SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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____________March 31, 1996______________________
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________to__________________________________
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
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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)
(215)538-5600
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Registrant's Telephone Number, Including Area Code
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___________
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 May 14, 1996
Common Stock, par value $1.25 1,423,998
<PAGE>
QNB CORP. AND SUBSIDIARY
FORM 10-Q
QUARTER ENDED MARCH 31, 1996
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS PAGE
Consolidated Statements of Income for Three
Months Ended March 31, 1996 and 1995 1
Consolidated Balance Sheets at March 31, 1996
and December 31, 1995 2
Consolidated Statements of Cash Flows for Three
Months Ended March 31, 1996 and 1995 3
Notes to Consolidated Financial Statements 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 5
PART II - OTHER INFORMATION
OTHER INFORMATION 14
<PAGE>
QNB Corp.
CONSOLIDATED STATEMENTS OF INCOME and Subsidiary
<TABLE>
<CAPTION>
(in thousands, except per share data)
(unaudited)
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Three Months Ended March 31, 1996 1995
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<S> <C> <C>
Interest Income
Interest and fees on loans $3,313 $3,318
Interest and dividends on investment securities available-for-sale 818 771
Interest and dividends on investment securities held-to-maturity:
Taxable 536 471
Tax-exempt 122 84
Interest on Federal funds sold 51 63
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Total interest income 4,840 4,707
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Interest Expense
Interest on deposits
NOW accounts 151 165
Money market accounts 257 293
Savings 189 204
Time 1,155 985
Time over $100,000 226 241
Interest on short-term borrowings 63 45
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Total interest expense 2,041 1,933
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Net interest income 2,799 2,774
Provision for possible loan losses 100 250
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Net interest income after provision for possible loan losses 2,699 2,524
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Non-Interest Income
Fees for services to customers 249 217
Mortgage servicing fees 55 59
Net gain (loss) on investment securities 70 (8)
Net gain on sale of loans 55 5
Other operating income 67 51
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Total non-interest income 496 324
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Non-Interest Expense
Salaries and employee benefits 1,238 1,319
Net occupancy expense 170 162
Furniture and equipment expense 148 174
Insurance expense 23 173
Other real estate owned expense 45 126
Other expense 516 511
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Total non-interest expense 2,140 2,465
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Income before income taxes 1,055 383
Provision for income taxes 294 81
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Net Income $ 761 $ 302
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Net Income Per Share $ .53 $ .21
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Cash Dividends Per Share $ .14 $ .125
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</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
-1-
<PAGE>
QNB Corp.
CONSOLIDATED BALANCE SHEETS and Subsidiary
<TABLE>
<CAPTION>
(in thousands)
(unaudited)
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March 31, December 31,
1996 1995
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<S> <C> <C>
Assets
Cash and due from banks $ 10,646 $ 12,950
Federal funds sold 3,778 2,907
Investment securities
available-for-sale 53,564 55,380
held-to-maturity (market value $43,754 and $42,861) 43,837 42,515
Total loans, net of unearned income of $375 and $382 153,480 155,957
Allowance for possible loan losses (2,411) (2,384)
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Net loans 151,069 153,573
Premises and equipment, net 4,575 4,536
Other real estate owned 775 775
Accrued interest receivable 2,008 1,943
Other assets 1,857 1,470
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Total assets $272,109 $276,049
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Liabilities
Deposits
Demand, noninterest-bearing $ 26,943 $ 31,882
NOW accounts 36,254 39,477
Money market accounts 37,849 36,853
Savings 35,247 33,841
Time 86,601 86,382
Time over $100,000 15,738 14,452
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Total deposits 238,632 242,887
Short-term borrowings 9,760 10,099
Accrued interest payable 1,098 1,040
Other liabilities 1,518 1,157
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Total liabilities 251,008 255,183
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Commitments and contingencies
Shareholders' Equity
Common stock, par value $1.25 per share;
authorized 5,000,000 shares; issued 1,423,998 shares and 1,423,838 shares 1,780 1,780
Surplus 4,288 4,283
Retained earnings 15,142 14,581
Unrealized holding (losses) gains, net of taxes,
on investment securities available-for-sale (109) 222
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Total shareholders' equity 21,101 20,866
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Total liabilities and shareholders' equity $272,109 $276,049
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</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
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<PAGE>
QNB Corp.
