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, 1997
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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
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(State or Other Jurisdiction of (I.R.S. Employer
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 13, 1997
Common Stock, par value $1.25 1,428,241
<PAGE>
QNB CORP. AND SUBSIDIARY
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 1997
INDEX
PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>
ITEM 1. FINANCIAL STATEMENTS PAGE
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<S> <C>
Consolidated Statements of Income for Three and
Nine Months Ended September 30, 1997 and 1996.....................................1
Consolidated Balance Sheets at September 30, 1997
and December 31, 1996..............................................................2
Consolidated Statements of Cash Flows for Nine
Months Ended September 30, 1997 and 1996...........................................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...........................................................................18
</TABLE>
<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,
1997 1996 1997 1996
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<S> <C> <C> <C> <C>
Interest Income
Interest and fees on loans ....................................................... $ 3,601 $ 3,363 $10,600 $10,047
Interest and dividends on investment securities available-for-sale ............... 1,094 920 3,036 2,555
Interest and dividends on investment securites held-to-maturity .................. 641 680 1,923 1,995
Interest on Federal funds sold ................................................... 62 68 154 170
------- ------- ------- -------
Total interest income ........................................................ 5,398 5,031 15,713 14,767
------- ------- ------- -------
Interest Expense
Interest on deposits:
NOW accounts ................................................................. 191 224 523 518
Money market accounts ........................................................ 245 255 709 768
Savings ...................................................................... 189 197 573 583
Time ......................................................................... 1,343 1,212 3,977 3,515
Time over $100,000 ........................................................... 255 216 703 647
Interest on short-term borrowings ................................................ 78 70 225 198
------- ------- ------- -------
Total interest expense ....................................................... 2,301 2,174 6,710 6,229
------- ------- ------- -------
Net interest income .......................................................... 3,097 2,857 9,003 8,538
Provision for possible loan losses ............................................... 100 100 300 300
------- ------- ------- -------
Net interest income after provision for possible loan losses ................. 2,997 2,757 8,703 8,238
------- ------- ------- -------
Non-lnterest lncome
Fees for services to customers ................................................... 265 287 803 802
Mortgage servicing fees .......................................................... 43 52 136 159
Net gain on investment securities ................................................ -- 1 165 94
Net gain on sale of loans ........................................................ 24 21 66 60
Other operating income ........................................................... 150 66 380 188
------- ------- ------- -------
Total non-interest income .................................................... 482 427 1,550 1,303
------- ------- ------- -------
Non-Interest Expense
Salaries and employee benefits ................................................... 1,301 1,308 3,955 3,853
Net occupancy expense ............................................................ 166 173 491 507
Furniture and equipment expense .................................................. 172 179 517 497
Marketing expense ................................................................ 61 61 202 204
Supplies expense ................................................................. 40 60 132 158
Professional fees ................................................................ 38 54 127 137
Insurance expense ................................................................ 27 22 78 67
Other real estate owned expense .................................................. 80 50 178 140
Other expense .................................................................... 353 364 1,083 1048
------- ------- ------- -------
Total non-interest expense ................................................... 2,238 2,271 6,763 6,611
------- ------- ------- -------
Income before income taxes .................................................... 1,241 913 3,490 2,930
Provision for income taxes ....................................................... 361 245 1,008 801
------- ------- ------- -------
Net Income ....................................................................... $ 880 $ 668 $ 2,482 $ 2,129
======= ======= ======= =======
Net Income Per Share ............................................................. $ .62 $ .48 $ 1.74 $ 1.50
======= ======= ======= =======
Cash Dividends Per Share ......................................................... $ .16 $ .14 $ .48 $ .42
======= ======= ======= =======
</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,
1997 1996
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<S> <C> <C>
Assets
Cash and due from banks ........................................................................ $ 9,468 $ 12,459
Federal funds sold ............................................................................. 4,166 6,480
Investment securities
available-for-sale ........................................................................... 70,090 52,779
held-to-maturity (market value $43,001 and $42,760) .......................................... 42,743 42,699
Total loans, net of unearned income of $356 and $432 ........................................... 158,917 159,278
Allowance for possible loan losses ........................................................... (2,657) (2,585)
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Net loans ................................................................................ 156,260 156,693
Premises and equipment, net .................................................................... 4,068 4,358
Other real estate owned ........................................................................ 983 1,395
Accrued interest receivable .................................................................... 2,018 1,689
Other assets ................................................................................... 1,698 1,895
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Total assets ................................................................................... $ 291,494 $ 280,447
========= =========
Liabilities
Deposits
Demand, noninterest-bearing .................................................................. $ 30,213 $ 32,033
NOW accounts ................................................................................. 40,943 39,566
Money market accounts ........................................................................ 34,177 31,847
Savings ...................................................................................... 34,189 34,287
Time ......................................................................................... 97,408 94,878
Time over $100 000 ........................................................................... 17,943 14,133
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Total deposits ........................................................................... 254,873 246,744
Short-term borrowings ......................................................................... 9,226 8,675
Accrued interest payable ....................................................................... 1,076 1,012
Other liabilities .............................................................................. 1,204 1,241
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Total liabilities .............................................................................. 266,379 257,672
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Commitments and contingencies
Shareholders' Equity
Common stock, par value $1.25 per share;
authorized 5,000,000 shares; issued 1,428,241 shares and 1,425,951 shares .................... 1,785 1,782
Surplus ........................................................................................ 4,348 4,296
Retained earnings .............................................................................. 18,382 16,585
Unrealized holding gains, net of taxes, on investment securities available-for-sale ............ 600 112
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Total shareholders' equity ..................................................................... 25,115 22,775
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Total liabilities and shareholders' equity ..................................................... $ 291,494 $ 280,447
========= =========
</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, 1997 l996
