SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000
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OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________________ to ________________________
Commission file number 0-17706
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QNB Corp.
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(Exact Name of Registrant as Specified in Its Charter)
Pennsylvania 23-2318082
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
10 North Third Street, Quakertown, PA 18951-9005
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (215) 538-5600
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Not Applicable
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Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report.
Indicate by check |X| whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No
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Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at May 12, 2000
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Common Stock, par value $1.25 1,491,526
<PAGE>
QNB CORP. AND SUBSIDIARY
FORM 10-Q
QUARTER ENDED JUNE 30, 2000
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (Unaudited) PAGE
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Consolidated Statements of Income for Three and
Six Months Ended June 30, 2000 and 1999.......................... 1
Consolidated Balance Sheets at June 30, 2000
and December 31, 1999............................................ 2
Consolidated Statements of Cash Flows for
Six Months Ended June 30, 2000 and 1999.......................... 3
Notes to Consolidated Financial Statements.......................... 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION.................... 7
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK...........21
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS...................................................22
ITEM 2. CHANGES IN SECURITIES ..............................................22
ITEM 3. DEFAULTS UPON SENIOR SECURITIES ....................................22
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITIES HOLDERS..............22
ITEM 5. OTHER INFORMATION ..................................................22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ...................................23
<PAGE>
<TABLE>
<CAPTION>
QNB Corp. and Subsidiary
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share data)
(unaudited)
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Three Months Six Months
Ended June 30, Ended June 30,
2000 1999 2000 1999
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<S> <C> <C> <C> <C>
Interest Income
Interest and fees on loans ................................................... $3,678 $3,572 $ 7,139 $ 7,167
Interest and dividends on investment securities:
Taxable ............................................................. 2,112 1,896 4,220 3,575
Tax-exempt .......................................................... 330 242 649 434
Interest on Federal funds sold ............................................... 10 72 26 119
Interest on interest-bearing balances ........................................ 5 1 8 1
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Total interest income .......................................... 6,135 5,783 12,042 11,296
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Interest Expense
Interest on deposits
Interest-bearing demand accounts .................................... 156 105 300 198
Money market accounts ............................................... 273 199 487 390
Savings ............................................................. 187 176 358 345
Time ................................................................ 1,552 1,432 3,083 2,869
Time over $100,000 .................................................. 255 304 521 597
Interest on short-term borrowings ............................................ 142 92 232 188
Interest on Federal Home Loan Bank advances .................................. 338 231 663 231
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Total interest expense ......................................... 2,903 2,539 5,644 4,818
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Net interest income ............................................ 3,232 3,244 6,398 6,478
Provision for loan losses .................................................... -- 60 -- 120
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Net interest income after provision for loan losses ............ 3,232 3,184 6,398 6,358
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Non-Interest Income
Fees for services to customers ............................................... 307 298 605 564
Mortgage servicing fees ...................................................... 31 29 60 63
Net (loss) gain on investment securities available-for-sale .................. 39 77 105 163
Net gain on sale of loans .................................................... 38 40 42 145
Other operating income ....................................................... 276 227 496 409
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Total non-interest income ...................................... 691 671 1,308 1,344
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Non-Interest Expense
Salaries and employee benefits ............................................... 1,405 1,431 2,825 2,869
Net occupancy expense ........................................................ 167 164 332 326
Furniture and equipment expense .............................................. 227 219 450 425
Marketing expense ............................................................ 129 114 198 205
Other expense ................................................................ 578 532 1,073 1,052
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Total non-interest expense ..................................... 2,506 2,460 4,878 4,877
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Income before income taxes .......................................... 1,417 1,395 2,828 2,825
Provision for income taxes ................................................... 332 341 648 727
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Net Income .......................................................... $1,085 $1,054 $ 2,180 $ 2,098
================================================================================================================================
Net Income Per Share - Basic ........................................ $ .72 $ .70 $ 1.44 $ 1.39
================================================================================================================================
Net Income Per Share - Diluted ...................................... $ .72 $ .70 $ 1.44 $ 1.38
================================================================================================================================
Cash Dividends Per Share ............................................ $ .24 $ .20 $ .47 $ .40
================================================================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
Page 1
<PAGE>
<TABLE>
<CAPTION>
QNB Corp. and Subsidiary
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
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June 30, December 31,
2000 1999
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<S> <C> <C>
Assets
Cash and due from banks............................................................................ $ 14,965 $ 19,352
Investment securities
available-for-sale............................................................................. 107,010 97,609
held-to-maturity (market value $44,619 and $46,572)............................................ 46,099 48,302
Total loans, net of unearned income of $222 and $235............................................... 182,755 173,764
Allowance for loan losses.......................................................................... (3,108) (3,196)
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Net loans................................................................................. 179,647 170,568
Premises and equipment, net........................................................................ 5,179 4,840
Other real estate owned............................................................................ 104 348
Accrued interest receivable ....................................................................... 2,148 2,045
Other assets....................................................................................... 7,626 7,425
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Total assets....................................................................................... $ 362,778 $ 350,489
==============================================================================================================================
Liabilities
Deposits
Demand, non-interest-bearing................................................................... $ 38,489 $ 35,510
Interest bearing demand accounts............................................................... 49,501 47,448
Money market accounts.......................................................................... 34,130 30,002
Savings........................................................................................ 37,708 35,660
Time........................................................................................... 116,033 117,160
Time over $100,000............................................................................. 19,326 20,386
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Total deposits............................................................................ 295,187 286,166
Short-term borrowings.............................................................................. 11,322 8,925
Federal Home Loan Bank advances.................................................................... 25,000 25,000
Accrued interest payable........................................................................... 1,356 1,420
Other liabilities.................................................................................. 1,558 1,516
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Total liabilities.................................................................................. 334,423 323,027
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Commitments and contingencies
Shareholders' Equity
Common stock, par value $1.25 per share;
5,000,000 shares authorized; 1,511,965 shares and 1,509,029 shares issued;
1,495,796 and 1,509,029 shares outstanding..................................................... 1,800 1,796
Surplus............................................................................................ 4,479 4,458
Retained earnings.................................................................................. 25,280 23,812
Accumulated other comprehensive loss............................................................... (2,738) (2,604)
Treasury stock, at cost; 16,169 shares at June 30, 2000............................................ (466) --
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Total shareholders' equity......................................................................... 28,355 27,462
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Total liabilities and shareholders' equity......................................................... $ 362,778 $ 350,489
==============================================================================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
Page 2
<PAGE>
<TABLE>
<CAPTION>
QNB Corp. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
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Six Months Ended June 30, 2000 1999
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<S> <C> <C>
Operating Activities
Net income .............................................................................. $ 2,180 $ 2,098
Adjustments to reconcile net income to net cash provided by operating activities
Provision for loan losses ............................................................. -- 120
Net recovery of charged off loans ..................................................... -- 6
Depreciation and amortization ......................................................... 327 304
Securities gains ...................................................................... (105) (163)
Net gain on sale of loans ............................................................. (42) (144)
Proceeds from sales of residential mortgages .......................................... 626 9,270
Originations of residential mortgages held-for-sale ................................... (817) (6,009)
Proceeds from sales of student loans .................................................. 1,980 1,670
Gain on sale of other real estate owned ............................................... (8) (48)
Deferred income tax provision ......................................................... 52 (12)
Change in income taxes payable ........................................................ 81 134
Net increase in interest and dividends receivable ..................................... (103) (164)
Net amortization of premiums and discounts ............................................ (10) (1)
Net (decrease) increase in interest payable ........................................... (64) 354
Increase in other assets .............................................................. (222) (472)
(Decrease) increase in other liabilities .............................................. (1) 10
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Net cash provided by operating activities ............................................. 3,874 6,953
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Investing Activities
Proceeds from maturities and calls of investment securities
available-for-sale .................................................................... 3,657 14,319
held-to-maturity ...................................................................... 2,886 8,437
Proceeds from sales of investment securities
available-for-sale .................................................................... 2,402 7,453
Purchase of investment securities
available-for-sale .................................................................... (15,545) (54,855)
held-to-maturity ...................................................................... (686) (10,006)
Net increase in Federal funds sold ...................................................... -- (3,431)
Net increase in loans ................................................................... (10,826) (3,152)
Net purchases of premises and equipment ................................................. (666) (311)
Proceeds from the sale of other real estate owned ....................................... 252 213
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Net cash used by investing activities ................................................. (18,526) (41,333)
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Financing Activities
Net increase in non-interest-bearing deposits ........................................... 2,979 721
Net increase in interest-bearing deposits ............................................... 6,042 12,593
Net increase (decrease) in short-term borrowings ........................................ 2,397 (3,831)
Proceeds from Federal Home Loan Bank advances ........................................... -- 25,000
Cash dividends paid ..................................................................... (712) (602)
Proceeds from issuance of common stock .................................................. 25 25
Purchases of treasury stock ............................................................. (466) --
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Net cash provided by financing activities ............................................. 10,265 33,906
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Decrease in cash and cash equivalents ................................................. (4,387) (474)
Cash and cash equivalents at beginning of year ........................................ 19,352 14,020
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Cash and cash equivalents at end of period ............................................ $ 14,965 $ 13,546
======================================================================================================================
Supplemental Cash Flow Disclosures
Interest paid ........................................................................... $ 5,708 $ 4,464
Income taxes paid ....................................................................... 500 590
Non-Cash Transactions
Change in net unrealized holding gains (losses), net of taxes, on investment securities (134) (2,053)
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
Page 3
<PAGE>
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000 AND 1999, AND DECEMBER 31, 1999
(Unaudited)
1. REPORTING AND ACCOUNTING POLICIES
The accompanying consolidated financial statements include the accounts of QNB
Corp. and its wholly owned subsidiary, The Quakertown National Bank, (QNB). All
significant intercompany accounts and transactions are eliminated in the
consolidated statements.
