SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10Q
(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, 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
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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, 1998
Common Stock, par value $1.25 1,431,912
<PAGE>
QNB CORP. AND SUBSIDIARY
FORM 10Q
QUARTER ENDED SEPTEMBER 30, 1998
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS PAGE
Consolidated Statements of Income for Three
and Nine Months Ended September 30, 1998 and 1997.......... 1
Consolidated Balance Sheets at September 30, 1998
and December 31, 1997...................................... 2
Consolidated Statements of Cash Flows for Nine
Months Ended September 30, 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
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK...................................................... 21
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.................................................. 22
(See Regulation S-K Item 305)
ITEM 2. CHANGES IN SECURITIES.............................................. 22
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.................................... 22
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITIES HOLDERS............. 22
ITEM 5. OTHER INFORMATION.................................................. 22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................... 22
<PAGE>
QNB Corp. and Subsidiary
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(in thousands, except share data)
(unaudited)
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Three Months Nine Months
Ended September 30, Ended September 30,
1998 1997 1998 1997
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<S> <C> <C> <C> <C>
Interest Income
Interest and fees on loans ................................. $ 3,602 $ 3,601 $11,004 $10,600
Interest and dividends on investment securities:
Taxable ................................................ 1,737 1,599 4,994 4,558
Tax-exempt ............................................. 167 136 467 401
Interest on interest-bearing balances ...................... 4 -- 4 --
Interest on Federal funds sold ............................. 72 62 256 154
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Total interest income ............................. 5,582 5,398 16,725 15,713
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Interest Expense
Interest on deposits
NOW accounts ........................................... 155 191 448 523
Money market accounts .................................. 233 245 707 709
Savings ................................................ 204 189 608 573
Time ................................................... 1,513 1,343 4,349 3,977
Time over $100,000 ..................................... 290 255 854 703
Interest on short-term borrowings .......................... 96 78 257 225
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Total interest expense ............................ 2,491 2,301 7,223 6,710
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Net interest income ............................... 3,091 3,097 9,502 9,003
Provision for loan losses .................................. 100 100 300 300
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Net interest income after provision for loan losses 2,991 2,997 9,202 8,703
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Non-Interest Income
Fees for services to customers ............................. 281 265 796 803
Mortgage servicing fees .................................... 37 43 123 136
Net gain on investment securities available-for-sale ....... 7 -- 75 165
ain on sale of loans ....................................... 60 24 224 66
Other operating income ..................................... 163 150 446 380
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Total non-interest income ......................... 548 482 1,664 1,550
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Non-Interest Expense
Salaries and employee benefits ............................. 1,344 1,301 4,068 3,955
Net occupancy expense ...................................... 172 166 488 491
Furniture and equipment expense ............................ 174 172 493 517
Marketing expense .......................................... 87 61 275 202
Supplies expense ........................................... 37 40 131 132
Professional fees .......................................... 39 38 100 127
Insurance expense .......................................... 25 27 73 78
Other real estate owned expense ............................ 56 80 121 178
Other expense .............................................. 414 353 1,259 1,083
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Total non-interest expense ........................ 2,348 2,238 7,008 6,763
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Income before income taxes ............................. 1,191 1,241 3,858 3,490
Provision for income taxes ................................ 327 361 1,076 1,008
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Net Income .............................................. $ 864 $ 880 $ 2,782 $ 2,482
================================================================================================================
Net Income Per Share Basic .............................. $ .60 $ .62 $ 1.94 $ 1.74
================================================================================================================
Net Income Per Share Diluted ............................ $ .60 $ .61 $ 1.93 $ 1.73
================================================================================================================
Cash Dividends Per Share ................................ $ .18 $ .16 $ .54 $ .48
================================================================================================================
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
Form 10-Q
Page 1
<PAGE>
QNB Corp. and Subsidiary
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(in thousands)
(unaudited)
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September 30, December 31,
1998 1997
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<S> <C> <C>
Assets
Cash and due from banks ..................................................... $ 11,511 $ 12,574
Federal funds sold .......................................................... 2,424 2,022
Investment securities
available-for-sale ...................................................... 72,266 75,920
held-to-maturity (market value $50,060 and $40,713) ..................... 49,480 40,400
Total loans, net of unearned income of $376 and $448 ........................ 169,115 167,720
Allowance for loan losses ................................................... (2,983) (2,670)
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Net loans .......................................................... 166,132 165,050
Premises and equipment, net ................................................. 4,231 4,066
Other real estate owned ..................................................... 631 1,564
Accrued interest receivable ................................................. 1,995 2,007
Other assets ................................................................ 4,856 2,169
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Total assets ................................................................ $ 313,526 $ 305,772
====================================================================================================================
Liabilities
Deposits
Demand, non-interest-bearing ............................................ $ 35,324 $ 38,692
NOW accounts ............................................................ 40,729 42,176
Money market accounts ................................................... 31,840 32,520
Savings ................................................................. 36,705 36,629
Time .................................................................... 108,494 101,447
Time over $100,000 ...................................................... 18,901 15,702
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Total deposits ..................................................... 271,993 267,166
Short-term borrowings ....................................................... 10,958 10,342
Accrued interest payable .................................................... 1,182 1,057
Other liabilities ........................................................... 1,454 1,375
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Total liabilities ........................................................... 285,587 279,940
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Commitments and contingencies
Shareholders' Equity
Common stock, par value $1.25 per share;
authorized 5,000,000 shares; issued
1,431,912 shares and 1,431,240 shares ................................... 1,790 1,789
Surplus ..................................................................... 4,394 4,369
Retained earnings ........................................................... 20,811 18,801
Accumulated other comprehensive income ...................................... 944 873
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Total shareholders' equity .................................................. 27,939 25,832