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<S> <C> <C>
Operating Activities
Net income ....................................................................................... $ 2,482 $ 2,129
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for possible loan losses .............................................................. 300 300
Depreciation and amortization ................................................................... 364 372
Securities gains ................................................................................ (165) (94)
Net gain on sale of loans ....................................................................... (66) (60)
Writedowns, net of (gains) losses on sales of other real estate owned ........................... (17) 35
Deferred income tax provision ................................................................... (26) (30)
Change in income taxes payable .................................................................. 82 (119)
Net (increase) decrease in interest and dividends receivable .................................... (329) 63
Net amortization of premiums and discounts ...................................................... 4 41
Net increase in interest payable ................................................................ 64 10
Increase in other assets ........................................................................ (82) (269)
(Decrease) increase in other liabilities ........................................................ (65) 83
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Net cash provided by operating activities ....................................................... 2,546 2,461
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Investing Activities
Proceeds from maturities and calls of investment securities
available-for-sale ............................................................................. 7,893 11,147
held-to-maturity ............................................................................... 3,821 6,794
Proceeds from sales of investment securities
available-for-sale ............................................................................. 9,951 15,526
Purchase of investment securities
available-for-sale ............................................................................. (34,276) (25,656)
held-to-maturity ............................................................................... (3,844) (7,689)
Net decrease (increase) in Federal funds sold .................................................. 2,314 (6,905)
Proceeds from sale of student loans ............................................................ 1,469 1,442
Proceeds from sales of residential mortgages .................................................... 2,107 2,660
Originations of residential mortgages held-for-sale .............................................. (575) (1,995)
Net increase in loans ............................................................................ (2,802) (5,389)
Net purchases of premises and equipment .......................................................... (74) (239)
Proceeds from the sale of other real estate owned ................................................ 429 274
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Net cash used by investing activities .......................................................... (13,587) (10,030)
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Financing Activities
Net (decrease) increase in noninterest-bearing deposits .......................................... (1,820) 1,032
Net increase in interest-bearing deposits ........................................................ 9,949 11,823
Net increase (decrease) in short-term borrowings ................................................. 551 (3,381)
Cash dividends paid .............................................................................. (685) (598)
Proceeds from issuance of common stock ........................................................... 55 11
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Net cash provided by financing activities ...................................................... 8,050 8,887
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(Decrease) increase in cash and cash equivalents ............................................... (2,991) 1,318
Cash and cash equivalents at beginning of year ................................................. 12,459 12,950
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Cash and cash equivalents at end of period ..................................................... $ 9,468 $ 14,268
========= =========
Supplemental Cash Flow Disclosures
Interest paid .................................................................................... $6,646 $ 6,219
Income taxes paid ................................................................................ 930 950
Non-Cash Transactions
Transfer of loans to other real estate owned ................................................... -- 957
Change in net unrealized holding gains (losses), net of taxes, on investment securities......... 488 (362)
</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, 1997 AND 1996, AND DECEMBER 31, 1996
(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, 1997, as well as the
respective statements of income and cash flows for the three and nine month
periods ended September 30, 1997 and 1996, are unaudited. These financial
statements should be read in conjunction with the audited financial statements
and notes thereto included in QNB's 1996 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 year's financial statements have been reclassified to conform to the
current year's presentation. These reclassifications had no effect on net
income.
2. PER SHARE DATA
The following average shares were used for the computation of earnings per
share:
For the Nine Months
Ended September 30,
1997 1996
Average shares 1,427,502 1,424,002
In February 1997, the Financial Accounting Standards Board issued Statement No.
128, Earnings per Share, which is required to be adopted on December 31, 1997.
At that time, QNB will be required to change the method currently used to
compute earnings per share and to restate all prior periods. Under the new
requirements for calculating primary earnings per share, the dilutive effect of
stock options will be excluded. The impact of Statement 128 on the calculation
of primary earnings per share and fully diluted earnings per share is not
expected to be material.
3. ACQUISITION
On October 30, 1997, The Quakertown National Bank (the Bank) completed its
purchase of certain assets and liabilities of the Quakertown office of First
Lehigh Bank. The Bank purchased approximately $6,800,000 of deposits. The
transaction was accounted for using the purchase method.
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 120 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."
In addition to historical information, this management discussion and analysis
contains forward-looking statements. The forward-looking statements contained
herein are subject to certain risks and uncertainties that could cause actual
results to differ materially from those projected in the forward-looking
statements. Readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect management's analysis only as of the
date hereof. The Corporation undertakes no obligation to publicly revise or
update these forward-looking statements to reflect events or circumstances that
arise after the date hereof.
RESULTS OF OPERATIONS
QNB recorded earnings of $880,000 or $.62 per share for the three month period
ending September 30, 1997. This represents a record quarter for the Corporation
and a 31.7 percent increase from net income of $668,000 or $.48 per share
reported for the same period in 1996. For the nine month periods ending
September 30, 1997 and 1996, net income and earnings per share were $2,482,000
and $1.74 and $2,129,000 and $1.50, respectively.
Higher net interest income and non-interest income and lower non-interest
expense all contributed to the increase in reported earnings for the quarter.
Net interest income increased $240,000 or 8.4 percent to $3,097,000 for the
three month period ending September 30, 1997. A 4.4 percent increase in average
earning assets combined with a 16 basis point increase in the net interest
margin account for the increase in net interest income. The receipt of
approximately $58,000 in interest on non-accrual loans accounts for
approximately 9 basis points of the increase in the net interest margin.
Non-interest income increased $55,000 or 12.9 percent while non-interest expense
decreased $33,000 or .5 percent. Rental income on other real estate owned and
the gain on the sale of other real estate owned contributed to the improvement
in non-interest income. Higher fee-based product income for merchant processing
and check cards offset a decline in fees on deposit accounts and mortgage
servicing fees. The improvement in non-interest expense is a result of lower
costs associated with loan origination and maintenance, employee benefit costs
and legal expense. An increase in other real estate owned expense partially
offset these improvements. QNB continuously looks for areas to increase its fee
based revenue while also seeking to control costs.