The consolidated balance sheet as of June 30, 2000, as well as the respective
statements of income and cash flows for the three and the six month periods
ended June 30, 2000 and 1999, are unaudited. These financial statements should
be read in conjunction with the audited financial statements and notes thereto
included in QNB's 1999 Annual Report incorporated in the Form 10-K.
The financial statements reflect all adjustments, which in the opinion of
management are necessary for a fair presentation of the results of the interim
periods and are of a normal and recurring nature. The results for the periods
presented are not necessarily indicative of the full year. Certain accounts in
last year's financial statements have been reclassified to conform to the
current year's presentation. These reclassifications had no effect on net
income.
2. PER SHARE DATA
The following sets forth the computation of basic and diluted earnings per share
(share and per share data have been restated to reflect the 5% stock dividend
issued June 30, 2000 and are not in thousands):
<TABLE>
<CAPTION>
For the Three Months For the Six Months
Ended June 30, Ended June 30,
------------------------ -------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Numerator for basic and diluted earnings $1,085 $1,054 $2,180 $2,098
per share-net income
Denominator for basic earnings per share- 1,507,996 1,507,724 1,509,477 1,506,957
weighted average shares outstanding
Effect of dilutive securities-employee 360 6,966 153 8,674
stock options
Denominator for diluted earnings per 1,508,326 1,514,690 1,509,630 1,515,631
share-adjusted weighted average
shares outstanding
Earnings per share-basic $ .72 $ .70 $ 1.44 $ 1.39
Earnings per share-diluted $ .72 $ .70 $ 1.44 $ 1.38
</TABLE>
Page 4
<PAGE>
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000 AND 1999, AND DECEMBER 31, 1999
(Unaudited)
2. PER SHARE DATA (Continued)
There were 38,640 and 15,540 stock options that were anti-dilutive for the
three-month periods ended June 30, 2000 and 1999 and 48,195 stock options that
were anti-dilutive for the six-month period ended June 30, 2000.
3. COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity of a business entity
during a period from transactions and other events and circumstances, excluding
those resulting from investments by and distributions to owners. For QNB, the
sole component of other comprehensive income is the unrealized holding gains and
losses on available-for-sale investment securities.
The following shows the components and activity of comprehensive income during
the periods ended June 30, 2000 and 1999 (net of the income tax effect):
For the Six Months
Ended June 30,
---------------------
2000 1999
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Unrealized holding losses arising during
the period on securities held $ (65) $(1,945)
Reclassification adjustment equal to
beginning unrealized for all sold securities (69) (108)
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Net change in unrealized during the period (134) (2,053)
Unrealized holding (losses) gains, beginning of period (2,604) 916
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Unrealized holding (losses) gains, end of period $(2,738) $(1,137)
======= =======
Net income $ 2,180 $ 2,098
Other comprehensive (loss) income, net of tax:
Unrealized holding losses arising during the period (134) (2,053)
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Comprehensive Income $ 2,046 $ 45
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Page 5
<PAGE>
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000 AND 1999, AND DECEMBER 31, 1999
(Unaudited)
4. STOCK REPURCHASE PLAN
In March of 2000, the Board of Directors of QNB Corp. authorized the repurchase
of up to 4.99 percent of the shares of QNB Corp's outstanding common stock. Such
repurchases may be made in open market or privately negotiated transactions. The
repurchased shares will be held in treasury and will be available for general
corporate purposes. As of June 30, 2000 QNB Corp. repurchased 16,169 shares at
an average cost of $28.83 per share.
Page 6
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
QNB Corp. (the "Corporation") is a bank holding company headquartered in
Quakertown, Pennsylvania which provides a full range of commercial and retail
banking services through its banking subsidiary, The Quakertown National Bank
(the "Bank"), a 123 year old community bank with locations in Upper Bucks,
Northern Montgomery and Southern Lehigh Counties. The results of operations and
financial condition discussed herein are presented on a consolidated basis and
the consolidated entity is referred to herein as "QNB." Per share data has been
adjusted to reflect the 5% stock dividend issued June 30, 2000.
In addition to historical information, this management discussion and analysis
contains forward-looking statements. The forward-looking statements contained
herein are subject to certain risks and uncertainties that could cause actual
results to differ materially from those projected in the forward-looking
statements. Readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect management's analysis only as of the
date hereof. The Corporation undertakes no obligation to publicly revise or
update these forward-looking statements to reflect events or circumstances that
arise after the date hereof. Readers should carefully review the risk factors
described in other documents the Corporation files from time to time with the
Securities and Exchange Commission, including the quarterly reports on Form 10-Q
filed by the Corporation in 2000, and any Current Reports on Form 8-K filed by
the Corporation.
RESULTS OF OPERATIONS
QNB recorded earnings of $1,085,000 or $.72 per share on a diluted basis for the
three month period ended June 30, 2000. This represents a 2.9 percent increase
from net income of $1,054,000 or $.70 per share-diluted reported for the second
quarter of 1999. For the six month periods ended June 30, 2000 and 1999, net
income was $2,180,000 and $2,098,000, respectively, an increase of 3.9 percent.
Net income per share diluted was $1.44 and $1.38 for the corresponding six-month
periods.
A lower effective income tax rate, the lack of need to increase the allowance
for loan losses and an increase in other non-interest income contributed to the
increase in net income for three-month period ended June 30, 2000. The lower
effective income tax rate is a result of the increase in the proportion of
tax-exempt assets to total assets. This resulted in the reporting of slightly
lower net interest income and a lower provision for income taxes for the
quarter. However, when net interest income is converted to a tax-equivalent
basis net interest income increased.
Net interest income declined slightly despite a 4.9 percent increase in average
earning assets. Net interest income decreased .4 percent to $3,232,000 for the
quarter ended June 30, 2000 as compared to $3,244,000 for the quarter ended June
30, 1999. However, on a tax-equivalent basis net interest income increased by
1.0 percent to $3,460,000 from $3,426,000. Net interest income was negatively
impacted by a lower net interest margin which declined from 4.25 percent during
the second quarter of 1999 to 4.10 percent for the second quarter of 2000.
