UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Form 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1999
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-17706
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QNB CORP.
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-2318082
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(State or other jurisdiction of (I.R.S. Employer 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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Securities registered pursuant to Section 12(b) of the Act: None.
Title of each class Name of each exchange on which registered
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1.25 par value
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(Title of class)
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(Title of class)
Indicate by check mark 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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[Cover page 1 of 2 pages]
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ]
As of March 20, 2000, 1,439,273 shares of Common Stock of the registrant
were outstanding and the aggregate market value of the Common Stock of the
registrant, held by nonaffiliates was approximately $30,703,852.
DOCUMENTS INCORPORATED BY REFERENCE
Annual Report to Stockholders for 1999 - Part I, Item 3
Part II, Items 6, 7 and 8
Proxy Statement dated April 14, 2000 - Part III, Items 10, 11, 12 and 13
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FORM 10-K INDEX
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PART I
Item 1 Business........................................................................... 4
Item 2 Properties.........................................................................11
Item 3 Legal Proceedings..................................................................12
Item 4 Submission of Matters to a Vote of Security Holders................................12
PART II
Item 5 Market for Registrant's Common Stock and Related Stockholder Matters...............12
Item 6 Selected Financial Data............................................................13
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operation.....................................................13
Item 7A Quantitative and Qualitative Disclosures about Market Risk.........................13
Item 8 Financial Statements and Supplementary Data........................................13
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.....................................................13
PART III
Item 10 Directors and Executive Officers of the Registrant.................................13
Item 11 Executive Compensation.............................................................14
Item 12 Security Ownership of Certain Beneficial Owners and Management.....................14
Item 13 Certain Relationships and Related Transactions.....................................14
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K....................14
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PART I
ITEM 1. BUSINESS
QNB CORP.
QNB Corp. was incorporated under the laws of the Commonwealth of
Pennsylvania on June 4, 1984. QNB Corp. is registered with the Federal Reserve
Board as a bank holding company under Bank Holding Company Act of 1956 and
conducts its business through its wholly-owned subsidiary, The Quakertown
National Bank. The principal business of QNB Corp., through The Quakertown
National Bank, is commercial banking and consists of, among other things,
attracting deposits from the general public and using these funds in making
commercial loans, residential mortgage loans, consumer loans, and purchasing
investment securities.
QNB Corp. was organized for the purpose of becoming the holding company of
The Quakertown National Bank. Pursuant to a Plan of Reorganization approved by
The Quakertown National Bank's stockholders, QNB Corp.'s application to the
Federal Reserve Board of Governors requesting approval to become a bank holding
company was approved on September 11, 1984. In accordance with the terms of the
Plan of Reorganization, each share of The Quakertown National Bank's common
stock previously outstanding was automatically converted into one share of QNB's
common stock and The Quakertown National Bank became a wholly owned subsidiary
of QNB Corp. QNB Corp's primary asset is its investment in The Quakertown
National Bank. QNB Corp's primary assets also include an investment portfolio
consisting of stock in various financial institutions. The investment portfolio
accounts for less than 1.00% of QNB Corp.'s total consolidated assets.
THE QUAKERTOWN NATIONAL BANK
The Quakertown National Bank is a national banking association organized in
1877. The Quakertown National Bank is chartered under the National Banking Act
to engage in the various activities of a commercial bank and is subject to
federal and state laws applicable to commercial banks.
The Quakertown National Bank is a full-service commercial bank that
provides most major financial services. The Quakertown National Bank's principal
office is located in Bucks County, Pennsylvania. The Quakertown National Bank
also operates five other full-service branches, an operations facility and an
administrative office. For more information relating to The Quakertown National
Bank's properties, see Item 2. Properties. The Quakertown National Bank had 121
full-time employees and 33 part-time employees, at March 16, 2000. There are
employees of The Quakertown National Bank who are also employees of QNB Corp.
As of December 31, 1999 QNB Corp., on a consolidated basis, had total
assets of $350,489,000, total deposits of $286,166,000, and total shareholders'
equity of $27,462,000.
We have made forward-looking statements in this document, and in documents
that we incorporate by reference, that are subject to risks and uncertainties.
Forward-looking statements include the information concerning possible or
assumed future results of operations of QNB Corp. The Quakertown National Bank
or the combined company. When we use words such as "believes," or "expects,"
"anticipates" or similar expressions, we are making forward-looking statements.
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Readers should note that many factors, some of which are discussed
elsewhere in this document and in the documents that we incorporate by
reference, could affect the future financial results of QNB Corp., The
Quakertown National Bank or the combined company and could cause those results
to differ materially from those expressed in our forward-looking statements
contained or incorporated by reference in this document. These factors include
the following:
o operating, legal and regulatory risks;
o economic, political, and competitive forces affecting our banking,
securities, asset management and credit services businesses; and
o rapidly changing technology; and
o the risk that our analysis of these risks and forces could be
incorrect and/or that the strategies developed to address them
could be unsuccessful.
See also, page 8 of QNB Corp.'s 1999 annual report to shareholders,
"Management's Discussion and Analysis-Consolidated Financial Review"
incorporated here by reference, which page is included as Exhibit 13.1
MARKET AREA
The Quakertown National Bank's primary market area is Quakertown,
Pennsylvania and its surrounding communities and includes parts of Upper Bucks
County, Southern Lehigh County, and Northern Montgomery County. The Quakertown
National Bank is not dependent upon a single customer, or a few customers, the
loss of which would have a material adverse effect on The Quakertown National
Bank.
LENDING ACTIVITIES
General. The Quakertown National Bank offers a variety of loan products to
its customers; including residential real estate mortgages, commercial,
construction, home equity, business, consumer, and student loans. The Quakertown
National Bank's loan portfolio totaled $173,764,000 and $176,443,000 at December
31, 1999 and 1998, respectively. The portfolio represented approximately 49.6%
and 54.3% of The Quakertown National Bank's total assets at December 31, 1999
and 1998, respectively.
Residential Mortgage Loans. The Quakertown National Bank offers primarily 1
and 3 year adjustable rate mortgages, 7 year balloon mortgages, and 15, 20 and
30 year fixed rate loans. The Quakertown National Bank has generally sold,
without recourse, its mortgage loans in the secondary mortgage market. During
1999 and 1998 substantially all originations of loans to individuals for
residential mortgages with maturities of 20 years or greater were sold in the
secondary market.
The Quakertown National Bank originates mortgage loans up to a 95% maximum
loan-to-value ratio provided the amount above 80% is covered by private mortgage
insurance. The borrower pays for private mortgage insurance.
All mortgages sold in the secondary market conform to the loan-to-value
ratios and underwriting standards dictated by the secondary market. The
Quakertown National Bank sells a majority of the mortgages to the Federal Home
Loan Mortgage Corporation. The Quakertown National Bank retains servicing
rights.
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The Quakertown National Bank also offers home equity loans and lines of
credit which are included in real estate residential loans. Real estate
residential loans in the aggregate amount of $68,945,000 and $71,052,000
represented 39.6% and 40.2% of gross loans at December 31, 1999 and 1998.
Commercial Loans. The Quakertown National Bank offers commercial loans,
including lines of credit or commitment, term loans, commercial mortgages,
letters of credit, and tax-free loans.
The Quakertown National Bank's commercial and industrial loan portfolio
totaled $32,003,000 and $35,003,000 at December 31, 1999 and 1998, respectively.
Commercial and industrial loans represented approximately 18.4% and 19.8% of The
Quakertown National Bank's total gross loans at December 31, 1999 and 1998
respectively. 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.
Commercial real estate loans in the aggregate amount of $64,853,000 and
$60,708,000 represented 37.3% and 34.3% of The Quakertown National Bank's gross
loan portfolio at December 31, 1999 and 1998, respectively, while construction
loans, including commercial and residential, totaled $258,000 and $782,000 for
the same periods. Commercial real estate loans include all loans collateralized
at least in part by commercial real estate, but may not be for the expressed
purpose of conducting commercial real estate transactions.
Construction, commercial and industrial, and commercial real estate lending
generally entails significant additional risk as compared with residential
mortgage lending. These loans typically involve larger loan balances to single
borrowers or groups of related borrowers.
Consumer Loans. The Quakertown National Bank's consumer loan portfolio
totaled $6,005,000 and $5,864,000 at December 31, 1999 and 1998, respectively.
Consumer loans represented 3.5% and 3.3% of The Quakertown National Bank's total
gross loans at December 31, 1999 and 1998, respectively. Consumer loans include
automobile loans, student loans and other consumer type credit not secured by
real estate.
INVESTMENT ACTIVITIES
At December 31, 1999 and 1998, QNB Corp.'s investment portfolio, on a
consolidated basis, aggregated $145,911,000 and $120,153,000. The portfolios
consisted primarily of United States government and federal agency obligations,
mortgage-backed securities, and state and municipal securities. Subject to
applicable limits The Quakertown National Bank is also permitted to invest in
corporate bonds and QNB Corp. is permitted to invest in equity securities. The
Quakertown National Bank accounts for its investments based on Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." The Quakertown National Bank records investment
securities available-for-sale at market value with the unrealized holding gain
or loss, net of taxes, included in shareholders' equity. The Quakertown National
Bank records investment securities held-to-maturity at amortized cost. At
December 31, 1999 and 1998, the balance of the available-for-sale portfolio was
$97,609,000 and $70,088,000 and the balance of the held-to-maturity portfolio
was $48,302,000 and $50,065,000, respectively.
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The Quakertown National Bank views its investment portfolio as a secondary
source of liquidity and stable earnings. The Chief Operating Officer, the Chief
Financial Officer, or either of then, together with one other member of the
asset/liability committee, make decisions concerning the selection of
investments for The Quakertown National Bank's portfolio. The Quakertown
National Bank's investment policy, as approved by the Board of Directors,
dictates the maturity and types of investments for The Quakertown National Bank.
The Quakertown National Bank's strategy has been to invest in:
o Short and medium term United States government and federal agency
obligations and callable bonds;
o Longer term mortgage-backed securities; and
o State and municipal securities.
The available-for-sale and held-to-maturity investment portfolios had
weighted average maturities of 7 years 4 months, and 6 years, respectively, at
December 31, 1999.
SOURCES OF FUNDS
Deposits. The Quakertown National Bank offers a variety of deposit
products, including:
o Checking accounts;
o Passbook and statement savings;
o Money market accounts;
o Interest-bearing demand accounts;
o Certificates of deposit; and
o Jumbo certificates of deposit.
The Federal Deposit Insurance Corporation insures deposits of The Quakertown
National Bank up to $100,000.
Borrowings. The Quakertown National Bank is a member of the Federal Home
Loan Bank of Pittsburgh. As a member, The Quakertown National Bank may obtain
advances from the Federal Home Loan Bank secured by otherwise unencumbered
qualifying assets including 1-4 family residential mortgage loans and United
States government agency notes, bonds and mortgage-backed securities. The
Quakertown National Bank pledges its Federal Home Loan Bank stock to secure
these advances. Advances are made under several different credit programs, each
of which has its own interest rate and range of maturities. Federal Home Loan
Bank advances are generally available to meet seasonal and other withdrawals of
deposit accounts and to expand lending and investment activities. At December
31, 1999, The Quakertown National Bank had $25,000,000 in outstanding advances.
In addition, The Quakertown National Bank has a $5,000,000 unsecured federal
funds line granted by its correspondent bank.
COMPETITION
The Quakertown National Bank competes actively with other commercial banks
in its market area. Competition exists for:
o New deposits;
o Type and scope of services offered;
o Interest rates on interest-bearing deposits and loans; and
o Other aspects of banking, such as convenience and fee schedules.
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In addition, The Quakertown National Bank, like other commercial banks,
encounters competition from other non-bank financial institutions including:
o Savings banks;
o Savings and loans;
o Insurance companies;
o Credit unions;
o Finance companies;
o Mutual funds; and
o Government agencies.
In addition, large regional and national banks located in Philadelphia and
Allentown are active in servicing companies based in The Quakertown National
Bank's market area.
For additional information with respect to QNB Corp.'s business activities,
see Part II, Item 7 of this Form 10-K.
SUPERVISION AND REGULATION
QNB Corp. and its subsidiary, The Quakertown National Bank, operate in a
heavily regulated environment. The general cost of compliance with numerous
federal and state laws and regulations currently has, and in the future may
have, a negative impact on the results of operations of QNB Corp. and The
Quakertown National Bank.
From time to time, various types of federal and state legislation have been
proposed that could result in additional regulation of, and restrictions on, the
business of QNB Corp. and The Quakertown National Bank. It cannot be predicted
whether such legislation will be adopted or, if adopted, how such legislation
would affect the business of QNB Corp. and The Quakertown National Bank. As a
consequence of the extensive regulation of commercial banking activities in the
United States, QNB Corp.'s and The Quakertown National Bank's business is
particularly susceptible to being affected by federal legislation and
regulations that may increase the cost of doing business. Except as specifically
described above, Management believes that the effect of the provisions of the
aforementioned legislation on the liquidity, capital resources, and results of
operations of QNB Corp. will be immaterial. Management is not aware of any other
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
Corp.'s results of operations.
Further, the business of QNB Corp. is also affected by the state of the
financial services industry in general. As a result of legal and industry
changes, Management predicts that the industry will continue to experience an
increase in consolidations and mergers as the financial services industry
strives for greater cost efficiencies and market share. Management believes that
such consolidations and mergers may enhance its competitive positions as a
community bank.
Gramm-Leach-Bliley. On November 12, 1999, President Clinton signed into law
the Gramm-Leach-Bliley Act of 1999, which is also known as the Financial
Services Modernization Act. The act repeals some Depression-era banking laws and
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will permit banks, insurance companies and securities firms to engage in each
others' business after complying with certain conditions and regulations which
are yet to be finalized. The act grants to community banks the power to enter
new financial markets as a matter of right that larger institutions have managed
to do on an ad hoc basis. At this time, our company has no plans to pursue these
additional possibilities.
Our company does not believe that the Financial Services Modernization Act
will have an immediate positive or negative material effect on our operations.
However, the act may have the result of increasing the amount of competition
that our company faces from larger financial service companies, many of whom
have substantially more financial resources than our company, which may now
offer banking services in addition to insurance and brokerage services.
Pending Legislation. Management cannot anticipate what changes Congress may
enact, or, if enacted, their impact on QNB Corp.'s financial position and
reported results of operation. As a consequence of the extensive regulation of
commercial banking activities in the United States, QNB Corp.'s and The
Quakertown National Bank's business is particularly susceptible to being
affected by federal and state legislation and regulations that may increase the
costs of doing business. See also, page 27 of QNB Corp.'s 1999 annual report,
incorporated here by reference which page is included at Exhibit 13.1.
Effects of Inflation. Inflation has some impact on QNB Corp.'s and The
Quakertown National Bank's operating costs. Unlike many industrial companies,
however, substantially all of QNB Corp.'s assets and liabilities are monetary in
nature. As a result, interest rates have a more significant impact on QNB
Corp.'s and The Quakertown National Bank's performance than the general level of
inflation. Over short periods of time, interest rates may not necessarily move
in the same direction or in the same magnitude as prices of goods and services.
Risk Based Capital. The Federal Reserve Board, the FDIC and the Comptroller
of the Currency have issued certain risk-based capital guidelines, which
supplement existing capital requirements. See pages 24 and 25 of QNB Corp.'s
1999 annual report for information concerning QNB Corp.'s capital ratios,
incorporated here by reference, which pages are included at Exhibit 13.1.
Holding Company Regulation
As a registered holding company under the Bank Holding Company Act, QNB
Corp. is regulated by the Federal Reserve Board. QNB Corp. is also subject to
the provisions of section 115 of the Pennsylvania Banking Code of 1965.
As a bank holding company, QNB Corp. is required to file with the Federal
Reserve Board an annual report and such additional information regarding the
holding company and its subsidiary bank as required under the Bank Holding
Company Act.
The Bank Holding Company Act prohibits QNB Corp. from acquiring:
o direct or indirect control of more than 5% of the voting stock of any
bank; or
o substantially all of the assets of any bank; or
o merging with another bank holding company;
Without the prior approval of the Federal Reserve. The Pennsylvania Department
of Banking also must approve any similar consolidation. Pennsylvania law permits
Pennsylvania bank holding companies to control an unlimited number of banks.
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The Bank Holding Company Act restricts QNB Corp. from engaging in
activities to those that the Federal Reserve has found:
o to be closely related to banking; and
o which are expected to produce benefits for the public that will
outweigh any potential adverse effects.
To this end, the Bank Holding Company Act prohibits QNB Corp. from:
o engaging in most non-banking businesses; or
o acquiring ownership or control of more than 5% of the outstanding
voting stock of any company engaged in a non-banking business; unless
o the Federal Reserve has determined that the non-banking business is
closely related to banking.
Under the Bank Holding Company Act, the Federal Reserve may require a bank
holding company to end a non-banking business if it constitutes a serious risk
to the financial soundness and stability of any bank subsidiary of the bank
holding company.
Bank Regulation
The Quakertown National Bank operates as a national bank subject to
regulation and examination by the Office of the Comptroller of the Currency.
The Office of the Comptroller of the Currency regulates all areas of a
national bank's commercial banking operations including loans, mergers,
establishment of branches and other aspects of operations. The Office of the
Comptroller of the Currency also regulates the level of dividends which can be
declared. For more information see QNB Corp.'s 1999 annual report which is
incorporated here by reference.
The Quakertown National Bank is also regulated by the Federal Reserve
System and the Federal Deposit Insurance Corporation. The major function of the
Federal Deposit Insurance Corporation with respect to insured member banks is to
pay depositors to the extent provided by law in the event an insured bank is
closed without adequately providing for payment of the claims of depositors.
Federal Deposit Insurance Corporation insured banks are subject to certain
Federal Deposit Insurance Corporation requirements designed to maintain the
safety and soundness of individual banks and the banking system. In addition,
the Federal Deposit Insurance Corporation along with the Comptroller of the
Currency and the Federal Reserve Board has adopted regulations which define and
set the minimum requirements for capital adequacy based on risk. See pages 24
and 25 of QNB Corp's 1999 annual report, "Management's Discussion and
Analysis-Capital Adequacy," incorporated by reference herein, which pages are
included at Exhibit 13.1. The Federal Reserve Board, the Federal Deposit
Insurance Corporation and Federal and State law extensively regulate other
various aspects of the banking business, including, but not limited to,
permissible types and amounts of loans, investments and other activities,
branching, interest rates on loans and the safety and soundness of banking
practices.
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Environmental Laws. Neither QNB Corp. nor The Quakertown National Bank
anticipates that compliance with environmental laws and regulations will have
any material effect on capital, expenditures, earnings, or on its competitive
position. However, environmentally related hazards have become a source of high
risk and potentially unlimited liability for financial institutions.
Environmentally contaminated properties owned by an institution's borrowers may
result in a drastic reduction in the value of the collateral securing the
institution's loans to such borrowers, high environmental clean up costs to the
borrower affecting its ability to repay the loans, the subordination of any lien
in favor of the institution to a state or federal lien securing clean up costs,
and liability to the institution for clean up costs if it forecloses on the
contaminated property or becomes involved in the management of the borrower. To
minimize this risk, The Quakertown National Bank may require an environmental
examination of and report with respect to the property of any borrower or
prospective borrower if circumstances affecting the property indicate a
potential for contamination, taking into consideration a potential loss to the
institution in relation to the borrower. Such examination must be performed by
an engineering firm experienced in environmental risk studies and acceptable to
the institution, and the cost of such examinations and reports are the
responsibility of the borrower. These costs may be substantial and may deter
prospective borrowers from entering into a loan transaction with The Quakertown
National Bank. QNB Corp. is not aware of any borrower who is currently subject
to any environmental investigation or clean up proceeding that is likely to have
a material adverse effect on the financial condition or results of operations of
The Quakertown National Bank.
In 1995, the Pennsylvania General Assembly enacted the Economic Development
Agency, Fiduciary and Lender Environmental Liability Protection Act which, among
other things, provides protection to lenders from environmental liability and
remediation costs under the environmental laws for releases and contamination
caused by others. A lender who engages in activities involved in the routine
practices of commercial lending, including, but not limited to, the providing of
financial services, holding of security interests, workout practices,
foreclosure or the recovery of funds from the sale of property shall not be
liable under the environmental acts or common law equivalents to the
Pennsylvania Department of Environmental Resources or to any other person by
virtue of the fact that the lender engages in such commercial lending practice.
A lender, however, will be liable if it, its employees or agents, directly cause
an immediate release or directly exacerbate a release of regulated substance on
or from the property, or knowingly and willfully compelled the borrower to
commit an action which caused such release or violate an environmental act. The
Economic Development Agency, Fiduciary and Lender Environmental Liability
Protection Act, however, does not limit federal liability which still exists
under certain circumstances.
Federal Reserve Board Requirements
Regulation D of the Federal Reserve Board imposes reserve requirements on
all depository institutions, including The Quakertown National Bank, that
maintain transaction accounts or non-personal time and savings accounts. These
reserves may be in the form of cash or non-interest bearing deposits with the
Philadelphia Federal Reserve Bank. Under current Regulation D, The Quakertown
National Bank must establish reserves equal to 3.0% of the first $39.3 million
of net transaction accounts and 10.0% of the remainder. The reserve requirement
on non-personal savings and time deposits is 0.0%. Demand balances due from
depository institutions in the United States are used as a deduction against the
reserve. At December 31, 1999, The Quakertown National Bank met applicable
Federal Reserve Board reserve requirements.
ITEM 2. PROPERTIES
The Quakertown National Bank and Corporation's main office is located at 10
North Third Street, Quakertown, Pennsylvania. The Quakertown National Bank
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conducts business from its main office and five other retail offices located in
Upper Bucks, Southern Lehigh, and Northern Montgomery Counties. The Quakertown
National Bank owns its main office, two retail locations, its operations
facility, and the computer facility. The Quakertown National Bank leases its
remaining retail properties. The leases on the properties generally contain
renewal options. Management considers that its facilities are adequate for its
business.
The following table details The Quakertown National Bank's properties:
Location
Quakertown, Pa. - Downtown Office Owned
10 North Third Street
Quakertown, Pa. - Towne Bank Center Owned
320 West Broad Street
Quakertown, Pa. - Computer Center Owned
- 121 West Broad Street
Quakertown, Pa. - Country Square Office Leased
240 South West End Boulevard
Dublin, Pa. - Dublin Branch Leased
161 North Main Street
Pennsburg, Pa. - Pennsburg Square Branch Leased
410-420 Pottstown Ave
Coopersburg, Pa. - Coopersburg Branch Owned
51 South Third Street
Perkasie, Pa. - Perkasie Branch Owned
607 Chestnut Street
In management's opinion, the above properties are in good condition and
are adequate for QNB Corp.'s purposes.
ITEM 3. LEGAL PROCEEDINGS
Management, after consulting with QNB Corp.'s legal counsel, is not aware
of any litigation that would have a material adverse effect on the consolidated
financial position of QNB Corp. There are no proceedings pending other than
ordinary routine litigation incident to the business of QNB Corp. and its
subsidiary, The Quakertown National Bank. In addition, no material proceedings
are known to be contemplated by governmental authorities against QNB Corp. or
The Quakertown National Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
QNB Corp. had 694 shareholders of record as of March 20, 2000; however, QNB
Corp. believes, based on the number of annual reports and proxy statements
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requested by nominee holders of QNB Corp.'s Common Stock, that the number of
beneficial holders exceeds 950. See Page 44 of the 1999 annual report,
"Corporate Information-Stock Information" and page 43 of the 1999 annual report,
"Notes to Consolidated Financial Statements-Note 20-Regulatory Restrictions,"
incorporated here by reference which pages are included in Exhibit 13.1.
ITEM 6. SELECTED FINANCIAL AND OTHER DATA
The information required by Item 6 is incorporated by reference to the
information appearing under the caption "Selected Financial and Other Data" on
page 28 of QNB Corp.'s annual report, incorporated here by reference which page
is attached as Exhibit 13.1.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information required by Item 7 is incorporated by reference to the
information appearing under the caption "Management's Discussion and Analysis"
on pages 7 to 28 of QNB Corp.'s annual report incorporated here by reference
which page is attached as Exhibit 13.1.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by Item 7A is incorporated by reference to the
information appearing under the caption "Interest Rate Sensitivity" on pages 25
through 27 of QNB Corp.'s annual report which pages are attached as Exhibit
13.1.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by Item 8 and the auditor's report are
incorporated by reference to pages 29 to 44 of QNB Corp.'s Annual Report which
is attached as Exhibit 13.1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item, relating to directors, executive
officers, control persons is set forth in the sections captioned "Election of
Directors" and "Executive Officers of Registrant" of the QNB Corp's definitive
proxy statement to be used in connection with the 2000 annual meeting of
shareholders, on pages 8 and 17 which pages are incorporated here by reference.