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Total liabilities and shareholders' equity .................................. $ 313,526 $ 305,772
====================================================================================================================
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
Form 10-Q
Page 2
<PAGE>
QNB Corp. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOW
<TABLE>
<CAPTION>
(in thousands)
(unaudited)
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Nine Months Ended September 30, 1998 1997
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<S> <C> <C>
Operating Activities
Net income .................................................................... $ 2,782 $ 2,482
Adjustments to reconcile net income to net cash
provided by operating activities
Provision for loan losses ................................................... 300 300
Depreciation and amortization ............................................... 334 364
Securities gains ............................................................ (75) (165)
Net gain on sale of loans ................................................... (224) (66)
Proceeds from sales of residential mortgages ................................ 9,930 2,107
Originations of residential mortgages held-for-sale ......................... (8,166) (575)
Net losses (gains) on sales or writedowns of other real estate owned ........ 9 (17)
Deferred income tax provision ............................................... (89) (26)
Change in income taxes payable .............................................. 83 82
Net decrease (increase) in interest and dividends receivable ................ 12 (329)
Net amortization of premiums and discounts .................................. 10 4
Net increase in interest payable ............................................ 125 64
Increase in other assets .................................................... (122) (82)
Increase (decrease) in other liabilities .................................... 61 (65)
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Net cash provided by operating activities ................................... 4,970 4,078
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Investing Activities
Proceeds from maturities and calls of investment securities
available-for-sale .......................................................... 19,286 7,893
held-to-maturity ............................................................ 12,703 3,821
Proceeds from sales of investment securities
available-for-sale .......................................................... 6,146 9,951
Purchase of investment securities
available-for-sale .......................................................... (21,638) (34,276)
held-to-maturity ............................................................ (21,750) (3,844)
Net (increase) decrease in Federal funds sold ................................... (402) 2,314
Proceeds from sales of student loans ............................................ 1,589 1,469
Net increase in loans ......................................................... (4,573) (2,802)
Net purchases of premises and equipment ....................................... (501) (74)
Proceeds from the sale of other real estate owned ............................. 973 429
Purchase of single premium life insurance ..................................... (2,557) --
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Net cash used by investing activities ....................................... (10,724) (15,119)
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Financing Activities
Net decrease in non-interest-bearing deposits .............................. (3,368) (1,820)
Net increase in interest-bearing deposits .................................. 8,195 9,949
Net increase in short-term borrowings ...................................... 616 551
Cash dividends paid ........................................................ (772) (685)
Proceeds from issuance of common stock ..................................... 20 55
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Net cash provided by financing activities ................................... 4,691 8,050
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Decrease in cash and cash equivalents ....................................... (1,063) (2,991)
Cash and cash equivalents at beginning of year .............................. 12,574 12,459
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Cash and cash equivalents at end of period .................................. $ 11,511 $ 9,468
======================================================================================================================
Supplemental Cash Flow Disclosures
Interest paid ................................................................. $ 7,098 $ 6,646
Income taxes paid ............................................................. 1,075 930
Non-Cash Transactions
Change in net unrealized holding gains (losses),
net of taxes, on investment securities ...................................... 71 488
Transfer of loans to other real estate owned .................................... 49 --
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
Form 10-Q
Page 3
<PAGE>
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 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 September 30, 1998, as well as the
respective statements of income and cash flows for the three and nine month
periods ended September 30, 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):
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Numerator for basic and diluted earnings $ 864 $ 880 $ 2,782 $ 2,482
per share-net income
Denominator for basic earnings per share- 1,431,912 1,428,139 1,431,547 1,427,502
Weighted average shares outstanding
Effect of dilutive securities-employee 10,997 6,018 9,866 5,734
Stock options
Denominator for diluted earnings per 1,442,909 1,434,157 1,441,413 1,433,236
share-adjusted weighted average
shares outstanding
Earnings per share-basic $ .60 $ .62 $ 1.94 $ 1.74
Earnings per share-diluted $ .60 $ .61 $ 1.93 $ 1.73
</TABLE>
Form 10-Q
Page 4
<PAGE>
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998 AND 1997, AND DECEMBER 31, 1997
(Unaudited)
3. COMPREHENSIVE INCOME
In September 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
sole component of other 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 September 30, 1998 $ 112
Reclassification adjustment equal to beginning unrealized for all sold securities (41)
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Net change in unrealized during the period 71
Unrealized, beginning of period 873
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Unrealized, end of period $ 944
Net income $2,782
Other comprehensive income, net of tax:
Unrealized holding gains arising during the period 71
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Comprehensive Income $2,853
======
</TABLE>
Total comprehensive income for the three month periods ending September 30, 1998
and 1997 was $892,000 and $1,397,000, respectively. Comprehensive income for the
nine month period ending September 30, 1997 was $2,970,000.
Form 10-Q
Page 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 121 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 - OVERVIEW
QNB recorded earnings of $864,000 or $.60 per share on a diluted basis for the
three month period ending September 30, 1998. This represents a slight decline
from net income of $880,000 or $.61 per share-diluted reported for the same
period in 1997. For the nine month periods ending September 30, 1998 and 1997,
net income was $2,782,000 and $2,482,000, respectively an increase of 12.1
percent. Net income per share-diluted was $1.93 and $1.73 for the corresponding
nine month periods.
When examining the results for the quarter it is important to examine core
earnings, which excludes the net gain or loss on the sale of loans, investment
securities and other real estate owned and the recovery of interest on
non-accrual loans. Core earnings increased approximately 3.3 percent to $836,000
for the third quarter of 1998. Included in net interest income in the third
quarter of 1997 was the recovery of interest on a non-accrual loan of $58,000.
Also, during the third quarter of 1997 QNB recorded a gain on the sale of a
foreclosed property totaling $25,000. During the third quarter of 1998 a loss of
$25,000 was recorded on the sale of a property and devaluation of another. Net
gains on the sale of loans and investment securities were $67,000 and $24,000
for the respective three month periods ending September 30, 1998 and 1997.
Net interest income declined slightly when comparing the two quarters, despite
a 7.6 percent increase in average earning assets. Net interest income for the
three months ended September 30, 1998 was $3,091,000 compared to $3,097,000 for
the same period in 1997. As stated above, the results for 1997 include the
recovery of interest on a non-accrual loan of $58,000. The decline in market
interest rates, represented by the Treasury yield curve, accelerated during the
third quarter of 1998. This had a negative impact on both net interest income
and the net interest margin, as rates on earning assets, particularly loans and
investment securities declined quicker and to a greater degree than rates on
interest-bearing liabilities.
