Back to GetFilings.com
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, 2002
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission file number 0-17706
QNB Corp.
(Exact Name of Registrant as Specified in Its Charter)
Pennsylvania 23-2318082
(State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.)
10 North Third Street, Quakertown, PA 18951-9005
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (215) 538-5600
Not Applicable
Former Name, Former Address and Former Fiscal Year, if Changed Since Last
Report.
Indicate by check /s/ whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at August 9, 2002
Common Stock, par value $1.25 1,539,639
QNB CORP. AND SUBSIDIARY
FORM 10-Q
QUARTER ENDED JUNE 30, 2002
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) PAGE
Consolidated Statements of Income for Three and
Six Months Ended June 30, 2002 and 2001 ............................. 1
Consolidated Balance Sheets at June 30, 2002
and December 31, 2001 ............................................... 2
Consolidated Statements of Cash Flows for Six
Months Ended June 30, 2002 and 2001 ................................. 3
Notes to Consolidated Financial Statements ............................. 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION ................................... 7
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK .......................................................... 26
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS ...................................................... 27
ITEM 2. CHANGES IN SECURITIES .................................................. 27
ITEM 3. DEFAULTS UPON SENIOR SECURITIES ........................................ 27
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITIES HOLDERS................. 27
ITEM 5. OTHER INFORMATION ..................................................... 28
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ...................................... 28
QNB Corp. and Subsidiary
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share data)
(unaudited)
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2002 2001 2002 2001
-------- -------- -------- --------
INTEREST INCOME
Interest and fees on loans .................................. $ 3,755 $ 3,761 $ 7,440 $ 7,478
Interest and dividends on investment securities:
Taxable ................................................ 2,691 2,438 5,298 4,725
Tax-exempt ............................................. 495 411 950 792
Interest on Federal funds sold .............................. 31 113 79 182
Interest on interest-bearing balances ....................... 2 4 3 10
-------- -------- -------- --------
Total interest income ............................. 6,974 6,727 13,770 13,187
-------- -------- -------- --------
INTEREST EXPENSE
Interest on deposits
Interest-bearing demand accounts ....................... 83 123 157 262
Money market accounts .................................. 141 287 290 612
Savings ................................................ 128 152 246 311
Time ................................................... 1,510 1,701 3,102 3,337
Time over $100,000 ..................................... 444 321 900 598
Interest on short-term borrowings ........................... 68 155 140 338
Interest on Federal Home Loan Bank advances ................. 728 701 1,438 1,284
-------- -------- -------- --------
Total interest expense ............................ 3,102 3,440 6,273 6,742
-------- -------- -------- --------
Net interest income ............................... 3,872 3,287 7,497 6,445
Provision for loan losses ................................... -- -- -- --
-------- -------- -------- --------
Net interest income after provision for loan losses 3,872 3,287 7,497 6,445
-------- -------- -------- --------
NON-INTEREST INCOME
Fees for services to customers .............................. 381 360 739 709
ATM and debit card income ................................... 128 120 237 218
Income on cash surrender value of insurance ................. 79 36 158 65
Mortgage servicing fees ..................................... 21 27 36 54
Net (loss) gain on investment securities available-for-sale . (95) 179 (159) 240
Net gain on sale of loans ................................... 81 90 222 116
Other operating income ...................................... 114 94 210 186
-------- -------- -------- --------
Total non-interest income ......................... 709 906 1,443 1,588
-------- -------- -------- --------
NON-INTEREST EXPENSE
Salaries and employee benefits .............................. 1,621 1,462 3,173 2,933
Net occupancy expense ....................................... 200 199 406 417
Furniture and equipment expense ............................. 251 257 479 491
Marketing expense ........................................... 117 108 261 241
Third party services ........................................ 145 118 279 219
Telephone, postage and supplies expense ..................... 135 128 268 266
State taxes ................................................. 81 92 174 164
Other expense ............................................... 336 320 640 596
-------- -------- -------- --------
Total non-interest expense ........................ 2,886 2,684 5,680 5,327
Income before income taxes ............................. 1,695 1,509 3,260 2,706
Provision for income taxes .................................. 341 325 631 534
-------- -------- -------- --------
NET INCOME ............................................. $ 1,354 $ 1,184 $ 2,629 $ 2,172
======== ======== ======== ========
NET INCOME PER SHARE - BASIC ........................... $ .88 $ .77 $ 1.71 $ 1.40
======== ======== ======== ========
NET INCOME PER SHARE - DILUTED ......................... $ .87 $ .76 $ 1.70 $ 1.40
======== ======== ======== ========
CASH DIVIDENDS PER SHARE ............................... $ .30 $ .27 $ .60 $ .54
======== ======== ======== ========
The accompanying notes are an integral part of the consolidated
financial statements.
Page 1
QNB Corp. and Subsidiary
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
JUNE 30, DECEMBER 31,
2002 2001
--------- ---------
ASSETS
Cash and due from banks ........................................................ $ 16,124 $ 18,220
Federal funds sold ............................................................. 5,788 5,661
Investment securities
Available-for-sale ........................................................ 191,234 168,102
Held-to-maturity (market value $41,602 and $43,048) ....................... 40,833 42,798
Total loans, net of unearned income of $247 and $270 ........................... 209,466 202,211
Allowance for loan losses ...................................................... (2,879) (2,845)
--------- ---------
Net loans ............................................................ 206,587 199,366
Cash surrender value of insurance .............................................. 7,162 6,998
Premises and equipment, net .................................................... 5,563 5,614
Accrued interest receivable .................................................... 2,853 2,497
Other assets ................................................................... 3,054 2,018
--------- ---------
Total assets ................................................................... $ 479,198 $ 451,274
========= =========
LIABILITIES
Deposits
Demand, non-interest-bearing .............................................. $ 45,173 $ 40,078
Interest-bearing demand accounts .......................................... 58,313 55,083
Money market accounts ..................................................... 35,951 35,599
Savings ................................................................... 43,031 37,160
Time ...................................................................... 141,126 134,967
Time over $100,000 ........................................................ 45,677 41,844
- -------------------------------------------------------------------------------- --------- ---------
Total deposits ....................................................... 369,271 344,731
Short-term borrowings .......................................................... 12,383 13,451
Federal Home Loan Bank advances ................................................ 55,000 53,000
Accrued interest payable ....................................................... 1,876 2,143
Other liabilities .............................................................. 2,064 2,730
--------- ---------
Total liabilities .............................................................. 440,594 416,055
========= =========
Commitments and contingencies
SHAREHOLDERS' EQUITY
Common stock, par value $1.25 per share;
authorized 5,000,000 shares;1,592,982 and 1,589,702 issued;
1,539,639 and 1,536,359 shares outstanding ................................ 1,991 1,987
Surplus ........................................................................ 8,736 8,681
Retained earnings .............................................................. 26,652 24,946
Accumulated other comprehensive gain ........................................... 2,719 1,099
Treasury stock, at cost: 53,343 shares at June 30, 2002 and December 31, 2001 .. (1,494) (1,494)
--------- ---------
Total shareholders' equity ..................................................... 38,604 35,219
--------- ---------
Total liabilities and shareholders' equity ..................................... $ 479,198 $ 451,274
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
Page 2
QNB Corp. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
SIX MONTHS ENDED JUNE 30, 2002 2001
-------- --------
OPERATING ACTIVITIES
Net income ........................................................................... $ 2,629 $ 2,172
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization ........................................................ 371 394
Securities losses (gains) ............................................................ 159 (240)
Net gain on sale of loans ............................................................ (222) (116)
Proceeds from sales of residential mortgages ......................................... 10,230 4,103
Originations of residential mortgages held-for-sale .................................. (9,734) (4,687)
Proceeds from sales of student loans ................................................. 1,703 2,350
Income on cash surrender value of insurance .......................................... (158) (65)
Deferred income tax provision ........................................................ 18 54
Change in income taxes payable ....................................................... 94 202
Net increase in interest receivable .................................................. (356) (394)
Net amortization of premiums and discounts ........................................... 218 7
Net (decrease) increase in interest payable .......................................... (267) 353
(Increase) decrease in other assets .................................................. (1,125) 9
Decrease in other liabilities ........................................................ (1,594) (675)
-------- --------
Net cash provided by operating activities ............................................ 1,966 3,467
-------- --------
INVESTING ACTIVITIES
Proceeds from maturities and calls of investment securities
available-for-sale ................................................................... 30,177 30,127
held-to-maturity ..................................................................... 7,848 5,586
Proceeds from sales of investment securities
available-for-sale ................................................................... 1,684 1,160
Purchase of investment securities
available-for-sale ................................................................... (52,779) (63,894)
held-to-maturity ..................................................................... (5,955) (8,080)
Net (increase) decrease in Federal funds sold ........................................ (127) 2,006
Net increase in loans ................................................................ (9,232) (6,297)
Recovery of charged-off loans ........................................................ 34 --
Net purchases of premises and equipment .............................................. (320) (118)
-------- --------
Net cash used by investing activities ................................................ (28,670) (39,510)
-------- --------
FINANCING ACTIVITIES
Net increase in non-interest-bearing deposits ........................................ 5,095 2,368
Net increase in interest-bearing deposits ............................................ 19,445 15,386
Net decrease in short-term borrowings ................................................ (1,068) (299)
Proceeds from Federal Home Loan Bank advances ........................................ 2,000 25,000
Cash dividends paid .................................................................. (923) (825)
Proceeds from issuance of common stock ............................................... 59 19
Purchases of treasury stock .......................................................... -- (321)
-------- --------
Net cash provided by financing activities ............................................ 24,608 41,328
-------- --------
(Decrease) increase in cash and cash equivalents ..................................... (2,096) 5,285
Cash and cash equivalents at beginning of year ....................................... 18,220 14,466
-------- --------
Cash and cash equivalents at end of period ........................................... $ 16,124 $ 19,751
======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid ........................................................................ $ 6,540 $ 6,389
Income taxes paid .................................................................... 505 260
Non-Cash Transactions
Change in net unrealized holding gains, net of taxes, on available-for-sale securities 1,620 1,037
The accompanying notes are an integral part of the consolidated financial
statements.
