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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 for the fiscal year ended DECEMBER 31, 2004
[ ] For the transition period from __________________________ to TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
Commission file number 0-17706
[LOGO OMITTED]
(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)
15 NORTH THIRD STREET, QUAKERTOWN, PA 18951-9005
- ---------------------------------------------- -------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (215) 538-5600
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
COMMON STOCK, $.625 PAR VALUE N/A
- ------------------------------
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO ____
-------
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2).
YES X NO ____
-------
As of March 1, 2005, 3,098,098 shares of Common Stock of the Registrant were
outstanding. As of June 30, 2004, the aggregate market value of the Common Stock
of the Registrant, held by nonaffiliates was approximately $84,025,540 based
upon the average bid and ask price of the common stock as reported on the OTC
BB.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's Proxy Statement dated for the annual meeting of its
shareholders to be held May 17, 2005 are incorporated by reference in Part III
and IV of this report.
FORM 10-K INDEX
PART I PAGE
Item 1 Business.....................................................................................3
Item 2 Properties...................................................................................8
Item 3 Legal Proceedings............................................................................8
Item 4 Submission of Matters to a Vote of Security Holders..........................................8
PART II
Item 5 Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities..............................................9
Item 6 Selected Financial Data.....................................................................10
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations.............................................................10
Item 7A Quantitative and Qualitative Disclosures about Market Risk..................................32
Item 8 Financial Statements and Supplementary Data.................................................34
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure..............................................................59
Item 9A Controls and Procedures.....................................................................59
Item 9B Other Information ..........................................................................59
PART III
Item 10 Directors and Executive Officers of the Registrant..........................................60
Item 11 Executive Compensation......................................................................60
Item 12 Security Ownership of Certain Beneficial Owners and Management .............................60
Item 13 Certain Relationships and Related Transactions..............................................60
Item 14 Principal Accounting Fees and Services......................................................60
PART IV
Item 15 Exhibits, Financial Statement Schedules.....................................................61
2
PART I
FORWARD-LOOKING STATEMENTS
In addition to historical information, this document contains forward-looking
statements. Forward-looking statements are typically identified by words or
phrases such as "believe," "expect," "anticipate," "intend," "estimate,"
"project" and variations of such words and similar expressions, or future or
conditional verbs such as "will," "would," "should," "could," "may" or similar
expressions. The U.S. Private Securities Litigation Reform Act of 1995 provides
safe harbor in regard to the inclusion of forward-looking statements in this
document and documents incorporated by reference.
Shareholders should note that many factors, some of which are discussed
elsewhere in this document and in the documents that we incorporate by
reference, could affect the future financial results of the Corporation and its
subsidiary and could cause those results to differ materially from those
expressed in our forward-looking statements contained or incorporated by
reference in this document. These factors include, but are not limited, to the
following:
o Operating, legal and regulatory risks
o Economic, political and competitive forces affecting our line of
business
o The risk that our analysis of these risks and forces could be
incorrect, and/or that the strategies developed to address them
could be unsuccessful
o Volatility in interest rates
o Increased credit risk
QNB Corp. (herein referred to as QNB) cautions that these forward-looking
statements are subject to numerous assumptions, risks and uncertainties, all of
which change over time, and QNB assumes no duty to update forward-looking
statements. Management cautions readers not to place undue reliance on any
forward-looking statements. These statements speak only as of the date made, and
they advise readers that various factors, including those described above, could
affect QNB's financial performance and could cause our actual results or
circumstances for future periods to differ materially from those anticipated or
projected. Except as required by law, we do not undertake, and specifically
disclaim any obligation, to publicly release any revisions to any
forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
ITEM 1. BUSINESS
OVERVIEW
QNB Corp. was incorporated under the laws of the Commonwealth of Pennsylvania on
June 4, 1984. QNB Corp. is registered with the Federal Reserve Board as a bank
holding company under the Bank Holding Company Act of 1956 and conducts its
business through its wholly-owned subsidiary, The Quakertown National Bank.
The Quakertown National Bank is a national banking association organized in
1877. The Quakertown National Bank is chartered under the National Banking Act
and is subject to Federal and state laws applicable to commercial banks.
The Quakertown National Bank is engaged in the general commercial banking
business and provides a full range of banking services and trust services to its
customers. These banking services consist of, among other things, attracting
deposits and using these funds in making commercial loans, residential mortgage
loans, consumer loans, and purchasing investment securities. These deposits are
in the form of time, demand and savings accounts. Such time deposits include
certificates of deposit and individual retirement accounts. The Bank's savings
accounts include money market accounts, club accounts, interest-bearing demand
accounts and traditional statement savings accounts.
o The Quakertown National Bank's principal office is located in
Quakertown, Bucks County, Pennsylvania. The Quakertown National Bank
also operates seven other full service community banking offices in
Bucks, Montgomery and Lehigh counties in southeastern Pennsylvania.
o At December 31, 2004, QNB had total assets of approximately
$583,644,000, total loans of approximately $268,048,000, total deposits
of approximately $466,488,000 and total shareholders' equity of
approximately $45,775,000.
o For the year ended December 31, 2004, QNB reported record net income of
$6,203,000 compared to net income for the year ended December 31, 2003
of $5,648,000, an increase of 9.8 percent.
o At the end of 2004, QNB experienced its ninth consecutive year of
increased earnings and increased dividends.
3
At February 14, 2005, The Quakertown National Bank had 141 full time employees
and 36 part-time employees. These employees have a customer-oriented philosophy,
a strong commitment to service and a "sincere interest" in their customers'
success. They maintain close contact with both the residents and local business
communities in which they serve, responding to customer requests timely.
COMPETITION AND MARKET AREA
The banking business is highly competitive, and the profitability of QNB Corp.
depends principally upon The Quakertown National Bank's ability to compete in
its market area. We face intense competition within our market both in making
loans and attracting deposits. The upper Bucks, southern Lehigh, and northern
Montgomery areas have a high concentration of financial institutions including
large national and regional banks, community banks, savings institutions and
credit unions. Some of our competitors offer products and services that we
currently do not offer, such as private banking. However, we have been able to
compete effectively with other financial institutions by emphasizing technology,
including internet-banking and electronic bill pay, and customer service,
including local decision-making on loans, the establishment of long-term
customer relationships and customer loyalty, and products and services designed
to address the specific needs of our customers.
Our competition for loans and deposits comes principally from commercial banks,
savings institutions, credit unions and non-bank financial service providers.
Factors in successfully competing for deposits include providing attractive
rates, low fees, convenient locations and hours of operation and alternative
delivery systems. Successful loan origination tends to depend on size, rate and
terms of the loan. Many competitors within the Bank's primary market have
substantially higher legal lending limits.
Our success is dependent to a significant degree on economic conditions in
eastern Pennsylvania, especially upper Bucks, southern Lehigh and northern
Montgomery counties, which we define as our primary market. The banking industry
is affected by general economic conditions including the effects of inflation,
recession, unemployment, real estate values, trends in the national and global
economies, and other factors beyond our control.
SUPERVISION AND REGULATION
Bank holding companies and banks operate in a highly regulated environment and
are regularly examined by Federal and state regulatory authorities. Federal
statutes that apply to QNB and its subsidiaries include the Gramm-Leach-Bliley
Act (GLBA), the Bank Holding Company Act of 1956 (BHCA), the Federal Reserve Act
and the Federal Deposit Insurance Act. In general, these statutes establish the
corporate governance and eligible business activities of QNB, certain
acquisition and merger restrictions, limitations on inter-company transactions,
such as loans and dividends, and capital adequacy requirements, among other
regulations.
To the extent that the following information describes statutory or regulatory
provisions, it is qualified in its entirety by references to the particular
statutory or regulatory provisions themselves. Proposals to change banking laws
and regulations are frequently introduced in Congress, the state legislatures,
and before the various bank regulatory agencies. QNB cannot determine the
likelihood of passage or timing of any such proposals or legislation or the
impact they may have on QNB and its subsidiary. A change in law, regulations or
regulatory policy may have a material effect on QNB and its subsidiary.
BANK HOLDING COMPANY REGULATION
QNB is registered as a bank holding company and is subject to the regulations of
the Board of Governors of the Federal Reserve System (the Federal Reserve) under
the BHCA. In addition, QNB Corp., as a Pennsylvania business corporation, is
also subject to the provisions of Section 115 of the Pennsylvania Banking Code
of 1965.
Bank holding companies are required to file periodic reports with, and are
subject to examination by, the Federal Reserve. The Federal Reserve's
regulations require a bank holding company to serve as a source of financial and
managerial strength to its subsidiary banks. As a result, the Federal Reserve,
pursuant to its "source of strength" regulations, may require QNB Corp. to
commit its resources to provide adequate capital funds to The Quakertown
National Bank during periods of financial distress or adversity. The support may
be required at times when QNB Corp. is unable to provide such support.
Depending on the circumstances, Federal Reserve approval may be required before
QNB Corp. may begin to engage in any non-banking activity and before any
non-banking business may be acquired by QNB.
DIVIDEND RESTRICTIONS
Federal and state laws regulate the payment of dividends by QNB Corp's
subsidiary. Under the National Bank Act, The Quakertown National Bank is
required to obtain the prior approval of the OCC for the payment of dividends if
4
the total of all dividends declared by it in one year would exceed its net
profits for the current year plus its retained net profits for the two preceding
years, less any required transfers to surplus. In addition, the bank may only
pay dividends to the extent that its retained net profits (including the portion
transferred to surplus) exceed statutory bad debts. Under the FDIA, the bank is
prohibited from paying any dividends, making other distributions or paying any
management fees if, after such payment, it would fail to satisfy its minimum
capital requirements. See also "Supervision and Regulation - Bank Regulation".
Further, it is the policy of the Federal Reserve that bank holding companies
should pay dividends only out of current earnings. Federal banking regulators
also have the authority to prohibit banks and bank holding companies from paying
a dividend if they should deem such payment to be an unsafe or unsound practice.
