorded in 1996 relates to the sale of a
marketable equity security with a book value of $45,000 during the first
quarter.
QNB recorded a gain of $21,000 on the sale of loans during the third quarter of
1996. This compares to a $7,000 gain for the same period in 1995. The sale of
residential mortgages accounts for $19,000 of the gain during the third quarter
of 1996 while the sale of approximately $100,000 in student loans contributed a
$2,000 gain. The entire gain for the third quarter of 1995 relates to the sale
of residential mortgages. For the nine month periods ending September 30, 1996
and 1995 the net gains on the sale of loans was $60,000 and $97,000,
respectively. Net gains on the sale of student loans contributed $32,000 while
net gains on the sale of residential mortgages contributed $28,000 during 1996.
This compares to $68,000 for the gain on student loan sales and $29,000 for the
gain on mortgage sales for 1995. In June of 1995, QNB sold approximately
$2,600,000 of student loans to SallieMae.
The net gain or loss on residential mortgage sales is directly related to the
volume of mortgages sold and the timing of the sales relative to the interest
rate environment. QNB was operating in contrasting interest rate cycles during
the first nine months of 1996 and 1995. Higher rates at the end of 1994 and the
beginning of 1995 negatively impacted the volume of mortgages originated and
sold. A downturn in rates at the end of the first quarter and during the second
and third quarters of 1995 provided the environment to sell mortgages at a gain.
Interest rates reached their low during the beginning of 1996 before rapidly
increasing towards the end of February and throughout the second quarter and
most of the third quarter of 1996. This rapid increase in rates created a loss
on the mortgages sold or held for sale during the first half of the year. The
Federal Reserve Bank's inaction with respect to rates as well as the economic
information released in August and September caused interest rates to fall
dramatically which enabled QNB to sell mortgages at a gain in the third quarter
of 1996. As of September 30, 1996 QNB had approximately $100,000 in mortgage
loans classified as held for sale. These loans are accounted for at lower of
cost or market.
Other operating income increased $22,000 to $73,000 when comparing the two
quarters ending September 30, 1996 and 1995 and $47,000 to $207,000 when
comparing the nine month periods. During the third quarter of 1995, QNB began
selling mutual funds and annuities through a third party vendor. Commissions
earned on the sales of these products account for $9,000 and $21,000 of the
increase for the three and nine month periods. Higher commission income on the
sale of consumer loan life and disability insurance contributed approximately
$10,000 to the increase for the quarter and $13,000 for the nine month period.
Higher ATM card income, as a result of an increase in the number of cards
outstanding as well as an increase in the annual fee charged, accounts for
$3,000 and $12,000 of the increase during the three and nine month periods,
respectively. Merchant charge card income increased $7,000 for the nine month
period. The increase is a result of an increase in the volume of transactions
processed. QNB had a gain on the sale of equipment in 1995 of $9,000. There were
no equipment sales during 1996. QNB anticipates further increases in
non-interest income as a result of continued growth in the mutual fund and
annuity area as well as more income from merchant processing resulting from
changes in the pricing structure.
FORM 10-Q
Page 9
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST EXPENSE
Non-interest expense includes salaries and employee benefits, net occupancy
expense, furniture and equipment expense, marketing expense, supplies expense,
professional fees expense, insurance expense, other real estate owned expense,
and various other operating expenses. Total non-interest expense of $2,271,000
for the quarter ending September 30, 1996 represents an increase of $84,000 or
3.8 percent over levels reported in the third quarter of 1995. Total
non-interest expense for the nine months ending September 30, 1996 was
$6,611,000, a decrease of $767,000 or 10.4 percent from 1995 levels. The third
quarter of 1995 represents the initial results of the actions taken to reduce
non-interest expense. During the second quarter of 1995, QNB implemented a
revised reorganization plan which included the elimination of nine positions.
The improvement in expense when comparing the nine month periods is primarily
the result of the actions taken during the second quarter of 1995 to reduce
staffing levels and the impact of the reduction in F.D.I.C. insurance premiums.