The increase in net income for the nine month periods is primarily a result of
higher net interest income. Net interest income increased to $9,502,000 for the
nine months ending September 30, 1998 from $9,003,000 for the same period in
1997. An 8.2 percent increase in average earning assets offset a nine basis
point decline in
Form 10-Q
Page 6
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS (Continued)
the net interest margin. Declining interest rates on both loans and investment
securities negatively impacted the net interest margin.
Return on average assets was 1.09 percent and 1.20 percent while the return on
average equity was 12.86 percent and 14.47 percent for the three months ending
September 30, 1998 and 1997, respectively. For the nine month periods ending
September 30, 1998 and 1997, return on average assets was 1.20 percent and 1.16
percent and the return on average equity was 14.29 percent and 14.10
percent, 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 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.
When comparing the three month periods ending September 30, 1998 and 1997, net
interest income declined slightly. Net interest income decreased to $3,091,000
for the quarter ending September 30, 1998 from $3,097,000 for the same quarter
in 1997. A 7.6 percent increase in average earning assets was offset by a 31
basis point decrease in the net interest margin. The recovery of interest on a
non-accrual loan contributed $58,000 to net interest income during the third
quarter of 1997. Excluding this recovery, the net interest margin would have
declined by approximately 22 basis points when comparing the two quarters. The
fall in market interest rates, represented by the U.S. Treasury yield curve,
picked up dramatically during the third quarter of 1998 as signs of a global
economic crisis created a flight to quality in the U.S. Treasury market. These
declining interest rates had a negative impact on the yield of QNB's loan and
investment securities portfolios. Despite falling market interest rates the
yield on funding sources increased by three basis points, as the competition for
deposits among financial institutions remained strong.
The yield on earning assets on a fully taxable equivalent basis was 7.69
percent for the third quarter of 1998 versus 7.98 percent for the third quarter
of 1997, while the rate paid on interest-bearing liabilities was 3.94 percent
and 3.91 percent for the respective three month periods ending September 30,
1998 and 1997. The net interest margin on a fully taxable equivalent basis for
the three month period ended September 30, 1998 was 4.35 percent compared to
4.66 percent for the same period in 1997. Positively impacting the yield on
earning assets and the net interest margin during the third quarter of 1997 was
the recognition of approximately $58,000 in interest income on a non-accrual
loan. Excluding the recognition of this interest, the yield on earning assets
would have been 7.90 percent and the net interest margin would have been 4.57
percent for the third quarter of 1997.
Declining interest rates during 1998, particularly during the second and third
quarters, negatively impacted the yield on both investment securities and
loans. While the yield on investment securities for the third quarter of 1998
of 6.50 percent represents a slight decrease from the 6.56 percent yield
recorded in the third quarter of 1997, it represents a 23 basis point decline
from the yield recorded during the first quarter of 1998
Form 10-Q
Page 7
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (Continued)
The lower interest rate environment has increased the prepayments on
mortgage-backed securities and callable agency bonds. The reinvestment of these
proceeds has been at lower rates. Helping to mitigate some of the impact of
lower rates on the total portfolio was 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. The yield on average loans was 8.61 percent for
the third quarter of 1998. This represents a decline from the yield of 8.87
percent, excluding the impact of the interest recognized on the non-accrual
loan, recorded during the third quarter of 1997 and the 8.89 percent yield
recorded for the first quarter of 1998. The decline in the yields on loans is a
result of falling market interest rates as well as the reduction of rates for
existing commercial loan customers. The extreme competition for loans is causing
the pricing of loans to decline. Average loans to average earning assets was
57.1 percent and 58.6 percent for the three month periods ending September 30,
1998 and 1997. This ratio declined despite a 4.8 percent increase in average
loans.
Net interest income for the nine month period ending September 30, 1998 was
$9,502,000, an increase of $499,000 over the $9,003,000 recorded in 1997. An 8.2
percent increase in average earning assets offset a 9 basis point decline in the
net interest margin. Total interest income increased $1,012,000 from $15,713,000
to $16,725,000 when comparing the nine month periods ending September 30, 1997
to September 30, 1998. The yield on earning assets, excluding the impact of the
interest on non-accrual loans for both periods, decreased from 7.95 percent to
7.83 percent, with the yield on loans declining from 8.90 percent to 8.75
percent. During the nine month period the yield on investment securities
increased from 6.58 percent to 6.60 percent. Average investment securities
increased 10.0 percent to $115,443,000 while average loans increased 5.6 percent
to $169,549,000.
Total interest expense increased $513,000 from $6,710,000 to $7,223,000 for the
nine month periods. The yield on interest-bearing liabilities increased slightly
from 3.89 percent to 3.91 percent, with the yield on interest-bearing deposits
increasing one basis point to 3.92 percent and the rate paid on short-term
borrowings increasing 34 basis points to 3.73 percent. Average interest-bearing
deposits increased 7.3 percent to $237,692,000 for the nine month period ending
September 30, 1998.
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. The average rate paid on time deposits increased
three basis points while the rate paid on NOW decreased 31 basis points. In the
beginning of 1998, 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 34 basis points when comparing the nine month
periods. 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 for the remainder of 1998
and the beginning of 1999 as a result of lower yields on earning assets, both
investment securities and loans. The lower rate environment will cause
prepayments on mortgage-backed securities and the pre-funding of agency bonds to
increase. This additional cash flow will most likely be reinvested in lower
yielding securities. With regard to loans, The Federal Reserve Bank lowered the
Federal funds rate by 50 basis points since September 29 1998. This was followed
by a matching drop in the prime rate, the rate that many of QNB's loans are
priced against. Yields
Form 10-Q
Page 8
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (Continued)
on loans may also decline as existing commercial loan customers with fixed
interest rates seek to have these rates lowered as well as new loans being
booked at lower rates. 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 may be 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 decline but to a
lesser degree and at a slower rate as the competition for funding sources
remains strong. QNB lowered the rate on most of its interest-bearing
liabilities by approximately 25 basis points in October. Since almost half of
QNB's deposits are time deposits the impact of lower rates is not immediate.