Excluding the impact of a wholesale funding transaction entered into during the
second quarter of 1999, the net interest margin for the three months ended June
30, 2000 and 1999 would have been 4.33 percent and 4.42 percent, a decrease of 9
basis points. Interest rates on deposit accounts, primarily time
Page 7
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS (Continued)
deposits, and other funding sources has increased to a greater degree than rates
on loans and investment securities as market interest rates have increased.
The continued low levels of non-performing assets enabled QNB to eliminate its
provision for loan loss during the first half of 2000. This expense was $60,000
during the second quarter of 1999.
Non-interest income increased from $671,000 during the second quarter of 1999 to
$691,000 during the three months ended June 30, 2000, an increase of 3.0
percent. Excluding gains and losses on the sale of investment securities and
loans during both periods, non-interest income increased approximately $60,000
or 10.8 percent. An increase in fee income related to debit card and ATM
transactions and an increase in insurance commissions on consumer loans and
commissions on official check transactions accounted for the increase in
non-interest income.
Non-interest expense increased $46,000 or 1.9 percent from $2,460,000 for the
second quarter of 1999 to $2,506,000 for the three months ended June 30, 2000.
An increase in professional fees resulting from the outsourcing of the internal
audit function and the use of a consultant for the selection of a new computer
system contributed to the variance. An increase in advertising expense also
contributed to the increase in non-interest expense.
Return on average assets was 1.21 percent and 1.23 percent while the return on
average equity was 14.08 percent and 14.75 percent for the three months ended
June 30, 2000 and 1999, respectively. For the six-month periods ended June 30,
2000 and 1999, return on average assets was 1.23 percent and 1.27 percent and
the return on average equity was 14.30 percent and 15.96 percent, respectively.
NET INTEREST INCOME
Net interest income is the primary source of operating income for QNB. Net
interest income is interest income, dividends, and fees on earning assets, less
interest expense incurred for funding sources. Earning assets primarily include
loans, investment securities and Federal funds sold. Sources used to fund these
assets include deposits, borrowed funds and shareholders' equity. Net interest
income is affected by changes in interest rates, the volume and mix of earning
assets and interest-bearing liabilities, and the amount of earning assets funded
by non-interest-bearing deposits.
Net interest income decreased .4 percent to $3,232,000 for the quarter ended
June 30, 2000 as compared to $3,244,000 for the quarter ended June 30, 1999.
However, on a tax-equivalent basis, which allows for the comparison of
tax-exempt loans and investments to taxable loans and investments, net interest
income increased by 1.0 percent from $3,426,000 for the three months ended June
30, 1999 to $3,460,000 for the same period ended June 30, 2000. This is a result
of an increase in the proportion of tax-exempt earning assets to total earning
assets. The yield on earning assets on a tax-equivalent basis was 7.54 percent
for the second quarter of 2000 versus 7.39 percent for the second quarter of
1999, while the rate paid on interest-bearing liabilities was 4.01 percent and
3.69 percent for the same periods. Interest rates on deposit accounts, primarily
time deposits, and other funding sources has increased to a greater degree than
rates on loans and investment securities as market interest rates have
increased, resulting in a decline in the net interest margin. The net interest
margin on a tax-equivalent basis declined 15 basis points to 4.10 percent for
the three-month period ended June 30, 2000 compared with 4.25 percent for the
same period in 1999. A 4.9 percent increase in average earning assets helped
offset the negative impact of a declining net interest margin.
Page 8
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (Continued)
Some of the growth in average earning assets was funded through a wholesale
funding transaction entered into in April 1999, whereby QNB borrowed $25,000,000
from the Federal Home Loan Bank at an average rate of 5.15 percent. These funds
were reinvested in investment securities with an average yield of 6.52 percent
for an initial spread of 137 basis points. In April, 2000, $5,000,000 of the
borrowed money re-priced at a higher rate, increasing the average borrowing cost
to 5.27 percent. Offsetting some of the increase in interest expense is an
increase in interest income resulting from the reinvestment of the cash flow
from the mortgage-backed security at higher rates also. This transaction has the
impact of increasing net interest income, but lowering the net interest margin.
Excluding the impact of this transaction, the net interest margin for the three
months ended June 30, 2000 and 1999 would have been 4.33 and 4.42 percent, a
decrease of 9 basis points.
The yield on earning assets increased when comparing the two quarters as
interest rates, as represented by the United States Treasury yield curve,
increased during the later part of 1999 and early 2000. The increase in the
yield on earning assets is primarily centered in loans, whose yield increased
from 8.21 percent for the second quarter of 1999 to 8.31 percent for the second
quarter of 2000. However, since the end of the second quarter of 1999 through
the end of the second quarter of 2000, the Prime rate on loans has increased 175
basis points from 7.75 percent to 9.50 percent. While QNB will see some benefit
in 2000 from these prime rate increases, the overall yield on the loan portfolio
will not increase proportionately since only approximately 13 percent of the
portfolio re-prices immediately with changes in the prime rate. The current
yield on loans has been negatively impacted by the decline in rates that
occurred in 1998. As rates hit historically low levels during 1998, many
borrowers, including commercial and consumer, selected fixed rate rather than
variable rate loans. Therefore, the loan portfolio has yielded minimal benefit
from rising rates during 1999 and 2000. Another factor in the decline in the
yield on loans is the current competitive environment for loans, both commercial
and consumer, from both banks and non-banks, which has prevented the rates from
increasing to the degree that Treasury rates and the Prime rate have increased.
QNB anticipates that the yield on loans will continue to increase during 2000 as
the impact of the increase in market interest rates are factored into new loans
as well as the impact of these higher rates on loans that do re-price over time.
Some of this impact has been realized as the yield on loans for the second
quarter of 2000 of 8.31 percent was an increase from the 8.11 percent for the
fourth quarter of 1999 and 8.15 percent for the first quarter of 2000.
When comparing the second quarter of 2000 to the second quarter of 1999, the
yield on investment securities increased to 6.67 percent from 6.47 percent. QNB
has been able to maintain the yield on investment securities through various
interest rate environments by actively managing its portfolio. When rates fell
in 1998 and cash flow increased as a result of prepayments on mortgage-backed
securities and callable agency securities, QNB was able to reduce the negative
impact on the yield in 1998 and 1999 by purchasing mortgage-backed securities,
whose yields did not decline to the same degree as Treasury securities and by
lengthening the average life of the portfolio with the purchase of some higher
yielding but longer term callable agency securities and tax-exempt municipal
securities. With the rise in rates in 1999, cash flow from mortgage-backed
securities and callable agency securities slowed resulting in fewer dollars
being reinvested at the higher rates. To take advantage of the higher interest
rate environment, QNB, during the third and fourth quarters of 1999, sold, at a
loss of $256,000, approximately $9,500,000 of securities yielding 6.25%, and
reinvested the proceeds in securities yielding 7.50 percent. This transaction
benefited QNB by increasing interest income in 2000. Also positively impacting
the yield during 2000 was the reinvestment of the excess liquidity created by
the Year 2000 issue at these higher interest rates. The positive results of
these transactions are evidenced by the 15 basis point increase in the yield on
the investment portfolio during the second quarter of 2000 from the yield
recorded during the fourth quarter
Page 9
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (Continued)
of 1999. The yield on the investment portfolio during the fourth quarter of 1999
was 6.52 percent compared to 6.67 percent for the second quarter of 2000.