Lower expenses related to other real estate owned also contributed to the
positive variance for the nine month period.
Salaries and benefits, the largest component of non-interest expense, increased
$29,000 or 2.3 percent to $1,294,000 for the quarter ending September 30, 1996
compared to the same quarter in 1995. Salaries expense increased $45,000 or 4.5
percent during the period while benefits expense decreased $16,000. Performance
increases as well as the addition of an officer level position contributed to
the increase in salary expense. Lower medical insurance costs and a smaller
accrual for pension expense were the primary contributors to the decrease in
benefits expense for the quarter.
Salaries and benefit expense for the nine month period ending September 30, 1996
was $3,823,000, a decrease of $305,000 or 7.4 percent from the same period in
1995. Salaries expense was $219,000 lower, while benefit expense declined
$86,000. The reduction in salary expense, when comparing the results for the
nine month periods, relates to the reorganization plan implemented during the
second quarter of 1995. The cost of the severance packages, expensed in the
second quarter of 1995, was $244,000. Performance increases and a small increase
in the number of full time equivalent employees offset some of the savings
realized. The decrease in benefits expense is also directly related to the
decline in the number of employees resulting from the reorganization. Payroll
tax expense declined $16,000 as a result of lower salaries expense. Medical and
life insurance premiums declined approximately $54,000 and pension expense
declined approximately $19,000. Lower rates for medical premiums also positively
impacted the amount of medical expense.
Net occupancy expense increased $4,000 or 2.4 percent while furniture and
equipment expense increased $6,000 or 3.5 percent when comparing the two
quarters ending September 30th. Slightly higher costs for building repairs and
maintenance accounted for the increase in net occupancy expense. An $11,000
reduction in depreciation expense on furniture and equipment was offset by an
$18,000 increase in equipment maintenance expense.
For the nine month periods ending September 30, 1996 and 1995, net occupancy
expense was $507,000 and $493,000, while furniture and equipment expense was
$497,000 and $543,000, respectively. The $14,000 increase in net occupancy
expense was primarily the result of higher utilities costs and building
maintenance costs of $6,000 and $8,000, respectively. The harsh winter of 1996
contributed to the increase in utility costs. The $46,000 or 8.5 percent decline
in furniture and equipment expense was a result of lower depreciation costs
which decreased $76,000. QNB uses an accelerated method of depreciation on its
furniture and equipment. This provides for higher expense in the earlier years
FORM 10-Q
Page 10
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST EXPENSE (Continued)
of an asset's life. A decline in the amount of furniture and equipment purchased
since 1993 along with lower depreciation expense as an asset ages account for
the decrease. Depreciation expense is anticipated to begin increasing as a
result of replacing older equipment and the need to keep up with changing
technology. Partially offsetting lower depreciation expense were higher costs
associated with equipment maintenance.
Marketing expense experienced a small decline when comparing the three month
periods ending September 30, 1996 and 1995. However, for the nine month period,
marketing expense increased $36,000 or 18.3 percent. A more focused marketing
strategy using targeted mailings as well as an increase in specific product
advertising directed at customers of consolidating banks contributed to the
increase in marketing expense.
Professional fees are comprised of legal, accounting and consulting expense. A
decline in consulting and accounting expense during the quarter enabled QNB to
report a decrease in professional fees of $7,000. The results for the third
quarter of 1995 include approximately $6,000 in costs associated with
outplacement services for employees terminated during the reorganization as well
as $3,000 in expense related to consulting on the interest rate risk model. For
the nine month period ending September 30, 1996 professional fees decreased
$53,000 to $137,000. Legal expense and accounting expense declined $15,000 and
$10,000, respectively, while consulting expense declined $28,000. Less reliance
on legal counsel for loan workout situations reduced the amount of legal
expense, while a change in accounting firms reduced the amount of accounting
expense. Costs associated with outplacement services in the second and third
quarters of 1995 was the primary reason for the higher consulting expense in
1995.
Insurance expense, which includes Federal Deposit Insurance Corporation
(F.D.I.C.) insurance, was $22,000 and $8,000 for the three months ending
September 30, 1996 and 1995 and $67,000 and $355,000 for the nine month periods.
