SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2000
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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 Identification No.)
Incorporation or Organization)
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 November 10, 2000
Common Stock, par value $1.25 1,484,951
<PAGE>
QNB CORP. AND SUBSIDIARY
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2000
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) PAGE
Consolidated Statements of Income for Three and
Nine Months Ended September 30, 2000 and 1999 .................... 1
Consolidated Balance Sheets at September 30, 2000
and December 31, 1999 ............................................ 2
Consolidated Statements of Cash Flows for Nine
Months Ended September 30, 2000 and 1999 ......................... 3
Notes to Consolidated Financial Statements ......................... 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION ............................... 7
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK ...................................................... 22
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS .................................................. 23
ITEM 2. CHANGES IN SECURITIES .............................................. 23
ITEM 3. DEFAULTS UPON SENIOR SECURITIES .................................... 23
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITIES HOLDERS ............. 23
ITEM 5. OTHER INFORMATION .................................................. 23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ................................... 23
i
<PAGE>
QNB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(in thousands, except share data)
(Unaudited)
============================================================================================================================
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2000 1999 2000 1999
<S> <C> <C> <C> <C>
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INTEREST INCOME
Interest and fees on loans ............................................ $ 3,741 $ 3,531 $ 10,880 $ 10,698
Interest and dividends on investment securities:
Taxable .......................................................... 2,144 2,143 6,364 5,718
Tax-exempt ....................................................... 349 298 998 732
Interest on Federal funds sold ........................................ 135 38 161 157
Interest on interest-bearing balances ................................. 6 1 14 2
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Total interest income ........................................ 6,375 6,011 18,417 17,307
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INTEREST INCOME
Interest on deposits
Interest-bearing demand accounts ................................. 192 141 492 339
Money market accounts ............................................ 428 198 915 588
Savings .......................................................... 187 178 545 523
Time ............................................................. 1,613 1,436 4,696 4,305
Time over $100,000 ............................................... 321 341 842 938
Interest on short-term borrowings ..................................... 114 109 346 297
Interest on Federal Home Loan Bank advances ........................... 345 328 1,008 559
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Total interest expense ....................................... 3,200 2,731 8,844 7,549
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Net interest income .......................................... 3,175 3,280 9,573 9,758
Provision for loan losses ............................................. - 60 - 180
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Net interest income after provision for loan losses .......... 3,175 3,220 9,573 9,578
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NON-INTEREST INCOME
Fees for services to customers ........................................ 329 318 934 882
Mortgage servicing fees ............................................... 22 32 82 95
Net gain (loss) on investment securities available-for-sale ........... 51 (142) 156 21
Net gain on sale of loans ............................................. 16 21 58 166
Other operating income ................................................ 251 192 747 601
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Total non-interest income .................................... 669 421 1,977 1,765
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NON-INTEREST EXPENSE
Salaries and employee benefits ........................................ 1,400 1,430 4,225 4,299
Net occupancy expense ................................................. 199 162 531 488
Furniture and equipment expense ....................................... 256 231 706 656
Marketing expense ..................................................... 76 78 274 283
Other expense ......................................................... 605 517 1,678 1,569
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Total non-interest expense ................................... 2,536 2,418 7,414 7,295
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Income before income taxes ....................................... 1,308 1,223 4,136 4,048
Provision for income taxes ............................................ 288 281 936 1,008
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NET INCOME ....................................................... $ 1,020 $ 942 $ 3,200 $ 3,040
============================================================================================================================
NET INCOME PER SHARE - BASIC ..................................... $ .68 $ .62 $ 2.13 $ 2.02
============================================================================================================================
NET INCOME PER SHARE - DILUTED.................................... $ .68 $ .62 $ 2.13 $ 2.01
============================================================================================================================
CASH DIVIDENDS PER SHARE ......................................... $ .24 $ .20 $ .71 $ .60
============================================================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
1
<PAGE>
QNB CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(in thousands)
(Unaudited)
----------------------------------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31,
2000 1999
<S> <C> <C>
----------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks ................................................... $ 13,835 $ 19,352
Federal funds sold ........................................................ 4,212 -
Investment securities
available-for-sale ................................................... 110,748 97,609
held-to-maturity (market value $43,142 and $46,572) .................. 44,170 48,302
Total loans, net of unearned income of $189 and $235 ...................... 181,638 173,764
Allowance for loan losses ............................................ (2,945) (3,196)
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Net loans ....................................................... 178,693 170,568
Premises and equipment, net ............................................... 5,669 4,840
Other real estate owned ................................................... - 348
Accrued interest receivable ............................................... 2,224 2,045
Other assets .............................................................. 7,179 7,425
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Total assets .............................................................. $ 366,730 $ 350,489
==========================================================================================================
LIABILITIES
Deposits
Demand, non-interest-bearing ......................................... $ 35,268 $ 35,510
Interest bearing demand accounts ..................................... 47,274 47,448
Money market accounts ................................................ 43,143 30,002
Savings .............................................................. 35,468 35,660
Time ................................................................. 116,288 117,160
Time over $100,000 ................................................... 18,084 20,386
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Total deposits .................................................. 295,525 286,166
Short-term borrowings ..................................................... 13,701 8,925
Federal Home Loan Bank advances ........................................... 25,000 25,000
Accrued interest payable .................................................. 1,306 1,420
Other liabilities ......................................................... 1,490 1,516
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Total liabilities ......................................................... 337,022 323,027
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Commitments and contingencies
SHAREHOLDERS' EQUITy
Common stock, par value $1.25 per share;
authorized 5,000,000 shares; issued 1,511,965 shares and 1,509,029
shares issued; 1,486,601 and 1,509,029 shares outstanding ............ 1,800 1,796
Surplus ................................................................... 4,479 4,458
Retained earnings ......................................................... 25,942 23,812
Accumulated other comprehensive loss ...................................... (1,790) (2,604)
Treasury stock, at cost; 25,364 shares at September 30, 2000 .............. (723) -
----------------------------------------------------------------------------------------------------------
Total shareholders' equity ................................................ 29,708 27,462
----------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity ................................ $ 366,730 $ 350,489
==========================================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
2
<PAGE>
QNB CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(in thousands)
(Unaudited)
----------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2000 1999
<S> <C> <C>
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OPERATING ACTIVITIES
Net income ................................................................... $ 3,200 $ 3,040
Adjustments to reconcile net income to net cash provided by operating
activities
Provision for loan losses ................................................. - 180