Return on average assets was 1.20 percent and .95 percent while the return on
average equity was 14.47 percent and 12.17 percent for the quarters ending
September 30, 1997 and 1996, respectively. For the nine month periods ending
September 30, 1997 and 1996, return on average assets was 1.16 percent and 1.04
percent while return on average equity was 14.10 percent and 13.36 percent,
respectively.
Higher net interest income and non-interest income contributed to the
improvement in earnings for the nine month period ending September 30, 1997. Net
interest income increased $465,000 or 5.5 percent as a result of a 4.7 percent
increase in average earning assets and a two basis point increase in the net
interest margin. Contributing to the increase in non-interest income for 1997
was the pre-tax gain on the sale of equity
Form 10-Q
Page 5
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS (Continued)
securities of $159,000. This compares to a gain of $70,000 on the sale of equity
securities during the first nine months of 1996. Excluding the gains on
securities sales non-interest income increased $176,000 when comparing the nine
month periods. This is primarily the result of rental income on other real
estate owned, the introduction of a check card product and increased
profitability in the merchant processing program. Non-interest expense increased
$152,000 or 2.3 percent in the first nine months of 1997 principally as a result
of increases in salaries and benefits expense, other real estate owned expense,
Federal Deposit Insurance premium expense and furniture and equipment expense.
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 non-interest-bearing deposits and shareholders' equity.
Net interest income for the three months ended September 30, 1997 was $3,097,000
compared to $2,857,000 for the quarter ending September 30, 1996. A 4.4 percent
increase in average earning assets combined with a 16 basis point increase in
the net interest margin account for the increase in net interest income. The
growth in earning assets during the quarter occurred in both loans and
investments with average loans increasing from $155,425,000 to $160,908,000 and
average investment securities increasing from $102,495,000 to $109,128,000. The
growth in earning assets was fueled by increases in deposits, both non-interest
bearing and interest-bearing. The net interest margin on a fully taxable
equivalent basis for the three month period ended September 30, 1997 was 4.66
percent compared to 4.50 percent for the same period in 1996. The receipt of
approximately $58,000 in interest on non-accrual loans accounts for
approximately 9 basis points of the increase in the net interest margin. The
increase in the net interest margin is a result of the yield on earning assets
increasing to a greater degree than the rate paid on sources of funds. The yield
on earning assets on a fully taxable equivalent basis was 7.98 percent for the
third quarter of 1997 versus 7.79 percent for the third quarter of 1996, while
the rate paid on interest-bearing liabilities was 3.91 percent and 3.81 percent
for the same periods. The higher yield on earning assets is a result of an
increase in the yield on investment securities from 6.47 percent to 6.56 percent
and an increase in the yield on loans from 8.74 percent to 9.01 percent.
Excluding the impact of the income received on non-accrual loans, the yield on
earning assets and the yield on loans would have been 7.90 percent and 8.87
percent, respectively. The yield on interest-bearing deposits increased from
3.84 percent to 3.92 percent while the yield on short-term borrowings increased
from 3.11 percent to 3.76 percent. Also, positively impacting the net interest
margin was the 9.0 percent increase in average non-interest bearing deposits.
Net interest income for the nine month period ending September 30, 1997 was
$9,003,000; an increase of $465,000 over the $8,538,000 recorded in 1996. A 4.7
percent increase in average earning assets and a two basis point increase in the
net interest margin contributed to the increase in net interest income. Total
interest income increased $946,000 from $14,767,000 to $15,713,000 when
comparing the nine month periods ending September 30, 1996 to September 30,
1997. The yield on earning assets increased from 7.85 percent to 7.97 percent,
with the yield on investment securities increasing from 6.45 percent to 6.58
percent and the yield on
Form 10-Q
Page 6
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (Continued)
loans increasing from 8.81 percent to 8.95 percent during the nine month
periods. Average investment securities increased 6.8 percent to $104,918,000
while average loans increased 3.8 percent to $160,596,000. Total interest
expense increased $481,000 from $6,229,000 to $6,710,000 for the nine month
periods. The rate paid on interest-bearing liabilities increased from 3.76
percent to 3.89 percent, with the yield on interest-earning deposits increasing
from 3.78 percent to 3.91 percent and the yield on short-term borrowings
increasing from 3.13 percent to 3.39 percent. Average interest-bearing deposits
increased 4.0 percent to $221,489,000 for the nine month period ending September
30, 1997. The net interest margin for the nine month periods ended September 30,
1997 and 1996 was 4.64 percent and 4.62 percent, respectively.
The increased yield on earning assets during both the three and nine month
periods was the result of higher yields on both investment securities and loans.
Contributing to the increased yield on investment securities was a higher level
of interest rates for most of the first nine months of 1997, the maturity and
sales of lower yielding investment securities and a slight lengthening of the
weighted average maturity of the investment portfolio. A higher prime rate of
interest for both the three and nine month periods of 1997 contributed to the
increase in the yield on loans. A significant portion of QNB's loan portfolio
adjusts with the prime rate. The average prime rate for the third quarter of
1997 was 8.50 percent compared to 8.25 percent for the third quarter of 1996 and
8.42 percent for the nine month period ending September 30, 1997 versus 8.31
percent for the same period in 1996. An extremely competitive local market for
loans has had a negative impact on the rates charged on loans.