The lower amount in the third quarter of 1995 is a result of a $37,000 refund
received. In August 1995, the F.D.I.C. announced that the Bank Insurance Fund
had met its legally set coverage ratios as of May 1995, and as a result premiums
for well capitalized institutions decreased by 83 percent starting with the
third quarter of 1995 assessment. The assessment for the third quarter of 1995
was approximately $21,000. In addition, since the Bank Insurance Fund had met
its required ratios in May of 1995, the F.D.I.C. refunded the amount mentioned
above. The reduction in insurance expense when comparing the nine month periods
is a direct result of the virtual elimination of F.D.I.C. insurance premiums in
1996. F.D.I.C. premiums for the nine month periods of 1996 and 1995 were $2,000
and $282,000, respectively. Lower premiums for directors and officers insurance
also contributed to the decline in total insurance expense during 1996. Starting
in 1997, QNB, as a result of Congress' passage of legislation to shore up the
Savings and Loan Industry's deposit insurance fund, will pay approximately
$35,000 in F.D.I.C. premiums.
Other real estate owned expense decreased $28,000 to $50,000 when comparing the
third quarter of 1996 to the same quarter of 1995. The higher expense in 1995
was primarily the result of the payment of several years' real estate taxes on
one property. Other real estate owned expense for the respective nine month
periods ending September 30, 1996 and 1995 was $140,000 and $365,000. The higher
amount in 1995 was primarily the result of write-downs and losses on the sale of
properties totaling $183,000. Losses on the sale of other real estate owned or
write downs to properties owned amounted to $35,000 in 1996. Higher real estate
taxes and maintenance costs on the properties in 1995 also contributed to the
higher expense in 1995.
FORM 10-Q
Page 11
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST EXPENSE (Continued)
The major categories that comprise other expense are postage, telecommunications
and loan related costs. Total other expense for the three months ending
September 30, 1996 was $375,000, an increase of $63,000 over the same period in
1995. The primary factors for the increase were costs associated with
foreclosing or repossessing assets. These include sheriff costs and the payment
of past due property taxes and property insurance on real estate collateralized
loans. These costs increased $21,000 when comparing the two quarters.
Other categories that showed significant increases were postage which increased
$8,000 and loan origination costs, including appraisal costs, searches, credit
reports, which increased $11,000. Costs associated with the education and
training of employees increased $9,000 when comparing the two quarters.
Total other expense for the nine month period ending September 30, 1996 was
$1,049,000, an increase of $103,000 over the same period in 1995. Higher postage
expense, foreclosure costs and loan origination costs accounted for $19,000,
$45,000 and $39,000 of the increase. A significant portion of the increase in
postage expense relates to direct mail marketing promotions. The increase in
foreclosure costs is related to the payment of real estate taxes and insurance
on several loans where the borrower has failed to make the payments.
INCOME TAXES
Applicable income taxes and effective tax rates were $245,000 or 26.8 percent
for the three month period ending September 30, 1996, and $214,000 or 23.0
percent for the same period in 1995. For the nine month periods ending September
30, 1996 and 1995, applicable income taxes and effective tax rates were $801,000
or 27.3 percent and $279,000 or 21.6 percent, respectively. The lower effective
tax rate in 1995 compared to 1996 is a function of lower taxable income and the
relationship between tax-exempt income to total income before taxes.
QNB utilizes an asset and liability approach for financial accounting and
reporting of income taxes. As of September 30, 1996 QNB's net deferred tax asset
was $824,000 of which $642,000 relates to the allowance for possible loan losses
and $72,000 resulted from the SFAS No. 115 adjustment for available-for-sale
investment securities. As of September 30, 1995 QNB's net deferred tax asset was
$851,000.
BALANCE SHEET ANALYSIS
The Balance Sheet Analysis reviews average balance sheet data for the nine
months ended September 30, 1996 compared with the twelve month average for the
year ended December 31, 1995 as well as the period ending balances for the same
time periods.