Depreciation and amortization ............................................. 521 464
Securities gains .......................................................... (156) (21)
Net gain on sale of loans ................................................. (58) (166)
Proceeds from sales of residential mortgages .............................. 1,143 10,562
Originations of residential mortgages held-for-sale ....................... (1,258) (7,219)
Proceeds from sales of student loans ...................................... 2,173 2,090
Gain on sale of other real estate owned ................................... (18) (107)
Deferred income tax provision ............................................. 113 23
Change in income taxes payable ............................................ 32 -
Net increase in interest and dividends receivable ......................... (179) (294)
Net amortization of premiums and discounts ................................ (32) 4
Net (decrease) increase in interest payable ............................... (114) 263
Increase in other assets .................................................. (319) (546)
Decrease in other liabilities ............................................. (26) (87)
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Net cash provided by operating activities ................................. 5,022 8,186
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INVESTING ACTIVITIES
Proceeds from maturities and calls of investment securities
available-for-sale ........................................................ 17,199 18,195
held-to-maturity .......................................................... 4,813 10,775
Proceeds from sales of investment securities
available-for-sale ........................................................ 3,735 12,834
Purchase of investment securities
available-for-sale ........................................................ (32,646) (71,215)
held-to-maturity .......................................................... (686) (10,909)
Net (increase) decrease in Federal funds sold ................................ (4,212) 4,869
Net increase in loans ........................................................ (10,125) (1,895)
Net purchases of premises and equipment ...................................... (1,350) (409)
Proceeds from the sale of other real estate owned ............................ 366 364
----------------------------------------------------------------------------------------------------------
Net cash used by investing activities ..................................... (22,906) (37,391)
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FINANCING ACTIVITIES
Net decrease in non-interest-bearing deposits ................................ (242) (3,525)
Net increase in interest-bearing deposits .................................... 9,601 9,628
Net increase (decrease) in short-term borrowings ............................. 4,776 (2,807)
Proceeds from Federal Home Loan Bank advances ................................ - 25,000
Cash dividends paid .......................................................... (1,070) (904)
Proceeds from issuance of common stock ....................................... 25 25
Purchases of treasury stock .................................................. (723) -
----------------------------------------------------------------------------------------------------------
Net cash provided by financing activities ................................. 12,367 27,417
----------------------------------------------------------------------------------------------------------
Decrease in cash and cash equivalents ..................................... (5,517) (1,788)
Cash and cash equivalents at beginning of year ............................ 19,352 14,020
----------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period ................................ $ 13,835 $ 12,232
==========================================================================================================
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid ................................................................ $ 8,958 $ 7,286
Income taxes paid ............................................................ 775 970
Non-Cash Transactions
Change in net unrealized holding gains (losses), net of taxes, on
investment securities ..................................................... 814 (2,833)
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
3
<PAGE>
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000 AND 1999, AND DECEMBER 31, 1999
(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, 2000, as well as the
respective statements of income and cash flows for the three and the nine month
periods ended September 30, 2000 and 1999, are unaudited. These financial
statements should be read in conjunction with the audited financial statements
and notes thereto included in QNB's 1999 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 have been restated to reflect the 5% stock dividend
issued June 30, 2000 and are not in thousands):
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
----------------------- -----------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Numerator for basic and diluted earnings
per share-net income .................... $ 1,020 $ 942 $ 3,200 $ 3,040
Denominator for basic earnings per share-
weighted average shares outstanding ..... 1,490,787 1,508,165 1,503,201 1,506,958
Effect of dilutive securities-employee
stock options ........................... 226 4,275 178 7,006
Denominator for diluted earnings per
share-adjusted weighted average
shares outstanding ...................... 1,491,013 1,512,440 1,503,379 1,513,964
Earnings per share-basic ................ $ 0.68 $ 0.62 $ 2.13 $ 2.02
Earnings per share-diluted .............. $ 0.68 $ 0.62 $ 2.13 $ 2.01
</TABLE>
4
<PAGE>
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000 AND 1999, AND DECEMBER 31, 1999
(UNAUDITED)
2. PER SHARE DATA (Continued)
There were 48,195 and 28,140 stock options that were anti-dilutive for the
three-month periods ended September 30, 2000 and 1999 and 48,195 and 15,540
stock options that were anti-dilutive for the nine-month period ended September
30, 2000 and 1999.
3. COMPREHENSIVE INCOME
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 periods ended September 30, 2000 and 1999 (net of the income tax effect):
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------- -------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Unrealized holding gains (losses) arising $ 982 ($ 874) $ 917 ($2,819)
during the period on securities held........
Reclassification adjustment equal to
beginning unrealized for all sold
securities ............................... (34) 94 (103) (14)
Net change in unrealized during the period.. 948 (780) 814 (2,833)
period
Unrealized, beginning of period ............ (2,738) (1,137) (2,604) 916
------- ------- ------- -------
Unrealized, end of period .................. ($1,790) ($1,917) ($1,790) ($1,917)
======= ======= ======= =======
Net income ................................. $ 1,020 $ 942 $ 3,200 $ 3,040
Other comprehensive (loss) income, net
of tax:
Unrealized holding gains (losses)
arising during the period ............ 948 (780) 814 (2,833)
Comprehensive Income ................... $ 1,968 $ 162 $ 4,014 $ 207
======= ======= ======= =======
</TABLE>
5
<PAGE>
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000 AND 1999, AND DECEMBER 31, 1999
(UNAUDITED)
4. STOCK REPURCHASE PLAN
In March of 2000, the Board of Directors of QNB Corp. authorized the repurchase
of up to 4.99 percent or 75,410 shares of QNB Corp's outstanding common stock.
Such repurchases may be made in open market or privately negotiated
transactions. The repurchased shares will be held in treasury and will be
available for general corporate purposes. As of September 30, 2000 QNB Corp.
repurchased 25,364 shares at an average cost of $28.51 per share.
6
<PAGE>
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000 AND 1999, AND DECEMBER 31, 1999
(UNAUDITED)
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 123 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." Per share data has been
adjusted to reflect the 5% stock dividend issued June 30, 2000.
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 2000, and any Current Reports on Form 8-K filed by
the Corporation.
RESULTS OF OPERATIONS-SUMMARY
QNB recorded earnings of $1,020,000 or $.68 per share on a diluted basis for the
three month period ended September 30, 2000. This represents an 8.3 percent
increase from net income of $942,000 or $.62 per share-diluted reported for the
third quarter of 1999. For the nine month periods ended September 30, 2000 and
1999, net income was $3,200,000 and $3,040,000, respectively, an increase of 5.3
percent. Net income per share diluted was $2.13 and $2.01 for the corresponding
nine-month periods.
When comparing the two quarters an increase in non-interest income offset a
decline in net interest income and an increase in non-interest expense. The cost
of acquiring and retaining deposits and short-term borrowings has increased to a
greater degree than the rates earned on loans and investments. This has resulted
in a decline in both net interest income and the net interest margin. When
comparing the three-month periods ended September 30, 2000 and 1999, net
interest income decreased 3.2 percent despite a 4.2 percent increase in average
earning assets. Net interest income which represents interest income, dividends,
and fees on earning assets, less interest expense incurred on funding sources,
declined to $3,175,000 for the quarter ended September 30, 2000 as compared to
$3,280,000 for the quarter ended September 30, 1999. The net interest margin
declined to 3.88 percent during the third quarter of 2000 from 4.13 percent for
the third quarter of 1999. The increased cost of funds is a result of higher
promotional rates on the Treasury Select Money Market account and the
competitive nature of the local market for certificates of deposit. The net
interest margin was also negatively impacted by a large influx of short-term
deposits during the third quarter of 2000 that earned a rate only slightly lower
than the assets they were invested in.
Non-interest income increased from $421,000 during the third quarter of 1999 to
$669,000 for the three months ended September 30, 2000, an increase of 58.9
percent. Excluding gains and losses on the sale of investment securities and
loans during both periods, non-interest income increased approximately $60,000
or 11.1 percent.