CONSOLIDATED STATEMENTS OF CASH FLOWS and Subsidiary
<TABLE>
<CAPTION>
(in thousands)
(unaudited)
- -----------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 1996 1995
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<S> <C> <C>
Operating Activities
Net income $ 761 $ 302
Adjustments to reconcile net income to net cash provided by operating activities
Provision for possible loan losses 100 250
Depreciation and amortization 119 154
Securities (gains) losses (70) 8
Net gain on sale of loans (55) (5)
Proceeds from sales of residential mortgages 789 250
Originations of residential mortgages held-for-sale (441) (80)
Writedowns, net of losses (gains) on sales of other real estate owned __ 77
Deferred income tax provision __ 2
Change in income taxes payable 195 83
Net increase in interest and dividends receivable (65) (227)
Net amortization of premiums and discounts 21 37
Net increase in interest payable 58 40
Other, net (218) (469)
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Net cash provided by operating activities 1,194 422
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Investing Activities
Proceeds from maturities and calls of investment securities
available-for-sale 5,864 238
held-to-maturity 1,481 360
Proceeds from sales of investment securities
available-for-sale 115 1,003
Purchase of investment securities
available-for-sale (4,620) (1,002)
held-to-maturity (2,797) __
Net (increase) decrease in Federal funds sold (871) 3,019
Proceeds from sales of student loans 1,194 __
Net decrease in loans 917 40
Net purchases of premises and equipment (158) (133)
Proceeds from the sale of other real estate owned __ 37
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Net cash provided by investing activities 1,125 3,562
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Financing Activities
Net decrease in noninterest-bearing deposits (4,939) (2,242)
Net increase (decrease) in interest-bearing deposits 684 (3,250)
Net decrease in short-term borrowings (339) (821)
Cash dividends paid (200) (178)
Proceeds from issuance of common stock 5 4
Other, net 166 166
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Net cash used by financing activities (4,623) (6,321)
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Decrease in cash and cash equivalents (2,304) (2,337)
Cash and cash equivalents at beginning of year 12,950 11,427
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Cash and cash equivalents at end of period $10,646 $9,090
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Supplemental Cash Flow Disclosures
Interest paid $1,983 $1,893
Income taxes paid 100 __
Non-Cash Transactions
Transfer of loans to other real estate owned __ 224
Change in net unrealized holding gains (losses), net of taxes, on investment securities (331) 885
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
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<PAGE>
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 March 31, 1996, as well as the respective
statements of income and cash flows for the three month period ended March 31,
1996 and 1995, are unaudited. The consolidated balance sheet as of December 31,
1995 is derived from QNB's audited 1995 Annual Report and the related footnotes
are referenced to 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 during the first quarter of 1996.
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 March 31, 1996 and 1995, the recorded investment in loans for which
impairment has been recognized in accordance with SFAS No. 114 totaled
$5,266,000 and $4,209,000, respectively, of which $4,377,000 and $2,192,000
related to loans with no valuation allowance and $889,000 and $2,017,000 related
to loans with a corresponding valuation allowance of approximately $240,000 and
$260,000, respectively. Most of the loans identified as impaired are
collateral-dependent.
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<PAGE>
QNB CORP. AND SUBSIDIARY
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
The intention of this section is to provide the reader with a better
understanding of the consolidated results of operations for the three month
period ended March 31, 1996 and 1995 and the financial condition at March 31,
1996 as compared to December 31, 1995 of QNB Corp. and its wholly owned
subsidiary, The Quakertown National Bank. The financial condition and results of
operations discussed herein are presented on a consolidated basis and the
consolidated entity is referred to herein as "QNB".