Average earning assets for the nine month period ended September 30, 1996
increased $3,707,000 or 1.5 percent to $257,210,000 from $253,503,000 at
December 31, 1995. The increase in average earning assets was primarily in the
categories average investment securities and average loans. Average investment
securities increased $2,216,000 or 2.3 percent while average loans increased
$2,841,000 or 1.9 percent. Residential mortgage loans and consumer loans,
primarily fixed rate home equity loans are the categories that showed the
greatest increase.
FORM 10-Q
Page 12
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS (Continued)
This growth was primarily funded through reductions in Federal funds sold, a
higher level of noninterest-bearing deposits and retained earnings. Average
Federal funds sold decreased $1,350,000 and average noninterest-bearing deposits
increased $1,385,000. Average shareholders' equity increased $1,347,000. Average
interest-bearing deposits increased slightly from $221,052,000 to $221,488,000.
While total non-interest bearing deposits did not change significantly, the
makeup of the deposits changed. Average interest-bearing checking accounts
increased $1,143,000 and average time deposits less than $100,000 increased
$3,347,000. Average money market accounts decreased $3,332,000 and average time
deposits greater than $100,000 decreased $1,413,000. The increase in
interest-bearing checking accounts is primarily related to the timing and amount
of seasonal deposits of a local school district. The increase in average time
deposits less than $100,000 and the corresponding decrease in money markets can
be partially attributed to a time deposit promotion which paid a high rate of
interest for two years with the opportunity for a one-time withdrawal with no
penalty.
Total assets at September 30, 1996 were $286,717,000, compared with $276,049,000
at December 31, 1995, an increase of 3.9 percent. Total deposits increased from
$242,887,000 at December 31, 1995 to $255,742,000 at September 30, 1996. The
deposits from the school district account for almost $6,500,000 of the increase
in total assets and total deposits from December 31, 1995 to September 30, 1996.
QNB anticipates the trend by adjusting its liquidity position through the use of
its investment portfolio and Federal funds sold.
The increase in assets from December 31, 1995 to September 30, 1996 is primarily
centered in Federal funds sold which increased $6,905,000 to $9,812,000. This
increase is a result of the school district deposits and will be temporary. The
Federal funds sold will be used to fund the withdrawal of the school district
deposits during the fourth quarter, will be invested in investment securities or
will be used to fund new loans. As stated in the 1995 annual report, QNB's focus
during 1996 is to develop new lending relationships as well as strengthening
existing relationships. This effort appears to be reaping benefits as total
loans have increased from $155,957,000 at December 31, 1995 and $153,737,000 at
June 30, 1996 to $158,234,000 at September 30, 1996. Total loans at September
31, 1995 were $150,915,000. During 1996, QNB used aggressive marketing campaigns
to book fixed rate home equity loans and automobile loans. The growth in the
commercial loan portfolio during the third quarter of 1996 was primarily the
result of participation loans with other community banks. QNB acts as the lead
bank in most of these participations. It is anticipated that loans to small
businesses will continue to increase during the fourth quarter of 1996 as a
result of additional participation loans as well as loans obtained through the
business development program. Loan growth remains a top priority for QNB going
forward.
As of December 31, 1995 QNB reported investment securities available-for-sale at
a fair value of $55,380,000 or $336,000 above the amortized cost of $55,044,000.
An unrealized holding gain, net of taxes, of $222,000 was reported as an
increase to shareholders' equity. Rapidly increasing interest rates at the end
of the first quarter and throughout the second quarter of 1996 created an
unrealized loss in the portfolio. As rates declined at the end of September the
unrealized loss decreased. As of September 30, 1996 QNB reported investment
securities available-for-sale at a fair value of $53,849,000 or $214,000 under
the amortized cost of $54,063,000. An unrealized holding loss, net of taxes, of
$140,000 was reported as a decrease to shareholders' equity.