However, approximately 68 percent of these deposits will reprice over the next
twelve months.
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 probable 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 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 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 provision for loan losses was $100,000 for both three month periods and
$300,000 for both nine month periods ending September 30, 1998 and 1997. Net
charge-offs in the third quarter of 1998 were $3,000 compared to $103,000 for
the same period in 1997. QNB had a net recovery of $13,000 for the first nine
months of 1998. This compares to a net charge-off $228,000 during the same
period of 1997. 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 that the provision for loan losses in the future
may decline slightly as asset quality continues to improve and as the ratio of
the allowance for loan losses to non-performing loans increases.
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 nine months of 1998 and amounted to .48 percent of total assets at
September 30, 1998. This compares to 1.07 percent at September 30, 1997 and .96
percent at December 31, 1997. Non-accrual loans were $856,000 and $2,022,000 at
September 30, 1998 and 1997. Non-accrual loans at December 31, 1997 were
$1,209,000. Other real estate owned was $631,000 at September 30, 1998 compared
to $983,000 at September 30, 1997 and $1,564,000 at December 31, 1997.
Management anticipates non-performing assets to continue to decrease, but at a
slower pace, as a result of selling other real estate owned and through payments
received on non-performing loans. However, a slowdown in the local economy
could eventually lead to an increase in non-performing loans.
Form 10-Q
Page 9
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
PROVISION FOR LOAN LOSSES (Continued)
There were no restructured loans as of September 30, 1998, December 31, 1997 or
September 30, 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 $2,983,000 and $2,670,000 at September 30,
1998 and December 31, 1997, respectively. The ratio of the allowance to total
loans was 1.76 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. 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, 1998 and 1997, the recorded investment in loans for which
impairment has been recognized totaled $788,000 and $1,782,000, respectively, of
which $588,000 and $1,329,000 related to loans with no valuation allowance and
$200,000 and $453,000 related to loans with a corresponding valuation allowance
of approximately $65,000 and $136,000, 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 $66,000 or 13.7
percent to $548,000 for the quarter ending September 30, 1998 when compared to
September 30, 1997. For the six month period total non-interest income increased
$114,000 or 7.4 percent to $1,664,000.
Fees for services to customers, the largest component of total non-interest
income, is primarily comprised of service charges on deposit accounts. These
fees increased 6.0 percent, to $281,000 from $265,000, when comparing the two
quarters, but declined .9 percent to $796,000 when comparing the nine month
periods. The increase in service charges when comparing the two quarters is
related to the collection of fees on check orders. During the third quarter of
1998, QNB restructured some of the features of its deposit products. One of the
changes included the collection of fees on check reorders. Previously, most
customers received free checks upon reorder. An increase in service charges on
business accounts also contributed to the positive variance in
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)
the third quarter of 1998. The primary reason for the decline in service charges
over the nine month period relates to a lower volume of overdrafts. Overdraft
income decreased by approximately $20,000 over the nine month period. This more
than offset increases in check order fees. QNB reviews all service charges and
fee schedules related to its products and services on an ongoing basis. QNB
prices its products and services competitively.
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, 1998 were $37,000 which represents a $6,000 decline from the same
period in 1997. The decrease in mortgage servicing fees for the quarter is a
result of a 3.2 percent decline in the average balance of mortgages sold and
serviced to $67,083,000. For the nine month period mortgage servicing fees
decreased $13,000 or 9.6 percent to $136,000. The average balance of mortgages
serviced was approximately $67,254,000 for the nine month period ending
September 30, 1998 compared to $70,908,000 for the first nine months of 1997.
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 some 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
amortization of the mortgage servicing asset recorded upon the sale of mortgages
also contributed to the decrease in mortgage servicing fees during both the
three and nine month periods. The amortization of the mortgage servicing asset
was $5,000 higher for the three month period and $10,000 higher for the nine
month period. QNB anticipates mortgage servicing income to increase slightly
over the next year due to the increase in the origination and sale of
residential mortgages resulting from lower interest rates.
Net gains on investment securities were $7,000 for the three months ended
September 30, 1998. There were no gains on investment securities during the
third quarter of 1997. The net gain recorded during the third quarter of 1998
was the result of the pre-funding of callable agency securities which had been
purchased at a discount. These gains of approximately $11,000 were partially
offset by the loss of $4,000 on the sale of an equity security.
Net gains on investment securities were $75,000 for the first nine months of
1998, compared to $165,000 for the first nine months of 1997. Gains on the sale
of equity securities included in these amounts were $58,000 and $159,000,
respectively. 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 $329,000 for a
gain of $159,000. With regard to gains on debt securities, QNB, during the first
quarter of 1998, 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. The gain on debt securities 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. QNB historically
experiences deposit outflows at the beginning of the year.
Form 10-Q
Page 11
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (Continued)
QNB recorded a gain of $60,000 on the sale of loans during the third quarter of
1998. This compares to a $24,000 gain for the same period in 1997. The sale of
residential mortgage loans accounts for $58,000 and $23,000 of the gains during
the respective three month periods. QNB sold approximately $2,700,000 and
$1,500,000 in residential mortgages in these quarters. Declining interest rates
to record low levels resulted in an increase in mortgage refinance activity.
This declining rate environment enabled QNB to sell these mortgages at a gain.
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.
For the nine month periods ending September 30, 1998 and 1997 net gains on the
sale of loans was $224,000 and $66,000, respectively. The sale of student loans
accounts for $38,000 and $33,000 of the gains, during the nine month periods of
1998 and 1997. QNB sold approximately $1,551,000 and $1,436,000 in student loans
during this period. The net gain on the sale of residential mortgage loans was
$186,000 and 33,000 for the nine month periods ending September 30, 1998 and
1997. 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 gains during 1998 is a result of both events.