Section 16(a) Beneficial Ownership Compliance. Section 16(a) of the
Securities Exchange Act of 1934 requires QNB Corp's officers and directors, and
persons who own more than 10 percent of a registered class of QNB Corp's equity
securities, to file reports of ownership and changes in ownership with the
Securities and Exchange Commission. Officers, directors and greater than 10
percent shareholders are required by Commission regulation to furnish QNB Corp.
with copies of all Section 16(a) forms they file.
13
<PAGE>
Based solely on its review of the copies of such forms received by it or
written representations from certain reporting persons that no Form 5s were
required for those persons. QNB Corp. believes that during the period January 1,
1999 through December 31, 1999, its officers and directors were in compliance
with all filing requirements applicable to them.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated by reference to the
information appearing under the caption "Executive Compensation" in the proxy
statement to be used in connection with the 2000 annual meeting of shareholders,
on pages 11-15 which pages are incorporated here by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated by reference to the
information appearing under the caption "Securities Ownership of Management" in
the proxy statement to be used in connection with the 2000 annual meeting of
shareholders, on pages 5 through 7, which pages are incorporated here by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated by reference to the
information appearing under the caption "Related Transactions" in the proxy
statement to be used in connection with the 2000 Annual Meeting of Shareholders,
on page 17, which page is incorporated here by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The following financial statements are included by reference in part II,
Item 8 hereof.
Independent Auditors' Report
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Cash Flows
Consolidated Statements of Changes in Stockholders' Equity
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
The financial statement schedules required by this Item are omitted
because the information is either inapplicable, not required or is in
the consolidated financial statements as a part of this Report.
3. The following exhibits are incorporated by reference herein or
annexed to this Form 10-K:
14
<PAGE>
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 April 13, 1998.)
3.2- Bylaws of Registrant, as amended. (Incorporated by reference
to Exhibit 3.1 of Registrants Form 10-Q filed with the
Commission on April 13, 1998.)
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).
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).
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.)
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.)
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.)
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.)
11.1- Statement re: Computation of Earnings per Share. (Incorporated
by Reference to page 35 of QNB Corp.'s 1999 Annual Report,
"Notes to Consolidated Financial Statements-Note 2-Earnings
Per Share," which is included herein at Exhibit 13.1.)
12.1- Statement re: Computation of Ratios. (Incorporated by
Reference to page 1 of QNB Corp.'s 1999 Annual Report, which
is included herein as Exhibit 13.1.)
13.1- Excerpts from the 1999 Annual Report to Shareholders.
21.1- Subsidiaries of the Registrant.
23.1- Consent of KPMG LLP, filed herewith.
(b) Reports on Form 8-K
None
(c) The exhibits required to be filed by this Item are listed under
Item 14(a)3 above.
(d) Not applicable
15
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
March 30, 2000
BY: /s/ Thomas J. Bisko
------------------------------------
Thomas J. Bisko
President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report is signed below by the following persons on behalf of the Registrant
and in the capacities and on the dates indicated.
<TABLE>
<S> <C> <C>
/s/ Thomas J. Bisko President, Chief Executive March 30, 2000
- ------------------------------------- Officer and Director
Thomas J. Bisko
/s/ Robert C. Werner Vice President March 30, 2000
- -------------------------------------
Robert C. Werner
/s/ Bret H. Krevolin Chief Accounting Officer March 30, 2000
- -------------------------------------
Bret H. Krevolin
/s/ Norman L. Baringer Director March 30, 2000
- -------------------------------------
Norman L. Baringer
/s/ Kenneth F. Brown Jr. Director March 30, 2000
- -------------------------------------
Kenneth F. Brown Jr.
/s/ Dennis Helf Director March 30, 2000
- -------------------------------------
Dennis Helf
</TABLE>
16
<PAGE>
SIGNATURES (Continued)
<TABLE>
<S> <C> <C>
/s/ Gary S. Parzych Director March 30, 2000
- -------------------------------------
Gary S. Parzych
/s/ Donald T. Knauss Director March 30, 2000
- -------------------------------------
Donald T. Knauss
/s/ Charles M. Meredith, III Director March 30, 2000
- -------------------------------------
Charles M. Meredith, III
/s/ Henry L. Rosenberger Director March 30, 2000
- -------------------------------------
Henry L. Rosenberger
/s/ Edgar L. Stauffer Director March 30, 2000
- -------------------------------------
Edgar L. Stauffer
</TABLE>
<PAGE>
QNB CORP.
FORM 10-K
FOR YEAR ENDED DECEMBER 31, 1999
EXHIBIT INDEX
Exhibit
3.1- Articles of Incorporation of Registrant, as amended
3.3- Bylaws of Registrant, as amended
10.1- Employment Agreement between the Registrant and Thomas
J. Bisko
10.2- Salary Continuation Agreement between the Registrant and
Thomas J. Bisko
10.3- QNB Corp. 1998 Stock Incentive Plan
10.4- QNB Corp. 1988 Stock Incentive Plan
10.5- QNB Corp. Employee Stock Purchase Plan
10.6- The Quakertown National Bank Profit Sharing and Section 401(k)
Salary Deferral Plan
11.1- Statement re: Computation of Earnings per Share
12.1- Statement re: Computation of Ratios
13.1- Excerpts from the 1999 Annual Report to Shareholders.
21.1- Subsidiaries of the Registrant.
23.1- Consent of KPMG LLP, filed herewith.
p.1
<PAGE>
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
(in thousands, except per share data)
- ----------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Financial Performance
Net interest income ................................ $12,891 $12,621 $12,056 $11,403 $11,379
Provision for loan losses .......................... 240 400 400 400 1,010
Non-interest income ................................ 2,231 2,154 1,919 1,710 1,313
Non-interest expense ............................... 9,907 9,655 9,191 8,864 9,459
Net income ......................................... 3,801 3,448 3,131 2,801 1,687
Per Share Data
Net income - basic ................................. $ 2.65 $ 2.41 $ 2.19 $ 1.97 $ 1.19
Net income - diluted ............................... 2.64 2.39 2.18 1.95 1.18
Book value ......................................... 19.11 19.77 18.05 15.97 14.66
Cash dividends ..................................... .84 .72 .64 .56 .50
Selected Average Balances
Total assets ....................................... $344,543 $310,492 $288,698 $274,533 $269,833
Total earning assets ............................... 322,363 292,000 272,226 258,308 253,503
Investment securities .............................. 143,716 116,241 107,087 98,376 96,042
Loans, net of unearned income ...................... 174,912 169,800 161,096 155,175 151,839
Deposits ........................................... 284,516 271,690 253,366 242,082 239,513
Borrowed funds ..................................... 27,827 9,468 8,911 8,317 7,955
Shareholders' equity ............................... 28,880 26,323 23,886 21,653 19,933
Balance Sheet Data
Total assets ....................................... $350,489 $324,672 $305,772 $280,447 $276,049
Investment securities available-for-sale ........... 97,609 70,088 75,920 52,779 55,380
Investment securities held-to-maturity ............. 48,302 50,065 40,400 42,699 42,515
Loans, net of unearned income ...................... 173,764 176,443 167,720 159,278 155,957
Deposits ........................................... 286,166 279,223 267,166 246,744 242,887
Borrowed funds ..................................... 33,925 14,491 10,342 8,675 10,099
Shareholders' equity ............................... 27,462 28,338 25,832 22,775 20,866
Selected Ratios
Return on average assets ........................... 1.10% 1.11% 1.08% 1.02% .63%
Return on average shareholders' equity ............. 13.16 13.10 13.11 12.94 8.46
Net interest margin ................................ 4.23 4.51 4.60 4.58 4.64
Average shareholders' equity to average total assets 8.38 8.48 8.27 7.89 7.39
</TABLE>
[GRAPHICS]
In the printed version of the document, a line graph appears
which depicts the following plot points:
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
Net Income Per Share - Diluted $ 1.18 $ 1.95 $ 2.18 $ 2.39 $ 2.64
Cash Dividends $ 0.50 $ 0.56 $ 0.64 $ 0.72 $ 0.84
Total Assets (in thousands) $276,049 $280,447 $305,772 $324,672 $350,489
<PAGE>
p. 2
LETTER TO SHAREHOLDERS
I am pleased to report another record financial performance for the Company. Net
income, at $3,801,000 exceeded the previous year's earnings of $3,448,000 by
10.24%. This represents a return on average assets of 1.10% and a return on
average equity of 13.16%. As a result, we increased your cash dividend by 16.7%
to $.84 per share.
Several factors contributed to the enhanced earnings performance. An increase in
net interest income coupled with a decrease in the provision for loan losses
offset an increase in non-interest expense to produce the favorable results.
It was also a year marked by faster than normal asset growth. Assets grew by 13%
on average from the prior year. A large portion of the growth was the result of
a wholesale funding transaction which transpired during the second quarter. We
entered into this transaction for the purpose of increasing net interest income
and earnings per share. The Company remains well capitalized.
I am disappointed to report, however, that the price of a share of our stock did
not rise in proportion to the earnings increase. In fact, the price dropped. The
bid price as of December 31, 1999 was $29. We can only speculate as to the
reasons why banking stocks in general and QNB Corp. in particular declined in
1999. Fears of Y2K problems and rising interest rates may be part of the reason.
Also, substantial amounts of investor funds have been diverted away from the
financial sector and into the technology sector. Regardless, solid earnings
performance has traditionally been rewarded by investors on a long term basis
and our future remains bright.
Our commitment to technology remained a theme throughout the fiscal year. We
successfully implemented a check imaging system. We also entered into a contract
with an internet banking system provider. We anticipate offering this new
internet banking product during the first half of the year 2000. It is important
to note that all of the technological advancements of the last two years have
been made during a period when we were preparing for any potential Y2K computer
related problems. I am very pleased to report that the transition from 1999 to
2000 went very smoothly. I would like to thank all QNB employees for their
tremendous collective effort during our Y2K testing program.
I am extremely pleased with the record performances of the last four years as
well as the future direction of the company. As we look forward to 2000 and
beyond, we will continue to examine opportunities to enhance our products and
services while providing them through a balance of technology and personal
attention.
As usual, thank you for your loyal support. And also I thank each and every
employee for their ongoing contribution to the success of the company.
/s/Thomas J. Bisko
- -----------------------------------
Thomas J. Bisko
President & CEO
<PAGE>
p. 3
MARKETING PAGE
<PAGE>
p. 4
MARKETING PAGE
<PAGE>
p. 5
MARKETING PAGE
<PAGE>
p. 6
MARKETING PAGE
<PAGE>
p. 7
Management's Discussion and Analysis 7
Consolidated Balance Sheets 29
Consolidated Statements of Income 30
Consolidated Statements of Shareholders' Equity 31
Consolidated Statements of Cash Flows 32
Notes to Consolidated Financial Statements 33
Independent Auditor's Report 44
Corporate Information 44
Directors, Officers & Office Locations 45
MANAGEMENT'S DISCUSSION AND ANALYSIS
AVERAGE BALANCES, RATES, AND INTEREST INCOME AND EXPENSE SUMMARY
(TAX-EQUIVALENT BASIS)
<TABLE>
<CAPTION>
1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
Average Average Average Average Average Average
Balance Rate Interest Balance Rate Interest Balance Rate Interest
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets
Interest-bearing balances $ 133 3.52% $ 5 $ 87 4.83% $ 4 $ 40 3.70% $ 2
Federal funds sold 3,602 5.20 187 5,872 5.34 314 4,003 5.50 220
Investment securities available-for-sale:
Taxable 89,053 6.46 5,756 71,040 6.51 4,624 64,272 6.52 4,190
Tax-exempt 4,224 7.18 303 491 8.21 40 404 8.17 33
Investment securities held-to-maturity:
Taxable 32,231 6.39 2,058 31,778 6.44 2,048 31,862 6.39 2,038
Tax-exempt 18,208 6.94 1,264 12,932 7.17 926 10,549 7.33 773
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment securities 143,716 6.53 9,381 116,241 6.57 7,638 107,087 6.57 7,034
Loans, net of unearned income 174,912 8.22 14,380 169,800 8.71 14,796 161,096 8.90 14,342
- ------------------------------------------------------------------------------------------------------------------------------------
Total earning assets 322,363 7.43 23,953 292,000 7.79 22,752 272,226 7.93 21,598
Cash and due from banks 12,137 10,395 9,584
Allowance for loan losses (3,065) (2,861) (2,673)
Other assets 13,108 10,958 9,561
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $344,543 6.95% $310,492 7.33% $288,698 7.48%
- ------------------------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Interest-bearing deposits
Interest-bearing demand accounts $ 45,339 1.06% 481 $ 41,988 1.37% 576 $ 40,262 1.75% 706
Money market deposit accounts 30,684 2.58 793 32,981 2.79 921 33,218 2.86 951
Savings accounts 37,312 1.86 693 37,216 2.12 789 35,215 2.17 765
Time deposits 112,109 5.20 5,830 106,324 5.48 5,824 97,944 5.48 5,365
Time deposits of $100,000 or more 23,289 5.33 1,241 19,502 5.73 1,117 16,502 5.86 968
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 248,733 3.63 9,038 238,011 3.88 9,227 223,141 3.92 8,755
Short-term borrowings 10,813 3.50 378 9,468 3.66 347 8,911 3.48 311
Federal Home Loan Bank advances 17,014 5.22 888 - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 276,560 3.73 10,304 247,479 3.87 9,574 232,052 3.91 9,066
- ------------------------------------------------------------------------------------------------------------------------------------
Non-interest-bearing deposits 35,783 33,679 30,225
Other liabilities 3,320 3,011 2,535
Shareholders' equity 28,880 26,323 23,886
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $344,543 2.99% $310,492 3.08% $288,698 3.14%
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest rate spread 3.70% 3.92% 4.02%
- ------------------------------------------------------------------------------------------------------------------------------------
Margin/net interest income 4.23% $13,649 4.51% $13,178 4.60% $12,532
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Tax-exempt securities and loans were adjusted to a tax-equivalent basis and are
based on the marginal Federal corporate tax rate of 34 percent. Non-accrual
loans are included in earning assets.
<PAGE>
p. 8
MANAGEMENT'S DISCUSSION AND ANALYSIS
CONSOLIDATED FINANCIAL REVIEW
The intent of this section is to provide the reader with a better understanding
of the consolidated results of operations and financial condition of QNB Corp.
and its wholly owned subsidiary, The Quakertown National Bank, for the years
1999, 1998 and 1997. The results of operations and financial condition are
presented on a consolidated basis and the consolidated entity is referred to as
"QNB." QNB's consolidated financial condition and results of operations consist
almost entirely of The Quakertown National Bank's financial condition and
results of operations. This section should be read in conjunction with the
financial statements and notes beginning on page 29. Current performance may not
be indicative of future performance. Tabular information is presented in
thousands, except share data.
QNB Corp. (the "Corporation") is a bank holding company headquartered in
Quakertown, Pennsylvania. The Corporation provides a full range of commercial
and retail banking services through its banking subsidiary, The Quakertown
National Bank (the "Bank"), a 122 year old community bank with locations in
Upper Bucks, Northern Montgomery and Southern Lehigh Counties.
In addition to historical information, this management discussion and analysis
contains forward-looking statements. The forward-looking statements 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 with the Securities and Exchange Commission. These include
Quarterly Reports on Form 10-Q to be filed by the Corporation in 2000, and any
Current Reports on Form 8-K filed by the Corporation.
RESULTS OF OPERATIONS
QNB had its fourth consecutive year of record earnings in 1999. QNB's earnings
for 1999 were $3,801,000, a 10.2 percent increase from the $3,448,000 reported
in 1998. This represents basic earnings per share of $2.65 for 1999, compared to
$2.41 for 1998. On a diluted basis, earnings per share was $2.64 and $2.39 for
1999 and 1998. The results for 1999 reflect higher net interest income, a
reduction in the provision for loan losses, and continued growth in non-interest
income. Net income for 1997 was $3,131,000 or $2.19 per share basic and $2.18
per share on a diluted basis.
Two important measures of profitability in the banking industry are an
institution's return on average assets and return on average shareholders'
equity. Return on average assets and return on average shareholders' equity were
1.10 percent and 13.16 percent, respectively, in 1999 compared with 1.11 percent
and 13.10 percent in 1998 and 1.08 percent and 13.11 percent in 1997.
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.
For purposes of this discussion, interest income and the average yield earned on
loans and investment securities is adjusted to a tax-equivalent basis as
detailed in the table that appears on page 7. This adjustment to interest income
is made for analysis purposes only. Interest income is increased by the amount
of savings of Federal income taxes, which QNB realizes by investing in certain
tax-exempt State and municipal securities and by making loans to certain
tax-exempt organizations. In this way, the ultimate economic impact of earnings
from various assets can be more easily compared.
The net interest rate spread is the difference between average rates received on
earning assets and average rates paid on interest-bearing liabilities, while the
net interest rate margin includes interest-free sources of funds.
On a fully tax-equivalent basis, net interest income for 1999 increased $471,000
or 3.6 percent to $13,649,000. A 10.4 percent increase in average earning assets
offset a decrease in the net interest margin. The net interest margin declined
by 28 basis points, while the net interest rate spread declined by 22 basis
points. The net interest rate spread decreased to 3.70 percent in 1999 from 3.92
percent in 1998, while the net interest rate margin decreased to 4.23 percent in
1999 from 4.51 percent in 1998. Both the spread and the margin were impacted by
several factors including a leverage transaction and the impact of the yield on
earning assets, particularly loans, declining to a greater degree than the rate
paid on interest bearing liabilities.
During the second quarter of 1999, QNB entered into a leverage transaction in
which it borrowed $25,000,000 from the Federal Home Loan Bank (FHLB) at an
average rate of 5.15 percent. These funds were invested in investment securities
with an average yield of 6.52 percent for a spread of 137 basis points. This
transaction had the impact of increasing tax-equivalent net interest income by
approximately $222,000, but lowering the net interest rate spread and net
interest rate margin. Excluding the impact of this transaction in 1999, the net
interest rate spread would have declined by 7 basis points to 3.85 percent and
the net interest rate margin would have declined by 11 basis points to 4.40
percent.
It is necessary to review the changes in market interest rates during 1999 and
1998 to understand the impact of changing interest rates on interest income and
interest expense. A rapidly growing U.S. economy, potential inflation fears
caused by tight labor markets, a stabilized global economy and concerns about
year-2000 computer disruptions caused interest rates to increase rapidly during
1999. In response to these events the Federal Reserve Bank took back the Federal
funds rate cuts they made during 1998 by increasing the target rate three times
from 4.75 percent to 5.50 percent as of December 31, 1999. The 30-year Treasury
bond, which began the year yielding 5.09 percent, ended the year at 6.48 percent
while the two-year Treasury bond increased from 4.53 percent at December 31,
1998 to 6.24 percent at December 31, 1999.
<PAGE>
p. 9
MANAGEMENT'S DISCUSSION AND ANALYSIS
During 1998, market interest rates, as represented by the U.S. Treasury yield
curve, declined dramatically as signs of a global economic crisis created a
flight to quality in the U.S. Treasury market. Adding to this decline was an
environment of low inflation in the U.S. economy. In response to these events
the Federal Reserve Bank lowered the Federal funds rate three times from 5.50
percent to 4.75 percent between the end of September and the middle of November.
As rates declined during the year, the yield curve continued to flatten and even
became inverted in the short-end. For example, at the end of June, 1998, the
spread between the two-year Treasury bond and the 30-year Treasury bond was only
15 basis points, and the rate on the two-year bond was higher than the five and
ten year bond. One result of the decline in rates and the flattening of the
yield curve was the widening of the spread on other investment securities,
especially mortgage-backed securities. The yield on these securities did not
decline to nearly the degree that Treasury securities declined. In response, QNB
increased its purchase of mortgage-backed securities during 1998.
Total interest income increased $1,201,000 in 1999 to $23,953,000. The
Rate-Volume Analysis table below highlights the impact of changing rates and
volumes on total interest income and interest expense. Growth in earning assets
contributed $2,212,000 to the increase in interest income, with higher
securities volume accounting for $1,886,000 of the increase and higher loan
volume accounting for $445,000 of the increase. Average investments increased
$27,475,000 or 23.6 percent, while average loans increased $5,112,000 or 3.0
percent. The majority of the increase in investment securities relates to the
leverage transaction that had the impact of increasing interest income by
approximately $1,110,000.
The impact of declining interest rates during 1998 had a negative result on
interest income and the yield on earning assets, particularly loans during 1999.
As rates hit historically low levels during 1998, many borrowers both commercial
and consumer, selected fixed rate rather than variable rate loans. Therefore,
the loan portfolio had minimal benefit from rising rates during 1999. The
decline in interest income resulting from lower yields on earning assets was
$1,011,000 during 1999, with loans responsible for $861,000 to the decline. The
yield on earning assets decreased 36 basis points to 7.43 percent with the
average rate on loans declining 49 basis points during 1999. The yield on loans
declined from 8.71 percent in 1998 to 8.22 percent in 1999. Despite the 75 basis
point increase in the prime rate during the course of 1999, the average prime
rate for the year declined 36 basis points from 8.36 percent for 1998 to 8.00
percent in 1999. While QNB will see some benefit in 2000 from these prime rate
increases, the overall yield on the loan portfolio will not increase
proportionately, since only approximately 13 percent of the portfolio reprices
immediately with changes in the prime rate. 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 had prevented the rates from
increasing to the degree that Treasury rates have increased.
Non-accrual loans of $484,000 in 1999 and $506,000 in 1998 resulted in the
nonrecognition of $55,000 and $70,000 in interest income for the respective
periods. The impact of non-accrual loans is included in the change due to rate
amount.
<TABLE>
<CAPTION>
RATE-VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME (TAX-EQUIVALENT BASIS)
- -----------------------------------------------------------------------------------------------------------------------------------
1999 vs. 1998 1998 vs. 1997
- -----------------------------------------------------------------------------------------------------------------------------------
Change due to Total Change due to Total
Volume Rate Change Volume Rate Change
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Interest-bearing balances ................................ $ 3 $ (2) $ 1 $ 2 - $ 2
Federal funds sold ....................................... (122) (5) (127) 104 $ (10) 94
Investment securities available-for-sale:
Taxable ............................................... 1,172 (40) 1,132 441 (7) 434
Tax-exempt ............................................ 307 (44) 263 7 - 7
Investment securities held-to-maturity:
Taxable ............................................... 28 (18) 10 (5) 15 10
Tax-exempt ............................................ 379 (41) 338 174 (21) 153
Loans .................................................... 445 (861) (416) 775 (321) 454
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest income ........................... 2,212 (1,011) 1,201 1,498 (344) 1,154
- -----------------------------------------------------------------------------------------------------------------------------------
Interest expense:
Interest-bearing demand accounts ......................... 46 (141) (95) 30 (160) (130)
Money market accounts .................................... (64) (64) (128) (7) (23) (30)
Savings .................................................. 2 (98) (96) 44 (20) 24
Time ..................................................... 317 (311) 6 459 - 459
Time over $100,000 ....................................... 217 (93) 124 176 (27) 149
Short-term borrowings .................................... 49 (18) 31 19 17 36
Federal Home Loan Bank advances 558 330 888 - - -
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest expense .......................... 1,125 (395) 730 721 (213) 508
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income ...................................... $1,087 $ (616) $ 471 $ 777 $(131) $ 646
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Variances which were not specifically attributed to volume or rate were
allocated proportionately between volume and rate. Tax-exempt securities and
loans were adjusted to a tax-equivalent basis and are based on the marginal
Federal corporate tax rate of 34 percent. Non-performing assets are treated as a
change due to rate.
<PAGE>
p. 10
MANAGEMENT'S DISCUSSION AND ANALYSIS
NET INTEREST INCOME (continued)
The yield on the total investment portfolio was 6.53 percent for 1999 and 6.57
percent in both 1998 and 1997. 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 potential negative impact of falling
rates on the yield in 1998 and 1999. They did this 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 declined 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 percent, and reinvested the proceeds in securities yielding 7.50
percent. This transaction benefits QNB by increasing interest income going
forward.
Total interest expense increased $730,000 or 7.6 percent in 1999 to $10,304,000.
Interest expense on the borrowings from the FHLB contributed $888,000 to the
increase. A 4.5 percent increase in average interest-bearing deposits resulted
in an increase in interest expense of $518,000. This increase was primarily in
the area of time deposits with average balances increasing by 7.6 percent and
interest expense increasing by $534,000. An 8.0 percent increase in
interest-bearing demand accounts contributed approximately $46,000 to the
increase in interest expense while a 7.0 percent decrease in average money
market accounts caused interest expense to decline by $64,000.
