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, 1998
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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 _________
Commission file number 0-17706
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QNB Corp.
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(Exact Name of Registrant as Specified in Its Charter)
Pennsylvania 23-2318082
- --------------------------------- -------------------
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
10 North Third Street, Quakertown, PA 18951-9005
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (215)538-5600
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Not Applicable
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Former Name, Former Address and Former Fiscal Year, if Changed Since Last
Report.
Indicate by check |X| whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No __
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, 1998
- ----------------------------- ---------------------------
Common Stock, par value $1.25 1,431,240
<PAGE>
QNB CORP. AND SUBSIDIARY
FORM 10-Q
QUARTER ENDED MARCH 31, 1998
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS PAGE
Consolidated Statements of Income for Three
Months Ended March 31, 1998 and 1997..........................1
Consolidated Balance Sheets at March 31, 1998
and December 31, 1997.........................................2
Consolidated Statements of Cash Flows for Three
Months Ended March 31, 1998 and 1997..........................3
Notes to Consolidated Financial Statements.............................4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION............................6
PART II - OTHER INFORMATION
OTHER INFORMATION.................................................... 18
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(in thousands, except share data)
(unaudited)
Three Months Ended March 31, 1998 1997
- --------------------------- ------ ------
<S> <C> <C>
Interest Income
Interest and fees on loans ................................. $3,625 $3,465
Interest and dividends on investment securities:
Taxable ................................................ 1,625 1,424
Tax-exempt ............................................. 140 130
Interest on Federal funds sold ............................. 65 44
------ ------
Total interest income ............................. 5,455 5,063
------ ------
Interest Expense
Interest on deposits
NOW accounts ........................................... 143 165
Money market accounts .................................. 235 231
Savings ................................................ 198 190
Time ................................................... 1,392 1,295
Time over $100,000 ..................................... 277 211
Interest on short-term borrowings .......................... 75 70
------ ------
Total interest expense ............................ 2,320 2,162
------ ------
Net interest income ............................... 3,135 2,901
Provision for loan losses .................................. 100 100
------ ------
Net interest income after provision for loan losses 3,035 2,801
------ ------
Non-Interest Income
Fees for services to customers ............................. 259 269
Mortgage servicing fees .................................... 42 45
Net gain on investment securities available-for-sale ....... 68 160
Net gain on sale of loans .................................. 54 34
Other operating income ..................................... 190 119
------ ------
Total non-interest income ......................... 613 627
------ ------
Non-Interest Expense
Salaries and employee benefits ............................. 1,361 1,351
Net occupancy expense ...................................... 156 163
Furniture and equipment expense ............................ 157 187
Marketing expense .......................................... 64 59
Supplies expense ........................................... 43 50
Professional fees .......................................... 32 49
Insurance expense .......................................... 24 27
Other real estate owned expense ............................ 46 35
Other expense .............................................. 385 358
------ ------
Total non-interest expense ........................ 2,268 2,279
------ ------
Income before income taxes ............................. 1,380 1,149
Provision for income taxes ................................. 403 328
------ ------
Net Income ............................................. $ 977 $ 821
====== ======
Net Income Per Share - Basic ........................... $ .68 $ .58
====== ======
Net Income Per Share - Diluted ......................... $ .68 $ .57
====== ======
Cash Dividends Per Share ............................... $ .18 $ .16
====== ======
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
1
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(in thousands)
(unaudited)
March 31, December 31,
1998 1997
--------- ------------
<S> <C> <C>
Assets
Cash and due from banks ................................ $ 11,740 $ 12,574
Federal funds sold ..................................... 10,247 2,022
Investment securities
available-for-sale ................................. 73,754 75,920
held-to-maturity (market value $40,872 and $40,713) 40,491 40,400
Total loans, net of unearned income of $425 and $448 ... 171,677 167,720
Allowance for loan losses .......................... (2,787) (2,670)
--------- ---------
Net loans ..................................... 168,890 165,050
Premises and equipment, net ............................ 4,103 4,066
Other real estate owned ................................ 822 1,564
Accrued interest receivable ............................ 1,921 2,007
Other assets ........................................... 2,201 2,169
--------- ---------
Total assets ........................................... $ 314,169 $ 305,772
========= =========
Liabilities
Deposits
Demand, non-interest-bearing ....................... $ 35,708 $ 38,692
NOW accounts ....................................... 42,461 42,176
Money market accounts .............................. 32,769 32,520
Savings ............................................ 38,358 36,629
Time ............................................... 103,307 101,447
Time over $100,000 ................................. 20,808 15,702
--------- ---------
Total deposits ................................ 273,411 267,166
Short-term borrowings .................................. 11,308 10,342
Accrued interest payable ............................... 1,153 1,057
Other liabilities ...................................... 1,612 1,375
--------- ---------
Total liabilities ...................................... 287,484 279,940
========= =========
Commitments and contingencies
Shareholders' Equity
Common stock, par value $1.25 per share;
authorized 5,000,000 shares; issued 1,431,240 shares 1,789 1,789
Surplus ................................................ 4,369 4,369
Retained earnings ...................................... 19,521 18,801
Accumulated other comprehensive income ................. 1,006 873
--------- ---------
Total shareholders' equity ............................. 26,685 25,832
--------- ---------
Total liabilities and shareholders' equity ............. $ 314,169 $ 305,772
========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
2
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(in thousands)