CAPITAL ADEQUACY
Bank holding companies are required to comply with the Federal Reserve's
risk-based capital guidelines. The required minimum ratio of total capital to
risk-weighted assets (including certain off-balance sheet activities, such as
standby letters of credit) is 8 percent. At least half of total capital must be
"Tier 1 capital". Tier 1 capital consists principally of common shareholders'
equity, plus retained earnings, less certain intangible assets. The remainder of
total capital may consist of the allowance for loan loss (Tier 2 capital). At
December 31, 2004, QNB Corp.'s Tier 1 capital and total (Tier 1 and Tier 2
combined) capital ratios were 12.25 percent and 12.98 percent, respectively.
In addition to the risk-based capital guidelines, the Federal Reserve requires a
bank holding company to maintain a minimum "leverage ratio". This requires a
minimum level of Tier 1 capital (as determined under the risk-based capital
rules) to average total consolidated assets of 4 percent for those bank holding
companies that have the highest regulatory examination ratings and are not
contemplating or experiencing significant growth or expansion. The Federal
Reserve expects all other bank holding companies to maintain a ratio of at least
1 percent to 2 percent above the stated minimum. At December 31, 2004, QNB
Corp.'s leverage ratio was 7.44 percent.
Pursuant to the "prompt corrective action" provisions of the FDIA, the federal
banking agencies have specified, by regulation, the levels at which an insured
institution is considered "well capitalized", "adequately capitalized",
"undercapitalized", "significantly undercapitalized", or "critically
undercapitalized." Under these regulations, an institution is considered "well
capitalized" if it satisfies each of the following requirements:
o Total risk-based capital ratio of 10 percent or more,
o Tier 1 risk-based capital ratio of 6 percent or more,
o Leverage ratio of 5 percent or more, and
o Not subject to any order or written directive to meet and maintain a
specific capital level
At December 31, 2004, QNB Corp. qualified as "well capitalized" under these
regulatory standards. See Note 20 of the Notes to Consolidated Financial
Statements included at Item 8 of this Report.
BANK REGULATION
The operations of The Quakertown National Bank are subject to Federal and state
statutes applicable to banks chartered under the banking laws of the United
States, to members of the Federal Reserve System, and to banks whose deposits
are insured by the FDIC. These operations are also subject to regulations of the
Office of the Comptroller of the Currency (OCC), the Federal Reserve, and the
FDIC.
The OCC, which has primary supervisory authority over The Quakertown National
Bank, regularly examines banks in such areas as reserves, loans, investments,
management practices and other aspects of operations. These examinations are
designed for the protection of depositors rather than QNB Corp.'s shareholders.
The bank must furnish annual and quarterly reports to the OCC, which has the
authority under the Financial Institutions Supervisory Act and the Federal
Deposit Insurance Act, to prevent a national bank from engaging in an unsafe or
unsound practice in conducting its business or from otherwise conducting
activities in violation of the law.
Federal and state banking laws and regulations govern, among other things, the
scope of a bank's business, the investments a bank may make, the reserves
against deposits a bank must maintain, the types and terms of loans a bank may
make and the collateral it may take, the activities of a bank with respect to
mergers and consolidations, and the establishment of branches. Pennsylvania law
permits statewide branching.
As a subsidiary bank of a bank holding company, The Quakertown National Bank is
subject to certain restrictions imposed by the Federal Reserve Act on extensions
of credit to QNB Corp. or its subsidiaries, on investments in the stock or other
securities of QNB Corp. or its subsidiaries, and on taking such stock or
securities as collateral for loans.
5
The Bank is a member of the Federal Reserve System and therefore, the policies
and regulations of the Federal Reserve Board have a significant impact on many
elements of the Bank's operations including the ability to grow deposits, loan
growth, the rate of interest earned and paid, levels of liquidity and levels of
required capital. Management cannot predict the effects of such policies and
regulations upon the Bank's business model and the corresponding impact they may
have on future earnings.
FDIC INSURANCE ASSESSMENTS
The Quakertown National Bank is subject to deposit insurance assessments by the
Federal Deposit Insurance Corporation (FDIC) based on the risk classification of
the Bank. The Quakertown National Bank was not subject to any regular insurance
assessments by the FDIC in 2004. Under current FDIC practices, The Quakertown
National Bank does not expect to be required to pay regular insurance
assessments to the FDIC in 2005.
Insured deposits are assessed to fund debt service on certain related Federal
government bonds. The current annualized rate established by the FDIC is $.017
per $100 of deposits. These assessment rates are set quarterly. The total
assessment paid by the Bank in 2004 was $64,000.
COMMUNITY REINVESTMENT ACT (CRA)
Under the Community Reinvestment Act, as amended, the OCC is required to assess
all financial institutions that it regulates to determine whether these
institutions are meeting the credit needs of the community that they serve. The
act focuses specifically on low and moderate-income neighborhoods. The OCC takes
an institution's record into account in its evaluation of any application made
by any of such institutions for, among other things:
o Approval of a branch or other deposit facility
o An office relocation or a merger
o Any acquisition of bank shares
The CRA, as amended, also requires that the OCC make publicly available the
evaluation of the bank's record of meeting the credit needs of its entire
community, including low and moderate-income neighborhoods. This evaluation
includes a descriptive rating of either outstanding, satisfactory, needs to
improve, or substantial noncompliance, and a statement describing the basis for
the rating. These ratings are publicly disclosed. The Bank's most recent CRA
rating was satisfactory.
MONETARY AND FISCAL POLICIES
The financial services industry, including QNB Corp. and The Quakertown
National Bank, is affected by the monetary and fiscal policies of government
agencies, including the Federal Reserve. Through open market securities
transactions and changes in its discount rate and reserve requirements, the
Federal Reserve exerts considerable influence over the cost and availability of
funds for lending and investment.
USA PATRIOT ACT
In October 2001, the President signed into the law the USA Patriot Act, which
strengthens anti-money laundering provisions of the Bank Secrecy Act. The Act
requires financial institutions to establish certain procedures to be able to
identify and verify the identity of its customers. Specifically, the new rules,
developed by the Secretary of the Treasury, require that the Bank have
procedures in place to:
o Verify the identity of persons applying to open an account,
o Ensure adequate maintenance of the records used to verify a person's
identity, and
o Determine whether a person is on any U.S. governmental agency list of
known or suspected terrorists or a terrorist organization
The Bank has implemented the required internal controls to ensure proper
compliance with the Patriot Act.
6
SARBANES-OXLEY ACT OF 2002
The Sarbanes-Oxley Act, signed into law July 30, 2002, was intended to bolster
public confidence in our nation's capital markets by imposing new duties and
penalties for non-compliance on public companies and their executives,
directors, auditors, attorneys and securities analysts. Some of the more
significant aspects of the act include:
o Corporate Responsibility for Financial Reports - requires Chief
Executive Officers (CEOs) and Chief Financial Officers (CFOs) to
personally certify and be accountable for their Corporations' financial
records and accounting and internal controls.
o Management Assessment of Internal Controls - requires auditors to
certify the Corporations' underlying controls and processes that are
used to compile the financial results.
o Real-time Issuer Disclosures - requires that companies provide real-time
disclosures of any events that may affect a firm's stock price or
financial performance within a 48-hour period.
o Criminal Penalties for Altering Documents - provides severe penalties
for "whoever knowingly alters, destroys, mutilates" any record or
document with intent to impede an investigation. Penalties include
monetary fines and prison time.
The act also imposes requirements for corporate governance, auditor independence
and accounting standards, executive compensation, insider loans and
whistleblower protection. As a result of Sarbanes-Oxley, QNB Corp. adopted a
Code of Business Conduct and Ethics applicable to its CEO, CFO and Controller,
which meets the requirements of Sarbanes-Oxley, to supplement its long-standing
Code of Ethics, which applies to all employees.
QNB Corp.'s Code of Business Conduct and Ethics can be found on the Company's
website at www.qnb.com.
ADDITIONAL INFORMATION
QNB Corp.'s principal executive offices are located at 15 North Third Street,
Quakertown, Pennsylvania 18951. Its telephone number is (215) 538-5600.
This annual report, including the exhibits and schedules filed as part of the
annual report on Form 10-K, may be inspected at the public reference facility
maintained by the Securities and Exchange Commission (SEC) at its public
reference room at 450 Fifth Street, NW, Washington, DC 20549 and copies of all
or any part thereof may be obtained from that office upon payment of the
prescribed fees. You may call the SEC at 1-800-SEC-0330 for further information
on the operation of the public reference room and you can request copies of the
documents upon payment of a duplicating fee, by writing to the SEC. In addition,
the SEC maintains a website that contains reports, proxy and information
statements and other information regarding registrants, including QNB Corp.,
that file electronically with the SEC which can be accessed at www.sec.gov.
QNB Corp. also makes its periodic and current reports available, free of charge,
on its website, www.qnb.com., as soon as reasonably practicable after such
material is electronically filed with the SEC. Information available on our
website is not a part of, and should not be incorporated into, this annual
report on Form 10-K.
7
ITEM 2. PROPERTIES
The Quakertown National Bank and QNB Corp.'s main office is located at 15 North
Third Street, Quakertown, Pennsylvania. The Quakertown National Bank conducts
business from its main office and seven other retail offices located in upper
Bucks, southern Lehigh, and northern Montgomery counties. The Quakertown
National Bank owns its main office, two retail locations, its operations
facility and an adjacent property for expansion, and a computer facility. The
Quakertown National Bank leases its remaining five retail properties. The leases
on the properties generally contain renewal options. Management considers that
its facilities are adequate for its business.
The following table details The Quakertown National Bank's properties:
Location
Quakertown, Pa. - Main Office Owned
15 North Third Street
Quakertown, Pa. - Towne Bank Center Owned
320-322 West Broad Street
Quakertown, Pa. - Computer Center Owned
121 West Broad Street
Quakertown, Pa. - Country Square Office Leased
240 South West End Boulevard
Quakertown, Pa. - Quakertown Commons Branch Leased
901 South West End Boulevard
Dublin, Pa. - Dublin Branch Leased
161 North Main Street
Pennsburg, Pa. - Pennsburg Square Branch Leased
410-420 Pottstown Ave
Coopersburg, Pa. - Coopersburg Branch Owned
51 South Third Street
Perkasie, Pa. - Perkasie Branch Owned
607 Chestnut Street
Souderton, Pa. - Souderton Branch Leased
750 Route 113
In management's opinion, these properties are in good condition and are adequate
for QNB Corp.'s purposes.