7
<PAGE>
RESULTS OF OPERATIONS-SUMMARY (CONTINUED)
During the third quarter of 1999, in response to rising interest rates, QNB sold
some lower yielding securities at a loss of approximately $150,000 and
reinvested the proceeds in higher yielding securities. During the third quarter
of 2000, QNB sold some equity securities at a gain of approximately $51,000. An
increase in fee income related to debit card and ATM transactions also
contributed to the increase in non-interest income when comparing the
three-month periods.
Non-interest expense increased $118,000 or 4.9 percent from $2,418,000 for the
third quarter of 1999 to $2,536,000 for the three months ended September 30,
2000. An increase in professional fees resulting from the outsourcing of the
internal audit function and costs associated with the installation and
conversion of a new computer system contributed to the increase in non-interest
expense. Additional costs related to the computer conversion will also impact
the results for the fourth quarter of 2000, its anticipated completion date.
Higher facility and equipment expense also contributed to the increase in
non-interest expense. Personnel expense decreased 2.1 percent when comparing the
two quarters. The continued low level of non-performing assets enabled QNB to
eliminate its provision for loan losses. This expense was $60,000 during the
third quarter of 1999.
Return on average assets was 1.09 percent and 1.04 percent while the return on
average equity was 13.03 percent and 12.82 percent for the three months ended
September 30, 2000 and 1999, respectively. For the nine-month periods ended
September 30, 2000 and 1999, return on average assets was 1.18 percent and 1.19
percent and the return on average equity was 13.87 percent and 14.22 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.
Net interest income decreased 3.2 percent to $3,175,000 for the quarter ended
September 30, 2000 as compared to $3,280,000 for the quarter ended September 30,
1999. The yield on earning assets on a tax-equivalent basis was 7.52 percent for
the third quarter of 2000 versus 7.35 percent for the third quarter of 1999,
while the rate paid on interest-bearing liabilities was 4.21 percent and 3.74
percent for the same periods. Interest rates on deposit accounts and short-term
borrowings have increased to a greater degree than rates on loans and investment
securities as market interest rates have increased, resulting in a decline in
the net interest margin. The net interest margin on a tax-equivalent basis
declined 25 basis points to 3.88 percent for the three-month period ended
September 30, 2000 compared with 4.13 percent for the same period in 1999. The
net interest margin for the third quarter of 2000 of 3.88 percent compares to a
net interest margin of 4.10 percent for the second quarter of 2000. The decrease
between the second and third quarters of 2000 is primarily the result of a 20
basis point increase in the cost of funds and a 2 point decrease in the yield on
earning assets. The increased cost of funds is a result of higher promotional
rates on the Treasury Select Money Market account and the competitive nature of
the local market for certificates of deposit. The net interest margin was also
negatively impacted by a large influx of short-term deposits during the third
quarter of 2000 that earned a rate only slightly lower than the assets they were
invested in. A 4.2 percent increase in average earning assets helped offset the
negative impact of a declining net interest margin.
8
<PAGE>
NET INTEREST INCOME (CONTINUED)
The yield on earning assets increased when comparing the two quarters as
interest rates, as represented by the United States Treasury yield curve,
increased during the later part of 1999 and early 2000. The increase in the
yield on earning assets is primarily centered in loans, whose yield increased
from 8.20 percent for the third quarter of 1999 to 8.38 percent for the third
quarter of 2000. However, since the end of the second quarter of 1999 through
the end of the third quarter of 2000, the Prime rate on loans has increased 175
basis points from 7.75 percent to 9.50 percent. While QNB will see some benefit
in 2000 and 2001 from these prime rate increases, the overall yield on the loan
portfolio will not increase proportionately since only approximately 13 percent
of the portfolio re-prices immediately with changes in the prime rate. The
current yield on loans has been negatively impacted by the decline in rates that
occurred in 1998. As rates hit historically low levels during 1998, many
borrowers, including commercial and consumer, selected fixed rate rather than
variable rate loans. Therefore, the loan portfolio has yielded minimal benefit
from rising rates during 1999 and 2000. Another factor in the decline in the
yield on loans is the current competitive environment for loans, both commercial
and consumer, from both banks and non-banks, which has prevented the rates from
increasing to the degree that Treasury rates and the Prime rate have increased.
QNB anticipates that the yield on loans will continue to increase during 2000 as
the impact of the increase in market interest rates are factored into new loans
as well as the impact of these higher rates on loans that do re-price over time.
Some of this impact has been realized as the yield on loans for the third
quarter of 2000 of 8.38 percent was an increase from the 8.11 percent for the
fourth quarter of 1999 and 8.15 percent for the first quarter of 2000.
When comparing the third quarter of 2000 to the third quarter of 1999, the yield
on investment securities increased to 6.61 percent from 6.47 percent. QNB has
been able to maintain the yield on investment securities through various
interest rate environments by actively managing its portfolio. When rates fell
in 1998 and cash flow increased as a result of prepayments on mortgage-backed
securities and callable agency securities, QNB was able to reduce the negative
impact on the yield in 1998 and 1999 by purchasing mortgage-backed securities,
whose yields did not decline to the same degree as Treasury securities and by
lengthening the average life of the portfolio with the purchase of some higher
yielding but longer term callable agency securities and tax-exempt municipal
securities. With the rise in rates in 1999, cash flow from mortgage-backed
securities and callable agency securities slowed resulting in fewer dollars
being reinvested at the higher rates. To take advantage of the higher interest
rate environment, QNB, during the third and fourth quarters of 1999, sold, at a
loss of $256,000, approximately $9,500,000 of securities yielding 6.25%, and
reinvested the proceeds in securities yielding 7.50 percent. This transaction
benefited QNB by increasing interest income in 2000. Also positively impacting
the yield during 2000 was the reinvestment of the excess liquidity created by
the Year 2000 issue at these higher interest rates. The yield on the overall
portfolio during the third quarter of 2000 was negatively impacted by the need
to invest approximately $16,000,000 in short-term temporary deposits into
short-term investments that paid slightly over the Federal funds rate. As of
September 30, 2000 the majority of these short-term deposits are no longer at
QNB.
Total interest expense increased $469,000 during the third quarter of 2000 to
$3,200,000. Rising market interest rates combined with the successful promotion
of the Treasury Select Money Market account and the competition for time
deposits caused rates on both deposits accounts and short-term borrowings to
increase when comparing the two quarters. The yield on interest bearing deposits
increased from 3.60 percent to 4.10 percent while the yield on short-term
borrowings increased from 3.72 percent to 4.15 percent for the quarters ended
September 30, 1999 and 2000. The yield on interest-bearing demand accounts
increased 36 basis points while the yield on time deposits and money market
accounts increased 41 basis points and 150 basis points. The Treasury Select
Indexed Money Market account, introduced at the end of the first quarter of
2000, is a variable rate account indexed to a
9
<PAGE>
NET INTEREST INCOME (CONTINUED)
percentage of the monthly average of the 91-day Treasury bill rate based on
balances in the account. This product pays a minimum 6.00 percent yield through
the end of 2000 for accounts with balances over $25,000. The average balance in
these accounts for the third quarter of 2000 was $14,201,000 and the balance as
of September 30, 2000 was $16,904,000 or 39.2 percent of total money market
accounts. The increase in the rate paid on time deposit accounts is a result of
the competitive interest rate environment for deposits, especially time deposits
and the re-pricing of lower rate time deposits at higher rates upon renewal. The
increase in the yield on short-term borrowings is a result of higher rates paid
on cash management accounts.
