SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June, 30, 2004
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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
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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)
15 North Third Street, Quakertown, PA 18951-9005
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (215)538-5600
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Not Applicable
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Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report.
Indicate by check |X| whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes_X__ No____
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes____ No__X__
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 August 10, 2004
Common Stock, par value $.625 3,096,865
<page>
QNB CORP. AND SUBSIDIARY
FORM 10-Q
QUARTER ENDED JUNE 30, 2004
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) PAGE
Consolidated Statements of Income for Three and
Six Months Ended June 30, 2004 and 2003............................1
Consolidated Balance Sheets at June 30, 2004
and December 31, 2003..............................................2
Consolidated Statements of Cash Flows for Six
Months Ended June 30, 2004 and 2003................................3
Notes to Consolidated Financial Statements............................4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION.................................9
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK ......................................................29
ITEM 4. CONTROLS AND PROCEDURES..............................................29
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS ...................................................30
ITEM 2. CHANGES IN SECURITIES ...............................................30
ITEM 3. DEFAULTS UPON SENIOR SECURITIES .....................................30
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITIES HOLDERS...............30
ITEM 5. OTHER INFORMATION ...................................................30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ....................................31
SIGNATURES
CERTIFICATIONS
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QNB CORP. AND SUBSIDIARY
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CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share data)
(unaudited)
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Three Months Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
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INTEREST INCOME
Interest and fees on loans................................................... $ 3,409 $ 3,660 $ 6,758 $ 7,223
Interest and dividends on investment securities:
Taxable.................................................................. 2,186 2,015 4,387 4,173
Tax-exempt............................................................... 546 504 1,095 1,046
Interest on Federal funds sold............................................... 12 40 33 76
Other interest income........................................................ 19 22 35 56
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Total interest income.......................................... 6,172 6,241 12,308 12,574
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INTEREST EXPENSE
Interest on deposits
Interest-bearing demand accounts.................................... 120 123 270 238
Money market accounts............................................... 57 78 118 165
Savings............................................................. 54 99 106 207
Time ............................................................... 1,006 1,152 2,002 2,317
Time over $100,000.................................................. 236 276 448 565
Interest on short-term borrowings............................................ 28 24 50 53
Interest on Federal Home Loan Bank advances.................................. 718 719 1,435 1,431
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Total interest expense......................................... 2,219 2,471 4,429 4,976
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Net interest income............................................ 3,953 3,770 7,879 7,598
Provision for loan losses.................................................... - - - -
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Net interest income after provision for loan losses............ 3,953 3,770 7,879 7,598
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NON-INTEREST INCOME
Fees for services to customers............................................... 526 461 972 875
ATM and debit card income.................................................... 152 151 280 282
Income on cash surrender value of insurance.................................. 70 78 138 155
Mortgage servicing income (loss)............................................. 69 (46) 63 (105)
Net gain on investment securities available-for-sale......................... 217 147 696 302
Net (loss) gain on sale of loans............................................. (2) 489 98 850
Other operating income....................................................... 141 146 296 305
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Total non-interest income...................................... 1,173 1,426 2,543 2,664
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Non-Interest Expense
Salaries and employee benefits............................................... 1,712 1,761 3,506 3,537
Net occupancy expense........................................................ 251 210 489 425
Furniture and equipment expense.............................................. 274 269 517 539
Marketing expense............................................................ 148 115 255 215
Third party services......................................................... 175 168 330 359
Telephone, postage and supplies expense...................................... 140 126 256 263
State taxes ............................................................... 119 92 231 175
Other expense........................................................... 362 336 675 643
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Total non-interest expense..................................... 3,181 3,077 6,259 6,156
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Income before income taxes ........................................ 1,945 2,119 4,163 4,106
Provision for income taxes................................................... 426 489 922 945
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Net Income.......................................................... $ 1,519 $ 1,630 $ 3,241 $ 3,161
====================================================================================================================================
Net Income Per Share - Basic........................................ $ .49 $ .53 $ 1.05 $ 1.02
====================================================================================================================================
Net Income Per Share - Diluted...................................... $ .48 $ .52 $ 1.02 $ 1.01
====================================================================================================================================
Cash Dividends Per Share............................................ $ .185 $ .165 $ .37 $ .33
====================================================================================================================================
<FN>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
</FN>
PAGE 1
QNB CORP. AND SUBSIDIARY
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CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
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JUNE 30, DECEMBER 31,
2004 2003
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ASSETS
Cash and due from banks................................................................................. $ 22,232 $ 21,534
Federal funds sold...................................................................................... - 4,532
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Total cash and cash equivalents................................................................ 22,232 26,066
Investment securities
Available-for-sale (cost $250,484 and $257,084).................................................... 248,276 260,631
Held-to-maturity (market value $7,255 and $12,334)...................................................... 7,118 12,012
Non-marketable equity securities........................................................................ 3,880 3,810
Loans held-for-sale..................................................................................... 125 1,439
Total loans, net of unearned income of $46 and $153 ................................................. 260,194 232,127
Allowance for loan losses............................................................................... (2,898) (2,929)
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Net loans...................................................................................... 257,296 229,198
Cash surrender value of insurance....................................................................... 7,728 7,585
Premises and equipment, net............................................................................. 5,271 5,090
Accrued interest receivable ............................................................................ 2,386 2,823
Other assets............................................................................................ 3,758 2,177
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Total assets............................................................................................ $ 558,070 $ 550,831
====================================================================================================================================
LIABILITIES
Deposits
Demand, non-interest-bearing....................................................................... $ 58,498 $ 50,468
Interest-bearing demand accounts................................................................... 91,768 107,648
Money market accounts.............................................................................. 38,370 38,373
Savings............................................................................................ 56,169 52,008
Time............................................................................................... 157,155 151,304
Time over $100,000................................................................................. 41,609 38,838
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Total deposits................................................................................. 443,569 438,639
Short-term borrowings................................................................................... 15,043 10,416
Federal Home Loan Bank advances......................................................................... 55,000 55,000
Accrued interest payable................................................................................ 1,146 1,285
Other liabilities....................................................................................... 1,534 2,051
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Total liabilities....................................................................................... 516,292 507,391
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Commitments and contingencies
SHAREHOLDERS' EQUITY
Common stock, par value $.625 per share;
authorized 10,000,000 shares; 3,203,531 and 3,202,065 shares issued;
3,096,845 and 3,095,379 shares outstanding......................................................... 2,002 2,001
Surplus ............................................................................................... 8,972 8,933
Retained earnings....................................................................................... 33,755 31,659
Accumulated other comprehensive (loss) gain, net........................................................ (1,457) 2,341
Treasury stock, at cost; 106,686 shares ................................................................ (1,494) (1,494)
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Total shareholders' equity.............................................................................. 41,778 43,440
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Total liabilities and shareholders' equity.............................................................. $ 558,070 $ 550,831
====================================================================================================================================
<FN>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
</FN>
PAGE 2
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QNB CORP. AND SUBSIDIARY
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CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
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SIX MONTHS ENDED JUNE 30, 2004 2003
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OPERATING ACTIVITIES
Net income......................................................................................... $ 3,241 $ 3,161
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization................................................................... 397 423
Securities gains .............................................................................. (696) (302)
Net gain on sale of loans....................................................................... (98) (850)
Loss on disposal of premises and equipment...................................................... - 9
Proceeds from sales of residential mortgages.................................................... 6,278 25,693
Originations of residential mortgages held-for-sale............................................. (4,990) (23,546)
Proceeds from sales of student loans............................................................ - 402
Originations of student loans................................................................... - (160)
Income on cash surrender value of insurance..................................................... (138) (155)
Life insurance proceeds/premiums, net........................................................... (5) (5)
Deferred income tax provision................................................................... 227 14
Change in income taxes payable.................................................................. 123 114
Net decrease in interest receivable............................................................. 437 136
Net amortization of premiums and discounts...................................................... 513 832
Net decrease in interest payable................................................................ (139) (95)
Increase in other assets ....................................................................... (310) (407)
(Decrease) increase in other liabilities........................................................ (231) 457
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Net cash provided by operating activities....................................................... 4,609 5,721
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INVESTING ACTIVITIES
Proceeds from maturities and calls of investment securities
available-for-sale.............................................................................. 36,958 47,323
held-to-maturity................................................................................ 4,897 12,048
Proceeds from sales of investment securities
available-for-sale.............................................................................. 42,820 28,315
Purchase of investment securities
available-for-sale.............................................................................. (72,901) (81,978)
Net change in non-marketable equity securities..................................................... (70) (148)
Net increase in loans.............................................................................. (28,021) (22,220)
Net purchases of premises and equipment............................................................ (578) (204)
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Net cash used by investing activities........................................................... (16,895) (16,864)
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FINANCING ACTIVITIES
Net increase in non-interest-bearing deposits...................................................... 8,030 11,064
Net (decrease) increase in interest-bearing non-maturity deposits.................................. (11,722) 6,554
Net increase in time deposits...................................................................... 8,622 10,852
Net increase (decrease) in short-term borrowings................................................... 4,627 (6,539)
Cash dividends paid................................................................................ (1,145) (1,020)
Proceeds from issuance of common stock............................................................. 40 110
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Net cash provided by financing activites........................................................ 8,452 21,021
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(Decrease) increase in cash and cash equivalents................................................ (3,834) 9,878
Cash and cash equivalents at beginning of year.................................................. 26,066 27,477
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Cash and cash equivalents at end of period...................................................... $ 22,232 $37,355
====================================================================================================================================
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid...................................................................................... $ 4,568 $ 5,071
Income taxes paid.................................................................................. 560 805
Non-Cash Transactions
Change in net unrealized holding (losses) gains, net of taxes,
on investment securities available-for-sale (3,798) 298
<FN>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
</FN>
PAGE 3
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004 AND 2003, AND DECEMBER 31, 2003
(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, 2004, as well as the respective
statements of income and cash flows for the three-month and six-month periods
ended March 31, 2004 and 2003, are unaudited. These financial statements should
be read in conjunction with the audited financial statements and notes thereto
included in QNB's 2003 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. Certain items in the 2003
financial statements have been reclassified to conform to the 2004 financial
statement presentation format. These reclassifications had no effect on net
income. The results for the periods presented are not necessarily indicative of
the full year. Tabular information other than share date is presented in
thousands of dollars.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amount 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.