Total interest expense increased $364,000 during the second quarter of 2000 to
$2,903,000. Interest expense on the borrowings from the Federal Home Loan Bank
contributed $107,000 to the increase. Rising market interest rates combined with
the competition for deposits caused rates on both deposits accounts and
short-term borrowings to increase when comparing the two quarters. The yield on
interest bearing deposits increased from 3.59 percent to 3.84 percent while the
yield on short-term borrowings increased from 3.41 percent to 4.39 percent for
the quarters ended June 30, 1999 and 2000. The yield on interest-bearing demand
accounts increased 33 basis points while the yield on time deposits and money
market accounts increased 17 basis points and 84 basis points. The competition
with other financial institutions and mutual funds for money market accounts and
the introduction of a new money market product toward the end of the first
quarter of 2000, The Treasury Select Indexed Money Market Account, contributed
to the increase in the rate paid on money market accounts. This product is a
variable rate account indexed to a percentage of the monthly average of the
91-day Treasury bill rate based on balances in the account. This product pays a
minimum 6.00 percent yield through the end of 2000 for accounts with balances
over $25,000. The increase in interest expense and the yield on short-term
borrowings is a result of higher rates paid on cash management accounts and the
175 basis point increase in the target Federal funds rate. QNB used Federal
funds to fund some of the loan growth during the second quarter of 2000
resulting in an increase in average Federal funds purchased by approximately
$2,143,000.
For the six-month period ended June 30, 2000, net interest income decreased
$80,000 to $6,398,000. On a tax-equivalent basis net interest income increased
$38,000 or .6 percent. The 7.6 percent growth in average earning assets was
partially offset by a 30 basis point decline in the net interest margin.
Excluding the impact of the wholesale funding transaction average earning assets
increased 2.5 percent and the net interest margin declined by 17 basis points.
Total interest income increased $746,000 from $11,296,000 to $12,042,000 when
comparing the six-month periods ended June 30, 1999 to June 30, 2000. The yield
on earning assets decreased from 7.52 percent to 7.49 percent, with the yield on
loans declining from 8.29 percent to 8.23 percent. During the six-month period
the yield on investment securities increased from 6.57 percent to 6.66 percent.
Average investment securities increased 20.9 percent to $157,064,000 while
average loans increased .1 percent to $177,171,000. Total interest expense
increased $826,000 from $4,818,000 to $5,644,000 for the six-month periods with
the interest on the Federal Home Loan Bank advances accounting for $432,000 of
the increase. The yield on interest-bearing liabilities increased from 3.66
percent to 3.94 percent. Average interest-bearing deposits increased 2.7 percent
to $251,845,000, while total average interest-bearing liabilities increased 8.6
percent to $288,236,000. The primary difference in the percent change is the
impact of the borrowings from the Federal Home Loan Bank, entered into at the
end of April 1999.
QNB anticipates the net interest margin to continue to decline because of an
increase in funding costs resulting from the competition for deposits, primarily
higher yielding time deposits, and the introduction of the Treasury Select Index
Money Market Account at the end of the first quarter of 2000.
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 losses in the
loan portfolio. Actual loan losses, net of recoveries, serve to reduce the
allowance.
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QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
PROVISION FOR LOAN LOSSES (Continued)
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.
There was no provision for loan losses for either the three or six-month period
ended June 30, 2000. The provision for loan losses was $60,000 and $120,000 for
the three and six-month periods ended June 30, 1999. QNB was able to eliminate
the provision for loan losses in 2000 as a result of continued low levels of
non-performing assets and delinquency. QNB had net charge-offs of $59,000 during
the second quarter of 2000 versus a net recovery of $1,000 for the second
quarter of 1999. For the six-month periods ended June 30, 2000 and 1999, QNB had
net charge-offs of $88,000 and net recoveries of $6,000, respectively. Net
charge-offs represent .10 percent of average loans for the six months ended June
30, 2000.
Non-performing assets (non-accruing loans, loans past due 90 days or more, and
other real estate owned) continued their positive trend downward during the
first half of 2000 and amounted to .16 percent of total assets at June 30, 2000.
This compares to .31 percent at June 30, 1999 and .25 percent at December 31,
1999. Non-accrual loans were $465,000 and $300,000 at June 30, 2000 and 1999.
Non-accrual loans at December 31, 1999 were $484,000. Other real estate owned
was $104,000 and $531,000 at June 30, 2000 and 1999 and $348,000 at December 31,
1999. QNB sold the remaining property in July 2000.
There were no restructured loans as of June 30, 2000, December 31, 1999 or June
30, 1999 as defined in Statement of Financial Accounting Standards No. 15,
"Accounting by Debtors and Creditors for Troubled Debt Restructurings," that
have not already been included in loans past due 90 days or more or non-accrual
loans.
The allowance for loan losses was $3,108,000 and $3,196,000 at June 30, 2000 and
December 31, 1999, respectively. The ratio of the allowance to total loans was
1.70 percent and 1.84 percent for the respective periods. While QNB believes
that its allowance is adequate to cover losses in the loan portfolio, there
remain inherent uncertainties regarding future economic events and their
potential impact on asset quality.
A loan is considered impaired, based on current information and events, if it is
probable that QNB will be unable to collect the scheduled payments of principal
or interest when due according to the contractual terms of the loan agreement.
The measurement of impaired loans is generally based on the present value of
expected future cash flows discounted at the historical effective interest rate,
except that all collateral-dependent loans are measured for impairment based on
the fair value of the collateral.
At June 30, 2000 and 1999, the recorded investment in loans for which impairment
has been recognized in accordance with SFAS No. 114 totaled $401,000 and
$207,000, respectively, of which $353,000 and $199,000 related to loans with no
valuation allowance. At June 30, 2000 and 1999 there were $48,000 and $8,000 in
impaired loans that had a valuation allowance against the entire amount. Most of
the loans identified as impaired are collateral-dependent.
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<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME
QNB, through its core banking business, generates various fees and service
charges. Total non-interest income is composed of service charges on deposit
accounts, mortgage servicing fees, gains on the sale of investment securities,
gains on the sale of residential mortgages and student loans, and other
miscellaneous fee income. QNB reviews all service charges and fee schedules
related to its products and services on an annual basis. Except for an increase
in overdraft fees during the first quarter of 1999 and the implementation of an
ATM surcharge for non-QNB customers in June, 2000, QNB has not materially
changed these fee schedules during 1999 or 2000. Total non-interest income
increased $20,000 or 3.0 percent to $691,000 for the quarter ended June 30, 2000
when compared to June 30, 1999. For the six-month period total non-interest
income decreased $36,000 or 2.7 percent to $1,308,000. Excluding gains on the
sale of investment securities and loans during both periods, non-interest income
for the three-month period increased $60,000 or 10.8 percent and for the
six-month period increased $125,000 or 12.1 percent.
Fees for services to customers, the largest component of total non-interest
income, is primarily comprised of service charges on deposit accounts. These
fees increased 3.0 percent, to $307,000 from $298,000, when comparing the two
quarters and 7.3 percent to $605,000 when comparing the six-month periods. An
increase in overdraft fee income accounts for approximately $14,000 of the
increase for the three-month period and $45,000 for the six-month period. During
the first quarter of 1999, QNB increased its fee for overdrafts by 12.0 percent.
An increase in fees related to the use of out-of-network ATMs contributed $4,000
to the overall increase for both the three and six month periods. A decline in
service charge income on business deposit accounts offset some of these
increases.
To date, when QNB sells its residential mortgages in the secondary market, it
retains servicing rights. A normal servicing fee is retained on all mortgage
loans sold and serviced. Mortgage servicing fees for the quarter ended June 30,
2000 were $31,000 which represents a $2,000 increase from the same period in
1999. For the six-month period mortgage servicing fees decreased $3,000 or 4.8
percent to $60,000. The increase in mortgage servicing fees for the quarter is
primarily a result of a decrease in the amortization of the mortgage servicing
asset booked at the time the loan is sold offsetting the impact of lower income
resulting from the servicing of fewer loans. QNB recognizes its obligation to
service financial assets that are retained in a transfer of assets in the form
of a servicing asset. The servicing asset is amortized in proportion to and over
a period of net servicing income or loss. Servicing assets are assessed for
impairment based on their fair value. During the second quarter of 2000, QNB
amortized approximately $11,000 of the mortgage servicing asset compared to
$14,000 during the second quarter of 1999. The average balance of mortgages
serviced for others was $63,946,000 for the second quarter of 2000 compared to
$68,720,000 for the second quarter of 1999. The average balance of mortgages
serviced was approximately $64,521,000 for the six-month period ended June 30,
2000 compared to $68,127,000 for the first six months of 1999, a decline of 5.3
percent. Rising interest rates have reduced the amount of mortgage origination
and sales activity. The timing of mortgage payments and delinquencies also
impacts the amount of servicing fees recorded.