ITEM 3. LEGAL PROCEEDINGS
Management, after consulting with legal counsel, is not aware of any litigation
that would have a material adverse effect on the consolidated financial position
of QNB Corp. There are no proceedings pending other than ordinary routine
litigation incidental to the business of QNB Corp. and its subsidiary, The
Quakertown National Bank. In addition, no material proceedings are known to be
contemplated by governmental authorities against QNB Corp. or The Quakertown
National Bank or any of their properties.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
8
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
STOCK INFORMATION
QNB Corp. common stock is traded in the over-the-counter (OTC) market.
Quotations for QNB Corp. common stock appear in the pink sheets published by the
National Quotations Bureau, Inc. QNB Corp. had 720 shareholders of record as of
March 1, 2005.
The following table sets forth representative high and low bid and ask stock
prices for QNB Corp. common stock on a quarterly basis during 2004 and 2003. All
periods presented have been restated to reflect the two-for-one stock split
distributed October 14, 2003.
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CASH
HIGH LOW DIVIDEND
BID ASK BID ASK PER SHARE
- --------------------------------------------------------------------------------
2004
First Quarter $ 34.800 $ 34.750 $ 33.100 $ 33.800 $ .185
Second Quarter 34.000 40.000 30.250 30.950 .185
Third Quarter 31.750 32.500 31.100 31.500 .185
Fourth Quarter 32.500 34.000 31.300 31.500 .185
- --------------------------------------------------------------------------------
2003
First Quarter $ 20.500 $ 24.500 $ 20.000 $ 20.625 $ .165
Second Quarter 22.750 24.500 20.300 21.500 .165
Third Quarter 31.375 35.000 22.750 23.375 .165
Fourth Quarter 34.750 39.000 31.000 32.000 .165
- --------------------------------------------------------------------------------
QNB Corp. has traditionally paid quarterly cash dividends on the last Friday of
each quarter. The Corporation expects to continue the practice of paying
quarterly cash dividends to its shareholders; however, future dividends are
dependent upon future earnings. Certain laws restrict the amount of dividends
that may be paid to shareholders in any given year. See "Supervision and
Regulation - Bank Regulation," found on page 5 of this Form 10-K filing, and
Note 20 of the Notes to Consolidated Financial Statements, found on page 57 of
this Form 10-K filing, for the information that discusses and quantifies this
regulatory restriction.
EQUITY COMPENSATION PLAN INFORMATION
The following table summarizes our equity compensation plan information as of
December 31, 2004. Information is included for both equity compensation plans
approved by QNB shareholders and equity compensation plans not approved by QNB
shareholders.
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NUMBER OF SHARES
NUMBER OF SHARES WEIGHTED-AVERAGE AVAILABLE FOR FUTURE
TO BE ISSUED UPON EXERCISE PRICE OF ISSUANCE UNDER EQUITY
EXERCISE OF OUTSTANDING COMPENSATION PLANS
OUTSTANDING OPTIONS, OPTIONS, WARRANTS [EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS AND RIGHTS REFLECTED IN COLUMN (A)]
- ------------------------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
- ------------------------------------------------------------------------------------------------------------------------------------
Equity compensation plans approved by QNB Corp. shareholders
1998 Stock Option Plan 182,392 $18.03 28,836
2001 Employee Stock Purchase Plan - - 30,888
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Equity compensation plans not approved by QNB Corp. shareholders
None - - --
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TOTALS 182,392 $18.03 59,724
====================================================================================================================================
9
ITEM 6. SELECTED FINANCIAL AND OTHER DATA
- ------------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME AND EXPENSE
Interest income............................................. $ 25,571 $ 25,139 $ 27,191 $ 26,928 $ 24,698
Interest expense............................................ 9,506 9,754 12,076 13,404 12,007
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income........................................ 16,065 15,385 15,115 13,524 12,691
Provision for loan losses................................... - - - - -
Non-interest income......................................... 4,687 4,200 2,989 3,070 2,791
Non-interest expense........................................ 12,845 12,683 11,945 11,080 10,232
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes ................................ 7,907 6,902 6,159 5,514 5,250
Provision for income taxes.................................. 1,704 1,254 1,204 1,078 1,144
- ------------------------------------------------------------------------------------------------------------------------------------
Net income.................................................. $ 6,203 $ 5,648 $ 4,955 $ 4,436 $ 4,106
====================================================================================================================================
PER SHARE DATA
Net income - basic.......................................... $ 2.00 $ 1.83 $ 1.61 $ 1.44 $ 1.30
Net income - diluted........................................ 1.95 1.79 1.59 1.43 1.30
Book value.................................................. 14.78 14.03 13.28 11.46 10.21
Cash dividends.............................................. .74 .66 .60 .54 .46
Average common shares outstanding - basic................... 3,096,360 3,091,640 3,078,550 3,088,020 3,146,642
Average common shares outstanding - diluted................. 3,178,152 3,153,305 3,109,353 3,094,735 3,147,239
BALANCE SHEET AT YEAR-END
Investment securities available-for-sale.................... $ 267,561 $ 260,631 $ 211,156 $ 165,362 $ 111,093
Investment securities held-to-maturity...................... 6,203 12,012 29,736 42,798 42,982
Non-marketable equity securities............................ 3,947 3,810 3,585 2,740 3,152
Loans held-for-sale......................................... 312 1,439 4,159 2,122 1,642
Loans, net of unearned income............................... 268,048 232,127 212,691 200,089 183,592
Other earning assets........................................ 4,140 5,381 10,310 5,888 3,226
Total assets................................................ 583,644 550,831 503,430 451,274 371,671
Deposits.................................................... 466,488 438,639 388,913 344,731 293,822
Borrowed funds.............................................. 68,374 65,416 69,485 66,541 42,819
Shareholders' equity........................................ 45,775 43,440 40,914 35,219 31,794
SELECTED FINANCIAL RATIOS
Net interest margin......................................... 3.32% 3.40% 3.68% 3.81% 4.02%
Net income as a percentage of:
Average total assets..................................... 1.10 1.07 1.03 1.07 1.13
Average shareholders' equity................................ 14.43 14.38 13.88 13.54 13.25
Average shareholders' equity to average total assets ....... 7.64 7.46 7.45 7.93 8.53
Dividend payout ratio....................................... 36.95 36.15 37.29 37.32 34.75
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
OVERVIEW
QNB had its ninth consecutive year of record earnings in 2004. QNB's net income
for 2004 were $6,203,000, a 9.8 percent increase from the $5,648,000 reported in
2003. This represents basic net income per share of $2.00 and $1.83 for 2004 and
2003, respectively. On a diluted basis, net income per share was $1.95 and $1.79
for 2004 and 2003, respectively. Net income for 2002 was $4,955,000, or $1.61
and $1.59 per share on a basic and diluted basis, respectively.
Two important measures of profitability in the banking industry are an
institution's return on average assets and return on average shareholders'
equity. Return on average assets and return on average shareholders' equity were
1.10 percent and 14.43 percent, respectively, in 2004 compared with 1.07 percent
and 14.38 percent in 2003 and 1.03 percent and 13.88 percent in 2002.
10
2004 VERSUS 2003
The 2004 results compared to 2003 included the following significant components:
o Net interest income increased $680,000, or 4.4 percent, to $16,065,000.
o Contributing to the increase in net interest income was a 6.8 percent
increase in average earning assets. The average balance of loans
increased by 8.6 percent, while the year-end 2003 to year-end 2004
balances increased 15.5 percent. Average deposits increased 7.3 percent
during 2004.
o The net interest margin declined 8 basis points to 3.32 percent.
Included in net interest income for 2004 is the recognition of $111,000
in interest on non-accrual loans.
o The Federal Reserve Bank Board raised the Federal funds rate from 1.00
percent to 2.25 percent during the last six months of 2004. The yield
curve flattened as short-term rates increased more than mid- and
long-term interest rates.
Non-interest income increased $487,000, or 11.6 percent, to $4,687,000.
o The net gain on the sale of investment securities increased $983,000,
while the net gain on the sale of loans decreased $769,000. The gain on
the sale of investment securities is primarily from the sales of equity
securities. The decline in the gain on the sale of loans is a result of
the decline in mortgage activity resulting from higher interest rates.
o A $141,000 gain on the liquidation of assets relinquished by a borrower
partially offsets the $350,000 charge-off recorded through the allowance
for loan losses during the third quarter of 2004, related to this loan.
o Service charges on deposit accounts increased $151,000, primarily a
result of an increase in overdraft income.
o Non-interest income in 2003 included tax-exempt life insurance proceeds
of $109,000 and dividends from QNB's interest in a title insurance
company of $70,000.
Non-interest expense increased $162,000, or 1.3 percent, to $12,845,000.
o Salary and benefit expense decreased by $32,000. Contributing to the
lower salary expense was a reduction in incentive compensation of
$247,000.
o The opening of QNB's first supermarket branch in 2004 contributed to the
increase in net occupancy, furniture and fixtures and marketing expense.
o The effective tax rate was 21.6 percent for 2004 compared to 18.2
percent for 2003. Contributing to the lower effective tax rate in 2003
was the reversal of a $95,000 tax valuation recorded in 2002. The
receipt of $109,000 in tax-exempt life insurance proceeds also had a
beneficial impact on the effective tax rate in 2003.
2003 VERSUS 2002
The 2003 results compared to 2002 included the following significant components:
Net interest income increased $270,000, or 1.8 percent, to $15,385,000.
o Contributing to the increase in net interest income was a 9.9 percent
increase in average earning assets. This offset a 28 basis point
reduction in the net interest margin to 3.40 percent.
o Average deposits increased by 12.7 percent, while average loans and
investment securities increased by 10.4 percent and 8.4 percent,
respectively.
Non-interest income increased $1,211,000, or 40.5 percent, to $4,200,000.
o A record low interest rate environment resulted in significant mortgage
refinancing activity. The increased activity resulted in an increase in
the gain on the sale of loans of $247,000.
o The loss on investment securities was $134,000 in 2003 compared to a
loss of $779,000 in 2002.
o Tax-exempt proceeds from life insurance was $109,000
Non-interest expense increased $738,000, or 6.2 percent, to $12,683,000.
o Personnel expense increased $664,000 with a new incentive compensation
plan contributing $257,000 to the increase. Medical insurance premiums
increased $68,000.
o The effective tax rate was 18.2 percent for 2003 compared to 19.5
percent for 2002. The lower effective tax rate in 2003 was a result of
the items discussed above, relating to the tax valuation and life
insurance proceeds.