Page 3
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002 AND 2001, AND DECEMBER 31, 2001
(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, 2002, as well as the respective
statements of income and cash flows for the three and the six-month periods
ended June 30, 2002 and 2001, are unaudited. These financial statements should
be read in conjunction with the audited financial statements and notes thereto
included in QNB's 2001 Annual Report incorporated in the Form 10-K.
The financial statements reflect all adjustments, which in the opinion of
management are necessary for a fair presentation of the results of the interim
periods and are of a normal and recurring nature. The results for the periods
presented are not necessarily indicative of the full year.
2. PER SHARE DATA
The following sets forth the computation of basic and diluted earnings per share
(share and per share data have been restated to reflect the 5% stock dividend
issued June 29, 2001 and are not in thousands):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Numerator for basic and diluted earnings $ 1,354 $ 1,184 $ 2,629 $ 2,172
per share-net income
Denominator for basic earnings per share- 1,538,929 1,546,834 1,538,575 1,549,446
weighted average shares outstanding
Effect of dilutive securities-employee 14,049 2,034 11,634 1,546
stock options
Denominator for diluted earnings per 1,552,978 1,548,868 1,550,209 1,550,992
share-adjusted weighted average
shares outstanding
Earnings per share-basic $ .88 $ .77 $ 1.71 $ 1.40
Earnings per share-diluted $ .87 $ .76 $ 1.70 $ 1.40
There were 37,641 stock options that were anti-dilutive for both the three and
six-month periods ended June 30, 2001.
Form 10-Q
Page 4
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002 AND 2001, AND DECEMBER 31, 2001
(UNAUDITED)
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, 2002 and 2001 (net of the income tax effect):
For the Three Months Ended For the Six Months
June 30, Ended June 30,
2002 2001 2002 2001
---- ---- ---- ----
Unrealized holding gains (losses) arising
during the period on securities held $2,363 $ (21) $1,515 $1,195
Reclassification adjustment for sold securities
63 (118) 105 (158)
------ ----- ------ ------
Net change in unrealized gains (losses) during
the period 2,426 (139) 1,620 1,037
Unrealized holding gains (losses),
beginning of period 293 1,112 1,099 (64)
------ ------ ------ ------
Unrealized holding gains, end of period $2,719 $973 $2,719 $973
====== ====== ====== ======
Net income $1,354 $1,184 $2,629 $2,172
Other comprehensive income, net of tax:
Unrealized holding gains (losses)
arising during the period 2,426 (139) 1,620 1,037
------ ------ ------ ------
Comprehensive Income $3,780 $1,045 $4,249 $3,209
====== ====== ====== ======
4. STOCK REPURCHASE PLAN
In March of 2000, the Board of Directors of QNB Corp. authorized the repurchase
of up to 4.99 percent or 79,180 of the shares of QNB Corp's outstanding common
stock. Such repurchases may be made in open market or privately negotiated
transactions. The repurchased shares will be held in treasury and will be
available for general corporate purposes. Through June 30, 2002 QNB Corp.
repurchased 53,343 shares at an average cost of $28.01 per share.
Form 10-Q
Page 5
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002 AND 2001, AND DECEMBER 31, 2001
(UNAUDITED)
5. ACQUIRED INTANGIBLE ASSETS
The following table presents Intangible Asset information as of June 30, 2002:
Amortized Intangible Assets Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
------ ------------ ------
Purchased deposit premium $511 $238 $273
Mortgage servicing asset 304 - 304
--- ---- ----
Total $815 $238 $577
The following table presents Intangible Asset information as of December 31,
2001:
Amortized Intangible Assets Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
------ ------------ ------
Purchased deposit premium $511 $213 $298
Mortgage servicing asset 240 - 240
---- ---- ----
Total $271 $213 $538
AGGREGATE AMORTIZATION EXPENSE
For the Six Months ended June 30, 2002 $25
ESTIMATED AMORTIZATION EXPENSE
For the Year Ended 12/31/02 $51
For the Year Ended 12/31/03 51
For the Year Ended 12/31/04 51
For the Year Ended 12/31/05 51
For the Year Ended 12/31/06 51
Form 10-Q
Page 6
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.
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 the Bank, which are prepared
in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires the Bank to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. The Bank 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. The Bank 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.
The Bank 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-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.
Form 10-Q
Page 7
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
CRITICAL ACCOUNTING POLICIES AND ESTIMATES (CONTINUED)
ALLOWANCE FOR LOAN LOSSES
The Bank maintains an allowance for loan losses, which is intended to absorb
probable 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 by management as adequate.
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. The Bank'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 adequacy of
the allowance for loan losses.
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 accounting principles
generally accepted in the United States of America (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. The Bank 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 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
Form 10-Q
Page 8
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)
on matters that may, at least in part go beyond the Bank'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 of 2002 of $1,354,000 or $.87 per
share on a diluted basis. This compares to $1,184,000 or $.76 per share for the
same period in 2001. Net income for the first six months of 2002 was $2,629,000
or $1.70 per share, a 21.0 percent increase over the $2,172,000 or $1.40 per
share for the comparable period in 2001. Results for both the second quarter and
six months of 2002 represent records for QNB.
An increase in net interest income, resulting from significant growth in
deposits and the investment of these deposits in loans and investment
securities, was the primary contributor to the increase in net income when
comparing the second quarter of 2002 to the second quarter of 2001. Net interest
income increased from $3,287,000 for the second quarter of 2001 to $3,872,000
for the second quarter of 2002. Included in net interest income is the
recognition of $94,000 in interest on non-accrual loans that have been paid in
full. There was no such recognition of income in the second quarter of 2001.
Average deposits increased $61,444,000 or 20.0 percent when comparing the second
quarters of 2002 and 2001, with non-interest bearing demand deposits increasing
21.2 percent during this period. This is significant since these deposits
provide a low cost of funds. During this same period average loans increased
$20,561,000 or 11.0 percent and average investment securities increased
$43,982,000 or 23.5 percent. When comparing the second quarters of 2002 and 2001
the net interest margin was 3.80 percent compared to 3.75 percent. Excluding the
impact of the recognition of interest on non-accrual loans the net interest
margin would have been 3.72 percent for the second quarter of 2002.