STOCK SPLIT
On August 19, 2003 the Board of Directors authorized a two-for-one split of the
Company's common stock, affected by a distribution on October 14, 2003 of one
share for each one share held of record at the close of business on September
30, 2003. All earnings per share and common stock information is presented as if
the stock split occurred prior to the earliest year included in these financial
statements.
STOCK BASED COMPENSATION
At June 30, 2004, QNB has a stock-based employee compensation plan that is
accounted for under the recognition and measurement principles of APB Opinion
No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations.
No stock-based employee compensation cost is reflected in net income, as all
options granted under the plan had an exercise price equal to the market value
of the underlying common stock on the date of grant. The "fair value" approach
under SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, takes into account
the time value of the option and will generally result in compensation expense
being recorded. Each year since the inception of SFAS No. 123, QNB has
disclosed, in the notes to the financial statements contained in its annual
report to shareholders, what the earnings impact would have been had QNB elected
the "fair value" approach under SFAS No. 123. Such disclosure is now required on
a quarterly basis in accordance with SFAS No. 148, ACCOUNTING FOR STOCK-BASED
COMPENSATION - TRANSITION AND DISCLOSURE - AN AMENDMENT OF FASB STATEMENT NO.
123.
Form 10-Q
Page 4
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QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004 AND 2003, AND DECEMBER 31, 2003
(UNAUDITED)
The following table illustrates the effect of net income and earnings per share
if the company had applied the fair value recognition provisions of FASB
Statement No. 123 to stock-based employee compensation.
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
---- ---- ---- ----
Net income, as reported $1,519 $1,630 $3,241 $3,161
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects 26 26 44 52
Pro forma net income $1,493 $1,604 $3,197 $3,109
Earnings per share
Basic - as reported $0.49 $0.53 $1.05 $1.02
Basic - pro forma $0.48 $0.52 $1.03 $1.01
Diluted - as reported $0.48 $0.52 $1.02 $1.01
Diluted - pro forma $0.47 $0.51 $1.01 $0.99
2. PER SHARE DATA
The following sets forth the computation of basic and diluted earnings per share
(share and per share data are not in thousands):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
---- ---- ---- ----
Numerator for basic and diluted earnings
per share-net income $1,519 $1,630 $3,241 $3,161
Denominator for basic earnings per share-
weighted average shares outstanding 3,095,927 3,091,502 3,095,653 3,089,196
Effect of dilutive securities-employee
stock options 82,305 44,709 83,531 40,899
Denominator for diluted earnings per
share- adjusted weighted average
shares outstanding 3,178,232 3,136,211 3,179,184 3,130,095
Earnings per share-basic $0.49 $0.53 $1.05 $1.02
Earnings per share-diluted $0.48 $0.52 $1.02 $1.01
Form 10-Q
Page 5
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QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004 AND 2003, AND DECEMBER 31, 2003
(UNAUDITED)
2. PER SHARE DATA (Continued):
There were 20,000 stock options that were anti-dilutive for the three-month
period ended June 30, 2004. There were no stock options that were anti-dilutive
for the three-month period ended June 30, 2003 or the six-month periods ended
June 30, 2004 or 2003.
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, 2004 and 2003 (net of the income tax effect):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
---- ---- ---- ----
Unrealized holding (losses) gains arising during
the period on securities held $(4,964) $434 $(3,339) $497
Reclassification adjustment for sold securities (143) (97) (459) (199)
------- ---- ------- -------
Net change in unrealized (losses) gains during
the period (5,107) 337 (3,798 298
Unrealized holding gains, beginning of period 3,650 3,564 2,341 3,603
------- ---- ------- -------
Unrealized holding (losses) gains, end of period $(1,457) $3,901 $(1,457) $3,901
======= ====== ======== ======
Net income $1,519 $ 1,630 $3,241 $3,161
Other comprehensive income, net of tax:
Unrealized holding (losses) gains arising during
the period (5,107) 337 (3,798) 298
-------- ------ ------ ------
Comprehensive (loss) income $(3,588) $1,967 $(557) $3,459
======== ====== ====== ======
Form 10-Q
Page 6
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QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004 AND 2003, AND DECEMBER 31, 2003
(UNAUDITED)
4. LOANS
The following table presents Loans by category as of June 30, 2004 and December
31, 2003:
June 30, December 31,
2004 2003
-------- -----------
Commercial and industrial $59,975 $47,196
Agricultural 11 14
Construction 6,706 9,056
Real estate-commercial 95,706 86,707
Real estate-residential 92,009 83,703
Consumer 5,833 5,604
------- -------
Total loans 260,240 232,280
Less unearned income 46 153
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Total loans net of unearned income $260,194 $232,127
======== ========
5. INTANGIBLE ASSETS
The following table presents Intangible Asset information as of June 30, 2004:
- ------------------------------------ ----------------------- ------------------------- ----------------------
Amortized Intangible Assets Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
- ------------------------------------ ----------------------- ------------------------- ----------------------
Purchased deposit premium $511 $341 $170
- ------------------------------------ ----------------------- ------------------------- ----------------------
Mortgage servicing asset 732 144 588
- ------------------------------------ ----------------------- ------------------------- ----------------------
Total $1,243 $485 $758
- ------------------------------------ ----------------------- ------------------------- ----------------------
The following table presents Intangible Asset information as of December 31,
2003:
- ------------------------------------ ----------------------- ------------------------- ----------------------
Amortized Intangible Assets Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
- ------------------------------------ ----------------------- ------------------------- ----------------------
Purchased deposit premium $511 $315 $196
- ------------------------------------ ----------------------- ------------------------- ----------------------
Mortgage servicing asset 741 159 582
- ------------------------------------ ----------------------- ------------------------- ----------------------
Total $1,252 $474 $778
- ------------------------------------ ----------------------- ------------------------- ----------------------
AGGREGATE AMORTIZATION EXPENSE
For the Six Months ended June 30, 2004 $97
ESTIMATED AMORTIZATION EXPENSE
For the Year Ended 12/31/04 $144
For the Year Ended 12/31/05 149
For the Year Ended 12/31/06 136
For the Year Ended 12/31/07 114
For the Year Ended 12/31/08 59
Form 10-Q
Page 7
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QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004 AND 2003, AND DECEMBER 31, 2003
(UNAUDITED)
6. RECENT ACCOUNTING PRONOUNCEMENTS
STOCK-BASED COMPENSATION
On March 31, 2004, the FASB issued a proposed Statement, SHARE-BASED PAYMENT AN
AMENDMENT OF FASB STATEMENTS NO. 123 AND APB NO. 95, that addresses the
accounting for share-based payment transactions in which an enterprise receives
services in exchange for (a) equity instruments of the enterprise or (b)
liabilities that are based on the fair value of the enterprise's equity
instruments or that may be settled by the issuance of such equity instruments.
Under the FASB's proposal, all forms of share-based payments to employees,
including employee stock options, would be treated the same as other forms of
compensation by recognizing the related cost in the income statement. The
expense of the award would generally be measured at fair value at the grant
date. Current accounting guidance requires that the expense relating to
so-called fixed plan employee stock options only be disclosed in the footnotes
to the financial statements. The proposed Statement would eliminate the ability
to account for share-based compensation transactions using APB Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. QNB is currently evaluating this
proposed statement and its effects on its results of operations.
Form 10-Q
Page 8
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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. The Corporation through its wholly owned subsidiary,
The Quakertown National Bank (the "Bank"), has been serving the residents and
businesses of Upper Bucks, Northern Montgomery and Southern Lehigh Counties in
Pennsylvania since 1877. The Bank is a locally managed community bank that
provides a full range of commercial, retail banking and trust and investment
management services. The consolidated entity is referred to herein as "QNB".
THIS REPORT INCLUDES FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT WITH RESPECT TO FINANCIAL PERFORMANCE
AND OTHER FINANCIAL AND BUSINESS MATTERS. FORWARD-LOOKING STATEMENTS ARE
TYPICALLY IDENTIFIED BY WORDS OR PHRASES SUCH AS "BELIEVE," "EXPECT,"
"ANTICIPATE," "INTEND," "ESTIMATE," "POSITION" AND VARIATIONS OF SUCH WORDS AND
SIMILAR EXPRESSIONS, OR FUTURE OR CONDITIONAL VERBS SUCH AS "WILL," "WOULD,"
"SHOULD," "COULD," "MAY" OR SIMILAR EXPRESSIONS. THE CORPORATION CAUTIONS THAT
THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO NUMEROUS ASSUMPTIONS, RISKS AND
UNCERTAINTIES, ALL OF WHICH CHANGE OVER TIME, AND THE CORPORATION ASSUMES NO
DUTY TO UPDATE FORWARD LOOKING STATEMENTS. ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS.
IN ADDITION TO FACTORS PREVIOUSLY DISCLOSED BY THE CORPORATION AND THOSE
IDENTIFIED ELSEWHERE HEREIN, THE FOLLOWING FACTORS, AMONG OTHERS, COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM FORWARD LOOKING STATEMENTS: INCREASED
CREDIT RISK; THE INTRODUCTION, WITHDRAWAL, SUCCESS AND TIMING OF BUSINESS
INITIATIVES AND STRATEGIES; CHANGES IN COMPETITIVE CONDITIONS; THE INABILITY TO
SUSTAIN REVENUE AND EARNINGS GROWTH; CHANGES IN ECONOMIC CONDITIONS, INTEREST
RATES AND FINANCIAL AND CAPITAL MARKETS; INFLATION; CHANGES IN INVESTMENT
PERFORMANCE; CUSTOMER DISINTERMEDIATION; CUSTOMER BORROWING, REPAYMENT,
INVESTMENT AND DEPOSIT PRACTICES; CUSTOMER ACCEPTANCE OF QNB PRODUCTS AND
SERVICES; AND THE IMPACT, EXTENT AND TIMING OF TECHNOLOGICAL CHANGES, CAPITAL
MANAGEMENT ACTIVITIES, ACTIONS OF THE FEDERAL RESERVE BOARD AND LEGISLATIVE AND
REGULATORY ACTIONS AND REFORMS.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Discussion and analysis of the financial condition and results of operations are
based on the consolidated financial statements of QNB, which are prepared in
accordance with accounting principles generally accepted in the United States of
America (GAAP). The preparation of these financial statements requires QNB to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. QNB evaluates estimates on an on-going basis, including those
related to the allowance for loan losses, non-accrual loans, other real estate
owned, other-than-temporary investment impairments, intangible assets, stock
option plan and income taxes. QNB bases its estimates on historical experience
and various other factors and assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
QNB believes the following critical accounting policies affect its more
significant judgments and estimates used in preparation of its consolidated
financial statements: allowance for loan losses, income taxes and other-than-
Form 10-Q
Page 9
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
CRITICAL ACCOUNTING POLICIES AND ESTIMATES (CONTINUED)
temporary investment security impairment. Each estimate is discussed below. The
financial impact of each estimate is discussed in the applicable sections of
Management's Discussion and Analysis.