The increase in the rate paid on interest-bearing liabilities for both the three
and nine month periods was the result of higher rates on time deposits and a
change in rate structure on money market accounts, savings accounts and cash
management accounts. During the first quarter of 1997, QNB introduced a 30 month
certificate of deposit that enables the holder to increase the interest rate
twice during the term of the certificate, should rates offered on the 30 month
time deposit increase. As a result of this promotion QNB experienced a small
shift of funds from lower yielding non-maturity deposits to higher yielding time
deposits. During the third quarter of 1997 QNB changed the rate structure on
money market accounts, savings accounts and cash management accounts to a tiered
structure that pays a higher rate of interest on higher balances. The largest
impact was on cash management accounts, the rate on which was increased
significantly to compete with brokerage house and mutual fund money market
products.
QNB anticipates a decline in the net interest margin during the fourth quarter
of 1997 as rates earned on loans continue to decline due to the competitive
environment. Also negatively impacting the net interest margin will be a decline
in the yield on the investment portfolio as market interest rates have declined
sharply during the beginning of the fourth quarter and a slightly higher yield
on interest-bearing liabilities resulting from the purchase of deposits from
First Lehigh Bank.
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
Form 10-Q
Page 7
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
PROVISION FOR POSSIBLE LOAN LOSSES (Continued)
credit, current and projected credit worthiness of the borrower, current value
of the underlying collateral, levels of and trends in delinquencies and
non-accrual 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 three month periods
and $300,000 for both nine month periods ending September 30, 1997 and 1996. Net
charge-offs in the third quarter of 1997 were $103,000 compared to $30,000 for
the same period in 1996. Net charge-offs were $228,000 and $108,000 for the nine
month periods ending September 30, 1997 and 1996, respectively. QNB's net
charge-offs as a percentage of average loans was .19 percent (annualized) for
the nine month period ended September 30, 1997, compared with .09 percent for
the same 1996 period. The charge-off of a group of investment property loans to
one borrower account for $98,000 of the gross charge-offs in the third quarter
of 1997. Management anticipates the provision for possible loan losses to remain
near current levels as long as asset quality continues to improve as expected
and charge-off levels remain relatively low.
Non-performing assets (non-accruing loans, loans past due 90 days or more, and
other real estate owned) decreased 16.2 percent from the second quarter of 1997.
Non-performing assets at September 30, 1997 were $3,118,000 or 1.07 percent of
total assets compared to $3,719,000 or 1.26 percent of total assets at June 30,
1997. Non-performing assets have shown dramatic improvement when compared to the
levels reported at September 30, 1996 and December 31, 1996. Non-performing
assets at these dates were $6,021,000 or 2.10 percent of total assets and
$4,260,000 or 1.52 percent of total assets, respectively.
Non-accrual loans were $2,022,000 and $4,429,000 at September 30, 1997 and 1996.
Non-accrual loans at December 31, 1996 were $2,700,000. Non-accrual loans are
anticipated to decrease to less than 1.0 percent of total loans by December 31,
1997 as a result of the foreclosure on a group of loans and as payments are
received on other loans. Other real estate owned was $983,000 at September 30,
1997 compared to $1,423,000 at September 30, 1996 and $1,395,000 at December 31,
1996. Other real estate owned is anticipated to increase as of December 31, 1997
as a result of the foreclosures mentioned previously. Management anticipates
total non-performing assets to decline during the fourth quarter of 1997 to
represent less than 1.0 percent of total assets and to improve further in 1998
as a result of sales of other real estate.
There were no restructured loans as of September 30, 1997, December 31, 1996 or
September 30, 1996 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 non-accrual
loans.
The allowance for possible loan losses was $2,657,000 and $2,585,000 at
September 30, 1997 and December 31, 1996, respectively. The ratio of the
allowance to total loans was 1.67 percent and 1.62 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.
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.
Form 10-Q
Page 8
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
PROVISION FOR POSSIBLE LOAN LOSSES (Continued)
Under the 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.
At September 30, 1997 and 1996, the recorded investment in loans for which
impairment has been recognized in accordance with SFAS No. 114 totaled
$1,782,000 and $4,331,000, respectively, of which $1,329,000 and $2,232,000
related to loans with no valuation allowance and $453,000 and $2,099,000 related
to loans with a corresponding valuation allowance of approximately $136,000 and
$576,000, respectively. Most of the loans identified as impaired are
collateral-dependent.
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 $55,000 or 12.9
percent to $482,000 for the quarter ending September 30, 1997 when compared to
September 30, 1996. For the nine month period total non-interest income
increased $247,000 or 19.0 percent to $1,550,000.
Fees for services to customers, the largest component of total non-interest
income, is primarily comprised of service charges on deposit accounts. These
fees decreased 7.7 percent, to $265,000 from $287,000, when comparing the two
quarters and increased $1,000 to $803,000 when comparing the nine month periods.
A lower volume of overdraft charges, reduced fee income on business checking
accounts and a decrease in fees related to reduced volume usage of
out-of-network ATM machines were the primary reasons for the decline during the
quarter. QNB reviews all service charges and fee schedules related to its
products and services on an ongoing basis. QNB prices its products and services
extremely competitively. QNB has not materially changed these schedules during
1997 or 1996.
To date, when QNB sells 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
September 30, 1997 were $43,000 which represents a $9,000 decline from the same
period in 1996. The decrease in mortgage servicing fees for the quarter is a
result of a 7.9 percent decline in the average balance of mortgages sold and
serviced to $69,270,000. For the nine month period mortgage servicing fees
decreased $23,000 or 14.5 percent to $136,000. The average balance of mortgages
serviced was approximately $70,908,000 for the nine month period ending
September 30, 1997 compared to $77,075,000 for the first nine months of 1996.
The decrease in the volume of mortgages serviced for others is a result of the
origination of fewer residential mortgages, management's decision to retain 15
and 20 year mortgages, which would have been sold in prior years and payments
received on mortgages serviced. 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" also impacts the level of
servicing income
Form 10-Q
Page 9
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (Continued)
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 is required to be measured at each reporting date to determine any
potential impairment. The amortization of the servicing asset reduces the amount
of servicing income recorded.