These items as well as others will be explained more thoroughly in the next
sections.
11
AVERAGE BALANCES, RATES, AND INTEREST INCOME AND EXPENSE SUMMARY (TAX-EQUIVALENT BASIS)
2004 2003 2002
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE INTEREST BALANCE RATE INTEREST BALANCE RATE INTEREST
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ASSETS
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Federal funds sold................... $ 6,834 1.37% $ 93 $ 11,236 1.12% $ 126 $ 9,363 1.63% $ 152
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Investment securities:
U.S. Treasury..................... 6,536 1.97 129 6,697 2.65 177 6,530 4.45 291
U.S. Government agencies.......... 35,239 3.65 1,286 37,392 4.27 1,595 29,844 5.47 1,632
State and municipal............... 51,548 6.54 3,369 46,631 6.86 3,199 42,235 7.10 2,998
Mortgage-backed and CMOs.......... 141,464 4.25 6,012 124,002 4.19 5,195 118,135 5.40 6,382
Other............................. 29,890 5.33 1,594 31,870 5.39 1,719 30,840 6.11 1,885
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Total investment securities..... 264,677 4.68 12,390 246,592 4.82 11,885 227,584 5.79 13,188
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Loans:
Commercial real estate............... 114,804 5.88 6,748 105,670 6.19 6,545 90,346 7.58 6,852
Residential real estate.............. 20,820 6.22 1,296 24,630 6.78 1,669 27,628 7.16 1,979
Home equity loans.................... 54,910 5.71 3,134 47,741 6.43 3,070 41,286 7.11 2,934
Commercial and industrial............ 41,511 5.02 2,084 35,927 5.25 1,885 31,553 6.38 2,014
Consumer loans....................... 5,673 9.32 529 6,299 9.87 622 6,779 8.90 603
Tax-exempt loans..................... 12,627 5.23 661 10,261 6.17 633 11,190 6.91 773
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Total loans, net of unearned
income* ..................... 250,345 5.77 14,452 230,528 6.26 14,424 208,782 7.26 15,155
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Other earning assets................. 4,866 1.63 80 4,882 1.84 90 3,188 3.40 108
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Total earning assets............ 526,722 5.13 27,015 493,238 5.38 26,525 448,917 6.37 28,603
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Cash and due from banks.............. 20,074 18,207 15,495
Allowance for loan losses............ (2,843) (2,937) (2,887)
Other assets......................... 18,629 18,266 17,969
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Total assets.................... $ 562,582 4.80% $ 526,774 5.04% $479,494 5.97%
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LIABILITIES AND SHAREHOLDERS' EQUITY
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Interest-bearing deposits
Interest-bearing demand accounts.... $ 100,684 .68% 681 $ 87,570 .63% 554 $ 61,006 .64% 393
Money market accounts................ 44,364 .99 441 36,138 .83 298 37,171 1.51 559
Savings ............................. 54,613 .39 215 50,616 .64 324 41,764 1.19 497
Time ................................ 156,511 2.65 4,153 152,321 2.96 4,511 141,854 4.12 5,843
Time over $100,000 .................. 40,880 2.42 990 43,289 2.49 1,080 46,354 3.48 1,614
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Total interest-bearing deposits. 397,052 1.63 6,480 369,934 1.83 6,767 328,149 2.71 8,906
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Short-term borrowings................ 11,938 1.03 124 10,226 1.04 106 13,880 1.90 264
Federal Home Loan Bank advances...... 55,000 5.28 2,902 55,000 5.24 2,881 54,540 5.33 2,906
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Total interest-bearing
liabilities .................. 463,990 2.05 9,506 435,160 2.24 9,754 396,569 3.05 12,076
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Non-interest-bearing deposits........ 52,691 49,164 43,569
Other liabilities.................... 2,926 3,164 3,649
Shareholders' equity................. 42,975 39,286 35,707
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Total liabilities and
shareholders' equity......... $ 562,582 1.69% $ 526,774 1.85% $479,494 2.52%
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Net interest rate spread............. 3.08% 3.14% 3.32%
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Margin/net interest income........... 3.32% $17,509 3.40% $ 16,771 3.68% $16,527
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Tax-exempt securities and loans were adjusted to a tax-equivalent basis and are
based on the marginal Federal corporate tax rate of 34 percent.
Non-accrual loans are included in earning assets.
* Includes loans held-for-sale.
12
NET INTEREST INCOME
The following table presents the adjustment to convert net interest income to
net interest income on a fully taxable equivalent basis for the years ended
December 2004, 2003 and 2002.
NET INTEREST INCOME
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DECEMBER 31, 2004 2003 2002
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Total interest income..................................................................... $ 25,571 $ 25,139 $ 27,191
Total interest expense.................................................................... 9,506 9,754 12,076
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Net interest income....................................................................... 16,065 15,385 15,115
Tax equivalent adjustment................................................................. 1,444 1,386 1,412
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Net interest income (fully taxable equivalent)............................................ $ 17,509 $ 16,771 $ 16,527
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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 earnings. Net interest income is
affected by changes in interest rates, the volume and mix of earning assets and
interest-bearing liabilities, and the amount of earning assets funded by
non-interest-bearing deposits.
For purposes of this discussion, interest income and the average yield earned on
loans and investment securities are adjusted to a tax-equivalent basis as
detailed in the table that appears on page 12. This adjustment to interest
income is made for analysis purposes only. Interest income is increased by the
amount of savings of Federal income taxes, which QNB realizes by investing in
certain tax-exempt state and municipal securities and by making loans to certain
tax-exempt organizations. In this way, the ultimate economic impact of earnings
from various assets can be more easily compared.
The net interest rate spread is the difference between average rates received on
earning assets and average rates paid on interest-bearing liabilities, while the
net interest margin includes interest-free sources of funds.
On a fully tax-equivalent basis, net interest income for 2004 increased
$738,000, or 4.4 percent, to $17,509,000. As has been the trend, the ability to
increase net interest income is a result of the growth in deposits and the
investment of these deposits into profitable loans and investment securities.
This growth in earning assets has been able to offset the continued decline in
the net interest margin resulting from the low interest rate environment of the
past few years. While core deposits continued to increase, a significant
contributor to the growth in deposits in 2004 was additional deposits of local
municipalities and school districts. The majority of the growth in these
deposits is seasonal and will likely be withdrawn during the first and second
quarters of 2005. These deposits were primarily invested in securities whose
cash flow will closely match the anticipated run-off of the deposits.
Average earning assets increased 6.8 percent in 2004 while the net interest
margin and net interest rate spread declined by 8 basis points and 6 basis
points, respectively. The net interest margin decreased to 3.32 percent in 2004
from 3.40 percent in 2003, while the net interest rate spread decreased to 3.08
percent in 2004 from 3.14 percent in 2003. Included in net interest income for
2004 is the recognition of $111,000 in interest on non-accrual loans that have
been paid in full. Excluding the impact of the recognition of interest on
non-accrual loans, the net interest margin would have been 3.30 percent for
2004.
The interest rate graph on this page shows the trend in market interest rates
for the period 2002-2004.
The year 2003 began with expectations of a slowly improving economy and rising
interest rates. While the economy did show signs of growth, the uncertainty
created by the war in Iraq as well as concerns over the lack of job growth and
deflation kept interest rates at historically low levels. Interest rates were
extremely volatile over the course of 2003. The two-year, 10-year and 30-year
Treasury bonds all reached historic lows on June 13, 2003 of 1.10 percent, 3.13
percent and 4.17 percent, respectively. At the end of June, the Federal Reserve
Board dropped the Federal funds rate by 25 basis points to 1.00 percent. One
result of these record low rates was a sharp increase in residential mortgage
loan activity, both purchase mortgages and refinances. Interest rates rebounded
quickly with the 10-year hitting its high for the year of 4.61 percent in early
September and the 30-year hitting its high of 5.45 percent in August. The
shorter end of the yield curve was slower to react as a result of indications by
the Federal Reserve Board that it would be patient in raising the Federal funds
rate. The two-year Treasury bond reached its high for the year of 2.12 percent
in early December before finishing the year at 1.82 percent. The 10-year and
30-year bonds ended the year at 4.25 percent and 5.07 percent, respectively.
13
RATE-VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME (TAX-EQUIVALENT BASIS)
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2004 VS. 2003 2003 VS. 2002
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CHANGE DUE TO TOTAL CHANGE DUE TO TOTAL
VOLUME RATE CHANGE VOLUME RATE CHANGE
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Interest income:
Federal funds sold.......................................... $ (49) $ 16 $ (33) $ 31 $ (57) $ (26)
Investment securities available-for-sale:
U.S. Treasury.......................................... (4) (44) (48) 7 (121) (114)
U.S. Government agencies............................... (92) (217) (309) 412 (449) (37)
State and municipal.................................... 337 (167) 170 312 (111) 201
Mortgage-backed and CMOs............................... 731 86 817 317 (1,504) (1,187)
Other.................................................. (107) (18) (125) 63 (229) (166)
Loans:
Commercial real estate................................. 566 (363) 203 1,162 (1,469) (307)
Residential real estate................................ (258) (115) (373) (215) (95) (310)
Home equity loans...................................... 461 (397) 64 459 (323) 136
Commercial and industrial.............................. 293 (94) 199 279 (408) (129)
Consumer loans......................................... (62) (31) (93) (43) 62 19
Tax-exempt loans....................................... 146 (118) 28 (64) (76) (140)
Other earning assets........................................ - (10) (10) 58 (76) (18)
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Total interest income.............................. 1,962 (1,472) 490 2,778 (4,856) (2,078)
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Interest expense:
Interest-bearing demand accounts............................ 83 44 127 171 (10) 161
Money market accounts....................................... 68 75 143 (15) (246) (261)
Savings..................................................... 25 (134) (109) 106 (279) (173)
Time ....................................................... 125 (483) (358) 431 (1,763) (1,332)
Time over $100,000.......................................... (60) (30) (90) (107) (427) (534)
Short-term borrowings....................................... 18 - 18 (70) (88) (158)
Federal Home Loan Bank advances............................. - 21 21 24 (49) (25)
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Total interest expense............................. 259 (507) (248) 540 (2,862) (2,322)
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Net interest income......................................... $ 1,703 $ (965) $ 738 $ 2,238 $(1,994) $ 244
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The year 2004 may be viewed as a turning point. It marks the year when the
Federal Reserve Board began tightening monetary policy after taking rates down
to 40 year lows. Using a "measured pace" strategy of tightening, the Board,
beginning in June, raised the Federal funds rate five times by 25 basis points
each time, bringing the overnight rate to 2.25 percent at the end of the year.