The average rates paid on deposit accounts and short-term borrowings lagged the
increase in Treasury rates during 1999. These rates are likely to increase
during the year 2000, as the increase in Treasury rates is passed on to the
consumer in the form of higher deposit rates, particularly time deposit rates.
The rate paid on total interest-bearing liabilities, including the borrowings
from the FHLB, decreased to 3.73 percent in 1999 from 3.87 percent in 1998. The
rate paid on interest-bearing deposit accounts decreased to 3.63 percent in 1999
from 3.88 percent in 1998.
The impact of changing interest rates resulted in interest expense declining by
approximately $395,000 during 1999. The majority of this decline was in time
deposits. Many of QNB's customers prefer time deposits with a maturity of one
year or less. When rates declined during 1998 many of these deposits were
repriced at significantly lower rates, accounting for the decline in yield
during 1999. In anticipation of higher rates QNB promoted a competitive 36-month
time deposit. The purpose was to decrease QNB's sensitivity to increases in
short-term interest rates. The average rate paid on time deposits less than
$100,000 decreased from 5.48 percent in 1998 to 5.20 percent in 1999 and the
rate paid on time deposits of $100,000 or more decreased from 5.73 percent to
5.33 percent. Also positively impacting interest expense was the decline in
yield on interest-bearing demand accounts. The average rate paid on these
accounts declined from 1.37 percent in 1998 to 1.06 percent in 1999. QNB was
able to reduce the rate on these accounts as they are deemed to be relatively
insensitive to changing interest rates. An 8.0 percent increase in the average
balance between 1998 and 1999 is an indication of this.
When comparing 1998 to 1997, net interest income on a fully tax-equivalent basis
increased $646,000 or 5.2 percent to $13,178,000. A 7.3 percent increase in
average earning assets offset a decrease in the net interest margin. The net
interest margin declined by nine basis points, while the net interest rate
spread declined by ten basis points. The net interest rate spread decreased to
3.92 percent in 1998 from 4.02 percent in 1997, while the net interest rate
margin decreased to 4.51 percent in 1998 from 4.60 percent in 1997. The negative
impact of rates paid on interest-bearing liabilities declining to a lesser
degree than the rates earned on assets, especially loans, was reduced by an 11.4
percent increase in non-interest-bearing deposits.
Total interest income increased $1,154,000 in 1998 to $22,752,000. Growth in
earning assets contributed $1,498,000 to the increase in interest income, with
higher securities volume accounting for $617,000 of the increase and higher loan
volume accounting for $775,000 of the increase. Average investments increased
$9,154,000 or 8.5 percent, while average loans increased $8,704,000 or 5.4
percent.
[GRAPHICS]
In the printed version of the document, a line graph appears
which depicts the following plot points:
<TABLE>
<CAPTION>
1995 1996 1997 1998 1999
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Net Interest Income
(tax-equivalent, in thousands) 11772 11871 12532 13178 13649
</TABLE>
Declining interest rates had a negative impact on interest income and the yield
on earning assets, particularly loans. The decline in interest income resulting
from lower yields on earning assets was $344,000 during 1998. The yield on
earning assets decreased 14 basis points to 7.79 percent with the average rate
on Federal funds sold and loans declining 16 basis points and 19 basis points,
respectively, during 1998. The decline in the average yield on Federal funds
sold is a direct result of the action taken by the Federal Reserve Bank in
reducing the Federal funds rate. The yield on loans declined from 8.90 percent
in 1997 to 8.71 percent in 1998, partially as a result of declining market
interest rates. A major factor in the decline in the yield on loans was the
reduction in rates for existing commercial loan customers. The extreme
competition for loans caused the rate on loans to decline significantly. Another
result of the lower interest rate environment was the selection by customers of
fixed rate rather than variable rate loans, both in the residential mortgage and
commercial loan sectors.
<PAGE>
p. 11
MANAGEMENT'S DISCUSSION AND ANALYSIS
The yield on the total investment portfolio was 6.57 percent for both 1998 and
1997. QNB was able to maintain the yield on the investment portfolio for the
year despite falling interest rates. The sale of approximately $9,000,000 in
securities with a weighted average yield of 5.69 percent at the end of 1997 and
the beginning of 1998 assisted in the maintenance of the yield. These funds were
reinvested in higher yielding securities with slightly longer maturities. Also
helping to maintain the yield on the portfolio was the increase in the
percentage of mortgage-backed securities and tax-exempt municipal securities in
the portfolio. These types of securities tend to have higher yields. The yields
on these types of securities also did not decline to the same magnitude as
Treasury securities during 1998. The yield on the portfolio did decline
throughout 1998 as the lower interest rate environment increased the prepayments
on mortgage-backed securities and callable agency securities. The reinvestment
of these proceeds has been at lower rates.
Total interest expense increased $508,000 or 5.6 percent in 1998 to $9,574,000.
A 6.6 percent increase in average interest-bearing liabilities resulted in an
increase in interest expense of $721,000. This increase was primarily in the
area of time deposits with average balances increasing by 9.9 percent and
interest expense increasing by $635,000. A 4.3 percent increase in
interest-bearing demand accounts and a 5.7 percent increase in average savings
accounts contributed approximately $30,000 and $44,000 to the increase in
interest expense.
Despite falling market interest rates in 1998 as indicated by the Treasury yield
curve, the rates paid on deposits and short-term borrowings did not decline to
the same degree as rates on earning assets. This was a function of the strong
competition among financial institutions for consumer deposits. The rate paid on
total interest-bearing liabilities decreased to 3.87 percent in 1998 from 3.91
percent in 1997. The impact of changing interest rates resulted in interest
expense declining by approximately $213,000 during 1998. The majority of this
decline was in interest-bearing demand accounts, which accounted for $160,000 of
the savings. QNB was able to reduce the rate on these accounts as they are
deemed to be relatively insensitive to changing interest rates. The average rate
paid on interest-bearing demand accounts decreased from 1.75 percent in 1997 to
1.37 percent in 1998. The competition for funds is evidenced by the inability to
reduce interest rates on certificates of deposit and short-term borrowings. The
yield on time deposits less than $100,000 remained stable at 5.48 percent while
the yield on short-term borrowings, primarily cash management accounts, actually
increased from 3.48 percent in 1997 to 3.66 percent in 1998. During the third
quarter of 1997, QNB changed the rate structure on money market accounts and
cash management accounts to a tiered structure that pays a higher rate of
interest on higher balances. The largest impact was on the cash management
account, which was increased significantly to compete with brokerage accounts
and mutual fund money market products.
Management expects the net interest margin to decline during 2000, as a result
of higher funding costs and the full years' impact of the leverage transaction.
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 inherent losses
in the loan portfolio. Actual loan losses, net of recoveries, serve to reduce
the allowance. The provision for loan losses was $240,000 for 1999 compared to
$400,000 for both 1998 and 1997. QNB was able to reduce the provision for loan
losses in 1999 as a result of maintaining low levels of non-performing and
delinquent loans as well as having net recoveries for 1999. Net recoveries were
$5,000 for 1999 compared to net charge-offs of $119,000 in 1998 and $315,000 in
1997. This amounts to .003 percent, .07 percent and .20 percent of average loans
during the corresponding three years.
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 or losses on the sale of investment
securities, gains on the sale of residential mortgage loans 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 1999, QNB has not materially changed these fee
schedules during 1999, 1998 or 1997. The development of new products and
services should help generate additional non-interest income. Total non-interest
income was $2,231,000 in 1999 compared to $2,154,000 in 1998, an increase of 3.6
percent. Excluding the gains and losses on the sale of investment securities and
loans in both 1999 and 1998 non-interest income increased 21.9 percent. The
increase in non-interest income in 1999 followed a 12.2 percent increase when
comparing the $2,154,000 reported in 1998 to the $1,919,000 recorded in 1997.
Fees for services to customers are primarily comprised of service charges on
deposit accounts. These fees increased $250,000 or 26.3 percent during 1999 to
$1,202,000. An increase in overdraft fee income accounts for approximately
$205,000 of the overall increase. An increase in both the fee and volume of
overdrafts contributed to the higher overdraft income. During the first quarter
of 1999, QNB increased its fee for overdrafts by 12.0 percent. Also positively
impacting fee income in 1999 was an increase in income related to low balance
savings accounts and an increase in income for charges related to the use of
out-of-network Automated Teller Machines (ATMs). QNB does not currently
surcharge for the use of its ATMs.
Fees for services to customers declined $12,000 or 1.2 percent to $952,000 when
comparing 1998 to 1997. A decline in overdraft income resulting from a lower
volume of overdrafts was partially offset by an increase in income related to
low balance savings accounts and out-of-network ATM charges.
To date, when QNB sells its residential mortgages in the secondary market, it
retains servicing rights. A normal servicing fee is retained on all loans sold
and serviced. Mortgage servicing fees decreased $31,000 or 19.9 percent in 1999,
to $125,000. This followed a decrease of $25,000 or 13.8 percent in 1998, to
$156,000. The decline in mortgage servicing fees is primarily a result of an
increase in the amortization of the mortgage servicing asset booked at the time
the loan is sold. 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 the period of net
servicing income or loss. Servicing assets are assessed for impairment based on
their fair value. The impact of amortization and impairment of the mortgage
servicing asset was $50,000, $35,000 and $6,000 in 1999, 1998 and 1997.
<PAGE>
p. 12
MANAGEMENT'S DISCUSSION AND ANALYSIS
NON-INTEREST INCOME (continued)
The volume of mortgages serviced as well as the timing of mortgage payments and
the level of delinquent mortgages also impacts the amount of servicing fees
recorded. The level of mortgages serviced decreased only $47,000 or .1 percent
to $65,753,000 at December 31, 1999. The average balance of mortgages serviced
for others increased .9 percent in 1999 to $67,619,000. The increase in interest
rates during 1999 and the related slowdown in mortgage refinancing activity,
particularly in the second half of 1999, significantly reduced the amount of
loans originated and sold. During 1999, QNB originated $7,400,000 in mortgages
held-for-sale and sold $10,890,000. This compares to $15,321,000 originated and
$13,351,000 sold in 1998.
The .1 percent decrease in mortgages serviced from year-end 1998 to year-end
1999 followed a 2.9 percent decline between 1997 and 1998. The average balance
of mortgages serviced decreased 4.7 percent between 1997 and 1998. The decrease
in the volume of mortgages serviced for others during 1998 was a result of
payments, both recurring and from refinances, outpacing the origination and sale
of new residential mortgages. The volume of mortgages serviced for others
declined in 1998 despite a significant increase in the amount of mortgages sold
during the year. QNB sold approximately $13,351,000 in mortgages during 1998
compared to only $2,493,000 during 1997. Management's decision to retain more
15-year mortgages, which would have been sold in prior years, has also reduced
the amount of mortgages sold and serviced.
Management anticipates that mortgage servicing fees may continue to decline as
principal reductions outpace loans sold and the amount of amortization of the
mortgage servicing asset increases.
QNB recorded a loss on the sale of investment securities of $139,000 during
1999. This compares to a gain of $66,000 in 1998. Net losses on the sale of debt
securities were approximately $257,000, while net gains on the sale of equity
securities were $118,000 in 1999. During the third and fourth quarters of 1999,
in response to rising interest rates, QNB sold approximately $9,500,000 of
securities yielding 6.25 percent, and reinvested the proceeds in securities
yielding 7.50 percent. This transaction benefits QNB by increasing interest
income going forward.
The net gain on the sale of investment securities of $66,000 in 1998 represents
a decline of $68,000 from the gain recorded in 1997. Net gains on the sale of
equity securities were $38,000, while net gains on debt securities were
approximately $28,000 in 1998. The prepayment of agency securities that were
originally purchased at a discount contributed approximately $22,000 to the gain
on debt securities recorded in 1998. In addition, during the first quarter of
1998, QNB sold approximately $5,000,000 in lower yielding agency securities at a
gain of $6,000. These securities had a weighted average yield of 5.61 percent.
They were sold for liquidity purposes and to continue the repositioning of the
portfolio that began in late 1997.
The net gain on the sale of investment securities was $134,000 in 1997. This
amount represents gains on the sale of equity securities of $159,000 netted
against a net loss of $25,000 on the sale of debt securities. During the fourth
quarter of 1997, QNB sold approximately $4,000,000 in lower yielding securities
at a loss of $31,000. These securities had an average yield of 5.80 percent. The
proceeds of this sale were used to fund higher yielding loans that were booked
near the end of the year. Earlier in 1997, approximately $9,500,000 of U.S.
Treasury and agency securities were sold for liquidity purposes at a gain of
$6,000.
The Corporation owns a portfolio of equity securities, consisting of stocks of
other financial institutions. At December 31, 1999, these securities had an
amortized cost of $2,715,000 and a market value of $2,656,000.
Student and residential mortgage loans to be sold are identified at origination.
The net gain on the sale of loans was $178,000, $290,000 and $81,000 in 1999,
1998 and 1997. Included within these amounts are gains on the sale of student
loans of $42,000, $38,000 and $35,000, respectively. QNB sold approximately
$2,219,000, $1,599,000 and $1,464,000 of loans to SallieMae during these three
years. The amount of the gain depends upon the size and type of loans
originated. The reduced amount of the gain relative to the volume of the loans
sold in 1999 and 1998 is a result of the change in pricing for student loans by
the U.S. Government. The amount of income, both interest income and gains on the
sale may continue to decline in the future depending upon action taken by the
U.S. Government with regard to the allowable interest rate charged on student
loans.
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. Net gains on the sale of residential mortgages were $136,000 in
1999, $252,000 in 1998 and $46,000 in 1997. The implementation of SFAS No. 122
as superceded by SFAS No. 125 increased the gain on the sale of residential
mortgages in these years by approximately $112,000, $137,000 and $25,000.
Significant interest rate swings during the three years has had a major impact
on the volume of mortgages originated and the gains recorded on the sale of
these mortgages. QNB sold approximately $10,890,000, $13,351,000 and $2,493,000
of residential mortgages in the secondary market in 1999, 1998 and 1997. Of the
amount of loans sold in 1999, approximately $3,601,000 had been originated in
1998. Rising interest rates during 1999 slowed the refinancing activity and
reduced the origination of mortgage loans. QNB originated approximately
<TABLE>
<CAPTION>
Change from Prior Year
----------------------
NON-INTEREST INCOME COMPARISON 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
1999 1998 1997 Amount Percent Amount Percent
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Fees for services to customers ............ $1,202 $ 952 $ 964 $ 250 26.3% $ (12) (1.2)%
Mortgage servicing fees ................... 125 156 181 (31) (19.9) (25) (13.8)
Net (loss) gain on investment securities .. (139) 66 134 (205) (310.6) (68) (50.7)
Net gain on sale of loans ................. 178 290 81 (112) (38.6) 209 258.0
Other operating income .................... 865 690 559 175 25.4 131 23.4
- ------------------------------------------------------------------------------------------------------------------------------------
Total ................................ $2,231 $2,154 $1,919 $ 77 3.6% $ 235 12.2%
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
p. 13
MANAGEMENT'S DISCUSSION AND ANALYSIS
<TABLE>
<CAPTION>
Change from Prior Year
----------------------
NON-INTEREST EXPENSE COMPARISON 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
1999 1998 1997 Amount Percent Amount Percent
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Salaries and employee benefits .......... $5,696 $5,561 $5,411 $ 135 2.4% $ 150 2.8%
Net occupancy expense ................... 669 666 666 3 .5 - -
Furniture and equipment expense ......... 908 733 697 175 23.9 36 5.2
Marketing expense ....................... 379 371 303 8 2.2 68 22.4
Other real estate owned expense ......... 64 312 273 (248) (79.5) 39 14.3
Other expense ........................... 2,191 2,012 1,841 179 8.9 171 9.3
- ------------------------------------------------------------------------------------------------------------------------------------
Total .............................. $9,907 $9,655 $9,191 $ 252 2.6% $ 464 5.0%
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
$7,400,000 in mortgages held-for-sale in 1999 compared to $15,321,000 in 1998.
Rising rates also had the impact of reducing the net gains on the sales.
In contrast, declining interest rates to record low levels 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.
During 1998, QNB originated approximately $15,321,000 in mortgages
held-for-sale. This compares to $1,052,000 in 1997. During the third quarter of
1997, declining interest rates provided an opportunity to sell, at a gain, some
lower yielding 15 and 20 year mortgages that had been in the portfolio since
1995.
As of December 31, 1999, there were no residential mortgage loans held-for sale,
while as of December 31 1998, residential mortgages held for sale were
approximately $3,601,000. These loans are accounted for at the lower of cost or
market. The volume of mortgage originations and sales may continue to decrease
during 2000 as a result of a slowdown in both new mortgages and refinancing
activity caused by higher interest rates. Rising rates could also create a loss
on the sale if rates increase prior to the sale of the originated mortgages.
Other operating income was $865,000, $690,000 and $559,000 in 1999, 1998 and
1997. The $175,000 or 25.4 percent increase in 1999 is primarily the result of
increased earnings on the cash surrender value of single premium life insurance
policies that went into effect in September, 1998. Also contributing to the
increase in other operating income was higher debit card, merchant processing,
check order and mutual fund income. The earnings on the cash surrender value of
life insurance increased $121,000 when comparing 1999 to 1998. The $59,000
increase in debit card income and the $18,000 increase in merchant processing
income were a result of the increase in the number of transactions.
Commissions on check orders increased $25,000 in 1999 as a result of a
restructure in QNB's deposit products. 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, many customers
received free checks upon reorder. Also, as part of the product restructuring,
many customers now receive a free QNB debit card. These customers previously
paid an annual fee of $15. This change had the impact of reducing ATM card
income by $14,000 in 1999. Also, negatively impacting other non-interest income
was the sale of several revenue generating properties, which reduced the income
from other real estate owned by $55,000 in 1999.
The $131,000 or 23.4 percent increase between 1998 and 1997 is partially the
result of earnings on the cash surrender value of single premium life insurance
policies. These policies provided approximately $38,000 in tax-exempt income in
1998. Also contributing to the increase in other operating income were increases
in debit card and ATM interchange income of $39,000 and $16,000, respectively.
These increases relate to higher usage of the debit card and an increased usage
of QNB's ATMs by non-QNB customers. QNB does not currently surcharge for the use
of its machines and as a result has experienced increased activity. Most other
banks in QNB's market area surcharge for the use of ATMs by non-customers. QNB
receives a fee from the owner of the ATM network when non-customers use a QNB
machine. The recognition of fees from official checks increased approximately
$18,000 when comparing 1998 to 1997. QNB entered an arrangement with a third
party vendor for official check services in the latter part of 1997. A refund of
State sales tax of $21,000, based on an appeal of previous years' payments, and
a reimbursement of prior year's costs of approximately $15,000 related to a
terminated bill pay product, also contributed to the increase in other operating
income between 1997 and 1998. Partially offsetting these increases is a decline
in rental income on other real estate owned of $28,000. Most of the properties
that generated rental income were disposed of during 1998.
NON-INTEREST EXPENSE
Non-interest expense is comprised of costs related to salaries and employee
benefits, net occupancy, furniture and equipment, marketing, other real estate
owned and various other operating expenses. Total non-interest expense in 1999
increased $252,000 or 2.6 percent to $9,907,000. This followed an increase of
5.0 percent between 1997 and 1998. Total non-interest expense for 1998 and 1997
was $9,655,000 and $9,191,000, respectively. Despite the increase in
non-interest expense, QNB's overhead efficiency ratio, which represents
non-interest expense divided by net operating revenue on a tax-equivalent basis,
remained stable over the past three years.
Salaries and benefits expense is the largest component of non-interest expense.
Salary and benefits expense for 1999 was $5,696,000, an increase of $135,000 or
2.4 percent over 1998 levels. Salary expense for 1999 increased $155,000 or 3.4
percent to $4,649,000, while benefits expense decreased by $20,000 or 1.9
percent to $1,047,000. The decline in benefits expense is a result of a
reduction in QNB's State unemployment tax rate and a reduced contribution to the
Money Purchase Pension Plan resulting from an increase in employee forfeitures.
The unemployment tax rate, based on unemployment experience, should continue to
decline in 2000.
<PAGE>
p. 14
MANAGEMENT'S DISCUSSION AND ANALYSIS
NON-INTEREST EXPENSE (continued)
Salaries and benefits expense for 1998 compared to 1997 increased $150,000 or
2.8 percent to $5,561,000. Salary expense for 1998 increased by $182,000 or 4.2
percent to $4,494,000, while benefits expense decreased by $32,000 to
$1,067,000. The increase in base salary expense is primarily related to
performance increases and a slight increase in the number of full-time
equivalent employees during 1998.
The decline in benefits expense during 1998 is a result of a decrease in
employer paid health costs, a decline in the State unemployment tax rate and a
reduction in expense related to employee education. With regard to health costs,
savings related to lower medical and hospitalization premiums of $30,000 were
partially offset by increases in dental and vision premiums of $11,000 in 1998.
State unemployment taxes decreased by $24,000 in 1998 as a result of a reduction
in the tax rate. Education expense decreased $12,000 or 42.6 percent in 1998.
This is a result of the completion of courses of study by several employees in
1997 or early 1998.
Net occupancy expense was $669,000 in 1999 compared to $666,000 for both 1998
and 1997. When comparing 1999 to 1998, reductions in insurance, utility and real
estate taxes totaling $15,000 were offset by an increase in building repairs and
maintenance costs of $18,000.
When comparing 1998 to 1997, utility costs declined by approximately $13,000 or
9.1 percent. These savings were a function of the relatively mild temperatures
experienced during 1998. These savings were offset by small increases in branch
rent expense, building taxes, maintenance and insurance.
Net occupancy expenses will likely increase in 2000 as a result of both higher
depreciation expense and branch rent expense. These increased costs relate to
the renovation and expansion of an existing branch location at the end of 1999,
as well as the opening of a new branch location in Hilltown Township,
Pennsylvania anticipated in the fall of 2000.
Furniture and equipment expense was $908,000 for 1999, an increase of $175,000
or 23.9 percent. Increased investment in technology, which began during 1998
with the implementation of the first three phases of a wide area network and the
conversion to a new telephone system, continued in 1999 with the implementation
of a check imaging system and the next phases of the wide area network. These
projects were a major contributor to the $150,000 increase in depreciation
expense when comparing 1999, to 1998. Another factor in the increase in
furniture and equipment expense was a $25,000 increase in equipment maintenance
costs.
Furniture and equipment expense was $733,000 in 1998, an increase of $36,000 or
5.2 percent when compared to 1997. The increase is a result of higher
depreciation expense of $18,000 resulting primarily from the investment in
technology described above. Also contributing to the increase in furniture and
equipment expense were higher equipment maintenance costs of $23,000 or 7.8
percent. Some of this increase was a result of maintenance costs on a used
mainframe system purchased for use in Year 2000 testing.
Furniture and equipment expense will continue to increase in 2000 as a result of
higher depreciation expense associated with QNB's continued expansion of its
investment in new technology. This will include the introduction of Internet
banking during the second quarter of 2000, the conversion to a new core
processing system in the fourth quarter as well as the completion of the final
phases of the wide-area network. The addition of the new branch will also result
in higher furniture and equipment expense in 2000.
Marketing expense for 1999 was $379,000, an increase of 2.2 percent from the
$371,000 reported in 1998. An increase in expense related to promotional items,
contributions and sponsorships was partially offset by a reduction in billboard
advertising. During 1998, QNB used billboard 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 and specifically within our
marketplace with the CoreStates/First Union merger.
[GRAPHIC]
In this printed version of the document, a line graph
appears which depicts the following plot points:
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
Efficiency Ratio 72.29% 65.27% 63.60% 62.97% 62.39%
Marketing expense increased $68,000 or 22.4 percent in 1998 to $371,000 when
compared to 1997. Included within this variance is an increase in donation
expense of 96.1 percent. This increase in donations resulted from two
significant pledges made during 1998, including a $40,000 donation to the Main
Street Program, "Quakertown Alive", a program designed for the revitalization of
downtown Quakertown. Also contributing to the increase in marketing expense was
higher advertising expense of $18,000 or 14.7 percent. As mentioned above QNB
used additional print, radio and billboard advertising for both image
advertising and product advertising during 1998. QNB anticipates an increase in
marketing expense in 2000 as a result of the introduction of a new variable rate
money market product during the first quarter of 2000, an increased emphasis on
lending promotions, the launching of Internet banking and the opening of the new
branch.
Other real estate expense was $64,000 in 1999 compared to $312,000 in 1998 and
$273,000 in 1997. Other real estate expense during 1999 was comprised of costs
associated with maintaining the properties: taxes, utilities, insurance,
maintenance, etc., of $128,000 and net gains on the sale and/or write-down of
properties of $64,000. The majority of the maintenance expense relates to the
environmental clean up of one property which was sold during the third quarter
of 1999.