There were no sales on investment securities during the third quarter of 1997.
Gains on the sale of investment securities were $1,000 for the third quarter of
1996. This small gain 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 deposits of a local school
district. A new arrangement was made with the school district in 1997 to help
reduce the volatility of these deposits. For the nine month periods ending
September 30, 1997 and 1996 the net gain on the sale of investment securities
was $165,000 and $94,000, respectively. Net gains on the sale of debt securities
were $6,000 for the first nine months of 1997 compared to $24,000 for the same
period in 1996. The gain in 1997 was a result of the sale of approximately
$6,500,000 of U.S. Treasury and U.S. agency securities during the second quarter
and $3,467,000 of agency securities during the first quarter. These securities
were primarily sold for liquidity reasons. With regard to 1996, in addition to
the transaction mention previously for the third quarter, QNB recorded a gain of
$23,000 during the second quarter. This resulted from the sale of approximately
$5,500,000 in U.S. Treasury and agency securities. QNB took advantage of a steep
slope in the short-end of the Treasury yield curve to "pre-fund" bonds that
would have matured 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 and
also increase the overall book yield on the portfolio.
The Corporation owns a small portfolio of marketable equity securities, bank
stocks. QNB took advantage of the run-up of stock prices during the beginning of
1997 and sold securities with a cost basis of $329,000 for a gain of $159,000.
$70,000 of the gain recorded in 1996 relates to the sale of a marketable equity
security with a book value of $45,000.
QNB recorded a gain of $24,000 on the sale of loans during the third quarter of
1997. This compares to a $21,000 gain for the same period in 1996. The sale of
approximately $1,500,000 of residential mortgages and $87,000 of student loans
accounts for $23,000 and $1,000 of the gains, respectively in 1997. Declining
interest rates during the third quarter of 1997 provided the opportunity to sell
some lower yielding 15 and 20 year mortgages that had been in portfolio. The
sale of approximately $587,000 in residential mortgages during the third quarter
of 1996 provided a gain of $19,000. As of September 30, 1997 and 1996, QNB had
approximately $169,000 and $100,000 in mortgage loans classified as held for
sale. These loans are accounted for at lower of cost or market.
For the nine month periods ended September 30, 1997 and 1996 net gains on the
sale of loans was $66,000 and $60,000, respectively. The gain on the sale of
student loans was $33,000 and $32,000 while the gain on the sale of residential
mortgages was $33,000 and $28,000, respectively during these nine month periods.
QNB sold approximately $1,436,000 and $1,410,000 in student loans during the
first nine months of 1997 and 1996. 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. Proceeds from the sale of residential
mortgages were approximately $2,107,000 and $2,660,000 during the first nine
months of 1997 and 1996. Declining interest rates in 1997 enabled QNB to sell
mortgages at a gain while rising interest rates in 1996 created a smaller gain
despite the higher volume of mortgages sold.
Form 10-Q
Page 10
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (Continued)
Other operating income increased $84,000 to $150,000 when comparing the three
month periods and $192,000 to $380,000 when comparing the nine month periods
ending September 30, 1997 and 1996. The recognition of rental income on other
real estate owned accounts for $29,000 and $91,000 of the increase for the three
and nine month periods. Income on the check card introduced in December 1996
accounts for an additional $18,000 and $46,000 of the improvement for the three
and nine month periods. The sale of a property within other real estate owned
provided a gain of $25,000 during the third quarter of 1997. Merchant processing
income provided an additional $7,000 during the third quarter of 1997 compared
to 1996 and an additional $16,000 when comparing the nine month periods. At the
end of 1996 QNB analyzed its merchant processing operations and adjusted the
pricing for the service to make it more profitable. QNB's practice of not
surcharging ATM customers has provided additional income through a higher
interchange fee. QNB receives a fee from the non-customer's bank when
non-customers use a Quakertown National Bank machine. The volume of these
non-customer transactions has increased as a result of other banks in the market
area surcharging transactions.
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 $2,238,000
for the quarter ending September 30, 1997 represents a decrease of $33,000 or
1.5 percent over levels reported in the third quarter of 1996. Total
non-interest expense for the nine months ending September 30, 1997 was
$6,763,000, an increase of $152,000 or 2.3 percent over 1996 levels.
Salaries and benefits, the largest component of non-interest expense, decreased
$7,000 or 0.5 percent to $1,301,000 for the quarter ending September 30, 1997
compared to the same quarter in 1996. Salaries expense increased $18,000 or 1.7
percent during the period to $1,055,000 while benefits expense decreased $25,000
or 9.2 percent to $246,000. The reduction in salary expense is primarily related
to the elimination of an officer level position and the timing of replacing
terminated employees. The decrease in benefits expense is primarily the result
of the timing of the expense for Federal and State unemployment taxes. These
taxes decreased $11,000 in the third quarter of 1997 as a result of accruing
these costs on a monthly basis versus expensing them when paid as was done in
1996. This resulted in a higher expense in the first quarter of 1997 and a lower
expense in the second and third quarters. Costs associated with employee
education declined $9,000 during the quarter. This is a function of the timing
of the payments and the reduction in the number of employees taking classes.
Lower medical premiums and life and disability insurance premiums also
contributed to the decline in benefits expense.
