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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 September 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 (I.R.S. Employer Identification No.)
Incorporation or Organization)
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 [X] whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at November 8, 2002
Common Stock, par value $1.25 1,540,086
QNB CORP. AND SUBSIDIARY
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2002
INDEX
PAGE
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Statements of Income for Three and
Nine Months Ended September 30, 2002 and 2001............ 1
Consolidated Balance Sheets at September 30, 2002
and December 31, 2001.................................... 2
Consolidated Statements of Cash Flows for Nine
Months Ended September 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............................. 10
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK.................................................... 31
ITEM 4. CONTROLS AND PROCEDURES.......................................... 31
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS................................................ 32
ITEM 2. CHANGES IN SECURITIES............................................ 32
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.................................. 32
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITIES HOLDERS........... 32
ITEM 5. OTHER INFORMATION................................................ 32
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................. 32
SIGNATURES
CERTIFICATIONS
QNB Corp. and Subsidiary
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share data)
(unaudited)
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Nine Months
Ended September 30, Ended September 30,
2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Interest and fees on loans............................................... $3,755 $3,825 $11,195 $11,303
Interest and dividends on investment securities:
Taxable.......................................................... 2,590 2,529 7,888 7,254
Tax-exempt ...................................................... 508 415 1,458 1,207
Interest on Federal funds sold .......................................... 46 65 125 247
Interest on interest-bearing balances.................................... 1 2 4 12
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest income .................................... 6,900 6,836 20,670 20,023
- -----------------------------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE
Interest on deposits
Interest-bearing demand accounts ................................ 108 110 265 372
Money market accounts ........................................... 140 243 430 855
Savings.......................................................... 131 151 377 462
Time............................................................. 1,461 1,729 4,563 5,066
Time over $100,000............................................... 388 337 1,288 935
Interest on short-term borrowings........................................ 63 114 203 452
Interest on Federal Home Loan Bank advances.............................. 735 710 2,173 1,994
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest expense.................................... 3,026 3,394 9,299 10,136
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income ...................................... 3,874 3,442 11,371 9,887
Provision for loan losses................................................ - - - -
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses....... 3,874 3,442 11,371 9,887
- -----------------------------------------------------------------------------------------------------------------------------------
NON-INTEREST INCOME
Fees for services to customers .......................................... 433 348 1,172 1,057
ATM and debit card income................................................ 132 126 369 344
Income on cash surrender value of insurance ............................. 87 35 245 100
Mortgage servicing fees.................................................. 22 17 58 71
Net (loss) gain on investment securities available-for-sale.............. (418) 81 (577) 321
Net gain on sale of loans ............................................... 120 64 342 180
Other operating income .................................................. 149 100 359 286
- -----------------------------------------------------------------------------------------------------------------------------------
Total non-interest income................................. 525 771 1,968 2,359
- -----------------------------------------------------------------------------------------------------------------------------------
NON-INTEREST EXPENSE
Salaries and employee benefits .......................................... 1,565 1,494 4,738 4,427
Net occupancy expense.................................................... 216 215 622 632
Furniture and equipment expense.......................................... 255 236 734 727
Marketing expense........................................................ 114 91 375 332
Third party services .................................................... 161 136 440 355
Telephone, postage and supplies expense.................................. 131 129 399 395
State taxes ............................................................. 81 58 255 222
Other expense ........................................................... 338 316 978 912
- -----------------------------------------------------------------------------------------------------------------------------------
Total non-interest expense ............................... 2,861 2,675 8,541 8,002
- -----------------------------------------------------------------------------------------------------------------------------------
Income before income taxes....................................... 1,538 1,538 4,798 4,244
Provision for income taxes............................................... 282 329 913 863
- -----------------------------------------------------------------------------------------------------------------------------------
NET INCOME....................................................... $1,256 $1,209 $ 3,885 $ 3,381
===================================================================================================================================
NET INCOME PER SHARE - BASIC..................................... $ .82 $ .78 $ 2.52 $ 2.19
===================================================================================================================================
NET INCOME PER SHARE - DILUTED .................................. $ .81 $ .78 $ 2.50 $ 2.18
===================================================================================================================================
CASH DIVIDENDS PER SHARE......................................... $ .30 $ .27 $ .90 $ .81
===================================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
PAGE 1
QNB Corp. and Subsidiary
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
- ----------------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
2002 2001
- ----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks........................................................................ $ 17,624 $ 18,220
Federal funds sold ............................................................................ 13,638 5,661
Investment securities
Available-for-sale ....................................................................... 212,760 168,102
Held-to-maturity (market value $37,302 and $43,048)....................................... 36,461 42,798
Total loans, net of unearned income of $218 and $270 .......................................... 210,260 202,211
Allowance for loan losses...................................................................... (2,891) (2,845)
- ----------------------------------------------------------------------------------------------------------------------------------
Net loans.......................................................................... 207,369 199,366
Cash surrender value of insurance.............................................................. 7,261 6,998
Premises and equipment, net ................................................................... 5,504 5,614
Accrued interest receivable.................................................................... 2,526 2,497
Other assets .................................................................................. 2,030 2,018
- ----------------------------------------------------------------------------------------------------------------------------------
Total assets .................................................................................. $505,173 $451,274
==================================================================================================================================
LIABILITIES
Deposits
Demand, non-interest-bearing.............................................................. $ 47,462 $ 40,078
Interest-bearing demand accounts ......................................................... 68,397 55,083
Money market accounts..................................................................... 38,414 35,599
Savings .................................................................................. 42,357 37,160
Time...................................................................................... 144,149 134,967
Time over $100,000 ....................................................................... 44,760 41,844
- ----------------------------------------------------------------------------------------------------------------------------------
Total deposits .................................................................... 385,539 344,731
Short-term borrowings.......................................................................... 19,887 13,451
Federal Home Loan Bank advances................................................................ 55,000 53,000
Accrued interest payable ...................................................................... 1,838 2,143
Other liabilities.............................................................................. 2,721 2,730
- ----------------------------------------------------------------------------------------------------------------------------------
Total liabilities.............................................................................. 464,985 416,055
- ----------------------------------------------------------------------------------------------------------------------------------
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.............................................................................. 27,446 24,946
Accumulated other comprehensive income......................................................... 3,509 1,099
Treasury stock, at cost: 53,343 shares at September 30, 2002 and December 31, 2001 ............ (1,494) (1,494)
- ----------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity..................................................................... 40,188 35,219
- ----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity .................................................... $505,173 $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)
- --------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2002 2001
- --------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income................................................................................ $ 3,885 $ 3,381
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization.......................................................... 578 583
Securities losses (gains).............................................................. 577 (321)
Net gain on sale of loans ............................................................. (342) (180)
Proceeds from sales of residential mortgages........................................... 13,477 6,732
Originations of residential mortgages held-for-sale ................................... (13,711) (7,084)
Proceeds from sales of student loans................................................... 1,846 2,543
Income on cash surrender value of insurance ........................................... (245) (100)
Deferred income tax provision ......................................................... (113) 72
Change in income taxes payable......................................................... 58 175
Net increase in interest receivable.................................................... (29) (382)
Net amortization of premiums and discounts ............................................ 446 111
Net (decrease) increase in interest payable............................................ (305) 446
Increase in other assets .............................................................. (125) (219)
Decrease in other liabilities.......................................................... (1,352) (473)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities.............................................. 4,645 5,284
- --------------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from maturities and calls of investment securities
available-for-sale..................................................................... 41,890 35,750
held-to-maturity....................................................................... 12,190 9,342
Proceeds from sales of investment securities
available-for-sale..................................................................... 4,585 17,193
Purchase of investment securities
available-for-sale..................................................................... (88,151) (95,859)
held-to-maturity....................................................................... (5,955) (8,080)
Net (increase) decrease in Federal funds sold............................................. (7,977) 2,678
Net increase in loans..................................................................... (9,319) (19,222)
Recovery of charged-off loans............................................................. (46) -
Net purchases of premises and equipment .................................................. (468) (182)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities ................................................. (53,159) (58,380)
- --------------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net increase in non-interest-bearing deposits ............................................ 7,384 899
Net increase in interest-bearing deposits................................................. 33,424 29,444
Net increase (decrease) in short-term borrowings.......................................... 6,436 (1,079)
Proceeds from Federal Home Loan Bank advances............................................. 2,000 25,000
Cash dividends paid ...................................................................... (1,385) (1,240)
Proceeds from issuance of common stock.................................................... 59 19
Purchases of treasury stock .............................................................. - (435)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities ............................................. 47,918 52,608
================================================================================================================================
Decrease in cash and cash equivalents ................................................. (596) (488)
Cash and cash equivalents at beginning of year ........................................ 18,220 14,466
- --------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period ............................................ $ 17,624 $ 13,978
================================================================================================================================
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid ............................................................................ $ 9,604 $ 9,690
Income taxes paid......................................................................... 955 600
Non-Cash Transactions
Change in net unrealized holding gains, net of taxes,
on available-for-sale securities...................................................... 2,410 2,002
The accompanying notes are an integral part of the consolidated financial
statements.