<PAGE>
p. 15
MANAGEMENT'S DISCUSSION AND ANALYSIS
When comparing 1998 to 1997, the increase is primarily the result of the net
loss on the disposition or write-down of properties during the year. Net losses
amounted to $152,000 in 1998 compared to $25,000 in 1997. The loss in 1998 was
primarily related to the write-down of two properties. Partially offsetting
these losses were lower costs related to taxes, insurance and maintenance of the
properties. Maintenance type costs were $160,000 in 1998 as compared to $248,000
in 1997. These costs decreased $88,000 from 1997 to 1998 as a result of owning
fewer properties. Management anticipates other real estate expense to continue
to decline in 2000 as the costs associated with the two remaining properties are
eliminated when they are sold.
The major categories included in other expense are postage, supplies,
professional services, telecommunications, insurance and state taxes. Other
expense increased $179,000 or 8.9 percent in 1999 to $2,191,000. Higher
professional services costs primarily related to the outsourcing of the internal
audit function during the fourth quarter of 1999 and the use of a consultant to
assist in the selection of a new core processing system contributed to $41,000
of the increase in 1999. A $37,000 increase in debit card expense and an $82,000
increase in losses on checking accounts also contributed to the variance between
1999 and 1998. The increase in debit card expense is related to the increase in
usage of the card and costs associated with a mass reissue to replace cards
expiring at the end of 1999. Telephone costs increased $29,000 while postage
expense decreased $29,000 when comparing the two years. The increase in
telephone expense primarily relates to the line costs associated with the wide
area network while the reduction in postage expense relates to efficiencies
gained through the check imaging process. State taxes consisting of sales and
use tax and capital stock tax increased $25,000 while insurance costs increased
by $18,000. Partially offsetting these increases was a reduction in the accrual
of directors' deferred compensation of $82,000. The higher directors' deferred
compensation expense in 1998 reflects an adjustment to the interest rate
assumption caused by the decline in market interest rates.
Other expense was $2,012,000 in 1998 and $1,841,000 in 1997. One of the reasons
for the increase between 1997 and 1998 was the increase in the accrual for a
director's deferred compensation plan described above. The amortization of the
deposit premium, relating to the acquisition completed during the fourth quarter
of 1997, accounted for $43,000 of the increase. Increased supplies and postage
expense accounted for $20,000 and $22,000, respectively, of the increase between
1997 and 1998.
INCOME TAXES
QNB uses the asset and liability method to provide for income taxes. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect of a change in tax rates on deferred tax
assets and liabilities is recognized in income in the period that includes the
enactment date.
Applicable income taxes and effective tax rates were $1,174,000 or 23.6 percent
for 1999 compared to $1,272,000 or 26.9 percent for 1998, and $1,253,000 or 28.6
percent for 1997. The reduction in the effective tax rate over the past three
years is a result of an increase in income from tax-exempt municipal securities
and loans and an increase in tax-exempt income from earnings on single premium
life insurance.
FINANCIAL CONDITION
Compared to the merger activities of the two previous years, 1999 was a
relatively quiet year for the financial services industry. Year 2000 preparation
was the main focus for most companies during 1999. In addition, a decline in
stock values and market capitalization for many financial service companies kept
them on the acquisition sideline during the year. Competition for both loans and
deposits remained strong during 1999. QNB's primary competition in the banking
segment of the financial services industry is comprised of a large super
regional bank, several large community banks and a thrift institution. The
consolidation of the banking industry that has taken place and the increased
availability of loans from all types of companies in the financial services
industry have led to increased price competition for both deposits and loans.
Insurance companies have become a major competitor in the lending arena.
Continued strong performances of sectors in the stock markets as well as record
inflows of cash into mutual funds have also had a direct impact on the
competition for deposits.
This competition did have an impact on QNB in 1999. Total assets at year-end
1999 were $350,489,000, compared with $324,672,000 at December 31, 1998, an
increase of 8.0 percent. However, $25,000,000 of this growth was achieved
through borrowings from the FHLB. Growth rates for 1998 and 1997 were 6.2
percent and 9.0 percent. The growth in 1997 was enhanced by the purchase of
approximately $6,800,000 of deposits from the Quakertown office of First Lehigh
Bank on October 30, 1997. Excluding this purchase, assets would have increased
by 6.6 percent in 1997. Growth in both loans and deposits is one of the primary
goals of QNB in 2000.
Average total assets increased 11.0 percent or $34,051,000 in 1999 to
$344,543,000. Excluding the impact of the borrowings from the FHLB, average
total assets would have increased 5.5 percent. Average total assets increased
7.5 percent or $21,794,000 in 1998. Total loans at December 31, 1999, was
$173,764,000, a decrease of 1.5 percent from December 31, 1998. This followed a
5.2 percent increase from December 31, 1997 to December 31, 1998. Average total
loans increased 3.0 percent in 1999 and 5.4 percent in 1998. Loan growth was and
remains one of the primary goals of QNB. Funding sources, which include deposits
and borrowed money, increased 9.0 percent from year-end 1998 to year-end 1999
and 5.8 percent from year-end 1997 to year-end 1998. Excluding the borrowings
from the FHLB, funding sources would have increased by .5 percent in 1999.
Average funding sources increased 11.1 percent in 1999 and 7.2 percent in 1998.
Excluding the borrowings from the FHLB, average funding sources would have
increased by 5.0 percent in 1999. The following discussion will further detail
QNB's financial condition during 1999 and 1998.
<PAGE>
p. 16
MANAGEMENT'S DISCUSSION AND ANALYSIS
<TABLE>
<CAPTION>
INVESTMENT PORTFOLIO HISTORY
- -----------------------------------------------------------------------------------------------------------------
December 31, 1999 1998 1997
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Investment Securities Available-for-Sale
U.S. Treasuries ...................................................... $ 6,499 $ 9,180 $ 9,633
U.S. Government agencies ............................................. 40,396 47,356 55,586
State and municipal securities ....................................... 6,371 518 511
Mortgage-backed securities ........................................... 37,485 9,338 8,152
Equity and other debt securities ..................................... 6,858 3,696 2,038
- -----------------------------------------------------------------------------------------------------------------
Total investment securities available-for-sale .................... $ 97,609 $ 70,088 $ 75,920
- -----------------------------------------------------------------------------------------------------------------
Investment Securities Held-to-Maturity
State and municipal securities ....................................... $ 19,346 $ 14,668 $ 10,136
Mortgage-backed securities ........................................... 28,956 35,319 30,186
Equity securities .................................................... - 78 78
- -----------------------------------------------------------------------------------------------------------------
Total investment securities held-to-maturity ...................... $ 48,302 $ 50,065 $ 40,400
- -----------------------------------------------------------------------------------------------------------------
Total investment securities ....................................... $145,911 $120,153 $116,320
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
INVESTMENT PORTFOLIO WEIGHTED AVERAGE YIELDS
- ------------------------------------------------------------------------------------------------------------------------------------
Under 1-5 5-10 Over 10
December 31, 1999 1 Year Years Years Years Total
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Investment Securities Available-for-Sale
U.S. Treasuries:
Fair value .................................................. $ 3,507 $ 2,992 - - $ 6,499
Weighted average yield ...................................... 6.25% 5.79% 6.04%
U.S. Government agencies:
Fair value .................................................. - $11,788 $28,608 - $40,396
Weighted average yield ...................................... 6.72% 6.65% 6.67%
State and municipal securities:
Fair value .................................................. - - - $6,371 $ 6,371
Weighted average yield ...................................... 7.18% 7.18%
Mortgage-backed securities:
Fair value .................................................. $ 1,180 $ 5,326 $30,979 - $37,485
Weighted average yield ...................................... 6.61% 6.65% 6.59% 6.60%
Equity and other debt securities:
Fair value .................................................. $ 6,858 - - - $ 6,858
Weighted average yield ...................................... 5.94% 5.94%
- ------------------------------------------------------------------------------------------------------------------------------------
Total fair value ............................................... $11,545 $20,106 $59,587 $6,371 $97,609
Weighted average yield ......................................... 6.10% 6.57% 6.62% 7.18% 6.58%
- ------------------------------------------------------------------------------------------------------------------------------------
Investment Securities Held-to-Maturity
State and municipal securities:
Amortized cost .............................................. $ 55 $ 5,138 $14,153 - $19,346
Weighted average yield ...................................... 8.64% 7.29% 6.74% 6.89%
Mortgage-backed securities:
Amortized cost .............................................. $ 2,603 $14,744 $ 8,174 $3,435 $28,956
Weighted average yield ...................................... 6.32% 6.54% 6.41% 6.55% 6.48%
- ------------------------------------------------------------------------------------------------------------------------------------
Total amortized cost ........................................... $ 2,658 $19,882 $22,327 $3,435 $48,302
Weighted average yield ......................................... 6.37% 6.73% 6.62% 6.55% 6.64%
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Securities are assigned to categories based on stated contractual maturity
except for mortgage-backed securities which are based on anticipated payment
periods. See interest rate sensitivity section for practical payment and
repricing characteristics. Tax-exempt securities were adjusted to a
tax-equivalent basis and are based on the marginal Federal corporate tax rate of
34 percent. Weighted average yields on investment securities available-for-sale
are based on historical cost.
<PAGE>
p. 17
MANAGEMENT'S DISCUSSION AND ANALYSIS
INVESTMENT SECURITIES AND OTHER
SHORT-TERM INVESTMENTS
Investment policies, approved by QNB's Board of Directors, include standards
regarding permissible investment categories, credit quality, maturity intervals
and investment concentrations. Total investment securities at December 31, 1999
and 1998 were $145,911,000 and $120,153,000. At December 31, 1999 and 1998,
approximately 79.8 percent and 85.1 percent of QNB's investment securities were
either U.S. Government or U.S. Government agency debt securities, or U.S.
Government agency issued mortgage-backed securities.
[GRAPHIC]
In the printed version of the document, a line graph
appears which depicts the following plot points:
Investment Portfolio
U.S. Treasuries $ 6,499
U.S. Government agencies $40,396
State and municipal securities $ 6,371
Mortgage-backed securities $37,485
Equity securities $ 6,858
QNB did not hold any securities which, in the aggregate from any issuer
(excluding the U.S. Government and its agencies), were in excess of 10 percent
of shareholders' equity. In addition, Federal funds sold, which would be
affected by the economic status of the banking industry, are short-term in
nature and sold to banks with a minimum "A" rating at the date of the sale.
Average investment securities increased $27,475,000 or 23.6 percent to
$143,716,000 in 1999 compared with a $9,154,000 or 8.5 percent increase in 1998.
The significant increase in the investment portfolio is primarily the result of
the $25,000,000 wholesale funding transaction entered into with the FHLB during
the second quarter of 1999. This transaction had the impact of increasing
average investment securities by approximately $17,014,000 in 1999. The increase
in the size of the investment portfolio in 1998 was fueled by the growth in
average funding sources, which increased by $18,881,000. This growth was
enhanced by the purchase of approximately $6,800,000 in deposits from another
financial institution during the fourth quarter of 1997.
Average Federal funds sold decreased 38.7 percent in 1999 to $3,602,000, after
increasing 46.7 percent between 1998 and 1997. The lower balance of Federal
funds sold during 1999 was a result of QNB having access to additional sources
of liquidity with both the FHLB and its correspondent bank, and the increase in
vault cash in response to Year 2000 liquidity needs.
The amount of activity in the investment portfolio remained high with over
$53,100,000 in maturities, calls, or sales and over $84,300,000 in purchases
during 1999. In light of the activity the composition of the portfolio changed
significantly. The strategy during 1999 was to increase the percentage of the
portfolio in tax-exempt State and municipal securities and mortgage-backed
securities and to reduce the reliance on callable U.S. Government agency
securities. U.S. Government agency securities decreased to 27.7 percent of the
portfolio at December 31, 1999, from 39.4 percent of the portfolio at December
31, 1998. Mortgage-backed securities increased to 45.5 percent from 37.2 percent
of the portfolio and State and municipal securities increased to 17.6 percent
from 12.6 percent of the portfolio at December 31, 1999 and 1998. The decrease
in the percentage of the portfolio in U.S. Government agency securities and the
offsetting increase in mortgage-backed securities and municipal securities is a
result of management's opinion that these sectors provided more value than the
callable agency sector.
Management anticipates that investment portfolio activity will slow during 2000
as a result of higher interest rates which causes the prepayments on
mortgage-backed securities to slow and reduces the likelihood of the securities
with call features to be exercised. These factors reduce the available funds for
reinvestment. The anticipated strategy entering 2000 is to continue to focus on
the purchase of mortgage-backed securities and tax-exempt State and municipal
securities.
At December 31, 1999 and 1998, investment securities totaling $43,963,000 and
$44,715,000 were pledged as collateral for repurchase agreements, public
deposits and other deposits as provided by law.
QNB accounts for its investments by classifying its securities into three
categories. Securities that QNB has the positive intent and ability to hold to
maturity are classified as held-to-maturity securities and reported at amortized
cost. Debt and equity securities that are bought and held principally for the
purpose of selling them in the near term are classified as trading securities
and reported at fair value, with unrealized gains and losses included in
earnings. Debt and equity securities not classified as either held-to-maturity
securities or trading securities are classified as available-for-sale securities
and reported at fair value, with unrealized gains and losses, net of tax,
excluded from earnings and reported as a separate component of shareholders'
equity. Management determines the appropriate classification of securities at
the time of purchase. QNB held no trading securities as of December 31, 1999 and
1998.
[GRAPHIC]
In the printed version of the document, a line graph
appears which depicts the following plot points:
T.E. Yield on Securities Portfolio vs. Average 5-Year Treasury Yield
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
Total Investment Securities 5.38% 6.21% 5.71% 4.54% 6.34%
5-Year Treasury 6.35% 6.45% 6.57% 6.57% 6.53%
<PAGE>
p. 18
MANAGEMENT'S DISCUSSION AND ANALYSIS
INVESTMENTS AVAILABLE-FOR-SALE
Available-for-sale investment securities include securities that management
intends to use as part of its asset/liability management strategy. These
securities may be sold in response to changes in market interest rates and
related changes in the securities prepayment risk or in response to the need for
liquidity. The available-for-sale portfolio is primarily comprised of U.S.
Treasuries and U.S. Government agencies due to their high degree of liquidity.
Also included are certain mortgage-backed securities to ensure QNB's ability to
react to changes in prepayment activity and longer maturity State and municipal
securities. At December 31, 1999, the fair value of investment securities
available-for-sale was $97,609,000 or $3,947,000 below the amortized cost of
$101,556,000. This compares to a fair value of $70,088,000 or $1,387,000 above
the amortized cost of $68,701,000 at December 31, 1998. An unrealized holding
loss of $2,604,000 was recorded as a decrease to shareholders' equity as of
December 31, 1999, while an unrealized holding gain, net of taxes, of $916,000
was recorded as an increase to shareholders' equity at December 31, 1998. The
available-for-sale portfolio had a weighted average maturity of approximately 7
years at December 31, 1999 and 4 years, 10 months at December 31, 1998. The
weighted average tax-equivalent yield was 6.58 percent and 6.52 percent at
December 31, 1999 and 1998. The purchase of some longer maturity mortgage-backed
securities and State and municipal securities account for the increase in the
average life of the portfolio. Rapidly rising interest rates during 1999, in
conjunction with the purchase of some longer maturity investments, created the
unrealized holding loss in the portfolio.
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 of the debt securities and because of prepayments on
mortgage-backed securities. The interest rate sensitivity analysis on page 25
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 and 6 months at December 31, 1999, and
1 year and 2 months at December 31, 1998, based on these assumptions. The small
difference in weighted average life and expected weighted average life as of
December 31, 1999 is due to the fact that most of the securities with call
options are anticipated to go to their final maturity. The shorter expected
weighted average life in 1998 was a result of the callable nature of the U.S.
Government agency securities and the anticipated prepayments on mortgage-backed
securities given the low interest rate environment entering 1999.
INVESTMENTS HELD-TO-MATURITY
Investment securities held-to-maturity are recorded at amortized cost. Included
in this portfolio are State and municipal securities with original maturities
primarily of 10 years or less and mortgage-backed securities, primarily
collateralized mortgage obligations. They are designated as held-to-maturity as
they are purchased with the intent and ability to hold to maturity. At December
31, 1999 and 1998, the amortized cost of investment securities held-to-maturity
was $48,302,000 and $50,065,000, and the fair value was $46,572,000 and
$50,473,000, respectively. The held-to-maturity portfolio had a weighted average
maturity of approximately 6 years at December 31 1999 and 3 years, 10 months at
December 31 1998. The weighted average tax-equivalent yield was 6.64 percent and
6.70 percent at December 31, 1999 and 1998. The increase in the weighted average
maturity is a function of rising rates, which caused the prepayments on the
mortgage-backed securities to slow. It is anticipated that interest rates will
continue to increase during 2000.
LOANS
QNB's primary function and responsibility is to accept deposits and to make
loans to meet the credit needs of the communities it serves. Loans are the most
significant component of earning assets. Inherent within the lending function is
the evaluation and acceptance of credit risk and interest rate risk along with
the opportunity cost of alternative deployment of funds. QNB manages credit risk
associated with its lending activities through portfolio diversification,
underwriting policies and procedures, and loan monitoring practices.
QNB has comprehensive policies and procedures that define and govern both
commercial and retail loan origination and management of risk. All loans are
underwritten in a manner that emphasizes the borrowers' capacity to pay. The
measurement of capacity to pay delineates the potential risk of non-payment or
default. The higher potential for default determines the need for and amount of
collateral required. QNB makes unsecured loans when the capacity to pay is
considered substantial. As capacity lessens, collateral is required to provide a
secondary source of repayment and to mitigate the risk of loss. Various policies
and procedures provide guidance to the lenders on such factors as amount, terms,
price, maturity and appropriate collateral levels. Each risk factor is
considered critical to assuring that QNB receives an adequate return for the
risk undertaken, and that the risk of loss is minimized.
QNB effectively manages the risk associated with commercial loans, which
generally have balances larger than retail loans, by having lenders work in
tandem with credit underwriting personnel. In addition, a Loan Committee and a
committee of the Board of Directors review loan requests, on a weekly basis,
that meet certain qualifications.
QNB's commercial lending activity is focused on small businesses within the
local community. Commercial and industrial loans represent commercial purpose
loans that are either secured by collateral other than real estate or unsecured.
Real estate commercial loans include commercial purpose loans collateralized at
least in part by commercial real estate. These loans may not be for the express
purpose of conducting commercial real estate transactions. Real estate
residential loans include loans secured by one-to-four family units. These loans
include home equity loans, loans to individuals for residential mortgages, and
commercial purpose loans. Substantially all originations of loans to individuals
for residential mortgages with maturities of 20 years or greater are sold in the
secondary market. Included in real estate residential loans at December 31, 1998
were $3,601,000 of residential mortgage loans held-for-sale. These loans were
carried at the lower of aggregate cost or market. There were no real estate
residential mortgage loans held-for-sale at December 31, 1999.
Loans, net of unearned income, decreased $2,679,000 to $173,764,000 at December
31, 1999. The decline in loans when comparing outstanding loans at December 31,
1999 and 1998 is a result of several factors including: increasing interest
rates which slowed residential mortgage and consumer loan originations, the sale
of several of QNB's commercial customers' businesses, and the increase in the
number of financial service companies competing for commercial loans. Also
contributing to the decline was the sale in 1999, of $3,601,000 of residential
mortgage loans classified as held for sale as of December 31, 1998.
The loan portfolio composition changed slightly from year-end 1998. Loans
collateralized by commercial and residential properties increased to 76.9
percent of the portfolio at December 31, 1999, from 74.5 percent of the
portfolio at December 31, 1998. Commercial and industrial loans
<PAGE>
p. 19
MANAGEMENT'S DISCUSSION AND ANALYSIS
<TABLE>
<CAPTION>
LOAN PORTFOLIO
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 1999 1998 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Commercial and industrial ...................................... $ 32,003 $ 35,003 $ 32,794 $ 22,973 $ 27,002
Agricultural ................................................... 1,935 3,446 2,845 2,828 2,451
Construction ................................................... 258 782 813 3,640 6,641
Real estate-commercial ......................................... 64,853 60,708 58,783 57,589 51,368
Real estate-residential ........................................ 68,945 71,052 67,621 66,203 61,339
Consumer ....................................................... 6,005 5,864 5,312 6,477 7,538
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans ................................................. 173,999 176,855 168,168 159,710 156,339
Less unearned income ........................................... 235 412 448 432 382
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans, net of unearned income ......................... $173,764 $ 76,443 $167,720 $159,278 $155,957
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
LOAN MATURITIES AND INTEREST SENSITIVITY
- ------------------------------------------------------------------------------------------------------------------------------------
Under 1-5 Over
December 31, 1999 1 Year Years 5 Years Total
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial and industrial ................................................. $ 13,335 $ 17,075 $ 1,593 $ 32,003
Agricultural .............................................................. 100 207 1,628 1,935
Construction .............................................................. 258 - - 258
Real estate-commercial .................................................... 7,822 11,025 46,006 64,853
Real estate-residential ................................................... 6,571 18,473 43,901 68,945
Consumer .................................................................. 2,199 3,729 77 6,005
- ------------------------------------------------------------------------------------------------------------------------------------
Total .................................................................. $ 30,285 $ 50,509 $ 93,205 $173,999
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Demand loans, loans having no stated schedule of repayment and no stated
maturity, are included in under one year.
The following shows the amount of loans due after one year that have fixed,
variable or adjustable interest rates at December 31, 1999:
Loans with fixed predetermined interest rates $86,901
Loans with variable or adjustable interest rates $56,813
<TABLE>
<CAPTION>
NON-PERFORMING ASSETS
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 1999 1998 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Loans past due 90 days or more not on non-accrual status
Commercial and industrial ...................................... - - $ 99 - $ 66
Construction ................................................... - - - - -
Real estate-commercial ......................................... - - - - 107
Real estate-residential ........................................ $ 33 $ 4 60 $ 162 96
Consumer ....................................................... 6 1 - 3 3
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans past due 90 days or more and accruing ............ 39 5 159 165 272
Loans accounted for on a non-accrual basis
Commercial and industrial ...................................... 54 9 25 43 120
Construction ................................................... - - - - 686
Real estate-commercial ......................................... 171 220 744 1,790 2,588
Real estate-residential ........................................ 259 277 440 867 1,084
Consumer ....................................................... - - - - 10
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-accrual loans ...................................... 484 506 1,209 2,700 4,488
Other real estate owned ........................................... 348 696 1,564 1,395 775
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-performing assets .................................. $871 $1,207 $2,932 $4,260 $5,535
- ------------------------------------------------------------------------------------------------------------------------------------
Total as a percent of total assets ................................ .25% .37% .96% 1.52% 2.01%
</TABLE>
<PAGE>
p. 20
MANAGEMENT'S DISCUSSION AND ANALYSIS
<TABLE>
<CAPTION>
ALLOWANCE FOR LOAN LOSS ALLOCATION
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 1999 1998 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
Percent Percent Percent Percent Percent
Gross Gross Gross Gross Gross
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at end of period applicable
to:
Commercial and industrial .... $ 684 18.4% $ 269 19.8% $ 205 19.5% $ 115 14.4% $ 792 17.3%
Agricultural ................. 31 1.1 14 2.0 13 1.7 13 1.8 13 1.6
Construction .................... 42 .1 3 .4 3 .5 34 2.3 43 4.2
Real estate-commercial .......... 902 37.3 262 34.3 354 34.9 643 36.1 363 32.9
Real estate-residential ......... 494 39.6 273 40.2 215 40.2 378 41.4 547 39.2
Consumer ........................ 64 3.5 33 3.3 37 3.2 39 4.0 44 4.8
Unallocated ..................... 979 2,097 1,843 1,363 582
- ------------------------------------------------------------------------------------------------------------------------------------
Total ...................... $3,196 100.0% $ 2,951 100.0% $ 2,670 100.0% $2,585 100.0% $2,384 100.0%
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Gross loans represent loans before unamortized net loan fees. Percent gross
loans lists the percentage of each loan type to total loans.