(unaudited)
Three Months Ended March 31, 1998 1997
-------- --------
<S> <C> <C>
Operating Activities
Net income .............................................................................. $ 977 $ 821
Adjustments to reconcile net income to net cash provided by operating activities
Provision for loan losses ............................................................. 100 100
Depreciation and amortization ......................................................... 100 124
Securities gains ...................................................................... (68) (160)
Net gain on sale of loans ............................................................. (54) (34)
Net gains on sales or writedowns of other real estate owned ........................... (41) (1)
Deferred income tax provision ......................................................... (23) (29)
Change in income taxes payable ........................................................ 419 346
Net decrease (increase) in interest and dividends receivable .......................... 86 (248)
Net amortization of premiums and discounts ............................................ (1) 8
Net increase in interest payable ...................................................... 96 97
Increase in other assets .............................................................. (142) (226)
Decrease in other liabilities ......................................................... (117) (44)
-------- --------
Net cash provided by operating activities ............................................. 1,332 754
-------- --------
Investing Activities
Proceeds from maturities and calls of investment securities
available-for-sale .................................................................... 9,222 4,060
held-to-maturity ...................................................................... 3,082 785
Proceeds from sales of investment securities
available-for-sale .................................................................... 5,114 3,467
Purchase of investment securities
available-for-sale .................................................................... (11,906) (14,105)
held-to-maturity ...................................................................... (3,167) (995)
Net increase in Federal funds sold ...................................................... (8,225) (86)
Proceeds from sales of student loans .................................................... 211 1,126
Proceeds from sales of residential mortgages ............................................ 2,051 325
Originations of residential mortgages held-for-sale ..................................... (1,631) (327)
Net increase in loans ................................................................... (4,516) (3,440)
Net purchases of premises and equipment ................................................. (138) (16)
Proceeds from the sale of other real estate owned ....................................... 783 221
-------- --------
Net cash used by investing activities ................................................. (9,120) (8,985)
-------- --------
Financing Activities
Net decrease in non-interest-bearing deposits ........................................... (2,984) (145)
Net increase in interest-bearing deposits ............................................... 9,229 6,105
Net increase in short-term borrowings ................................................... 966 1,662
Cash dividends paid ..................................................................... (257) (228)
Proceeds from issuance of common stock .................................................. -- 30
-------- --------
Net cash provided by financing activities ............................................. 6,954 7,424
-------- --------
Decrease in cash and cash equivalents ................................................. (834) (807)
Cash and cash equivalents at beginning of year ........................................ 12,574 12,459
-------- --------
Cash and cash equivalents at end of period ............................................ $ 11,740 $ 11,652
======== ========
Supplemental Cash Flow Disclosures
Interest paid ........................................................................... $ 2,224 $ 2,065
Income taxes paid ....................................................................... -- --
Non-Cash Transactions
Change in net unrealized holding gains (losses), net of taxes, on investment securities 133 (622)
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
3
<PAGE>
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998 AND 1997, AND DECEMBER 31, 1997
(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, 1998, as well as the respective
statements of income and cash flows for the three month period ended March 31,
1998 and 1997, are unaudited. These financial statements should be read in
conjunction with the audited financial statements and notes thereto included in
QNB's 1997 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 sets forth the computation of basic and diluted earnings per share
(share and per share data are not in thousands):
For the Three Months
Ended March 31,
1998 1997
---------- ----------
Numerator for basic and diluted earnings...... $ 977 $ 821
per share-net income
Denominator for basic earnings per share-
Weighted average shares outstanding......... 1,431,240 1,426,709
Effect of dilutive securities-employee
Stock options............................... 7,845 5,690
Denominator for diluted earnings per
share- adjusted weighted average
shares outstanding.......................... 1,439,085 1,432,399
Earnings per share-basic...................... $ .68 $ .58
Earnings per share-diluted.................... $ .68 $ .57
4
<PAGE>
3. COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No.
130, "Reporting Comprehensive Income." SFAS No. 130 requires the inclusion of
comprehensive income, either in a separate statement, or as part of a combined
statement of income and comprehensive income in a full set of general-purpose
financial statements.
Comprehensive income is defined as the change in equity of a business entity
during a period from transactions and other events and circumstances, excluding
those resulting from investments by and distributions to owners. For QNB, the
primary component of comprehensive income is the unrealized holding gains and
losses on available-for-sale investment securities.
The following shows the components and activity of comprehensive income during
the period (net of the income tax effect):
<TABLE>
<S> <C>
Unrealized holding gains arising during the period on securities held at March 31, 1998... $ 166
Reclassification adjustment equal to beginning unrealized for all sold securities ........ (30)
-------
Net change in unrealized during the period .......................................... 133
Unrealized, beginning of period .......................................................... 873
-------
Unrealized, end of period ................................................................ $ 1,006
</TABLE>
5
<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. Readers should carefully review the risk factors
described in other documents the Corporation files from time to time with the
Securities and Exchange Commission, including the quarterly reports on Form 10-Q
filed by the Corporation in 1998, and any Current Reports on Form 8-K filed by
the Corporation.