The 125 basis point increase in the Federal funds rate was matched by a similar
increase in the two-year Treasury bond between December 31, 2003 and December
31, 2004, while the 10-year bond fell by one basis point. This flattening of the
yield curve is generally not a positive for financial institutions, as deposits
tend to be priced off the shorter end of the yield curve while loans and
investment securities tend to be priced off the middle part of the yield curve.
This could result in deposit rates increasing at a faster pace than rates on
earning assets, further compressing the net interest margin.
The Rate-Volume Analysis table, as presented on a tax-equivalent basis above,
highlights the impact of changing rates and volumes on total interest income and
interest expense. Total interest income increased $490,000, or 1.8 percent, in
2004 to $27,015,000. The increase in interest income was a result of an increase
in earning assets offsetting the continued impact of declining yields. The
increase in interest income attributable to volume was $1,962,000, while the
decrease related to declining yields was $1,472,000. Despite the increase in
market interest rates off their historic lows, the long period of historically
low interest rates has had the impact of lowering the yield on earning assets as
loans and investment securities either repriced or were originated at lower
interest rates. The yield on earning assets on a tax-equivalent basis was 5.13
percent for 2004 compared to 5.38 percent for 2003.
Interest income on investment securities increased $505,000 for 2004 as average
balances increased 7.3 percent. This offset a decline of 14 basis points in
average yield to 4.68 percent. QNB increased its holdings of amortizing
securities including mortgage-backed securities and collateralized mortgage
obligations (CMOs) in an effort to increase both the yield and cash flow from
the portfolio, in anticipation of rising interest rates.
Interest income on loans increased by only $28,000 in 2004 as the 8.6 percent
increase in average balances was almost completely offset by the impact of
declining rates in the portfolio. The volume increase in loans was centered
primarily in commercial purpose loans and home equity loans, many of which are
indexed to the prime rate. The yield on loans decreased 49 basis points to 5.77
percent when comparing 2004 to 2003. The rate of increase in loan yields in 2005
will be impacted by how quickly and to what degree the Federal Reserve Board
continues to increase interest rates and how much the competitive nature of the
business will keep loan rates down.
14
Total interest expense decreased $248,000, or 2.5 percent, in 2004 to
$9,506,000. The impact of lower interest rates on interest expense, particularly
with regard to time deposits, offset the impact of the growth in deposits.
Volume growth resulted in interest expense increasing by $259,000 while lower
interest rates reduced interest expense by $507,000. A 7.3 percent increase in
average interest-bearing deposits resulted in an increase in interest expense of
$241,000. A $13,114,000, or 15.0 percent, increase in average interest-bearing
demand accounts contributed $83,000 to the increase in interest expense while an
$8,226,000, or 22.8 percent, increase in average money market accounts
contributed $68,000 in additional expense. As discussed previously, the majority
of the growth in interest bearing demand deposits and money market accounts can
be attributed to the successful development of relationships with several
municipal organizations and school districts.
The rate paid on total interest-bearing liabilities decreased to 2.05 percent in
2004 from 2.24 percent in 2003. The rate paid on interest-bearing deposit
accounts decreased to 1.63 percent in 2004 from 1.83 percent in 2003. Lower
rates paid on savings accounts and time deposits decreased interest expense by
$134,000 and $513,000, respectively, in 2004. The average rate paid on savings
accounts decreased 25 basis points to .39 percent while the average rate paid on
time deposits decreased 25 basis points to 2.61 percent. The rate on money
market accounts increased from .83 percent for 2003 to .99 percent for 2004.
This is primarily the result of two events. First, QNB had to pay a higher rate
to attract the municipal deposits, second, the rising short-term interest rates
in the second half of 2004 impacted 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. Management expects
interest expense and the rate paid on interest-bearing liabilities to increase
throughout 2005 as higher short-term market rates of interest result in higher
rates paid initially on money market accounts and time deposits. This will be
followed by higher rates paid on interest-bearing demand accounts and savings
accounts, accounts that tend to lag as rates increase.
When comparing 2003 to 2002, net interest income on a fully tax-equivalent basis
increased $244,000, or 1.5 percent, to $16,771,000. The increase in net interest
income was the result of the growth in deposits and the investment of these
deposits into profitable loans and investment securities. Average earning assets
increased 9.9 percent in 2003. This growth helped offset the impact on net
interest income resulting from a decline in the net interest margin. The net
interest margin declined by 28 basis points, while the net interest rate spread
declined by 18 basis points. The net interest rate margin decreased to 3.40
percent in 2003 from 3.68 percent in 2002, while the net interest rate spread
decreased to 3.14 percent in 2003 from 3.32 percent in 2002.
Total interest income decreased $2,078,000, or 7.3 percent, in 2003 to
$26,525,000. The significant decline in interest rates and the extended period
of these historically low interest rates resulted in interest income decreasing
by $4,856,000 in 2003 and the yield on earning assets decreasing by 99 basis
points to 5.38 percent for 2003. The growth in earning assets resulted in an
increase in interest income of $2,778,000, helping to partially offset the
impact of lower rates.
Interest income on investment securities decreased $1,303,000, with the yield on
investment securities decreasing 97 basis points to 4.82 percent. The impact of
lower interest rates on interest income on investment securities was $2,414,000.
The decline in interest rates resulted in heavy cash flow from callable agency
bonds and municipal securities, mortgage-backed securities and CMOs. These funds
as well as new funds from deposit growth were reinvested in lower-yielding
securities. Another result of the increase in prepayments on mortgage-backed
securities and CMOs purchases at a premium was an increase in the amortization
of the premium on these securities. The net amortization on investment
securities was $1,204,000 in 2003 compared to $793,000 in 2002. The increase in
premium amortization has the impact of reducing interest income and the yield on
the portfolio. An 8.4 percent increase in the average balance of investment
securities resulted in additional interest income of approximately $1,111,000,
partially negating the impact of declining rates.
Interest income on loans declined by $731,000, with the yield on loans
decreasing 100 basis points to 6.26 percent. Lower interest rates produced a
reduction in interest on loans of $2,309,000, while a 10.4 percent increase in
average balances resulted in an increase in interest income of $1,578,000. Most
of the rate impact was in commercial purpose loans and home equity loans. Many
of these loans are indexed to the prime rate, which declined on average 55 basis
points between 2003 and 2002. Another contributor to the decline in interest
income from rates on loans was the impact of the refinancing of residential
mortgage, home equity and commercial loans into lower yielding loans.
Total interest expense decreased $2,322,000, or 19.2 percent, in 2003 to
$9,754,000. The impact of falling interest rates on interest expense offset the
impact of the growth in deposits. Volume growth resulted in interest expense
increasing by $540,000 while lower interest rates on deposits and borrowings
reduced interest expense by $2,862,000. A 12.7 percent increase in average
interest-bearing deposits resulted in an increase in interest expense of
$586,000. A $26,564,000, or 43.5 percent, increase in average interest-bearing
demand accounts contributed $171,000 to the increase in interest expense while
an $8,852,000, or 21.2 percent, increase in average savings accounts contributed
$106,000 in additional expense. As discussed previously, the majority of the
growth in interest-bearing demand deposits can be attributed to the successful
development of relationships with several municipal organizations. The continued
growth in savings deposits can be attributed to consumers looking for the
relative safety of bank deposits despite the low interest rate environment.
Average balances on time deposits increased by 3.9 percent, contributing
$324,000 to the increase in interest expense. A $10,467,000 increase in average
time deposits with balances less than $100,000 offset a $3,065,000 decrease in
average time deposits with balances of $100,000 or more.
15
The average rates paid on deposit accounts, short-term borrowings and Federal
Home Loan Bank (FHLB) advances decreased in 2003. The rate paid on total
interest-bearing liabilities, including the borrowings from the FHLB, decreased
to 2.24 percent in 2003 from 3.05 percent in 2002. The rate paid on
interest-bearing deposit accounts decreased to 1.83 percent in 2003 from 2.71
percent in 2002. Lower rates paid on money market accounts and savings accounts
decreased interest expense by $246,000 and $279,000, respectively, in 2003.
Among these transaction accounts, the average rate paid on money market accounts
was impacted the most by the decline in interest rates. The yield on money
market accounts declined 68 basis points from 1.51 percent in 2002 to .83
percent in 2003. Contributing to the decline in the yield on money market
accounts was the sharp decline in the yield on the Treasury Select Money Market
Account. The continued decline in the 91-day Treasury rate in 2003 resulted in
significantly lower rates on this product as compared to 2002. The average rate
paid on savings accounts decreased from 1.19 percent in 2002 to .64 percent in
2003.
The continuing low interest rate environment had a greater impact on time
deposits in 2003 as many time deposits with longer original maturities repriced
lower during the year. Interest expense on time deposits was $2,190,000 lower in
2003 as a result of lower interest rates. The average rate paid on time deposits
decreased from 3.96 percent in 2002 to 2.86 percent in 2003.
Management expects net interest income to increase slightly in 2005 as a result
of the growth in earning assets offsetting a net interest margin that will
likely be stable or decline slightly. The yield curve is expected to flatten
further in 2005, as the Federal Reserve Board continues to increase short-term
interest rates. A flat yield curve will continue to put pressure on the net
interest margin.