<TABLE>
<CAPTION>
ALLOWANCE FOR LOAN LOSSES
- ------------------------------------------------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Allowance for loan losses:
Balance, January 1 ........................................ $2,951 $2,670 $2,585 $2,384 $2,024
Charge-offs
Commercial and industrial .............................. 3 8 16 44 4
Construction ........................................... - - 10 - -
Real estate-commercial ................................. - 50 99 115 320
Real estate-residential ................................ 4 81 189 52 325
Consumer ............................................... 15 13 30 48 54
- ------------------------------------------------------------------------------------------------------------------------------------
Total charge-offs ...................................... 22 152 344 259 703
Recoveries
Commercial and industrial .............................. - 8 7 35 12
Construction ........................................... - - 1 - -
Real estate-commercial ................................. 8 6 - - 10
Real estate-residential ................................ 12 10 9 8 4
Consumer ............................................... 7 9 12 17 27
- ------------------------------------------------------------------------------------------------------------------------------------
Total recoveries ....................................... 27 33 29 60 53
- ------------------------------------------------------------------------------------------------------------------------------------
Net recoveries (charge-offs) .............................. 5 (119) (315) (199) (650)
Provision for loan losses ................................. 240 400 400 400 1,010
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31 ...................................... $3,196 $2,951 $2,670 $2,585 $2,384
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans:
Average ................................................ $174,912 $169,800 $161,096 $155,175 $151,839
Year-end ............................................... 173,764 176,443 167,720 159,278 155,957
Ratios:
Net (recoveries) charge-offs to:
Average loans .......................................... - .07% .20% .13% .43%
Loans at year-end ...................................... - .07 .19 .12 .42
Allowance for loan losses .............................. (.16)% 4.03 11.80 7.70 27.27
Provision for loan losses .............................. (2.08) 29.75 78.75 49.75 64.36
Allowance for loan losses to:
Average loans .......................................... 1.83% 1.74% 1.66% 1.67% 1.57%
Loans at year-end ...................................... 1.84 1.67 1.59 1.62 1.53
Non-performing loans ................................... 611.09 577.50 195.20 90.20 50.10
</TABLE>
<PAGE>
p. 21
MANAGEMENT'S DISCUSSION AND ANALYSIS
LOANS (continued)
decreased to 18.4 percent of the portfolio at year-end 1999 from 19.8 percent at
December 31, 1998. Consumer loans increased slightly from 3.3 percent at
year-end 1998 to 3.5 percent at December 31, 1999.
The commercial and industrial loan category, which had shown the largest amount
of growth over the past two years, was impacted the most, decreasing $3,000,000
or 8.6 percent to $32,003,000 at December 31, 1999. Prior to 1999 commercial and
industrial loans had increased 6.7 percent in 1998 and 42.8 percent in 1997.
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. Loans secured by commercial real estate increased by
$4,145,000 or 6.8 percent to $64,853,000 at December 31, 1999. QNB's commercial
loans are not considered to be concentrated, except those loans to real estate
developers and investors which account for $19,448,000 or 11.2 percent of the
loan portfolio at December 31, 1999. This is down significantly from the
$25,289,000 or 14.3 percent at December 31, 1998. Concentration is based upon
Standard Industrial Classification codes used for bank regulatory purposes and
is considered to be 10 percent or more of total loans. Diversification is
achieved through lending to various industries located within the market area.
This diversification is believed to reduce risk associated with changes in
economic conditions.
Residential real estate loans decreased by $2,107,000 or 3.0 percent to
$68,945,000 at December 31, 1999. Included in the balance as of December 31,
1998 were $3,601,000 in residential mortgages held-for-sale. These were sold
early in 1999. Rising interest rates during 1999 slowed the amount of mortgage
activity. There were no mortgages held-for-sale at December 31, 1999. Prior to
1999, residential mortgage loans had shown growth partially as a result of a
change in strategy with respect to selling loans in the secondary market. A plan
to accept a small percentage of quality loans that were nonconforming to Freddie
Mac standards and therefore are not salable to them also contributed to the
growth. These include loans that have excess land value, loans that exceed a
dollar threshold or loans where the debt to income ratio slightly exceeds
Freddie Mac's guidelines but where QNB has had an ongoing relationship with the
customer.
Aggressive fixed rate home equity loan promotions and pricing during the past
four years have also impacted the growth of loans secured by residential real
estate. The increase in home equity loans has had a negative impact on the
amount of consumer loans outstanding. Customers chose to benefit from the
competitive rate of home equity loans as well as the tax deductibility of the
interest by paying off other loans with home equity loans. Additionally, up
until 1998, consumer loans outstanding had declined as a result of the decision
made in 1995 to discontinue indirect vehicle lending through automobile dealers.
The increase in consumer loans in both 1999 and 1998 is primarily the result of
an increase in five-year automobile loans. QNB has priced these loans
aggressively to compete with other financial institutions and directly with
automobile dealers.
Management's primary focus during recent years has been asset quality and the
reduction of non-performing assets. With the achievement of this goal during
1997 and 1998, management's focus switched to loan and deposit growth. To help
achieve these goals QNB initiated a business development and calling program
encompassing lending personnel, branch personnel and executive management. The
focus of this program is to both develop new lending and deposit relationships
as well as strengthen existing relationships. This program is the first step in
developing a sales culture throughout the institution. The introduction of
Internet banking, the development of a centralized customer service center as
well as the anticipated opening of a branch in a new geographic market in 2000
are other strategies that will help achieve these goals.
NON-PERFORMING ASSETS
Non-performing assets include accruing loans past due 90 days or more,
non-accruing loans, restructured loans and other real estate owned. QNB
continues to reduce its level of non-performing assets. The chart below shows
the improvement in non-performing assets over the past five years. Total
non-performing assets were $871,000 at December 31, 1999, or .25 percent of
total assets. This represents a reduction of 27.8 percent from the December 31,
1998 balance of $1,207,000. Non-performing assets at December 31, 1998
represented .37 percent of total assets. The percentage of non-performing assets
at December 31, 1999 is at a historically low level for QNB. It is management's
goal to continue to reduce the level of non-performing assets in 2000 through
the sale of other real estate owned.
Non-accrual loans are those on which the accrual of interest has ceased.
Commercial loans are placed on non-accrual status immediately if, in the opinion
of management, collection is doubtful, or when principal or interest is past due
90 days or more and collateral is insufficient to protect principal and
interest. Interest accrued, but not collected at the date a loan is placed on
non-accrual status, is reversed and charged against interest income. Subsequent
cash receipts are applied either to the outstanding principal or recorded as
interest income, depending on management's assessment of ultimate collectibility
of principal and interest. Loans are returned to an accrual status when the
borrower's ability to make periodic principal and interest payments has returned
to normal (i.e. - brought current with respect to principal and interest, or
restructured) and the paying capacity of the borrower and/or the underlying
collateral is deemed sufficient to protect principal and interest. Consumer
loans are not automatically placed on non-accrual status when principal or
interest payments are 90 days past due, but in most instances are charged-off
when deemed uncollectible or after reaching 120 days past due.
[GRAPHIC]
In the printed version of the document, a line graph
appears which depicts the following plot points:
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
Non-performing Assets
(in thousands) $5,535 $4,260 $2,932 $1,207 $ 871
<PAGE>
p. 22
MANAGEMENT'S DISCUSSION AND ANALYSIS
NON-PERFORMING ASSETS (continued)
Included in the loan portfolio are loans on non-accrual status of $484,000 and
$506,000 at December 31, 1999 and 1998. If interest on non-accrual loans had
been accrued throughout the period, interest income for the years ended December
31, 1999, 1998 and 1997 would have increased approximately $55,000, $70,000 and
$154,000, respectively. The amount of interest income on these loans included in
net income in 1999, 1998 and 1997 was $21,000, $17,000 and $7,000. There were no
restructured loans as of December 31, 1999 or 1998, as defined in SFAS 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.
Other real estate owned totaled $348,000 at December 31, 1999 and $696,000 at
December 31, 1998. This real estate is recorded at the fair value of the
property less estimated costs to sell. At December 31, 1999, $244,000 of the
balance is under agreement of sale.
Loans not included in past due, non-accrual or restructured categories, but
where known information about possible credit problems causes management to be
uncertain as to the ability of the borrowers to comply with the present loan
repayment terms totaled $2,581,000 and $1,225,000 at December 31, 1999 and 1998,
respectively.
ALLOWANCE FOR LOAN LOSSES
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.
QNB utilizes a risk weighting system that assigns a risk code to every
commercial loan. This risk weighting system is supplemented with a program that
encourages account officers to identify potentially deteriorating loan
situations. The officer analysis program is used to complement the on-going
analysis of the loan portfolio performed during the loan review function. In
addition, QNB has a committee that meets quarterly to review the adequacy of the
allowance for loan losses based on the current and projected status of all
relevant factors pertaining to the loan portfolio. In addition, regulatory
authorities, as an integral part of their examinations, periodically review the
allowance for loan losses. They may require additions to the allowance based
upon their judgements using information available to them at the time of
examination.
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 effective interest rate, except
that all collateral-dependent loans are measured for impairment based on the
fair value of the collateral.
At December 31, 1999 and 1998, the recorded investment in loans for which
impairment has been recognized totaled $379,000 and $439,000, of which $310,000
and $430,000 required no valuation allowance. As of December 31, 1999 and 1998,
$69,000 and $9,000 of loans required a valuation allowance on the entire amount.
Most of the loans identified as impaired are collateral-dependent. For the years
ended December 31, 1999, 1998 and 1997, the average recorded investment in
impaired loans was approximately $323,000, $945,000 and $2,105,000. QNB
recognized $67,000, $133,000 and $86,000 of interest income on these loans in
1999, 1998 and 1997.
Net recoveries were $5,000 for 1999 compared to net charge-offs of $119,000 in
1998 and $315,000 in 1997. This level of charge-offs represents .07 percent of
average loans in 1998, compared with .20 percent in 1997. Gross charge-offs in
1998 were $152,000. Approximately $81,000 of these charge-offs relate to a loan
to one borrower. This loan was transferred into other real estate owned in 1998
and sold in 1999. The decline in net charge-offs in 1998 and the reporting of a
net recovery in 1999 is a function of the dramatic improvement in loan quality.
Non-performing loans, including delinquent loans, are at a historically low
level for QNB.
The allowance for loan losses was $3,196,000 at December 31, 1999, which
represents 1.84 percent of total loans, compared to $2,951,000 and 1.67 percent
of total loans at December 31, 1998. While the allowance is allocated to
specific loans or loan categories, the total allowance is considered available
for losses in the entire loan portfolio. While QNB believes that its allowance
is adequate to cover losses in the loan portfolio, inherent uncertainties remain
regarding future economic events and their potential impact on asset quality.
DEPOSITS
QNB primarily attracts deposits from within its market area by offering various
deposit products, including: demand deposits, interest-bearing demand accounts,
money market accounts, savings accounts and certificates of deposit.
Total deposits increased 2.5 percent to $286,166,000 at December 31, 1999. As
was the case in 1998, the increase was centered in time deposits, which
increased $10,505,000 or 8.3 percent between 1998 and 1999. The continued
popularity of the "Flex12" certificates of deposit as well as the promotion of a
competitive "No Penalty" 36-month time deposit were the impetus behind the
growth. 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. Total deposits increased 4.5 percent to $279,223,000 at
December 31, 1998, from $267,166,000 at year-end 1997. The increase was
primarily in time deposits, which increased $9,892,000 or 8.4 percent between
1997 and 1998. 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 this increase.
<PAGE>
p. 23
MANAGEMENT'S DISCUSSION AND ANALYSIS
<TABLE>
<CAPTION>
AVERAGE DEPOSITS BY MAJOR CLASSIFICATION
- ------------------------------------------------------------------------------------------------------------------------------------
1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
Balance Rate Balance Rate Balance Rate
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Non-interest-bearing deposits ...................... $ 35,783 - $ 33,679 - $ 30,225 -
Interest-bearing demand accounts ................... 45,339 1.06% 41,988 1.37% 40,262 1.75%
Money market accounts .............................. 30,684 2.58 32,981 2.79 33,218 2.86
Savings ............................................ 37,312 1.86 37,216 2.12 35,215 2.17
Time ............................................... 112,109 5.20 106,324 5.48 97,944 5.48
Time deposits of $100,000 or more .................. 23,289 5.33 19,502 5.73 16,502 5.86
- ------------------------------------------------------------------------------------------------------------------------------------
Total ......................................... $284,516 3.18% $271,690 3.40% $253,366 3.46%
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Three months or less ............................... $ 3,627 $ 3,204 $ 3,189
Over three months through six months ............... 2,859 3,610 3,396
Over six months through twelve months .............. 4,350 6,445 4,665
Over twelve months ................................. 9,550 4,318 4,452
- ------------------------------------------------------------------------------------------------------------------------------------
Total ......................................... $20,386 $17,577 $15,702
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
An analysis of the change in average deposits provides a more meaningful measure
of deposit change. Average total deposits increased 4.7 percent in 1999 and 7.2
percent in 1998. Average non-interest-bearing deposits increased 6.2 percent to
$35,783,000 in 1999. This followed an 11.4 percent increase in 1998.
Non-interest-bearing and interest bearing demand deposits are important sources
of funds for QNB because they are low cost. Average interest-bearing demand
accounts increased 8.0 percent in 1999 to $45,339,000 and 4.3 percent in 1998 to
$41,988,000. The increase in non-interest-bearing deposit accounts and
interest-bearing demand accounts is a result of a number of factors, including:
the successful results of the business development program, as well as the
addition of new customers resulting from the merger activity. QNB has been able
to capitalize on the frustration of some former CoreStates customers. Many of
these customers wanted to return to a community bank for personalized customer
service and reasonable fees.
Higher rates on time deposits as well as the flexibility of the "Flex12" account
have had a negative affect on both money market accounts and savings accounts.
Average money market accounts decreased 7.0 percent in 1999 to $30,684,000. QNB
will introduce a variable rate money market account that is tied to the 91-day
Treasury bill during the first quarter of 2000. This product is intended to be
competitive with brokerage money market products. Average savings accounts
increased slightly in 1999 to $37,312,000. This followed an increase of 5.7
percent between 1997 and 1998. The popularity of the "Youth Trek" children's
savings program contributed to the increase in total savings accounts during
1998. This program stresses the importance of saving money and uses the motto
"Your Future is Bright, When You Save For It." The program features are fun yet
educational and have been embraced by numerous children in the community. As of
December 31, 1999, there were 3,748 children participating in the program.
Average time deposits increased 7.6 percent in 1999 and 9.9 percent in 1998.
Average time deposits represent approximately 47.6 percent and 46.3 percent of
total average deposits for 1999 and 1998. As mentioned previously, the promotion
of the 36-month certificate of deposit in 1999 and the introduction of the
"Flex12" certificate of deposit in 1998 had a significant impact on the growth
in time deposits. To continue to attract and retain deposits, QNB will have to
be competitive with respect to rates and will have to continuously develop new
products that appeal to customers.
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 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 totaled $118,196,000 at December 31, 1999 and $93,860,000 at
December 31, 1998. These sources were adequate to meet seasonal deposit
withdrawals during 1999 and should be adequate to meet normal fluctuations in
loan demand and deposit withdrawals. Approximately $43,963,000 and $44,715,000
of available-for-sale securities at
<PAGE>
p. 24
MANAGEMENT'S DISCUSSION AND ANALYSIS
LIQUIDITY (continued)
December 31, 1999 and 1998 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 increased $5,332,000 to $19,352,000 at December 31, 1999. This
follows increases in 1998 and 1997 of $1,446,000 and $115,000. The large
increase in 1999 is a result of liquidity planning for potential Year 2000
concerns. Most of the increase was achieved through the reduction of Federal
funds sold. 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 $10,070,000 in cash flow in 1999, compared to $4,064,000 in 1998 and
$6,020,000 in 1997. Proceeds from the sale of residential mortgages in excess of
mortgage originations provided $3,627,000 of the total from operating activities
in 1999. Proceeds from the sale of student loans provided $2,261,000 in cash in
1999. The origination of residential mortgages held-for-sale in excess of the
proceeds from the sale of residential mortgages of $1,718,000 were a use of cash
in 1998. This cash was realized during the first quarter of 1999 with the sale
of $3,601,000 in mortgages that had been classified as held-for-sale as of
December 31, 1998. Proceeds from the sale of residential mortgages in excess of
originations of mortgages held-for-sale of $1,487,000 contributed to the
increase in cash provided by operating activities in 1997. Proceeds from the
sale of student loans in 1998 and 1997 provided $1,637,000 and $1,499,000 of
cash. Partially offsetting this inflow of cash in 1997 was an increase in
interest receivable and an increase in other assets, primarily the deposit
premium.
Net cash used by investing activities was $29,956,000 in 1999. The purchase of
investment securities exceeded the maturity, call and sale of securities by
$31,235,000 in 1999. The $25,000,000 wholesale funding transaction provided most
of the additional cash for the purchases. An increase in loans, excluding
residential mortgage originations, of $3,026,000 was also a use of cash during
1999. A decrease in Federal funds sold, as discussed above, and proceeds from
the sale of other real estate owned provided $4,869,000 and $412,000 of cash
during 1999. Net cash used by investing activities of $17,833,000 in 1998 was
primarily the result of loan growth. The net increase in loans was $8,771,000 in
1998. The purchase of investment securities exceeding the maturity, call or sale
of securities totaled $3,717,000 in 1998. An increase in Federal funds sold of
$2,847,000 and the purchase of single premium life insurance for $2,557,000 were
additional uses of cash. Proceeds from the sale of other real estate owned
provided $1,016,000 in cash during 1998. Net cash used by investing activities
of $27,157,000 in 1997 was primarily a result of the purchase of investment
securities exceeding the maturity, call or sale of securities, and loan growth.
Purchases of investment securities totaled over $51,000,000 while proceeds from
securities were only $31,595,000. The net increase in loans, excluding
residential mortgage originations, was over $12,000,000. A decrease in Federal
funds sold of $4,458,000 funded some of this activity in 1997.
Cash provided by financing activities was $25,218,000 during 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
$10,505,000 since December 31, 1998. An aggressive 36-month time deposit
promotion during the third and fourth quarters of 1999 stimulated most of the
growth. Time deposits over $100,000 accounted for $2,809,000 of the total
increase. These deposits tend to be short-term in nature and pay a higher rate
of interest. Non-interest bearing demand deposits and short-term borrowings,
primarily cash management accounts, decreased $3,573,000 and $5,566,000 in 1999.
Cash provided by financing activities of $15,215,000 in 1998 was primarily the
result of an increase in time deposits and repurchase agreements during the
year. Time deposits increased $9,892,000, while outstanding balances on
repurchase agreements increased $4,501,000. The popularity of the "Flex12"
certificate of deposit, as discussed previously, was the catalyst for the growth
in time deposits. A more competitive interest rate on the repurchase agreements
provided the impetus for the growth in this product in 1998. Cash provided by
financing activities of $21,252,000 in 1997 was a result of strong deposit
growth. Non-interest-bearing deposits increased $6,659,000 while
interest-bearing deposits increased $13,763,000. Increased marketing and
business development activities along with competitive rates and products
contributed to the growth in deposits. The purchase of $6,800,000 in deposits
also contributed to the increase in cash provided by financing activities during
1997.
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 December 31, 1999 was
$27,462,000 or 7.84 percent of total assets, compared to shareholders' equity of
$28,338,000 or 8.73 percent at December 31, 1998. At December 31, 1999,
shareholders' equity included a negative adjustment of $2,604,000 related to the
unrealized holding loss, net of taxes, on investment securities
available-for-sale, while shareholders' equity at December 31, 1998 included a
positive adjustment of $916,000. Without these adjustments, shareholders' equity
to total assets would have been 8.58 percent and 8.45 percent at December 31,
1999 and 1998, respectively. Rising interest rates, combined with the purchase
of some longer maturity investment securities, contributed to the swing from a
gain position at the end of 1998 to a loss position at the end of 1999.
<TABLE>
<CAPTION>
CAPITAL ANALYSIS
- ---------------------------------------------------------------------------------------
December 31, 1999 1998
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Tier I
Shareholders' equity ....................................... $ 27,462 $ 28,338
Net unrealized securities losses (gains) ................... 2,604 (916)
Net unrealized losses equity securities .................... (39) -
Intangible assets .......................................... (400) (451)
- ---------------------------------------------------------------------------------------
Total Tier I risk-based capital ............................ 29,627 26,971
Tier II
Allowable portion of the allowance
for loan losses .......................................... 2,438 2,411
- ---------------------------------------------------------------------------------------
Total risk-based capital ................................... $ 32,065 $ 29,382
- ---------------------------------------------------------------------------------------
Risk-weighted assets ....................................... $194,299 $192,344
- ---------------------------------------------------------------------------------------
Capital Ratios
- ---------------------------------------------------------------------------------------
December 31, 1999 1998
- ---------------------------------------------------------------------------------------
Tier I capital/risk-weighted assets ........................ 15.25% 14.02%
Total risk-based capital/risk-weighted assets .............. 16.50 15.28
Tier I capital/average assets (leverage ratio) ............. 8.38 8.58
</TABLE>
<PAGE>
p. 25
MANAGEMENT'S DISCUSSION AND ANALYSIS
<TABLE>
<CAPTION>
INTEREST RATE SENSITIVITY
- ------------------------------------------------------------------------------------------------------------------------------------
Within 3 to 6 6 months 1 to 3 3 to 5 After
December 31, 1999 3 months months to 1 year years years 5 years Total
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Assets
Interest-bearing balances ................ $ 281 - - - - - $ 281
Federal funds sold ....................... - - - - - - -
Investment securities* ................... 10,621 $ 3,030 $ 5,917 $ 26,105 $ 27,476 $ 76,709 149,858
Loans .................................... 32,293 9,161 17,453 51,529 40,301 23,027 173,764
- ------------------------------------------------------------------------------------------------------------------------------------
Total rate sensitive assets .............. 43,195 12,191 23,370 77,634 67,777 99,736 $323,903
Total cumulative assets .................. $43,195 $ 55,386 $ 78,756 $ 156,390 $ 224,167 $ 323,903
- ------------------------------------------------------------------------------------------------------------------------------------
Liabilities
Interest-bearing non-maturing deposits ... $12,703 $ 4,664 $ 9,215 $ 59,295 $ 15,000 $ 12,233 $113,110
Time deposits less than $100,000 ......... 20,507 13,714 23,015 55,876 4,039 9 117,160
Time deposits over $100,000 .............. 3,743 2,859 4,350 8,980 454 - 20,386
Short-term borrowings .................... 8,925 - - - - - 8,925
Federal Home Loan Bank advances .......... - 5,000 - 5,000 15,000 - 25,000
- ------------------------------------------------------------------------------------------------------------------------------------
Total rate sensitive liabilities ......... 45,878 26,237 36,580 129,151 34,493 12,242 $284,581
Total cumulative liabilities ............. $45,878 $ 72,115 $ 108,695 $ 237,846 $ 272,339 $ 284,581
- ------------------------------------------------------------------------------------------------------------------------------------
Gap during period ........................ $(2,683) $(14,046) $ (13,210) $ (51,517) $33,284 $ 87,494 $ 39,322
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative gap ........................... $(2,683) $(16,729) $ (29,939) $ (81,456) $ (48,172) $ 39,322
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative gap/earning assets ............ (.83)% (5.16)% (9.24)% (25.15)% (14.87)% 12.14%
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative gap ratio ..................... .94 .77 .72 .66 .82 1.14
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Excludes unrealized holding loss on available-for-sale securities of $3,947.
Average shareholders' equity and average total assets were $28,880,000 and
$344,543,000 during 1999, an increase of 9.7 percent and 11.0 percent compared
to 1998. The ratio of average total equity to average total assets declined
slightly to 8.38 percent for 1999, compared to 8.48 percent for 1998. The
decline in the ratio is a result of the growth in assets exceeding the retention
of capital, primarily as a result of the advance from the Federal Home Loan
Bank. Excluding this transaction average assets would have increased by
approximately 5.5 percent and the average total equity to average total assets
ratio would have been approximately 8.82 percent in 1999.
The Corporation is subject to restrictions on the payment of dividends to its
stockholders pursuant to the Pennsylvania Business Corporation Law as amended
(the "BCL"). The BCL operates generally to preclude dividend payments if the
effect thereof would render the Corporation insolvent, as defined. As a
practical matter, the Corporation's payment of dividends is contingent upon its
ability to obtain funding in the form of dividends from the Bank. Payment of
dividends to the Corporation by the Bank is subject to the restrictions set
forth in the National Bank Act. Generally, the National Bank Act would permit
the Bank to declare dividends in 2000 of approximately $3,782,000, plus an
amount equal to the net profits of the Bank in 2000 up to the date of any such
dividend declaration. QNB Corp. paid dividends to its shareholders of $.84 per
share in 1999, an increase of 16.7 percent from the $.72 per share paid in 1998.
QNB is subject to various regulatory capital requirements as issued by Federal
regulatory authorities. Regulatory capital is defined in terms of Tier I capital
(shareholders' equity excluding unrealized gains or losses on available-for-sale
securities, and intangible assets), Tier II capital which includes a portion of
the allowance for loan losses, and total capital (Tier I plus Tier 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 total risk-based capital and 4.00 percent for leverage. Under the
requirements, QNB has a Tier I capital ratio of 15.25 percent and 14.02 percent,
a total risk-based ratio of 16.50 percent and 15.28 percent, and a leverage
ratio of 8.38 percent and 8.58 percent at December 31, 1999 and 1998,
respectively. The increase in both the Tier I and total risk-based capital
ratios in light of the decline in the leverage ratio is a function of the fact
that most of the investments purchased with the borrowings from the Federal Home
Loan Bank have a zero risk weighting and therefore did not increase
risk-weighted assets.