Gains on the sale of investment securities were $39,000 for the second quarter
of 2000 and $105,000 for the first six months of 1999. This compares to gains of
$77,000 in the second quarter of 1999 and $163,000 for the six-month period
ended June 30, 1999. QNB owns a small portfolio of marketable equity securities.
The gains recorded during both 2000 and 1999 relate to the sale of securities
out of this portfolio. During the second quarter of 1999, QNB sold, at
breakeven, approximately $7,000,000 of callable agency securities that were
likely to be called. These securities were sold for liquidity reasons. There
were no sales out of the fixed income portfolio during the second quarter of
2000.
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QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (Continued)
QNB recorded a gain of $38,000 on the sale of loans during the second quarter of
2000. This compares to a $40,000 gain for the same period in 1999. For the
six-month periods ended June 30, 2000 and 1999 net gains on the sale of loans
were $42,000 and $145,000, respectively. The sale of student loans accounts for
$33,000 and $30,000 of the gains during the second quarter of 2000 and 1999. QNB
sold approximately $1,719,000 and $1,497,000 in student loans during the second
quarter of 2000 and 1999. Gains on the sale of student loans accounted for
$36,000 and $33,000 of the total gains during the six-month periods ended June
30, 2000 and 1999, respectively.
The net gain on the sale of residential mortgage loans was $5,000 and $10,000
for the three-month periods ended June 30, 2000 and 1999 and $6,000 and $112,000
for the respective six-month periods. The net gain on residential mortgage sales
is directly related to the volume of mortgages sold and the timing of the sales
relative to the interest rate environment. Rising interest rates during late
1999 and the first two quarters of 2000 reduced the amount of mortgage
origination and sales activity. QNB originated $683,000 and $1,377,000 in
residential mortgages held for sale during the second quarter of 2000 and 1999
and $817,000 and $6,009,000 during the respective six-month periods. Proceeds
from the sale of residential mortgages were approximately $524,000 and
$1,844,000 during the second quarters of 2000 and 1999, respectively. For the
six-month periods proceeds from the sale of residential mortgage loans amounted
to $626,000 and $9,270,000. Declining interest rates at the end of 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. The increase in interest rates during the first quarter of 1999,
prevented QNB from selling these loans at a larger gain. As of June 30, 2000 and
1999, QNB had approximately $191,000 and $377,000 in mortgage loans classified
as held for sale. These loans are accounted for at lower of cost or market.
Other operating income increased $49,000 or 21.6 percent to $276,000 when
comparing the three-month periods ended June 30, 2000 and 1999 and $87,000 or
21.3 percent to $496,000 when comparing the six-month periods. Higher debit card
income resulting from an increase in the number of transactions, contributed an
additional $17,000 and $37,000 to other income for the three and six-month
periods. The implementation of an ATM surcharge for non-QNB customers in June
2000 contributed $13,000 to other income. An increase in insurance commission
income on consumer loans and commissions on official check transactions also
contributed to the increase in other income when comparing the three and
six-month periods. An increase in the earnings on the cash surrender value of
life insurance contributed an additional $5,000 and $10,000 to other income for
the three and six-month periods. These positive variances were offset by a
decline in the recognition of rental income on other real estate owned of
$13,000 for the six-month period. The rental income decreased as a result of the
sale of some revenue generating properties.
The development of new products and services should help generate additional
non-interest income and reduce QNB's reliance on net-interest income. An example
was the introduction of QNB-Online, our Internet Banking and online bill-pay
product, at the end of the first quarter of 2000.
NON-INTEREST EXPENSE
Non-interest expense is comprised of costs related to salaries and employee
benefits, net occupancy, furniture and equipment, marketing, and various other
operating expenses. Total non-interest expense of $2,506,000 for the quarter
ended June 30, 2000 represents an increase of $46,000 or 1.9 percent from levels
reported in the second quarter of 1999. Total non-interest expense for the six
months ended June 30, 2000 was $4,878,000, an increase of $1,000 over 1999
levels.
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QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST EXPENSE (Continued)
Salaries and benefits, the largest component of non-interest expense, decreased
$26,000 or 1.8 percent to $1,405,000 for the quarter ended June 30, 2000
compared to the same quarter in 1999. Salary expense decreased $18,000 or 1.6
percent during the period to $1,149,000 while benefits expense decreased $8,000
or 3.0 percent to $256,000. For the six-month period ended June 30, 2000
salaries and benefits expense decreased $44,000 or 1.5 percent compared to 1999.
Salary expense decreased $23,000 or 1.0 percent while benefits expense decreased
$21,000 or 3.8 percent. Excluding the accrual for bonuses in both years, salary
expense increased $17,000 or 1.6 percent for the quarter and $47,000 or 2.2
percent for the six-month period. The decrease in benefits expense for both
periods is primarily the result of a reduction in QNB's State unemployment tax
rate.
Net occupancy expense increased $3,000 or 1.8 percent for the three-month
periods and $6,000 or 1.8 percent when comparing the six-month periods ended
June 30, 2000 and 1999. An increase in rent expense and an increase in
depreciation on leasehold improvements related to the expansion and renovation
of one branch at the end of 1999 contributed to the increase in net occupancy
expense for both the three and six-month periods. Higher utility costs also
contributed to the increase in net occupancy expense. These higher costs were
partially offset by a reduction in expense for building repairs and maintenance,
security expense and real estate taxes. Net occupancy expense will likely
increase during the remainder of 2000 as a result of higher depreciation
expense, repairs and maintenance expense and branch rent expense. These
increased costs relate to the renovation of several locations as well as the
opening of a new branch in Hilltown Township, Pennsylvania anticipated in the
fall of 2000.
Furniture and equipment expense increased $8,000 or 3.7 percent when comparing
the three-month periods ended June 30, 2000 and 1999, respectively and $25,000
or 5.9 percent when comparing the six-month periods. The increase in furniture
and equipment expense for both the three-month and six-month periods is centered
in depreciation and maintenance expense. The higher depreciation relates to the
continued investment in technology as well as costs related to the renovation of
the branch. QNB-Online, the check imaging system, the wide area network and a
new telephone system are some examples of the technology implemented in the past
two years. The increase in equipment maintenance costs relates to general
increases in contract pricing as well as additional costs for maintenance on new
systems. Furniture and equipment expense will increase during 2000 and 2001 as
the new branch is put into service and a new bank-wide computer system is
installed. Both should be completed during the fourth quarter of 2000.
Marketing expense increased $15,000 or 13.2 percent to $129,000 for the quarter
ended June 30, 2000 but decreased $7,000 or 3.4 percent when comparing the
six-month periods. Advertising expense increased $25,000 for the three-month
period and $29,000 for the six-month period. The introduction of QNB-Online and
the Treasury Select Money Market Product along with an increase in the
advertising of loan products contributed to the increase in advertising expense.
The increase in advertising expense for the quarter was partially offset by a
$6,000 reduction in contributions and sponsorships. This difference is primarily
the result of the timing of contributions. For the six-month period
contributions and sponsorships decreased $21,000, primarily as a result of a
large contribution during the first quarter of 1999. Promotional items decreased
$13,000 when comparing the six-month periods.
Total other expense for the three months ended June 30, 2000 was $578,000, an
increase of $46,000 or 8.6 percent over the same period in 1999. For the
six-month period other expense increased $21,000 or 2.0 percent to $1,073,000.
The major categories that comprise other expense are postage, supplies,
professional services, telecommunication costs, insurance expense and state
taxes. Professional fees increased $32,000 for
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QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST EXPENSE (Continued)
the quarter and $40,000 for the six-month period. These increases resulted
primarily from the outsourcing of the internal audit function and the use of a
consultant for the selection of a new computer system. These costs were
partially offset by a reduction in legal expense. Also contributing to the
increase in other expense for the quarter were higher telephone, courier, state
tax, ATM and debit card expenses. For the six-month period deposit insurance
costs increased $13,000, postage expense $7,000 and debit card expense $16,000.