Proceeds from the sale of residential mortgages was approximately $9,930,000 and
$2,107,000 for the nine month periods. Declining interest rates during 1998
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 September 30, 1998 QNB had approximately $306,000 in mortgage
loans classified as held for sale. These loans are accounted for at lower of
cost or market.
Other operating income increased $13,000 to $163,000 when comparing the three
month periods ending September 30, 1998 and 1997, and increased $66,000 when
comparing the nine month periods. For the quarter, earnings on the single
premium life insurance policies amounted to $12,000. These agreements went into
effect in September, 1998. Increases in check card and ATM interchange income
totaling $13,000 were offset by lower rental income on other real estate owned
of $3,000 and a decline in commissions on the sale of mutual funds of $7,000.
The temporary loss of a mutual fund representative and the volatile stock market
contributed to the decline in these commissions. Fees related to official checks
increased approximately $5,000 when comparing the two quarters. Other operating
income during the third quarter of 1997 includes a gain on the sale of other
real estate of $25,000, while the third quarter of 1998 includes the
reimbursement of prior years costs of approximately $15,000 related to the
terminated bill pay product.
The increase in other income when comparing the nine month periods includes
increases in check card and ATM interchange income of $29,000 and $12,000,
respectively. These increases relate to higher usage of the checkcard and an
increased usage of QNB's ATM machines by non-QNB customers. QNB does not
surcharge for the use of its machines and as a result has experienced increased
activity. QNB receives a fee from the non-customer's bank when non-customers
use a Quakertown National Bank machine. The earnings on the life insurance
product and the reimbursement of prior years costs as discussed above also
contributed to the increase when comparing the nine month periods. The
recognition of fees from official checks contributed $16,000 to the total
increase in other operating income. Partially offsetting these positive
increases was a $12,000 decline in mutual fund commission income. The results
for the nine month period of 1997 also includes a net gain on the sale of other
real estate owned of approximately $17,000.
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
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 $2,348,000
for the quarter ending September 30, 1998 represents an increase of $110,000 or
4.9 percent from levels reported in the third quarter of 1997. Total
non-interest expense for the nine months ending September 30, 1998 was
$7,008,000, an increase of $245,000 or 3.6 percent over 1997 levels.
Salaries and benefits, the largest component of non-interest expense, increased
$43,000 or 3.3 percent to $1,344,000 for the quarter ending September 30, 1998
compared to the same quarter in 1997. Salaries expense increased $49,000 or 4.6
percent during the period to $1,104,000 while benefits expense decreased $6,000
or 2.4 percent to $240,000. Annual merit increases in addition to a slight
increase in the number of employees account for the increase during 1998. The
decline in benefits expense is a result of lower medical and unemployment
compensation costs.
Salaries and benefit expense for the nine month period ending September 30, 1998
was $4,068,000, an increase of $113,000 or 2.9 percent from the same period in
1997. Salary expense was $125,000 or 4.0 percent higher, while benefit expense
was $12,000 or 1.5 percent lower. The increase in salary expense is primarily a
reflection of annual merit increases and a small increase in the number of full
time equivalent employees. The decline in benefit expense relates to lower
medical costs and State unemployment compensation costs. Lower medical costs
resulted from an increase in the number of employees waiving coverage and an
increase in the employee cost sharing percentage. These savings were partially
offset by a $12,000 increase in the accrual for retirement plan expense.
Net occupancy expense increased $6,000 or 3.6 percent for the three month
period, but decreased $3,000 or .6 percent for the nine month period. The
increase in expense during the three month period is a result of slightly higher
building repairs, maintenance and securities costs. Lower utility costs, due to
the relatively mild winter and spring account for the decline in net occupancy
expense when comparing the nine month periods. Furniture and equipment expense
increased $2,000 or 1.2 percent when comparing the three month periods ending
September 30, 1998 and 1997, but decreased $24,000 or 4.7 percent when comparing
the nine month periods. The increase during the quarter was a result of an
increase in depreciation expense resulting from the implementation of the first
phase of the wide area network.
The significant decrease in furniture and equipment expense when comparing the
nine month periods is the result of lower depreciation expense of $27,000. 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. As was experienced
during the third quarter of 1998, depreciation expense is anticipated to
continue to increase during the next year as QNB invests in new computer
technology and as older equipment is replaced.
Marketing expense increased $26,000 to $87,000 for the quarter ending September
30, 1998 and $73,000 to $275,000 for the nine month period. The increase during
the quarter is a result of additional print, radio and bill board advertising
to promote specific products and QNB's image of being an independent community
bank in light of the merger activity taking place in the industry. A $40,000
pledge to the Main Street Program, a
Form 10-Q
Page 13
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST EXPENSE (Continued)
program designed for the revitalization of downtown Quakertown, also contributed
to the increase in marketing expense for the nine month period.
Professional fees decreased $27,000 or 21.3 percent when comparing the nine
month periods. 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 decreased $24,000 to $56,000 when comparing the
third quarter of 1998 to the same quarter of 1997 and $57,000 to $178,000 when
comparing the nine month periods. The lower amount in 1998 is a reflection in
the reduction in the number of properties owned and the costs of taxes,
insurance and maintenance on these properties. Other real estate expense during
the third quarter of 1998 includes the net loss on the sale or write-down of
properties totaling $25,000. Management anticipates other real estate expense to
decline in 1999 as the costs associated with these properties are eliminated as
they are sold.
Total other expense for the three months ending September 30, 1998 was $414,000,
an increase of $61,000 or 17.3 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. An increase in
the use of third party vendors contributed $11,000 to the variance. Checkcard
expense and check production costs both increased $7,000 when comparing the
quarters. Director related expenses increased $12,000 when comparing the
periods.
For the nine month period ending September 30, 1998, other non-interest expense
increased $176,000 or 16.3 percent to $1,259,000 when compared to the same
period in 1997. An increase in the accrual for a director's deferred
compensation plan accounted for $70,000 of the increase. This increase reflects
an adjustment to the interest rate assumption caused by the decline in market
interest rates. The amortization of the deposit premium accounted for $38,000 of
the increase. Increases in third party vendor services, directors fees, customer
meeting and entertainment expenses and state taxes were partially offset by
declines in training expense and fraud losses.