RESULTS OF OPERATIONS
QNB recorded record earnings of $977,000 or $.68 per share on a diluted basis
for the three month period ending March 31, 1998. This represents a 19.0 percent
increase from net income of $821,000 or $.57 per share-diluted reported for the
first quarter of 1997.
Continued improvement in core operating income accounted for most of the
increase in net income. Net interest income which represents interest income,
dividends, and fees on earning assets, less interest expense incurred on funding
sources, increased 8.1 percent to $3,135,000 for the quarter ending March 31,
1998 as compared to $2,901,000 for the period ending March 31, 1997. Significant
growth in average earning assets accounts for most of the improvement in net
interest income. Average earning assets increased 7.8 percent when comparing the
two quarters. Also positively impacting net interest income was a slight
increase in the net interest margin from 4.65 percent to 4.67 percent.
Non-interest income declined $14,000 or 2.2 percent and non-interest expense
declined $11,000 or .5 percent when comparing the two periods. Contributing to
the results during the first quarter of 1998 were pre-tax gains on the sale of
loans, securities and other real estate owned of $164,000. This compares to
pre-tax gains of $196,000 during the first quarter of 1997.
Return on average assets was 1.31 percent and 1.19 percent while the return on
average equity was 15.63 percent and 14.50 percent for the quarters ending March
31, 1998 and 1997, respectively.
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
6
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (Continued)
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 March 31, 1998 was $3,135,000
compared to $2,901,000 for the period ending March 31, 1997. A 7.8 percent
increase in average earning assets and a 2 basis point increase in the net
interest margin contributed to the increase in net interest income between the
periods. The yield on earning assets on a fully taxable equivalent basis was
7.99 percent for the first quarter of 1998 versus 7.98 percent for the first
quarter of 1997, while the rate paid on interest-bearing liabilities was 3.89
percent and 3.88 percent for the same periods. The net interest margin on a
fully taxable equivalent basis for the three month period ended March 31, 1998
was 4.67 percent compared to 4.65 percent for the same period in 1997.
The slightly higher yield on earning assets is a result of an increase in the
yield on investment securities. The yield on investment securities increased to
6.73 percent from 6.59 percent while the yield on loans decreased slightly to
8.89 percent from 8.90 percent when comparing the three months ended March 31,
1998 to March 31, 1997. The increase in the yield on investments was primarily
the result of the sale of approximately $9,000,000 in securities with a weighted
average yield of 5.80 percent at the end of 1997 and the beginning of 1998.
These funds were reinvested in higher yielding securities with slightly longer
maturities. Approximately $2,675,000 was invested in ten year tax-exempt
municipal securities. Average loans to average earning assets was 59.2 percent
and 60.8 percent for the periods ending March 31, 1998 and 1997. This ratio
declined despite a 5.0 percent increase in average loans.
The small increase in the rate paid on interest-bearing liabilities was
primarily the result of higher rates on time deposits and short-term borrowings
offset by lower rates on NOW and savings accounts. The average rate paid on time
deposits increased 6 basis points while the rate paid on NOW and savings
accounts decreased 33 basis points and 4 basis points, respectively. QNB lowered
the rate paid on its interest-checking NOW accounts because these accounts are
relatively insensitive to changes in interest rates and to partially offset
higher rates paid on other more rate sensitive accounts. The yield on short-term
borrowings, primarily cash management accounts, increased 58 basis points when
comparing the two quarters. During the third quarter of 1997 QNB changed the
rate structure on its cash management accounts to a tiered structure that pays a
higher rate of interest on higher balances. This was done to compete with
brokerage house and mutual fund money market products. Management expects the
net interest margin to decline throughout the rest of 1998 as a result of lower
yields on earning assets, particularly loans. Yields on loans will decline as
existing commercial loan customers continue to seek to have their rates lowered.
The extreme competition for loans is causing the pricing of loans to decline. If
QNB can achieve its primary goals of loan growth and an increase in the
loan-to-average earning asset ratio, the impact on interest income and the net
interest margin of lower rates maybe lessened as QNB can generally yield more on
its loans than it can on its investment securities. With regard to deposits,
management anticipates that rates will remain near current levels as the
competition for funding sources remains strong.
PROVISION FOR LOAN LOSSES
The provision for loan losses represents management's determination of the
amount necessary to be charged to operations to bring the allowance for 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.
7
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
PROVISION FOR LOAN LOSSES (Continued)
Management uses various tools to assess the adequacy of the allowance for loan
losses. One tool is a methodology recommended by the Office of the Comptroller
of the Currency. This methodology considers a number of relevant factors
including: historical loan loss experience, the assigned risk rating of the
credit, current and projected credit worthiness of the borrower, current value
of the underlying collateral, levels 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 loan
losses.