Non-interest income decreased from $906,000 for the second quarter of 2001 to
$709,000 for the second quarter of 2002. Included in the results for 2002 were
gains on the sale of loans of $81,000 and net losses from the sale and other
than temporary impairment of equity securities of $95,000. This compares to
gains on the sale of loans and investments of $90,000 and $179,000,
respectively, during the second quarter of 2001. Excluding the gains and losses
from loan and investment securities during both periods, non-interest income
increased by $86,000 or 13.5 percent. An increase in income from bank-owned life
insurance, debit card income, overdraft income and trust and mutual fund fee
income accounts for most of the increase in non-interest income. Non-interest
expense
Form 10-Q
Page 9
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS (CONTINUED)
increased from $2,684,000 for the second quarter of 2001 to $2,886,000 for the
second quarter of 2002. An increase in personnel expenses of $159,000 accounts
for the increase in non-interest expense.
Return on average assets was 1.14 percent and 1.16 percent while the return on
average equity was 15.42 percent and 14.67 percent for the three months ended
June 30, 2002 and 2001, respectively. For the six-month periods ended June 30,
2002 and 2001, return on average assets was 1.13 percent and 1.10 percent and
the return on average equity was 15.23 percent and 13.61 percent, respectively.
NET INTEREST INCOME
Net interest income is the primary source of operating income for QNB. Net
interest income is interest income, dividends, and fees on earning assets, less
interest expense incurred for funding sources. Earning assets primarily include
loans, investment securities and Federal funds sold. Sources used to fund these
assets include deposits, borrowed funds and shareholders' equity. Net interest
income is affected by changes in interest rates, the volume and mix of earning
assets and interest-bearing liabilities, and the amount of earning assets funded
by non-interest-bearing deposits.
Net interest income increased 17.8 percent to $3,872,000 for the quarter ended
June 30, 2002 as compared to $3,287,000 for the quarter ended June 30, 2001. 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
17.6 percent from $3,600,000 for the three months ended June 30, 2001 to
$4,233,000 for the same period ended June 30, 2002. Included in net interest
income is the recognition of $94,000 in interest on non-accrual loans that have
been paid in full. There was no such recognition of income in the second quarter
of 2001. As mentioned previously, the growth in net interest income is a result
of the tremendous growth in deposits and the investment of these deposits into
profitable loans and investment securities. Average deposits increased
$61,444,000 or 20.0 percent when comparing the second quarters of 2002 and 2001.
Deposit growth was aided by the continued volatility and decline of the stock
market, as funds flowed out of stocks and mutual funds and flowed into deposits,
particularly short-term time deposits and savings accounts. These deposits were
used to fund the $20,561,000 or 11.0 percent increase in average loans and the
$43,982,000 or 23.5 percent increase in average investment securities.
Some of the growth when comparing the second quarter of 2002 to the second
quarter of 2001 was funded by wholesale funding transactions. During the fourth
quarter of 2001 and the first quarter of 2002, QNB borrowed $5,000,000 in total
from the Federal Home Loan Bank (FHLB). These funds reprice quarterly at
three-month LIBOR plus 9 basis points. These funds were invested in securities
that also reprice with three- month LIBOR plus 194 basis points for a spread of
185 basis points. During the second quarter of 2002 $1,000,000 of the securities
priced at LIBOR plus 100 basis points were sold and replaced with a security
priced at LIBOR plus 210 basis points. This increased the yield on the
$5,000,000 of investments from LIBOR plus 194 basis points to LIBOR plus 210
basis points and the spread on the transaction to 201 basis points. These
transactions have the impact of increasing net interest income, but lowering the
net interest margin.
Form 10-Q
Page 10
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (CONTINUED)
During 2001, in response to a slowing economy and the events of September 11,
the Federal Reserve Bank lowered the Federal funds target rate 11 times and 475
basis points to 1.75 percent, its lowest level in 40 years. Market interest
rates as represented by the Treasury yield curve also fell sharply during this
period. This had the impact of lowering the yield on earning assets and the rate
paid on interest-bearing liabilities. While the Federal Reserve Bank has not
taken any action with respect to the Federal funds rate during the first half of
2002, market interest rates have been volatile, increasing during the first
quarter of 2002 and than declining back to near 2001 lows during the second
quarter of 2002. The yield on earning assets on a tax-equivalent basis was 6.59
percent for the second quarter of 2002 versus 7.33 percent for the second
quarter of 2001, while the rate paid on interest-bearing liabilities was 3.16
percent and 4.07 percent for the same periods. Excluding the impact of the
recognition of the non-accrual income the yield on earning assets was 6.51
percent. The net interest margin, on a tax-equivalent basis, increased 5 basis
points to 3.80 percent for the three-month period ended June 30, 2002 compared
with 3.75 percent for the same period in 2001. Excluding the recognition of
non-accrual income the net interest margin was 3.72 percent, a decline of 3
basis points from the second quarter of 2001.
The prime rate on loans also dropped 11 times during 2001 from 9.50 percent to
4.75 percent. The average prime rate when comparing the second quarter of 2001
to the second quarter of 2002 decreased 258 basis points, from 7.33 percent to
4.75 percent. The yield on loans, excluding non-accrual interest, decreased 99
basis points to 7.19 percent when comparing the second quarter of 2001 to the
second quarter of 2002. 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 small 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 and commercial loans into lower yielding loans. The yield on the loan
portfolio may continue to decline in 2002 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.
When comparing the second quarter of 2002 to the second quarter of 2001, the
yield on investment securities decreased to 6.04 percent from 6.65 percent. With
the decline in interest rates cash flow from callable agency bonds,
mortgage-backed securities and CMOs increased. These funds as well as new funds
from deposit growth were reinvested in lower yielding securities. The yield on
the investment portfolio may continue to decline during 2002, as higher yielding
securities are replaced at lower rates.
While total interest income on a tax-equivalent basis increased $295,000 when
comparing the second quarter of 2002 to the second quarter of 2001, total
interest expense decreased $338,000. The rate paid on interest bearing deposits
decreased from 3.81 percent to 2.84 for the quarters ended June 30, 2001 and
2002. Lower rates paid on interest-bearing demand accounts, money market
accounts and savings accounts contributed to the $40,000, $146,000 and $24,000
decrease in interest expense for these products. The average rate paid on money
market accounts declined 146 basis points when comparing the second quarter of
2002 yield of 1.58 percent to the second quarter of 2001 yield of 3.04 percent.
Contributing to the decline in the yield 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 sharp decline in the 91-day
Treasury rate resulted in significantly lower rates on this product. In
Form 10-Q
Page 11
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (CONTINUED)
response to lower market rates of interest QNB lowered the rates paid on
interest bearing transaction accounts and savings accounts. The average rate
paid on interest bearing transaction accounts declined 40 basis points to .58
percent while the average rate paid on savings accounts declined 43 basis points
to 1.23 percent when comparing the second quarter of 2002 to the second quarter
of 2001.
Most of the growth in deposits has occurred in time deposits. For customers,
time deposits, particularly those with maturities of one year or less, have
provided relative value compared to rates on money market and savings accounts.
One such deposit is the "Flex 12" certificate of deposit. This product has a
twelve-month maturity, allows for one no-penalty withdrawal, enables the holder
to add funds to the account, and pays a competitive interest rate. Average time
deposits have increased $43,895,000 to $191,006,000 when comparing the second
quarter of 2002 to the same period in 2001. Of this increase $27,426,000 has
been in time deposits with balances of $100,000 or more. The average rate paid
on time declined from 5.51 percent to 4.10 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 yield in either a rising or
falling rate environment. The yield on time deposits should continue to decline
in 2002 as these deposits mature and reprice at lower rates. However, the rate
of decline will likely slow as many of these deposits have already repriced at
lower rates. The yield on non-maturity interest-bearing deposits which reprice
immediately when their rates are changed will likely not decline as they have
reached levels where only minimal reduction in rates is possible.
The rate paid on short-term borrowings decreased from 3.62 percent to 2.08
percent. Most of these borrowings are indexed with the Federal funds rate. The
average rate paid on the FHLB advances decreased from 5.62 percent during the
second quarter of 2001 to 5.31 percent during the second quarter of 2002. Most
of the advances from the FHLB have fixed rates.