FORM 10-Q
Page 13
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS (Continued)
Investment securities held-to-maturity are reported at amortized cost. As of
September 30, 1996 and December 31, 1995, QNB had securities classified as
held-to-maturity with an amortized cost of $43,428,000 and $42,515,000 and a
market value of $43,259,000 and $42,861,000, respectively.
The $526,000 increase in other assets from December 31, 1995 to September 30,
1996 resulted from an increase in deferred taxes, income taxes receivable and
prepaid expenses. The increase in deferred taxes relates to the change in the
unrealized holding gain on investment securities at year end to an unrealized
holding loss on investment securities at September 30, 1996.
LIQUIDITY
Liquidity represents an institution's ability to generate cash or otherwise
obtain funds at reasonable rates to satisfy commitments to borrowers and demands
of depositors. QNB tries to manage the coordination of its mix of cash, Federal
funds sold, investment securities and loans in order to match the volatility,
seasonality, interest sensitivity and growth trends of its deposit funds.
Liquidity is provided from asset sources through maturities and repayments of
loans and investment securities, net interest income and fee income. The
portfolio of investments available-for-sale and QNB's policy of selling its
residential mortgage originations and student loans in the secondary market also
provide a strong source of liquidity.
Cash and due from banks, Federal funds sold, available-for-sale securities and
loans held-for-sale were $78,029,000 and $71,898,000 at September 30, 1996 and
December 31, 1995. These sources were adequate to meet seasonal deposit
withdrawals during 1996 and should be adequate to meet normal fluctuations in
loan demand and or deposit withdrawals. Approximately $40,200,000 and
$32,792,000 of available-for-sale securities at September 30, 1996 and December
31, 1995 were pledged as collateral for repurchase agreements, public deposits
and other deposits as provided by law.
The consolidated statements of cash flows present the changes in cash and cash
equivalents from operating, investing and financing activities. QNB's cash and
cash equivalents increased $1,318,000 to $14,268,000 at September 30, 1996. This
compares to a $549,000 decrease during the first nine months of 1995. After
adjusting net income for non-cash transactions, operating activities provided
$3,043,000 in cash flow in the first nine months of 1996, compared to $1,242,000
in the same period of 1995. Net cash used by investing activities was
$10,695,000 during the first nine months of 1996. This resulted largely from the
increase in Federal funds sold of $6,905,000 and a net increase in loans of
$5,389,000. The purchases of investment securities of $33,345,000 replaced the
maturities, calls and sales of investment securities which totaled $33,467,000.
The increase in loan demand combined with the seasonal nature of the school
district deposits warranted the increase in Federal funds sold. Net cash used by
investing activities of $11,260,000 during the first nine months of 1995
resulted largely from the purchase of $23,350,000 of investment securities far
exceeding the maturities, calls and sales of investment securities of
$4,435,000. Investment activity increased during the second and third quarters
of 1995 as a result of an increase in funding sources and the proceeds from the
sale of student loans and residential mortgage loans. Since loan demand was
weak, available funds went to the purchase of investments. Net cash provided by
financing activities of $8,970,000 during the first nine months of 1996 was the
result of an increase in both noninterest-bearing and interest-bearing deposits
of $1,032,000 and $11,823,000, respectively. Approximately $6,500,000 of the
FORM 10-Q
Page 14
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
LIQUIDITY (Continued)
increase in interest-bearing deposits relates to the increase in balances from
the school district. A decline in short-term borrowings of $3,381,000 offset
some of these increases. Net cash provided by financing activities of $9,469,000
during the first nine months of 1995 was the result of an increase in
interest-bearing deposits and short-term borrowings. The increase in
interest-bearing deposits in 1995 was primarily due to the influx of deposits
from the school district.
CAPITAL ADEQUACY
A strong capital position is fundamental to support continued growth and
profitability, to serve the needs of depositors, and to yield an attractive
return for shareholders. QNB's shareholders' equity at September 30, 1996 was
$22,046,000 or 7.69 percent of total assets compared to shareholders' equity of
$20,866,000 or 7.56 percent at December 31, 1995. Shareholders' equity at
September 30, 1996 includes a negative adjustment of $140,000 related to
unrealized holding losses, net of taxes, on investment securities available-for-
sale, while shareholders' equity at December 31, 1995 includes a positive
adjustment of $222,000. Without these adjustments shareholders' equity to total
assets would have been 7.74 percent and 7.48 percent at September 30,1996 and
December 31, 1995.