The Federal Deposit Insurance Corporation Improvement Act of 1991 established
five capital level designations ranging from "well capitalized" to "critically
undercapitalized." At December 31, 1999 and 1998 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 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.
<PAGE>
p. 26
MANAGEMENT'S DISCUSSION AND ANALYSIS
INTEREST RATE SENSITIVITY (continued)
Gap analysis measures the difference between volumes of rate-sensitive assets
and liabilities and quantifies these repricing differences for various time
intervals. Static gap analysis describes interest rate sensitivity at a point in
time. However, it alone does not accurately measure the magnitude of changes in
net interest income since changes in interest rates do not impact all categories
of assets and liabilities equally or simultaneously. Interest rate sensitivity
analysis also involves assumptions on certain categories of assets and deposits.
For purposes of interest rate sensitivity analysis, assets and liabilities are
stated at their contractual maturity, estimated likely call date, or earliest
repricing opportunity. Mortgage-backed securities and amortizing loans are
scheduled based on their anticipated cash flow. Savings accounts, including
passbook, statement savings, money market, and interest-bearing demand accounts,
do not have a stated maturity or repricing term and can be withdrawn or repriced
at any time. This may impact QNB's margin if more expensive alternative sources
of deposits are required to fund loans or deposit runoff. Management projects
the repricing characteristics of these accounts based on historical performance
and assumptions that it believes reflect their rate sensitivity.
A positive gap results when the amount of interest rate sensitive assets exceeds
interest rate sensitive liabilities. A negative gap results when the amount of
interest rate sensitive liabilities exceeds interest rate sensitive assets.
QNB primarily focuses on the management of the one-year interest rate
sensitivity gap. At December 31, 1999, interest-earning assets scheduled to
mature or likely to be called, repriced or repaid in one year were $78,756,000.
Interest-sensitive liabilities scheduled to mature or reprice within one year
were $108,695,000. The one year cumulative gap, which reflects QNB's interest
sensitivity over a period of time, was a negative $29,939,000 at December 31,
1999. The cumulative one-year gap equals (9.24) 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 in 2000 is expected to remain near amounts reported in 1999. The
forecasted growth in assets and deposits is offset by an anticipated decline in
the net interest margin resulting from higher interest rates.
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 previously described.
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
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 36-month certificate of deposit
promotion during the third and fourth quarters of 1999 was partially in response
to the desire to reduce QNB's liability sensitive position.
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 December 31, 1999, QNB did not have any
hedging transactions in place such as interest rate swaps, caps or floors.
<PAGE>
p. 27
MANAGEMENT'S DISCUSSION AND ANALYSIS
The table below summarizes estimated changes in net interest income over a
twelve-month period, under various interest rate scenarios.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
Change in Interest Rates Net Interest Income Dollar Change Percent Change
- ----------------------------------------------------------------------------------------------------------------
December 31, 1999
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
+300 Basis Points $11,439 $(1,353) (10.58)%
+200 Basis Points 11,893 (899) (7.03)
+100 Basis Points 12,342 (450) (3.52)
FLAT RATE 12,792 - -
- -100 Basis Points 13,240 448 3.50
- -200 Basis Points 13,278 486 3.80
- -300 Basis Points 12,962 170 1.33
- ----------------------------------------------------------------------------------------------------------------
December 31, 1998
- ----------------------------------------------------------------------------------------------------------------
+300 Basis Points $11,651 $(1,180) (9.20)%
+200 Basis Points 12,079 (752) (5.86)
+100 Basis Points 12,507 (324) (2.53)
FLAT RATE 12,831 - -
- -100 Basis Points 13,018 187 1.46
- -200 Basis Points 12,940 109 .85
- -300 Basis Points 12,653 (178) (1.39)
</TABLE>
IMPACT OF YEAR 2000
All users of automated systems, including information systems, faced the Year
2000 challenge. Many computer systems process data using only two digits to
represent the year of a transaction, rather than storing the full four-digit
year. If renovations were not done to these systems, they may not operate
properly when the last two digits become "00," which occurred on January 1,
2000. The problem could affect a wide variety of automated systems, including
mainframe systems, personal computers, application processing systems, resource
allocation systems, communications systems, environmental systems, and other
information systems. These potential shortcomings could result in system failure
or miscalculations causing disruptions of operations.
While lingering concern exists about certain dates during Year 2000, the most
significant date, January 1, 2000, has passed without incident. As of the date
of this filing QNB has not experienced any significant Year 2000 problems
relating to its internal or third party computer systems. Nor has QNB
experienced any issues regarding the ability of commercial customers to meet
debt service as a result of Year 2000 issues. QNB will continue to monitor
systems for problems in the future, however the costs related to that process
are not expected to be significant. The total cost for Year 2000 compliance has
been under $100,000 to date.
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.
<PAGE>
p. 28
MANAGEMENT'S DISCUSSION AND ANALYSIS
<TABLE>
<CAPTION>
CONSOLIDATED QUARTERLY FINANCIAL DATA
- ------------------------------------------------------------------------------------------------------------------------------------
Quarters Ended 1999 Quarters Ended 1998
March 31 June 30 Sept. 30 Dec. 31 March 31 June 30 Sept. 30 Dec. 31
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income ...................... $ 5,513 $ 5,783 $ 6,011 $ 5,888 $5,455 $5,688 $5,582 $5,470
Interest expense ..................... 2,279 2,539 2,731 2,755 2,320 2,412 2,491 2,351
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income .................. 3,234 3,244 3,280 3,133 3,135 3,276 3,091 3,119
Provision for loan losses ............ 60 60 60 60 100 100 100 100
Non-interest income .................. 673 671 422 465 551 524 523 556
Non-interest expense ................. 2,417 2,460 2,419 2,611 2,206 2,413 2,323 2,713
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes ........... 1,430 1,395 1,223 927 1,380 1,287 1,191 862
Provision for income taxes ........... 386 341 281 166 403 346 327 196
- ------------------------------------------------------------------------------------------------------------------------------------
Net Income ........................... $ 1,044 $ 1,054 $ 942 $ 761 $ 977 $ 941 $ 864 $ 666
- ------------------------------------------------------------------------------------------------------------------------------------
Net Income Per Share - basic ......... $ .73 $ .73 $ .66 $ .53 $ .68 $ .66 $ .60 $ .47
- ------------------------------------------------------------------------------------------------------------------------------------
Net Income Per Share - diluted ....... $ .72 $ .73 $ .65 $ .53 $ .68 $ .65 $ .60 $ .46
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
SELECTED FINANCIAL AND OTHER DATA
- -----------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1999 1998 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Income and Expense
Interest income ........................................ $ 23,195 $22,195 $21,122 $ 19,816 $19,716
Interest expense ....................................... 10,304 9,574 9,066 8,413 8,337
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income .................................... 12,891 12,621 12,056 11,403 11,379
Provision for loan losses .............................. 240 400 400 400 1,010
Non-interest income .................................... 2,231 2,154 1,919 1,710 1,313
Non-interest expense ................................... 9,907 9,655 9,191 8,864 9,459
- -----------------------------------------------------------------------------------------------------------------------------------
Income before income taxes ............................. 4,975 4,720 4,384 3,849 2,223
Provision for income taxes ............................. 1,174 1,272 1,253 1,048 536
- -----------------------------------------------------------------------------------------------------------------------------------
Net income ............................................. $ 3,801 $ 3,448 $ 3,131 $ 2,801 $ 1,687
- -----------------------------------------------------------------------------------------------------------------------------------
Per Share Data
Net income - basic ..................................... $ 2.65 $ 2.41 $ 2.19 $ 1.97 $ 1.19
Net income - diluted ................................... 2.64 2.39 2.18 1.95 1.18
Book value ............................................. 19.11 19.77 18.05 15.97 14.66
Cash dividends ......................................... .84 .72 .64 .56 .50
Average common shares outstanding - basic .............. 1,435,848 1,431,724 1,427,981 1,424,112 1,421,378
Average common shares outstanding - diluted ............ 1,441,076 1,441,436 1,433,943 1,433,179 1,426,720
Balance Sheet at Year-end
Loans, net of unearned income .......................... $ 173,764 $ 176,443 $ 167,720 $ 159,278 $ 155,957
Investment securities available-for-sale ............... 97,609 70,088 75,920 52,779 55,380
Investment securities held-to-maturity ................. 48,302 50,065 40,400 42,699 42,515
Other earning assets ................................... 281 4,986 2,151 6,488 2,915
Total assets ........................................... 350,489 324,672 305,772 280,447 276,049
Deposits ............................................... 286,166 279,223 267,166 246,744 242,887
Borrowed funds ......................................... 33,925 14,491 10,342 8,675 10,099
Shareholders' equity ................................... 27,462 28,338 25,832 22,775 20,866
Selected Financial Ratios
Net interest margin .................................... 4.23% 4.51% 4.60% 4.58% 4.64%
Net income as a percentage of:
Average total assets ................................ 1.10 1.11 1.08 1.02 .63
Average shareholders' equity ........................ 13.16 13.10 13.11 12.94 8.46
Average shareholders' equity to average total assets ... 8.38 8.48 8.27 7.89 7.39
Dividend payout ratio .................................. 31.74 29.90 29.22 28.47 42.13
</TABLE>
<PAGE>
p. 29
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
(in thousands)
December 31, 1999 1998
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash and due from banks ..................................................... $ 19,352 $ 14,020
Federal funds sold .......................................................... - 4,869
Investment securities
Available-for-sale ..................................................... 97,609 70,088
Held-to-maturity (market value $46,572 and $50,473) .................... 48,302 50,065
Total loans, net of unearned income of $235 and $412 ........................ 173,764 176,443
Allowance for loan losses .............................................. (3,196) (2,951)
- ---------------------------------------------------------------------------------------------------------------
Net loans .......................................................... 170,568 173,492
Premises and equipment, net ................................................. 4,840 4,520
Other real estate owned ..................................................... 348 696
Accrued interest receivable ................................................. 2,045 1,900
Other assets ................................................................ 7,425 5,022
- ---------------------------------------------------------------------------------------------------------------
Total assets ................................................................ $350,489 $324,672
- ---------------------------------------------------------------------------------------------------------------
Liabilities
Deposits
Demand, non-interest-bearing ........................................... $ 35,510 $ 39,083
Interest-bearing demand accounts ....................................... 47,448 46,411
Money market accounts .................................................. 30,002 29,918
Savings ................................................................ 35,660 36,770
Time ................................................................... 117,160 109,464
Time over 100,000 ...................................................... 20,386 17,577
- ---------------------------------------------------------------------------------------------------------------
Total deposits ..................................................... 286,166 279,223
Short-term borrowings ....................................................... 8,925 14,491
Federal Home Loan Bank advances ............................................. 25,000 -
Accrued interest payable .................................................... 1,420 1,185
Other liabilities ........................................................... 1,516 1,435
- ---------------------------------------------------------------------------------------------------------------
Total liabilities ........................................................... 323,027 296,334
- ---------------------------------------------------------------------------------------------------------------
Commitments and contingencies
Shareholders' Equity
Common stock, par value $1.25 per share;
authorized 5,000,000 shares; issued 1,437,171 shares
and 1,433,066 shares ...................................................... 1,796 1,791
Surplus ..................................................................... 4,458 4,413
Retained earnings ........................................................... 23,812 21,218
Accumulated other comprehensive (loss) income ............................... (2,604) 916
- ---------------------------------------------------------------------------------------------------------------
Total shareholders' equity .................................................. 27,462 28,338
- ---------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity .................................. $350,489 $324,672
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE>
p. 30
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
(in thousands, except share data)
Year Ended December 31, 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest Income
Interest and fees on loans .................................................. $14,154 $14,568 $14,141
Interest and dividends on investment securities:
Taxable ................................................................ 7,815 6,671 6,227
Tax-exempt ............................................................. 1,034 638 532
Interest on Federal funds sold .............................................. 187 314 220
Interest on interest-bearing balances ....................................... 5 4 2
- ---------------------------------------------------------------------------------------------------------------------
Total interest income .............................................. 23,195 22,195 21,122
- ---------------------------------------------------------------------------------------------------------------------
Interest Expense
Interest on deposits
Interest-bearing demand accounts ....................................... 481 576 706
Money market accounts .................................................. 793 921 951
Savings ................................................................ 693 789 765
Time ................................................................... 5,830 5,824 5,365
Time over $100,000 ..................................................... 1,241 1,117 968
Interest on short-term borrowings ........................................... 378 347 311
Interest on Federal Home Loan Bank advances ................................. 888 - -
- ---------------------------------------------------------------------------------------------------------------------
Total interest expense ............................................. 10,304 9,574 9,066
- ---------------------------------------------------------------------------------------------------------------------
Net interest income ................................................ 12,891 12,621 12,056
Provision for loan losses ................................................... 240 400 400
- ---------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses ................ 12,651 12,221 11,656
- ---------------------------------------------------------------------------------------------------------------------
Non-Interest Income
Fees for services to customers .............................................. 1,202 952 964
Mortgage servicing fees ..................................................... 125 156 181
Net (loss) gain on investment securities available-for-sale ................. (139) 66 134
Net gain on sale of loans ................................................... 178 290 81
Other operating income ...................................................... 865 690 559
- ---------------------------------------------------------------------------------------------------------------------
Total non-interest income .......................................... 2,231 2,154 1,919
- ---------------------------------------------------------------------------------------------------------------------
Non-Interest Expense
Salaries and employee benefits .............................................. 5,696 5,561 5,411
Net occupancy expense ....................................................... 669 666 666
Furniture and equipment expense ............................................. 908 733 697
Marketing expense ........................................................... 379 371 303
Other real estate owned expense ............................................. 64 312 273
Other expense 2,191 2,012 1,841
- ---------------------------------------------------------------------------------------------------------------------
Total non-interest expense ......................................... 9,907 9,655 9,191
- ---------------------------------------------------------------------------------------------------------------------
Income before income taxes ............................................. 4,975 4,720 4,384
Provision for income taxes .................................................. 1,174 1,272 1,253
- ---------------------------------------------------------------------------------------------------------------------
Net Income ............................................................. $ 3,801 $ 3,448 $ 3,131
- ---------------------------------------------------------------------------------------------------------------------
Net Income Per Share - Basic ........................................... $ 2.65 $ 2.41 $ 2.19
- ---------------------------------------------------------------------------------------------------------------------
Net Income Per Share - Diluted ......................................... $ 2.64 $ 2.39 $ 2.18
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE>
p. 31
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
Accumulated
Other
Number Comprehensive Comprehensive Common Retained
(in thousands, except share data) of Shares Income Income Stock Surplus Earnings Total
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 1,425,951 - $ 112 $1,782 $4,296 $16,585 $22,775
- ------------------------------------------------------------------------------------------------------------------------------------
Net income ................................. - $3,131 - - - 3,131 3,131
Other comprehensive income, net of tax
Unrealized holding gains on
investment securities
available-for-sale .................. - 849 - - - - -
Reclassification adjustment for
gains included in net income ........ - (88)
------
Other comprehensive income ............ - 761 761 - - - 761
------
Comprehensive income ....................... $3,892
======
Cash dividends paid
($.64 per share) ...................... - - - - - (915) (915)
Stock issued - 401(k) plan ................. 311 - - - 9 - 9
Stock issued - Employee stock purchase plan 1,154 - - 2 34 - 36
Stock issued for options exercised ......... 3,824 - - 5 30 - 35
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 ................. 1,431,240 - 873 1,789 4,369 18,801 25,832
- ------------------------------------------------------------------------------------------------------------------------------------
Net income ................................. - $3,448 - - - 3,448 3,448
Other comprehensive income, net of tax
Unrealized holding gains on
investment securities
available-for-sale .................. - 87 - - - - -
Reclassification adjustment for
gains included in net income ........ - (44)
------
Other comprehensive income ............ - 43 43 - - - 43
------
Comprehensive income ....................... $3,491
======
Cash dividends paid
($.72 per share) ...................... - - - - - (1,031) (1,031)
Stock issue - Employee stock purchase plan . 1,226 - - 1 44 - 45
Stock issued for options exercised ......... 600 - - 1 - - 1
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 ................. 1,433,066 - 916 1,791 4,413 21,218 28,338
- ------------------------------------------------------------------------------------------------------------------------------------
Net income ................................. - $3,801 - - - 3,801 3,801
Other comprehensive income, net of tax
Unrealized holding (losses) on
investment securities
available-for-sale ................. - (3,612) - - - - -
Reclassification adjustment for
losses included in net income ....... - 92
------
Other comprehensive loss .............. - (3,520) (3,520) - - - (3,520)
------
Comprehensive income ....................... $ 281
======
Cash dividends paid
($.84 per share) - - - - - (1,207) (1,207)
Stock issue - Employee stock purchase plan . 1,493 - - 2 46 - 48
Stock issued for options exercised ......... 2,612 - - 3 (1) - 2
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 ................. 1,437,171 - $(2,604) $1,796 $4,458 $23,812 $27,462
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE>
p. 32
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(in thousands)
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating Activities
Net income ............................................................................... $ 3,801 $ 3,448 $ 3,131
Adjustments to reconcile net income to net cash provided by
operating activities
Provision for loan losses .............................................................. 240 400 400
Depreciation and amortization .......................................................... 655 505 491
Securities losses (gains) .............................................................. 139 (66) (134)
Net gain on sale of loans .............................................................. (178) (290) (81)
Proceeds from sales of residential mortgages ........................................... 11,027 13,603 2,539
Originations of residential mortgages held-for-sale .................................... (7,400) (15,321) (1,052)
Proceeds from sales of student loans ................................................... 2,261 1,637 1,499
Loss (gain) on disposal of premises and equipment ...................................... 1 (2) 1
Writedowns, net of (gains) losses on sales of other real estate owned .................. (64) 152 25
Deferred income tax provision .......................................................... (16) (164) (24)
Change in income taxes payable ......................................................... 3 28 (10)
Net (increase) decrease in accrued interest receivable ................................. (145) 107 (318)
Net amortization of premiums and discounts ............................................. 5 14 4
Net increase in accrued interest payable ............................................... 235 128 45
Increase in other assets ............................................................... (577) (181) (632)
Increase in other liabilities .......................................................... 81 60 134
Other 2 6 2
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities .............................................. 10,070 4,064 6,020
- ------------------------------------------------------------------------------------------------------------------------------------
Investing Activities
Proceeds from maturities and calls of investment securities
available-for-sale ..................................................................... 22,548 26,332 11,506
held-to-maturity ....................................................................... 12,603 16,578 6,170
Proceeds from sales of investment securities
available-for-sale ..................................................................... 17,976 6,227 13,919
Purchase of investment securities
available-for-sale ..................................................................... (73,453) (26,650) (47,310)
held-to-maturity ....................................................................... (10,909) (26,204) (3,844)
Net decrease (increase) in Federal funds sold ............................................ 4,869 (2,847) 4,458
Net increase in loans .................................................................... (3,026) (8,771) (12,284)
Net purchases of premises and equipment .................................................. (976) (957) (200)
Proceeds from the sale of other real estate owned ........................................ 412 1,016 428
Purchase of single premium life insurance ................................................ - (2,557) -
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities .................................................. (29,956) (17,833) (27,157)
- ------------------------------------------------------------------------------------------------------------------------------------
Financing Activities
Net (decrease) increase in non-interest-bearing deposits ................................. (3,573) 391 6,659
Net increase in interest-bearing deposits ................................................ 10,516 11,666 13,763
Net (decrease) increase in short-term borrowings ........................................ (5,566) 4,149 1,667
Proceeds from Federal Home Loan Bank advances ............................................ 25,000 - -
Cash dividends paid ...................................................................... (1,207) (1,031) (915)
Proceeds from issuance of common stock ................................................... 48 40 78
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities .............................................. 25,218 15,215 21,252
- ------------------------------------------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents .................................................. 5,332 1,446 115
Cash and cash equivalents at beginning of year ......................................... 14,020 12,574 12,459
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year ............................................... $ 19,352 $ 14,020 $ 12,574
- ------------------------------------------------------------------------------------------------------------------------------------
Supplemental Cash Flow Disclosures
Interest paid ............................................................................ $ 10,069 $ 9,446 $ 9,021
Income taxes paid ........................................................................ 1,170 1,395 1,280
Non-Cash Transactions
Transfer of loans to other real estate owned ........................................... - 300 622
Change in net unrealized holding gains or losses, net of taxes, on investment securities (3,520) 43 761
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE>
p. 33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
- --------
QNB Corp. through its subsidiary bank, The Quakertown National Bank, provides a
full range of banking services to individual and corporate customers through its
branch banking system located in Upper Bucks, Northern Montgomery and Southern
Lehigh Counties in Pennsylvania. QNB Corp. manages its business as a single
operating segment. The Quakertown National Bank is subject to competition from
other financial institutions and other financial services companies with respect
to these services and customers. QNB Corp. is also subject to the regulations of
certain federal agencies and undergoes periodic examinations by such regulatory
authorities.
Basis of Financial Statement Presentation
- -----------------------------------------
The consolidated financial statements include the accounts of QNB Corp. (the
"Corporation") and its wholly owned subsidiary, The Quakertown National Bank
(the "Bank"). The consolidated entity is referred to herein as "QNB". Such
statements have been prepared in accordance with generally accepted accounting
principles and general practice within the banking industry. All significant
intercompany accounts and transactions have been eliminated in the consolidated
financial statements. Tabular information other than share data is presented in
thousands of dollars. Certain previously reported amounts have been reclassified
to conform to current presentation standards. These reclassifications had no
effect on net income.
Use of Estimates
- ----------------
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from such estimates.
Investment Securities
- ---------------------
Investment securities that QNB has the positive intent and ability to hold to
maturity are classified as held-to-maturity securities and reported at amortized
cost. Debt and equity securities that are bought and held principally for the
purpose of selling in the near term are classified as trading securities and
reported at fair value, with unrealized gains and losses included in earnings.
Debt and equity securities not classified as either held-to-maturity securities
or trading securities are classified as available-for-sale securities and
reported at fair value, with unrealized gains and losses, net of tax, excluded
from earnings and reported as a separate component of shareholders' equity.
Management determines the appropriate classification of securities at the time
of purchase.
Available-for-sale securities include securities that management intends to
use as part of its asset/liability management strategy and that may be sold in
response to changes in market interest rates and related changes in the
securities' prepayment risk or to meet liquidity needs.
Premiums and discounts on debt securities are recognized in interest income
using a constant yield method. Gains and losses on sales of investment
securities are computed on the specific identification method and included in
non-interest income.
Loans
- -----
Loans are stated at the principal amount outstanding, net of deferred loan fees
and costs. Interest income is accrued on the principal amount outstanding. Loan
origination and commitment fees and related direct costs are deferred and
amortized to income over the term of the respective loan and loan commitment
period as a yield adjustment.
Loans held-for-sale primarily consist of residential mortgage loans and student
loans and are carried at the lower of aggregate cost or market value. Gains and
losses on residential mortgages held-for-sale are included in non-interest
income.
Non-Performing Assets
- ---------------------
Non-performing assets are comprised of non-accrual loans and other real estate
owned. Non-accrual loans are those on which the accrual of interest has ceased.
Commercial loans are placed on non-accrual status immediately if, in the opinion
of management, collection is doubtful, or when principal or interest is past due
90 days or more and collateral is insufficient to cover principal and interest.
Interest accrued, but not collected at the date a loan is placed on non-accrual
status, is reversed and charged against interest income. Subsequent cash
receipts are applied either to the outstanding principal or recorded as interest
income, depending on management's assessment of ultimate collectibility of
principal and interest. Loans are returned to an accrual status when the
borrower's ability to make periodic principal and interest payments has returned
to normal (i.e. - brought current with respect to principal or interest or
restructured) and the paying capacity of the borrower and/or the underlying
collateral is deemed sufficient to cover principal and interest. Consumer loans
are not automatically placed on non-accrual status when principal or interest
payments are 90 days past due, but in most instances, are charged-off when
deemed uncollectible or after reaching 120 days past due.
Other real estate owned is comprised of properties acquired through foreclosure
proceedings or acceptance of a deed in lieu of foreclosure. Other real estate
owned is recorded at the lower of the carrying value of the loan or the fair
value of the property. Loan losses arising from the acquisition of such
properties are charged against the allowance for loan losses. Holding expenses
related to the operation and maintenance of properties are expensed as incurred.