ALLOWANCE FOR LOAN LOSSES
QNB maintains an allowance for loan losses, which is intended to absorb probable
known and inherent losses in the outstanding loan portfolio. The allowance is
reduced by actual credit losses and is increased by the provision for loan
losses and recoveries of previous losses. The provisions for loan losses are
charged to earnings to bring the total allowance for loan losses to a level
considered necessary by management.
The allowance for loan losses is based on management's continuing review and
evaluation of the loan portfolio. The level of the allowance is determined by
assigning specific reserves to individually identified problem credits and
general reserves to all other loans. The portion of the allowance that is
allocated to internally criticized and non-accrual loans is determined by
estimating the inherent loss on each credit after giving consideration to the
value of underlying collateral. The general reserves are based on the
composition and risk characteristics of the loan portfolio, including the nature
of the loan portfolio, credit concentration trends, historic and anticipated
delinquency and loss experience, as well as other qualitative factors such as
current economic trends.
Management emphasizes loan quality and close monitoring of potential problem
credits. Credit risk identification and review processes are utilized in order
to assess and monitor the degree of risk in the loan portfolio. QNB's lending
and loan administration staff are charged with reviewing the loan portfolio and
identifying changes in the economy or in a borrower's circumstances which may
affect the ability to repay debt or the value of pledged collateral. A loan
classification and review system exists that identifies those loans with a
higher than normal risk of uncollectibility. Each commercial loan is assigned a
grade based upon an assessment of the borrower's financial capacity to service
the debt and the presence and value of collateral for the loan. An independent
loan review group tests risk assessments and evaluates the adequacy of the
allowance for loan losses. Management meets monthly to review the credit quality
of the loan portfolio and quarterly to review the allowance for loan losses.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review QNB's allowance for losses on loans.
Such agencies may require QNB to recognize additions to the allowance based on
their judgments about information available to them at the time of their
examination.
Management believes that it uses the best information available to make
determinations about the adequacy of the allowance and that it has established
its existing allowance for loan losses in accordance with GAAP. If circumstances
differ substantially from the assumptions used in making determinations, future
adjustments to the allowance for loan losses may be necessary and results of
operations could be affected. Because future events affecting borrowers and
collateral cannot be predicted with certainty, there can be no assurance that
increases to the allowance will not be necessary should the quality of any loans
deteriorate as a result of the factors discussed above.
INCOME TAXES. QNB accounts for income taxes under the asset/liability method.
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, as well as operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates
Form 10-Q
Page 10
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
CRITICAL ACCOUNTING POLICIES AND ESTIMATES (CONTINUED):
INCOME TAXES (CONTINUED)
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. A valuation allowance is established
against deferred tax assets when in the judgment of management, it is more
likely than not that such deferred tax assets will not become available. Because
the judgment about the level of future taxable income is dependent to a great
extent on matters that may, at least in part go beyond QNB's control, it is at
least reasonably possible that management's judgment about the need for a
valuation allowance for deferred taxes could change in the near term.
OTHER THAN TEMPORARY IMPAIRMENT OF INVESTMENT SECURITIES
Securities are evaluated periodically to determine whether a decline in their
value is other than temporary. Management utilizes criteria such as the
magnitude and duration of the decline, in addition to the reasons underlying the
decline, to determine whether the loss in value is other than temporary. The
term "other than temporary" is not intended to indicate that the decline is
permanent, but indicates that the prospects for a near-term recovery of value is
not necessarily favorable, or that there is a lack of evidence to support
realizable value equal to or greater than carrying value of the investment. Once
a decline in value is determined to be other than temporary, the value of the
security is reduced and a corresponding charge to earnings is recognized.
RESULTS OF OPERATIONS
QNB reported net income for the second quarter 2004 of $1,519,000 or $.48 per
common share on a diluted basis. This compares to $1,630,000 or $.52 per share
diluted for the same period in 2003. Net income for the first six months of 2004
was $3,241,000 or $1.02 per diluted share, a 2.5 percent increase over the
$3,161,000 or $1.01 per diluted share for the comparable period in 2003.
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 was 1.12 percent and 1.27 percent while the
return on average equity was 14.39 percent and 16.83 percent for the three
months ended June 30, 2004 and 2003, respectively. For the six-month periods
ended June 30, 2004 and 2003, return on average assets was 1.20 percent and 1.25
percent and the return on average equity was 15.50 percent and 16.61 percent,
respectively.
Contributing to the results for the second quarter of 2004 compared with the
second quarter of 2003 were the following:
o $183,000 increase in net interest income resulting from a 6.5 percent
increase in average earning assets offsetting a 4 basis point reduction
in the net interest margin to 3.38 percent for the second quarter of
2004 from 3.42 percent for the second quarter of 2003.
o Recognized $21,000 in interest and fees during the second quarter of
2004 on the pay-off of a loan that had not been accruing interest. This
recognition had an impact on the net interest margin of approximately 1
basis point.
o Interest rates increase significantly during the quarter and remain
volatile. Federal Reserve Bank Board raises Federal funds rate by .25
percent on June 30, 2004.
Form 10-Q
Page 11
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATION (CONTINUED)
o Mortgage servicing income $69,000 for the quarter in 2004 compared to a
loss of $46,000 in 2003. Primarily a result of the recovery of the
valuation allowance.
o Gain on investment securities $217,000 in 2004 compared to $147,0000 in
2003. Loss taken on restructure of fixed income portfolio offset by
gains from the equity portfolio.
o Higher interest rates reduce residential mortgage loan activity. Loss
on sale of loans $2,000 in the 2004 quarter compared to $489,000 in
gains in 2003.
o Non-interest expense increases 3.4 percent, some of the increase
relates to the opening of QNB's first supermarket branch.
o 3.7 percent increase in average loans, primarily commercial. Total
loans increase 10.7 percent from March 31, 2004 to June 30, 2004.
o 13.2 percent increase in average investment securities.
o 6.0 percent increase in average deposits centered in growth of
non-interest bearing and interest-bearing demand accounts and savings
accounts. Increase in interest-bearing demand accounts primarily a
result of municipal and school district deposits.
o Average short-term borrowings increase $4,352,000. Federal funds
purchased $7,949,000 at June 30, 2004. Used to fund significant loan
growth during the quarter.
These items as well as others will be explained more thoroughly in the next
sections.
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 increased 4.9 percent to $3,953,000 for the quarter ended
June 30, 2004 as compared to $3,770,000 for the quarter ended June 30, 2003. 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
5.0 percent from $4,105,000 for the three months ended June 30, 2003 to
$4,309,000 for the same period ended June 30, 2004. As has been the trend for
the past three years, the ability to increase net interest income is a result of
the tremendous growth in deposits and the investment of these deposits into
profitable loans and investment securities. The increase in average deposits
when comparing the second quarter of 2004 to the second quarter of 2003
primarily reflects the deposit growth achieved during 2003, particularly during
the third quarter of 2003. This growth was once again aided by economic
uncertainty, the conflict in Iraq and the threat of terrorism. Investors
continued to look to the safety of bank deposits and the U.S. Government bond
market. Also contributing to the growth in deposits during 2003, with an impact
on second quarter and six-month averages for 2004, was significant increases in
deposits of local municipalities and school districts. The majority of the
growth in these deposits is seasonal with a significant amount already withdrawn
during the first half of 2004. It is anticipated that these funds will be
re-deposited during the third quarter of 2004. These deposits were primarily
invested in securities whose cash flow will closely match the anticipated
run-off of the deposits.
Form 10-Q
Page 12
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (CONTINUED)
Average deposits increased $24,667,000 or 6.0 percent when comparing the second
quarters of 2004 and 2003. These deposits were used to fund the $8,593,000 or
3.7 percent increase in average loans and the $30,263,000 or 13.2 percent
increase in average investment securities.
The historically low interest rate environment of the past three years ended
during the second quarter of 2004 as interest rates turned higher in
anticipation of strong growth in the U.S economy and fears of inflation caused
by higher oil prices. Interest rates have been volatile during the first six
months of 2004. The two-year treasury security, which started 2004 at 1.82
percent, hit a low for 2004 of 1.46 percent in mid March and a high or 2.93
percent in mid June before ending the quarter at 2.68 percent. The 10-year
treasury had a similar pattern, starting the year at 4.25 percent, reaching a
low of 3.68 percent and a high of 4.87 percent before ending the quarter at 4.58
percent. On June 30, 2004 and August 10, 2004 the Federal Reserve Board raised
the target Federal funds rate by .25 percent to 1.50 percent. Despite the
increase in market interest rates during the second quarter of 2004, the long
period of historically low interest rates has had the impact of lowering the
yield on earning assets and the rate paid on interest-bearing liabilities, as
loans, investment securities and time deposits either repriced at lower rates or
were originated at lower interest rates. The yield on earning assets on a
tax-equivalent basis was 5.13 percent for the second quarter of 2004 versus 5.48
percent for the second quarter of 2003, while the rate paid on interest-bearing
liabilities was 1.99 percent and 2.34 percent for the same periods. The net
interest margin, on a tax-equivalent basis, declined 4 basis points to 3.38
percent for the three-month period ended June 30, 2004 compared with 3.42
percent for the same period in 2003.