Shareholders' equity averaged $21,280,000 for the first nine months of 1996 and
$19,933,000 during all of 1995, an increase of 6.8 percent. The ratio of average
total equity to average total assets improved to 7.79 percent for 1996, compared
to 7.39 percent for 1995. Book value per share rose to $15.48 at September 30,
1996 from $14.66 at year-end 1995. The market price was $32.25 bid and $33.50
ask at September 30, 1996, compared with $29.00 bid and $31.00 ask at December
31, 1995.
QNB Corp. and the Quakertown National Bank are subject to various regulatory
capital requirements as issued by Federal regulatory authorities. Regulatory
capital is defined in terms of Tier I capital (shareholders' equity excluding
unrealized gains or losses on available-for-sale securities), Tier II capital
which includes a portion of the allowance for loan losses, and total capital
(Tier I plus II). Risk-based capital ratios are expressed as a percentage of
risk-weighted assets. Risk-weighted assets are determined by assigning various
weights to all assets and off-balance sheet arrangements, such as letters of
credit and loan commitments, based on associated risk. Regulators have also
adopted minimum Tier I leverage ratio standards, which measures the ratio of
Tier I capital to total assets.
The minimum regulatory capital ratios are 4.00 percent for Tier I, 8.00 percent
for the total risk-based and 3.00 percent for leverage. Under the requirements,
QNB has a Tier I capital ratio of 12.80 percent and 12.16 percent, a total risk-
based ratio of 14.05 percent and 13.42 percent and a leverage ratio of 7.92
percent and 7.48 percent at September 30, 1996 and December 31, 1995,
respectively.
The Federal Deposit Insurance Corporation Improvement Act of 1991 established
five capital level designations ranging from "well capitalized" to "critically
undercapitalized." At September 30, 1996 and December 31, 1995 QNB met the "well
capitalized" criteria which requires minimum Tier I and total risk-based capital
ratios of 6.00 percent and 10.00 percent, respectively and a Tier I leverage
ratio of 5.00 percent.
FORM 10-Q
Page 15
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INTEREST RATE SENSITIVITY
Since the assets and liabilities of QNB have diverse repricing characteristics
that influence net interest income, management analyzes its interest sensitivity
through the use of gap analysis and simulation models. Interest rate sensitivity
management seeks to minimize the effect of interest rate changes on net interest
margins and interest rate spreads and provide growth in net interest income
through periods of changing interest rates. The Asset/Liability Management
Committee (ALCO) is responsible for managing interest rate risk and for
evaluating the impact of changing interest rate conditions on net interest
income.
Gap analysis measures the difference between volumes of rate-sensitive assets
and liabilities and quantifies these repricing differences for various time
intervals. Static gap analysis describes interest rate sensitivity at one point
in time. However, it alone does not accurately measure the magnitude of changes
in net interest income since changes in interest rates do not impact all
categories of assets and liabilities equally or simultaneously. Interest rate
sensitivity analysis also involves assumptions on certain categories of assets
and deposits. For purposes of interest rate sensitivity analysis, assets and
liabilities are stated at either their contractual maturity, estimated likely
call date, or earliest repricing opportunity. Mortgage-backed securities and
amortizing loans are scheduled based on their anticipated cash flow. Savings
accounts, including passbook, statement savings, money market, and NOW accounts,
do not have a stated maturity or repricing term and can be withdrawn or repriced
at any time. This may impact QNB's margin if more expensive alternative sources
of deposits are required to fund loans or deposit runoff. Management projects
the repricing characteristics of these accounts based on historical performance
and assumptions that it believes reflect their rate sensitivity. A positive gap
results when the amount of interest rate sensitive assets exceeds interest rate
sensitive liabilities. A negative gap results when the amount of interest rate
sensitive liabilities exceeds interest rate sensitive assets.