For the nine-month period ended September 30, 2000, net interest income
decreased $185,000 or 1.9 percent to $9,573,000. On a tax-equivalent basis net
interest income decreased $42,000 or .4 percent. The smaller percentage decrease
on a tax-equivalent basis is the result of an increase in the proportion of
tax-exempt earning assets, particularly investment securities, to total earning
assets. The 6.4 percent growth in average earning assets was offset by a 28
basis point decline in the net interest margin. Excluding the impact of the
wholesale funding transaction average earning assets increased 3.2 percent and
the net interest margin declined by 20 basis points. Total interest income
increased $1,110,000 from $17,307,000 to $18,417,000 when comparing the
nine-month periods ended September 30, 1999 to September 30, 2000. The yield on
earning assets increased from 7.46 percent to 7.50 percent, with the yield on
loans increasing from 8.26 percent to 8.28 percent. During the nine-month period
the yield on investment securities increased from 6.53 percent to 6.65 percent.
Average investment securities increased 13.3 percent to $158,317,000 while
average loans increased 1.3 percent to $178,247,000. Total interest expense
increased $1,295,000 or 17.2 percent from $7,549,000 to $8,844,000 for the
nine-month periods with the interest on the Federal Home Loan Bank advances
accounting for $449,000 of the increase and interest expense on money market
accounts and time deposits contributing $327,000 and $295,000 to the increase.
The yield on interest-bearing liabilities increased from 3.69 percent to 4.03
percent. Average interest-bearing deposits increased 3.6 percent to
$256,648,000, while total average interest-bearing liabilities increased 7.1
percent to $292,886,000. The primary difference in the percent change is the
impact of the borrowings from the Federal Home Loan Bank, entered into at the
end of April 1999.
QNB anticipates the net interest margin to decline further in the fourth quarter
of 2000 before recovering slightly during the first and second quarters of 2001.
The improvement in the net interest margin in 2001 should result from higher
yields on loans, as existing loans re-price and new loans are booked at higher
rates, and the end of the promotional rate on the Treasury Select Indexed Money
Market account.
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
loss to a level considered adequate in relation to the risk of loss in the loan
portfolio. Actual loan losses, net of recoveries, serve to reduce the allowance.
The determination of an appropriate level of the allowance for loan losses is
based upon an analysis of the risk inherent in QNB's loan portfolio. Management
uses various tools to assess the adequacy of the allowance for loan losses. One
tool is a model recommended by the Office of the Comptroller of the Currency.
This model considers a number of relevant factors including: historical loan
loss experience, the assigned risk rating of the credit, current and projected
credit worthiness of the borrower, current value of the underlying collateral,
levels of and trends in delinquencies and non-accrual loans, trends in volume
and terms of loans, concentrations of credit, and national and local economic
trends and conditions. This model is supplemented with another analysis that
also incorporates exceptions to QNB's loan policy and QNB's portfolio exposure
to borrowers with large dollar concentration, defined as exceeding 25% of QNB's
legal lending limit. Other tools include ratio analysis and peer group analysis.
10
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PROVISION FOR LOAN LOSSES (CONTINUED)
There was no provision for loan losses for either the three or nine-month period
ended September 30, 2000. The provision for loan losses was $60,000 and $180,000
for the three and nine-month periods ended September 30, 1999. QNB's management
determined no provision for loan losses was necessary in 2000 as a result of
continued low levels of non-performing assets and delinquency. QNB had net
charge-offs of $163,000 during the third quarter of 2000 versus a net recovery
of $3,000 for the third quarter of 1999. Approximately $154,000 of the total
loans charged off for the third quarter of 2000 represents a loan to one
borrower. For the nine-month periods ended September 30, 2000 and 1999, QNB had
net charge-offs of $251,000 and net recoveries of $9,000, respectively. Net
charge-offs represent .14 percent of average loans for the nine months ended
September 30, 2000.
Non-performing assets (non-accruing loans, loans past due 90 days or more, and
other real estate owned) continued their positive trend downward during 2000 and
amounted to .12 percent of total assets at September 30, 2000. This compares to
.29 percent at September 30, 1999 and .25 percent at December 31, 1999.
Non-accrual loans were $450,000 and $454,000 at September 30, 2000 and 1999.
Non-accrual loans at December 31, 1999 were $484,000. Other real estate owned
was $439,000 at September 30, 1999 and $348,000 at December 31, 1999. QNB sold
the remaining property, with a cost basis of $104,000, at a gain of
approximately $10,000 in July 2000.
There were no restructured loans as of September 30, 2000, December 31, 1999 or
September 30, 1999 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 $2,945,000 and $3,196,000 at September 30,
2000 and December 31, 1999, respectively. The ratio of the allowance to total
loans was 1.62 percent and 1.84 percent for the respective periods. The ratio of
the allowance for loan losses to non-performing loans was 645.83 percent and
611.09 percent at September 30, 2000 and December 31, 1999. 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.
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, 2000 and 1999, the recorded investment in loans for which
impairment has been recognized in accordance with SFAS No. 114 totaled $389,000
and $364,000, respectively, of which $344,000 related to loans with no valuation
allowance for both periods. At September 30, 2000 and 1999 there were $45,000
and $20,000 in impaired loans that had a valuation allowance against the entire
amount. Most of the loans identified as impaired are collateral-dependent.
11
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QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME
QNB, through its core banking business, generates various fees and service
charges. Total non-interest income is composed of service charges on deposit
accounts, mortgage servicing fees, gains on the sale of investment securities,
gains on the sale of residential mortgages and student loans, and other
miscellaneous fee income. QNB reviews all service charges and fee schedules
related to its products and services on an annual basis. Except for an increase
in overdraft fees during the first quarter of 1999 and the implementation of an
ATM surcharge for non-QNB customers in June 2000, QNB has not materially changed
these fee schedules during 1999 or 2000. Total non-interest income increased
$248,000 or 58.9 percent to $669,000 for the quarter ended September 30, 2000
when compared to September 30, 1999. For the nine-month period total
non-interest income increased $212,000 or 12.0 percent to $1,977,000. Excluding
gains and losses on the sale of investment securities and loans during both
periods, non-interest income for the three-month period increased $60,000 or
11.1 percent and for the nine-month period increased $185,000 or 11.7 percent.
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 3.5 percent, to $329,000 from $318,000, when comparing the two
quarters and 5.9 percent to $934,000 when comparing the nine-month periods. An
increase in overdraft fee income accounts for approximately $4,000 of the
increase for the three-month period and $49,000 for the nine-month period.
During the first quarter of 1999, QNB increased its fee for overdrafts by 12.0
percent. An increase in fees related to the use of out-of-network ATMs
contributed $11,000 to the overall increase for the three-month period and
$14,000 for the nine-month period. A decline in service charge income on
business deposit accounts offset some of these increases.
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 ended September
30, 2000 were $22,000 which represents a $10,000 decrease from the same period
in 1999. For the nine-month period mortgage servicing fees decreased $13,000 or
13.7 percent to $82,000. The decrease in mortgage servicing fees for both the
quarter and the nine month period is the result of both an increase in the
amortization of the mortgage servicing asset booked at the time the loan is sold
and the impact of lower income resulting from the servicing of fewer loans. QNB
recognizes its obligation to service financial assets that are retained in a
transfer of assets in the form of a servicing asset. The servicing asset is
amortized in proportion to and over a period of net servicing income or loss.