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 118 year old community bank with locations in Upper Bucks,
Northern Montgomery and Southern Lehigh Counties.
RESULTS OF OPERATIONS
QNB reported net income of $761,000 or $.53 per share for the three month period
ending March 31, 1996. This represents a significant increase in net income from
the $302,000 or $.21 per share reported for the first quarter of 1995.
The near record earnings for the first quarter of 1996 was 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.
Also positively impacting the results for the first quarter of 1996 was the
elimination of the Federal Deposit Insurance Corporation (F.D.I.C.) insurance
premiums. A lower provision for possible loan losses when comparing the quarters
ending March 31, 1996 and 1995 also contributed to the increase in net income.
NET INTEREST INCOME
Net interest income increased slightly for the three month period ending March
31, 1996 to $2,799,000 compared to $2,774,000 for the same period last year. A
3.2 percent increase in average earning assets when comparing the two quarters
offset a six basis point decrease in the net interest margin. While total
interest income grew 2.8 percent for the first quarter of 1996, to $4,840,000
from $4,707,000 in the first quarter of 1995, interest expense increased 5.6
percent over the same period. Interest expense was $2,041,000 and $1,933,000 for
the three months ended March 31, 1996 and 1995, respectively.
The yield on earning assets on a fully taxable equivalent basis was 7.79 percent
for the first quarter of 1996 versus 7.78 percent for the first quarter of 1995,
while the rate paid on interest-bearing liabilities was 3.73 percent and 3.59
percent for the same periods. QNB was able to sustain its yield on earning
assets despite the lower prime rate in the first quarter of 1996. The average
prime rate for the first quarter of 1996 was 8.34 percent compared to 8.83
percent for the first quarter of 1995. Higher yields on QNB's investment
portfolio when comparing the two quarters assisted in maintaining the yield on
earning assets. The increase in the cost of interest-bearing liabilities was
primarily due to higher rates paid on time deposits. The net interest margin on
a fully taxable equivalent basis for the three month period ended March 31, 1996
was 4.58 percent compared to 4.64 percent for the same period in 1995.
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<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
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 model
recommended by the Office of the Comptroller of the Currency. This model
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
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 the first quarter of
1996 compared to $250,000 for the same period in 1995. The primary reason for
the higher provision for possible loan losses during the first quarter of 1995,
was the partial charge-off of a group of loans to one borrower for the purpose
of low income residential investment properties. Net charge-offs in the first
quarter of 1996 were $73,000 compared to $294,000 for the same period in 1995.
QNB's net charge-offs as a percentage of average loans was .19 percent
(annualized) for the three month period ended March 31, 1996, compared with .76
percent for the same 1995 period.
Nonperforming assets (nonaccruing loans, loans past due 90 days or more, and
other real estate owned) amounted to 2.29 percent of total assets at March 31,
1996 compared with 2.35 percent at March 31, 1995 and 2.01 percent at December
31, 1995. Nonperforming assets have increased slightly when comparing the March
31, 1996 balance of $6,239,000 to the March 31,1995 balance of $6,186,000.
Nonperforming assets have also increased from the December 31, 1995 balance of
$5,535,000. The increase during the first quarter of 1996 is in the area of
nonaccrual loans which increased $917,000 from year-end 1995 and $1,704,000 from
the first quarter of 1995 to $5,397,000. The increase in nonaccrual loans from
year-end is primarily the result of a group of loans to one borrower for the
purpose of acquiring rental properties. Other real estate owned was $775,000 at
March 31, 1996 and December 31, 1995 and $2,083,000 at March 31, 1995. The
decrease in other real estate owned from the first quarter of 1995 was primarily
due to the sale of a property during the second quarter of 1995. Management
anticipates a reduction in nonaccrual loans during the second quarter of 1996,
but an increase in other real estate owned as QNB acquires the deeds to the
collateral securing some of these loans.