For the six-month period ended June 30, 2002, net interest income increased
$1,052,000 or 16.3 percent to $7,497,000. On a tax-equivalent basis net interest
income increased $1,140,000 or 16.2 percent. The 17.7 percent growth in average
earning assets was partially offset by a 5 basis point decline in the net
interest margin. The net interest margin on a tax-equivalent basis was 3.76
percent for the six-month period ended June 30, 2002 compared with 3.81 percent
for the same period in 2001. Excluding the impact of the recognition of interest
on non-accrual loans during the second quarter of 2002, the net interest margin
declined by 10 basis points.
As mentioned previously some of the growth in earning assets was funded through
a series of wholesale funding transactions. In addition to the $5,000,000 in
FHLB advances in the fourth quarter of 2001 and the first quarter of 2002, QNB,
during the first quarter of 2001, borrowed $25,000,000 from the FHLB at an
average rate of 5.71 percent. These funds were reinvested in securities with an
average yield of 7.07 percent, for an initial spread of 136 basis points. For
the six-month period ended June 30, 2002, these borrowings contributed an
additional $8,050,000 to the growth in average earning assets when compared to
the six-month period ended June 30, 2001.
Total interest income increased $583,000 from $13,187,000 to $13,770,000 when
comparing the six-month periods ended June 30, 2001 to June 30, 2002. The yield
on earning assets decreased from 7.45 percent to 6.63 percent, with the yield on
Federal funds sold declining 304 basis points between the six-month periods. The
yield on loans decreased from 8.25 percent to 7.37 percent and the yield on
investment securities decreased
Form 10-Q
Page 12
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (CONTINUED)
from 6.73 percent to 6.16 percent for the six-month periods. The yield on the
loan portfolio and investment portfolio are slower to react to changes in
interest rates compared to the yield on Federal funds sold which changes
immediately with action by the Federal Reserve Bank. Average investment
securities increased 24.1 percent to $222,987,000 while average loans increased
11.5 percent to $207,458,000.
Total interest expense decreased $469,000 from $6,742,000 to $6,273,000 for the
six-month periods with interest on interest-bearing demand deposit accounts,
money market accounts and savings accounts accounting for $105,000, $322,000 and
$65,000 of the decrease. The yield on these accounts declined 56 basis points,
161 basis points and 50 basis points when comparing the average rate paid for
the six-month periods ended June 30, 2002 and 2001. Interest expense on time
deposits increased $67,000 as the impact of the significant increase in average
balances offset the decline in the average rate paid. The average rate paid on
time deposits for the six months ended June 30, 2002 and 2001 was 4.27 percent
and 5.56 percent, respectively. Interest expense on short-term borrowings
declined by $198,000 as the rates paid on these accounts react more closely to
changes in the Federal Funds rate. The additional borrowings from the FHLB
contributed an additional $154,000 in interest expense when comparing the
six-month periods.
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 loan portfolio. Actual loan losses, net of recoveries,
serve to reduce the allowance.
The determination of an appropriate level of the allowance for loan losses is
based upon an analysis of the risk inherent in QNB's loan portfolio. Management
uses various tools to assess the adequacy of the allowance for loan losses. One
tool is a model recommended by the Office of the Comptroller of the Currency.
This model considers a number of relevant factors including: historical loan
loss experience, the assigned risk rating of the credit, current and projected
credit worthiness of the borrower, current value of the underlying collateral,
levels of and trends in delinquencies and non-accrual loans, trends in volume
and terms of loans, concentrations of credit, and national and local economic
trends and conditions. This model is supplemented with another analysis that
also incorporates exceptions to QNB's loan policy and QNB's portfolio exposure
to borrowers with large dollar concentration, defined as exceeding 50% of QNB's
legal lending limit. 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, 2002 or 2001 as charged off
loans, non-performing assets and delinquent loans remained at low levels
relative to the allowance for loan losses. QNB had a net recovery of $31,000
during the first quarter of 2002 and a net charge-off of $15,000 during the
first quarter of 2001.
QNB had net recoveries of $3,000 and $34,000 for the three and six-month periods
ended June 30, 2002. This compares to net charge-offs of $13,000 and $27,000 for
the same periods ended June 30, 2001.
Non-performing assets (non-accruing loans, loans past due 90 days or more, and
other real estate owned) continued to decline during the second quarter of 2002.
Non-performing assets amounted to .08 percent of total assets at June 30, 2002.
This compares to .18 percent at June 30, 2001 and .13 percent at December 31,
Form 10-Q
Page 13
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
PROVISION FOR LOAN LOSSES (CONTINUED)
2001. Non-accrual loans were $363,000 and $244,000 at June 30, 2002 and 2001.
Non-accrual loans at December 31, 2001 were $280,000.
The decrease in non-performing assets was in the category of past due loans 90
days or more. These loans amounted to $4,000 at June 30, 2002 compared to
$509,000 at June 30, 2001 and $316,000 at December 31, 2001. The increase in
past due loans primarily relates to two borrowers, one of which has cured
subsequent to June 30, 2001. Overall delinquency, including loans past due 90
days or more, also improved during the second quarter of 2002 and represented
..49 percent of total loans at June 30, 2002. This compares to 1.35 percent and
..83 percent at June 30, 2001 and December 31, 2001, respectively. QNB did not
have any other real estate owned as of June 30, 2002, December 31, 2001 or June
30, 2001.
There were no restructured loans as of June 30, 2002, December 31, 2001 or June
30, 2001 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 $2,879,000 and $2,845,000 at June 30, 2002 and
December 31, 2001, respectively. The ratio of the allowance to total loans was
1.37 percent and 1.41 percent at both period end dates. 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, 2002 and 2001, the recorded investment in loans for which impairment
has been recognized in accordance with SFAS No. 114 totaled $283,000 and
$193,000, respectively, of which $283,000 and $157,000 related to loans with no
valuation allowance. At June 30, 2002 and 2001 there were $0 and $36,000 in
impaired loans that had a valuation allowance against the entire amount. Most of
the loans identified as impaired are collateral-dependent.
QNB anticipates no provision for loan losses will be necessary in 2002 as long
as credit quality remains high with non-performing assets, delinquent loans and
charge-offs remaining low. These factors could be negatively impacted if the
economy is slow to recover in 2002. Strong growth in the loan portfolio could
also impact the need for a provision for loan losses in the future.
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 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
Form 10-Q
Page 14
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
PROVISION FOR LOAN LOSSES (CONTINUED)
examination process, periodically review the Company's allowance for losses on
loans. Such agencies may require the Company 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 student loans, and other
miscellaneous fee income. QNB reviews all service charges and fee schedules
related to its products and services on an annual basis. QNB has not materially
changed these fee schedules during 2001 or 2002. In December 2001, QNB
implemented "Free Checking" for personal non-interest bearing checking accounts
and "No-Bounce", an overdraft protection service that will pay overdrafts up to
a predetermined level on all eligible checking accounts.
Total non-interest income decreased $197,000 or 21.7 percent to $709,000 for the
quarter ended June 30, 2002 when compared to June 30, 2001. For the six-month
period total non-interest income decreased $145,000 or 9.1 percent to
$1,443,000. Excluding gains on the sale of investment securities and loans
during both periods, non-interest income for the three-month period increased
$86,000 or 13.5 percent and for the six-month period increased $148,000 or 12.0
percent.
Fees for services to customers, the largest component of total non-interest
income, are primarily comprised of service charges on deposit accounts. These
fees increased 5.8 percent, to $381,000 when comparing the two quarters and 4.2
percent to $739,000 when comparing the six-month periods. A $19,000 increase in
service charges on business checking accounts and a $26,000 increase in
overdraft income offset the $19,000 in fee income lost as a result of the
implementation of "Free Checking" when comparing the two quarters. For the
six-month period business checking account fees increased $36,000 and overdraft
income increased $39,000. This offset a $38,000 decline in service charges on
personal checking accounts. The increase in business service charge income is a
function of the lower earnings credit rate, resulting from the decline in
interest rates, applied against balances to offset service charges incurred. The
introduction of "Free Checking" for personal non-interest bearing checking
accounts will result in a reduction of service charge income in 2002. These fees
amounted to $70,000 in 2001. Management believes that the loss of this income
will be offset by the benefit of an increase in low costing deposit balances and
an increase in fees as a result of "No-Bounce".