Servicing assets are assessed for impairment based on their fair value. During
the third quarter of 2000, QNB amortized approximately $18,000 of the mortgage
servicing asset compared to $11,000 during the third quarter of 1999. The payoff
of several loans contributed $6,000 to the increase in amortization. The average
balance of mortgages serviced for others was $62,445,000 for the third quarter
of 2000 compared to $67,592,000 for the third quarter of 1999. The average
balance of mortgages serviced was approximately $63,824,000 for the nine-month
period ended September 30, 2000 compared to $67,946,000 for the first nine
months of 1999, a decline of 6.1 percent. Rising interest rates have reduced the
amount of mortgage origination and sales activity. The timing of mortgage
payments and delinquencies also impacts the amount of servicing fees recorded.
Gains on the sale of investment securities were $51,000 for the third quarter of
2000 and $156,000 for the first nine months of 2000. This compares to a loss of
$142,000 in the third quarter of 1999 and a gain of $21,000 for the nine-month
period ended September 30, 1999. QNB owns a small portfolio of marketable equity
securities. The gains recorded during both the three and nine month periods of
2000 relate to the net gains on the sale of some of these equity securities. The
loss for the three-month period ended September 30, 1999 was a result of
management's decision, in response to rising interest rates, to sell
approximately $5,500,000 of lower yielding securities at a loss of approximately
$150,000 and to reinvest the proceeds in higher yielding securities.
12
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QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (continued)
Gains from the equity portfolio were $8,000 for the third quarter of 1999 and
$171,000 for the nine-month period ended September 30, 1999.
QNB recorded a gain of $16,000 on the sale of loans during the third quarter of
2000. This compares to a $21,000 gain for the same period in 1999. For the
nine-month periods ended September 30, 2000 and 1999 net gains on the sale of
loans were $58,000 and $166,000, respectively. The sale of student loans
accounts for $3,000 and $5,000 of the gains during the third quarter of 2000 and
1999. QNB sold approximately $193,000 and $414,000 in student loans during the
third quarter of 2000 and 1999. Gains on the sale of student loans accounted for
$39,000 of the total gains during both nine-month periods ended September 30,
2000 and 1999. For the nine-month periods ended September 30, 2000 and 1999, QNB
sold approximately $2,134,000 and $2,051,000 in student loans.
The net gain on the sale of residential mortgage loans was $13,000 and $16,000
for the three-month periods ended September 30, 2000 and 1999 and $19,000 and
$127,000 for the respective nine-month periods. The net gain on residential
mortgage sales is directly related to the volume of mortgages sold and the
timing of the sales relative to the interest rate environment. Rising interest
rates during late 1999 and the first half of 2000 reduced the amount of mortgage
origination and sales activity. QNB originated $441,000 and $1,210,000 in
residential mortgages held for sale during the third quarter of 2000 and 1999
and $1,258,000 and $7,219,000 during the respective nine-month periods. Proceeds
from the sale of residential mortgages were approximately $531,000 and
$1,292,000 during the third quarters of 2000 and 1999, respectively. For the
nine-month periods proceeds from the sale of residential mortgage loans amounted
to $1,143,000 and $10,562,000. As of September 30, 2000 and 1999, QNB had
approximately $95,000 and $112,000 in mortgage loans classified as held for
sale. These loans are accounted for at lower of cost or market.
Other operating income increased $59,000 or 30.7 percent to $251,000 when
comparing the three-month periods ended September 30, 2000 and 1999 and $146,000
or 24.3 percent to $747,000 when comparing the nine-month periods. Higher debit
card income resulting from an increase in the number of transactions,
contributed an additional $23,000 and $60,000 to other income for the three and
nine-month periods. The implementation of an ATM surcharge for non-QNB customers
in June 2000 contributed $34,000 to other income for the three-month period and
$47,000 for the nine-month period. The implementation of an ATM surcharge has
had the impact of decreasing the number of transactions by non-QNB customers at
QNB ATM machines. This has resulted in a reduction in interchange income of
approximately $14,000 for both the three and nine month periods.
The sale during the year 2000 of the remaining properties classified as other
real estate owned resulted in the elimination of rental income on these
properties during the third quarter of 2000. Rental income was $11,000 during
the third quarter on 1999. For the nine-month period rental income decreased
$25,000. An increase of commissions on official check transactions and the sale
of checks to depositors increased non-interest income by $22,000 for the
three-month period and $21,000 for the nine-month period. An increase in the
earnings on the cash surrender value of life insurance contributed an additional
$11,000 to other income for the nine-month period. Merchant processing income
also increased $10,000 when comparing the nine-month periods ended September 30,
2000 and 1999.
13
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QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST EXPENSE
Non-interest expense is comprised of costs related to salaries and employee
benefits, net occupancy, furniture and equipment, marketing, and various other
operating expenses. Total non-interest expense of $2,536,000 for the quarter
ended September 30, 2000 represents an increase of $118,000 or 4.9 percent from
levels reported in the third quarter of 1999. Total non-interest expense for the
nine months ended September 30, 2000 was $7,414,000, an increase of $119,000 or
1.6 percent over 1999 levels.
Salaries and benefits, the largest component of non-interest expense, decreased
$30,000 or 2.1 percent to $1,400,000 for the quarter ended September 30, 2000
compared to the same quarter in 1999. Salary expense decreased $37,000 or 3.1
percent during the period to $1,143,000 while benefits expense increased $7,000
or 2.8 percent to $257,000. For the nine-month period ended September 30, 2000
salaries and benefits expense decreased $74,000 or 1.7 percent compared to 1999.
Salary expense decreased $60,000 or 1.7 percent while benefits expense decreased
$14,000 or 1.7 percent. Excluding the accrual for bonuses in both years, salary
expense increased $39,000 or 3.5 percent for the quarter and $85,000 or 2.6
percent for the nine-month period. Other events have had an impact on salary and
benefit expense when comparing 2000 to 1999. The outsourcing of several
functions, including internal audit and the courier service and the tight labor
market during the year 2000 are two such events. QNB has had to increase wages
in certain areas of the bank to retain and attract employees.
The increase in benefit expense during the quarter is a result of both higher
medical insurance costs and retirement plan contributions. For the nine-month
period higher costs in these areas was offset by a reduction in QNB's State
unemployment rate. The lower rate has reduced the cost by $23,000 for the
nine-month period.
Net occupancy expense increased $37,000 or 22.8 percent for the three-month
period and $43,000 or 8.8 percent when comparing the nine-month periods ended
September 30, 2000 and 1999. Repairs and renovations at several locations
contributed to the $23,000 increase in building repairs and maintenance expense
when comparing the three-month periods. An increase in rent expense of $11,000
and an increase in depreciation on leasehold improvements of $6,000 also
contributed to the increase in net occupancy expense for the three-month period.
These higher costs are primarily related to the expansion and renovation of one
branch at the end of 1999. These same items also impacted the results when
comparing the nine-month periods ended September 30, 2000 and 1999. Net
occupancy expense will increase in 2001 as a result of the costs associated with
the new branch in Hilltown Township, Pennsylvania anticipated to open in January
2001.