The provision for loan losses was $100,000 for both the first quarter of 1998
and 1997. QNB had a net recovery of $17,000 for the first quarter of 1998. This
compares to a net charge-off in the first quarter of 1997 of $8,000. Management
anticipates the provision for loan losses in 1998 will remain near 1997 levels
despite the expected continuing improvement in asset quality. Anticipated loan
growth will make any reduction in the provision for loan losses unlikely.
Non-performing assets (non-accruing loans, loans past due 90 days or more, and
other real estate owned) continued their positive trend downward during the
first quarter of 1998 and amounted to .74 percent of total assets at March 31,
1998. This compares to 1.19 percent at March 31, 1997 and .96 percent at
December 31, 1997. Non-accrual loans were $1,172,000 and $2,180,000 at March 31,
1998 and 1997. Non-accrual loans at December 31, 1997 were $1,209,000. Other
real estate owned was $822,000 at March 31, 1998 compared to $1,175,000 at March
31, 1997 and $1,564,000 at December 31, 1997. Management anticipates
non-performing assets to continue to decline resulting from the sale of other
real estate owned and through payments received on non-performing loans.
There were no restructured loans as of March 31, 1998, December 31, 1997 or
March 31, 1997 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 loan losses was $2,787,000 and $2,670,000 at March 31, 1998
and December 31, 1997, respectively. The ratio of the allowance to total loans
was 1.62 percent and 1.59 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. 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.
8
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
PROVISION FOR LOAN LOSSES (Continued)
At March 31, 1998 and 1997, the recorded investment in loans for which
impairment has been recognized in accordance with SFAS No. 114 totaled
$1,098,000 and $2,086,000, respectively, of which $1,089,000 and $1,082,000
related to loans with no valuation allowance and $9,000 and $1,004,000 related
to loans with a corresponding valuation allowance of approximately $9,000 and
$197,000, 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 decreased $14,000 or 2.2
percent to $613,000 for the quarter ending March 31, 1998 when compared to March
31, 1997.
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 3.7 percent, to $259,000 from $269,000, when comparing the two
quarters. Charges related to a lower volume of overdrafts account for most of
the decline.
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 March
31, 1998 were $42,000 which represents a $3,000 decline from the same period in
1997. The decrease in mortgage servicing fees for the quarter is a result of a
6.8 percent decline in the average balance of mortgages sold and serviced to
$67,650,000. The decrease in the volume of mortgages serviced for others is a
result of payments, both recurring and from refinances, outpacing the
origination and sale of new residential mortgages. Management's decision to
retain most 15 and some 20 year mortgages, which would have been sold in prior
years has also reduced the amount of mortgages sold and 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. 125 (SFAS
No. 125), also impacts the level of servicing income recorded. In June 1996,
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities," was issued. This statement is effective for
transactions entered into after December 31, 1996 and is required to be applied
prospectively. This statement superceded SFAS No. 122 "Accounting for Mortgage
Servicing Rights" which was effective January 1, 1996.
SFAS No. 125 requires an entity to recognize its obligation to service financial
assets that are retained in a transfer of assets in the form of a servicing
asset or liability. The servicing asset or liability is to be amortized in
proportion to and over the period of net servicing income or loss. The
amortization of the servicing asset reduces the amount of servicing income
recorded. Servicing assets and liabilities are to be assessed for impairment
based on their fair value.
Gains on the sale of investment securities were $68,000 for the first quarter of
1998, compared to $160,000 for the first three months of 1997. QNB owns a small
portfolio of marketable equity securities, bank stocks. During the first quarter
of 1998 QNB sold a holding with a cost basis of $28,000 at a gain of $62,000.
This compares to a similar sale during the first quarter of 1997 when QNB sold
securities with a cost basis of
9
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (Continued)
$329,000 for a gain of $159,000. During the first quarter of 1998 QNB sold
approximately $5,000,000 in lower yielding agency securities at a gain of
$6,000. These securities had a weighted average yield of 5.81 percent and were
sold for both liquidity purposes and to reposition the portfolio. During the
first quarter of 1997 QNB sold approximately $3,467,000 of available-for-sale
agency debt securities at a gain of $1,000. This sale was also done for
liquidity purposes. QNB historically experiences deposit outflows at the
beginning of the year.
QNB recorded a gain of $54,000 on the sale of loans during the first quarter of
1998. This compares to a $34,000 gain for the same period in 1997. The sale of
residential mortgages and the sale of student loans accounts for $52,000 and
$2,000 of the gains, respectively in 1998. For the same period in 1997 the sale
of residential mortgage loans accounted for $6,000 of the gain while the sale of
student loans represented $28,000 of the gain. QNB sold approximately $209,000
and $1,098,000 in student loans during the first quarter of 1998 and 1997. The
bulk of the student loan sales in 1998 occurred in April at a gain of $33,000.
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. The larger gain in 1998 is a result of both events. Proceeds from
the sale of residential mortgages was approximately $2,051,000 and $325,000
during the first quarter of 1998 and 1997. Declining interest rates during the
first quarter presented an opportunity for many borrowers to refinance their
mortgages at lower rates. This provided an opportunity for QNB to originate and
sell more mortgages. As of March 31, 1998 QNB had approximately $1,243,000 in
mortgage loans classified as held for sale. These loans are accounted for at
lower of cost or market.