The yield on loans decreased 62 basis points to 5.73 percent when comparing the
second quarter of 2003 to the second quarter of 2004. The average prime rate
when comparing the second quarter of 2003 to the second quarter of 2004
decreased 23 basis points, from 4.23 percent to 4.00 percent. While QNB was
negatively impacted from the decline in prime rate, the overall yield on the
loan portfolio did not decrease proportionately, since only a percentage of the
loan portfolio re-prices immediately with changes in the prime rate. A greater
contributor to the decline in yield on the loan portfolio was the impact of the
refinancing of residential mortgage, home equity and commercial loans into lower
yielding loans. The yield on the loan portfolio may continue to decline during
2004 as fixed rate loans are refinanced at lower rates, adjustable rate loans
re-price down as they reach their reset date and new loans are booked at the
current lower rates. The rate of decline or increase in loan yields will also be
determined by how quickly and to what degree the Federal Reserve Board continues
to increase interest rates. In anticipation of rising rates during 2004, QNB,
particularly with regard to commercial loans, has attempted to originate
floating rate loans indexed to the prime rate. This should help increase the
yield on the loan portfolio as interest rates increase.
When comparing the second quarter of 2004 to the second quarter of 2003, the
yield on investment securities decreased 20 basis points to 4.71 percent from
4.91 percent. The decline in the yield is primarily a result of the reinvestment
of cash flow from the investment portfolio into lower yielding securities as
well as the growth in deposits being invested in a lower interest rate
environment. During the fourth quarter of 2003 and the first half of 2004, QNB
entered into several transactions in an effort to reposition the portfolio in
anticipation of rising rates during 2004. These transactions were performed in
an effort to reduce extension risk on mortgage backed securities and CMO's
should interest rates rise and also to increase the overall yield on the
portfolio. The yield on the investment portfolio of 4.71 percent for the second
quarter of 2004 represents an increase from the 4.56 percent yield achieved
during the fourth quarter of 2003.
The increase in interest rates during the second quarter of 2004 in conjunction
with management's attempt to manage the prepayment situation by selling out of
certain faster paying CMO's and mortgage backed
Form 10-Q
Page 13
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (CONTINUED)
securities and purchasing lower coupon, lower premium mortgage backed securities
and CMOs has had the impact of slowing the prepayments on mortgage backed
securities and CMO's. This reduces the amount of amortization of premiums on
these bonds resulting in higher interest income and a higher yield. Amortization
expense on investment securities for the second quarter of 2004 was $184,000
compared to $303,000 for the same period in 2003.
While total interest income on a tax-equivalent basis decreased $48,000 when
comparing the second quarter of 2004 to the second quarter of 2003, total
interest expense decreased $252,000. The rate paid on interest bearing deposits
decreased from 1.93 percent to 1.55 percent for the quarters ended June 30, 2003
and 2004. The impact of lower rates on time deposits was the greatest
contributor to the decline in total interest expense and the rate paid on
interest bearing deposits. Total interest expense on time deposits decreased
$186,000 when comparing the two quarters. The average rate paid on time deposits
declined from 2.92 percent to 2.55 percent when comparing the two periods. Like
fixed-rate loans, certificates of deposit reprice over time and therefore have
less of an immediate impact on costs in either a rising or falling rate
environment. However, given the extended period of low interest rates, most time
deposits have already repriced lower and therefore the costs of time deposits
will likely not decline further. In fact, the yields on time deposits will
likely increase during the remainder of 2004 as the competition for these
deposits has already pushed rates higher. Average time deposits decreased
$686,000 to $195,589,000 when comparing the second quarter of 2004 to the same
period in 2003. A $1,973,000 increase in average time deposits with balances
less than $100,000 partially offset a $2,659,000 decrease in average time
deposits with balances of $100,000 or more.
Lower rates paid on money market accounts and savings accounts contributed to
the $21,000 and $45,000 decrease in interest expense for these products. The
average rate paid on money market accounts declined 29 basis points when
comparing the second quarter of 2004 cost of .62 percent to the second quarter
of 2003 cost of .91 percent. Contributing to the decline in the cost on money
market accounts was the decline in the rate paid on the Treasury Select Money
Market Account. This product is a variable rate account indexed to the monthly
average of the 91-day Treasury bill based on balances in the account. The yield
on this product will increase as short-term interest rates increase. In response
to lower market rates of interest in 2003 QNB lowered the rates paid on savings
accounts. The average rate paid on savings accounts declined 38 basis points to
..39 percent when comparing the second quarter of 2004 to the second quarter of
2003. When comparing the second quarter of 2004 to the second quarter of 2003
average money market accounts increased $2,839,000 while average savings
accounts increased $3,897,000. The continued growth in savings deposits can be
attributed to consumers looking for the relative safety of bank deposits despite
the low interest rate environment. The challenge will be to retain these
deposits as interest rates increase and confidence in the equity markets
improves.
Interest expense on interest bearing demand accounts decreased from $123,000 to
$120,000, while the cost of these accounts decreased from .63 percent to .52
percent, when comparing the three-month periods ended June 30, 2003 and 2004.
The average balance on these accounts increased from $77,951,000 to $93,103,000
when comparing the same two periods. As discussed previously, the majority of
the growth in interest bearing demand deposits can be attributed to the
successful development of relationships with several municipal organizations.
Management does not expect the cost of non-maturity interest-bearing deposits,
which reprice immediately when their rates are changed, to decline further. The
more likely scenario is that rates on non-maturity deposits will begin to rise
during 2004, as interest rates begin to increase as the economy improves.
Form 10-Q
Page 14
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (CONTINUED)
For the six-month period ended June 30, 2004, net interest income increased
$281,000 or 3.7 percent to $7,879,000. On a tax-equivalent basis net interest
income increased $301,000 or 3.6 percent. Included in net interest income for
the first six months of 2004 was $65,000 in interest and fees recognized on the
pay-off of three loans that had not been accruing interest. The increase in net
interest income is a result of the increase in average earning assets offsetting
the decline in the net interest margin. Average earning assets increased 7.1
percent while the net interest margin declined 12 basis points. The net interest
margin on a tax-equivalent basis was 3.40 percent for the six-month period ended
June 30, 2004 compared with 3.52 percent for the same period in 2003. The
recognition of interest and fees on non-accrual loans during the first half of
2004 had the impact of increasing the net interest margin by three basis points.
Total interest income decreased $266,000 from $12,574,000 to $12,308,000 when
comparing the six-month periods ended June 30, 2003 to June 30, 2004. The
decline in interest income is a result of the extended period of lower interest
rates. The yield on earning assets decreased from 5.63 percent to 5.15 percent,
with the yield on investment securities declining from 5.11 percent to 4.74
percent and the yield on loans declining from 6.47 percent to 5.79 percent
between the six-month periods. Average loans increased 4.5 percent to
$238,683,000 while average investment securities increased 12.5 percent to
$258,365,000.
Total interest expense decreased $547,000 from $4,976,000 to $4,429,000 for the
six-month periods with interest on money market accounts, savings accounts and
time deposits accounting for $47,000, $101,000 and $432,000 of the decrease. The
yield on these accounts declined 30 basis points, 45 basis points and 44 basis
points when comparing the average rate paid for the six-month periods ended June
30, 2004 and 2003. Interest expense on interest-bearing demand accounts
increased $32,000 to $270,000 as average balances increased $20,475,000 to
$96,671,000 for the six-month period ended June 30, 2004. Interest expense on
short-term borrowings declined by $3,000 as the average rate paid on these
accounts declined from 1.21 percent to .87 percent and the average balances
increased from $8,858,000 to $11,613,000.
QNB anticipates net interest income to increase over the next few quarters as a
result of both growth in earning assets, particularly loans, and an improvement
in the net interest margin. While average loans grew by only 3.7 percent when
comparing the second quarter of 2004 to the same quarter in 2003, total loans
increased by 9.6 percent from June 30, 2003 to June 30, 2004. Much of the loan
growth during the second quarter of 2004 occurred during the month of June and
will be reflected in the averages for the third quarter. Total loans have
increased 12.1 percent from December 31, 2003 to June 30, 2004. The net interest
margin should be positively impacted by this growth, as loans tend to earn
higher yields than investment securities. The net interest margin should also be
positively impacted by the investment security swap transaction entered into
during the second quarter of 2004 as well as the asset sensitivity position of
the balance sheet that should benefit QNB as interest rates increase. The
magnitude of this benefit will be influenced by the rate of increases by the
Federal Reserve Bank Board as well as QNB's ability to control the amount of
increase in deposit rates.
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 that represents management's best estimate of the known and
inherent losses in the existing loan portfolio. Actual loan losses, net of
recoveries, serve to reduce the allowance.
The determination of an appropriate level of the allowance for loan losses is
based upon an analysis of the risk inherent in QNB's loan portfolio. Management
uses various tools to assess the adequacy of the allowance for
Form 10-Q
Page 15
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
PROVISION FOR
LOAN LOSSES (CONTINUED)
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. Other tools include ratio
analysis and peer group analysis.
QNB's management determined no provision for loan losses was necessary for
either the three or six-month periods ended June 30, 2004 or 2003 as charged off
loans, non-performing assets and delinquent loans remained at low levels
relative to the allowance for loan losses. QNB had net charge-offs of $21,000
during the second quarter of 2004 and a net recovery of $4,000 during the second
quarter of 2003. For the six-month periods ended June 30, 2004 and 2003 QNB had
net charge-offs of $31,000 and $1,000, respectively.
Non-performing assets (non-accruing loans, loans past due 90 days or more, other
real estate owned and other repossessed assets) remained low amounting to .08
percent and .10 percent of total assets at June 30, 2004 and 2003. This compares
to .15 percent at December 31, 2003. Non-accrual loans were $384,000 and
$477,000 at June 30, 2004 and 2003. Non-accrual loans at December 31, 2003 were
$818,000. QNB did not have any other real estate owned as of June 30, 2004,
December 31, 2003 or June 30, 2003. Repossessed assets were $4,000 at June 30,
2004 and 5,000 at June 30, 2003. There were no repossessed assets as of December
31, 2003.
There were no restructured loans as of June 30, 2004, December 31, 2003 or June
301, 2003 as defined in Statement of Financial Accounting Standards No. 15,
"Accounting by Debtors and Creditors for Troubled Debt Restructurings," that
have not already been included in loans past due 90 days or more or non-accrual
loans.