PAGE 3
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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 September 30, 2002, as well as the
respective statements of income and cash flows for the three and the nine-month
periods ended September 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. Tabular information
other than share data is presented in thousands of dollars.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amount of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from such estimates.
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 Nine Months
Ended September 30, Ended September 30,
2002 2001 2002 2001
---- ---- ---- ----
Numerator for basic and diluted earnings per $ 1,256 $ 1,209 $ 3,885 $ 3,381
share-net income
Denominator for basic earnings per share- 1,539,639 1,540,562 1,538,934 1,546,452
weighted average shares outstanding
Effect of dilutive securities-employee stock 17,110 3,976 13,589 2,287
options
Denominator for diluted earnings per 1,556,749 1,544,538 1,552,523 1,548,739
share-adjusted weighted average shares
outstanding
Earnings per share-basic $ .82 $ .78 $ 2.52 $ 2.19
Earnings per share-diluted $ .81 $ .78 $ 2.50 $ 2.18
There were 27,445 and 37,641 stock options that were anti-dilutive for the
three and nine-month periods ended September 30, 2001, respectively.
Form 10-Q
Page 4
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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 September 30, 2002 and 2001 (net of the income tax effect):
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2002 2001 2002 2001
---- ---- ---- ----
Unrealized holding gains arising during the
period on securities held $ 514 $1,018 $2,029 $2,214
Reclassification adjustment for sold securities 276 (53) 381 (212)
----- ----- ----- -----
Net change in unrealized gains during the
period 790 965 2,410 2,002
Unrealized holding gains (losses),
beginning of period 2,719 973 1,099 (64)
----- ----- ----- -----
Unrealized holding gains, end of period $3,509 $1,938 $3,509 $1,938
===== ===== ===== =====
Net income $1,256 $1,209 $3,885 $3,381
Other comprehensive income, net of tax:
Unrealized holding gains arising during 790 965 2,410 2,002
the period ----- ----- ----- -----
Comprehensive Income $2,046 $2,174 $6,295 $5,383
===== ===== ===== =====
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 September 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
SEPTEMBER 30, 2002 AND 2001, AND DECEMBER 31, 2001
(UNAUDITED)
5. INTANGIBLE ASSETS
The following table presents Intangible Asset information as of September 30,
2002:
- ----------------------------------------------------------------------------------------------------------
Amortized Intangible Assets Gross Carrying Amount Accumulated Amortization Net Carrying Amount
- ----------------------------------------------------------------------------------------------------------
Purchased deposit premium $511 $251 $260
- ----------------------------------------------------------------------------------------------------------
Mortgage servicing asset 319 - 319
--- - ---
- ----------------------------------------------------------------------------------------------------------
Total $751 $251 $579
- ----------------------------------------------------------------------------------------------------------
The following table presents Intangible Asset information as of December 31,
2001:
- ----------------------------------------------------------------------------------------------------------
Amortized Intangible Assets Gross Carrying Amount Accumulated Amortization Net Carrying Amount
- ----------------------------------------------------------------------------------------------------------
Purchased deposit premium $511 $213 $298
- ----------------------------------------------------------------------------------------------------------
Mortgage servicing asset 240 - 240
--- ---
- ----------------------------------------------------------------------------------------------------------
Total $271 $213 $538
- ----------------------------------------------------------------------------------------------------------
The gross carrying amount of the mortgage servicing assets
is net of amortization:
AGGREGATE AMORTIZATION EXPENSE
For the Nine Months ended September 30, 2002 $38
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
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 AND 2001, AND DECEMBER 31, 2001
(UNAUDITED)
6. RECENT ACCOUNTING PRONOUNCEMENTS
GOODWILL AND OTHER INTANGIBLE ASSETS
In June 2001, the FASB issued Statement No. 142, "Goodwill and Other Intangible
Assets." The Statement addresses financial accounting and reporting for acquired
goodwill and other intangible assets and supersedes APB Opinion No. 17,
Intangible Assets. It addresses how intangible assets that are acquired
individually or with a group of other assets (but not those acquired in a
business combination) should be accounted for in financial statements upon their
acquisition. The Statement also addresses how goodwill and other intangible
assets should be accounted for after they have been initially recognized in the
financial statements.
The provisions of the Statement are required to be applied starting with fiscal
years beginning after December 15, 2001, except that goodwill and intangible
assets acquired after June 30, 2001, will be subject immediately to the
nonamortization and amortization provisions of the Statement. Early application
is permitted for entities with fiscal years beginning after March 15, 2001,
provided that the first interim financial statements have not previously been
issued. The Statement is required to be applied at the beginning of an entity's
fiscal year and to be applied to all goodwill and other intangible assets
recognized in its financial statements at that date. The adoption of this
Statement did not have an impact on QNB's consolidated earnings, financial
condition or equity.
ASSET RETIREMENT OBLIGATIONS
In June 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations." This Statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. It applies to legal
obligations associated with the retirement of long-lived assets that result from
the acquisition, construction, development and (or) the normal operation of a
long-lived asset, except for certain obligations of lessees. As used in this
Statement, a legal obligation is an obligation that a party is required to
settle as a result of an existing or enacted law, statute, ordinance, or written
or oral contract or by legal construction of a contract under the doctrine of
promissory estoppel. This Statement requires that the fair value of a liability
for an asset retirement obligation be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The associated
asset retirement costs are capitalized as part of the carrying amount of the
long-lived asset.
This Statement amends FASB Statement No. 19, Financial Accounting and Reporting
by Oil and Gas Producing Companies, and it applies to all entities. It is
effective for financial statements issued for fiscal years beginning after June
15, 2002. Earlier application is encouraged. There is no expected impact on
earnings, financial condition, or equity upon adoption of Statement No. 143.
Form 10-Q
Page 7
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 AND 2001, AND DECEMBER 31, 2001
(UNAUDITED)
6. RECENT ACCOUNTING PRONOUNCEMENTS (Continued):
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS
In August 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This Statement addresses financial
accounting and reporting for the impairment or disposal of long-lived assets and
supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of. However, the Statement retains the
fundamental provisions of Statement 121 for
(a) recognition and measurement of the impairment of long-lived assets to be
held and used and (b) measurement of long-lived assets to be disposed of by
sale.
This Statement supersedes the accounting and reporting provisions of APB Opinion
No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of
a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions, for the disposal of a segment of a business. However,
this Statement retains the requirement of Opinion 30 to report discontinued
operations separately from continuing operations and extends that reporting to a
component of an entity that either has been disposed of (by sale, by
abandonment, or in distribution to owners) or is classified as held for sale.
This Statement also amends ARB No. 51, Consolidated Financial Statements, to
eliminate the exception to consolidation for a temporarily controlled
subsidiary.
The provisions of this Statement are effective for financial statements issued
for fiscal years beginning after December 15, 2001, and interim periods within
those fiscal years, with earlier application encouraged. The provisions of this
Statement generally are to be applied prospectively. The adoption of this
Statement did not have an impact on QNB's consolidated earnings, financial
condition or equity.
COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." This Statement addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)."
The provisions of this Statement are effective for exit or disposal activities
that are initiated after December 31, 2002, with early application encouraged.
QNB does not expect the adoption of this Statement to have an impact on its
consolidated earnings, financial condition or equity.
Form 10-Q
Page 8
QNB CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002 AND 2001, AND DECEMBER 31, 2001
(UNAUDITED)
6. RECENT ACCOUNTING PRONOUNCEMENTS (Continued):
ACQUISITIONS OF CERTAIN FINANCIAL INSTITUTIONS -
In October 2002, the FASB issued Statement No. 147, Acquisitions of Certain
Financial Institutions, which amends SFAS No. 72, Accounting for Certain
Acquisitions of Banking or Thrift Institutions, SFAS No.144, Accounting for the
Impairment or Disposal of Long-Lived Assets, and FASB Interpretation No. 9.
Except for transactions between two or more mutual enterprises, this Statement
removes acquisitions of financial institutions from the scope of both Statement
No. 72 and Interpretation 9 and requires that those transactions be accounted
for in accordance with FASB Statements No. 141, Business Combinations, and No.
142, Goodwill and Other Intangible Assets. Thus, the requirement in paragraph 5
of Statement No. 72 to recognize any excess of the fair value of liabilities
assumed over the fair value of tangible and identifiable intangible assets
acquired as an unidentifiable intangible asset no longer applies to acquisitions
of businesses within the scope of this Statement. In addition, this Statement
amends Statement No. 144 to include in its scope long-term customer-relationship
intangible assets of financial institutions such as depositor- and
borrower-relationship intangible assets and credit cardholder intangible assets.
Consequently, those intangible assets are subject to the same undiscounted cash
flow recoverability test and impairment loss recognition and measurement
provisions that Statement No. 144 requires for other long-lived assets that are
held and used.