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. Despite a $350,000 charge-off during the third
quarter of 2004, management's analysis of the allowance for loan losses
determined no provision for loan losses was necessary in 2004 as non-performing
assets and delinquent loans declined and remained at reasonable levels relative
to the allowance for loan losses. Additionally, there was no provision for loan
losses recorded in 2003 or 2002. While QNB has not recorded a provision for loan
losses in the past five years, strong growth in the loan portfolio as well as
deterioration in credit quality could impact the need for a provision for loan
losses in the future.
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 check card income, income on bank-owned life insurance,
mortgage servicing fees, gains or losses on the sale of investment securities,
gains on the sale of residential mortgage loans, and other miscellaneous fee
income.
Total non-interest income was $4,687,000 in 2004 compared to $4,200,000 in 2003,
an increase of 11.6 percent. Excluding gains and losses on the sale of
investment securities and loans in both years, non-interest income increased
$273,000 or 8.0 percent. Included in the results for 2004 was a gain on the sale
of repossessed assets of $141,000. Included in the results for 2003 was the
recognition of $109,000 from life insurance proceeds.
When comparing 2003 to 2002, non-interest income increased 40.5 percent from
$2,989,000 to $4,200,000. Excluding gains and losses on the sale of securities
and loans, non-interest income increased 10.3 percent between 2002 and 2003.
Fees for services to customers, the largest component of non-interest income,
are primarily comprised of service charges on deposit accounts. These fees
increased $151,000, or 8.2 percent, during 2004 to $2,000,000. Overdraft income
increased 15.7 percent and accounted for $241,000 of the total increase in
service charge income. The increase in overdraft income is a result of an
increase in the fee effective March 1, 2004. Partially offsetting the increase
when comparing 2003 to 2004 was a $33,000 reduction in service charge income on
non-interest bearing business checking accounts. The decline in the service
charges on business accounts reflects the impact of a higher earnings credit
rate, resulting from the increases in short-term interest rates, applied against
balances to offset service charges incurred.
When comparing 2003 to 2002, fees for services to customers increased $215,000,
or 13.2 percent, during 2003 to $1,849,000. Overdraft income increased $213,000,
or 16.1 percent, during 2003, reflecting an increase in both the volume of
overdrafts as well as the fee charged. The overdraft fee was increased 7.1
percent during the fourth quarter of 2002.
ATM and debit card income is primarily comprised of 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 $598,000 for 2004, an increase of $57,000 or 10.5
percent from the amount recorded in 2003. This followed an increase of $32,000
or 6.3 percent between 2002 and 2003. Debit card income increased $41,000, or
10.5 percent, to $432,000 in 2004. Debit card income was $391,000 in 2003 and
$355,000 in 2002. 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.
Debit card income was negatively impacted in the second half of 2003 as a result
of the legal settlement between the card companies and the retailers. This
settlement resulted in a reduction in the amount earned per transaction.
16
CHANGE FROM PRIOR YEAR
---------------------------
NON-INTEREST INCOME COMPARISON 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002 AMOUNT PERCENT AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------------------------
Fees for services to customers........... $2,000 $1,849 $1,634 $ 151 8.2% $ 215 13.2%
ATM and debit card income................ 598 541 509 57 10.5 32 6.3
Income on bank-owned life insurance...... 300 330 372 (30) (9.1) (42) (11.3)
Mortgage servicing fees.................. 112 12 97 100 833.3 (85) (87.6)
Net gain (loss) on investment securities. 849 (134) (779) 983 733.6 645 82.8
Net gain on sale of loans................ 154 923 676 (769) (83.3) 247 36.5
Other operating income................... 674 679 480 (5) (.7) 199 41.5
- ------------------------------------------------------------------------------------------------------------------------------------
Total.................................... $4,687 $4,200 $2,989 $ 487 11.6% $ 1,211 40.5%
====================================================================================================================================
Income on bank-owned life insurance represents the earnings on life insurance
policies in which the Bank is the beneficiary. The earnings on these policies
were $300,000, $330,000 and $372,000 for 2004, 2003 and 2002, respectively. The
insurance carriers reset the rates on these policies annually. The decline in
income over the three-year period is a result of a lower earnings rate resulting
from the lower interest rate environment.
When QNB sells its residential mortgages in the secondary market, it retains
servicing rights. A normal servicing fee is retained on all loans sold and
serviced. QNB recognizes its obligation to service financial assets that are
retained in a transfer of assets in the form of a servicing asset. The servicing
asset is amortized in proportion to and over the period of net servicing income
or loss. Servicing assets are assessed for impairment based on their fair value.
Mortgage servicing fees were $112,000 in 2004 compared to $12,000 in 2003 and
$97,000 in 2002. The increase in mortgage servicing fees in 2004 is a result of
both a reduction in the amount of mortgage servicing fees amortized as well as a
positive change in the fair market value adjustment. Both of these are a result
of a slowdown in mortgage refinancing activity in 2004. Amortization expense was
$122,000 in 2004 and $174,000 in 2003. QNB recorded a positive market valuation
adjustment of $26,000 in 2004, compared with a valuation allowance of $18,000 in
2003. QNB recorded amortization expense of $91,000 and a positive market
valuation adjustment of $34,000 in 2002. For additional information on
intangible assets see Note 8 of the Notes to Consolidated Financial Statements
included as Item 8 of this Report.
QNB recorded a net gain on investment securities of $849,000 in 2004. Included
in this amount are net gains of $613,000 on the sale of equity securities from
the Corporation's portfolio. In addition, QNB recorded net gains of $236,000
from the fixed income security portfolio in 2004. The fixed income securities
portfolio represents a significant portion of QNB's earning assets and is also a
primary tool in liquidity and asset/liability management. QNB actively manages
its fixed income portfolio and entered into several transactions during 2004 in
an effort to take advantage of changes in the shape of the yield curve, changes
in spread relationships in different sectors and for liquidity purposes as
needed.
QNB recorded a net loss on investment securities of $134,000 in 2003. Included
in this loss was a $105,000 write-down of marketable equity securities whose
decline in market value below cost was deemed to be other-than-temporary. These
securities were determined to be impaired. During 2003, QNB realized net gains
of $128,000 on the sale of equity securities. In the fixed income portfolio, QNB
recorded losses of $157,000 during 2003. Over the course of the year, several
transactions were entered into in an effort to reposition the portfolio. The
goals of these transactions were to reduce the amount of current cash flow from
the portfolio, reduce the impact of premium amortization and to increase the
overall yield in the portfolio. QNB recorded a net loss on investment securities
of $779,000 in 2002. Included in this loss was a $702,000 write-down of
marketable equity securities whose decline in market value below cost was deemed
to be other-than-temporary.
The net gain on the sale of loans was $154,000, $923,000 and $676,000 in 2004,
2003 and 2002, respectively. Included within the gains on sale recorded in 2003
and 2002 are gains on the sale of student loans of $35,000 and $49,000,
respectively. Effective June 30, 2002, QNB terminated its agreement with the
Student Loan Marketing Association. QNB no longer originates student loans for
sale, but originates on a referral basis. The balance in the portfolio was sold
during the second quarter of 2003. Residential mortgage loans to be sold are
identified at origination. The net gain on the sale of residential mortgage
loans was $154,000, $888,000 and $627,000 for the years 2004, 2003 and 2002,
respectively. 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. The larger gains recorded in 2003 and 2002 reflect
the impact of the residential refinancing wave that took place in those years as
interest rates were declining to record lows. Included in the gains on the sale
of residential mortgages in these years were $66,000, $345,000 and $246,000
related to the recognition of mortgage servicing assets.
Other operating income was $674,000, $679,000 and $480,000 in 2004, 2003 and
2002, respectively. Included in the results for 2003 was the recognition of
$109,000 from life insurance proceeds and dividends from the title insurance
company of $70,000. No dividends from the title insurance company were received
in 2004. When comparing 2004 to 2003, trust and retail brokerage income
increased $35,000 while net gains on sales of repossessed assets increased
$143,000.
17
When comparing 2003 to 2002, retail brokerage income increased $38,000,
dividends from the title insurance company increased $41,000 and merchant
processing income increased $43,000. The increase in merchant processing income
is a result of an increase in both the number of merchants and the number of
transactions processed. Included in other operating income in 2002 was a $21,000
recovery of a check card transaction that had been charged off in 2001.
Financial service organizations, including QNB, are challenged to demonstrate
that they can generate an increased contribution to revenue from non-interest
sources. QNB will continue to analyze other opportunities and products that
could enhance its fee-based businesses.
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 in
2004 increased $162,000, or 1.3 percent, to $12,845,000. This followed an
increase in non-interest expense of $738,000, or 6.2 percent, between 2002 and
2003. Despite the increase in non-interest expense, QNB's overhead efficiency
ratio, which represents non-interest expense divided by net operating revenue on
a tax-equivalent basis, declined from approximately 61.2 percent in 2002 to 57.9
percent in 2004.
Salaries and benefits expense is the largest component of non-interest expense.
Salary and benefits expense for 2004 was $7,163,000, a decrease of $32,000, or
..4 percent, over 2003. Salary expense decreased $53,000, or .9 percent, in 2004
to $5,747,000. A portion of salary expense relates to the bank's incentive
compensation plan, which provides for the sharing with all employees (excluding
senior management) of incremental income above a Board determined level. This
plan resulted in a payout of $119,000, or 2.7 percent, of eligible salary in
2004. This compares to a payout of $457,000, or 10.5 percent, of eligible salary
in 2003. Salary expense, without the incentive compensation payout, increased
$285,000, or 5.3 percent, in 2004. QNB monitors, through the use of various
surveys, the competitive salary information in its markets and makes adjustments
where appropriate.
[BAR CHART OMITTED, PLOT POINTS FOLLOWS]
2000 62.06%
2001 62.11%
2002 61.21%
2003 60.48%
2004 57.87%
Benefits expense increased by $21,000, or 1.5 percent, to $1,416,000 in 2004.
The largest increase was in medical and dental premiums, which increased
$55,000, or 7.6 percent. This is a result of the general increase in medical
insurance costs. This increase was partially offset by an increase in employee
withholdings for these benefits of $26,000 and decreases in payroll taxes and
workers' compensation premiums of $9,000 and $7,000, respectively.