The allowance for loan losses was $2,898,000 and $2,929,000 at June 30, 2004 and
December 31, 2003, respectively. The ratio of the allowance to total loans was
1.11 percent and 1.26 percent at the respective period end dates. The 12.1
percent growth in total loans between December 31, 2003 and June 30, 2004 was
the primary factor in the decline in this ratio. 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, 2004 and 2003, the recorded investment in loans for which impairment
has been recognized in accordance with SFAS No. 114 totaled $382,000 and
$452,000, respectively. No valuation allowance was necessary on these loans.
Most of the loans identified as impaired are collateral-dependent.
Management in determining the allowance for loan losses makes significant
estimates. 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
Form 10-Q
Page 16
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
PROVISION FOR LOAN LOSSES (CONTINUED)
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,
various regulatory agencies, as an integral part of their examination process,
periodically review QNB's allowance for losses on loans. Such agencies may
require QNB to recognize additions to the allowance based on their judgments
about information available to them at the time of their examination.
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, ATM and debit card income, income on bank owned life insurance,
mortgage servicing fees, gains or losses on the sale of investment securities,
gains on the sale of residential mortgage 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 to the
overdraft fee effective March 1, 2004, QNB has not materially changed these fee
schedules during 2003 or the first half of 2004.
Total non-interest income decreased $253,000 or 17.7 percent to $1,173,000 for
the quarter ended June 30, 2004 when compared to June 30, 2003. For the
six-month period total non-interest income decreased $121,000 or 4.5 percent to
$2,543,000. Excluding gains and losses on the sale of investment securities and
loans during both periods, non-interest income for the three-month period
increased $168,000 or 21.3 percent and for the six-month period increased
$237,000 or 15.7 percent.
Fees for services to customers, the largest component of total non-interest
income, is primarily comprised of service charges on deposit accounts. These
fees increased 14.1 percent, to $526,000 from $461,000, when comparing the two
quarters and 11.1 percent or $97,000 to $972,000 when comparing the six-month
periods. The increase in the overdraft fee in March 2004, as well as an increase
in the volume of overdrafts contributed to the $81,000 or 21.6 percent increase
in overdraft income when comparing the three month periods and $116,000 or 16.0
percent increase when comparing the six month periods ended June 30, 2004 and
2003. Partially offsetting the increase when comparing the quarters was a
$10,000 reduction in service charge income on non-interest bearing and
interest-bearing checking accounts.
Income on cash surrender value of insurance represents the earnings on life
insurance policies in which the Bank is the beneficiary. The earnings on these
policies were $70,000 and $78,000 for the three months ended June 30, 2004 and
2003, respectively. For the six-month period earnings on these policies
decreased $17,000 to $138,000. The insurance carriers reset the rates on these
policies annually. The decline in income between 2003 and 2004 is a result of a
lower earnings rate resulting from the lower interest rate environment.
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. 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.
Mortgage servicing fees for the three and six-month periods ended June 30, 2004
was $69,000 and $63,000, respectively. Included in these amounts is a $51,000
and $29,000 positive adjustment to the valuation allowance for impairment
resulting from the increase in interest rates
Form 10-Q
Page 17
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (CONTINUED)
during the second quarter of 2004. Mortgage servicing fees for the three month
and six month periods ended June 30, 2003 were a loss of $46,000 and $105,000,
respectively. Included in these amounts is a $53,000 and $128,000 valuation
allowance for impairment. This impairment in 2003 was a result of the
historically high prepayment speeds on mortgages resulting from the record level
of mortgage refinancing activity created by the low interest rate environment.
Excluding the valuation allowance adjustments mortgage servicing income would
have been $18,000 for the second quarter of 2004 compared to $7,000 for the
second quarter of 2003 and $34,000 compared to $23,000 for six-month periods
ended June 30, 2004 and 2003.
Other factors impacting mortgage servicing income is the amount of amortization
of the mortgage servicing asset and the amount of mortgages serviced. When
mortgage refinancing activity is high amortization expense tends to increase
because when a loan is paid off, the servicing asset related to that mortgage
must be expensed. Amortization expense for the three-month periods ended June
30, 2004 and 2003 was $35,000 and $43,000, respectively. For the respective
six-month periods amortization expense was $71,000 and $74,000. The average
balance of mortgages serviced for others was $83,677,000 for the second quarter
of 2004 compared to $79,923,000 for the second quarter of 2003, an increase of
4.7 percent. The average balance of mortgages serviced was approximately
$84,362,000 for the six-month period ended June 30, 2004 compared to $77,413,000
for the first six months of 2003, an increase of 9.0 percent. The timing of
mortgage payments and delinquencies also impacts the amount of servicing fees
recorded.
Net gains on the sale of investment securities were $217,000 for the second
quarter of 2004. This compares to net gains of $147,000 for the same period in
2003. For the second quarter of 2004, QNB recorded net losses on the sale of
fixed income securities of $95,000 and net gains from the equity portfolio of
$312,000. During the second quarter of 2004 QNB entered into two significant
bond transactions. The objective of the first transaction was to increase
interest income and the yield on the portfolio by taking advantage of the 100+
increase in rates that occurred during the quarter and the continued steepness
of the yield curve. QNB sold approximately $22 million of bonds at a loss of
$165k. These bonds had an average book yield of 3.46%. With the proceeds QNB
purchased bonds with an average yield of 5.13% for a pick-up of 167 basis
points. It is estimated that the pre-tax income pickup to the average life of
the bonds sold, 2.2 years, is approximately $477,000. The breakeven period on
recouping the loss on the sale is approximately 7.5 months. The transaction did
result in a slight increase in duration. The second transaction was entered into
to clean up some CMO pools that had small balances. QNB sold approximately $2.1
million, 15 pools, at a gain of $69k. With regard to the second quarter of 2003,
QNB recognized a gain of $137,000 on the sale of marketable equity securities
and a gain of $10,000 on the sale of debt securities.
Net security gains were $696,000 and $302,000 for the six-month periods ended
June 30, 2004 and 2003. For the six-month period 2004 gains from the equity
portfolio were $581,000 while gains from the fixed income portfolio were
$115,000. In addition to the two transactions discussed above, QNB, during the
first quarter of 2004, sold approximately $17,000,000 in securities in three
transactions. The first transaction, was for liquidity purposes, and involved
the sale of approximately $6,800,000 of the lowest coupon, slowest paying
mortgage-backed securities whose average life would extend in a rising interest
rate environment. The primary purpose of this transaction was to fund a
short-term timing difference between the withdrawal of some municipal deposits
and the anticipated call of the securities purchased to match these withdrawals.
This transaction resulted in a gain of $25,000. The second transaction involved
the sale of the three lowest yielding corporate bonds at a gain of $84,000.
Since spreads on corporate bonds had tightened, management determined that there
was better value in switching to the agency sector, thereby taking a gain, and
reducing credit risk without sacrificing yield or extending duration
significantly. The final transaction resulted in the sale of approximately
$7,600,000 in low
Form 10-Q
Page 18
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (CONTINUED)
yielding callable agency bonds with high coupons that would likely be called in
a short-time period. This transaction resulted in a gain of approximately
$101,000.
Included in net security gains for the six-month period ended June 30, 2003 were
gains of $277,000 from the sale of debt securities and $25,000 related to
activity in the marketable equity securities portfolio. Included in the net gain
on the equity portfolio for the six-month period was a $126,000 write-down of
securities whose decline in market value below cost was deemed to be other than
temporary. These securities were determined to be impaired. With regard to the
sale of debt securities, QNB sold approximately $28 million of mortgage-backed
securities and CMO's that were prepaying at very fast speeds. The proceeds were
used to purchase lower coupon mortgage backed securities and CMO's. The purpose
of these transactions was to reduce the amount of cash flow being received and
also the amount of premium amortization being recorded. Management will continue
to look at strategies that will result in an increase in the yield or
improvement in the structure of the investment portfolio.
QNB recorded a net loss of $2,000 on the sale of loans during the second quarter
of 2004. This compares to a $489,000 gain for the same period in 2003. For the
six-month periods ended June 30, 2004 and 2003 net gains on the sale of loans
were $98,000 and $850,000, respectively. The sale of residential mortgages
accounts for the entire gain in 2004 and $487,000 of the gain for the second
quarter of 2003 and $843,000 of the gain for the six-month period 2003. The sale
of student loans accounts for $2,000 and $7,000 of the gain in the three and six
month periods of 2003. QNB sold approximately $138,000 and $395,000 in student
loans during the second quarter and first half of 2003. Effective June 30, 2002
QNB terminated its agreement with the Student Loan Marketing Association (SLMA).
QNB no longer originates student loans for sale but works on a fee based
referral basis instead. The remaining balance in the portfolio was sold during
the second quarter of 2003.
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. As mentioned previously, the decline in interest rates during 2003
to historically low levels resulted in record mortgage refinancing activity and
significant gains on the sale of these loans in 2003. With the increase in rates
during 2004, mortgage activity has slowed significantly. Gains are usually
recorded as rates fall while rising rates tend to result in losses. QNB
originated $2,312,000 and $15,481,000 in mortgages held for sale during the
second quarter of 2004 and 2003 and $4,990,000 and $23,546,000 during the
respective six-month periods. Proceeds from the sale of residential mortgages
were approximately $2,355,000 and $15,785,000 during the second quarters of 2004
and 2003, respectively. For the six-month periods proceeds from the sale of
residential mortgage loans amounted to $6,278,000 and $25,693,000, respectively.
As of June 30, 2004 and 2003 QNB had $125,000 and $2,356,000 in mortgage loans
classified as held for sale. These loans are accounted for at lower of cost or
market.
Other operating income decreased $5,000 to $141,000 during the second quarter of
2004. A $14,000 increase in retail brokerage income and a $3,000 increase in
merchant processing income were offset by a $22,000 decrease in dividends from
QNB's minority ownership of Bankers Settlement Services of Eastern Pennsylvania,
LLC, a title insurance company. The dividend decrease reflects the sharp decline
in residential mortgage refinance activity in 2004.
For the six-month period other operating income decreased $9,000 or 3.0 percent
to $296,000. Included in other operating income in 2003 was a $47,000 derivative
gain on residential mortgage loans held for sale that have been committed but
not settled and $26,000 in dividends from the title insurance company. This loss
of income was partially offset by a $23,000 increase in retail brokerage income,
an $11,000 increase in merchant
Form 10-Q
Page 19
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (CONTINUED)
processing income, an $8,000 increase in commission on the sale of checks to
customers, an $8,000 increase in safe deposit box income and a $9,000 refund of
prior years sales tax payments.