With some exceptions, the requirements of Statement No. 147 are effective
October 1, 2002. QNB does not expect the adoption of this Statement to have an
impact on QNB Corp's consolidated earnings, financial condition, or equity.
Form 10-Q
Page 9
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
QNB Corp. (the "Corporation") is a bank holding company headquartered in
Quakertown, Pennsylvania. The Corporation through its wholly owned subsidiary,
The Quakertown National Bank (the "Bank"), has been serving the residents and
businesses of Upper Bucks, Northern Montgomery and Southern Lehigh Counties in
Pennsylvania since 1877. The Bank is a locally managed community bank that
provides a full range of commercial, retail banking and trust and investment
management services. The consolidated entity is referred to herein as "QNB".
THIS REPORT INCLUDES FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT WITH RESPECT TO FINANCIAL PERFORMANCE
AND OTHER FINANCIAL AND BUSINESS MATTERS. FORWARD-LOOKING STATEMENTS ARE
TYPICALLY IDENTIFIED BY WORDS OR PHRASES SUCH AS "BELIEVE," "EXPECT,"
"ANTICIPATE," "INTEND," "ESTIMATE," "POSITION" AND VARIATIONS OF SUCH WORDS AND
SIMILAR EXPRESSIONS, OR FUTURE OR CONDITIONAL VERBS SUCH AS "WILL," "WOULD,"
"SHOULD," "COULD," "MAY" OR SIMILAR EXPRESSIONS. THE CORPORATION CAUTIONS THAT
THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO NUMEROUS ASSUMPTIONS, RISKS AND
UNCERTAINTIES, ALL OF WHICH CHANGE OVER TIME, AND THE CORPORATION ASSUMES NO
DUTY TO UPDATE FORWARD LOOKING STATEMENTS. ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS.
IN ADDITION TO FACTORS PREVIOUSLY DISCLOSED BY THE CORPORATION AND THOSE
IDENTIFIED ELSEWHERE HEREIN, THE FOLLOWING FACTORS, AMONG OTHERS, COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM FORWARD LOOKING STATEMENTS: INCREASED
CREDIT RISK; THE INTRODUCTION, WITHDRAWAL, SUCCESS AND TIMING OF BUSINESS
INITIATIVES AND STRATEGIES; CHANGES IN COMPETITIVE CONDITIONS; THE INABILITY TO
SUSTAIN REVENUE AND EARNINGS GROWTH; CHANGES IN ECONOMIC CONDITIONS, INTEREST
RATES AND FINANCIAL AND CAPITAL MARKETS; INFLATION; CHANGES IN INVESTMENT
PERFORMANCE; CUSTOMER DISINTERMEDIATION; CUSTOMER BORROWING, REPAYMENT,
INVESTMENT AND DEPOSIT PRACTICES; CUSTOMER ACCEPTANCE OF QNB PRODUCTS AND
SERVICES; AND THE IMPACT, EXTENT AND TIMING OF TECHNOLOGICAL CHANGES, CAPITAL
MANAGEMENT ACTIVITIES, ACTIONS OF THE FEDERAL RESERVE BOARD AND LEGISLATIVE AND
REGULATORY ACTIONS AND REFORMS.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Discussion and analysis of the financial condition and results of operations
are based on the consolidated financial statements of QNB, which are prepared
in accordance with accounting principles generally accepted in the United
States of America (GAAP). The preparation of these financial statements
requires QNB to make estimates and judgments that affect the reported amounts
of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. QNB evaluates estimates on an on-going
basis, including those related to the allowance for loan losses, non-accrual
loans, other real estate owned, other-than-temporary investment impairments,
intangible assets, stock option plan and income taxes. QNB bases its estimates
on historical experience and various other factors and assumptions that are
believed to be reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or conditions.
QNB believes the following critical accounting policies affect its more
significant judgments and estimates used in preparation of its consolidated
financial statements: allowance for loan losses, income taxes and other-than-
Form 10-Q
Page 10
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
CRITICAL ACCOUNTING POLICIES AND ESTIMATES (CONTINUED)
temporary investment security impairment. Each estimate is discussed below. The
financial impact of each estimate is discussed in the applicable sections of
Management's Discussion and Analysis.
ALLOWANCE FOR LOAN LOSSES
QNB maintains an allowance for loan losses, which is intended to absorb
probable known and inherent losses in the outstanding loan portfolio. The
allowance is reduced by actual credit losses and is increased by the provision
for loan losses and recoveries of previous losses. The provisions for loan
losses are charged to earnings to bring the total allowance for loan losses to
a level considered necessary by management.
The allowance for loan losses is based on management's continuing review and
evaluation of the loan portfolio. The level of the allowance is determined by
assigning specific reserves to individually identified problem credits and
general reserves to all other loans. The portion of the allowance that is
allocated to internally criticized and non-accrual loans is determined by
estimating the inherent loss on each credit after giving consideration to the
value of underlying collateral. The general reserves are based on the
composition and risk characteristics of the loan portfolio, including the
nature of the loan portfolio, credit concentration trends, historic and
anticipated delinquency and loss experience, as well as other qualitative
factors such as current economic trends.
Management emphasizes loan quality and close monitoring of potential problem
credits. Credit risk identification and review processes are utilized in order
to assess and monitor the degree of risk in the loan portfolio. QNB's lending
and loan administration staff are charged with reviewing the loan portfolio and
identifying changes in the economy or in a borrower's circumstances which may
affect the ability to repay debt or the value of pledged collateral. A loan
classification and review system exists that identifies those loans with a
higher than normal risk of uncollectibility. Each commercial loan is assigned a
grade based upon an assessment of the borrower's financial capacity to service
the debt and the presence and value of collateral for the loan. An independent
loan review group tests risk assessments and evaluates the adequacy of the
allowance for loan losses. Management meets monthly to review the credit
quality of the loan portfolio and quarterly to review the allowance for loan
losses.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review QNB's allowance for losses on loans.
Such agencies may require QNB to recognize additions to the allowance based on
their judgments about information available to them at the time of their
examination.
Management believes that it uses the best information available to make
determinations about the adequacy of the allowance and that it has established
its existing allowance for loan losses in accordance with GAAP. If
circumstances differ substantially from the assumptions used in making
determinations, future adjustments to the allowance for loan losses may be
necessary and results of operations could be affected. Because future events
affecting borrowers and collateral cannot be predicted with certainty, there
can be no assurance that increases to the allowance will not be necessary
should the quality of any loans deteriorate as a result of the factors
discussed above.
INCOME TAXES. QNB accounts for income taxes under the asset/liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases, as well as operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates
Form 10-Q
Page 11
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
CRITICAL ACCOUNTING POLICIES AND ESTIMATES (CONTINUED):
INCOME TAXES (CONTINUED)
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. A valuation allowance is established
against deferred tax assets when in the judgment of management, it is more
likely than not that such deferred tax assets will not become available.
Because the judgment about the level of future taxable income is dependent to a
great extent on matters that may, at least in part go beyond QNB's control, it
is at least reasonably possible that management's judgment about the need for a
valuation allowance for deferred taxes could change in the near term. At
September 30, 2002 QNB did not have a valuation allowance for deferred taxes.
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 third quarter of 2002 of $1,256,000 or $.81 per
share on a diluted basis. This represents an increase of 3.9 percent compared
to $1,209,000 or $.78 per diluted share for the same period in 2001. Net income
for the first nine months of 2002 was $3,885,000 or $2.50 per diluted share, a
14.9 percent increase over the $3,381,000 or $2.18 per diluted share for the
comparable period in 2001. Results for the nine-month period of 2002 represent
a record 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 third quarter of 2002 to the third quarter of 2001. Net interest
income increased $432,000 or 12.6 percent from $3,442,000 for the third quarter
of 2001 to $3,874,000 for the third quarter of 2002. Included in net interest
income in the third quarter of 2002 is the recognition of $99,000 in interest
on non-accrual loans that have been paid in full. There was no such recognition
of income in the third quarter of 2001.
Uncertainty in the equity markets has resulted in the continuing growth of
total deposits. Total deposits have increased 11.8 percent from December 31,
2001 to September 30, 2002 and 18.9 percent from September 30, 2001 to
September 30, 2002. Average deposits increased $58,337,000 or 18.3 percent when
comparing the third quarters of 2002 and 2001, with non-interest bearing demand
deposits increasing 24.6 percent during this period. This is significant since
these deposits provide a low cost source of funds. During this same period
average loans increased $14,118,000 or 7.3 percent and average investment
securities increased $41,232,000 or 21.1 percent. When comparing the third
quarters of 2001 and 2002 the net interest margin decreased from 3.77 percent
to 3.69 percent. Excluding the impact of the recognition of interest on
non-accrual loans the net interest margin would have been 3.61 percent for the
third quarter of 2002. The net interest margin contracted as a result of the
Form 10-Q
Page 12
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS (CONTINUED)
continuing low interest rate environment that has resulted in yields on loans
and investment securities declining to a greater degree and at faster pace than
rates on deposits.