Salary and benefits expense for 2003 was $7,195,000, an increase of $664,000, or
10.2 percent, over 2002. Salary expense for 2003 increased $458,000, or 8.6
percent, to $5,800,000. The increase in salary expense when comparing 2003 to
2002 was related to the $257,000 increase in incentive compensation, merit
increases and an increase in the number of employees. The number of full time
equivalent employees increased by five when comparing 2003 to 2002.
Benefits expense increased by $206,000, or 17.3 percent, to $1,395,000 in 2003.
Payroll taxes increased $56,000, or 13.9 percent, primarily as a result of the
increase in salary expense. Medical and dental premiums increased $68,000, or
17.9 percent. This is a result of the general increase in medical insurance
costs as well as an increase in the number of employees covered by the plan.
Retirement plan expense increased $63,000, or 18.9 percent, between 2002 and
2003. This expense was impacted by an extra pay period in 2003. There were 27
pay periods in 2003 compared to 26 pay periods in a normal year. This accounts
for approximately $15,000 of the increase. Also impacting retirement plan
expense was the increase in eligible salary. When comparing 2003 to 2002,
workers compensation insurance premiums increased $12,000, or 47.2 percent.
CHANGE FROM PRIOR YEAR
---------------------------
NON-INTEREST EXPENSE COMPARISON 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002 AMOUNT PERCENT AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------------------------
Salaries and employee benefits............ $ 7,163 $ 7,195 $ 6,531 $(32) (.4)% $ 664 10.2 %
Net occupancy expense..................... 1,013 859 861 154 17.9 (2) (.2)
Furniture and equipment expense........... 1,148 1,111 1,060 37 3.3 51 4.8
Marketing expense......................... 557 536 598 21 3.9 (62) (10.4)
Third party services...................... 680 741 640 (61) (8.2) 101 15.8
Telephone, postage and supplies........... 521 556 545 (35) (6.3) 11 2.0
State taxes............................... 375 331 335 44 13.3 (4) (1.2)
Other expense............................. 1,388 1,354 1,375 34 2.5 (21) (1.5)
- ------------------------------------------------------------------------------------------------------------------------------------
Total................................ $ 12,845 $12,683 $11,945 $162 1.3 % $ 738 6.2 %
====================================================================================================================================
18
Net occupancy expense for 2004 was $1,013,000, an increase of $154,000 from the
amount reported in 2003. Contributing to the increase was higher costs related
to building maintenance, utilities and rent. The addition of the new supermarket
branch as well as some repairs to existing branch locations contributed to the
increase in net occupancy expense.
Marketing expense increased $21,000, or 3.9 percent, in 2004 to $557,000. In
2004, the largest increases were in public relations and sales promotions of
$19,000 and $13,000, respectively. These increases were primarily related to the
costs associated with opening the new branch. When comparing 2003 to 2002,
marketing expense decreased $62,000, or 10.4 percent, to $536,000. During 2002,
QNB made several large long-term charitable pledges to not-for-profit
organizations, clubs and community events in the local communities we serve.
These contributions were $90,000 less in 2003 than 2002.
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 support
services include trust services, retail non-deposit services, correspondent
banking services, statement printing and mailing, investment security
safekeeping and supply management services. Third party services expense was
$680,000 in 2004 compared to $741,000 in 2003 and $640,000 in 2002. The higher
costs in 2003 compared to both 2004 and 2002, primarily relate to the use of
consultants for technology projects as well as for human resource purposes.
Partially offsetting the decrease in consulting costs in 2004 were higher
internal and external auditing costs resulting from the increase in corporate
governance as required under the Sarbanes-Oxley Act. Also contributing to the
higher third party service expense in 2003 as compared to 2002, was the
outsourcing of the printing and mailing of statements which began in the second
quarter of 2003.
INCOME TAXES
Applicable income taxes and effective tax rates were $1,704,000, or 21.6
percent, for 2004 compared to $1,254,000, or 18.2 percent, for 2003, and
$1,204,000, or 19.5 percent, for 2002. The higher effective tax rate in 2004 was
a result of a decrease in the proportion of tax-exempt income from investment
securities, loans and bank-owned life insurance to pretax income. Also
contributing to the lower effective tax rate in 2003 was the reversal of a
$95,000 tax valuation recorded in previous periods. The reversal of the
valuation allowance was a result of the ability to realize tax benefits
associated with certain impaired securities due to the increase in unrealized
gains of certain equity securities held by QNB Corp. The receipt of $109,000 in
tax-exempt life insurance proceeds also had a positive impact on the effective
tax rate in 2003. For a more comprehensive analysis of income tax expense and
deferred taxes, refer to Note 12 in the Notes to Consolidated Financial
Statements.
FINANCIAL CONDITION
Financial service organizations today are challenged to demonstrate they can
generate sustainable and consistent earnings growth in an increasingly
competitive environment. Managing the balance sheet in a low interest rate
environment has been a major challenge during the past three years. The
flattening of the yield curve that occurred in 2004 will likely continue into
2005 as the short-term part of the yield curve increases, in response to the
action of the Federal Reserve Bank, more than the longer end of the curve.
QNB's primary competition in the banking segment of the financial services
industry ranges from a mutual thrift institution, to several large community
banks, to a few super-regional banks. The landscape in which QNB operates
continues to change as several community banks in the area have merged with
larger locally or regionally headquartered community banks. In addition, other
strong competitors continue to move into QNB's market area. The slower economy,
which has reduced the demand for loans, and the increased availability of loans
from a variety of financial service providers has led to increased price
competition for loans. Deposit growth, which for years was a concern of the
banking industry, remained strong. A challenge in 2005 will be to retain and
grow these deposits, particularly if the stock market continues to improve. The
pricing of deposits has also become very competitive, with many institutions
offering higher promotional rates. QNB will continue to price its deposits
competitively, but attempt to do so in a manner that will minimize the negative
impact on the net interest margin.
Total assets at year-end 2004 were $583,644,000, compared with $550,831,000 at
December 31, 2003, an increase of $32,813,000 or 6.0 percent. This followed
growth during 2003 of 9.4 percent. Average total assets increased 6.8 percent,
or $35,808,000, in 2004 to $562,582,000 and 9.9 percent, or $47,280,000, in
2003. This growth in assets was a result of continued growth in funding sources.
Funding sources, which include deposits and borrowed money, increased 6.1
percent from year-end 2003 to year-end 2004 and 11.5 percent from year-end 2002
to year-end 2003. Average funding sources increased 6.7 percent in 2004 and 10.0
percent in 2003.
Total loans, excluding loans held-for-sale, at December 31, 2004 were
$268,048,000, an increase of 15.5 percent from December 31, 2003. This followed
a 9.1 percent increase from December 31, 2002 to December 31, 2003. Average
total loans increased 8.6 percent in 2004 and 10.4 percent in 2003. This loan
growth was achieved despite the slow growing economy and the extreme competitive
environment for both commercial and consumer loans. Loan growth remains one of
the primary goals of QNB.
The following discussion will further detail QNB's financial condition during
2004 and 2003.
19
INVESTMENT PORTFOLIO HISTORY
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
INVESTMENT SECURITIES AVAILABLE-FOR-SALE
U.S. Treasuries........................................................................... $ 6,114 $ 6,792 $ 6,641
U.S. Government agencies.................................................................. 46,478 43,279 29,480
State and municipal securities............................................................ 45,992 41,076 26,783
Mortgage-backed securities................................................................ 67,510 66,476 70,748
Collateralized mortgage obligations (CMO)................................................. 70,789 68,761 44,409
Other debt securities..................................................................... 21,972 25,214 24,530
Equity securities......................................................................... 8,706 9,033 8,565
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment securities available-for-sale......................................... $267,561 $ 260,631 $211,156
- ------------------------------------------------------------------------------------------------------------------------------------
INVESTMENT SECURITIES HELD-TO-MATURITY
State and municipal securities............................................................ $ 6,203 $ 11,180 $ 19,745
Collateralized mortgage obligations (CMO)................................................. -- 832 9,991
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment securities held-to-maturity........................................... $ 6,203 $ 12,012 $ 29,736
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment securities............................................................ $273,764 $ 272,643 $240,892
====================================================================================================================================
INVESTMENT SECURITIES AND OTHER SHORT-TERM INVESTMENTS
Total investment securities at December 31, 2004 and 2003 were $273,764,000 and
$272,643,000, respectively. For the same periods, approximately 68.4 percent and
65.9 percent, respectively, of QNB's investment securities were either U.S.
Government or U.S. Government agency debt securities, or U.S. Government agency
issued mortgage-backed securities or collateralized mortgage obligation
securities (CMO). As of December 31, 2004, QNB held no securities of any one
issue or any one issuer (excluding the U.S. Government and its agencies) that
were in excess of 10 percent of shareholders' equity.
Average investment securities increased $18,085,000, or 7.3 percent, to
$264,677,000 in 2004 compared with a $19,008,000, or an 8.4 percent, increase in
2003. Average Federal funds sold decreased 39.2 percent in 2004 to $6,834,000.
This followed a 20.0 percent increase during 2003 to $11,236,000. The higher
level of Federal funds sold in 2003 was a result of the desire to have more
liquidity to support the significant increase in deposits, particularly
short-term time deposits and transaction accounts during 2003. In 2004,
management made the decision to reduce Federal funds sold balances by purchasing
short-term investment securities. This was done for the purpose of improving net
interest income. In addition, Federal funds sold, which would be affected by the
economic status of the banking industry, and are short-term in nature, were only
sold to banks with a minimum Sheshunoff rating of "B", an independent rating
service, at the date of the sale.
In light of the fact that QNB's investment portfolio represents a significant
portion of earning assets and interest income, QNB actively manages the
portfolio in an attempt to maximize earnings, while still considering liquidity
needs and interest rate risk. There was a significant amount of activity in the
portfolio during 2004. In response to both significant swings in interest rates
and the shape of the yield curve, QNB performed several purchase and sales
transactions. Proceeds from the sale of investments were $66,715,000 in 2004. In
addition, proceeds from maturities, calls and prepayments of securities were
$61,145,000. These proceeds were used to purchase $130,878,000 in securities
during 2004. Despite the amount of activity in the portfolio, the composition of
the portfolio remained relatively unchanged between 2003 and 2004.