Salaries and benefit expense for the nine month period ending September 30, 1997
was $3,955,000, an increase of $102,000 or 2.7 percent from the same period in
1996. Salaries expense was $87,000 or 2.9 percent higher, while benefit expense
was $15,000 or 1.9 percent higher. Included in salary expense for the nine
months ended September 30, 1997 was $27,000 in severance expense and $42,000 in
bonus accruals. There was no severance expense or bonus expense during the first
nine months of 1996. Excluding these items salary expense increased $18,000 or
0.6 percent. The increase in benefits expense is primarily the result of the
timing of the expense for Federal and State unemployment taxes and an increase
in the State unemployment tax rate. These taxes increased $18,000 in the first
nine months of 1997 as a result of accruing these costs versus expensing them
when paid as was done in 1996. Also contributing to the increase in benefits
expense were higher medical premiums of $7,000, higher retirement benefit costs
of $9,000 and higher payroll taxes of $6,000. Partially
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)
offsetting these increases were lower life and disability premiums of $13,000
and lower educational costs of $13,000. QNB anticipates an increase in salary
and benefit expense during the fourth quarter of 1997 as open positions are
filled and employee education costs are paid.
Net occupancy expense decreased $7,000 or 4.1 percent for the three month period
and $16,000 or 3.2 percent for the nine month period. Lower depreciation expense
on buildings and leasehold improvements account for $5,000 and $16,000 of the
decrease for the respective periods. Building repairs and maintenance expense
was also lower by $7,000 and $16,000 for the three and nine month periods.
Slightly higher utility costs and branch rent expense offset some of the savings
above. Furniture and equipment expense decreased $7,000 or 3.9 percent when
comparing the three month periods ending September 30, 1997 and 1996,
respectively. Depreciation expense declined $9,000 during the period. For the
nine month period ended September 30, furniture and equipment expense increased
$20,000 to $517,000 with equipment maintenance costs increasing $15,000 and
depreciation expense increasing $7,000. The increase in equipment maintenance
expense relates primarily to computer equipment.
Supplies expense decreased $20,000 or 33.3 percent to $40,000 for the three
month period and $26,000 or 16.5 percent to $132,000 for the nine month period
ending September 30, 1997. This improvement is a function of better expense
control through a competitive bid process.
Professional fees decreased $16,000 to $38,000 for the three month period and
$10,000 for the nine month period to $127,000. The reimbursement of legal costs
from prior periods as well as the improvement in asset quality contributed to
the $17,000 decrease in legal expense for the quarter and $15,000 for the nine
month period. Accounting costs increased $4,000 for the quarter and $9,000 for
the nine month period. The increase in accounting fees is partially related to
costs associated with the acquisition of the deposits of the First Lehigh Branch
in Quakertown.
Insurance expense, which includes Federal Deposit Insurance Corporation
(F.D.I.C.) insurance premiums as well as directors and officers liability
insurance, banker's bond and worker's compensation insurance, increased $5,000
for the three month period to $27,000 and $11,000 for the nine month period to
$78,000. F.D.I.C. insurance premiums increased $7,000 for the three month period
and $21,000 for the nine month period. In August 1995, the FDIC announced that
the Bank Insurance Fund (BIF) had met its legally set coverage ratios as of May
1995. By obtaining the coverage ratios the FDIC premiums for "well capitalized"
institutions in 1996 were eliminated except for the legally set annual minimum
of $2,000. This minimum has subsequently been eliminated in 1997. However, as a
result of the Deposit Insurance Act of 1996, QNB contributes to the payment of
the Financing Corporation (FICO) obligations. Lower premiums for workers
compensation and directors and officers insurance partially offset the increase
in the F.D.I.C. assessment.
Other real estate owned expense increased $30,000 to $80,000 when comparing the
third quarter of 1997 to the same quarter of 1996 and $38,000 when comparing the
nine month periods. The higher amount in 1997 reflects the cost of repairs and
maintenance on a couple of properties and the payment of real estate taxes.
Losses on the sale of other real estate owned or write-downs to properties owned
amounted to $35,000 in 1996. Management anticipates an increase in other real
estate expense in the fourth quarter resulting from the foreclosure of five
additional properties in October.
Form 10-Q
Page 12
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST EXPENSE (Continued)
Total other expense for the three months ending September 30, 1997 was $353,000,
a decrease of $11,000 from the same period in 1996. Lower loan origination
expense, primarily costs of appraisals and credit reports, and lower foreclosure
costs contributed to the decrease in total other expense. These savings offset
increases in postage expense and check card expense. For the nine month period
other expense increased $35,000 or 3.3 percent to $1,083,000. An increase in
directors fees resulting from an increase in the number of Bank directors and
the per meeting cost accounted for $13,000 of the increase. Costs related to the
startup, distribution and maintenance of the check card account for $31,000 of
the increase. An increase in fraud losses, postage expense and employee training
costs offset lower commercial loan appraisal costs and foreclosure costs when
comparing the two nine month periods ending September 30, 1997 and 1996.
INCOME TAXES
Applicable income taxes and effective tax rates were $361,000 or 29.1 percent
for the three month period ending September 30, 1997, and $245,000 or 26.8
percent for the same period in 1996. For the nine month periods ending September
30, 1997 and 1996, applicable income taxes and effective tax rates were
$1,008,000 or 28.9 percent and $801,000 or 27.3 percent, respectively. The
higher effective tax rate in 1997 compared to 1996 is a function of higher
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, 1997 QNB's net deferred tax asset
was $494,000 of which $663,000 relates to the allowance for possible loan
losses. QNB had a deferred tax liability of $309,000 as of September 30, 1997 as
a result of the SFAS No. 115 adjustment for the unrealized gain on
available-for-sale investment securities. As of September 30, 1996 QNB's net
deferred tax asset was $824,000 of which $642,000 related to the allowance for
possible loan losses and $72,000 was a result of the SFAS No. 115 adjustment for
the unrealized loss on available-for-sale investment securities.
BALANCE SHEET ANALYSIS
The Balance Sheet Analysis reviews average balance sheet data for the nine
months ended September 30, 1997 compared with the twelve month average for the
year ended December 31, 1996 as well as the period ending balances for the same
time periods.