Non-interest income decreased from $771,000 for the third quarter of 2001 to
$525,000 for the third quarter of 2002. Included in the results for 2002 were
gains on the sale of loans of $120,000 and net losses from the sale of fixed
income securities and impairment of equity securities of $418,000. This
compares to gains on the sale of loans and investments of $64,000 and $81,000
during the third quarter of 2001. Excluding the gains and losses from loan and
investment securities during both periods, non-interest income increased by
$197,000 or 31.5 percent. An increase in overdraft income, income from
bank-owned life insurance, debit card income and trust and mutual fund fee
income accounts for most of the increase in non-interest income. Non-interest
expense increased from $2,675,000 for the third quarter of 2002 to $2,861,000
for the third quarter of 2002, an increase of 7.0 percent. An increase in
personnel expense, marketing expense and consulting expense accounts for
$71,000, $23,000 and $20,000 of the increase in non-interest expense.
Return on average assets was 1.03 percent and 1.14 percent while the return on
average equity was 13.76 percent and 14.52 percent for the three months ended
September 30, 2002 and 2001, respectively. For the nine-month periods ended
September 30, 2002 and 2001, return on average assets was 1.09 percent and 1.11
percent and the return on average equity was 14.72 percent and 13.93 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 12.6 percent to $3,874,000 for the quarter ended
September 30, 2002 as compared to $3,442,000 for the quarter ended September
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 12.5 percent from $3,760,000 for the three months ended
September 30, 2001 to $4,231,000 for the same period ended September 30, 2002.
Included in net interest income is the recognition of $99,000 in interest on
non-accrual loans that have been paid in full. There was no such recognition of
income in the third 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 $58,337,000 or 18.3 percent when comparing the third
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. In addition, at the end of the third quarter of 2002 QNB successfully
acquired the deposits of a local school district. This deposit growth was used
to fund the $14,118,000 or 7.3 percent increase in average loans and the
$41,232,000 or 21.1 percent increase in average investment securities.
Form 10-Q
Page 13
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (CONTINUED)
Some of the growth when comparing the third quarter of 2002 to the third
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.
Market interest rates as represented by the Treasury yield curve have declined
since the beginning of 2001 and have remained at or near record low levels for
much of 2002. 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. This
lower interest rate environment has 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 nine months of 2002, market interest rates have been
volatile, increasing during the first quarter of 2002 and than declining to
record low levels during the third quarter of 2002. The yield on earning assets
on a tax-equivalent basis was 6.33 percent for the third quarter of 2002 versus
7.18 percent for the third quarter of 2001, while the rate paid on
interest-bearing liabilities was 2.99 percent and 3.87 percent for the same
periods. Excluding the impact of the recognition of the non-accrual income the
yield on earning assets was 6.25 percent. The net interest margin, on a
tax-equivalent basis, decreased 8 basis points to 3.69 percent for the
three-month period ended September 30, 2002 compared with 3.77 percent for the
same period in 2001. Excluding the recognition of non-accrual income the net
interest margin was 3.61 percent, a decline of 16 basis points from the third
quarter of 2001 and 11 basis points from the second quarter of 2002.
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 third quarter of 2001
to the third quarter of 2002 decreased 181 basis points, from 6.56 percent to
4.75 percent. The yield on loans, excluding non-accrual interest, decreased 88
basis points to 7.12 percent when comparing the third quarter of 2001 to the
third 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 and 2003 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 third quarter of 2002 to the third quarter of 2001, the
yield on investment securities decreased to 5.69 percent from 6.49 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. In addition,
with the increase in prepayments the average life of the mortgage-backed
securities and CMOs has decreased resulting in an increase in the amortization
of premiums and a reduction in income and yield. The yield on the investment
portfolio may continue to decline for the
Form 10-Q
Page 14
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (CONTINUED)
remainder of 2002 and into 2003, as higher yielding securities are replaced at
lower rates and premium amortization increases.
While total interest income on a tax-equivalent basis increased $103,000 or
$4,000 when excluding the recognition of non-accrual interest, when comparing
the third quarter of 2002 to the third quarter of 2001, total interest expense
decreased $368,000. The rate paid on interest bearing deposits decreased from
3.60 percent to 2.66 for the quarters ended September 30, 2001 and 2002. Lower
rates paid on interest-bearing demand accounts, money market accounts and
savings accounts contributed $2,000, $103,000 and $20,000 to the decrease in
interest expense. The average rate paid on money market accounts declined 112
basis points when comparing the third quarter of 2002 yield of 1.48 percent to
the third quarter of 2001 yield of 2.60 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 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 18 basis points to .68 percent while the average rate paid on
savings accounts declined 37 basis points to 1.22 percent when comparing the
third quarter of 2002 to the third 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 $32,290,000 to $189,953,000 when comparing the third
quarter of 2002 to the same period in 2001. Of this increase $17,874,000 has
been in time deposits with balances of $100,000 or more. The average rate paid
on time declined from 5.20 percent to 3.86 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
for the remainder of 2002 and the beginning of 2003 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 3.03 percent to 1.86
percent. Most of these borrowings are indexed with the Federal funds rate. The
average rate paid on the FHLB advances decreased from 5.63 percent during the
third quarter of 2001 to 5.30 percent during the third quarter of 2002. Most of
the advances from the FHLB have fixed rates and therefore the rate paid on the
FHLB advances will remain relatively stable in either rising or falling rate
environments. Some of the advances have convertible features; however, interest
rates would have to increase considerably for this conversion feature to be
exercised and therefore increase the cost of the borrowings.
For the nine-month period ended September 30, 2002, net interest income
increased $1,484,000 or 15.0 percent to $11,371,000. On a tax-equivalent basis
net interest income increased $1,611,000 or 14.9 percent. The 16.7 percent
growth in average earning assets was partially offset by a 6 basis point
decline in the net interest
Form 10-Q
Page 15
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NET INTEREST INCOME (CONTINUED)
margin. The net interest margin on a tax-equivalent basis was 3.73 percent for
the nine-month period ended September 30, 2002 compared with 3.79 percent for
the same period in 2001. Excluding the $200,000 impact of the recognition of
interest on non-accrual loans during the first nine months of 2002, the net
interest margin declined by 12 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 nine-month period ended September 30, 2002, these borrowings contributed an
additional $7,022,000 to the growth in average earning assets when compared to
the nine-month period ended June 30, 2001.
Total interest income increased $647,000 from $20,023,000 to $20,670,000 when
comparing the nine-month periods ended September 30, 2001 to September 30,
2002. The yield on earning assets decreased from 7.35 percent to 6.47 percent,
with the yield on Federal funds sold declining 269 basis points between the
nine-month periods. The yield on loans decreased from 8.16 percent to 7.22
percent and the yield on investment securities decreased from 6.65 percent to
5.99 percent for the nine-month periods. The yield on earning assets and loans
for the nine-month period ended September 30, 2002 excludes the interest
recognized on non-accrual loans. 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 23.1 percent to
$227,520,000 while average loans increased 10.1 percent to $207,383,000.
Total interest expense decreased $837,000 from $10,136,000 to $9,299,000 for
the nine-month periods with interest on interest-bearing demand deposit
accounts, money market accounts and savings accounts accounting for $107,000,
$425,000 and $85,000 of the decrease. The yield on these accounts declined 39
basis points, 144 basis points and 46 basis points when comparing the average
rate paid for the nine-month periods ended September 30, 2002 and 2001.
Interest expense on time deposits decreased $150,000 as the impact of the
significant increase in average balances was offset by the decline in the
average rate paid. The average rate paid on time deposits for the nine months
ended September 30, 2002 and 2001 was 4.15 percent and 5.45 percent,
respectively. Interest expense on short-term borrowings declined by $249,000 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
$179,000 in interest expense when comparing the nine-month periods.
The net interest margin will likely continue to decline over the next few
quarters as the yield on investment securities and loans decline to a greater
degree than the rates paid on funding sources. The cash flow from the
investment and loan portfolios will likely be reinvested at lower rates and
loans with re-pricing features will likely re-price at lower rates also. On the
deposit side, interest-bearing transaction accounts do not have much ability to
re-price lower while the rates paid on time deposits will decline slightly as
some of the time deposits that have not matured and re-priced in the past year
will do so.
Form 10-Q
Page 16
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
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 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 nine month periods ended September 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 net recoveries of
$12,000 and $5,000 during the third quarter of 2002 and 2001. For the
nine-month periods ended September 30, 2002 and 2001, QNB had a net recovery of
$46,000 and a net charge-off of $22,000, respectively.
Non-performing assets (non-accruing loans, loans past due 90 days or more, and
other real estate owned) increased slightly during the third quarter of 2002.