NON-INTEREST EXPENSE
Non-interest expense is comprised of costs related to salaries and employee
benefits, net occupancy, furniture and equipment, marketing, third party
services and various other operating expenses. Total non-interest expense of
$3,181,000 for the quarter ended June 30, 2004 represents an increase of
$104,000 or 3.4 percent from levels reported in the second quarter of 2003.
Total non-interest expense for the six months ended June 30, 2004 was
$6,259,000, an increase of $103,000 or 1.7 percent over 2003 levels
Salaries and benefits, the largest component of non-interest expense, decreased
$49,000 or 2.8 percent to $1,712,000 for the quarter ended June 30, 2004
compared to the same quarter in 2003. Salary expense decreased $84,000 or 5.8
percent during the period to $1,359,000 while benefits expense increased $35,000
or 10.8 percent to $353,000. Included in salary expense for the three months
ended June 30, 2003 was an accrual of $155,000 related to the incentive
compensation plan. There was no accrual in the three month period ended June 30,
2004. Excluding the impact of the accrual for the incentive compensation plan in
2003, salary expense increased 5.5 percent for the three-month period. Merit
increases and an increase in the number of employees contributed to the increase
in salary expense. The number of full time-equivalent employees increased by six
when comparing the second quarters of 2004 and 2003. Contributing to the
increase in full time-equivalent employees was the opening of a supermarket
branch during the second quarter of 2004. The increase in benefits expense is
primarily the result of an increase in medical insurance premiums and costs
associated with employee education.
For the six-month period ended June 30, 2004 salaries and benefits expense
decreased $31,000 to $3,506,000 compared to the same period in 2003. Salary
expense decreased by $59,000 or 2.1 percent while benefits expense increased by
$28,000 or 4.1 percent when comparing the two periods. Included in salary
expense for the six months ended June 30, 2004 and 2003 were accruals of
$100,000 and $300,000 related to the incentive compensation plan. Excluding the
impact of the accruals for the incentive compensation plan salary expense
increased 5.5 percent for the six-month period. The number of full
time-equivalent employees increased by four when comparing the six-month
periods. QNB monitors, through the use of various surveys, the competitive
salary information in its markets and makes adjustments where appropriate.
Net occupancy expense increased $41,000 to $238,000 when comparing the second
quarter of 2004 to the second quarter of 2003. For the six-month period, net
occupancy expense increased $64,000 to $489,000. Contributing to the increase in
both the three and six-month periods was higher costs related to building
maintenance, utilities and rent expense. The addition of the new supermarket
branch contributed to the increase in net occupancy expense.
Furniture and equipment expense increased $5,000 or 1.9 percent to $274,000 when
comparing the three-month periods ended June 30, 2004 and 2003 but decreased
$22,000 or 4.1 percent to $517,000 when comparing the six-month periods. For the
three-month periods a $14,000 increase in equipment maintenance expense offset a
$9,000 reduction in depreciation expense. For the six-month periods depreciation
expense decreased $26,000 while equipment maintenance costs increased by
$10,000. Depreciation expense will likely increase during the second half of
2004 as several technology projects are completed.
Form 10-Q
Page 20
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST EXPENSE (CONTINUED)
Marketing expense increased $33,000 to $148,000 for the quarter ended June 30,
2004 and $40,000 to $$255,000 for the six-month period. Advertising expense
increased $22,000 and public relations expense increased $7,000 when comparing
the two quarters. An increase use of billboards for product advertising, along
with costs associated with the opening of the new branch, contributed to the
increase in these categories. In addition to the items mentioned for the
three-month period, costs associated with a customer newsletter and an increase
in contributions and sponsorships contributed to the increase for the six-month
period.
Third party services are comprised of professional services including legal,
accounting and auditing and consulting services as well as fees paid to outside
vendors for support services of day-to-day operations. These include Trust
services, retail non-deposit services, correspondent banking services,
investment security safekeeping and supply management services, to name a few.
Third party services expense was $175,000 in the second quarter of 2004 compared
to $168,000 for the second quarter of 2003. An increase in auditing costs and
technology services was partially offset by lower costs related to Trust
services. For the six-month period third party services decreased $29,000 to
$330,000. The use of an executive search firm in 2003 to fill an open Trust
officer position was the primary contributor to the higher third party service
expense in 2003. Also contributing to the higher costs in 2003 were consulting
and training costs related to the installation of an upgrade to the item
processing system. Partially offsetting these items were higher internal and
external auditing costs and costs associated with the outsourcing of the
statement printing and mailing function which began in the second quarter of
2003.
Telephone, postage and supplies expense was $140,000 for the three months ended
June 30, 2004 compared to $126,000 for the same period ended June 30, 2003. For
the six-month periods these categories decreased $7,000 to $256,000. The
outsourcing of the statement mail function mentioned above, contributed to the
$5,000 and $28,000 decrease in postage expense for the three and six month
periods. Telephone expense increased $11,000 when comparing the three-month
periods and $14,000 when comparing the six-month periods. The increase in
telephone expense for the quarter relates to costs associated with an additional
T-1 line as well as costs associated with the new branch.
The major components of other expense are regulatory costs, insurance costs,
membership fees, courier expense, ATM and debit card expense, loan origination
costs and directors fees. Other expense for the second quarter of 2004 was
$362,000, an increase of $26,000 or 7.7 percent. Contributing to the variance
was a $14,000 increase in ATM and debit card expense, a $4,000 increase in
directors and officers insurance and a $5,000 increase in classified
advertising. For the six-month period other expense increased $32,000 or 5.0
percent to $675,000. These same categories increased $23,000, $9,000 and $7,000,
respectively. The increase in the ATM and debit card expense relates to both an
increase in rates by the processor and an increase in usage by customers. The
increase in insurance costs relates primarily to an increase in coverage while
the increase in classified advertising relates to filling open staff positions
as well as positions for the new branch.
INCOME TAXES
QNB utilizes an asset and liability approach for financial accounting and
reporting of income taxes. As of June 30, 2004 QNB's net deferred tax asset was
$1,443,000. The primary components of deferred taxes are a deferred tax asset of
$739,000 relating to the allowance for loan losses and a deferred tax asset of
$751,000 resulting from the SFAS No.115 adjustment for available-for-sale
investment securities. As of June 30, 2003 QNB's net deferred tax liability was
$1,168,000. A deferred tax asset of $726,000 related to the allowance for loan
losses was offset by a deferred tax liability of $2,009,000 resulting from the
SFAS No. 115 adjustment
Form 10-Q
Page 21
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INCOME TAXES (CONTINUED)
for available-for-sale investment securities. The decrease in the market value
of the available-for-sale investment portfolio resulting from increasing
interest rates accounts for the change to a deferred tax asset from a deferred
tax liability.
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. A valuation allowance of $138,000 was established as of March 31,
2003 to offset a portion of the tax benefits associated with certain impaired
securities that management believed may not be realizable. This valuation
allowance was reversed during 2003 as a result of the ability to realize tax
benefits associated with certain impaired securities, due to the increase in
unrealized gains of certain equity securities. Based upon these and other
factors, management believes it is more likely than not that QNB will realize
the benefits of these remaining deferred tax assets. The net deferred tax asset
(liability) is included in other assets (liabilities) on the consolidated
balance sheet.
Applicable income taxes and effective tax rates were $426,000 or 21.9 percent
for the three-month period ended June 30, 2004, and $489,000 or 23.1 percent for
the same period in 2003. The lower rate for the second quarter of 2004 compared
to the second quarter of 2003 is a result of an increase in the proportion of
tax-free loan and investment income and income from bank owned life insurance
relative to pre-tax income. For the six-month period applicable income taxes and
effective tax rates were $922,000 or 22.2 percent and $945,000 or 23.0 percent
Contributing to the higher effective tax rate for the six-month period in 2003
was an additional $43,000 valuation allowance on capital losses recorded during
the first quarter of 2003 for the impairment of equity securities. The effective
tax rate without the valuation allowance would have been 22.0 percent.
BALANCE SHEET ANALYSIS
The Balance Sheet Analysis reviews average balance sheet data for the six months
ended June 30, 2004 and 2003, as well as the period ended balances as of June
30, 2004 and December 31, 2003.
Average earning assets for the six-month period ended June 30, 2004 increased
$33,485,000 or 7.1 percent to $508,534,000 from $475,049,000 for the six months
ended June 30, 2003. Average investments increased $28,662,000 or 12.5 percent
while average loans increased $10,201,000 or 4.5 percent. Average Federal funds
sold decreased $5,984,000 when comparing these same periods.
While average loan growth was modest when comparing the two six-month periods,
significant loan growth has occurred since both June 30, 2003 and December 31,
2003. Total loans have increased 9.6 percent between June 30, 2003 and June 30,
2004 and 12.1 percent since December 31, 2003. The year over year comparison
takes out some of the seasonality of commercial line of credit borrowings. A
major factor in the growth in total loans is the use of a formal business
development and calling program encompassing lending personnel, branch personnel
and executive management. This program was strengthened in 2003 by the
appointment of a business development officer. The focus of this program is to
both develop new lending and deposit relationships as well as strengthen
existing relationships. The initial business development process was enhanced in
2002 with the development of a bank-wide sales initiative that concentrated on
sales training, particularly with regard to identifying lending opportunities.
This program was further expanded in 2003 to include an incentive compensation
program that rewards employees not only for loan growth, but also for asset
quality and profitability. Despite the weak economy and extremely competitive
environment, QNB was successful in increasing total loans, while maintaining
excellent asset quality.
Form 10-Q
Page 22
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS (CONTINUED)
Average commercial loans and average home equity loans increased $12,434,000 and
$6,064,000, when comparing the first half of 2004 to the first half of 2003
while average residential mortgage loans and average consumer type loans
decreased $7,531,000 and $892,000 during this same period. The increase in
average commercial loans reflects the success of the business development
program mentioned above. The 13.1 percent increase in home equity loans reflects
their popularity with consumers; especially those refinancing existing
residential mortgage loans, because they have lower origination costs than
residential mortgage loans. It also reflects the introduction of a more
competitive variable rate home equity line of credit priced at prime minus .50
percent introduced in late 2003. The decrease in residential mortgage loans is a
result of the decision by management to sell most residential mortgage loan
production in the secondary market because of the interest rate risk associated
with the low interest rates.