Average earning assets for the nine month period ended September 30, 1997
increased $11,007,000 or 4.3 percent to $269,315,000 from $258,308,000 at
December 31, 1996. Average loans and average investments increased $5,421,000
and $6,542,000, respectively while average Federal funds sold decreased
$958,000. The increase in average loans is a direct result of the commercial
business development program implemented to increase QNB's loan to deposit ratio
and an aggressive marketing campaign for home equity loans. Average commercial
loans increased $3,608,000, average consumer loans increased $855,000 and
average mortgage loans increased $958,000 when comparing the two periods. The
increase in consumer loans is primarily in fixed rate home equity loans.
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)
The growth in average earning assets was primarily funded by increased
interest-bearing deposits, principally time deposits. Average time deposits
increased $9,303,000 and average interest bearing checking accounts (NOW
accounts) increased $1,096,000. Average money market accounts declined
$3,220,000. The movement of funds from money market accounts to time deposits
reflects the sensitivity of these funds to rising time deposit rates as well as
the impact of the "double bump" certificate of deposit promotion. Average
shareholders' equity increased $1,879,000 to $23,532,000.
Total assets at September 30, 1997 were $291,494,000, compared with $280,447,000
at December 31, 1996, an increase of 3.9 percent. Total deposits increased from
$246,744,000 at December 31, 1996 to $254,873,000 at September 30, 1997. While
this trend is encouraging, it represents a decline from June 30, 1997 total
assets of $294,072,000 and total deposits of $259,428,000. It is anticipated
that total assets will surpass $300,000,000 by the end of 1997, primarily as a
result of the purchase of $6,800,000 of deposits from First Lehigh Bank. The
increase in assets from December 31, 1996 to September 30, 1997 is primarily
centered in investment securities, which increased $17,355,000 during the
period.
As of December 31, 1996 QNB reported investment securities available-for-sale at
a fair value of $52,779,000 or $170,000 above the amortized cost of $52,609,000.
An unrealized holding gain, net of taxes, of $112,000 was reported as an
increase to shareholders' equity. As of September 30, 1997 QNB reported
investment securities available-for-sale at a fair value of $70,090,000 or
$909,000 over the amortized cost of $69,181,000. An unrealized holding gain, net
of taxes, of $600,000 is reported as an increase to shareholders' equity. The
increase in the unrealized holding gain from December to September is a result
of the increase in the value of the bank stock portfolio and an increase in the
value of debt securities as interest rates have declined.
The available-for-sale portfolio had a weighted average maturity of
approximately 4 years and 8 months and 4 years and 1 month at September 30, 1997
and December 31, 1996, respectively. The weighted average maturity is based on
the stated contractual maturity of all securities except for mortgage-backed
securities, which are based on estimated average life. The maturity of the
portfolio may be shorter because of call features in many debt securities and
because of prepayments on mortgage-backed securities. The interest rate
sensitivity analysis reflects the expected maturity distribution of the
securities portfolio based upon estimated call dates and anticipated cash flows
assuming management's most likely interest rate environment. The expected
weighted average life of the available-for-sale portfolio was 1 year and 9
months at September 30, 1997 and 2 years and 1 month at December 31, 1996, based
on these assumptions. Many of the purchases of investments during the quarter
included securities with slightly longer maturities and call dates.
Investment securities held-to-maturity are reported at amortized cost. As of
September 30, 1997 and December 31, 1996, QNB had securities classified as
held-to-maturity with an amortized cost of $42,743,000 and $42,699,000 and a
market value of $43,001,000 and $42,760,000, respectively. The held-to-maturity
portfolio had a weighted average maturity of approximately 3 years and 2 months
at September 30, 1997 and 3 years and 6 months at December 31, 1996.
Form 10-Q
Page 14
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
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 certain
residential mortgage originations and student loans in the secondary market also
provide sources of liquidity.
Cash and due from banks, Federal funds sold, available-for-sale securities and
loans held-for-sale were $83,893,000 and $71,821,000 at September 30, 1997 and
December 31, 1996. These sources were adequate to meet seasonal deposit
withdrawals during the first half of 1997 and should be adequate to meet normal
fluctuations in loan demand and or deposit withdrawals. Approximately
$38,412,000 and $34,381,000 of available-for-sale securities at September 30,
1997 and December 31, 1996 were pledged as collateral for repurchase agreements,
public deposits and other deposits as provided by law. The Bank will be
considering membership in the Federal Home Loan Bank. This would provide QNB
with an additional source of liquidity. The acquisition of deposits from the
Quakertown branch of First Lehigh Bank provided approximately $6,800,000 in
additional funds to QNB. This transaction was completed on October 30, 1997.
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 $2,991,000 to $9,468,000 at September 30, 1997. This
compares to a $1,318,000 increase during the first nine months of 1996. After
adjusting net income for non-cash transactions, operating activities provided
$2,546,000 in cash flow in the first nine months of 1997, compared to $2,461,000
in the same period of 1996.
Net cash used by investing activities was $13,587,000 during the first nine
months of 1997. This resulted largely from the purchase of investment securities
exceeding sales and maturities by $16,455,000 and a net increase in loans of
$2,802,000. A decrease in Federal funds sold provided $2,314,000 while proceeds
from the sale of loans provided $3,576,000. With the reduced volatility of the
deposits of a local school district QNB has been able to reduce the amount of
Federal funds sold. With slow loan growth, this has meant an increase in
investment securities, primarily available-for-sale securities. Net cash used by
investing activities of $10,030,000 during the first nine months of 1996
resulted largely from the increase in Federal funds sold of $6,905,000 and a net
increase in loans of $5,389,000. The purchase 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 in 1996. Proceeds from the sale of loans provided cash of
$4,102,000 during the first nine months of 1996.