Furniture and equipment expense increased $25,000 or 10.8 percent when comparing
the three-month periods ended September 30, 2000 and 1999, respectively and
$50,000 or 7.6 percent when comparing the nine-month periods. The increase in
furniture and equipment expense for both the three-month and nine-month periods
is centered in depreciation expense, which increased $28,000 for the quarter and
$46,000 for the nine-month period. The higher depreciation costs relate to the
continued investment in technology as well as costs related to the renovation of
the branch. QNB-Online, the check imaging system, the wide area network and a
new telephone system are some examples of the technology implemented in the past
two years. Also impacting furniture and equipment expense for the nine-month
period was an increase in equipment maintenance costs. The increase in these
costs relates to general increases in contract pricing as well as additional
costs for maintenance on new systems. Furniture and equipment expense will
continue to increase during 2000 and 2001 as a new bank-wide computer system is
installed during the fourth quarter of 2000 and the new branch is put into
service in 2001.
14
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST EXPENSE (Continued)
Marketing expense decreased $2,000 or 2.6 percent to $76,000 for the quarter
ended September 30, 2000 and $9,000 or 3.2 percent when comparing the nine-month
periods. Advertising expense increased $7,000 for the three-month period and
$36,000 for the nine-month period. The introduction of QNB-Online and the
Treasury Select Money Market Product along with an increase in the advertising
of loan products and time deposit promotions contributed to the increase in
advertising expense. The increase in advertising expense for the quarter was
offset by a reduction in public relation costs. This difference is primarily
timing related. For the nine-month period the increase in advertising was offset
by a decrease in contributions and sponsorships and a decrease in promotional
item costs.
Total other expense for the three months ended September 30, 2000 was $605,000,
an increase of $88,000 or 17.0 percent over the same period in 1999. For the
nine-month period other expense increased $109,000 or 6.9 percent to $1,678,000.
The major categories that comprise other expense are postage, supplies,
professional services, telecommunication costs, insurance expense and state
taxes. Professional fees increased $24,000 for the quarter and $64,000 for the
nine-month period. These increases resulted primarily from the outsourcing of
the internal audit function. Also contributing to the increase in other expense
for the quarter and the nine-month period was $33,000 in expenses related to the
computer conversion. Net expense for other real estate owned increased $17,000
when comparing the three-month periods and $19,000 when comparing the nine-month
periods. Included in the third quarter of 1999 was the gain on the sale of other
real estate owned of $60,000 compared to $10,000 for the third quarter of 2000.
However, expenses related to the maintenance of these properties declined
$33,000 when comparing the two quarters. For the nine-month period deposit
insurance costs increased $20,000, couriers expense $11,000, ATM network costs
$14,000 and debit card expense $9,000. Partially offsetting these increases was
a $24,000 decrease in supplies expense and a $49,000 decrease in charged-off
checking accounts.
INCOME TAXES
Applicable income taxes and effective tax rates were $288,000 or 22.0 percent
for the three-month period ended September 30, 2000, and $281,000 or 23.0
percent for the same period in 1999. For the nine-month period applicable income
taxes and effective rates were $936,000 or 22.6 percent and $1,008,000 or 24.9
percent, respectively. The reduction in the effective tax rate when comparing
2000 to 1999 is a result of an increase in income from tax-exempt municipal
securities and loans and an increase in dividend income subject to the 70
percent exclusion.
QNB utilizes an asset and liability approach for financial accounting and
reporting of income taxes. As of September 30, 2000, QNB's net deferred tax
asset was $1,801,000. Included in the deferred tax asset was $758,000 relating
to the allowance for loan losses and $922,000 resulting from the SFAS No.115
adjustment for available-for-sale investment securities. As of December 31,
1999, QNB's net deferred tax asset was $2,335,000. A deferred tax asset of
$843,000 relating to the allowance for loan losses and a $1,342,000 SFAS No.115
adjustment account for most of the deferred tax asset at December 31, 1999. At
September 30, 1999, QNB's net deferred tax asset was $1,944,000. Included in the
deferred tax asset was $823,000 relating to the allowance for loan losses and
$988,000 resulting from the SFAS No. 115 adjustment.
15
<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 nine
months ended September 30, 2000 and 1999, as well as the period ending balances
as of September 30, 2000 and December 31, 1999.
Average earning assets for the nine-month period ended September 30, 2000
increased $20,458,000 or 6.4 percent to $340,249,000 from $319,791,000 for the
nine months ended September 30, 1999. Average investments and average loans
increased $18,585,000 or 13.3 percent and $2,356,000 or 1.3 percent,
respectively while average Federal funds sold decreased $727,000. The large
increase in the investment portfolio is a result of the growth in funding
sources, both retail and wholesale, outpacing the growth in loans. The advance
from the Federal Home Loan Bank funded approximately $10,700,000 of the increase
in average investment securities when comparing the nine-month periods. The
increase in the investment portfolio was primarily centered in mortgage-backed
securities and tax-exempt municipal securities.
Average mortgage loans declined $2,484,000 when comparing the nine-month
periods. The decline in the average balance of mortgage loans is a result of
rising interest rates during the later part of 1999 and the beginning of 2000
which has slowed down the origination of both new mortgage loans and refinances.
In contrast, consumer loans, primarily home equity loans continue to increase.
Average consumer loans increased $2,882,000 or 8.0 percent to $38,977,000 when
comparing the nine-month periods. The increase in consumer loans is primarily
the result of aggressive fixed rate home equity loan promotions and pricing
during the past two years. Average commercial loans increased 1.8 percent when
comparing the nine-month periods. Growth in the commercial loan portfolio has
been difficult as several of QNB's larger customers have sold their businesses
and paid off their loans over the past year. The current environment for
commercial loans is extremely competitive with community banks, regional banks,
finance companies, leasing companies, insurance companies and others, all
striving to lend to the small to medium size business customer. The entrance
into the Hilltown, Pennsylvania market in January 2000 should help enhance the
growth prospects for both loans and deposits.
In addition to borrowing from the Federal Home Loan Bank, the growth in average
earning assets was funded by increases in interest-bearing demand accounts,
money market accounts and time deposits. Average interest-bearing demand
accounts increased $3,563,000, average money market accounts increased
$4,056,000 and average time deposits increased $2,252,000. Additional deposits
by several municipalities primarily account for the increase in interest-bearing
demand deposits. The increase in money market accounts is a result of the
introduction and promotion of the Treasury Select Money Market Account. This
product is a variable rate account indexed to a percentage of the monthly
average of the 91-day Treasury bill rate based on balances in the account. This
product pays a minimum 6.00 percent yield through the end of 2000 for accounts
opened prior to October 1, 2000 and with balances over $25,000. Attractive rates
on time deposits, relative to rates on other interest-bearing accounts along
with the promotion of several time deposit specials over the past year
contributed to the increase in time deposits. Average non-interest bearing
deposits decreased $542,000 or 1.5 percent when comparing the nine-month
periods. Average total deposits increased 2.9 percent when comparing the
nine-month periods. The slow growth in deposits has created the need to look for
other sources of funds, including the Federal Home Loan Bank and the purchase of
Federal funds.