ATM and debit card income is primarily comprised of interchange income on debit
cards and ATM surcharge income for the use of QNB ATM machines by non-QNB
customers. ATM and debit card income was $128,000 for the second quarter of
2002, an increase of $8,000 or 6.7 percent from the amount recorded during the
second quarter of 2001. For the six-month periods ATM and debit card income
increased 8.7 percent to $237,000. Debit card income increased $17,000 or 24.2
percent for the three-month periods and $31,000 or 23.0 percent when comparing
the six-month periods ended June 30, 2002 and 2001. The increase in debit card
income is a result of increased acceptance by consumers of the card as a means
of paying for goods and services. ATM transaction surcharge income decreased
$8,000 or 20.0 percent when comparing the second quarter of 2002 to the second
quarter of 2001. For the six-month period ATM transaction surcharge income
decreased $4,000 or 6.8 percent. This charge was increased during the second
quarter of 2001 from $1.00 per transaction to $1.50 per transaction.
Form 10-Q
Page 15
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (CONTINUED)
The decline in income when analyzing the quarter is a result of a reduction in
the number of transactions by non-QNB customers at QNB machines. This could be a
function of both the greater use of the card as a debit card and the increase in
the fee. Also negatively impacting ATM income was a reduction in fee come from
the annual card fee. For the three and six month periods income derived from the
annual card fee decreased $3,000 and $6,000, respectively. This decline is a
result of the simplification of deposit products resulting in this fee being
eliminated for many customers.
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 increased from $36,000 during the second quarter of 2001 to $79,000
during the second quarter of 2002. For the six-month periods this income
increased from $65,000 to $158,000. This increase is primarily the result of the
purchase of an additional $3,000,000 of insurance during the fourth quarter of
2001. An increase in the earnings rate on another policy also contributed to the
increase in income.
To date, when QNB sells its residential mortgages in the secondary market, it
retains servicing rights. A normal servicing fee is retained on all mortgage
loans sold and serviced. Mortgage servicing fees for the quarter ended June 30,
2002 were $21,000 which represents a $6,000 decrease from the same period in
2001. For the six-month period mortgage servicing fees decreased $18,000 or 33.3
percent to $36,000. The decrease in mortgage servicing fees for both the quarter
and six-month period is primarily a result of an increase in the amortization of
the mortgage-servicing asset. QNB recognizes its obligation to service financial
assets that are retained in a transfer of assets in the form of a servicing
asset. The servicing asset is amortized in proportion to and over a period of
net servicing income or loss. Servicing assets are assessed for impairment based
on their fair value. For the three and six month periods ended June 30, 2002,
QNB amortized approximately $20,000 and $39,000 of the mortgage servicing asset
compared to $11,000 and $22,000 during the same periods in 2001. The lower
interest rate environment of 2002 and 2001 has resulted in a significant amount
of mortgage refinancing activity. The average balance of mortgages serviced for
others was $67,323,000 for the second quarter of 2002 compared to $59,834,000
for the second quarter of 2001. The average balance of mortgages serviced was
approximately $66,611,000 for the six-month period ended June 30, 2002 compared
to $59,979,000 for the first six months of 2001, an increase of 11.1 percent.
The timing of mortgage payments and delinquencies also impacts the amount of
servicing fees recorded.
QNB recorded a net loss of $95,000 on the sale or other than temporary
impairment of investment securities during the second quarter of 2002. For the
six-month period ended June 30, 2000 the net loss was $159,000. Included in
these amounts were losses of $118,000 for the quarter and $200,000 for the
six-month period related to the write-down of marketable equity securities that
declined in market value below cost, which was deemed to be other than
temporary. Gains on the sale of investment securities were $179,000 and $240,000
for the three-month and six-month periods ended June 30, 2001. These gains were
a result of sales of marketable equity securities.
QNB recorded a gain of $81,000 on the sale of loans during the second quarter of
2002. This compares to a $90,000 gain for the same period in 2001. For the
six-month periods ended June 30, 2002 and 2001 net gains on the sale of loans
were $222,000 and $116,000, respectively. The sale of student loans accounts for
$15,000 and $39,000 of the gains during the second quarter of 2002 and 2001. QNB
sold approximately $785,000 and $2,041,000 in student loans during the second
quarter of 2002 and 2001. Gains on the sale of student loans accounted for
$32,000 and $43,000 of the total gains during the six-month periods ended June
30, 2002 and 2001, respectively. For the six-month periods ended June 30, 2002
and 2001, QNB sold approximately
Form 10-Q
Page 16
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (CONTINUED)
$1,671,000 and $2,307,000 of loans. The decrease in the gain on the sale relates
to the lower volume of loans sold and a change in pricing by the Government
agencies that purchase these loans.
The net gain on residential mortgage sales is directly related to the volume of
mortgages sold and the timing of the sales relative to the interest rate
environment. As mentioned previously, the dramatic decline in interest rates
during 2001 and particularly during the fourth quarter of 2001 led to record
mortgage refinancing activity. This activity remained strong during the first
half of 2002 as interest rates remain low. The net gain on the sale of
residential mortgage loans were $66,000 and $51,000 for the three-month periods
ended June 30, 2002 and 2001 and $190,000 and $73,000 for the respective
six-month periods. QNB originated $2,923,000 and $3,027,000 in residential
mortgages held for sale during the second quarter of 2002 and 2001 and
$9,734,000 and $4,687,000 during the respective six-month periods. Proceeds from
the sale of residential mortgages were approximately $2,593,000 and $3,365,000
during the second quarters of 2002 and 2001, respectively. For the six-month
periods proceeds from the sale of residential mortgage loans amounted to
$10,230,000 and $4,103,000, respectively. At June 30, 2002 and 2001, QNB had
approximately $508,000 and $729,000 in mortgage loans classified as held for
sale. These loans are accounted for at lower of cost or market.
Other operating income increased $20,000 or 21.3 percent to $114,000 when
comparing the three-month periods ended June 30, 2002 and 2001 and $24,000 or
12.9 percent to $210,000 when comparing the six-month periods. Trust income and
retail brokerage income increased $9,000 and $19,000 when comparing the
three-month periods and $17,000 and 20,000 when comparing the six-month periods.
Also contributing to the increase in other operating income was an increase in
insurance commissions derived from loan products. These commissions increased
$6,000 for the three-month period and $8,000 for the six-month period. Partially
offsetting these increases were declines in income from official checks and
merchant income. Official check income declined $8,000 for the quarter and
$22,000 for the six-month period. This decline is a function of the lower
interest rate environment. Merchant income decreased $4,000 when comparing the
quarters.
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
$2,886,000 for the quarter ended June 30, 2002 represents an increase of
$202,000 or 7.5 percent from levels reported in the second quarter of 2001.
Total non-interest expense for the six months ended June 30, 2002 was
$5,680,000, an increase of $353,000 or 6.6 percent over 2001 levels.
Salaries and benefits, the largest component of non-interest expense, increased
$159,000 or 10.9 percent to $1,621,000 for the quarter ended June 30, 2002
compared to the same quarter in 2001. Salary expense increased $131,000 or 11.0
percent during the period to $1,321,000 while benefits expense increased $28,000
or 10.2 percent to $300,000. For the six-month period ended June 30, 2002
salaries and benefits expense increased $240,000 or 8.2 percent compared to
2001. Salary expense increased $205,000 or 8.7 percent while benefits expense
increased $35,000 or 6.1 percent. The increase in salary expense is related to
merit increases, incentive compensation and the increase in the number of
employees. The accrual for incentive compensation increased $62,000 when
comparing the two quarters and $82,000 when comparing the six-month periods. The
number of full time-equivalent employees increased by two when comparing both
the three and six month periods.
Form 10-Q
Page 17
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST EXPENSE (CONTINUED)
Contributing to the increase in benefits expense for both the three and
six-month periods is an $11,000 increase in payroll tax expense. Also
contributing to the increase for the quarter were higher medical and dental
insurance premiums of $8,000. Higher retirement plan expense and workers
compensation premium expense also contributed to the increase in benefits
expense for the quarter. For the six-month period medical premium costs
decreased $2,000 while dental premium expense and retirement plan expense
increased $7,000 each. The decline in medical insurance premiums for the
six-month period is a result of employees either opting out of coverage or
switching to lower cost coverage.