Other operating income increased $71,000 to $190,000 when comparing the three
month periods ending March 31, 1998 and 1997. The gain on the sale of other real
estate owned accounts for $39,000 of the increase; while the recognition of
rental income on other real estate owned contributed $11,000 of the increase.
Check card and ATM interchange income increased $10,000 and $5,000,
respectively.
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 $2,268,000
for the quarter ending March 31, 1998 represents a decrease of $11,000 or .5
percent from levels reported in the first quarter of 1997.
Salaries and benefits, the largest component of non-interest expense, increased
$10,000 or .7 percent to $1,361,000 for the quarter ending March 31, 1998
compared to the same quarter in 1997. Salaries expense increased $4,000 or .4
percent during the period to $1,059,000 while benefits expense increased $6,000
or 2.0 percent to $302,000. Included in salary expense during the period ended
March 31, 1997 was $27,000 in severance expense. Excluding this item salary
expense increased $31,000 or 3.0 percent. An increase in the accrual for
retirement plan expense accounts for the increase in benefits expense.
Net occupancy expense decreased $7,000 or 4.3 percent while furniture and
equipment expense decreased $30,000 or 16.0 percent when comparing the three
month periods ending March 31, 1998 and 1997, respectively.
10
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST EXPENSE (Continued)
Lower utility costs, due to the relatively mild winter account for the decline
in net occupancy expense. The significant decrease in furniture and equipment
expense is the result of lower depreciation expense of $23,000 and equipment
maintenance expense of $8,000. QNB uses an accelerated method of depreciation on
its furniture and equipment. This provides for higher expense in the earlier
years of an asset's life. QNB has purchased relatively little furniture and
equipment during the past three years. These smaller amounts of purchases along
with lower depreciation expense as an asset ages, account for the decline in
depreciation expense. Depreciation expense is anticipated to increase during the
year as QNB invests in new computer technology and as older equipment is
replaced. The decrease in equipment maintenance expense relates to the removal
of some older equipment from maintenance agreements.
Supplies expense decreased $7,000 or 14.0 percent to $43,000 for the quarter
ending March 31, 1998. This improvement is a function of better expense control
through a competitive bid process and the timing of purchases. In addition, QNB
has replaced many of its purchased forms, which are expensive, with documents
printed from a desktop printer.
Professional fees decreased $17,000 or 34.7 percent when comparing the quarters
ending March 31, 1998 and 1997. Less reliance on legal counsel for loan workout
situations resulting from the improvement in asset quality along with the
reimbursement of some previously expensed legal costs account for the decline.
Other real estate owned expense increased $11,000 to $46,000 when comparing the
first quarter of 1998 to the same quarter of 1997. The higher amount in 1998
relates to the payment of real estate taxes on several properties as well as the
cost of repairs on one property. Management anticipates other real estate
expense to decline during the year as the costs associated with these properties
are eliminated as they are sold.
Total other expense for the three months ending March 31, 1998 was $385,000, an
increase of $27,000 or 7.5 percent over the same period in 1997. The
amortization of the deposit premium relating to the acquisition completed during
the fourth quarter of 1997 accounts for $13,000 of the increase. Increases in
postage expense, directors fees, check printing costs and appraisal costs were
partially offset by declines in check card expense and fraud losses. Other
expense in the first quarter of 1997 included costs related to the startup and
distribution of the check card.
INCOME TAXES
Applicable income taxes and effective tax rates were $403,000 or 29.2 percent
for the three month period ending March 31, 1998, and $328,000 or 28.6 percent
for the same period in 1997. The slightly higher effective tax rate in 1998
compared to 1997 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 March 31, 1998 QNB's net deferred tax asset was
$319,000. A deferred tax asset of $699,000 relating to the allowance for loan
losses was partially offset by a deferred tax liability of $518,000 resulting
from the SFAS No.115 adjustment for available-for-sale investment securities. As
of March 31, 1997 QNB's net deferred tax asset was $1,082,000 of which $668,000
related to the allowance for loan losses and $263,000 resulted from the SFAS No.
115 adjustment.
11
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS
The Balance Sheet Analysis reviews average balance sheet data for the three
months ended March 31, 1998 and 1997, as well as the period ending balances as
of March 31, 1998 and December 31, 1997.
Average earning assets for the three month period ended March 31, 1998 increased
$20,587,000 or 7.8 percent to $283,539,000 from $262,952,000 for the quarter
ending March 31, 1997. Average loans and average investments increased
$8,009,000 and $10,962,000, respectively while Federal funds sold increased
$1,644,000. The increase in average loans is a result of the business
development program developed over the past couple of years, competitive pricing
and participation relationships with other local community banks. Average
commercial loans increased $6,371,000 and average residential mortgage loans
increased $1,039,000. The increase in commercial loans is primarily in the area
of commercial and industrial loans. Although a certain amount of these loans are
considered unsecured, the majority are secured by non-real estate collateral
such as equipment, vehicles, accounts receivable and inventory. The growth in
the residential mortgage portfolio is a result of increased mortgage
originations spurred by the refinancing resulting from lower interest rates.