INCOME TAXES
Applicable income taxes and effective tax rates were $327,000 or 27.5 percent
for the three month period ending September 30, 1998, and $361,000 or 29.1
percent for the same period in 1997. For the nine month period applicable income
taxes and effective rates were $1,076,000 or 27.9 percent and $1,008,000 or 28.9
percent, respectively. The lower effective tax rate during the third quarter of
1998 is a result of a higher percentage of tax-exempt income to total income
before taxes. QNB has increased its percentage of both tax exempt municipal
securities and loans to total earning assets. The lower effective tax rate for
the nine month period of 1998 is primarily the result of tax credits received on
an investment in a low income housing project and the increase in the relative
percentage of tax-exempt earning assets.
Form 10-Q
Page 14
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INCOME TAXES (Continued)
QNB utilizes an asset and liability approach for financial accounting and
reporting of income taxes. As of September 30, 1998 QNB's net deferred tax asset
was $423,000. A deferred tax asset of $772,000 relating to the allowance for
loan losses was partially offset by a deferred tax liability of $486,000
resulting from the SFAS No. 115 adjustment for available-for-sale investment
securities. As of September 30, 1997 QNB's net deferred tax asset was $494,000
of which $663,000 related to the allowance for 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.
BALANCE SHEET ANALYSIS
The Balance Sheet Analysis reviews average balance sheet data for the nine
months ended September 30, 1998 and 1997, as well as the period ending balances
as of September 30, 1998 and December 31, 1997.
Average earning assets for the nine month period ended September 30, 1998
increased 8.2 percent to $291,326,000 from $269,315,000 for the nine months
ending September 30, 1997. Average loans and average investments increased
$8,953,000 and $10,525,000, respectively while Federal funds sold increased
$2,451,000. The increase in average loans is a result of the business
development program developed over the past couple of years, competitive pricing
on commercial, residential mortgage and home equity loans and participation
relationships with other local community banks. Average commercial, residential
mortgage and consumer loans increased approximately $5,588,000, $1,857,000 and
$1,508,000, respectively. 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 increase in the consumer
loan portfolio is a result of home equity loan promotions and attractive
interest rates.
The growth in average investment securities were primarily in the categories of
U.S. Government agency bonds, municipal bonds and mortgage-backed securities.
Agency securities, primarily callable bonds, increased $5,399,000, while
municipal bonds increased $2,067,000 and mortgage-backed securities $2,053,000
when comparing the nine month periods. During the third quarter of 1998, QNB's
purchases were concentrated in the area of mortgage-backed securities. These
bonds were purchased to replace U.S. agency securities which were called and
existing mortgage-backed paper whose payments had increased due to the decline
in interest rates.
The growth in average earning assets was primarily funded by increased
interest-bearing deposits, principally time deposits. Average interest-bearing
deposits increased $16,203,000 or 7.3 percent while non-interest bearing
deposits increased $3,782,000 or 12.9 percent when comparing the nine month
periods. Average time deposits increased $12,001,000 while average NOW accounts
and savings accounts increased $1,855,000 and $2,208,000, respectively. The
purchase of approximately $6,800,000 in deposits from First Lehigh Bank in the
fourth quarter of 1997, 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 $3,772,000 and tend to have
short maturities. Attractive rates on time deposits relative to rates on other
interest-bearing accounts along with the introduction of the Flex12 certificate
of deposit contributed to the increase in time deposits. The Flex12 has a twelve
month maturity, allows for one no penalty withdrawal, enables the holder to add
funds to the account and pays a competitive rate.
Form 10-Q
Page 15
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS (Continued)
Total assets at September 30, 1998 were $313,526,000, compared with $305,772,000
at December 31, 1997, an increase of 2.5 percent for the nine month period. The
increase in assets from December 31, 1997 to September 30, 1998 is primarily
centered in investment securities which increased $5,426,000, loans which
increased $1,395,000 and other assets which increased $2,687,000 during the
period. The increase in other assets is the result of the purchase of
approximately $2,557,000 in single premium life insurance policies for executive
officers and some directors of QNB. These policies earn between 5.85 percent and
6.00 percent tax free and replace the group term life insurance policies of the
executive officers and enhance the funding side of the directors deferred
compensation plan.
Total deposits increased from $267,166,000 at December 31, 1997 to $271,993,000
at September 30, 1998. Total time deposits increased $10,246,000, with time
deposits less than $100,000 increasing $7,047,000. Interest-bearing transaction
accounts and Money market accounts declined $1,447,000 and $680,000,
respectively while non-interest bearing transaction accounts declined
$3,368,000. The increase in time deposits is a result of the higher rates on
these deposits relative to rates on savings and transaction type in conjunction
with the promotion of a new product, the Flex 12 Certificate of Deposit.
At September 30, 1998 the fair value of investment securities available-for-sale
was $72,266,000 or $1,431,000 above the amortized cost of $70,835,000. 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 $944,000 and $873,000 was recorded as an increase to shareholders' equity at
September 30, 1998 and December 31, 1997. Falling interest rates increased the
market value of the fixed income debt security portfolio and more than offset
the price depreciation of the equity portfolio resulting from the stock market
correction in the third quarter of 1998.
The available-for-sale portfolio had a weighted average maturity of
approximately 4 years and 10 months at September 30, 1998 and 5 years at
December 31, 1997. 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 3 months at September 30, 1998 and
1 year and 10 months at December 31, 1997, based on these assumptions. The
shortening of the expected average life of the portfolio is a result of the
decline in interest rates thereby increasing the likelihood of some of the
callable agency bonds to be called earlier and an increase in the level of
prepayments on mortgage-backed securities.