Net occupancy expense increased $1,000 when comparing the second quarter of 2002
to the second quarter of 2001. Increases in branch rent expense of $4,000 and
building repairs and maintenance expense of $3,000 were offset by a $7,000
decline in utility costs. The decline in utility costs is a function of a
decline in energy costs and decreased usage, which is weather related. QNB
expects the usage to increase during the third quarter as a result of the hot
summer. For the six-month period, net occupancy expense decreased $11,000 or 2.6
to $406,000. Utility expense decreased $23,000 or 29.8 percent and building
repairs and maintenance costs decreased $4,000 or 5.1 percent. Partially
offsetting this was a $13,000 increase in branch rent expense that can be
attributed to an increase in the monthly rent at one location and the opening of
the Souderton branch in January 2001.
Furniture and equipment expense decreased $6,000 or 2.3 percent when comparing
the three-month periods ended June 30, 2002 and 2001 and $12,000 or 2.4 percent
when comparing the six-month periods. Depreciation and amortization expense
decreased $11,000 and $22,000 when comparing the three-month and six-month
periods, respectively. Partially offsetting this were increased equipment
maintenance costs of $7,000 and $9,000 for the same periods. Depreciation and
amortization expense is anticipated to increase in the third and fourth quarters
as several large projects are completed and put into service.
Marketing expense increased $9,000 to $117,000 for the quarter ended June 30,
2002 and $20,000 to $261,000 when comparing the six-month periods. For the
three-month period increases in public relation and sales promotional expense
offset a reduction in advertising costs. Some of these variances relate to the
timing of the expenditure. For the six-month period advertising costs decreased
$12,000 and sales promotional expense decreased $4,000. The higher costs in the
first half of 2001 pertain to the opening of the new branch in Souderton and the
opening of the Trust and Investment Management area. Donations expense increased
$36,000 when comparing the six-month periods. This is a result of an increase in
contributions and sponsorships to clubs and community events in the local
communities we serve.
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 $145,000 in the second quarter of 2002 compared
to $118,000 for the second quarter of 2001. For the six-month periods ended June
30, 2002 and 2001 third party service expense was $279,000 and 219,000,
respectively. Third party costs related to the operation of the trust department
increased $5,000 and $11,000 when comparing the respective periods. Consultant
expense increased $11,000 when comparing the two quarters and $24,000 when
comparing the six-month periods. This increase is primarily the result of the
development of a bank-wide sales initiative that is focused on sales training.
In conjunction with this program is a service initiative that will work to
enhance the exceptional personal service that our customers deserve. Increased
expenses related to correspondent banking activity and security safekeeping also
contributed to the increase in third party service expense.
Form 10-Q
Page 18
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST EXPENSE (CONTINUED)
The major categories that comprise other expense are regulatory costs, insurance
costs, membership fees, courier expense, ATM and debit card expense and
directors fees. When comparing the three-month periods ended June 30, 2002 and
2001 total other expense increased $16,000 to $336,000. Contributing to this
increase was an $8,000 increase in charged-off checking accounts, a $5,000
increase in the Comptroller of the Currency assessment and an $11,000 increase
in ATM and debit card expenses. For the six-month period total other expense
increased $44,000 or 7.4 percent to $640,000. Contributing to this increase was
a $17,000 increase in charged-off checking accounts, a $10,000 increase in the
Comptroller of the Currency assessment and a $19,000 increase in ATM and debit
card expenses.
INCOME TAXES
Applicable income taxes and effective tax rates were $341,000 or 20.1 percent
for the three-month period ended June 30, 2002, and $325,000 or 21.5 percent for
the same period in 2001. For the six-month period applicable income taxes and
effective rates were $631,000 or 19.4 percent and $534,000 or 19.7 percent,
respectively. The reduction in the effective tax rate when comparing 2002 to
2001 is a result of an increase in income from tax-exempt municipal securities
and loans as well as the income from the bank owned life insurance relative to
total pre-tax income.
QNB utilizes an asset and liability approach for financial accounting and
reporting of income taxes. As of June 30, 2002, QNB's net deferred tax liability
was $579,000. A deferred tax asset of $738,000 relating to the allowance for
loan losses was offset by a deferred tax liability of $1,401,000 resulting from
the SFAS No. 115 adjustment for available-for-sale investment securities. At
June 30, 2001, QNB's net deferred tax asset was $290,000. Included in the
deferred tax asset was $752,000 relating to the allowance for loan losses
partially offset by a deferred tax liability of $501,000 resulting from the SFAS
No. 115 adjustment fort available-for-sale investment securities. An increase in
the market value of the available-for-sale investment portfolio resulting from
declining interest rates accounts for the change to a deferred tax liability
from a deferred tax asset.
BALANCE SHEET ANALYSIS
The Balance Sheet Analysis reviews average balance sheet data for the six months
ended June 30, 2002 and 2001, as well as the period ending balances as of June
30, 2002 and December 31, 2001.
Average earning assets for the six-month period ended June 30, 2002 increased
$66,259,000 or 17.7 percent to $440,009,000 from $373,750,000 for the six months
ended June 30, 2001. Average investments increased $43,362,000 while average
loans and Federal funds sold increased $21,423,000 and $1,538,000, respectively.
The large increase in the investment portfolio is the result of the strong
growth in deposits as well as the additional borrowings from the FHLB. These
advances were used to fund specific investment strategies. The additional
advances from the FHLB averaged $8,050,000 more for the first half of 2002
compared to the first half of 2001.
Form 10-Q
Page 19
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS (CONTINUED)
The 11.5 percent increase in average loans is a result of the development of a
business development and calling program encompassing lending personnel, branch
personnel and executive management. The focus of this program is to both develop
new lending and deposit relationships as well as strengthen existing
relationships. The addition of the new branch location and geographic market was
also key to the growth in loans. Average commercial loans increased $12,664,000
while average residential mortgage loans and consumer loans increased $3,194,000
and $5,638,000 when comparing the first half of 2002 to the first half of 2001.
The increase in residential mortgage loans is a result of the increase in the
amount of variable rate loans, primarily loans that are fixed rate for the first
seven years than adjust annually thereafter. The increase in consumer loans is
the result of aggressive fixed rate home equity loan promotions and pricing. QNB
continues to sell the majority of its fixed rate residential mortgage loans.
In addition to borrowing from the Federal Home Loan Bank, the growth in average
earning assets was funded by increases in non-interest-bearing and
interest-bearing deposit accounts. Average non-interest bearing demand accounts
increased $8,001,000 or 24.0 percent, while interest-bearing deposit accounts
increased $55,576,000 or 20.9 percent. The growth in average interest-bearing
deposit accounts is primarily centered in time deposits, which increased
$46,223,000. Included in that amount is an increase in average time deposits
over $100,000 of $28,423,000. For customers, time deposits, particularly those
with maturities of one year or less, have provided relative value compared to
rates on money market and savings accounts. One such deposit is the "Flex 12"
certificate of deposit. This product has a twelve-month maturity, allows for one
no-penalty withdrawal, enables the holder to add funds to the account, and pays
a competitive interest rate. Average interest bearing transaction accounts
increased $7,363,000 and average savings accounts increased $4,182,000 when
comparing the first half of 2002 to the first half of 2001. During this same
period average money market accounts decreased by $2,192,000.
Total assets at June 30, 2002 were $479,198,000, compared with $451,274,000 at
December 31, 2001, an increase of 6.2 percent for the year. The increase in
assets from December 31, 2001 to June 30, 2002 is primarily centered in
investment securities and loans, which increased $21,167,000 and $7,255,000,
respectively. This growth was primarily funded by a $24,540,000 increase in
total deposits. Total deposits increased from $344,731,000 at December 31, 2001
to $369,271,000 at June 30, 2002. A $9,992,000 increase in time deposits is the
primary reason for the increase in total deposits. During this same period
savings accounts increased by $5,871,000 and non-interest bearing and interest
bearing demand accounts increased by $5,095,000 and $3,230,000, respectively.