Partially offsetting these increases was a $16,000 decrease in supplies expense
and a $39,000 decrease in charged-off checking accounts.
INCOME TAXES
Applicable income taxes and effective tax rates were $332,000 or 23.4 percent
for the three-month period ended June 30, 2000, and $341,000 or 24.4 percent for
the same period in 1999. For the six-month period applicable income taxes and
effective rates were $648,000 or 22.9 percent and $727,000 or 25.7 percent,
respectively. The reduction in the effective tax rate when comparing 2000 to
1999 is a result of an increase in income from tax-exempt municipal securities
and loans and an increase in dividend income subject to the 70 percent
exclusion.
QNB utilizes an asset and liability approach for financial accounting and
reporting of income taxes. As of June 30, 2000, QNB's net deferred tax asset was
$2,350,000. Included in the deferred tax asset was $813,000 relating to the
allowance for loan losses and $1,410,000 resulting from the SFAS No.115
adjustment for available-for-sale investment securities. As of December 31,
1999, QNB's net deferred tax asset was $2,335,000. A deferred tax asset of
$843,000 relating to the allowance for loan losses and a $1,342,000 SFAS No.115
adjustment account for most of the deferred tax asset at December 31, 1999. At
June 30, 1999, QNB's net deferred tax asset was $1,578,000. Included in the
deferred tax asset was $802,000 relating to the allowance for loan losses and
$586,000 resulting from the SFAS No. 115 adjustment.
BALANCE SHEET ANALYSIS
The Balance Sheet Analysis reviews average balance sheet data for the six months
ended June 30, 2000 and 1999, as well as the period ending balances as of June
30, 2000 and December 31, 1999.
Average earning assets for the six-month period ended June 30, 2000 increased
$23,746,000 or 7.6 percent to $335,415,000 from $311,669,000 for the six months
ended June 30, 1999. Average investments and average loans increased $27,144,000
and $159,000, respectively while average Federal funds sold decreased
$3,809,000. The large increase in the investment portfolio is a result of the
growth in funding sources, both retail and wholesale, outpacing the growth in
loans. The advance from the Federal Home Loan Bank funded approximately
$16,000,000 of the increase in average investment securities when comparing the
six-month periods.
Average mortgage loans declined $3,111,000 when comparing the six-month periods.
The decline in the average balance of mortgage loans is a result of rising
interest rates which has slowed down the origination of both new mortgage loans
and refinances. In contrast, consumer loans, primarily home equity loans
continue to increase. Average consumer loans increased $3,467,000 or 9.8 percent
to $38,894,000 when comparing the six-month periods. The increase in consumer
loans is primarily the result of aggressive fixed rate home equity loan
promotions and pricing during the past two years. Average commercial loans
increased slightly when
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QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS (Continued)
comparing the six-month periods. Growth in the commercial loan portfolio has
been difficult as several of QNB's larger customers have sold their businesses
and paid off their loans over the past year. Some growth was achieved during the
second quarter of 2000 as total loans increased by $8,991,000 or 5.2 percent to
$182,755,000 at June 30, 2000 from $173,764,000 at December 31, 1999.
In addition to borrowing from the Federal Home Loan Bank, the growth in average
earning assets was funded by a reduction in cash retained for Year 2000 concerns
and increases in interest-bearing demand accounts and time deposits. Average
interest-bearing demand accounts increased $4,358,000, while average time
deposits increased $2,621,000. Additional deposits by several municipalities,
primarily account for the increase in interest-bearing demand deposits.
Attractive rates on time deposits, relative to rates on other interest-bearing
accounts along with the promotion of several time deposit specials over the past
year contributed to the increase in time deposits. Average money market accounts
increased $460,000 when comparing the six-month periods. However, money market
account balances should increase further as a result of the introduction of the
Treasury Select Money Market Account. Money market accounts at June 30, 2000
were $34,130,000 an increase of $4,128,000 or 13.8 percent compared to December
31, 1999. Average non-interest bearing deposits decreased $854,000 or 2.4
percent when comparing the six-month periods. Average total deposits increased
2.1 percent when comparing the six-month periods. The slow growth in deposits
has created the need to look for other sources of funds, including the Federal
Home Loan Bank and the purchase of Federal funds.
Total assets at June 30, 2000 were $362,778,000, compared with $350,489,000 at
December 31, 1999, an increase of 3.5 percent for the six months. The increase
in assets from December 31, 1999 is primarily in investment securities and loans
which increased by $7,198,000 and $8,991,000, respectively. The increase in
investment securities is primarily the result of the redeployment of excess Year
2000 cash into agency securities, tax-exempt State and municipal securities and
equity securities. The increase in loans is the result of both new loans and
seasonal line of credit usage. Commercial and industrial loans and home equity
loans account for most of the increase in total loans. Other real estate owned
decreased from $348,000 at December 31, 1999 to $104,000 at June 30, 2000 as a
result of the sale of one property. The remaining property was sold on July 31,
2000.
Total deposits increased from $286,166,000 at December 31, 1999 to $295,187,000
at June 30, 2000 and short-term borrowings increased from $8,925,000 to
$11,322,000 at these same dates. The $2,979,000 increase in non-interest bearing
demand deposits from December 31, 1999 to June 30, 2000 is primarily the result
of deposits by mortgage settlement companies for month-end mortgage settlements.
These funds tend to stay on deposit for only a couple of days. Money market
accounts increased by $4,128,000 as a result of the introduction of the Treasury
Select Money Market account and the guaranteed 6.00 percent rate till December
31, 2000 for balances in excess of $25,000. Savings accounts increased
$2,048,000 while time deposits decreased $2,187,000 from December 31, 1999 to
June 30, 2000. The decline in time deposits is a result of the introduction of
the Treasury Select Money Market account which provides a high rate of interest
along with the ability to make deposits or withdrawals at any time. Extremely
competitive rates for time deposits by other financial institutions have also
had a negative impact on growth in these accounts. The increase in short-term
borrowings is a result of an increase in cash management balances.
At June 30, 2000 the fair value of investment securities available-for-sale was
$107,010,000 or $4,148,000 below the amortized cost of $111,158,000. This
compares to a fair value of $97,609,000 or $3,947,000 below the amortized cost
of $101,556,000 at December 31, 1999. An unrealized holding loss, net of taxes,
of
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QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS (Continued)
$2,738,000 and $2,604,000 was recorded as a decrease to shareholders' equity at
June 30, 2000 and December 31, 1999. The increase in interest rates, combined
with the inverted shape of the yield curve as well as the purchase of some
mortgage-backed securities during the first quarter of 2000 contributed to the
increase in the unrealized holding loss.
The available-for-sale portfolio had a weighted average maturity of
approximately 8 years at June 30, 2000 and 7 years at December 31, 1999. The
weighted average tax-equivalent yield was 6.68 percent and 6.58 percent at June
30, 2000 and December 31, 1999. The weighted average maturity is based on the
stated contractual maturity of all securities except for mortgage-backed
securities, which are based on estimated average life. The maturity of the
portfolio may be shorter because of call features in many debt securities and
because of prepayments on mortgage-backed securities. The interest rate
sensitivity analysis reflects the expected maturity distribution of the
securities portfolio based upon estimated call dates and anticipated cash flows
assuming management's most likely interest rate environment. The expected
weighted average life of the available-for-sale portfolio was 7 years, 2 months
at June 30, 2000 and 6 years, 6 months at December 31, 1999, based on these
assumptions. The slight extension of the expected average life of the portfolio
is a result of the purchase of some longer-term mortgage-backed securities and
tax-exempt municipal securities and the lengthening of the CMO portfolio caused
by higher interest rates and the inversion of the Treasury yield curve. If rates
were to decline by 100 or 200 basis points the average life of the
available-for-sale portfolio would decline to 6 years or 3 years, 6 months,
respectively. Falling rates would create additional cash flow from the
prepayment on mortgage-backed securities and CMOs. In addition, some callable
agency securities would likely be called, creating additional cash flow.