QNB's decision to retain in portfolio more residential mortgage loans also
positively impacted the balance of the portfolio.
The growth in average earning assets was primarily funded by increased
interest-bearing deposits, principally time deposits. Average interest-bearing
deposits increased $16,252,000 or 7.5 percent while non-interest bearing
deposits increased $4,503,000 or 16.7 percent when comparing the two quarters.
Average time deposits increased $10,692,000 while average NOW accounts and
savings accounts increased $2,831,000 and $1,990,000, respectively. The purchase
of approximately $6,800,000 in deposits from First Lehigh Bank contributed to
the increase in total deposits. A significant portion of the increase in time
deposits were accounts with balances over $100,000. These average balances
increased $4,586,000. Attractive rates on these products compared to rates on
money market accounts contributed to the increase. These deposits tend to have
short maturities. Average shareholders' equity increased $2,391,000 to
$25,356,000.
Total assets at March 31, 1998 were $314,169,000, compared with $305,772,000 at
December 31, 1997, an increase of 2.8 percent for the quarter. Total deposits
increased from $267,166,000 at December 31, 1997 to $273,411,000 at March 31,
1998. This trend is encouraging as QNB historically has experienced deposit
run-off during the first half of the year. The increase in assets from December
31, 1997 to March 31, 1998 is primarily centered in Federal funds sold and loans
which increased $8,225,000 and $3,957,000, respectively during the period. Total
investment securities decreased $2,075,000 during the quarter. The higher
balance of Federal funds sold at March 31, 1998 is in response to the increase
in short-term $100,000 time deposits as well as the increase in balances held by
abstract companies who clear mortgage settlements through QNB. These deposits
tend to be short-term in nature. Total time deposits increased $6,966,000, with
time deposits over $100,000 increasing $5,106,000. Savings accounts increased
$1,729,000 while non-interest bearing deposits declined by $2,984,000 from
December 31, 1997 to March 31, 1998.
At March 31, 1998 the fair value of investment securities available-for-sale was
$73,754,000 or $1,525,000 above the amortized cost of $72,229,000. This compares
to a fair value of $75,920,000 or $1,323,000 above the amortized cost of
$74,597,000 at December 31, 1997. An unrealized holding gain, net of taxes, of
$1,006,000 and $873,000 was recorded as an increase to shareholders' equity at
March 31, 1998 and December 31, 1997. Falling interest rates as well as
continued price appreciation in the stock market contributed to the increase in
the fair value of the investment portfolio.
12
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS (Continued)
The available-for-sale portfolio had a weighted average maturity of
approximately 5 years and 5 months and 5 years at March 31, 1998 and December
31, 1997, 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 2 years and 1 month at March 31, 1998 and 1
year and 10 months at December 31, 1997, based on these assumptions. The slight
extension of the expected average life of the portfolio is a result of the sale
of some shorter maturity securities, the pre-funding of some callable securities
and the reinvestment of these funds into securities with slightly longer
maturities and call dates.
Investment securities held-to-maturity are reported at amortized cost. As of
March 31, 1998 and December 31, 1997, QNB had securities classified as
held-to-maturity with an amortized cost of $40,491,000 and $40,400,000 and a
market value of $40,872,000 and $40,713,000, respectively. The held-to-maturity
portfolio had a weighted average maturity of approximately 3 years and 6 months
and 2 years and 10 months at March 31, 1998 and December 31, 1997. The increase
in the average maturity is a result of the purchase of approximately $2,675,000
of ten year tax-exempt municipal securities.
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 $98,365,000 and $91,915,000 at March 31, 1998 and
December 31, 1997. These sources were adequate to meet seasonal deposit
withdrawals during the first quarter of 1998 and should be adequate to meet
normal fluctuations in loan demand and or deposit withdrawals. Approximately
$35,163,000 and $36,510,000 of available-for-sale securities at March 31, 1998
and December 31, 1997 were pledged as collateral for repurchase agreements,
public deposits and other deposits as provided by law. The Bank is currently in
the process of applying for membership in the Federal Home Loan Bank. This would
provide QNB with an additional source of liquidity through the ability to borrow
both short-term and longer term funds from the Federal Home Loan Bank. Approval
is expected during the third quarter of 1998.
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 $834,000 to $11,740,000 at March 31, 1998. This
compares to a $807,000 decrease during the first three months of 1997. After
adjusting net income for non-cash transactions, operating activities provided
$1,332,000 in cash flow in the first three months of 1998, compared to $754,000
in the same period of 1997. Higher net income along with the change in accrued
interest receivable account for most of the difference between the periods.