Non-performing assets amounted to .15 percent of total assets at September 30,
2002. This compares to .11 percent at September 30, 2001 and .13 percent at
December 31, 2001. The increase in non-performing assets was in the category of
non-accrual loans. These loans amounted to $686,000 and $246,000 at September
30, 2002 and 2001. Non-accrual loans at December 31, 2001 were $280,000.
Non-performing assets in the category of past due loans 90 days or more
decreased when comparing September 30, 2002 to September 30, 2001 and December
31, 2001. These loans amounted to $64,000 at September 30, 2002 compared to
$216,000 at September 30, 2001 and $316,000 at December 31, 2001. Overall
delinquency, including loans past due 90 days or more, while slightly higher
than the second quarter of 2002, showed improvement when compared to September
30, 2001 and December 31, 2001. Total delinquency represented .67 percent of
total loans at September 30, 2002 and .49 percent at June 30, 2002. This
compares to .99 percent and .83 percent at September 30, 2001 and December 31,
2001, respectively. QNB did not have any other real estate owned as of
September 30, 2002, December 31, 2001 or September 30, 2001.
There were no restructured loans as of September 30, 2002, December 31, 2001 or
September 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.
Form 10-Q
Page 17
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
PROVISION FOR LOAN LOSSES (CONTINUED)
The allowance for loan losses was $2,891,000 and $2,845,000 at September 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 September 30, 2002 and 2001, the recorded investment in loans for which
impairment has been recognized in accordance with SFAS No. 114 totaled $605,000
and $196,000, respectively, of which $605,000 and $81,000 related to loans with
no valuation allowance. At September 30, 2002 and 2001 there were $0 and
$115,000 in impaired loans that had a valuation allowance against the entire
amount. Most of the loans identified as impaired are collateral-dependent. The
loans recognized as impaired at September 30, 2002 represent loans to one
borrower.
QNB anticipates no provision for loan losses will be necessary for the
remainder of 2002 and possibly part of 2003 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 or 2003. 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 examination process, periodically review QNB's allowance
for losses on loans. Such agencies may require QNB to recognize additions to
the allowance based on their judgments about information available to them at
the time of their examination.
NON-INTEREST INCOME
QNB, through its core banking business, generates various fees and service
charges. Total non-interest income is composed of service charges on deposit
accounts, ATM and debit card income, income on bank owned life insurance,
mortgage servicing fees, gains or losses on the sale of investment securities,
gains on the sale of residential mortgage loans and 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. 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. During the third
quarter of 2002 QNB increased its overdraft fee by 7.1 percent.
Form 10-Q
Page 18
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (CONTINUED)
Total non-interest income decreased $246,000 or 31.9 percent to $525,000 for
the quarter ended September 30, 2002 when compared to September 30, 2001. For
the nine-month period total non-interest income decreased $391,000 or 16.6
percent to $1,968,000. Excluding gains and losses on the sale of investment
securities and loans during both periods, non-interest income for the
three-month period increased $197,000 or 31.5 percent and for the nine-month
period increased $345,000 or 18.6 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 $85,000 or 24.4 percent, to $433,000 when comparing the two
quarters and $115,000 or 10.9 percent to $1,172,000 when comparing the
nine-month periods. A $10,000 increase in service charges on business checking
accounts and a $100,000 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. The 38.2 percent increase in overdraft income when comparing
the two quarters is a result of both the increased fee implemented during the
third quarter and an increase in the volume of overdrafts. For the nine-month
period business checking account fees increased $45,000 and overdraft income
increased $138,000. This offset a $57,000 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". QNB charges a fee
to customers who use an out of network ATM machine. As a result of the purchase
of the MAC network by the STAR network there are now more machines available to
QNB customers. This has resulted in $9,000 reduction in fee income when
comparing the two quarters and $24,000 for the nine-month period.
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 $132,000 for the third quarter of
2002, an increase of $6,000 or 4.8 percent from the amount recorded during the
third quarter of 2001. For the nine-month periods ATM and debit card income
increased 7.3 percent to $369,000. Debit card income increased $9,000 or 10.6
percent for the three-month periods and $39,000 or 18.3 percent when comparing
the nine-month periods ended September 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 $4,000 or 10.5 percent when comparing the third quarter of 2002 to
the third quarter of 2001. For the nine-month period ATM transaction surcharge
income decreased $8,000 or 8.1 percent to $96,000. This charge was increased
during the second quarter of 2001 from $1.00 per transaction to $1.50 per
transaction.
The decline in ATM transaction surcharge income 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 nine month periods income derived
from the annual card fee decreased $3,000 and $8,000, respectively. This
decline is a result of the simplification of deposit products resulting in this
fee being eliminated for many customers.
Form 10-Q
Page 19
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (CONTINUED)
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 $35,000 during the third quarter of 2001 to $87,000
during the third quarter of 2002. For the nine-month periods this income
increased from $100,000 to $245,000. 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. 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. Mortgage servicing fees for the quarter ended
September 30, 2002 were $22,000 which represents a $5,000 increase from the
same period in 2001. The increase in income for the period is primarily related
to the increase in the average balance of mortgages services for others. The
average balance of mortgages serviced for others was $66,724,000 for the third
quarter of 2002 compared to $59,796,000 for the third quarter of 2001.
For the nine-month period mortgage servicing fees decreased $13,000 or 18.3
percent to $58,000. The decrease in mortgage servicing fees for the nine-month
period is primarily a result of an increase in the amortization of the
mortgage-servicing asset. For the nine-month period ended September 30, 2002,
QNB amortized approximately $57,000 of the mortgage-servicing asset compared to
$41,000 during the same period 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 was approximately
$66,649,000 for the nine-month period ended September 30, 2002 compared to
$59,917,000 for the first nine months of 2001, an increase of 11.2 percent. The
timing of mortgage payments and delinquencies also impacts the amount of
servicing fees recorded.
QNB recorded a net loss of $418,000 on the sale or other than temporary
impairment of investment securities during the third quarter of 2002. For the
nine-month period ended September 30, 2002 the net loss was $577,000. Included
in these amounts were losses of $351,000 for the quarter and $550,000 for the
nine-month period related to the write-down of marketable equity securities
whose declined in market value below cost were deemed to be other than
temporary. Also during the third quarter of 2002 QNB sold approximately
$3,000,000 of corporate bonds at a net loss of $67,000.
Net gains on the sale of investment securities were $81,000 and $321,000 for
the three-month and nine-month periods ended September 30, 2001. Included in
the net gains for the three and nine month periods ended September 30, 2001 was
a loss of $623,000 related to the write-down of marketable equity securities
whose decline in market value below cost was deemed to be other than temporary.
Offsetting this loss were gains on marketable equity securities during the
quarter of $287,000 and gains on the sale of fixed income securities of
$417,000. QNB sold approximately $15,000,000 in callable agency securities and
collateralized mortgage obligations (CMO) at a gain of $363,000.
Mortgage-backed securities were purchased with the proceeds from this
transaction. The purpose of this transaction was to reduce the exposure to
callable agency securities and
Form 10-Q
Page 20
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (CONTINUED)
increased cash flow from the CMO's in a falling interest rate environment. QNB
also recorded a gain of $54,000 from the receipt of stock from an insurance
company that converted from a mutual holding company to a stock company.
QNB recorded a gain of $120,000 on the sale of loans during the third quarter
of 2002. This compares to a $64,000 gain for the same period in 2001. For the
nine-month periods ended September 30, 2002 and 2001 net gains on the sale of
loans were $342,000 and $180,000, respectively. The sale of student loans
accounts for $3,000 and $4,000 of the gains during the third quarter of 2002
and 2001. QNB sold approximately $140,000 and $190,000 in student loans during
the third quarter of 2002 and 2001. Gains on the sale of student loans
accounted for $34,000 and $47,000 of the total gains during the nine-month
periods ended September 30, 2002 and 2001, respectively. For the nine-month
periods ended September 30, 2002 and 2001, QNB sold approximately $1,812,000
and $2,497,000 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. Effective June 30, 2002 QNB terminated its agreement
with the Student Loan Marketing Association (SLMA). QNB will no longer be
originating student loans for sale but will be working on a referral basis
instead. The remaining balance in portfolio should be sold during the first
quarter of 2003.
The net gain on residential mortgage sales is directly related to the volume of
mortgages sold and the timing of the sales relative to the interest rate
environment. As mentioned previously, the 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 2002 as
interest rates on residential mortgage loans reached historically low levels.
The net gain on the sale of residential mortgage loans were $117,000 and
$60,000 for the three-month periods ended September 30, 2002 and 2001 and
$308,000 and $133,000 for the respective nine-month periods. QNB originated
$3,977,000 and $2,397,000 in residential mortgages held for sale during the
third quarter of 2002 and 2001 and $13,711,000 and $7,084,000 during the
respective nine-month periods. Proceeds from the sale of residential mortgages
were approximately $3,247,000 and $2,629,000 during the third quarters of 2002
and 2001, respectively. For the nine-month periods proceeds from the sale of
residential mortgage loans amounted to $13,477,000 and $6,732,000,
respectively. The larger gain on the sale of mortgage loans relative to the
amount of mortgage loans sold during both the three-month and nine-month
periods of 2002 is a function of the speed and magnitude of the drop in
interest rates that has occurred in 2002. At September 30, 2002 and 2001, QNB
had approximately $1,255,000 and $468,000 in mortgage loans classified as held
for sale. These loans are accounted for at lower of cost or market.