There were no restructured loans as of March 31, 1996, December 31, 1995 or
March 31, 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 $2,411,000 and $2,384,000 at March
31, 1996 and December 31, 1995, respectively. The ratio of the allowance to
total loans was 1.57 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.
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<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
PROVISION FOR POSSIBLE LOAN LOSSES (Continued)
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.
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 $172,000 or 53.1
percent to $496,000 for the quarter ending March 31, 1996 when compared to March
31, 1995. The primary reason for the increase when comparing the two quarters is
higher fees for services to customers and gains on the sale of investment
securities and loans.
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 14.7 percent when comparing the two quarters from $217,000 to
$249,000. Higher overdraft fees account for $20,000 of the increase, while
higher fees on business deposit accounts contributed approximately $6,000 to the
increase.
While QNB sells a majority of its residential mortgages in the secondary market,
it retains servicing rights. A normal servicing fee is retained on all mortgage
loans sold and serviced. Mortgage servicing fees for the quarter ending March
31, 1996 were $55,000 which represents a $4,000 or 6.8 percent decrease from the
same period in 1995. The decrease in mortgage servicing fees for the quarter is
a result of a 6.9 percent decrease in the average balance of mortgages serviced.
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 an
increase in interest rates. The timing of mortgage payments and delinquencies
also impacts the amount of servicing fees recorded. The implementation of
Statement of Financial Accounting Standards No. 122 (SFAS No. 122), "Accounting
for Mortgage Servicing Rights" beginning January 1, 1996 will also impact the
level of servicing income recorded.
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 during the first quarter of 1996.
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<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
NON-INTEREST INCOME (Continued)
Gains on the sale of investment securities were $70,000 for the first quarter of
1996, compared to a loss of $8,000 for the same period in 1995. The gain in 1996
relates to the sale of a marketable equity security with a book value of
$45,000. There were no sales of debt securities during the first quarter of
1996.
The net gain on the sale of loans was $55,000 and $5,000 for the respective
quarters ending March 31, 1996 and 1995. Gains on the sale of approximately
$1,165,000 in student loans represent $29,000 of the total while gains on the
sale of residential mortgage loans represent approximately $26,000 of the gains
recorded in 1996. The $5,000 gain in the first quarter of 1995 represents the
gain from the sale of mortgages. There were no sales of student loans during the
first quarter of 1995.
The net gain 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. Rising interest rates during the first quarter of 1995 reduced the
number of mortgages originated and sold. During the first quarter of 1995, QNB
originated only $80,000 in mortgages held-for-sale and sold only $245,000. As
rates declined during 1995 the amount of mortgages originated increased.
Interest rates reached their low during the beginning of 1996 before rapidly
increasing towards the end of February. During the quarter, QNB originated
$441,000 in residential mortgage loans held-for-sale and sold $763,000. Included
in the $26,000 net gain is a $6,000 writedown on $202,000 in mortgages
held-for-sale at March 31, 1996. This writedown is a result of the increase in
interest rates towards the end of the quarter. A further increase in rates could
increase the loss as well as reduce the amount of mortgages originated.
Other operating income increased $16,000 to $67,000 when comparing the two
quarters ending March 31, 1996 and 1995. 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 $4,000 of the
increase. An increase in merchant charge card income accounts for $3,000 of the
increase while higher ATM card income accounts for $5,000 of the increase. The
increase in merchant charge card income is a result of an increase in the volume
of transactions processed, while higher ATM card income is the result of an
increase in the number of cards outstanding as well as an increase in the annual
fee charged.
NON-INTEREST EXPENSE
Non-interest expense includes salaries and employee benefits, net occupancy
expense, furniture and equipment expense, insurance expense, other real estate
owned expense, and various other operating expenses. Total non-interest expense
of $2,140,000 for the quarter ending March 31, 1996 represents a decrease of
$319,000 or 12.9 percent over levels reported in the first quarter of 1995. This
decrease 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.