Net cash provided by financing activities of $8,050,000 during the first nine
months of 1997 was the result of an increase in interest-bearing deposits,
primarily time deposits and money market accounts, which increased $6,340,000
and $2,330,000, respectively. A time deposit promotion during the first half of
the year contributed to the increase. Time deposits over $100,000 represent
$3,810,000 of the increase in time deposits. Non-interest bearing deposits
decreased $1,820,000 during the first nine months of 1997. Net cash provided by
financing activities of $8,887,000 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
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.
Form 10-Q
Page 15
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
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, 1997 was
$25,115,000 or 8.62 percent of total assets compared to shareholders' equity of
$22,775,000 or 8.12 percent of total assets at December 31, 1996. Shareholders'
equity at September 30, 1997 includes a positive adjustment of $600,000 related
to unrealized holding gains, net of taxes, on investment securities
available-for-sale, while shareholders' equity at December 31, 1996 includes a
positive adjustment of $112,000. Without these adjustments shareholders' equity
to total assets would have been 8.41 percent and 8.08 percent at September 30,
1997 and December 31, 1996.
Shareholders' equity averaged $23,532,000 for the first nine months of 1997 and
$21,653,000 during all of 1996, an increase of 8.7 percent. The ratio of average
total equity to average total assets improved to 8.24 percent for 1997, compared
to 7.89 percent for 1996. The increase in the equity to asset ratio is a
function of higher net income, an increase in capital retention despite
increasing the cash dividend in both 1997 and 1996 and modest asset growth.
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 measure the ratio of Tier
I capital to average 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 14.15 percent and 13.15 percent, a total
risk-based ratio of 15.40 percent and 14.40 percent and a leverage ratio of 8.42
percent and 8.14 percent at September 30, 1997 and December 31, 1996,
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, 1997 and December 31, 1996 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.
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.
Form 10-Q
Page 16
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INTEREST RATE SENSITIVITY (Continued)
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, 1997, interest earning assets scheduled to mature, likely to be
called, reprice or repay in one year were $102,479,000. Interest sensitive
liabilities scheduled to mature or reprice within one year were $99,150,000. The
one year cumulative gap, which reflects QNB's interest sensitivity over a period
of time, was a positive $3,329,000 at September 30, 1997. The cumulative
one-year gap equals 1.21 percent of total earning assets. This positive or asset
sensitive gap will generally benefit QNB in a rising interest rate environment,
while falling interest rates will negatively impact QNB. As of December 31, 1996
QNB had a slightly negative gap position of $1,672,000 at the one year time
frame. The shift to a positive gap position is a function of falling interest
rates changing the characteristics of some of the callable agency securities and
mortgage-backed securities to have shorter effective maturity dates. Interest
earning assets in the one year time band as of June 30, 1997 were $87,688,000,
$14,791,000 less than September 30, 1997. A lower interest rate environment has
shifted some of the callable agency securities to be considered likely to be
called within the next 12 months and has increased the estimated cash flows from
the mortgage-backed securities. Despite this movement QNB's positive gap
position has not changed dramatically since June 30, 1997 because of the
migration of the maturity of time deposits to within one year, an increase in
time deposits over $100,000 with maturities within one year and the increase in
variable rate NOW accounts. Interest sensitive liabilities scheduled to mature
or reprice within one year were $84,415,000, at June 30, 1997 $14,735,000 less
than September 30, 1997.
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 balance sheet growth and composition and interest rates
for the next year, net interest income for the next twelve months is expected to
increase compared to the prior twelve months.
If interest rates are 100 basis points lower 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. Conversely, if
interest rates are 100 basis points higher, net interest income for the most
likely scenario would decline slightly. These results are different than what
would be expected from using the static gap model. This shows the inherent
weakness of static gap. The primary reason for the difference between the
simulation model and the static gap is that the simulation model takes into
consideration the impact of changing rates on the callable agency securities and
mortgage backed securities.
Form 10-Q
Page 17
<PAGE>
QNB CORP. AND SUBSIDIARY
PART II. OTHER INFORMATION
SEPTEMBER 30, 1997
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
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 18
<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 13, 1997 By:
-------------------------
/s/ Thomas J. Bisko
-------------------------
Thomas J. Bisko
President/CEO
Date: November 13, 1997 By:
-------------------------
/s/ Robert C. Werner
-------------------------
Robert C. Werner
Vice President
Date: November 13, 1997 By:
-------------------------
/s/ Bret H. Krevolin
-------------------------
Bret H. Krevolin
Chief Accounting Officer
Form 10-Q
Page 19
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 9,468
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 4,166
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 70,090
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<INVESTMENTS-MARKET> 43,001
<LOANS> 158,917
<ALLOWANCE> 2,657
<TOTAL-ASSETS> 291,494
<DEPOSITS> 254,873
<SHORT-TERM> 9,226
<LIABILITIES-OTHER> 2,280
<LONG-TERM> 0
0
0
<COMMON> 1,785
<OTHER-SE> 23,330
<TOTAL-LIABILITIES-AND-EQUITY> 291,494
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<INTEREST-INVEST> 4,959
<INTEREST-OTHER> 154
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<INTEREST-DEPOSIT> 6,485
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<INTEREST-INCOME-NET> 9,003
<LOAN-LOSSES> 300
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<EXPENSE-OTHER> 6,763
<INCOME-PRETAX> 3,490
<INCOME-PRE-EXTRAORDINARY> 2,482
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<NET-INCOME> 2,482
<EPS-PRIMARY> 1.74
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<YIELD-ACTUAL> 4.64
<LOANS-NON> 2,022
<LOANS-PAST> 113
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 4,684
<ALLOWANCE-OPEN> 2,585
<CHARGE-OFFS> 246
<RECOVERIES> 18
<ALLOWANCE-CLOSE> 2,657
<ALLOWANCE-DOMESTIC> 2,657
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<ALLOWANCE-UNALLOCATED> 1,589
</TABLE>