The growth in average earning assets was funded by increases in
non-interest-bearing deposit accounts, interest-bearing deposit accounts and
short-term borrowings. Average non-interest bearing demand accounts increased
$3,379,000 or 7.1 percent, while average interest-bearing deposit accounts
increased $25,685,000 or 7.3 percent. The "Free Checking" promotion, as well as
the acquisition of new business accounts were significant factors in the
increase in non-interest bearing deposits.
The growth in average interest-bearing deposit accounts is primarily centered in
interest bearing demand deposit accounts which increased $20,475,000 or 26.9
percent. The majority of this growth can be attributed to the development of
relationships with several school districts and municipalities. Most of these
deposits are seasonal and were withdrawn during the first quarter of 2004. It is
anticipated that these funds will flow back in during the third quarter of 2004.
Average savings accounts increased $4,945,000 or 10.0 percent. The continued
growth in savings deposits can be attributed to consumers looking for the
relative safety of bank deposits despite the low interest rate environment. The
challenge will be to retain these deposits as interest rates increase and
confidence in the equity markets improves.
Average time deposits decreased $1,272,000 to $192,649,000 when comparing the
first half of 2004 to the same period in 2003. A $2,477,000 increase in average
time deposits with balances less than $100,000 partially offset a $3,749,000
decrease in average time deposits with balances of $100,000 or more. Increasing
time deposit balances will be a challenge because of the extreme rate
competition for time deposits, particularly with maturities over two years.
Matching or beating competitor's rates could have a negative impact on the net
interest margin.
Total assets at June 30, 2004 were $558,070,000, compared with $550,831,000 at
December 31, 2003, an increase of 1.3 percent. The slow growth in total assets
reflects the run-off of the municipal deposits as was expected. The increase in
assets from December 31, 2003 to June 30, 2004 was primarily centered in loans,
which increased $28,067,000. To help fund this loan growth, investment
securities decreased $17,249,000 and federal funds sold decreased $4,532,000. In
addition federal funds purchased increased $7,949,000. As mentioned previously,
investment securities were purchased to closely match the anticipated withdrawal
of the municipal deposits. The increase in other assets reflects the increase in
the deferred tax asset related to the FASB 115 available-for-sale market value
adjustment.
While total deposits increased $4,930,000 from $438,639,000 at December 31, 2003
to $443,569,000 at June 30, 2004, interest bearing demand accounts decreased
$15,880,000, with municipal interest bearing deposits decreasing $19,288,000.
Money market balances remained flat despite the withdrawal of $5,000,000 in
municipal funds. Growth in non-interest bearing demand accounts, savings
accounts and time deposits helped offset the impact from the withdrawal of the
municipal deposits. Non-interest bearing demand accounts
Form 10-Q
Page 23
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS (CONTINUED)
increased $8,030,000 or 15.9 percent to $58,498,000 at June 30, 2004. Savings
accounts increased $4,161,000 or 8.0 percent and time deposits increased
$8,622,000 or 4.5 percent from December 31, 2003 to June 30, 2004.
At June 30, 2004 the fair value of investment securities available-for-sale was
$248,276,000 or $2,208,000 below the amortized cost of $250,484,000. This
compares to a fair value of $260,631,000 or $3,547,000 above the amortized cost
of $257,084,000 at December 31, 2003. An unrealized holding loss, net of taxes,
of $1,457,000 was recorded as a decrease to shareholders' equity at June 30,
2004 while an unrealized holding gain of $2,341,000 was recorded as an increase
to shareholders' equity at December 31, 2003. The fairly significant rise in
interest rates during the second quarter of 2004 reduced the market value of the
investment securities below cost, thereby eliminating the unrealized gain and
creating an unrealized loss. As a result of the transactions mentioned earlier
as well as the reinvestment of proceeds from callable agency securities, CMO's
and mortgage-backed securities the composition of the portfolio has changed
since December 31, 2003. Agency securities have decreased from 16.1 percent of
the fixed income portfolio at December 31, 2003 to 7.9 percent of the portfolio
at June 30, 2004, while mortgage backed securities and CMO's have increased from
24.7 percent and 26.4 percent of the portfolio to 29.1 percent and 29.2 percent
of the portfolio during this same time period. The reduction in the agency
portfolio reflects the call of the bonds associated with the municipal deposits.
While the CMO portfolio has increased from December 31, 2003, it does reflect a
reduction from the 35.0 percent at March 31, 2004. This reduction from March
2004 to June 2004 is primarily the result of the two second quarter investment
transactions discussed earlier.
The available-for-sale portfolio had a weighted average maturity of
approximately 5 years and 8 months at June 30, 2004 and 4 years, 1 month at
December 31, 2003. The weighted average tax-equivalent yield was 4.76 percent
and 4.61 percent at June 30, 2004 and December 31, 2003. The weighted average
maturity is based on the stated contractual maturity of all securities except
for mortgage-backed securities and CMOs, 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
and CMOs. However, the estimated average life could be longer if rates were to
increase and principal payments on mortgage-backed securities and CMOs would
slow. The interest rate sensitivity analysis reflects the repricing term of the
securities portfolio based upon estimated call dates and anticipated cash flows
assuming management's most likely interest rate environment. The expected
repricing term of the available-for-sale portfolio was 4 years, 6 months at June
30, 2004 and 3 years, 7 months at December 31, 2003, based on these assumptions.
The increase in both weighted average maturity and repricing term reflect the
extension of the CMO and mortgage-backed portfolio with the increase in interest
rates and the call of the shorter agency bonds associated with the municipal
deposits. QNB rate shocks the investment portfolio to analyze the impact of
rising and falling interest rates. A 100 basis point increase in interest rates
would extend the average life of the available-for-sale portfolio to
approximately 6 years, 6 months and reduce the market value by approximately 4.4
percent while a 100 basis point decrease in interest rates would shorten the
average life by to approximately 4 years, 2 months and increase the market value
by approximately 3.0 percent.
During the second quarter of 2002, management and the Board of Directors
approved that all future purchases of investment securities will be categorized
as available-for-sale. While there is the potential for increased volatility of
shareholder's equity due to market value changes, management believes it will
provide for more flexibility in managing the portfolio. Investment securities
held-to-maturity are reported at amortized cost. The held-to-maturity portfolio
is primarily comprised of tax-exempt municipal securities. As of June 30, 2004
and December 31, 2003, QNB had securities classified as held-to-maturity with an
amortized cost of $7,118,000 and $12,012,000 and a market value of $7,255,000
and $12,334,000, respectively. The held-to-maturity portfolio had a
Form 10-Q
Page 24
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS (CONTINUED)
weighted average maturity of approximately 4 years, 3 months at June 30, 2004
and 2 years, 11 months at December 31, 2003. The weighted average tax-equivalent
yield was 6.65 percent at June 30, 2004 and 6.59 percent at December 31, 2003.
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 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 $10,000,000 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 $270,633,000 and $288,136,000 at June 30, 2004 and
December 31, 2003. These sources should be adequate to meet normal fluctuations
in loan demand and or deposit withdrawals. During the second quarter of 2004,
QNB used overnight borrowings from the FHLB and its Federal funds line to help
fund the significant loan growth at the end of the quarter. QNB could have sold
investment securities instead of using short-term borrowings to fund the loan
growth, but decided it made financial sense to use low costing funds as opposed
to selling higher yielding investment securities. In addition, the Federal funds
line has been used during the first half of 2004 because of small timing
differences between the withdrawal of funds by the municipalities and the
receipt of the proceeds from the securities matched against these deposits.
Federal funds sold were $7,949,000 at June 30, 2004.
Approximately $55,562,000 and $84,425,000 of available-for-sale securities at
June 30, 2004 and December 31, 2003 were pledged as collateral for repurchase
agreements and deposits of public funds. In addition, under terms of its
agreement with the Federal Home Loan Bank, 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 Federal Home Loan Bank. The
decline in the amount of pledged securities reflects the decline in balances
from the municipalities.
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 $3,834,000 to $26,066,000 at June 30, 2004. This
compares to a $9,878,000 increase during the six months of 2003. Operating
activities provided $4,609,000 in cash flow in the first six months of 2004,
compared to $5,721,000 in the same period of 2003. Net income and the net
activities associated with the origination and sale of residential mortgages
account for most of the net cash provided by operating activities during the
first half of 2004 and 2003. The reduction in net cash provided by operating
income when comparing the two periods is primarily the result of the slowdown in
residential mortgage activity.
Net cash used by investing activities was $16,895,000 and $16,864,000 during the
first six months of 2004 and 2003, respectively. The net increase in loans of
$28,021,000 and $22,220,000 was the primary use of cash during both periods.
Proceeds from the call, maturity and sales of investment securities exceeded the
purchase
Form 10-Q
Page 25
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
LIQUIDITY (CONTINUED)
of investment securities by $11,774,000 and $5,708,000 during the first six
months of 2004 and 2003, respectively. A significant portion of this activity in
2004 was used to fund the deposit run-off of the municipal deposits, as
expected.
Net cash provided by financing activities was $8,452,000 and $21,021,000 during
the first half of 2004 and 2003, respectively. Non-interest bearing deposits
increased $8,030,000 and time deposits increased $8,622,000 during the first six
months of 2004. Partially offsetting this growth was the decline in interest
bearing non-maturity deposits which decreased $11,722,000. The withdrawal of
$24,288,000 of municipal funds during the first half of 2004 contributed to this
decline in non-maturity deposits. It is anticipated that this money will be
re-deposited during the third quarter of 2004. Short-term borrowings increased
by $4,627,000 as a result of the Federal funds purchases as discussed above.
With regard to 2003, the increase in deposits of $28,470,000 offset the decline
in short-term borrowings of $6,539,000. The decrease in short-term borrowings is
primarily the reduction of balances held by one repurchase agreement customer.