At June 30, 2002 the fair value of investment securities available-for-sale was
$191,234,000 or $4,120,000 above the amortized cost of $187,114,000. This
compares to a fair value of $168,102,000 or $1,666,000 above the amortized cost
of $166,436,000 at December 31, 2001. An unrealized holding gain, net of taxes,
of $2,719,000 and $1,099,000 was recorded as an increase to shareholders' equity
at June 30, 2002 and December 31, 2001, respectively. Interest rates, which had
risen during the first quarter of 2002, declined sharply during the second
quarter of 2002. This resulted in the increase in the unrealized gain in the
portfolio. The growth in the portfolio is primarily a result of the growth in
deposits exceeding the growth in loans. Despite the growth in the portfolio, the
composition of the portfolio has not changed significantly since December 31,
2001. During the second quarter of 2002, management and the Board 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.
Form 10-Q
Page 20
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS (CONTINUED)
The available-for-sale portfolio had a weighted average maturity of
approximately 5 years and 3 months at June 30, 2002 and 5 years, 5 months at
December 31, 2001. The weighted average tax-equivalent yield was 6.01 percent
and 6.29 percent at June 30, 2002 and December 31, 2001. 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. 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 3 years, 6 months at June
30, 2002 and 4 years at December 31, 2001, based on these assumptions. The
decline in the weighted average maturity and expected repricing term is a
function of declining interest rates that increases the prepayments on
mortgage-backed securities and CMOs. Management's strategy of investing new
funds and the reinvestment of runoff into shorter maturity and average life
investments, in light of the low interest rate environment, has also had an
impact on the weighted average maturity of the portfolio. QNB expects the yield
on the investment portfolio to continue to decline as a result of the roll-off
of higher yielding securities into lower yielding securities.
Investment securities held-to-maturity are reported at amortized cost. As of
June 30, 2002 and December 31, 2001, QNB had securities classified as
held-to-maturity with an amortized cost of $40,833,000 and $42,798,000 and a
market value of $41,602,000 and $43,048,000, respectively. The held-to-maturity
portfolio had an expected repricing term of approximately 2 years, 7 months and
3 years, 1 month at June 30, 2002 and December 31, 2001. The weighted average
tax-equivalent yield was 6.20 percent and 6.28 percent at June 30, 2002 and
December 31, 2001.
LIQUIDITY
Liquidity represents an institution's ability to generate cash or otherwise
obtain funds at reasonable rates to satisfy commitments to borrowers and demands
of depositors. QNB manages its mix of cash, Federal funds sold, investment
securities and loans in order to match the volatility, seasonality, interest
sensitivity and growth trends of its deposit funds. Liquidity is provided from
asset sources through maturities and repayments of loans and investment
securities, net interest income and fee income. The portfolio of investment
securities available-for-sale and QNB's policy of selling certain residential
mortgage originations and student loans in the secondary market also provide
sources of liquidity. Additional sources of liquidity are provided by The
Quakertown National Bank's membership in the Federal Home Loan Bank and a
$5,000,000 unsecured Federal funds line granted by the Bank's correspondent.
Cash and due from banks, Federal funds sold, available-for-sale securities and
loans held-for-sale were $213,826,000 and $194,105,000 at June 30, 2002 and
December 31, 2001. These sources were adequate to meet deposit withdrawals and
loan demand during the first half of 2002 and should be adequate to meet normal
fluctuations in loan demand and or deposit withdrawals. QNB has been able to
fund the growth in earning assets during the first half of 2002 through
increased deposits and advances from the FHLB. QNB did not use its Federal funds
line, overnight borrowings from the FHLB or the Federal Reserve Bank discount
window to fund loan growth or deposit withdrawals during the first half of 2002.
Approximately $52,963,000 and $47,997,000 of available-for-sale securities at
June 30, 2002 and December 31, 2001 were pledged as collateral for repurchase
agreements and deposits of public funds as required by law. In addition, under
terms of its agreement with the Federal Home Loan Bank, QNB maintains otherwise
unencumbered qualifying
Form 10-Q
Page 21
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
LIQUIDITY (CONTINUED)
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 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 $2,096,000 to $16,124,000 at June 30, 2002. This
compares to a $5,285,000 increase during the first six months of 2001. The
increase in cash in 2001 is a result of a late delivery of a $5,586,000 cash
letter on June 29, 2001. These funds normally would have been invested in
Federal funds sold.
After adjusting net income for non-cash transactions, operating activities
provided $1,966,000 in cash flow in the first six months of 2002, compared to
$3,467,000 in the same period of 2001. The decrease in cash provided by
operating activities when comparing the two periods relates to an increase in
other assets as well as a reduction in other liabilities in 2002. The increase
in other assets relates to the maturity of an investment security on June 30,
2002, whose proceeds were not received until July 1, 2002. The decrease in other
liabilities relates to the purchase of a security in December 2001, that the
broker failed to deliver until January 2002. The purchase was booked as an
investment since QNB was the owner and a liability was recorded.
Net cash used by investing activities was $28,670,000 during the first six
months of 2002. Loan growth, particularly during the second quarter of 2002,
created a net increase in loans and a use of cash of $9,232,000. In addition,
the purchase of investment securities exceeded the maturity, call and sale of
securities by $19,025,000 during the first half of 2002. Most of the activity
relates to the deployment of the deposit growth experienced during the first six
months of 2002. Proceeds from calls and prepayments of securities continue to be
high, as interest rates remain low.
Net cash used by investing activities was $39,510,000 during the first half of
2001. The purchase of investment securities exceeded the maturity, call and sale
of securities by $35,101,000 during the first six months of 2001. This increase
relates primarily to the $25,000,000 in purchases as part of the leverage
transaction as well as the result of the increase in deposits during the first
six months of 2001. The large amount of proceeds from investment securities
relates to the decline in interest rates which resulted in the pre-funding of
callable agency bonds and increased the influx of cash flow on mortgage related
securities. Growth in loans created a net increase in loans of $6,297,000 during
the first six months of 2001. A decrease in federal funds sold of $2,006,000
provided cash during the first six months of 2001.
Net cash provided by financing activities was $24,608,000 during the first half
of 2002 and $41,328,000 during the six months of 2001. A $19,445,000 increase in
interest-bearing deposits and a $5,095,000 increase in non-interest bearing
demand deposits was the main source of funding during the first six months of
2002. An additional $2,000,000 advance from the FHLB also provided funding
during the first half of 2002. The $923,000 payment for the cash dividend, an
11.9 percent increase from 2001, was a use of cash in 2002. The large increase
in cash provided by financing activities in 2001 was a result of the $25,000,000
in advances from the Federal Home Loan Bank as well as a $17,176,000 increase in
time deposits. The cash dividend, which was increased by 12.5 percent in 2001,
of $825,000 and the purchase of $321,000 of treasury stock during the first six
months of 2001 were both a use of cash and a reduction to shareholders' equity.
Form 10-Q
Page 22
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
CAPITAL ADEQUACY
A strong capital position is fundamental to support continued growth and
profitability, to serve the needs of depositors, and to yield an attractive
return for shareholders. QNB's shareholders' equity at June 30, 2002 was
$38,604,000 or 8.06 percent of total assets compared to shareholders' equity of
$35,219,000 or 7.80 percent at December 31, 2001. Shareholders' equity at June
30, 2002 includes a positive adjustment of $2,719,000 related to unrealized
holding gains, net of taxes, on investment securities available-for-sale, while
shareholders' equity at December 31, 2001 includes a positive adjustment of
$1,099,000. Without these adjustments shareholders' equity to total assets would
have been 7.49 percent and 7.56 percent at June 30, 2002 and December 31, 2001.
The decline in the capital to asset ratio is a result of the significant growth
in deposits and the resultant growth in assets during the first half of 2002
exceeding the growth in equity.
On March 30, 2000, the Board of Directors of QNB Corp. approved a plan to
repurchase up to 4.99 percent or 79,180 shares of QNB Corp's outstanding common
stock in open market and privately negotiated transactions. As of June 30, 2002
and December 31, 2001, 53,343 shares had been repurchased at an average cost of
$28.01 per share. These shares are recorded as Treasury stock at cost and reduce
total shareholder's equity.