Gains and losses upon disposition are reflected in earnings as realized.
<PAGE>
p. 34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Allowance for Loan Losses
- -------------------------
The provision for loan losses charged to operating expense reflects the amount
deemed appropriate by management to produce an adequate reserve to meet the
present and foreseeable risk characteristics of the existing loan portfolio.
Management's judgement is based on the evaluation of individual loans, past
experience, the assessment of current economic conditions, and other relevant
factors. Loan losses are charged directly against the allowance for loan losses
and recoveries on previously charged-off loans are added to the allowance.
Significant estimates are made by management in determining the allowance for
loan losses. Consideration is given to a variety of factors in establishing
these estimates including: current economic conditions, diversification of the
loan portfolio, delinquency statistics, results of loan reviews, borrowers'
perceived financial and managerial strengths, the adequacy of underlying
collateral, if collateral dependent, or the present value of future cash flows.
Since the allowance for loan losses is dependent, to a great extent, on
conditions that may be beyond QNB's control, it is at least reasonably possible
that management's estimates of the allowance for loan losses and actual results
could differ in the near term.
In addition, regulatory authorities, as an integral part of their examinations,
periodically review the allowance for loan losses. They may require additions to
the allowance based upon their judgements about information available to them at
the time of examination.
Accounting for impairment in the performance of a loan is required when it is
probable that all amounts, including both principal and interest, will not be
collected in accordance with the loan agreement. Impaired loans are measured
based on the present value of expected future cash flows discounted at the
loans' effective interest rate or, as a practical expedient, at the loans'
observable market price or the fair value of the collateral if the loans are
collateral dependent. Impairment criteria are applied to the loan portfolio
exclusive of smaller homogeneous loans such as residential mortgage and consumer
loans which are evaluated collectively for impairment.
Transfers and Servicing of
Financial Assets
- --------------------------
QNB continues to carry servicing assets, relating to mortgage loans it has sold.
Such servicing assets are recorded based on the relative fair values of the
servicing assets and loans sold at the date of transfer. The servicing asset is
amortized in proportion to and over the period of net servicing income.
Servicing assets are assessed for impairment based on their fair value.
Premises and Equipment
- ----------------------
Premises and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization are calculated principally on an
accelerated or straight-line basis over the estimated useful lives of the assets
as follows: buildings--10 to 40 years, and equipment--3 to 10 years, or, in the
case of leasehold improvements, over the term of the lease. Expenditures for
maintenance and repairs are charged to operations as incurred. Gains or losses
upon disposition are reflected in earnings as realized.
Income Taxes
- ------------
QNB Corp. and its subsidiary file a consolidated Federal income tax return and
the amount of income tax expense or benefit is computed and allocated on a
separate return basis. To provide for income taxes, QNB uses the asset and
liability method under which deferred tax assets and liabilities are recognized
for the future tax consequences attributable to the difference between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect of a change in tax rates on deferred tax assets and liabilities is
recognized in income in the period which includes the enactment date.
Net Income Per Share
- --------------------
Basic earnings per share excludes any dilutive effects of options and is
computed by dividing net income by the weighted average number of shares
outstanding during the period. Diluted earnings per share gives effect to all
dilutive potential common shares that were outstanding during the period.
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
primary component of comprehensive income is the unrealized holding gains or
losses on available-for-sale investment securities. Comprehensive income must be
shown 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.
<PAGE>
p. 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Segment Reporting
- -----------------
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information" establishes standards for the reporting of information about
operating segments by public business enterprises in their annual and interim
reports issued to shareholders.
SFAS No. 131 requires that a public business enterprise report financial and
descriptive information including profit or loss, certain revenue and expense
items, and segment assets, about its reportable operating segments. Operating
segments are defined as components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision-maker in deciding how to allocate resources and in assessing
performance.
This Statement is a disclosure requirement and does not have an effect on QNB's
financial position or results of operations. QNB operates its business as a
single operating segment therefore no additional disclosure is required.
Derivative Instruments and
Hedging Activities
- --------------------------
In June 1998, the FASB issued Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS No. 133). This Statement standardizes
the accounting for derivative instruments, including certain derivative
instruments imbedded in other contracts, and those used for hedging activities,
by requiring that an entity recognize those items as assets or liabilities in
the statement of financial position and measure them at fair value. The
Statement categorizes derivatives used for hedging purposes as either fair value
hedges, cash flow hedges, foreign currency fair value hedges, foreign currency
cash flow hedges, or hedges of net investments in foreign operations. The
Statement generally provides for matching of gain or loss recognition on the
hedging instrument with the recognition of the changes in the fair value of the
hedged asset or liability that are attributable to the hedged risk, so long as
the hedge is effective. QNB has not yet determined the impact, if any, of this
Statement, including its provisions for the potential reclassifications of
investment securities on earnings, financial condition or equity.
Statement of Cash Flows
- -----------------------
Cash and cash equivalents for purposes of this statement consist of cash and due
from banks.
NOTE 2 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share (share and per share data not in thousands):
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------
1999 1998 1997
- ------------------------------------------------------------------------
Numerator for basic
and diluted earnings
<S> <C> <C> <C>
per share - net income $3,801 $3,448 $3,131
- -------------------------------------------------------------------------
Denominator for basic
earnings per share - weighted
average shares outstanding 1,435,848 1,431,724 1,427,981
Effect of dilutive securities -
employee stock options 5,228 9,712 5,962
- -------------------------------------------------------------------------
Denominator for diluted earnings
per share - adjusted weighted
average shares outstanding 1,441,076 1,441,436 1,433,943
- -------------------------------------------------------------------------
Earnings per share - basic $2.65 $2.41 $2.19
Earnings per share - diluted $2.64 $2.39 $2.18
- -------------------------------------------------------------------------
</TABLE>
Note 3 - CASH AND DUE FROM BANKS
Included in cash and due from banks are reserves in the form of deposits with
the Federal Reserve Bank of $225,000 and $2,212,000 to satisfy federal
regulatory requirements as of December 31, 1999 and 1998.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
p.36
NOTE 4 - INVESTMENT SECURITIES
Available-For-Sale
The amortized cost and estimated fair values of investment securities
available-for-sale at December 31, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 1999 1998
Gross Gross Gross Gross
Aggregate unrealized unrealized Aggregate unrealized unrealized
fair holding holding Amortized fair holding holding Amortized
value gains losses cost value gains losses cost
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury........................ $ 6,499 $ 10 $ 27 $ 6,516 $ 9,180 $ 162 - $ 9,018
U.S. Government agencies............. 40,396 2 1,479 41,873 47,356 620 $ 20 46,756
State and municipal securities....... 6,371 7 508 6,872 518 27 - 491
Mortgage-backed securities........... 37,485 2 1,894 39,377 9,338 53 9 9,294
Equity and other debt securities..... 6,858 306 366 6,918 3,696 554 - 3,142
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment securities
available-for-sale............... $ 97,609 $ 327 $ 4,274 $ 101,556 $70,088 $1,416 $ 29 $68,701
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The amortized cost and estimated fair value of securities available-for-sale by
contractual maturity at December 31, 1999 are shown in the following table.
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties. Mortgage-backed securities are shown separately due to the
amortization and prepayment of principal occurring throughout the life of these
instruments.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Aggregate
fair Amortized
December 31, 1999 value cost
- --------------------------------------------------------------------------------
<S> <C> <C>
Due in one year or less....................... $ 3,557 $ 3,550
Due after one year through five years......... 14,780 15,009
Due after five years through ten years........ 28,608 29,880
Due after ten years........................... 6,371 6,872
Mortgage-backed securities.................... 37,485 39,377
Equity securities............................. 6,808 6,868
- --------------------------------------------------------------------------------
Total securities available-for-sale $ 97,609 $101,556
- --------------------------------------------------------------------------------
Proceeds from sales of investment securities available-for-sale are as follows:
- ------------------------------------------------------------------------------------------
1999 1998 1997
- ------------------------------------------------------------------------------------------
Proceeds....................................... $17,976 $ 6,227 $13,919
Gross gains.................................... 192 106 181
Gross losses................................... 331 40 47
</TABLE>
Held-To-Maturity
The amortized cost and estimated fair values of investment securities
held-to-maturity at December 31, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 1999 1998
Gross Gross Gross Gross
unrealized unrealized Aggregate unrealized unrealized Aggregate
Amortized holding holding fair Amortized holding holding fair
cost gains losses value cost gains losses value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
State and municipal securities...... $ 19,346 $ 42 $ 469 $ 18,919 $14,668 $360 - $15,028
Mortgage-backed securities.......... 28,956 - 1,303 27,653 35,319 110 $ 62 35,367
Equity securities................... - - - - 78 - - 78
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment securities
held-to-maturity................. $ 48,302 $ 42 $1,772 $ 46,572 $50,065 $470 $ 62 $50,473
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
p.37
NOTES TO CONSOLIDATED FINIANCIAL STATEMENTS
The amortized cost and estimated fair values of securities held-to-maturity by
contractual maturity at December 31, 1999, are shown in the following table.
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without penalties.
Mortgage-backed securities are shown separately due to the amortization and
prepayment of principal occurring throughout the life of these instruments.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Aggregate
December 31, 1999 Amortized fair
cost value
- --------------------------------------------------------------------------------
<S> <C> <C>
Due in one year or less.................... $ 55 $ 56
Due after one year through five years..... 5,138 5,173
Due after five years through ten years.... 14,153 13,690
Due after ten years........................ - -
Mortgage-backed securities................. 28,956 27,653
- --------------------------------------------------------------------------------
Total securities held-to-maturity $ 48,302 $46,572
- --------------------------------------------------------------------------------
</TABLE>
There were no sales of investment securities classified as held-to-maturity
during 1999, 1998 or 1997. At December 31, 1999 and 1998, investment securities
totaling $43,963,000 and $44,715,000 were pledged as collateral for repurchase
agreements and deposits of public funds as required by law.
<TABLE>
<CAPTION>
NOTE 5 - LOANS
- --------------------------------------------------------------------------------
December 31, 1999 1998
- --------------------------------------------------------------------------------
<S> <C> <C>
Commercial and industrial.................$ 32,003 $ 35,003
Agricultural.............................. 1,935 3,446
Construction.............................. 258 782
Real estate-commercial.................... 64,853 60,708
Real estate-residential................... 68,945 71,052
Consumer.................................. 6,005 5,864
- --------------------------------------------------------------------------------
Total loans............................... 173,999 176,855
Less unearned income...................... 235 412
- --------------------------------------------------------------------------------
Total loans, net of unearned income.......$ 173,764 $ 176,443
- --------------------------------------------------------------------------------
</TABLE>
Real estate commercial loans include all loans collateralized at least in part
by commercial real estate. These loans may not be for the expressed purpose of
conducting commercial real estate transactions.
Included in real estate residential loans at December 31, 1998 are $3,601,000 of
residential mortgage loans held-for-sale. There were no residential mortgage
loans held-for-sale as of December 31, 1999. Included in consumer loans at
December 31, 1999 and 1998 were $1,235,000 and $1,282,000 of student loans
held-for-sale.
At December 31, 1999 and 1998, the recorded investment in loans for which
impairment has been recognized totaled $379,000 and $439,000 of which $310,000
and $430,000 required no valuation allowance. As of December 31, 1999 and 1998,
$69,000 and $9,000 of loans required a valuation allowance on the entire amount.
Most of the loans identified as impaired are collateral-dependent. For the years
ended December 31, 1999, 1998 and 1997, the average recorded investment in
impaired loans was approximately $323,000, $945,000 and $2,105,000,
respectively. QNB recognized $67,000, $133,000 and $86,000 of interest income on
these loans in 1999, 1998 and 1997, respectively.
Included within the loan portfolio are loans on non-accrual status of $484,000
and $506,000 at December 31, 1999 and 1998, respectively. If interest on
non-accrual loans had been accrued throughout the period, interest income for
the years ended December 31, 1999, 1998 and 1997, would have increased
approximately $55,000, $70,000 and $154,000, respectively. The amount of
interest income on these loans that was included in net income in 1999, 1998 and
1997 was $21,000, $17,000 and $7,000, respectively.
QNB generally lends in its trade area which is comprised of Quakertown and
surrounding communities. To a large extent QNB makes loans collateralized at
least in part by real estate. Its lending activities could be affected by
changes in the general economy, the regional economy, or real estate values.
QNB's commercial loans are not considered to be concentrated, except those loans
to real estate developers and investors which account for $19,448,000 or 11.2
percent of the loan portfolio at December 31, 1999. This is down from 14.3
percent at December 31, 1998. Concentration is based upon Standard Industrial
Classification codes used for bank regulatory purposes and is considered to be
10 percent or more of total loans.
NOTE 6 - ALLOWANCE FOR LOAN LOSES
Activity in the allowance for loan losses is shown below:
- --------------------------------------------------------------------------------
December 31, 1999 1998 1997
- --------------------------------------------------------------------------------
Balance at beginning of year....... $2,951 $2,670 $2,585
- --------------------------------------------------------------------------------
Charge-offs........................ (22) (152) (344)
Recoveries......................... 27 33 29
- --------------------------------------------------------------------------------
Net recoveries (charge-offs)....... 5 (119) (315)
Provision for loan losses.......... 240 400 400
- --------------------------------------------------------------------------------
Balance at end of year............. $3,196 $2,951 $2,670
- --------------------------------------------------------------------------------
NOTE 7 - PREMISES AND EQUIPMENT
Premises and equipment, stated at cost less accumulated depreciation and
amortization, are summarized below:
- --------------------------------------------------------------------------------
December 31, 1999 1998
- --------------------------------------------------------------------------------
Land and buildings........................ $ 4,837 $ 4,838
Furniture and equipment................... 5,649 5,535
Leasehold improvements 844 469
- --------------------------------------------------------------------------------
Book value................................ 11,330 10,842
Accumulated depreciation
and amortization....................... (6,490) (6,322)
- --------------------------------------------------------------------------------
Net book value $ 4,840 $ 4,520
- --------------------------------------------------------------------------------
Depreciation and amortization expense on premises and equipment amounted to
$655,000, $505,000 and $491,000, for the years ended December 31, 1999, 1998 and
1997, respectively.
Rental expense on operating leases amounted to approximately $139,000, $135,000
and $131,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
Most leases have options for renewal. Future minimum annual rental payments due
on non-cancelable leases for each of the years 2000 through 2004 are
approximately $151,000, $151,000, $116,000, $84,000 and $82,000, respectively.
<PAGE>
p.38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
NOTE 8 - MORTGAGE SERVICING RIGHTS
The changes in mortgage servicing assets are as follows:
- -------------------------------------------------------------------------------
December 31, 1999 1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, beginning of year........ $ 159 $ 57 $ 38
Additions......................... 112 137 25
Less: amortization................ (50) (35) (6)
- -------------------------------------------------------------------------------
Balance, end of year $221 $159 $ 57
- -------------------------------------------------------------------------------
</TABLE>
NOTE 9 - TIME DEPOSITE
The aggregate amount of time deposits including deposits in denominations of
$100,000 or more was $137,546,000 and $127,041,000 at December 31, 1999 and
1998, respectively. The scheduled maturities of time deposits as of December 31,
1999 for the years 2000 through 2004 and thereafter are approximately
$66,699,000, $16,216,000, $50,127,000, $4,278,000, $216,000 and $10,000,
respectively.
<TABLE>
<CAPTION>
NOTE 10 -SHORT TERM BORROWINGS
- -------------------------------------------------------------------------------
Securities
Sold under Other
Agreements Short-term
December 31, to Repurchase(a) Borrowings(b)
- -------------------------------------------------------------------------------
1999
<S> <C> <C>
Balance................................. $ 7,849 $1,076
Maximum indebtedness at any month end.. 14,359 1,165
Daily average indebtedness outstanding. 9,966 847
Average rate paid for the year......... 3.37% 5.04%
Average rate on period-end borrowings.. 3.35 4.74
- -------------------------------------------------------------------------------
1998
Balance................................ $ 14,243 $ 248
Maximum indebtedness at any month end.. 14,243 633
Daily average indebtedness outstanding. 8,842 626
Average rate paid for the year......... 3.54% 5.41%
Average rate on period-end borrowings.. 3.37 4.11
- -------------------------------------------------------------------------------
</TABLE>
(a) Securities sold under agreements to repurchase mature within 30 days. The
repurchase agreements were collateralized by U.S. Treasury and U.S. Government
agency securities with an amortized cost of $11,986,493 and $17,388,000 and a
fair value of $11,528,000 and $17,664,000 at December 31, 1999 and 1998,
respectively.
(b) Other short-term borrowings include Federal funds purchased, Treasury tax
and loan notes and Federal Reserve discount window borrowings.
NOTE 11 - FHLB ADVANCES
Under terms of its agreement with the FHLB, QNB maintains otherwise unencumbered
qualifying assets (principally 1-4 family residential mortgage loans and U.S.
Government and Agency notes, bonds, and mortgage-backed securities) in the
amount of at least as much as its advances from the FHLB. QNB's FHLB stock of
$3,062,000 and $937,000 at December 31, 1999 and 1998 is also pledged to secure
these advances.
At December 31, 1999 there were $25,000,000 in outstanding advances with a
weighted average rate of 5.15%. These advances mature in 2009 but are
convertible, whereby the FHLB has the option at a predetermined time to convert
the fixed interest rate to an adjustable rate tied to LIBOR. QNB then has the
option to prepay these advances if the FHLB converts the interest rate.
NOTE 12- INCOME TAXES
The components of the provision for income taxes are as follows:
- -------------------------------------------------------------------------------
Year Ended December 31, 1999 1998 1997
- -------------------------------------------------------------------------------
Federal income taxes
currently payable.................. $1,190 $ 1,436 $1,277
Deferred income taxes................ (16) (164) (24)
- -------------------------------------------------------------------------------
Net provision........................ $1,174 $ 1,272 $1,253
- -------------------------------------------------------------------------------
At December 31, 1999, 1998 and 1997, the tax effects of temporary differences
that represent the significant portion of deferred tax assets and liabilities
are as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Year Ended December 31, 1999 1998 1997
- -------------------------------------------------------------------------------
Deferred tax assets
<S> <C> <C> <C>
Allowance for loan losses..................... $ 843 $ 762 $ 666
Net unrealized holding losses on
investment securities available-for-sale.... 1,342 - -
Other real estate owned reserves.............. 41 86 35
Deferred compensation......................... 174 171 142
Deferred loan fees............................ 14 19 32
Other......................................... 46 42 5
- -------------------------------------------------------------------------------
Total deferred tax assets................... 2,460 1,080 880
Deferred tax liabilities
Net unrealized holding gains on
investment securities available-for-sale - 472 450
Other........................................ 125 102 66
- -------------------------------------------------------------------------------
Total deferred tax liabilities............. 125 574 516
- -------------------------------------------------------------------------------
Net deferred tax asset....................... $ 2,335 $ 506 $ 364
- --------------------------------------------------------------------------------
</TABLE>
The realizability of deferred tax assets is dependent upon a variety of factors,
including the generation of future taxable income, the existence of taxes paid
and recoverable, the reversal of deferred tax liabilities and tax planning
strategies. Based upon these and other factors, management believes it is more
likely than not that QNB will realize the benefits of these deferred tax assets.
The net deferred tax asset is included in other assets on the consolidated
balance sheet.
A reconciliation between the statutory and effective tax rate for net income was
as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Year Ended December 31, 1999 1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Provision at statutory rate.......... 1,692 $ 1,605 $1,491
Tax-exempt interest income........... (459) (323) (276)
Cash surrender value insurance....... (55) (20) (6)
Other................................ (4) 10 44
- -------------------------------------------------------------------------------
Total provision $ 1,174 $ 1,272 $1,253
- -------------------------------------------------------------------------------
</TABLE>
NOTE 13 - EMPLOYEE BENEFIT PLANS
QNB maintains a money purchase defined contribution plan which covers all
employees who meet the age and service requirements. QNB makes contributions to
the money purchase plan equivalent to 5 percent of total compensation (as
defined by the plan). QNB contributed and expensed $187,046, $201,776 and
$191,633 to this plan in 1999, 1998 and 1997, respectively. QNB also has a
401(k) profit sharing plan pursuant to the provisions of 401(k)
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of the Internal Revenue Code. The plan covers substantially all employees
who meet the age and service requirements. The 401(k) plan provides for elective
employee contributions up to 9 percent of compensation and a matching company
contribution limited to 3 percent. QNB makes contributions to the profit sharing
plan as directed by its Board of Directors. For 1999, 1998 and 1997, QNB
contributed and expensed $109,305, $106,567 and $114,000, respectively, to the
401(k) profit sharing plan.
QNB's Employee Stock Purchase Plan (the "Plan") offers eligible employees an
opportunity to purchase from the Corporation shares of QNB Corp. Common Stock at
a 5 percent discount from the lesser of fair market value on the first or last
day of each offering period (as defined by the plan). The Plan authorizes the
issuance of 25,000 shares. As of December 31, 1999 3,873 shares were issued
under the plan. In 1999, 670 shares were issued at $33.73 per share and 823
shares were issued at $27.55 per share. In 1998, 672 shares were issued at
$30.40 per share and 554 shares were issued at $35.15 per share. During 1997,
1,154 shares were issued at $29.69 per share. The Plan is considered
compensatory as defined by SFAS No. 123, "Accounting for Stock-Based
Compensation," and as such, a charge to earnings of approximately $2,000, $6,000
and $2,000 was recorded for the difference between the purchase price and the
fair value on the date of issue in 1999, 1998 and 1997, respectively.
NOTE 14 - STOCK OPTION PLAN
QNB has two stock option plans (the "1988 Plan" and the "1998 Plan")
administered by a committee which consists of three or more members of QNB's
Board of Directors. Both the 1988 and 1998 Plans provide for the granting of
either (i) Non-Qualified Stock Options (NQSOs) or (ii) Incentive Stock Options
(ISOs). The exercise price of an option is the fair market value of QNB's common
stock at the date of grant, as defined by the plans.
The 1988 Plan authorizes the issuance of 82,000 shares. These options expire 5
years from the date of grant. The 1988 Plan expired on February 23, 1998. No
additional shares may be granted under the 1988 Plan. As of December 31, 1999,
there were 73,050 options granted and 38,400 outstanding under the 1988 Plan.
The 1998 Plan authorizes the issuance of 100,000 shares. The time periods by
which any option is exercisable under the 1998 Plan is determined by the
Committee but shall not commence before the expiration of six months or continue
beyond the expiration of ten years after the date the option is awarded. As of
December 31, 1999, there were 17,600 options granted and outstanding under the
1998 Plan.
Changes in total options outstanding during 1999, 1998 and 1997, were as
follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Number Exercise Price Average
of Options per Option Exercise Price
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
December 31, 1996 28,750 $17.63-$29.50 $22.75
ISOs Exercised (6,150) 17.63- 29.50 18.09
ISOs Granted 10,000 32.00 32.00
- -------------------------------------------------------------------------------
December 31, 1997 32,600 19.50- 32.00 26.46
ISOs Exercised (1,200) 19.50 19.50
ISOs Granted 12,000 34.00 34.00
- -------------------------------------------------------------------------------
December 31, 1998 43,400 19.50- 34.00 28.74
ISOs Exercised (5,000) 19.50 19.50
ISOs Granted 17,600 29.00- 37.00 35.73
- -------------------------------------------------------------------------------
December 31, 1999 56,000 $21.00-$37.00 $31.76
- -------------------------------------------------------------------------------
</TABLE>
The following table summarizes information about stock options outstanding at
December 31, 1999:
<TABLE>
<CAPTION>
Exercisable
-------------------------
Average
Exercise Price Range Options Average Life(1) Exercise Price
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
$21.00- $29.50 19,200 1.97 $26.20
32.00- 37.00 36,800 5.18 34.66
- -------------------------------------------------------------------------------
Total 56,000 4.08 $31.76
- -------------------------------------------------------------------------------
</TABLE>
(1) Average contractual life remaining in years
SFAS No. 123 provides an alternative method of accounting for stock-based
compensation arrangements. This method is based on fair value of the stock-based
compensation determined by an option pricing model utilizing various assumptions
regarding the underlying attributes of the options and QNB's stock, rather than
the existing method of accounting for stock-based compensation which is provided
in Accounting Principles Board Opinion No. 25 (APB No. 25), "Accounting for
Stock Issued to Employees." The Financial Accounting Standards Board encourages
entities to adopt the fair value based method, but does not require the adoption
of this method.
QNB applies APB No. 25 and related Interpretations in accounting for the Plan.