-8-
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
NON-INTEREST EXPENSE (Continued)
Salaries and benefits, the largest component of non-interest expense, decreased
$81,000 to $1,238,000 for the quarter ending March 31, 1996 compared to the same
quarter in 1995. Salaries expense decreased $57,000 during the period while
benefits expense decreased $24,000. The reduction in salary expense, when
comparing the results of the two quarters, is the result of the cost savings
related to the Corporate reorganization. In the second quarter of 1995, QNB
implemented a revised reorganization plan which included the elimination of nine
positions. QNB has reduced its full time equivalent employee figure from 141
employees at March 1995 to 134 employees at March 1996. Performance increases
offset some of the savings realized. The decrease in benefits expense is also
primarily the result in the reduction in the number of employees. Payroll tax
expense, pension plan expense and medical and life insurance premiums all
decreased.
Net occupancy expense increased $8,000 or 4.9 percent while furniture and
equipment expense decreased $26,000 or 14.9 percent when comparing the two
quarters ending March 31st. Higher utilities expense as a result of the harsh
winter of 1996 accounts for most of the increase in net occupancy expense. A
$34,000 reduction in depreciation expense on furniture and equipment offset
small increases in equipment maintenance and equipment rental expense and
contributed to the decrease in furniture and equipment expense.
Insurance expense, which includes Federal Deposit Insurance Corporation
(F.D.I.C.) insurance, was $23,000 and $173,000 for the three months ending March
31, 1996 and 1995. The reduction in insurance expense is a direct result of the
virtual elimination of F.D.I.C. insurance premiums. The expense for the first
quarter of 1996 was $1,000 compared to $149,000 for the first quarter of 1995.
It was determined that the Bank Insurance Fund had met its legally set coverage
ratios as of May 1995 and as a result the premiums for "well capitalized"
institutions were reduced.
Other real estate owned expense decreased $81,000 to $45,000 when comparing the
first quarter of 1996 to the first quarter of 1995. The higher expense in 1995
was primarily the result of a writedown on one property and the loss on
disposition of another property totaling $77,000.
INCOME TAXES
Applicable income taxes and effective tax rates were $294,000 or 27.9 percent
for the three month period ending March 31, 1996 and $81,000 or 21.1 percent for
the same period in 1995. The lower effective tax rate in 1995 compared to 1996
is a function of lower income before income taxes and the relationship between
tax-exempt income to total income before taxes.
QNB's method of accounting for income taxes changed under Statement of Financial
Accounting Standards No. 109 (SFAS No. 109) "Accounting for Income Taxes", which
became effective for fiscal years beginning after December 15, 1992. SFAS No.
109 requires an asset and liability approach for financial accounting and
reporting of income taxes. As of March 31, 1996 QNB's net deferred tax asset was
$778,000 of which $578,000 relates to the allowance for possible loan losses and
$56,000 is a result of the SFAS No. 115 adjustment for available-for-sale
investment securities. As of March 31, 1995 QNB's net deferred tax asset was
$1,242,000 of which $431,000 related to the allowance for possible loan losses
and $499,000 is a result of the SFAS No. 115 adjustment for available-for-sale
investment securities.
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<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
BALANCE SHEET ANALYSIS
The Balance Sheet Analysis reviews average balance sheet data for the three
months ended March 31, 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 three month period ended March 31, 1996 increased
$924,000 or .4 percent to $254,427,000 from $253,503,000 at December 31, 1995.
The increase in average earning assets was primarily the result of increases in
average loans. Average loans increased $2,938,000 or 1.9 percent. This growth
was not funded by increases in interest-bearing liabilities but through
reductions in investment securities and Federal funds sold. Average investment
securities decreased $129,000 while average Federal funds sold decreased
$1,902,000. Average interest-bearing liabilities decreased $1,927,000, primarily
as a result of a reduction in average NOW account balances. During the third
quarter of 1995, QNB was selected as the depository institution for a local
school district. These deposits are seasonal in nature with balances fluctuating
by as much as $10,000,000. These balances were at their highest during the third
quarter of 1995 and their lowest during the first quarter of 1996.