Investment securities held-to-maturity are reported at amortized cost. As of
September 30, 1998 and December 31, 1997, QNB had securities classified as
held-to-maturity with an amortized cost of $49,480,000 and $40,400,000 and a
market value of $50,060,000 and $40,713,000, respectively. The held-to-maturity
portfolio had a weighted average maturity of approximately 5 years and 11
months at September 30, 1998 and 2 years and 10 months at December 31, 1997. The
expected weighted average life of the held-to-maturity portfolio was 2 years
and 7 months at September 30, 1998 and 2 years and 10 months at December 31,
1997. The increase in the average maturity is a result of the growth in the ten
year municipal portfolio, whose balances increased from $10,136,000 at December
31, 1997 to $13,972,000 at September 30, 1998. And the growth in the
mortgage-backed portfolio, whose balances increased from $30,186,000 to
$35,430,000. Mortgage-backed securities which QNB purchases tend to have an
average-life of approximately 5 years.
Form 10-Q
Page 16
<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 $87,399,000 and $91,915,000 at September 30, 1998 and
December 31, 1997. These sources were adequate to meet seasonal deposit
withdrawals and loan demand during the first nine months of 1998 and should be
adequate to meet normal fluctuations in loan demand and or deposit withdrawals.
Approximately $38,337,000 and $36,510,000 of available-for-sale securities at
September 30, 1998 and December 31, 1997 were pledged as collateral for
repurchase agreements, public deposits and other deposits as provided by law.
Additional sources of liquidity, developed during the third quarter of 1998, are
provided by the Bank's membership in the Federal Home Loan Bank (FHLB) and a
$5,000,000 unsecured Federal funds line granted by the Bank's correspondent.
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 $1,063,000 to $11,511,000 at September 30, 1998. This
compares to a $2,991,000 decrease during the first nine months of 1997. After
adjusting net income for non-cash transactions, operating activities provided
$4,970,000 in cash flow in the first nine months of 1998, compared to $4,078,000
in the same period of 1997. Higher net income, an increase in residential
mortgage loan activity and a decline in interest receivable account for most of
the difference between the periods.
Net cash used by investing activities was $10,724,000 during the first nine
months of 1998. The purchase of investment securities in excess of proceeds from
maturities, calls or sales of $5,253,000 and the net increase in loans of
$4,573,000 were the primary activities that used cash. The purchase of
$2,557,000 of life insurance was also a use of cash. Proceeds from the sale of
other real estate owned and student loans provided $2,562,000 of cash. Net cash
used by investing activities was $15,119,000 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 $1,469,006 while proceeds from the sale
of student loans and other real estate owned provided $1,898,000.
Net cash provided by financing activities of $4,691,000 during the first nine
months of 1998 was the result of an increase in interest-bearing deposits,
primarily time deposits, which increased $10,236,000. Money market and NOW
accounts decreased over the same period by $2,127,000. An increase in the
balances of repurchase agreements, also provided cash. A reduction in
non-interest bearing deposits of $3,368,000 was a use of cash during the period.
The reduction in non-interest bearing deposits is a function of the timing of
deposits and withdrawals of several large deposit customers. 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 represents $3,810,000
of the increase in time deposits. Non-interest bearing deposits decreased
$1,802,000 during the first nine months of 1997.
Form 10-Q
Page 17
<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, 1998 was
$27,939,000 or 8.91 percent of total assets compared to shareholders' equity of
$25,832,000 or 8.45 percent at December 31, 1997
Shareholders' equity averaged $26,021,000 for the first nine months of 1998 and
$23,886,000 during all of 1997, an increase of 8.9 percent. The ratio of average
total equity to average total assets improved to 8.42 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 14.32 percent and 13.49 percent, a total
risk-based ratio of 15.58 percent and 14.74 percent and a leverage ratio of 8.46
percent and 8.23 percent at September 30, 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
under-capitalized." At September 30, 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
Form 10-Q
Page 18
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INTEREST RATE SENSITIVITY (Continued)
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 run-off. 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 September 30, 1998, interest-earning assets scheduled to
mature or likely to be called, repriced or repaid in one year were $113,155,000.
Interest-sensitive liabilities scheduled to mature or reprice within one year
were $116,953,000. The one year cumulative gap, which reflects QNB's interest
sensitivity over a period of time, was a negative $3,798,000 at September 30,
1998. The cumulative one-year gap equals -1.30 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 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 modestly
compared to the prior twelve months. The projected increase in net interest
income is primarily the result of forecasted growth in total earning assets and
a change in the composition of earning assets, with the loan to earning assets
ratio increasing slightly. These factors will be partially offset by a decrease
in the net interest margin. The actual results for the third quarter of 1998 did
not meet the expected results from the simulation model because of the timing
and magnitude of rate changes on funding sources. QNB was not able to decrease
rates on interest-bearing liabilities as quickly or to as large a degree as was
assumed in the model. The repricing of interest rates on liabilities tends to
lag changes in interest rates on assets, both up and down.
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
Form 10-Q
Page 19
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INTEREST RATE SENSITIVITY (Continued)
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 September 30, 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 ........................... $11,372 $(1,274) (10.08)%
+200 Basis Points ........................... 11,877 (769) (6.08)
+100 Basis Points ........................... 12,274 (372) (2.94)
FLAT RATE ................................... 12,646 - -
- -100 Basis Points ........................... 12,958 312 2.47
- -200 Basis Points ........................... 13,055 409 3.24
- -300 Basis Points ........................... 12,916 270 2.14
</TABLE>
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.
Form 10-Q
Page 20
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
IMPACT OF YEAR 2000 (Continued)
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 complete and proxy testing has
been completed at six other banks and open system testing completed at multiple
other sites. QNB has also received a third party review of QNB's core processing
system that concluded adequate progress in meeting established goals for Year
2000 qualification of the system and related products. In addition, QNB has
installed the updated software on our test system and has begun testing
in-house. Testing is anticipated to be completed by year end. QNB has completed
approximately 60 percent of the renovation phase.
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
substantially completed 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.
The only major investment in technology partially as a result of the Year 2000
was the purchase of an imaging system to do item processing. QNB's current item
processing system was deemed not to be Year 2000 compliant after QNB had
previously adopted a long range technology plan which included migrating to
imaging during 1999. The new system is scheduled to be installed during the
first quarter of 1999. The estimated cost of the imaging system is approximately
$300,000.