QNB focuses on the management of the one year interest rate sensitivity gap. At
September 30, 1996, interest earning assets scheduled to mature, likely to be
called, reprice or repay in one year were $102,088,000. Interest sensitive
liabilities scheduled to mature or reprice within one year were $113,948,000.
The one year cumulative gap, which reflects QNB's interest sensitivity over a
period of time, was a negative $11,860,000 at September 30, 1996. The cumulative
one-year gap equals 4.5 percent of total earning assets. This negative or
liability sensitive gap will generally benefit QNB in a falling interest rate
environment, while rising interest rates will negatively impact QNB.
QNB also uses a simulation model to assess the impact of changes in interest
rates on net interest income. The model reflects management's assumptions
related to asset yields and rates paid on liabilities, deposit sensitivity and
the size, composition and maturity or repricing characteristics of the balance
sheet. The assumptions are based on what management believes at that time to be
the most likely interest rate environment. Management also evaluates the impact
of higher and lower interest rates. Actual results may differ from simulated
results due to various factors including time, magnitude and frequency of
interest rate changes, the relationship or spread between various rates, loan
pricing and deposit sensitivity, and asset/liability strategies. Based on
management's estimate of the structure of the balance sheet and interest rates
for the next year, net interest income for the next twelve months is expected to
increase modestly compared to the prior twelve months.
If interest rates are 100 basis points higher than management's most likely
interest rate environment, the simulation model projects net interest income for
the next twelve months to slightly exceed the most likely scenario. Conversely,
if interest rates are 100 basis points lower, net interest income for the most
likely scenario would slightly decline.
FORM 10-Q
Page 16
<PAGE>
QNB CORP. AND SUBSIDIARY
PART II. OTHER INFORMATION
SEPTEMBER 30, 1996
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities
None.
Item 3. Default Upon Senior Securities
None.
Item 4. Submission of Matters to Vote of Securities Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None
FORM 10-Q
Page 17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
QNB Corp.
Date: November 14, 1996 By: /s/ Thomas J. Bisko
-------------------------------
Thomas J. Bisko
President/CEO
Date: November 14, 1996 By: /s/ Robert C. Werner
-------------------------------
Robert C. Werner
Vice President
Date: November 14, 1996 By: /s/ Bret H. Krevolin
-------------------------------
Bret H. Krevolin
Chief Accounting Officer
FORM 10-Q
Page 18
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1996
<CASH> 14,268
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 9,812
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 53,849
<INVESTMENTS-CARRYING> 43,428
<INVESTMENTS-MARKET> 43,259
<LOANS> 158,234
<ALLOWANCE> 2,576
<TOTAL-ASSETS> 286,717
<DEPOSITS> 255,742
<SHORT-TERM> 6,718
<LIABILITIES-OTHER> 2,211
<LONG-TERM> 0
0
0
<COMMON> 1,780
<OTHER-SE> 20,266
<TOTAL-LIABILITIES-AND-EQUITY> 286,717
<INTEREST-LOAN> 10,047
<INTEREST-INVEST> 4,550
<INTEREST-OTHER> 170
<INTEREST-TOTAL> 14,767
<INTEREST-DEPOSIT> 6,031
<INTEREST-EXPENSE> 6,229
<INTEREST-INCOME-NET> 8,538
<LOAN-LOSSES> 300
<SECURITIES-GAINS> 94
<EXPENSE-OTHER> 6,611
<INCOME-PRETAX> 2,930
<INCOME-PRE-EXTRAORDINARY> 2,129
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,129
<EPS-PRIMARY> 1.50
<EPS-DILUTED> 1.50
<YIELD-ACTUAL> 4.62
<LOANS-NON> 4,429
<LOANS-PAST> 169
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1,829
<ALLOWANCE-OPEN> 2,384
<CHARGE-OFFS> 164
<RECOVERIES> 56
<ALLOWANCE-CLOSE> 2,576
<ALLOWANCE-DOMESTIC> 2,576
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 1,115
</TABLE>