Other operating income increased $49,000 or 49.0 percent to $149,000 when
comparing the three-month periods ended September 30, 2002 and 2001. Included
in other operating income in the third quarter of 2002 was a $21,000 recovery
of a check card transaction that had been charged off in 2001. Trust income and
retail brokerage income increased $5,000 and $18,000 when comparing the
three-month periods. Income from QNB's investment in Banker's Settlement
Services Inc., a title company, increased $11,000 during the third quarter of
2002. This relates to the increase in residential mortgage loan activity in
2002. Partially offsetting these increases was a decline in income from
official checks. Official check income declined $6,000 for the quarter. This
decline is a function of the lower interest rate environment.
For the nine-month period ended September 30, 2002, other operating income
increased $73,000 or 25.5 percent to $359,000. Trust income and retail
brokerage income increased $22,000 and $37,000 during this period. Also
contributing to the increase in other operating income was an increase in
insurance commissions
Form 10-Q
Page 21
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST INCOME (CONTINUED)
derived from loan products. These commissions increased $7,000 for the
nine-month period. Income from the title insurance company increased $12,000
while recoveries of previously charged off items contributed $26,000 to other
operating income. Partially offsetting these increases were declines in income
from official checks. Official check income declined $28,000 for the nine-month
period.
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
$2,861,000 for the quarter ended September 30, 2002 represents an increase of
$186,000 or 7.0 percent from levels reported in the third quarter of 2001.
Total non-interest expense for the nine months ended September 30, 2002 was
$8,541,000, an increase of $539,000 or 6.7 percent over 2001 levels.
Salaries and benefits, the largest component of non-interest expense, increased
$71,000 or 4.8 percent to $1,565,000 for the quarter ended September 30, 2002
compared to the same quarter in 2001. Salary expense increased $70,000 or 5.8
percent during the period to $1,276,000 while benefits expense increased $1,000
or .3 percent to $289,000. For the nine-month period ended September 30, 2002
salaries and benefits expense increased $311,000 or 7.0 percent compared to
2001. Salary expense increased $275,000 or 7.7 percent while benefits expense
increased $36,000 or 4.1 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 $82,000 when
comparing the nine-month periods. The number of full time-equivalent employees
increased by four when comparing the three-month periods and three when
comparing the nine-month periods.
When comparing benefits expense for the three month periods ended September 30,
2002 to 2001, increases in payroll tax expense, retirement plan expense and
dental insurance premiums were offset by a reduction in medical insurance
premiums. Contributing to the increase in benefits expense for the nine-month
period is a $17,000 increase in payroll tax expense. During this same period
retirement plan expense increased $11,000 and dental insurance premiums
increased $9,000. Partially offsetting these increases was a decline in medical
insurance premiums of $18,000. The decline in medical insurance premiums 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 third quarter of 2002
to the third quarter of 2001. Increases in branch rent expense and utility
costs were offset by a decline in building repairs and maintenance expense. For
the nine-month period, net occupancy expense decreased $10,000 or 1.6 to
$622,000. Utility expense decreased $21,000 or 19.4 percent and building
repairs and maintenance costs decreased $9,000 or 6.6 percent. The decrease in
utility expense for the nine-month period is a function of lower prices and
lower usage as a result of the mild winter. Partially offsetting this was a
$19,000 increase in branch rent expense that can be attributed to an increase
in the monthly rent at two locations and the opening of the Souderton branch in
January 2001.
Furniture and equipment expense increased $19,000 or 8.1 percent when comparing
the three-month periods ended September 30, 2002 and 2001 and $7,000 or 1.0
percent when comparing the nine-month periods. Depreciation and amortization
expense increased $18,000 for the quarter but decreased $4,000 when comparing
the nine-month periods. The increase for the quarter is a result of the
completion of several large projects during
Form 10-Q
Page 22
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
NON-INTEREST EXPENSE (CONTINUED)
the third quarter of 2002. Depreciation and amortization expense is anticipated
to increase further in the fourth quarter as several other large projects are
completed and put into service. Also contributing to the increase in furniture
and equipment expense was higher equipment maintenance expense of $3,000 and
$12,000 for the respective three and nine month periods.
Marketing expense increased $23,000 to $114,000 for the quarter ended September
30, 2002 and $43,000 to $375,000 when comparing the nine-month periods. For the
three-month period advertising and promotions expense increased $12,000 while
donation and contribution expense increased $10,000. For the nine month period
donation and contribution expense increased $46,000. This is a result of an
increase in contributions and sponsorships to charities, 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 $161,000 in the third quarter of 2002 compared
to $136,000 for the third quarter of 2001. For the nine-month periods ended
September 30, 2002 and 2001 third party service expense was $440,000 and
$355,000, respectively. Consultant expense increased $20,000 when comparing the
two quarters and $44,000 when comparing the nine-month periods. Consulting
related to the implementation of a document imaging system accounts for most of
the increase when comparing the two quarters. For the nine-month period the
increase is a result of this expense plus 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.
Third party costs related to the operation of the trust department decreased
$5,000 for the quarter but increased $6,000 when comparing the respective
nine-month periods. Increased expenses related to correspondent banking
activity, security safekeeping and auditing and accounting fees also
contributed to the increase in third party service expense for both the
three-month and nine-month periods.
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 September 30,
2002 and 2001 total other expense increased $22,000 to $338,000. Contributing
to this increase was a $7,000 increase in employee training costs, a $5,000
increase in charged-off checking accounts, a $4,000 increase in the Comptroller
of the Currency assessment and an $2,000 increase in ATM and debit card
expenses. For the nine-month period total other expense increased $66,000 or
7.2 percent to $978,000. Contributing to this increase was an $11,000 increase
in employee training expense, a $22,000 increase in charged-off checking
accounts, a $14,000 increase in the Comptroller of the Currency assessment and
a $22,000 increase in ATM and debit card expenses.
INCOME TAXES
Applicable income taxes and effective tax rates were $282,000 or 18.3 percent
for the three-month period ended September 30, 2002, and $329,000 or 21.4
percent for the same period in 2001. For the nine-month period applicable
income taxes and effective rates were $913,000 or 19.0 percent and $863,000 or
20.3 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 bank owned life insurance relative to total pre-tax
income.
Form 10-Q
Page 23
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INCOME TAXES (CONTINUED)
QNB utilizes an asset and liability approach for financial accounting and
reporting of income taxes. As of September 30, 2002, QNB's net deferred tax
liability was $1,011,000. A deferred tax asset of $741,000 relating to the
allowance for loan losses and $289,000 related to unrealized losses on the
impairment of equity securities was offset by a deferred tax liability of
$1,964,000 resulting from the SFAS No. 115 adjustment for available-for-sale
investment securities. At September 30, 2001, QNB had a net deferred tax
liability of $224,000. This deferred tax liability was a result of the SFAS No.
115 adjustment for available-for-sale securities of $998,000 relating to the
unrealized holding gain on these securities. Partially offsetting this
liability was a deferred tax asset of $753,000 relating to the allowance for
loan losses. An increase in the market value of the available-for-sale
investment portfolio resulting from declining interest rates accounts for the
increase in the deferred tax liability when comparing the two periods.
BALANCE SHEET ANALYSIS
The Balance Sheet Analysis reviews average balance sheet data for the nine
months ended September 30, 2002 and 2001, as well as the period ending balances
as of September 30, 2002 and December 31, 2001.
Average earning assets for the nine-month period ended September 30, 2002
increased $63,831,000 or 16.7 percent to $444,934,000 from $381,103,000 for the
nine months ended September 30, 2001. Average investments increased $42,664,000
while average loans and Federal funds sold increased $18,962,000 and
$2,217,000, 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 borrowings were used to fund specific investment
strategies. The additional advances from the FHLB averaged $7,022,000 more for
the first nine months of 2002 compared to the same period in 2001.
The 10.1 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, especially commercial loans. The entrance
into the Souderton market has provided an opportunity to develop new
relationships. QNB will continue to cultivate this market for new
opportunities. Average commercial loans increased $10,116,000 while average
residential mortgage loans and consumer loans increased $2,317,000 and
$6,584,000 when comparing the first nine months of 2002 to the first nine
months of 2001. This loan growth was achieved during the slow growth economic
environment of 2001 and 2002. The increase in average commercial loans was
primarily in the categories of loans secured by real estate and tax-exempt
loans. The increase in residential mortgage loans is a result of the increase
in the amount of variable rate loans, primarily loans that have a fixed rate
for the first seven years than adjust annually thereafter. The amount of fixed
rate mortgage loans held in portfolio has decreased by 9.0 percent as
management has decided to reduce the amount of 15 year fixed rate mortgage
loans retained in this low interest rate environment. QNB continues to sell the
majority of its fixed rate residential mortgage loans. The increase in consumer
loans is the result of aggressive fixed rate home equity loan promotions and
pricing. Home equity loans have also been popular with consumers; especially
those refinancing existing residential mortgage loans, because they have lower
origination costs than residential mortgage loans.