Investment securities held-to-maturity are reported at amortized cost. As of
June 30, 2000 and December 31, 1999, QNB had securities classified as
held-to-maturity with an amortized cost of $46,099,000 and $48,302,000 and a
market value of $44,619,000 and $46,572,000, respectively. The held-to-maturity
portfolio had a weighted average maturity of approximately 6 years, 4 months at
June 30, 2000 and 6 years at December 31, 1999. The weighted average
tax-equivalent yield was 6.47 percent and 6.46 percent at June 30, 2000 and
December 31, 1999. The increase in the average maturity is a result of the
lengthening in the average life of the mortgage-backed portfolio caused by
higher interest rates. As interest rates increase mortgage prepayments and
mortgage refinance activity slows causing these securities to extend their
average life.
LIQUIDITY
Liquidity represents an institution's ability to generate cash or otherwise
obtain funds at reasonable rates to satisfy commitments to borrowers and demands
of depositors. QNB manages its mix of cash, Federal funds sold, investment
securities and loans in order to match the volatility, seasonality, interest
sensitivity and growth trends of its deposit funds. Liquidity is provided from
asset sources through maturities and repayments of loans and investment
securities, net interest income and fee income. The portfolio of investment
securities available-for-sale and QNB's policy of selling certain residential
mortgage originations and student loans in the secondary market also provide
sources of liquidity. Additional sources of liquidity are provided by The
Quakertown National Bank's membership in the Federal Home Loan Bank and a
$5,000,000 unsecured Federal funds line granted by the Bank's correspondent.
Cash and due from banks, Federal funds sold, available-for-sale securities and
loans held-for-sale were $122,486,000 and $118,196,000 at June 30, 2000 and
December 31, 1999. These sources were adequate to meet seasonal deposit
withdrawals during the first half of 2000 and should be adequate to meet normal
fluctuations in
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QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
LIQUIDITY (Continued)
loan demand and or deposit withdrawals. During the second quarter of 2000, QNB
used both its Federal funds line and overnight borrowings from the Federal Home
Loan Bank to fund loan growth. Management determined it was more beneficial to
use these short-term borrowing vehicles to fund the demand than to sell
investment securities. Approximately $39,113,000 and $43,963,000 of
available-for-sale securities at June 30, 2000 and December 31, 1999 were
pledged as collateral for repurchase agreements and deposits of public funds as
required by law.
The consolidated statements of cash flows present the changes in cash and cash
equivalents from operating, investing and financing activities. QNB's cash and
cash equivalents decreased $4,387,000 to $14,965,000 at June 30, 2000. This
compares to a $474,000 decrease during the first six months of 1999. The large
decrease in cash in 2000 is a result of liquidity planning for potential Year
2000 concerns. QNB increased cash at the end of 1999 as a contingency plan for
any potential Year 2000 problems. This excess cash was reinvested in investment
securities in January and February of 2000 after Year 2000 concerns passed.
After adjusting net income for non-cash transactions, operating activities
provided $3,874,000 in cash flow in the first six months of 2000, compared to
$6,953,000 in the same period of 1999. A higher volume of residential mortgage
loan activity in 1999 accounted for most of the difference between the periods.
Net cash used by investing activities was $18,526,000 during the first half of
2000. Loan growth, particularly during the second quarter of 2000, created a net
increase in loans and a use of cash of $10,826,000 during the first six months
of 2000. In addition, the purchase of investment securities exceeded the
maturity, call and sale of securities by $7,286,000 during the first half of
2000. Most of this activity relates to the reinvestment of the excess Year 2000
cash buildup. With the increase in interest rates at the end of 1999 and early
2000, cash flow from mortgage-backed securities and from callable bonds slowed,
reducing liquidity and the amount of cash available for reinvestment. Net cash
used by investing activities was $41,333,000 during the first six months of
1999. The purchase of investment securities exceeded the maturity, call and sale
of securities by $34,652,000 during the first half of 1999. The $25,000,000
wholesale funding transaction provided most of the additional cash for the
purchases. An increase in Federal funds sold of $3,431,000 and loans of
$3,152,000 were also a use of cash during 1999.
Net cash provided by financing activities was $10,265,000 during the first half
of 2000 and $33,906,000 during the six months of 1999. Increases in both
non-interest bearing demand accounts and interest-bearing deposits provided
$9,021,000 during the first six months of 2000. The introduction of the Treasury
Select Money Market Account provided the impetus for much of the growth in
interest-bearing deposits. Short-term borrowings increased $2,397,000 during the
first half of 2000, with cash management accounts increasing $2,747,000 and
Federal funds purchased decreasing $476,000 during this period. The cash
dividend of $712,000 and the purchase of $466,000 of treasury stock during the
first six months of 2000 were a both a use of cash and a reduction to
shareholder's equity. Net cash provided by financing activities was $33,906,000
during the first half of 1999 and $9,833,000 during the first half of 1998.
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 $10,286,000 during the first six months of 1999. Time deposits over
$100,000 accounted for $8,441,000 of the total increase. These deposits tend to
be short-term in nature and pay a higher rate of interest. During the first half
of 1999 short-term borrowings, primarily cash management accounts, decreased by
$3,831,000.
Page 18
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
CAPITAL ADEQUACY
A strong capital position is fundamental to support continued growth and
profitability, to serve the needs of depositors, and to yield an attractive
return for shareholders. QNB's shareholders' equity at June 30, 2000 was
$28,355,000 or 7.82 percent of total assets compared to shareholders' equity of
$27,462,000 or 7.84 percent at December 31, 1999. Shareholders' equity at June
30, 2000 includes a negative adjustment of $2,738,000 related to unrealized
holding losses, net of taxes, on investment securities available-for-sale, while
shareholders' equity at December 31, 1999 includes a negative adjustment of
$2,604,000. Without these adjustments shareholders' equity to total assets would
have been 8.57 percent and 8.58 percent at June 30,1999 and December 31, 1999.
On March 30, 2000, the Board of Directors of QNB Corp. approved a plan to
repurchase up to 4.99 percent of the shares of QNB Corp's outstanding common
stock in open market and privately negotiated transactions. As of June 30, 2000
16,169 shares had been repurchased at a cost of $466,000. These shares are
recorded as Treasury stock at cost and reduce total shareholder's equity. During
the second quarter the Board of Directors declared a 5 percent stock dividend
payable June 30, 2000. Per share information has been adjusted to reflect the
impact of the stock dividend.
Shareholders' equity averaged $30,656,000 for the first six months of 2000 and
$28,880,000 during all of 1999, an increase of 6.2 percent. The ratio of average
total equity to average total assets improved to 8.58 percent for 2000, compared
to 8.38 percent for 1999. The increase in the equity to asset ratio is a
function of higher net income and modest growth in average assets since the end
of 1999. The ratio increased despite the 18.3 percent increase in the cash
dividend and the repurchase of common stock, both of which reduce shareholder's
equity.
QNB Corp. and the Quakertown National Bank are subject to various regulatory
capital requirements as issued by Federal regulatory authorities. Regulatory
capital is defined in terms of Tier I capital (shareholders' equity excluding
unrealized gains or losses on available-for-sale securities), Tier II capital
which includes a portion of the allowance for loan losses, and total capital
(Tier I plus II). Risk-based capital ratios are expressed as a percentage of
risk-weighted assets. Risk-weighted assets are determined by assigning various
weights to all assets and off-balance sheet arrangements, such as letters of
credit and loan commitments, based on associated risk. Regulators have also
adopted minimum Tier I leverage ratio standards, which measure the ratio of Tier
I capital to total assets.