Through QNB's Year 2000 team, three areas of Year 2000 exposure have been
identified: 1) customer uncertainty; 2) utility and communication companies; and
3) indirect debit and ATM gateways. QNB is addressing these areas through its
Disaster Recovery Program. The existing Disaster Recovery Program is being
updated to include the additional risks posed by the Year 2000. The plan is
scheduled to be completed by December 31, 1998.
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
The information required herein is set forth in Item 2, above.
Form 10-Q
Page 21
<PAGE>
QNB CORP. AND SUBSIDIARY
PART II. OTHER INFORMATION
SEPTEMBER 30, 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
The following Exhibits are included in this Report:
Exhibit 3.1 Articles of Incorporation of Registrant, as amended.
(Incorporated by reference to Exhibit 3.1 of Registrants
Form 10-Q filed with the Commission on August 13, 1998).
Exhibit 3.2 Bylaws of Registrant, as amended. (Incorporated by
reference to Exhibit 3.1 of Registrants Form 10-Q filed
with the Commission on August 13, 1998).
Exhibit 10.1 Employment Agreement between the Registrant and Thomas J.
Bisko. (Incorporated by reference to Exhibit 10(a) of
Registrant's Current Report on Form 8-K filed with the
Commission on April 30, 1989).
Exhibit 10.2 Salary Continuation Agreement between the Registrant and
Thomas J. Bisko. (Incorporated by reference to Exhibit 10(b)
of Registrant's Current Report on Form 8-K filed with the
Commission on April 30, 1989).
Exhibit 10.3 Deferred Compensation Agreement between the Registrant and
Philip D. Miller. (Incorporated by reference to Exhibit
10(c) of registrant's Current Report on Form 8-K filed with
the Commission on April 30, 1989).
Exhibit 10.4 QNB Corp. Stock Incentive Plan. (Incorporated by reference
to Exhibit 4A to Registration Statement No. 333-16627 on
Form S-8, filed with the Commission on November 22, 1996).
Form 10-Q
Page 22
<PAGE>
PART II. OTHER INFORMATION
SEPTEMBER 30, 1998
Item 6 Exhibits and Reports on Form 8-K (Continued)
Exhibit 10.5 QNB Corp. Employee Stock Purchase Plan. (Incorporated by
reference to Exhibit 4B to Registration Statement No.
333-16627 on Form S-8, filed with the Commission on
November 22, 1996).
Exhibit 10.6 The Quakertown National Bank Profit Sharing and Section
401(k) Salary Deferral Plan. (Incorporated by reference to
Exhibit 4C to Registration Statement No. 333-16627 on Form
S-8, filed with the Commission on November 22, 1996).
Exhibit 11 Statement Re: Computation of Earnings Per Share.
(Included in Part 1, Item 1, hereof.)
Exhibit 27 Financial Data Schedule
Exhibit 99 Financial Data Schedule for September 30, 1997, revised
to reflect changes in Earnings Per Share.
(b) Reports on Form 8-K
None
Form 10-Q
Page 23
<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, 1998 By:
----------------------------
/s/ Thomas J. Bisko
----------------------------------
Thomas J. Bisko
President and CEO
Date: November 13, 1998 By:
----------------------------
/s/ Robert C. Werner
----------------------------------
Robert C. Werner
Vice President
Date: November 13, 1998 By:
----------------------------
/s/ Bret H. Krevolin
----------------------------------
Bret H. Krevolin
Chief Accounting Officer
Form 10-Q
Page 24
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 11,475
<INT-BEARING-DEPOSITS> 36
<FED-FUNDS-SOLD> 2,424
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 72,266
<INVESTMENTS-CARRYING> 49,480
<INVESTMENTS-MARKET> 50,060
<LOANS> 169,115
<ALLOWANCE> 2,983
<TOTAL-ASSETS> 313,526
<DEPOSITS> 271,993
<SHORT-TERM> 10,958
<LIABILITIES-OTHER> 2,636
<LONG-TERM> 0
0
0
<COMMON> 1,790
<OTHER-SE> 25,205
<TOTAL-LIABILITIES-AND-EQUITY> 313,526
<INTEREST-LOAN> 11,004
<INTEREST-INVEST> 5,461
<INTEREST-OTHER> 260
<INTEREST-TOTAL> 16,725
<INTEREST-DEPOSIT> 6,966
<INTEREST-EXPENSE> 7,223
<INTEREST-INCOME-NET> 9,502
<LOAN-LOSSES> 300
<SECURITIES-GAINS> 75
<EXPENSE-OTHER> 7,008
<INCOME-PRETAX> 3,858
<INCOME-PRE-EXTRAORDINARY> 2,782
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,782
<EPS-PRIMARY> 1.94
<EPS-DILUTED> 1.93
<YIELD-ACTUAL> 4.55
<LOANS-NON> 856
<LOANS-PAST> 6
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 2,400
<ALLOWANCE-OPEN> 2,670
<CHARGE-OFFS> 18
<RECOVERIES> 31
<ALLOWANCE-CLOSE> 2,983
<ALLOWANCE-DOMESTIC> 2,983
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 1,989
</TABLE>
<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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<LOANS> 158,917
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<TOTAL-ASSETS> 291,494
<DEPOSITS> 254,873
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<LIABILITIES-OTHER> 2,280
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0
0
<COMMON> 1,785
<OTHER-SE> 23,330
<TOTAL-LIABILITIES-AND-EQUITY> 291,494
<INTEREST-LOAN> 10,600
<INTEREST-INVEST> 4,959
<INTEREST-OTHER> 154
<INTEREST-TOTAL> 15,713
<INTEREST-DEPOSIT> 6,485
<INTEREST-EXPENSE> 6,710
<INTEREST-INCOME-NET> 9,003
<LOAN-LOSSES> 300
<SECURITIES-GAINS> 165
<EXPENSE-OTHER> 6,763
<INCOME-PRETAX> 3,490
<INCOME-PRE-EXTRAORDINARY> 2,482
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,482
<EPS-PRIMARY> 1.74
<EPS-DILUTED> 1.73
<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
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 1,589
</TABLE>