Form 10-Q
Page 24
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS (CONTINUED)
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 $8,298,000 or 24.2 percent, while interest-bearing deposit accounts
increased $53,512,000 or 19.7 percent. The growth in average interest-bearing
deposit accounts is primarily centered in time deposits, which increased
$41,528,000 or 28.1 percent. Included in that amount is an increase in average
time deposits over $100,000 of $24,868,000 or 107.5 percent. 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 $8,840,000 or 17.8 percent and
average savings accounts increased $4,483,000 or 12.2 percent when comparing
the first nine months of 2002 to the first nine months of 2001. During this
same period average money market accounts decreased by $1,339,000 or 3.5
percent. The increase in average interest bearing transaction accounts is
partially the result of acquiring the deposit relationship of one of the local
school districts during the third quarter of 2002.
Total assets at September 30, 2002 were $505,173,000, compared with
$451,274,000 at December 31, 2001, an increase of 11.9 percent for the year.
The increase in assets from December 31, 2001 to September 30, 2002 is
primarily centered in investment securities, loans and federal funds sold,
which increased $38,321,000, $8,049,000 and $7,977,000, respectively. This
growth was primarily funded by a $40,808,000 increase in total deposits. Total
deposits increased from $344,731,000 at December 31, 2001 to $385,539,000 at
September 30, 2002. Uncertainty in the equity markets has resulted in the
continuing growth of total deposits. Non-interest bearing and interest bearing
demand accounts increased by $7,384,000 and $13,314,000, respectively when
comparing September 30, 2002 to December 31, 2001. The increase in non-interest
bearing deposits is primarily the result of the popularity of the "free
checking" product introduced at the end of 2001. The growth in interest-bearing
demand accounts primarily relates to the school district account acquired
during the third quarter of 2002. During this same period money market accounts
and savings accounts increased by $2,815,000 and $5,197,000, respectively while
time deposits increased by $12,098,000.
At September 30, 2002 the fair value of investment securities
available-for-sale was $212,760,000 or $5,473,000 above the amortized cost of
$207,287,000. 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 $3,509,000 and $1,099,000 was recorded as an increase to
shareholders' equity at September 30, 2002 and December 31, 2001, respectively.
Interest rates, which had risen during the first quarter of 2002, declined
sharply during the second and third quarters 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.
The available-for-sale portfolio had a weighted average maturity of
approximately 4 years and 7 months at September 30, 2002 and 5 years, 5 months
at December 31, 2001. The weighted average tax-equivalent yield was 5.62
percent and 6.29 percent at September 30, 2002 and December 31, 2001. The
weighted average maturity is
Form 10-Q
Page 25
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
BALANCE SHEET ANALYSIS (CONTINUED)
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 2 years, 11 months at
September 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 as well as the likelihood of
securities with call options to be exercised. 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. The
decline in the yield on the portfolio is a result of the investment of new
deposits and the reinvestment of cash flow in the low interest rate
environment. Also impacting the yield on the portfolio is the increase in the
amortization of premiums on mortgage-backed securities and CMO's, that results
from the reduction in estimated average lives of these securities as
prepayments increase. 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
September 30, 2002 and December 31, 2001, QNB had securities classified as
held-to-maturity with an amortized cost of $36,461,000 and $42,798,000 and a
market value of $37,302,000 and $43,048,000, respectively. The held-to-maturity
portfolio had an expected repricing term of approximately 2 years, 2 months and
3 years, 1 month at September 30, 2002 and December 31, 2001. The weighted
average tax-equivalent yield was 6.15 percent and 6.28 percent at September 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 $245,554,000 and $194,105,000 at September 30, 2002
and December 31, 2001. These sources were adequate to meet deposit withdrawals
and loan demand during the first nine months 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 nine months 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 nine months of 2002. Approximately $64,237,000 and $47,997,000 of
available-for-sale securities at September 30, 2002 and
Form 10-Q
Page 26
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
LIQUIDITY (CONTINUED)
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 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 $596,000 to $17,624,000 at September 30, 2002. This
compares to a $488,000 decrease during the first nine months of 2001.
After adjusting net income for non-cash transactions, operating activities
provided $4,645,000 in cash flow in the first nine months of 2002, compared to
$5,284,000 in the same period of 2001. The decrease in cash provided by
operating activities when comparing the two periods relates to a reduction in
other liabilities in 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. The historically low interest rate
environment of 2002 has resulted in an increase in residential mortgage loan
activity. For the first nine months of 2002, $13,711,000 of mortgages-held-for
sale were originated compared to $7,084,000 for the same period in 2001.
Proceeds from the sale of residential mortgages were $13,477,000 and $6,732,000
during the first nine months of 2002 and 2001.
Net cash used by investing activities was $53,159,000 during the first nine
months of 2002. Loan growth created a net increase in loans and a use of cash
of $9,319,000. In addition, the purchase of investment securities exceeded the
maturity, call and sale of securities by $35,441,000 during the first nine
months of 2002. This activity relates to the deployment of the deposit growth
experienced in 2002 as well as the reinvestment of proceeds from calls and
prepayments of securities that continue to accelerate, as interest rates remain
low. Another use of cash was the increase in Federal funds sold of $7,977,000.
Management has elected, in light of the significant growth in deposits and the
potential volatility of these deposits, to keep a higher level of Federal funds
despite the low earnings rate.
Net cash used by investing activities was $58,380,000 during the first nine
months of 2001. The purchase of investment securities exceeded the maturity,
call and sale of securities by $41,654,000 during the first nine months of
2001. This increase partially relates 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 nine 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 $19,222,000 during the first nine months of 2001. A decrease in
federal funds sold of $2,678,000 provided cash during the first nine months of
2001.
Net cash provided by financing activities was $47,918,000 during the first nine
months of 2002 and $52,608,000 during the nine months of 2001. A $33,424,000
increase in interest-bearing deposits and a $7,384,000 increase in non-interest
bearing demand deposits was the main source of funding during the first nine
months of 2002. An additional $2,000,000 advance from the FHLB and an increase
in short-term borrowings, primarily cash management accounts, of $6,436,000
also provided funding during 2002. The $1,385,000 payment for the cash
dividend, an 11.7 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
Form 10-Q
Page 27
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
LIQUIDITY (CONTINUED)
Home Loan Bank as well as a $25,957,000 increase in time deposits. The cash
dividend, which was increased by 12.5 percent in 2001, of $1,240,000 and the
purchase of $435,000 of treasury stock during the first nine months of 2001
were both a use of cash and a reduction to shareholders' equity.
CAPITAL ADEQUACY
A strong capital position is fundamental to support continued growth and
profitability, to serve the needs of depositors, and to yield an attractive
return for shareholders. QNB's shareholders' equity at September 30, 2002 was
$40,188,000 or 7.96 percent of total assets compared to shareholders' equity of
$35,219,000 or 7.80 percent at December 31, 2001. Shareholders' equity at
September 30, 2002 includes a positive adjustment of $3,509,000 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 7.26 percent and 7.56 percent at
September 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 nine months 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 September 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 $35,278,000 for the first nine months of 2002 and
$32,756,000 during all of 2001, an increase of 7.7 percent. The ratio of
average total equity to average total assets declined to 7.43 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 nine months 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 12.33 percent and 12.37 percent, a total
risk-based ratio of 13.32 percent and 13.42 percent and a leverage ratio of
7.42 percent and 7.78 percent at September 30, 2002 and December 31, 2001,
respectively. The decline in the leverage ratio is a result of the significant
increase in average assets.
The Federal Deposit Insurance Corporation Improvement Act of 1991 established
five capital level designations ranging from "well capitalized" to "critically
undercapitalized." At September 30, 2002 and December 31, 2001
Form 10-Q
Page 28
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
CAPITAL (CONTINUED)
QNB met the "well capitalized" criteria which requires minimum Tier I and total
risk-based capital ratios of 6.00 percent and 10.00 percent, respectively, and a
Tier I leverage ratio of 5.00 percent.
INTEREST RATE SENSITIVITY
Since the assets and liabilities of QNB have diverse repricing characteristics
that influence net interest income, management analyzes interest sensitivity
through the use of gap analysis and simulation models. Interest rate
sensitivity management seeks to minimize the effect of interest rate changes on
net interest margins and interest rate spreads and to provide growth in net
interest income through periods of changing interest rates. The Asset/Liability
Management Committee (ALCO) is responsible for managing interest rate risk and
for evaluating the impact of changing interest rate conditions on net interest
income.