13
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
LIQUIDITY (Continued)
Net cash used by investing activities was $9,120,000 during the first quarter of
1998. The $8,225,000 increase in Federal funds sold was the largest factor. Loan
growth also was an investing activity that used cash. Proceeds from the sale,
maturity and call of securities of $17,418,000 exceeded the cost of the purchase
of securities of $15,073,000 and was a net provider of cash. Proceeds from the
sale of other real estate owned was also a provider of cash. Net cash used by
investing activities was $8,985,000 during the first three months of 1997. This
resulted largely from the purchase of investment securities exceeding sales and
maturities by $6,788,000 and a net increase in loans of $3,440,000. The sale of
one other real estate owned property provided $221,000 in cash.
Net cash provided by financing activities of $6,954,000 during the first quarter
of 1998 was the result of an increase in interest-bearing deposits, primarily
time deposits. A reduction in non-interest bearing deposits was a use of cash
during the period. Net cash provided by financing activities of $7,424,000
during the first three months of 1997 was the result of an increase in both
interest-bearing deposits, primarily time deposits, and short-term borrowings of
$6,105,000 and $1,662,000, respectively.
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, 1998 was
$26,685,000 or 8.49 percent of total assets compared to shareholders' equity of
$25,832,000 or 8.45 percent at December 31, 1997. Shareholders' equity at March
31, 1998 includes a positive adjustment of $1,006,000 related to unrealized
holding gains, net of taxes, on investment securities available-for-sale, while
shareholders' equity at December 31, 1997 includes a positive adjustment of
$873,000. Without these adjustments shareholders' equity to total assets would
have been 8.17 percent and 8.16 percent at March 31,1998 and December 31, 1997.
Shareholders' equity averaged $25,356,000 for the first three months of 1998 and
$23,886,000 during all of 1997, an increase of 6.2 percent. The ratio of average
total equity to average total assets improved to 8.41 percent for 1998, compared
to 8.27 percent for 1997. The increase in the equity to asset ratio is a
function of significantly higher net income, an increase in capital retention
despite increasing the cash dividend in both 1998 and 1997 and modest growth in
average assets.
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 total assets.
The minimum regulatory capital ratios are 4.00 percent for Tier I, 8.00 percent
for the total risk-based and 4.00 percent for leverage. Under the requirements,
QNB has a Tier I capital ratio of 13.62 percent and 13.49
14
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
CAPITAL ADEQUACY (Continued)
percent, a total risk-based ratio of 14.88 percent and 14.74 percent and a
leverage ratio of 8.37 percent and 8.23 percent at March 31, 1998 and December
31, 1997, 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, 1998 and December 31, 1997 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 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 to 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 a 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 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 primarily focuses on the management of the one-year interest rate
sensitivity gap. At March 31, 1998, interest-earning assets scheduled to mature
or likely to be called, repriced or repaid in one year were $110,129,000.
Interest-sensitive liabilities scheduled to mature or reprice within one year
were $115,972,000. The one year cumulative gap, which reflects QNB's interest
sensitivity over a period of time, was a negative $5,843,000 at March 31, 1998.
The cumulative one-year gap equals 1.99 percent of total earning assets. This
negative or liability sensitive gap will generally benefit QNB in a falling
interest rate environment, while rising interest rates could negatively impact
QNB.
QNB also uses a simulation model to assess the impact of changes in interest
rates on net interest income. The model reflects management's assumptions
related to asset yields and rates paid on liabilities, deposit sensitivity, and
the size, composition and maturity or repricing characteristics of the balance
sheet. The
15
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INTEREST RATE SENSITIVITY (Continued)
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. The projected increase in net interest income is
primarily the result of forecasted growth in total assets and a change in the
composition of earning assets, with the loan to earning assets ratio increasing.
These factors will be partially offset by a slight decrease in the net interest
margin.
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 slightly exceed the most likely scenario. Conversely,
if interest rates were 100 basis points higher, net interest income for the most
likely scenario would decline slightly. These results are consistent with the
results of the gap analysis described above.
Management believes that the assumptions utilized in evaluating the
vulnerability of QNB's net interest income to changes in interest rates
approximate actual experience; however, the interest rate sensitivity of QNB's
assets and liabilities as well as the estimated effect of changes in interest
rates on net interest income could vary substantially if different assumptions
are used or actual experience differs from the experience on which the
assumptions were based.
In the event QNB should experience a mismatch in its desired gap ranges or an
excessive decline in its net interest income subsequent to an immediate and
sustained change in interest rates, it has a number of options which it could
utilize to remedy such a mismatch. QNB could restructure its investment
portfolio through sale or purchase of securities with more favorable repricing
attributes. It could also emphasize loan products with appropriate maturities or
repricing attributes, or it could attract deposits or obtain borrowings with
desired maturities.
The nature of QNB's current operation is such that it is not subject to foreign
currency exchange or commodity price risk. Additionally, neither the Corporation
nor the Bank owns trading assets. At March 31, 1998, QNB did not have any
hedging transactions in place such as interest rate swaps, caps or floors.
The table below summarizes estimated changes in net interest income over a
twelve month period, under alternative interest rate scenarios.