Total assets at September 30, 2000 were $366,730,000, compared with $350,489,000
at December 31, 1999, an increase of 4.6 percent for the nine months. The
increase in assets from December 31, 1999 is primarily in investment securities,
loans and Federal funds sold which increased by $9,007,000, $7,874,000 and
$4,212,000,respectively. The increase in investment securities is the result of
both the increase in deposit balances and the redeployment of excess Year 2000
cash into agency securities, tax-exempt municipal securities
16
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS (Continued)
and equity securities. The increase in loans is the result of both new loans and
seasonal line of credit usage. Commercial and industrial loans and home equity
loans account for most of the increase in total loans. Total deposits increased
from $286,166,000 at December 31, 1999 to $295,525,000 at September 30, 2000 and
short-term borrowings increased from $8,925,000 to $13,701,000 at these same
dates. The growth in total deposits is centered in money market accounts, which
increased, by $13,141,000 from December 31, 1999 to September 30, 2000. As of
September 30, 2000 the Treasury Select Money Market account had balances of
$16,904,000. Time deposits decreased $3,174,000 from December 31, 1999 to
September 30, 2000. The decline in time deposits is partially the result of the
introduction of the Treasury Select Money Market account that provides a high
rate of interest along with the ability to make deposits or withdrawals at any
time. Extremely competitive rates for time deposits paid by other financial
institutions has also had a negative impact on growth in these accounts. The
increase in short-term borrowings is a result of an increase in cash management
balances.
At September 30, 2000 the fair value of investment securities available-for-sale
was $110,748,000 or $2,712,000 below the amortized cost of $113,460,000. This
compares to a fair value of $97,609,000 or $3,947,000 below the amortized cost
of $101,556,000 at December 31, 1999. An unrealized holding loss, net of taxes,
of $1,790,000 and $2,604,000 was recorded as a decrease to shareholders' equity
at September 30, 2000 and December 31, 1999. Declining interest rates during the
third quarter of 2000 helped reduce the unrealized loss in the portfolio.
The available-for-sale portfolio had a weighted average maturity of
approximately 8 years at September 30, 2000 and 7 years at December 31, 1999.
The weighted average tax-equivalent yield was 6.82 percent and 6.58 percent at
September 30, 2000 and December 31, 1999. 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 6 years, 4 months
at September 30, 2000 and 6 years, 6 months at December 31, 1999, based on these
assumptions. The slight shortening of the expected average life of the portfolio
is a result of an increase of prepayments on mortgage-backed securities and the
increased chance the call options on some agency securities being exercised as
interest rates have declined during the third quarter of 2000. This has offset
the impact of the purchase of some longer-term mortgage-backed securities and
tax-exempt municipal securities. If rates were to decline by 100 or 200 basis
points the average life of the available-for-sale portfolio would decline to 5
years 11 months or 4 years, 1 month, respectively. Falling rates would create
additional cash flow from the prepayment on mortgage-backed securities and CMOs.
In addition, some callable agency securities would likely be called, creating
additional cash flow.
Investment securities held-to-maturity are reported at amortized cost. As of
September 30, 2000 and December 31, 1999, QNB had securities classified as
held-to-maturity with an amortized cost of $44,170,000 and $48,302,000 and a
market value of $43,142,000 and $46,572,000, respectively. The held-to-maturity
portfolio had a weighted average maturity of approximately 5 years, 8 months at
September 30, 2000 and 6 years at December 31, 1999. The weighted average
tax-equivalent yield was 6.49 percent and 6.46 percent at September 30, 2000 and
December 31, 1999. The decrease in the average maturity is a result of the
shortening in the average life of the mortgage-backed portfolio caused by lower
interest rates during the third quarter of 2000. As interest rates decrease
mortgage prepayments and mortgage refinance activity increases creating
additional cash flow and reducing their average life.
17
<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 manages 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 investment
securities 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. Additional sources of liquidity are provided by The
Quakertown National Bank's membership in the Federal Home Loan Bank and a
$5,000,000 unsecured Federal funds line granted by the Bank's correspondent.
Cash and due from banks, Federal funds sold, available-for-sale securities and
loans held-for-sale were $129,964,000 and $118,196,000 at September 30, 2000 and
December 31, 1999. These sources were adequate to meet seasonal deposit
withdrawals during the year 2000 and should be adequate to meet normal
fluctuations in loan demand and or deposit withdrawals. QNB has been able to
fund the growth in earning assets during the first nine months of 2000 through
increased deposits and short-term borrowings. On several occasions, QNB used
both its Federal funds line and overnight borrowings from the Federal Home Loan
Bank to fund loan growth. Management determined it was more beneficial to use
these short-term borrowing vehicles to fund the demand than to sell investment
securities. Approximately $42,504,000 and $43,963,000 of available-for-sale
securities at September 30, 2000 and December 31, 1999 were pledged as
collateral for repurchase agreements and deposits of public funds as required by
law.
The consolidated statements of cash flows present the changes in cash and cash
equivalents from operating, investing and financing activities. QNB's cash and
cash equivalents decreased $5,517,000 to $13,835,000 at September 30, 2000. This
compares to a $1,788,000 decrease during the first nine months of 1999. The
large decrease in cash in 2000 is a result of liquidity planning for potential
Year 2000 concerns. QNB increased cash at the end of 1999 as a contingency plan
for any potential Year 2000 problems. This excess cash was reinvested in
investment securities in January and February of 2000 after Year 2000 concerns
passed.
After adjusting net income for non-cash transactions, operating activities
provided $5,022,000 in cash flow in the first nine months of 2000, compared to
$8,186,000 in the same period of 1999. A higher volume of residential mortgage
loan activity in 1999 accounted for most of the difference between the periods.
Net cash used by investing activities was $22,906,000 during the first nine
months of 2000. Loan growth, particularly during the second quarter of 2000,
created a net increase in loans and a use of cash of $10,125,000 during the
first nine months of 2000. In addition, the purchase of investment securities
exceeded the maturity, call and sale of securities by $7,585,000 during 2000.
Most of this activity relates to the reinvestment of the excess Year 2000 cash
buildup. With the increase in interest rates at the end of 1999 and early 2000,
cash flow from mortgage-backed securities and from callable bonds slowed
reducing liquidity and the amount of cash available for reinvestment. These cash
flows should increase if interest rates continue to decline. An increase in
Federal funds sold of $4,212,000 and the net purchase of premises and equipment
of $1,350,000 were a use of cash during 2000. The purchase of a new computer
system and cash outlays related to the new branch were the major purchases of
fixed assets. Net cash used by investing activities was $37,391,000 during the
first nine months of 1999. The purchase of investment securities exceeded the
maturity, call and sale of securities by $40,320,000 during 1999. The
$25,000,000 wholesale funding transaction provided most of the additional cash
for the purchases. An increase in loans of $1,895,000 was also a use of cash
during 1999. A decrease in Federal funds sold and proceeds from the sale of
other real estate owned provided $4,869,000 and $364,000 of cash during the
first nine months of 1999.