The following table sets forth pro forma net income and earnings per share as if
compensation expense was recognized for stock options in accordance with SFAS
No. 123.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Reported Pro forma
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income: 1999........... $ 3,801 $ 3,670
1998........... 3,448 3,385
1997........... 3,131 3,082
Basic earnings per share: 1999........... $ 2.65 $ 2.56
1998........... 2.41 2.36
1997........... 2.19 2.16
Diluted earnings per share: 1999........... $ 2.64 $ 2.55
1998........... 2.39 2.35
1997........... 2.18 2.15
- -------------------------------------------------------------------------------
</TABLE>
For purposes of computing pro forma results QNB estimated the fair value of
stock options on the date of the grant using the Black-Scholes option pricing
model. The model requires the use of numerous assumptions, many of which are
highly subjective in nature. Therefore, the pro forma results are, of necessity,
estimates of results of operations as if compensation expense had been
recognized for all stock-based compensation plans and are not indicative of the
impact on future periods. The following assumptions were used in the option
pricing model for purposes of estimating pro forma results.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Year ended December 31, 1999 1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Risk free interest rate............. 5.04% 5.49% 6.29%
Dividend yield...................... 2.44% 2.50% 2.50%
Volatility.......................... 25.47 23.00 20.00
Expected life....................... 10 yrs. 5 yrs. 5 yrs.
- -------------------------------------------------------------------------------
</TABLE>
The weighted average fair value of options granted during 1999, 1998 and 1997
was $11.27, $7.94 and $7.34, respectively.
<PAGE>
P.40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - RELATED PARTY TRANSACTIONS
The following table presents activity in the amounts due from directors,
principal officers, and their related interests. All of these transactions were
made in the ordinary course of business on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with other persons. Also, they did not involve a more
than normal risk of collectibility or present any other unfavorable features.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
<S> <C>
Balance, December 31, 1998.................. $ 6,552
New loans................................... 10,084
Repayments and other changes................ 12,622
- -------------------------------------------------------------------------------
Balance, December 31, 1999.................. $ 4,014
- -------------------------------------------------------------------------------
</TABLE>
QNB allowed its directors to defer a portion of their compensation. The amount
of deferred compensation accrued as of December 31, 1999 and 1998, was $512,000
and $504,000, respectively.
During 1999, QNB entered into an agreement, approved by the Board of Directors,
with a director for the improvement and renovation of certain of the Bank's
offices. The total paid during 1999 was $333,000.
NOTE 16 - COMMITMENTS AND CONTINGENCIES
In the normal course of business there are various legal proceedings,
commitments, and contingent liabilities which are not reflected in the financial
statements. Management does not anticipate any material losses as a result of
these transactions and activities. They include, among other things, commitments
to extend credit and standby letters of credit. Outstanding standby letters of
credit amounted to $1,241,000 and $1,657,000 and commitments to extend credit
totaled $38,760,000 and $36,422,000 at December 31, 1999 and 1998, respectively.
The maximum exposure to credit loss, which represents the possibility of
sustaining a loss due to the failure of the other parties to a financial
instrument to perform according to the terms of the contract, is represented by
the contractual amount of these instruments. QNB uses the same lending standards
and policies in making credit commitments as it does for on-balance sheet
instruments. The activity is controlled through credit approvals, control
limits, and monitoring procedures.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require the payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. QNB evaluates each customer's
creditworthiness on a case-by-case basis.
Standby letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. The credit risk and collateral
policy involved in issuing letters of credit are essentially the same as those
involved in extending loan commitments.
The amount of collateral obtained for letters of credit and commitments to
extend credit is based on management's credit evaluation of the customer.
Collateral varies but may include real estate, accounts receivable, marketable
securities, pledged deposits, inventory or equipment.
NOTE 17 - OTHER COMPREHENSIVE INCOME
The tax effects allocated to each component of "Other Comprehensive Income" are
as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Tax
Before-Tax (Expense) Net-of-tax
Amount Benefit Amount
- -------------------------------------------------------------------------------
Year Ended December 31, 1999
- ----------------------------
<S> <C> <C> <C>
Unrealized gains on securities
Unrealized holding losses arising
during the period............... $(5,473) $1,861 $ (3,612)
Reclassification adjustment for
losses included in net income.. 139 (47) 92
- -------------------------------------------------------------------------------
Other comprehensive income.......... $(5,334) $1,814 $ (3,520)
- -------------------------------------------------------------------------------
Year Ended December 31, 1998
- ----------------------------
Unrealized gains on securities
Unrealized holding gains arising
during the period............... $ 131 $ (44) $ 87
Reclassification adjustment for
gains included in net income.... (66) 22 (44)
- -------------------------------------------------------------------------------
Other comprehensive income $ 65 $ (22) $ 43
- -------------------------------------------------------------------------------
Year Ended December 31, 1997
- ----------------------------
Unrealized gains on securities
Unrealized holding gains arising
during the period.............. $ 1,287 $ (438) $ 849
Reclassification adjustment for
gains included in net income... (134) 46 (88)
- -------------------------------------------------------------------------------
Other comprehensive income $ 1,153 $ (392) $ 761
- -------------------------------------------------------------------------------
</TABLE>
<PAGE>
p.41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
All entities are required to disclose estimated fair values for their financial
instruments, whether or not recognized in the balance sheet. For QNB, as for
most financial institutions, substantially all of its assets and liabilities are
considered financial instruments.
Estimates of fair value are made at a specific point in time, based upon, where
available, relevant market prices and information about the financial
instrument. Such estimates do not include any premium or discount that could
result from offering for sale at one time the Company's entire holdings of a
particular financial instrument. For a substantial portion of the Company's
financial instruments, no quoted market exists. Therefore, estimates of fair
value are necessarily based on a number of significant assumptions regarding the
amount and timing of estimated future cash flows which are discounted to reflect
varying degrees of risk. Given the uncertainties surrounding these assumptions,
the reported fair values may not represent actual values of financial
instruments that could have been realized as of year-end or that will be
realized in the future. Use of different assumptions or methodologies is likely
to result in significantly different fair value estimates.
The fair value of non-interest bearing demand deposits, interest-bearing demand
accounts, money market accounts and savings accounts is equal to the carrying
amount because these deposits have no stated maturity. This approach to
estimating fair value excludes the significant benefit that results from the
low-cost funding provided by such deposit liabilities, as compared to
alternative sources of funding. As a consequence, the amounts disclosed may
distort the actual fair value of a banking organization that is a going concern.
The estimated fair values and carrying amounts are summarized as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
Estimated Carrying Estimated Carrying
Fair Value Amount Fair Value Amount
- ------------------------------------------------------------------------------------------------------------------------------------
Financial Assets
<S> <C> <C> <C> <C>
Cash and due from banks...................... $ 19,352 $ 19,352 $ 14,020 $14,020
Federal funds sold........................... - - 4,869 4,869
Investment securities available-for-sale..... 97,609 97,609 70,088 70,088
Investment securities held-to-maturity....... 46,572 48,302 50,473 50,065
Net loans.................................... 171,286 170,568 179,015 173,492
Accrued interest receivable.................. 2,045 2,045 1,900 1,900
Financial Liabilities
Deposits with no stated maturities........... 148,620 148,620 152,182 152,182
Deposits with stated maturities.............. 136,822 137,546 128,735 127,041
Short-term borrowings........................ 8,925 8,925 14,490 14,491
Federal Home Loan Bank advances.............. 24,556 25,000 - -
Accrued interest payable..................... 1,420 1,420 1,185 1,185
</TABLE>
The following methods and assumptions were used to estimate the fair value of
each major classification of financial instruments at December 31, 1999 and
1998.
Cash and due from banks, Federal funds sold, accrued interest receivable and
accrued interest payable:
Current carrying amounts approximate estimated fair value.
Investment securities:
Current quoted market prices were used to determine fair value.
Loans:
Fair values were estimated using the present value of the estimated cash flows,
using interest rates currently being offered for loans with similar terms to
borrowers of similar credit quality.
Deposit liabilities:
The fair value of deposits with no stated maturity (e.g. demand deposits,
interest-bearing demand accounts, money market accounts and savings accounts)
are by definition, equal to the amount payable on demand at the reporting date
(i.e. their carrying amounts). Deposits with a stated maturity (time deposits)
have been valued using the present value of cash flows discounted at rates
approximating the current market for similar deposits.
Short-term borrowings and Federal Home Loan Bank advances:
Short-term borrowings and advances from the Federal Home Loan Bank have been
valued using the present value of cash flows discounted at rates approximating
the current market for similar liabilities.
Off-balance-sheet instruments:
Off-balance-sheet instruments are primarily comprised of loan commitments which
are generally priced at market at the time of funding. Fees on commitments to
extend credit and standby letters of credit are deemed to be immaterial and
these instruments are expected to be settled at face value or expire unused. It
is impractical to assign any fair value to these instruments.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 - PARENT COMPANY FINANCIAL INFORMATION
Condensed financial statements of QNB Corp. only:
<TABLE>
<CAPTION>
Balance Sheets
- -------------------------------------------------------------------------------
December 31, 1999 1998
- -------------------------------------------------------------------------------
Assets
<S> <C> <C>
Cash and due from banks................... $ 20 $ 97
Investment securities available-for-sale.. 2,656 2,696
Investment in subsidiary.................. 24,812 25,706
Other assets.............................. 20 27
- -------------------------------------------------------------------------------
Total assets.............................. $27,508 $28,526
- -------------------------------------------------------------------------------
Liabilities
Other liabilities......................... $ 46 $ 188
Shareholders' equity
Common stock ............................. 1,796 1,791
Surplus................................... 4,458 4,413
Retained earnings......................... 23,812 21,218
Accumulated other comprehensive income.... (2,604) 916
- -------------------------------------------------------------------------------
Total liabilities and shareholders' equity $27,508 $ 28,526
- -------------------------------------------------------------------------------
</TABLE>
Statements of Income
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Year Ended December 31, 1999 1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Dividends from subsidiary....... $1,506 $1,911 $1,664
Interest and dividend income.... 78 56 31
Securities gains................ 117 39 159
Other income.................... 4 - 1
- -------------------------------------------------------------------------------
Total income................. 1,705 2,006 1,855
Expenses..................... 145 121 106
- -------------------------------------------------------------------------------
Income before applicable income
taxes and equity in undistributed
income of subsidiary....... 1,560 1,885 1,749
Income taxes (benefit).......... - (22) 22
- -------------------------------------------------------------------------------
Income before equity in undistributed
income of subsidiary......... 1,560 1,907 1,727
Equity in undistributed
income of subsidiary......... 2,241 1,541 1,404
- -------------------------------------------------------------------------------
Net income................... $3,801 $3,448 $3,131
- -------------------------------------------------------------------------------
</TABLE>
Statements of Cash Flows
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1999 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------------
Operating Activities
<S> <C> <C> <C>
Net income ......................................................................... $ 3,801 $ 3,448 $ 3,131
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed income from subsidiary .............................. (2,241) (1,541) (1,404)
Securities gain.............................................................. (117) (39) (159)
Decrease (increase) in other assets.............................................. 46 (46) 5
Increase (decrease) in other liabilities..................................... 46 (30) 20
Other........................................................................ - 6 3
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities....................................... 1,535 1,798 1,596
- -----------------------------------------------------------------------------------------------------------------------------------
Investing Activities
Purchase of investment securities................................................... (1,200) (1,044) (1,126)
Proceeds from sale of investment securities......................................... 747 205 488
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (453) (839) (638)
- ------------------------------------------------------------------------------------------------------------------------------------
Financing Activities
Cash dividends paid................................................................. (1,207) (1,031) (915)
Stock issue......................................................................... 48 40 78
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used by financing activities (1,159) (991) (837)
- ------------------------------------------------------------------------------------------------------------------------------------
(Decrease) increase in cash and cash equivalents................................ (77) (32) 121
Cash and cash equivalents at beginning of year.................................. 97 129 8
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 20 $ 97 $ 129
- ------------------------------------------------------------------------------------------------------------------------------------
Supplemental Cash Flow Disclosure
Non-Cash Transactions
Change in net unrealized holding gains or losses, net of taxes on investment securities $ (404) $ (103) $ 320
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
p.43
NOTE 20 - REGULATORY RESTRICTIONS
Dividends payable by the Corporation and the Bank are subject to various
limitations imposed by statutes, regulations and policies adopted by bank
regulatory agencies. Under current regulations regarding dividend availability,
the Bank may declare dividends in 2000 to the Corporation totaling $3,782,000,
plus additional amounts equal to the net profit earned by the Bank for the
period from January 1, 2000, through the date of declaration, less dividends
previously declared in 2000.
Both the Corporation and the Bank are subject to regulatory capital requirements
administered by Federal banking agencies. Failure to meet minimum capital
requirements can initiate actions by regulators that could have an effect on the
financial statements. Under the framework for prompt corrective action, both the
Corporation and the Bank must meet capital guidelines that involve quantitative
measures of their assets, liabilities, and certain off-balance-sheet items. The
capital amounts and classification are also subject to qualitative judgements by
the regulators. Management believes, as of December 31, 1999, that both the
Corporation and the Bank meet all capital adequacy requirements to which it is
subject.
As of the most recent notification, the Federal Reserve Bank and the Comptroller
of the Currency considered the Corporation and the Bank to be "well capitalized"
under the regulatory framework. There are no conditions or events since that
notification that management believes have changed the classification. To be
categorized as well capitalized, the Corporation and the Bank must maintain
minimum ratios set forth in the table below. The Corporation and the Bank's
actual capital amounts and ratios are presented below:
<TABLE>
<CAPTION>
Capital Levels
- -----------------------------------------------------------------------------------------------------------------------------------
Actual Adequately Capitalized Well Capitalized
As of December 31, 1999 Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------------------------------------------
Total risk-based capital (to risk weighted assets):(1)
<S> <C> <C> <C> <C> <C> <C>
Consolidated...................................... $ 32,065 16.50% $ 15,544 8.00% $ 19,430 10.00%
Bank.............................................. 29,382 15.33 15,330 8.00 19,163 10.00
Tier I capital (to risk weighted assets):(1)
Consolidated...................................... 29,627 15.25 7,772 4.00 11,658 6.00
Bank.............................................. 26,977 14.08 7,665 4.00 11,498 6.00
Tier I capital (to average assets):(1)
Consolidated...................................... 29,627 8.38 14,145 4.00 17,681 5.00
Bank.............................................. 26,977 7.69 14,036 4.00 17,545 5.00
- -----------------------------------------------------------------------------------------------------------------------------------
Capital Levels
- -----------------------------------------------------------------------------------------------------------------------------------
Actual Adequately Capitalized Well Capitalized
As of December 31, 1998 Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------------------------------------------
Total risk-based capital (to risk weighted assets):(1)
Consolidated...................................... $ 29,382 15.28% $ 15,388 8.00% $ 19,234 10.00%
Bank.............................................. 27,069 14.24 15,211 8.00 19,014 10.00
Tier I capital (to risk weighted assets):(1)
Consolidated...................................... 26,971 14.02 7,694 4.00 11,541 6.00
Bank.............................................. 24,685 12.98 7,605 4.00 11,408 6.00
Tier I capital (to average assets):(1)
Consolidated...................................... 26,971 8.58 12,575 4.00 15,719 5.00
Bank.............................................. 24,685 7.91 12,484 4.00 15,606 5.00
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) As defined by the regulators
<PAGE>
p.44
{LOGO}
INDEPENDENT AUDITORS REPORT
To the Board of Directors and Shareholders of QNB Corp:
We have audited the accompanying consolidated balance sheets of QNB Corp. and
subsidiary as of December 31, 1999 and 1998, and the related consolidated
statements of income, shareholders' equity, and cash flows for each of the years
in the three-year period ended December 31, 1999. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of QNB Corp. and
subsidiary as of December 31, 1999 and 1998, and the results of their operations
and their cash flows for each of the years in the three-year period ended
December 31, 1999 in conformity with generally accepted accounting principles.
/s/KPMG LLP
- ----------------
January 21, 2000
CORPORATE INFORMATION
ANNUAL MEETING
The Annual Meeting of Shareholders of QNB Corp. will be held at the offices of
The Quakertown National Bank, 320 West Broad Street, Quakertown, PA on May 16,
2000, at 11:00 a.m.
MARKET MAKERS
As of December 31, 1999, the following firms made a market in QNB Corp. common
stock:
Legg Mason Wood Walker, Inc. Ryan, Beck & Company
Allentown, PA 18105 Shrewsbury, NJ 07702
First Union Securities
Quakertown, PA 18951
TRANFER AGENT
Registrar and Transfer Company
10 Commerce Drive
Cranford, NJ 07016-3572
(800) 368-5948
FORM 10-K
A copy of QNB Corp.'s Annual Report on Form 10-K, as filed with
the Securities and Exchange Commission, is available, without charge to
shareholders, by writing L. Jane Mann, QNB Corp., P.O. Box 9005, Quakertown, PA
18951-9005.
The Annual Report and other Company reports are also filed electronically
through the Electronic Data Gathering, Analysis, and Retrieval System ("EDGAR")
which performs automated collection, validation, indexing, acceptance, and
forwarding of submissions to the Securities and Exchange Commission (SEC) and is
accessible by the public using the Internet at http://www.sec.gov./edgarhp.htm.
AUDITORS
KPMG LLP
1600 Market Street
Philadelphia, PA 19103
STOCK IMFORMATION
QNB Corp. common stock is traded in the over-the-counter market. Quotations
for QNB Corp. common stock appear in the pink sheets
published by the National Quotations Bureau, Inc.
The following table sets forth representative high and low bid and ask stock
prices for QNB Corp. common stock on a quarterly basis during 1999 and 1998:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Cash
High Low Dividend
Bid Ask Bid Ask Per Share
- -------------------------------------------------------------------------------
1999
<S> <C> <C> <C> <C> <C>
First Quarter $ 37 1/2 $ 42 $ 37 $ 41 $.21
Second Quarter 37 1/4 40 32 35 .21
Third Quarter 33 1/4 35 29 1/2 32 .21
Fourth Quarter 29 1/2 32 1/2 29 30 .21
1998
First Quarter $ 32 $ 34 $ 32 $ 34 $.18
Second Quarter 37 39 32 34 .18
Third Quarter 37 39 37 39 .18
Fourth Quarter 37 42 37 39 .18
- -------------------------------------------------------------------------------
</TABLE>
DIRECT DEPOSIT OF DIVIDENDS
Shareholders of record may elect to have dividends deposited directly to a
checking or savings account at their financial institution. For additional
information about Direct Deposit of Dividends, please write to: L. Jane Mann,
QNB Corp., P.O. Box 9005, Quakertown, PA 18951-9005.
<PAGE>
P.45
DIRECTORS , OFFICERS & LOCATIONS
DIRECTORS OF QNB CORP. AND
THE QUAKERTOWN NATIONAL BANK
Norman L. Baringer
Thomas J. Bisko
Kenneth F. Brown, Jr.
Dennis Helf
Donald T. Knauss
G. Arden Link*
Charles M. Meredith, III
Gary S. Parzych
Henry L. Rosenberger
Edgar L. Stauffer
* Director of The Quakertown National Bank only.
OFFICERS OF QNB CORP.
Thomas J. Bisko, President/Treasurer/CEO
Robert C. Werner, Vice President
Bret H. Krevolin, Chief Accounting Officer
Charles M. Meredith, III, Secretary
L. Jane Mann, Assistant Secretary
EXECUTIVE MANAGEMENT
OF THE QUAKERTOWN NATIONAL BANK
Thomas J. Bisko, President/Chief Executive Officer
Robert C. Werner, Executive Vice President/Chief Operating Officer
Bret H. Krevolin, Executive Vice President/Chief Financial Officer/Cashier
Bryan S. Lebo, Senior Vice President, Senior Lending Officer
Mary Ann Smith, Senior Vice President/Chief Information Officer
OFFICERS OF THE QUAKERTOWN NATIONAL BANK
Mary A. Ackerman, Technical Services Officer
Stephen W. Bauder, Assistant Vice President, Commercial Lending
Robert D. Beck, Vice President, Information Technology
Barbara A. Crafton, Mortgage Loan Originator
Jane S. Cygan, Loan Origination Officer
Walter C. Derr, Senior Vice President, Commercial Lending
Paul T. Dotzman, Assistant Vice President, Commercial Lending
Michael J. Fina, Esq., Vice President/Special Assets Officer
Lynn C. Geesaman, Assistant Vice President, Loan Services
Joseph C. Giacini, Programmer/Analyst, Technical Operations Supervisor
Heather J. Gossler, Vice President, Branch Administration
Linda A. Grawe, Vice President, Retail Lending
Scott W. Groner, Technical Services Director
Thomas S. Hartman, Credit Department Manager
Patrick D. Iampietro, Controller
Shari L. Jarrell, Loan Services Officer
Deborah E. Keller, Banking Officer, IRA/Savings
Carl P. Kessler, Assistant Vice President, Security/Compliance
Thomas R. Klee, Assistant Vice President, Commercial Lending
Christine S. Knerr, Banking Officer, Electronic Banking
Stacy A. Moyer, Human Resources Administrator
Ray C. Myers, Banking Officer
Scott G. Orzehoski, Vice President, Commercial Lending
Lisa A. Otery, Banking Officer, Deposit Services
David W. Quinn, Assistant Vice President/Operations Analyst
Shirley A. Rhodes, Assistant Cashier, General Ledger
Brian K. Schaffer, Marketing Director
Maryann S. Thompson, Commercial Documentation Supervisor
Robert S. Wehrheim, Facilities Director
Cameron B. Wentzel, Retail Loan Officer/Supervisor
Robert L. Wieand, Vice President, Commercial Lending
BRANCH LOCATIONS
DOWNTOWN OFFICE
3rd & West Broad Streets, Quakertown
Carol J. Schroding, Assistant Vice President/Branch Manager
Denise R. Kee, Banking Officer
COUNTRY SQUARE OFFICE
Country Square Shopping Center, Quakertown
Sharon L. Rotenberger, Assistant Vice President/Branch Manager
Doreen L. Little, Banking Officer
DUBLIN VILLAGE OFFICE
Dublin Village Plaza, Dublin
April B. Donahue, Branch Manager
COOPERSBURG OFFICE
Route 309, Coopersburg
Jeanette M. Shurow, Branch Manager
PENNSBURG OFFICE
Pennsburg Square Shopping Center, Pennsburg
Brian L. Heilman, Branch Manager
PERKASIE OFFICE
6th & Chestnut Streets, Perkasie
Deborah K. McDonald, Branch Manager
QNB-ONLINE INTERNET BANKING
www.QNB.com
ACCOUNT ACCESS 24-HOUR TELEPHONE BANKING
215-538-5760 or 800-491-9070
EXHIBIT 21.1
Subsidiaries of the Registrant
The Quakertown National Bank, incorporated in Pennsylvania.
EXHIBIT 23.1
Consent of KPMG LLP
The Board of Directors
QNB Corp.
We consent to incorporation by reference in the registration statements (No.
33-79802, No. 333-16627, and No. 333-91201) on Form S-8 of QNB Corp. of our
report dated January 21, 2000, relating to the consolidated balance sheets of
QNB Corp. and subsidiary as of December 31, 1999 and 1998, and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the years in the three-year period ended December 31, 1999, which report
appears in the December 31, 1999 annual report on Form 10-K of QNB Corp.
/s/ KPMG LLP
- --------------------------
March 30, 2000
Philadelphia, Pennsylvania
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 19,071
<INT-BEARING-DEPOSITS> 281
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 97,609
<INVESTMENTS-CARRYING> 48,302
<INVESTMENTS-MARKET> 46,572
<LOANS> 173,764
<ALLOWANCE> 3,196
<TOTAL-ASSETS> 350,489
<DEPOSITS> 286,166
<SHORT-TERM> 8,925
<LIABILITIES-OTHER> 2,936
<LONG-TERM> 25,000
0
0
<COMMON> 1,796
<OTHER-SE> 25,666
<TOTAL-LIABILITIES-AND-EQUITY> 350,489
<INTEREST-LOAN> 14,154
<INTEREST-INVEST> 8,849
<INTEREST-OTHER> 192
<INTEREST-TOTAL> 23,195
<INTEREST-DEPOSIT> 9,038
<INTEREST-EXPENSE> 10,304
<INTEREST-INCOME-NET> 12,891
<LOAN-LOSSES> 240
<SECURITIES-GAINS> (139)
<EXPENSE-OTHER> 9,907
<INCOME-PRETAX> 4,975
<INCOME-PRE-EXTRAORDINARY> 3,801
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,801
<EPS-BASIC> 2.65
<EPS-DILUTED> 2.64
<YIELD-ACTUAL> 4.23
<LOANS-NON> 484
<LOANS-PAST> 39
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 2,581
<ALLOWANCE-OPEN> 2,951
<CHARGE-OFFS> 22
<RECOVERIES> 27
<ALLOWANCE-CLOSE> 3,196
<ALLOWANCE-DOMESTIC> 3,196
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 979
</TABLE>