Average earning assets were 94.7 percent of average total assets for the three
months ended March 31, 1996, an increase from 93.9 percent at December 31, 1995.
Total assets averaged $268,807,000 for the first three months of 1996 compared
to $269,833,000 in 1995.
Total assets at March 31, 1996 were $272,109,000, compared with $276,049,000 at
December 31, 1995, a decrease of 1.4 percent. Total deposits decreased from
$242,887,000 at December 31, 1995 to $238,632,000 at March 31, 1996.
Historically, deposits and therefore assets of QNB decline during the first
quarter of the year, with growth occurring primarily over the second half of the
year. This trend was augmented by the addition of the school district
relationship. QNB anticipates the trend by adjusting its liquidity position
through the use of its investment portfolio and Federal funds sold.
The decrease in assets from December 31, 1995 was primarily due to a $2,477,000
decline in loan balances resulting from the sale of approximately $2,000,000 of
student loans and residential mortgage loans during the first quarter. As stated
in the 1995 annual report, QNB's focus during 1996 is to develop new lending
relationships as well as strengthen existing relationships. During the first
quarter of 1996 QNB used an aggressive marketing campaign to book approximately
$3,300,000 in fixed rate home equity loans. This marketing effort will continue
in the second quarter. In addition, it is anticipated that loans to small
businesses will increase during the second quarter of 1996 as a result of the
implementation of a formal business development program.
QNB adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" on December 31, 1993. SFAS No. 115 requires that these securities be
classified into three categories.
Securities that QNB has the positive intent and ability to hold to maturity are
classified as held-to-maturity securities and reported at amortized cost. Debt
and equity securities that are bought and held principally for the purpose of
selling them in the near term are classified as trading securities and reported
at fair value, with unrealized gains and losses included in earnings. Debt and
equity securities not classified as either held-to-maturity securities or
trading securities are classified as available-for-sale securities and reported
at fair value, with unrealized gains and losses, net of tax, excluded from
earnings and reported as a separate component of shareholders' equity.
Management determines the appropriate classification of securities at the time
of purchase.
-10-
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
BALANCE SHEET ANALYSIS (Continued)
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 of 1996 created an unrealized loss in the portfolio as of
March 31, 1996. As of March 31, 1996 QNB reported investment securities
available-for-sale at a fair value of $53,564,000 or $164,000 under the
amortized cost of $53,728,000. An unrealized holding loss, net of taxes, of
$109,000 was reported as a decrease to shareholders' equity.
Investment securities held-to-maturity are reported at amortized cost. As of
March 31, 1996 and December 31, 1995, QNB had securities classified as
held-to-maturity with an amortized cost of $43,837,000 and $42,515,000 and a
market value of $43,754,000 and $42,861,000, respectively.
Activity in the investment portfolio during the first quarter of 1996 was
limited to the replacement of securities that were called or matured. Both the
weighted average yield and the weighted average maturity of the portfolios
remained basically unchanged as a result of the activity during the quarter.
QNB primarily attracts deposits from within its market area by offering various
deposit products, including demand deposits, NOW accounts, money market
accounts, savings accounts and certificates of deposit. Total deposits decreased
$4,255,000 to $238,632,000 at March 31, 1996. The largest decline was in
noninterest-bearing balances which decreased $4,939,000 and NOW accounts which
decreased $3,223,000. The decline in non-interest bearing balances is a result
of "window dressing" of financial statements by commercial customers at
year-end. Average noninterest-bearing deposits were down only slightly from both
twelve month averages for 1995 and the average balance for the fourth quarter of
1995. The decline in NOW account balances is a result lower school district
deposits. Partially offsetting these decreases were increases in money market,
savings and time deposit accounts.