Gap analysis measures the difference between volumes of rate-sensitive assets
and liabilities and quantifies these repricing differences for various time
intervals. Static gap analysis describes interest rate sensitivity at a point
in time. However, it alone does not accurately measure the magnitude of changes
in net interest income since changes in interest rates do not impact all
categories of assets and liabilities equally or simultaneously. Interest rate
sensitivity analysis also involves assumptions on certain categories of assets
and deposits. For purposes of interest rate sensitivity analysis, assets and
liabilities are stated at their contractual maturity, estimated likely call
date, or earliest repricing opportunity. Mortgage-backed securities, CMOs and
amortizing loans are scheduled based on their anticipated cash flow. Savings
accounts, including passbook, statement savings, money market, and
interest-bearing demand accounts, do not have a stated maturity or repricing
term and can be withdrawn or repriced at any time. This may impact QNB's margin
if more expensive alternative sources of deposits are required to fund loans or
deposit runoff. Management projects the repricing characteristics of these
accounts based on historical performance and assumptions that it believes
reflect their rate sensitivity. The Treasury Select Indexed Money Market
account reprices monthly based on a percentage of the average of the 91-day
Treasury bill.
A positive gap results when the amount of interest rate sensitive assets
exceeds interest rate sensitive liabilities. A negative gap results when the
amount of interest rate sensitive liabilities exceeds interest rate sensitive
assets.
QNB primarily focuses on the management of the one-year interest rate
sensitivity gap. At September 30, 2002, interest-earning assets scheduled to
mature or likely to be called, repriced or repaid in one year were
$201,127,000. Interest-sensitive liabilities scheduled to mature or reprice
within one year were $200,795,000. The one-year cumulative gap, which reflects
QNB's interest sensitivity over a period of time, was a positive $332,000 at
September 30, 2002. The cumulative one-year gap equals .07 percent of total
rate sensitive assets. This slightly positive or asset sensitive gap position
at September 30, 2002 will generally benefit QNB in a rising interest rate
environment, while falling interest rates could negatively impact QNB. At June
30, 2002 and March 31, 2002, QNB had negative gap positions of $17,665,000 or
3.92 percent of total rate sensitive assets and $43,780,000 or 9.62 percent of
rate sensitive assets, respectively. QNB has been able to eliminate the
negative gap position by extending the maturity of its time deposits by
promoting time deposits with maturities of 30 months and longer. As of
September 30, 2002, $127,951,000 or 67.7 percent of time deposits mature or
reprice within the next twelve months. $142,369,000 or 76.2 percent of time
deposits mature or reprice within the next twelve months. This compares to
$142,369,000 or 76.2 percent at June 30, 2001 and
Form 10-Q
Page 29
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INTEREST RATE SENSITIVITY (CONTINUED)
$158,776,000 or 82.9 percent at March 31, 2002. The increase in cash flow from
the investment portfolio resulting from the decline in interest rates has also
been a factor in reducing the negative gap position.
QNB also uses a simulation model to assess the impact of changes in interest
rates on net interest income. The model reflects management's assumptions
related to asset yields and rates paid on liabilities, deposit sensitivity, and
the size, composition and maturity or repricing characteristics of the balance
sheet. The assumptions are based on what management believes at that time to be
the most likely interest rate environment. Management also evaluates the impact
of higher and lower interest rates.
Actual results may differ from simulated results due to various factors
including time, magnitude and frequency of interest rate changes, the
relationship or spread between various rates, loan pricing and deposit
sensitivity, and asset/liability strategies. Based on 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 2002 levels as rates on
earning assets continue to decline to a greater degree than rates on funding
sources.
If interest rates are 100 basis points higher than management's base case
interest rate environment, the simulation model projects net interest income
for the next twelve months to be slightly higher than the base case scenario.
If interest rates are 100 basis points lower than management's base case
interest rate environment, the model projects net interest income for the next
twelve months to be lower than the base case scenario. These results are
consistent with the results indicated by the gap analysis. However, the chart
that follows shows some of the inherent weaknesses of gap analysis as net
interest income does not increase or decrease by the same percentage in a
changing rate environment. In addition, the simulation results show that net
interest income actually declines as interest rates increase further. 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 September 30, 2002, QNB did
not have any hedging transactions in place such as interest rate swaps, caps or
floors.
Form 10-Q
Page 30
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
INTEREST RATE SENSITIVITY (CONTINUED)
The table below summarizes estimated changes in net interest income over a
twelve-month period, under alternative interest rate scenarios.
- -------------------------------------------------------------------------------------------------------------
Change in Interest Rates Net Interest Income Dollar Change Percent Change
- -------------------------------------------------------------------------------------------------------------
+300 Basis Points....................... $15,719 $ (80) (.51)%
+200 Basis Points....................... 15,953 154 .97
+100 Basis Points....................... 16,047 248 1.57
FLAT RATE............................... 15,799 - -
- -100 Basis Points....................... 14,928 (871) (5.51)
- -200 Basis Points....................... 13,981 (1,818) (11.51)
- -300 Basis Points....................... 13,126 (2,673) (16.92)
Management believes, given the current interest rate environment that it is
unlikely that interest rates would decline by 200 or 300 basis points.
OTHER ITEMS
Management is not aware of any current specific recommendations by regulatory
authorities or proposed legislation, which if they were implemented, would have
a material adverse effect upon the liquidity, capital resources, or results of
operations, although the general cost of compliance with numerous and multiple
federal and state laws and regulations does have, and in the future may have, a
negative impact on QNB's results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
The information required herein is set forth in Item 2, above.
ITEM 4. CONTROLS AND PROCEDURES
We maintain a system of controls and procedures designed to provide reasonable
assurance as to the reliability of the financial statements and other
disclosures included in this report, as well as to safeguard assets from
unauthorized use or disposition. We evaluated the effectiveness of the design
and operation of our disclosure controls and procedures under the supervision
and with the participation of management, including our Chief Executive Officer
and Chief Financial Officer, within 90 days prior to the filing date of this
report. Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective in timely alerting them to material information required to be
included in our periodic Securities and Exchange Commission filings. No
significant changes were made to our internal controls or other factors that
could significantly affect these controls subsequent to the date of their
evaluation.
Form 10-Q
Page 31
QNB CORP. AND SUBSIDIARY
PART II. OTHER INFORMATION
SEPTEMBER 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
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
The following Exhibits are included in this Report:
Exhibit 3(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).
Form 10-Q
Page 32
QNB CORP. AND SUBSIDIARY
PART II. OTHER INFORMATION
SEPTEMBER 30, 2002
Item 6. Exhibits and Reports on Form 8-K (Continued)
Exhibit 10.3 QNB Corp. 1998 Stock Incentive Plan. (Incorporated by
reference to Exhibit 4.3 to Registration Statement
No. 333-91201 on Form S-8, filed with the Commission on
November 18, 1999).
Exhibit 10.4 QNB Corp. 1988 Stock Incentive Plan. (Incorporated by
reference to Exhibit 4A to Registration Statement
No. 333-16627 on Form S-8, filed with the Commission on
November 22, 1996).
Exhibit 10.5 QNB Corp. Employee Stock Purchase Plan. (Incorporated by
reference to Exhibit 4B to Registration Statement
No. 333-16627 on Form S-8, filed with the Commission on
November 22, 1996).
Exhibit 10.6 The Quakertown National Bank Profit Sharing and
Section 401(k) Salary Deferral Plan. (Incorporated by
reference to Exhibit 4C to Registration Statement No.
333-16627 on Form S-8, filed with the Commission on
November 22, 1996).
Exhibit 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
None
Form 10-Q
Page 33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
QNB Corp.
Date: November 12, 2002 By: /s/ Thomas J. Bisko
------------------------
Thomas J. Bisko
President/CEO
Date: November 12, 2002 By: /s/ Robert C. Werner
------------------------
Robert C. Werner
Vice President
Date: November 12, 2002 By: /s/ Bret H. Krevolin
------------------------
Bret H. Krevolin
Chief Accounting Officer
Form 10-Q
Page 34
CERTIFICATION
I, Thomas J. Bisko, President and CEO, certify, that:
1. I have reviewed this quarterly report on Form 10-Q of QNB Corp.
2. Based on my knowledge, the quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report.
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this quarterly
report.
4. The registrant's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date.
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
the internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and
have identified for the registrant's auditors any material weaknesses
in internal controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrant's
internal controls.
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect the internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002 By: /s/ Thomas J. Bisko
Thomas J. Bisko
President and CEO
CERTIFICATION
I, Bret H. Krevolin, Chief Accounting Officer, certify, that:
1. I have reviewed this quarterly report on Form 10-Q of QNB Corp.
2. Based on my knowledge, the quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report.
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this quarterly
report.
4. The registrant's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date.
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
the internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and
have identified for the registrant's auditors any material weaknesses
in internal controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrant's
internal controls.
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect the internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002 By: /s/ Bret H. Krevolin
Bret H. Krevolin
Chief Accounting Officer