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, 2004 was
$41,778,000 or 7.49 percent of total assets compared to shareholders' equity of
$43,440,000 or 7.89 percent at December 31, 2003. Shareholders' equity at June
30, 2004 includes a negative adjustment of $1,457,000 related to unrealized
holding losses, net of taxes, on investment securities available-for-sale, while
shareholders' equity at December 31, 2003 includes a positive adjustment of
$2,341,000. Without these adjustments shareholders' equity to total assets would
have been 7.75 percent and 7.46 percent at June 30,2004 and December 31, 2003.
The increase in the ratio reflects the growth in retained earnings exceeding the
growth in total assets between December 31, 2003 and June 30, 2004.
Shareholders' equity averaged $42,040,000 for the first six months of 2004 and
$39,286,000 during all of 2003, an increase of 7.0 percent. The ratio of average
total equity to average total assets increased to 7.74 percent for 2004,
compared to 7.46 percent for 2003. The increase in the equity to asset ratio is
a function of the growth in average equity outpacing the growth in total average
assets.
QNB Corp. and the Quakertown National Bank are subject to various regulatory
capital requirements as issued by Federal regulatory authorities. Regulatory
capital is defined in terms of Tier I capital (shareholders' equity excluding
unrealized gains or losses on available-for-sale securities), Tier II capital
that 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 12.28 percent and 12.49 percent, a total
risk-based ratio of 13.12 percent and 13.39 percent and a leverage ratio of 7.78
percent and 7.38 percent at March 31, 2004 and December 31, 2003, respectively.
The decline in both the Tier I capital ratio and total risk-based ratio reflects
the change in the balance sheet composition with growth in loans, primarily
commercial loans and the reduction in investment securities and federal funds
sold. Loans are usually assigned a higher risk weighting than investment
securities and federal funds sold.
Form 10-Q
Page 26
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
CAPITAL ADEQUACY (CONTINUED)
The Federal Deposit Insurance Corporation Improvement Act of 1991 established
five capital level designations ranging from "well capitalized" to "critically
undercapitalized." At March 31, 2004 and December 31, 2003 QNB met the "well
capitalized" criteria which requires minimum Tier I and total risk-based capital
ratios of 6.00 percent and 10.00 percent, respectively and a Tier I leverage
ratio of 5.00 percent.
INTEREST RATE SENSITIVITY
Since the assets and liabilities of QNB have diverse repricing characteristics
that influence net interest income, management analyzes interest sensitivity
through the use of gap analysis and simulation models. Interest rate sensitivity
management seeks to minimize the effect of interest rate changes on net interest
margins and interest rate spreads and to provide growth in net interest income
through periods of changing interest rates. The Asset/Liability Management
Committee (ALCO) is responsible for managing interest rate risk and for
evaluating the impact of changing interest rate conditions on net interest
income.
Gap analysis measures the difference between volumes of rate-sensitive assets
and liabilities and quantifies these repricing differences for various time
intervals. Static gap analysis describes interest rate sensitivity at a point in
time. However, it alone does not accurately measure the magnitude of changes in
net interest income since changes in interest rates do not impact all categories
of assets and liabilities equally or simultaneously.
Interest rate sensitivity analysis also involves assumptions on certain
categories of assets and deposits. For purposes of interest rate sensitivity
analysis, assets and liabilities are stated at their contractual maturity,
estimated likely call date, or earliest repricing opportunity. Mortgage-backed
securities, CMOs 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. The Treasury Select Indexed Money
Market account reprices monthly based on a percentage of the average of the
91-day Treasury bill.
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 June 30, 2004, interest-earning assets scheduled to mature
or likely to be called, repriced or repaid in one year were $209,096,000.
Interest-sensitive liabilities scheduled to mature or reprice within one year
were $162,548,000. The one-year cumulative gap, which reflects QNB's interest
sensitivity over a period of time, was a positive $46,548,000 at June 30, 2004.
The cumulative one-year gap equals 8.78 percent of total rate sensitive assets.
These results are similar to QNB's one-year gap position at December 31, 2004.
This positive or asset sensitive gap will generally benefit QNB in a rising
interest rate environment, while falling 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
Form 10-Q
Page 27
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INTEREST RATE SENSITIVITY (CONTINUED)
assumptions are based on what management believes at that time to be the most
likely interest rate environment. Management also evaluates the impact of higher
and lower interest rates.
Actual results may differ from simulated results due to various factors
including time, magnitude and frequency of interest rate changes, the
relationship or spread between various rates, loan pricing and deposit
sensitivity, and asset/liability strategies. Based on the simulation model, net
interest income for the next twelve months is expected to increase compared to
the prior twelve months. This is a result of the growth in earning assets. The
net interest margin is anticipated to be relatively stable over the next twelve
months
If interest rates are 100 basis points higher than management's most likely
interest rate environment, the simulation model projects net interest income for
the next twelve months to be higher than the most likely scenario as a result of
an increase in the net interest margin. These results reflect the asset
sensitive position of the bank, particularly with regard to the variable rate
portion of the loan portfolio. If interest rates are 100 basis points lower than
management's most likely interest rate environment, the model projects net
interest income for the next twelve months to be significantly lower than the
most likely scenario. The reduction in net interest income is a result of floors
built into the deposit assumptions because management believes it would be
difficult to reduce rates paid on deposits much further. However, rates on
earning assets would reprice lower. The direction of these results is consistent
with the results anticipated by the gap analysis. While management performs a
downward rate shock of 100, 200 and 300 basis points, it believes, given the
level of interest rates at June 30, 2004, that it is unlikely that interest
rates would decline by 200 or 300 basis points.
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 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, 2004, QNB did not have any hedging
transactions in place such as interest rate swaps, caps or floors.
Form 10-Q
Page 28
<page>
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INTEREST RATE SENSITIVITY (CONTINUED)
The table below summarizes estimated changes in net interest income over a
twelve-month period, under alternative interest rate scenarios.
- ------------------------------------------------------------------------------------------------------------------------------
Change in Interest Rates Net Interest Income Dollar Change Percent Change
- ------------------------------------------------------------------------------------------------------------------------------
+300 Basis Points.......................................... $17,540 $1,285 7.91%
+200 BasisPoints........................................... 17,211 956 5.88
+100 BasisPoints........................................... 16,814 559 3.44
FLAT RATE.................................................. 16,255 - -
- -100 BasisPoints........................................... 14,868 (1,387) (8.53)
Management believes, given the current interest rate environment that it is
unlikely that interest rates would decline by 200 or 300 basis points.
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.
ITEM 4. CONTROLS AND PROCEDURES
We maintain a system of controls and procedures designed to provide reasonable
assurance as to the reliability of the financial statements and other
disclosures included in this report, as well as to safeguard assets from
unauthorized use or disposition. We evaluated the effectiveness of the design
and operation of our disclosure controls and procedures under the supervision
and with the participation of management, including our Chief Executive Officer
and Chief Financial Officer, within 90 days prior to the filing date of this
report. Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective in timely alerting them to material information required to be
included in our periodic Securities and Exchange Commission filings. No
significant changes were made to our internal controls or other factors that
could significantly affect these controls subsequent to the date of their
evaluation.
Form 10-Q
Page 29
<page>
QNB CORP. AND SUBSIDIARY
PART II. OTHER INFORMATION
JUNE 30, 2004
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 2004 Annual Meeting (the "Meeting") of the shareholders of QNB
Corp. (the Registrant") was held on May 18, 2004. Notice of the
Meeting was mailed to shareholders of record on or about April 19,
2004, 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
------- --- --------
Norman L. Baringer 2,507,265 1,290
Charles M. Meridith, III 2,475,959 32,596
Gary S. Parzych 2,507,961 594
The continuing directors of the Registrant are:
Kenneth F. Brown, Henry L. Rosenberger, Edgar L. Stauffer,
Dennis Helf, G. Arden Link and Thomas J. Bisko.
Item 5. Other Information
None.
Form 10-Q
Page 30
<page>
PART II. OTHER INFORMATION
JUNE 30, 2004
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
The following Exhibits are included in this Report:
Exhibit 3(i) Articles of Incorporation of Registrant, as amended.
(Incorporated by reference to Exhibit 3(i) of Registrants
Form 10-K filed with the Commission on March 30, 2004).
Exhibit 3(ii) Bylaws of Registrant, as amended. (Incorporated by
reference to Exhibit 3(ii) of Registrants Form 10-K filed
with the Commission on March 30, 2004).
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 and amended on April 3,2002 on Form 8-K filed
with the Commission on April 11, 2002).
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 The Quakertown National Bank Retirement Savings Plan.
(Incorporated by reference to Exhibit 10.4 of Registrants
Form 10-Q filed with the Commission on August 14, 2003).
Exhibit 10.5 Change of Control Agreement between Registrant and
Robert C. Werner (Incorporated by reference to Exhibit
10.7 of Registrants Form 10-Q filed with the Commission on
November 13, 2000.)
Exhibit 10.6 Change of Control Agreement between Registrant and
Bret H. Krevolin (Incorporated by reference to Exhibit
10.8 of Registrants Form 10-Q filed with the Commission on
November 13, 2000.)
Exhibit 10.7 QNB Corp. 2001 Employee Stock Purchase Plan. (Incorporated
by reference to Exhibit 99.1 to Registration Statement No.
333-67588 on Form S-8, filed with the Commission on August
15, 2001.)
Exhibit 11 Statement Re: Computation of Earnings Per Share.
(Included in Part I, Item I, hereof.)
Exhibit 32.1 Certification of Principal Executive Officer
Exhibit 32.2 Certification of Principal Financial Officer
Form 10-Q
Page 31
<page>
QNB CORP. AND SUBSIDIARY
PART II. OTHER INFORMATION
JUNE 30, 2004
Item 6. Exhibits and Reports on Form 8-K (Continued)
(b) Reports on Form 8-K
Filed April 28, 2004, Press release dated April 27, 2004
reporting first quarter 2004 net income.
Form 10-Q
Page 32
<page>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
QNB Corp.
Date: August 13, 2004 By: /s/ Thomas J. Bisko
-----------------------------
---------------------------
Thomas J. Bisko
President/CEO
Date: August 13, 2004 By: /s/ Robert C. Werner
-----------------------------
---------------------------
Robert C. Werner
Vice President
Date: August 13, 2004 By: /s/ Bret H. Krevolin
-----------------------------
---------------------------
Bret H. Krevolin
Chief Financial Officer
Form 10-Q
Page 33