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<PAGE>
LIQUIDITY (CONTINUED)
Net cash provided by financing activities was $12,367,000 during the first nine
months of 2000 and $27,417,000 during the same period in 1999. Increased
interest-bearing deposits provided $9,601,000 during the first nine months of
2000. The introduction of the Treasury Select Money Market Account provided the
impetus for much of the growth in interest-bearing deposits. As of September 30,
2000 the balance in these accounts were $16,904,000. Short-term borrowings
increased $4,776,000 during the first half of 2000, with cash management
accounts increasing $5,252,000 and Federal funds purchased decreasing $476,000
during this period. The cash dividend of $1,070,000 and the purchase of $723,000
of treasury stock during the first nine months of 2000 were both a use of cash
and a reduction to shareholder's equity. Net cash provided by financing
activities was $27,417,000 during the first nine months of 1999. Federal Home
Loan Bank advances provided $25,000,000 in funding during the second quarter of
1999. Another source of funds in 1999 was time deposits, which increased
$10,488,000 during the first nine months of 1999. Time deposits over $100,000
accounted for $7,956,000 of the total increase. These deposits tend to be
short-term in nature and pay a higher rate of interest. During the first nine
months of 1999 non-interest bearing demand deposits and short-term borrowings,
primarily cash management accounts, decreased by $3,525,000 and $2,807,000.
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, 2000 was
$29,708,000 or 8.10 percent of total assets compared to shareholders' equity of
$27,462,000 or 7.84 percent at December 31, 1999. Shareholders' equity at
September 30, 2000 includes a negative adjustment of $1,790,000 related to
unrealized holding losses, net of taxes, on investment securities
available-for-sale, while shareholders' equity at December 31, 1999 includes a
negative adjustment of $2,604,000. Without these adjustments shareholders'
equity to total assets would have been 8.59 percent and 8.58 percent at
September 30, 2000 and December 31, 1999.
On March 30, 2000, the Board of Directors of QNB Corp. approved a plan to
repurchase up to 4.99 percent of the shares of QNB Corp's outstanding common
stock in open market and privately negotiated transactions. As of September 30,
2000 25,364 shares had been repurchased at a cost of $723,000. These shares are
recorded as Treasury stock at cost and reduce total shareholder's equity. During
the second quarter the Board of Directors declared a 5 percent stock dividend
paid June 30, 2000. Per share information has been adjusted to reflect the
impact of the stock dividend.
Shareholders' equity averaged $30,809,000 for the first nine months of 2000 and
$28,880,000 during all of 1999, an increase of 6.7 percent. The ratio of average
total equity to average total assets improved to 8.50 percent for 2000, compared
to 8.38 percent for 1999. The increase in the equity to asset ratio is a
function of equity increasing at a faster pace than assets. Average assets have
increased 5.2 percent when comparing the nine-month average for 2000 to the
twelve-month average for 1999. Average shareholders' equity has increased more
than average assets despite the 18.3 percent increase in the cash dividend and
the repurchase of common stock, both of which reduce shareholder's equity.
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
19
<PAGE>
CAPITAL ADEQUACY (CONTINUED)
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 14.89 percent and 15.25 percent, a total
risk-based ratio of 16.14 percent and 16.50 percent and a leverage ratio of 8.33
percent and 8.38 percent at September 30, 2000 and December 31, 1999,
respectively.
The Federal Deposit Insurance Corporation Improvement Act of 1991 established
five capital level designations ranging from "well capitalized" to "critically
undercapitalized." At September 30, 2000 and December 31, 1999 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 re-pricing 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 re-pricing 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
re-pricing opportunity. Mortgage-backed securities and amortizing loans are
scheduled based on their anticipated cash flow. Savings accounts, including
passbook, statement savings, money market accounts; except for the Treasury
Select product, and interest-bearing demand accounts, do not have a stated
maturity or re-pricing term and can be withdrawn or re-priced 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 re-pricing
characteristics of these accounts based on historical performance and
assumptions that it believes reflect their rate sensitivity. Treasury Select
money market accounts re-price on a monthly basis. 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, 2000, interest-earning assets scheduled to
mature or likely to be called, re-priced or repaid in one year were $83,479,000.
Interest-sensitive liabilities scheduled to mature or re-price within one year
were $121,021,000.
20
<PAGE>
INTEREST RATE SENSITIVITY (CONTINUED)
The one year cumulative gap, which reflects QNB's interest sensitivity over a
period of time, was a negative $37,542,000 at September 30, 2000 and a negative
$29,939,000 at December 31, 1999. The cumulative one-year gap equals 10.24
percent and 8.54 percent of total assets at these respective dates. This
negative orliability sensitive gap will generally benefit QNB in a falling
interest rate environment, while rising interest rates could negatively impact
QNB. The increase in the negative gap position is primarily the result of the
Treasury Select Indexed Money Market product that re-prices on a monthly basis
and an increase in short-term borrowings.
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 re-pricing 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 the simulation model, net
interest income for the next twelve months is expected to decrease compared to
the prior twelve months. The projected decrease in net interest income is
primarily the result of the decrease in the net interest margin resulting for
the higher cost of funds.
If interest rates are 100 basis points lower than management's most likely
interest rate environment, the simulation model projects net interest income for
the next twelve months to exceed the most likely scenario. Conversely, if
interest rates were 100 basis points higher, net interest income for the most
likely scenario would decline. 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 that it could
utilize to remedy such a mismatch. QNB could restructure its investment
portfolio through the sale or purchase of securities with more favorable
re-pricing attributes. It could also emphasize loan products with appropriate
maturities or re-pricing 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, 2000, QNB did not have any
hedging transactions in place such as interest rate swaps, caps or floors.
21
<PAGE>
INTEREST RATE SENSITIVITY (CONTINUED)
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 .............. $11,350 $(1,001) (8.10)%
+200 Basis Points .............. 11,722 (629) (5.09)
+100 Basis Points .............. 12,045 (306) (2.48)
FLAT RATE ...................... 12,351 -- --
-100 Basis Points .............. 12,444 93 .75
-200 Basis Points .............. 12,240 (111) (.90)
-300 Basis Points .............. 11,781 570 (4.62)
</TABLE>
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.
22
<PAGE>
QNB CORP. AND SUBSIDIARY
PART II. OTHER INFORMATION
SEPTEMBER 30, 2000
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 10.1 of Registrants Form
10-K filed with the Commission on March 31,1999).
Exhibit 10.2 Salary Continuation Agreement between the Registrant and Thomas
J. Bisko. (Incorporated by reference to Exhibit 10.2 of
Registrants Form 10-K filed with the Commission on March 31,
1999).
Exhibit 10.3 QNB Corp. 1998 Stock Incentive Plan. (Incorporated by reference
to Exhibit 4.3 to Registration Statement No. 333-91201 on Form
S-8, filed with the Commission on November 18, 1999).
23
<PAGE>
Exhibit 10.4 QNB Corp. 1988 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).
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 10.7 Change of Control Agreement between Registrant and Robert C.
Werner.
Exhibit 10.8 Change of Control Agreement between Registrant and Bret H.
Krevolin.
Exhibit 11 Statement Re: Computation of Earnings Per Share. (Included in
Part I, Item I, hereof.)
Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K
None
24
<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 10, 2000 By:
-------------------------- ----------------------------------
Thomas J. Bisko
President/CEO
Date: November 10, 2000 By:
-------------------------- ----------------------------------
Robert C. Werner
Vice President
Date: November 10, 2000 By:
-------------------------- ----------------------------------
Bret H. Krevolin
Chief Accounting Officer
25