Shareholders' equity averaged $34,801,000 for the first six months of 2002 and
$32,756,000 during all of 2001, an increase of 6.2 percent. The ratio of average
total equity to average total assets declined to 7.42 percent for 2002, compared
to 7.93 percent for 2001. The decrease in the equity to asset ratio is a
function of the tremendous growth in average assets during the last quarter of
2001 and the first half of 2002. The stock repurchase plan mentioned above also
contributed to the decline in the ratio.
QNB Corp. and the Quakertown National Bank are subject to various regulatory
capital requirements as issued by Federal regulatory authorities. Regulatory
capital is defined in terms of Tier I capital (shareholders' equity excluding
unrealized gains or losses on available-for-sale securities), Tier II capital
which includes a portion of the allowance for loan losses, and total capital
(Tier I plus II). Risk-based capital ratios are expressed as a percentage of
risk-weighted assets. Risk-weighted assets are determined by assigning various
weights to all assets and off-balance sheet arrangements, such as letters of
credit and loan commitments, based on associated risk. Regulators have also
adopted minimum Tier I leverage ratio standards, which measure the ratio of Tier
I capital to total quarterly average 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 12.19 percent and 12.37 percent, a total
risk-based ratio of 13.18 percent and 13.42 percent and a leverage ratio of 7.45
percent and 7.78 percent at June 30, 2002 and December 31, 2001, respectively.
The decline in the Tier I and total risk-based capital ratio reflects the growth
in assets since December and the growth in loans which have a higher risk
weighting than most investment securities. The decline in the leverage ratio is
a result of the significant increase in average assets experienced in the fourth
quarter of 2001 and the first half of 2002.
The Federal Deposit Insurance Corporation Improvement Act of 1991 established
five capital level designations ranging from "well capitalized" to "critically
undercapitalized." At June 30, 2002 and December 31, 2001 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.
Form 10-Q
Page 23
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INTEREST RATE SENSITIVITY
Since the assets and liabilities of QNB have diverse 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, 2002, interest-earning assets scheduled to mature
or likely to be called, repriced or repaid in one year were $172,798,000.
Interest-sensitive liabilities scheduled to mature or reprice within one year
were $190,463,000. The one-year cumulative gap, which reflects QNB's interest
sensitivity over a period of time, was a negative $17,665,000 at June 30, 2002.
The cumulative one-year gap equals 3.92 percent of total rate sensitive assets.
This compares to a negative gap position of $43,780,000 or 9.62 percent of total
rate sensitive assets at March 31, 2002. This negative or liability sensitive
gap will generally benefit QNB in a falling interest rate environment, while
rising interest rates could negatively impact QNB. The negative gap position is
partially a result of the large increase in time deposits with a maturity of one
year or less. As of June 30, 2002, $142,369,000 or 76.2 percent of time deposits
mature or reprice within the next twelve months. This compares to $143,705,000
or 81.3 percent at December 31, 2001 and $158,776,000 or 82.9 percent at March
31, 2002. QNB has been trying to extend the maturity of its time deposits by
promoting a 36-month and 60 month time deposit product.
QNB also uses a simulation model to assess the impact of changes in interest
rates on net interest income. The model reflects management's assumptions
related to asset yields and rates paid on liabilities, deposit sensitivity, and
the size, composition and maturity or repricing characteristics of the balance
sheet. The assumptions are based on what management believes at that time to be
the most likely interest rate environment. Management also evaluates the impact
of higher and lower interest rates.
Form 10-Q
Page 24
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INTEREST RATE SENSITIVITY (CONTINUED)
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. The projected increase in net interest income is
principally a result of an increase in earning assets. The net interest margin
in the base case is anticipated to be slightly below 2001 levels.
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 slightly lower than the most likely scenario. 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 lower than the most likely scenario. These results show net
interest income declining in either a rising or falling interest rate
environment and are somewhat contrary to the results indicated by the gap
analysis and show some of the inherent weaknesses of gap analysis. For example,
gap analysis does not take into consideration interest rate floors on deposit
accounts or optionality found in the investment portfolio.
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, 2002, QNB did not have any hedging
transactions in place such as interest rate swaps, caps or floors.
The table below summarizes estimated changes in net interest income over a
twelve-month period, under alternative interest rate scenarios.
Change in Interest Rates Net Interest Income Dollar Change Percent Change
- ------------------------ ------------------- ------------- --------------
+300 Basis Points............................................. $14,764 $(944) (6.01)%
+200 Basis Points............................................. 15,336 (372) (2.37)
+100 Basis Points............................................. 15,667 (41) (.26)
FLAT RATE Points............................................. 15,708 -- --
- -100 Basis Points............................................. 14,973 (735) (4.68)
- -200 Basis Points............................................. 13,897 (1,811) (11.53)
- -300 Basis Points............................................. 13,605 (2,103) (13.39)
Form 10-Q
Page 25
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INTEREST RATE SENSITIVITY (CONTINUED)
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.
Form 10-Q
Page 26
QNB CORP. AND SUBSIDIARY
PART II. OTHER INFORMATION
JUNE 30, 2002
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 2002 Annual Meeting (the "Meeting") of the shareholders of QNB
Corp. (the Registrant") was held on May 21, 2002. Notice of the
Meeting was mailed to shareholders of record on or about April 22,
2002, 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
------- --- --------
Kenneth F. Brown 1,250,170 6,705
Henry L. Rosenberger 1,256,739 136
Edgar L. Stauffer 1,255,907 968
The continuing directors of the Registrant are:
Dennis Helf , G. Arden Link, Thomas J. Bisko, Gary S. Parzych, Norman L.
Baringer and Charles M. Meridith, III.
Form 10-Q
Page 27
QNB CORP. AND SUBSIDIARY
PART II. OTHER INFORMATION
JUNE 30, 2002
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
The following Exhibits are included in this Report:
Exhibit 3(i) Articles of Incorporation of Registrant, as amended.
(Incorporated by reference to Exhibit 3(i) of Registrants
Form 10-Q filed with the Commission on August 13,1998).
Exhibit 3(ii) Bylaws of Registrant, as amended. (Incorporated by
reference to Exhibit 3(ii) of Registrants Form 10-Q filed
with the Commission on August 13,1998).
Exhibit 10.1 Employment Agreement between the Registrant and Thomas J.
Bisko. (Incorporated by reference to Exhibit 10.1 of
Registrants Form 10-K filed with the Commission on March
31, 1999 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 QNB Corp. 1988 Stock Incentive Plan. (Incorporated by
reference to Exhibit 4A to Registration Statement No.
333-16627 on Form S-8, filed with the Commission on
November 22, 1996).
Exhibit 10.5 QNB Corp. Employee Stock Purchase Plan. (Incorporated by
reference to Exhibit 4B to Registration Statement No.
333-16627 on Form S-8, filed with the Commission on
November 22, 1996).
Exhibit 10.6 The Quakertown National Bank Profit Sharing and Section
401(k) Salary Deferral Plan. (Incorporated by reference to
Exhibit 4C to Registration Statement No. 333-16627 on Form
S-8, filed with the Commission on November 22, 1996).
Form 10-Q
Page 28
QNB CORP. AND SUBSIDIARY
PART II. OTHER INFORMATION
JUNE 30, 2002
Item 6. Exhibits and Reports on Form 8-K (Continued)
Exhibit 10.7 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 10.8 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 10.9 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 99.1 Certification of Principal Executive Officer
Exhibit 99.2 Certification of Principal Financial Officer
(b) Reports on Form 8-K
Filed April 11, 2002, Amendment dated April 3, 2002 to Mr.
Bisko's Employment Agreement dated September 2, 1986.
Form 10-Q
Page 29
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, 2002 By:
------------------------
/s/ Thomas J. Bisko
-------------------------------
Thomas J. Bisko
President/CEO
Date: August 13, 2002 By:
---------------------------
/s/ Robert C. Werner
-------------------------------
Robert C. Werner
Vice President
Date: August 13, 2002 By:
---------------------------
/s/ Bret H. Krevolin
-------------------------------
Bret H. Krevolin
Chief Accounting Officer
Form 10-Q
Page 30