<TABLE>
<CAPTION>
Change in Interest Rates Net Interest Income Dollar Change Percent Change
- ------------------------ ------------------- ------------- --------------
<S> <C> <C> <C>
+300 Basis Points $11,751 $(1,084) (8.45)%
+200 Basis Points 12,136 (699) (5.45)
+100 Basis Points 12,519 (316) (2.46)
FLAT RATE 12,835 -- --
- -100 Basis Points 13,207 372 2.90
- -200 Basis Points 13,322 487 3.79
- -300 Basis Points 13,282 447 3.48
</TABLE>
16
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
IMPACT OF YEAR 2000
QNB is currently in the process of addressing the challenge that faces all users
of automated systems, including information systems. Many computer systems
process transactions based on two digits representing the year of transaction,
rather than a full four digits. These computer systems may not operate properly
when the last two digits become "00", as will occur on January 1, 2000. The
problem could affect a wide variety of automated information systems, such as
mainframe applications, personal computers, communication systems, environmental
systems and other information systems.
At the beginning of 1997, QNB developed a five phase plan to address the year
2000 issue. These phases are Awareness, Assessment, Renovation, Validation and
Implementation. The Awareness phase included the establishment of a team of
employees, including executive management, and the development of strategies to
make employees and customers aware of the situation. The Assessment phase
included the identification of areas of operations critical for the delivery of
products and services. This phase also included the inventory of all hardware
and software applications and the identification of customer and vendor
interdependencies. The majority of the programs and applications used by QNB are
purchased from outside vendors. The vendors providing the software are
responsible for maintenance of the systems and modifications to enable
uninterrupted usage after December 31, 1999. These two phases have been
completed.
The Renovation phase includes vendor certification, code enhancement, and
hardware and software upgrades as needed. The vendor of QNB's core operating
system has informed management that changes are approximately 95 percent
complete and that certification of compliance should be received by June, 1998.
The Validation phase includes testing of all of the impacted applications, both
internally developed and third party provided. Testing of the systems has begun
and will continue throughout 1998. Contingency plans, if any are needed, will be
developed during 1998 to address any shortcomings that are identified. The
Implementation phase includes incorporating all changes, achieving certification
of year 2000 compliance and implementing contingency plans, if necessary. QNB's
plan also includes reviewing any potential risks associated with the loan and
investment portfolios due to the year 2000 issue. QNB's goal is to have the plan
complete and be fully compliant by December 31, 1998.
Based on the currently available information, management does not anticipate
that the cost to address year 2000 issues will have an impact on QNB's financial
condition, results of operations, liquidity or capital resources. A significant
portion of the anticipated costs are not expected to be incremental, but rather
will represent the redeployment of existing information technology resources.
OTHER ITEMS
Management is not aware of any current specific recommendations by regulatory
authorities or proposed legislation, which if they were implemented, would have
a material adverse effect upon the liquidity, capital resources, or results of
operations, although the general cost of compliance with numerous and multiple
federal and state laws and regulations does have, and in the future may have, a
negative impact on QNB's results of operations.
17
<PAGE>
QNB CORP. AND SUBSIDIARY
PART II. OTHER INFORMATION
MARCH 31, 1998
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
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: May 14, 1998 By:
------------
/s/ Thomas J. Bisko
------------------------
Thomas J. Bisko
President/CEO
Date: May 14, 1998 By:
------------
/s/ Robert C. Werner
------------------------
Robert C. Werner
Vice President
Date: May 14, 1998 By:
------------
/s/ Bret H. Krevolin
------------------------
Bret H. Krevolin
Chief Accounting Officer
19
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 11,724
<INT-BEARING-DEPOSITS> 16
<FED-FUNDS-SOLD> 10,247
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 73,754
<INVESTMENTS-CARRYING> 40,491
<INVESTMENTS-MARKET> 40,872
<LOANS> 171,677
<ALLOWANCE> 2,787
<TOTAL-ASSETS> 314,169
<DEPOSITS> 273,411
<SHORT-TERM> 11,308
<LIABILITIES-OTHER> 2,765
<LONG-TERM> 0
0
0
<COMMON> 1,789
<OTHER-SE> 23,890
<TOTAL-LIABILITIES-AND-EQUITY> 314,169
<INTEREST-LOAN> 3,625
<INTEREST-INVEST> 1,765
<INTEREST-OTHER> 65
<INTEREST-TOTAL> 5,455
<INTEREST-DEPOSIT> 2,245
<INTEREST-EXPENSE> 2,320
<INTEREST-INCOME-NET> 3,135
<LOAN-LOSSES> 100
<SECURITIES-GAINS> 68
<EXPENSE-OTHER> 2,268
<INCOME-PRETAX> 1,380
<INCOME-PRE-EXTRAORDINARY> 977
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 977
<EPS-PRIMARY> .68
<EPS-DILUTED> .68
<YIELD-ACTUAL> 4.67
<LOANS-NON> 1,172
<LOANS-PAST> 324
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1,915
<ALLOWANCE-OPEN> 2,670
<CHARGE-OFFS> 2
<RECOVERIES> 19
<ALLOWANCE-CLOSE> 2,787
<ALLOWANCE-DOMESTIC> 2,787
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 2,024
</TABLE>