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 $68,190,000 and $71,898,000 at March 31, 1996 and
December 31, 1995. These sources were adequate to meet seasonal deposit
withdrawals during the first quarter of 1996 and should be adequate to meet
normal fluctuations in loan demand and or deposit withdrawals. The Bank will be
applying for membership to the Federal Home Loan Bank during 1996. This will
provide QNB with a backup source of liquidity.
-11-
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
LIQUIDITY (Continued)
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 decreased $2,304,000 to $10,646,000 at March 31, 1996. This
compares to a $2,337,000 decrease during the first quarter of 1995. After
adjusting net income for non-cash transactions, operating activities provided
$1,194,000 in cash flow in the first quarter of 1996, compared to $422,000 in
the same period of 1995. Net cash provided by investing activities of $1,125,000
during the first three months of 1996 resulted largely from the net decrease in
loans as a result of payments and payoffs of loans exceeding originations and
the sale of student loans. As mentioned previously , investment security
activity during the quarter was limited to the replacement of maturities and
calls. Net cash provided by investing activities of $3,562,000 during the first
quarter of 1995 resulted largely from a decrease in Federal funds sold.
Investment activity during the quarter was minimal due to both the lack of
maturities and calls of investment securities and the decrease in funding
sources. Net cash used by financing activities of $4,623,000 during the first
three months of 1996 was the result of a decrease in noninterest-bearing
deposits. Net cash used by financing activities of $6,321,000 during the first
quarter of 1995 was the result of deposit withdrawals and a decrease in
short-term borrowings.
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 March 31, 1996 was
$21,101,000 or 7.75 percent of total assets compared to shareholders; equity of
$20,866,000 or 7.56 percent at December 31, 1995. March 31, 1996 shareholders'
equity includes a negative adjustment of $109,000 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 7.79 percent and 7.48 percent at March 31,1996 and December 31, 1995.
Shareholders' equity averaged $20,614,000 for the first quarter of 1996 and
$19,933,000 during 1995, an increase of 3.4 percent. The ratio of average total
equity to average total assets improved to 7.67 percent for 1996, compared to
7.39 percent for 1995. Book value per share rose to $14.82 at March 31, 1996
from $14.66 at year-end 1995. The market price was $32.00 bid and $34.00 ask at
March 31, 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), and 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 measure 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 12.68 percent and 12.16 percent, a total
risk-based ratio of 13.42 percent and 13.93 percent and a leverage ratio of 7.89
percent and 7.48 percent at March 31, 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 March 31, 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.
-12-
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
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
March 31, 1996, interest earning assets scheduled to mature, likely to be
called, reprice or repay in one year were $104,996,000. Interest sensitive
liabilities, scheduled to mature or reprice within one year were $107,936,000.
The one year cumulative gap, which reflects QNB's interest sensitivity over a
period of time, was a negative $2,940,000 at March 31, 1996. The cumulative
one-year gap equals 1.2 percent of total earning assets. This slightly negative
or liability sensitive gap will generally benefit QNB in a falling interest rate
environment, while rising interest rates will negatively impact QNB.
During the second quarter of 1995, QNB began using 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 by
approximately 3.6 percent compared with 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 exceed the most likely scenario by 1.3 percent.
Conversely, if interest rates are 100 basis points lower, net interest income
for the most likely scenario would decline by 1.5 percent.
-13-
<PAGE>
QNB CORP. AND SUBSIDIARY
PART II. OTHER INFORMATION
March 31, 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.
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: May 14, 1996 By:
/s/ Thomas J. Bisko
-------------------
Thomas J. Bisko
President
Date: May 14, 1996 By:
/s/ Robert C. Werner
--------------------
Robert C. Werner
Vice President
Date: May 14, 1996 By:
/s/ Bret H. Krevolin
--------------------
Bret H. Krevolin
Chief Accounting Officer
-14-
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