The minimum regulatory capital ratios are 4.00 percent for Tier I, 8.00 percent
for the total risk-based and 4.00 percent for leverage. Under the requirements,
QNB has a Tier I capital ratio of 14.74 percent and 15.25 percent, a total
risk-based ratio of 15.99 percent and 16.50 percent and a leverage ratio of 8.40
percent and 8.38 percent at June 30, 2000 and December 31, 1999, respectively.
The Federal Deposit Insurance Corporation Improvement Act of 1991 established
five capital level designations ranging from "well capitalized" to "critically
undercapitalized." At June 30, 2000 and December 31, 1999 QNB met the "well
capitalized" criteria which requires minimum Tier I and total risk-based capital
ratios of 6.00 percent and 10.00 percent, respectively, and a Tier I leverage
ratio of 5.00 percent.
Page 19
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INTEREST RATE SENSITIVITY
Since the assets and liabilities of QNB have diverse re-pricing characteristics
that influence net interest income, management analyzes interest sensitivity
through the use of gap analysis and simulation models. Interest rate sensitivity
management seeks to minimize the effect of interest rate changes on net interest
margins and interest rate spreads, and to provide growth in net interest income
through periods of changing interest rates. The Asset/Liability Management
Committee (ALCO) is responsible for managing interest rate risk and for
evaluating the impact of changing interest rate conditions on net interest
income. Gap analysis measures the difference between volumes of rate-sensitive
assets and liabilities and quantifies these re-pricing differences for various
time intervals. Static gap analysis describes interest rate sensitivity at a
point in time. However, it alone does not accurately measure the magnitude of
changes in net interest income since changes in interest rates do not impact all
categories of assets and liabilities equally or simultaneously. Interest rate
sensitivity analysis also involves assumptions on certain categories of assets
and deposits. For purposes of interest rate sensitivity analysis, assets and
liabilities are stated at their contractual maturity, estimated likely call
date, or earliest re-pricing opportunity. Mortgage-backed securities and
amortizing loans are scheduled based on their anticipated cash flow. Savings
accounts, including passbook, statement savings, money market, and
interest-bearing demand accounts, do not have a stated maturity or re-pricing
term and can be withdrawn or re-priced at any time. This may impact QNB's margin
if more expensive alternative sources of deposits are required to fund loans or
deposit runoff. Management projects the re-pricing characteristics of these
accounts based on historical performance and assumptions that it believes
reflect their rate sensitivity. 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 also uses a simulation model to assess the impact of changes in interest
rates on net interest income. The model reflects management's assumptions
related to asset yields and rates paid on liabilities, deposit sensitivity, and
the size, composition and maturity or re-pricing characteristics of the balance
sheet. The assumptions are based on what management believes at that time to be
the most likely interest rate environment. Management also evaluates the impact
of higher and lower interest rates.
Management believes that the assumptions utilized in evaluating the
vulnerability of QNB's net interest income to changes in interest rates
approximate actual experience; however, the interest rate sensitivity of QNB's
assets and liabilities as well as the estimated effect of changes in interest
rates on net interest income could vary substantially if different assumptions
are used or actual experience differs from the experience on which the
assumptions were based.
In the event QNB should experience a mismatch in its desired gap ranges or an
excessive decline in its net interest income subsequent to an immediate and
sustained change in interest rates, it has a number of options which it could
utilize to remedy such a mismatch. QNB could restructure its investment
portfolio through the sale or purchase of securities with more favorable
re-pricing attributes. It could also emphasize loan products with appropriate
maturities or re-pricing attributes, or it could attract deposits or obtain
borrowings with desired maturities.
No material changes in QNB's interest rate risk, market risk or strategies
occurred during the current period. A detailed discussion of market risk is
provided in the Form 10-K for the period ended December 31, 1999.
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 June 30, 2000, QNB did not have any hedging
transactions in place such as interest rate swaps, caps or floors.
Page 20
<PAGE>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
OTHER ITEMS
Management is not aware of any current specific recommendations by regulatory
authorities or proposed legislation, which if they were implemented, would have
a material adverse effect upon the liquidity, capital resources, or results of
operations, although the general cost of compliance with numerous and multiple
federal and state laws and regulations does have, and in the future may have, a
negative impact on QNB's results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
The information required herein is set forth in Item 2, above.
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QNB CORP. AND SUBSIDIARY
PART II. OTHER INFORMATION
JUNE 30, 2000
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities
None.
Item 3. Default Upon Senior Securities
None.
Item 4. Submission of Matters to Vote of Securities Holders
The 2000 Annual Meeting (the "Meeting") of the shareholders of QNB
Corp. (the Registrant") was held on May 16, 2000. Notice of the
Meeting was mailed to shareholders of record on or about April 14,
2000, together with proxy solicitation materials prepared in
accordance with Section 14(a) of the Securities Exchange Act of 1934,
as amended, and the regulations promulgated thereunder.
The Meeting was held for the following purpose:
(1) To elect three (3) Directors
There was no solicitation in opposition to the nominees of the Board
of Directors for election to the Board of Directors and all such
nominees were elected. The number of votes cast for or withheld, as
well as the number of abstentions and broker non-votes for each of the
nominees for election to the Board of Directors were as follows:
Nominee For Withhold
------- --- --------
Thomas J. Bisko 1,210,996 2,063
Dennis Helf 1,204,616 8,443
Donald T. Knauss 1,211,252 1,807
The continuing directors of the Registrant are:
Gary S. Parzych, Norman L. Baringer, Charles M. Meredith, III,
Kenneth F. Brown, Jr., Henry L. Rosenberger and Edgar L. Stauffer.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
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<PAGE>
The following Exhibits are included in this Report:
Exhibit 3.1 Articles of Incorporation of Registrant, as amended.
(Incorporated by reference to Exhibit 3.1 of Registrants Form
10-Q filed with the Commission on August 13, 1998).
Exhibit 3.2 Bylaws of Registrant, as amended. (Incorporated by reference to
Exhibit 3.1 of Registrants Form 10-Q filed with the Commission on
August 13, 1998).
Exhibit 10.1 Employment Agreement between the Registrant and Thomas J. Bisko.
(Incorporated by reference to Exhibit 10.1 of Registrants Form
10-K filed with the Commission on March 31, 1999).
Exhibit 10.2 Salary Continuation Agreement between the Registrant and Thomas
J. Bisko. (Incorporated by reference to Exhibit 10.2 of
Registrants Form 10-K filed with the Commission on March 31,
1999).
Exhibit 10.3 QNB Corp. 1998 Stock Incentive Plan. (Incorporated by reference
to Exhibit 4.3 to Registration Statement No. 333-91201 on Form
S-8, filed with the Commission on November 18, 1999).
Exhibit 10.4 QNB Corp. 1988 Stock Incentive Plan. (Incorporated by reference
to Exhibit 4A to Registration Statement No. 333-16627 on Form
S-8, filed with the Commission on November 22, 1996).
Exhibit 10.5 QNB Corp. Employee Stock Purchase Plan. (Incorporated by
reference to Exhibit 4B to Registration Statement No. 333-16627
on Form S-8, filed with the Commission on November 22, 1996).
Exhibit 10.6 The Quakertown National Bank Profit Sharing and Section 401(k)
Salary Deferral Plan. (Incorporated by reference to Exhibit 4C to
Registration Statement No. 333-16627 on Form S-8, filed with the
Commission on November 22, 1996).
Exhibit 11
Statement Re: Computation of Earnings Per Share. (Included in
Part I, Item I, hereof.)
Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K
Filed April 7, 2000, Plan approved by QNB Corp.'s Board of
Directors to repurchase up to 4.99 percent of the
Registrant's shares of outstanding common stock in the open
market or privately negotiated transactions.
Page 23
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
QNB Corp.
Date: August 11, 2000 By:
--------------- -------------------------------
Thomas J. Bisko
President/CEO
Date: August 11, 2000 By:
--------------- -------------------------------
Robert C. Werner
Vice President
Date: August 11, 2000 By:
--------------- -------------------------------
Bret H. Krevolin
Chief Accounting Officer
Page 24