Management anticipates the investment portfolio activity will be minimal during
2005 as prepayment activity slows and interest rates increase. It is also
anticipated that loan growth will outpace deposit growth, resulting in less
funds to invest. Based on prepayment projections, QNB estimates that
approximately $56,000,000, at a book yield of 3.85 percent, in cash flow from
the portfolio will be available for reinvestment. Of this amount, it is
anticipated that $20,000,000 will be used to fund withdrawals of municipal
deposits.
20
INVESTMENT PORTFOLIO WEIGHTED AVERAGE YIELDS
- ------------------------------------------------------------------------------------------------------------------------------------
UNDER 1-5 5-10 OVER 10
DECEMBER 31, 2004 1 YEAR YEARS YEARS YEARS TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
INVESTMENT SECURITIES AVAILABLE-FOR-SALE
U.S. Treasuries:
Fair value..................................................... $ 3,042 $ 3,072 -- -- $ 6,114
Weighted average yield......................................... 1.95% 2.11% -- -- 2.03%
U.S. Government agencies:
Fair value..................................................... -- $ 34,325 $ 12,153 -- $ 46,478
Weighted average yield......................................... -- 3.49% 3.60% -- 3.52%
State and municipal securities:
Fair value..................................................... -- $ 939 $ 14,304 $ 30,749 $ 45,992
Weighted average yield......................................... -- 3.37% 5.72% 6.53% 6.21%
Mortgage-backed securities:
Fair value..................................................... -- $ 67,510 -- -- $ 67,510
Weighted average yield......................................... -- 4.59% -- -- 4.59%
Collateralized mortgage obligations (CMO):
Fair value..................................................... -- $ 69,904 $ 885 -- $ 70,789
Weighted average yield......................................... -- 4.11% 4.10% -- 4.11%
Other debt securities:
Fair value..................................................... -- $ 5,408 $ 11,537 $ 5,027 $ 21,972
Weighted average yield......................................... -- 7.17% 7.48% 4.29% 6.61%
Equity securities:
Fair value..................................................... -- -- -- $ 8,706 $ 8,706
Weighted average yield......................................... -- -- -- 3.13% 3.13%
- ------------------------------------------------------------------------------------------------------------------------------------
Total fair value.................................................. $ 3,042 $181,158 $ 38,879 $ 44,482 $ 267,561
Weighted average yield ........................................... 1.95% 4.22% 5.46% 5.54% 4.59%
- ------------------------------------------------------------------------------------------------------------------------------------
INVESTMENT SECURITIES HELD-TO-MATURITY
State and municipal securities:
Amortized cost................................................. $ 300 $ 1,113 -- $ 4,790 $ 6,203
Weighted average yield......................................... 7.05% 6.00% -- 6.96% 6.79%
- ------------------------------------------------------------------------------------------------------------------------------------
Total amortized cost.............................................. $ 300 $ 1,113 -- $ 4,790 $ 6,203
Weighted average yield ........................................... 7.05% 6.00% -- 6.96% 6.79%
- ------------------------------------------------------------------------------------------------------------------------------------
Securities are assigned to categories based on stated contractual maturity
except for mortgage-backed securities and CMOs which are based on anticipated
payment periods. See interest rate sensitivity section for practical payment and
repricing characteristics. Tax-exempt securities were adjusted to a
tax-equivalent basis and are based on the marginal Federal corporate tax rate of
34 percent and a Tax Equity and Financial Responsibility Act (TEFRA) adjustment
of .15 percent. Weighted average yields on investment securities
available-for-sale are based on historical cost.
At December 31, 2004 and 2003, investment securities totaling $103,305,000 and
$84,425,000 were pledged as collateral for repurchase agreements and public
deposits. The increase is a result of the continuing success of acquiring
deposit relationships from municipalities and school districts.
QNB accounts for its investments by classifying its securities into three
categories. Securities that QNB has the positive intent and ability to hold to
maturity are classified as held-to-maturity securities and reported at amortized
cost. Debt and equity securities that are bought and held principally for the
purpose of selling them in the near term are classified as trading securities
and reported at fair value, with unrealized gains and losses included in
earnings. Debt and equity securities not classified as either held-to-maturity
securities or trading securities are classified as available-for-sale securities
and reported at fair value, with unrealized gains and losses, net of tax,
excluded from earnings and reported as a separate component of shareholders'
equity. Management determines the appropriate classification of securities at
the time of purchase. QNB held no trading securities at December 31, 2004 and
2003.
INVESTMENTS AVAILABLE-FOR-SALE
Available-for-sale investment securities include securities that management
intends to use as part of its asset/liability management strategy. These
securities may be sold in response to changes in market interest rates, related
changes in the securities prepayment risk or in response to the need for
liquidity. At December 31, 2004, the fair value of investment securities
available-for-sale was $267,561,000, or $1,561,000, above the amortized cost of
$266,000,000. This compares to a fair value of $260,631,000, or $3,547,000,
above the amortized cost of $257,084,000 at December 31, 2003. An unrealized
holding gain of $691,000 was recorded as an increase to shareholders' equity as
of December 31, 2004, while an unrealized holding gain of $2,341,000 was
recorded as an increase to shareholders' equity as of December 31, 2003. The
available-for-sale portfolio had a weighted average maturity of approximately 3
years, 7 months at December 31, 2004, and 4 years, 1 month at December 31, 2003.
The weighted average tax-equivalent yield was 4.59 percent and 4.61 percent at
December 31, 2004 and 2003.
21
The weighted average maturity is based on the stated contractual maturity or
likely call date of all securities except for mortgage-backed securities and
CMOs, which are based on estimated average life. The maturity of the portfolio
could be shorter if interest rates would decline and prepayments on
mortgage-backed securities and CMOs increase or if more securities are called.
However, the estimated average life could be longer if rates were to increase
and principal payments on mortgage-backed securities and CMOs would slow or
bonds anticipated to be called are not called. The interest rate sensitivity
analysis on page 32 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.
INVESTMENTS HELD-TO-MATURITY
Investment securities held-to-maturity are recorded at amortized cost. Included
in this portfolio are state and municipal securities. At December 31, 2004 and
2003, the amortized cost of investment securities held-to-maturity was
$6,203,000 and $12,012,000, and the fair value was $6,432,000 and $12,334,000,
respectively. The held-to-maturity portfolio had a weighted average maturity of
approximately 4 years, 5 months at December 31, 2004, and 2 years, 11 months at
December 31, 2003. The weighted average tax-equivalent yield was 6.79 percent
and 6.59 percent at December 31, 2004 and 2003. The increase in the weighted
average maturity is the result of the maturity or call of municipal bonds that
had a short average maturity at December 31, 2003.
LOANS
QNB's primary functions and responsibilities are to accept deposits and to make
loans to meet the credit needs of the communities it serves. Loans are a
significant component of earning assets. Inherent within the lending function is
the evaluation and acceptance of credit risk and interest rate risk along with
the opportunity cost of alternative deployment of funds. QNB manages credit risk
associated with its lending activities through portfolio diversification,
underwriting policies and procedures, and loan monitoring practices.
QNB has comprehensive policies and procedures that define and govern both
commercial and retail loan origination and management of risk. All loans are
underwritten in a manner that emphasizes the borrowers' capacity to pay. The
measurement of capacity to pay delineates the potential risk of non-payment or
default. The higher potential for default determines the need for and amount of
collateral required. QNB makes unsecured loans when the capacity to pay is
considered substantial. As capacity lessens, collateral is required to provide a
secondary source of repayment and to mitigate the risk of loss. Various policies
and procedures provide guidance to the lenders on such factors as amount, terms,
price, maturity and appropriate collateral levels. Each risk factor is
considered critical to ensuring that QNB receives an adequate return for the
risk undertaken, and that the risk of loss is minimized.
[BAR CHART OMITTED, PLOT POINTS FOLLOWS]
2000 $183,592
2001 $200,089
2002 $212,691
2003 $232,127
2004 $268,048
QNB manages the risk associated with commercial loans, which generally have
balances larger than retail loans, by having lenders work in tandem with credit
underwriting personnel. In addition, a bank loan committee and a committee of
the Board of Directors review certain loan requests on a weekly basis.
QNB's commercial lending activity is focused on small businesses within the
local community. Commercial and industrial loans represent commercial purpose
loans that are either secured by collateral other than real estate or unsecured.
Real estate commercial loans include commercial purpose loans collateralized at
least in part by commercial real estate. These loans may not be for the express
purpose of conducting commercial real estate transactions. Real estate
residential loans include loans secured by one-to-four family units. These loans
include fixed rate home equity loans, floating rate home equity lines of credit,
loans to individuals for residential mortgages, and commercial purpose loans.
Substantially all originations of loans to individuals for residential mortgages
with maturities of 20 years or greater are sold in the secondary market. At
December 31, 2004 and 2003, real estate residential loans held-for-sale were
$312,000 and $1,439,000, respectively. These loans are carried at the lower of
aggregate cost or market.
22
LOAN PORTFOLIO
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial and industrial......................................... $ 57,364 $ 47,196 $ 39,546 $ 39,694 $ 39,100
Agricultural...................................................... 8 14 176 2,622 3,027
Construction...................................................... 7,027 9,056 7,687 3,989 380
Real estate-commercial............................................ 98,397 86,707 74,125 71,112 65,271
Real estate-residential........................................... 99,893 83,703 84,907 77,273 70,745
Consumer.......................................................... 5,376 5,604 6,513 5,669 5,264
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans.................................................... 268,065 232,280 212,954 200,359 183,787
Less unearned income.............................................. 17 153 263 270 195
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans, net of unearned income ........................... $ 268,048 $ 232,127 $ 212,691 $ 200,089 $183,592
====================================================================================================================================
LOAN MATURITIES AND INTEREST SENSITIVITY
- ------------------------------------------------------------------------------------------------------------------------------------
UNDER 1-5 OVER
DECEMBER 31, 2004 1 YEAR YEARS 5 YEARS TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial and industrial....................................................... $ 22,199 $ 22,465 $ 12,700 $ 57,364
Agricultural.................................................................... -- 8 -- 8
Construction.................................................................... 996 6,031 -- 7,027
Real estate-commercial.......................................................... 7,651 10,851 79,895 98,397
Real estate-residential......................................................... 8,861 15,164 75,868 99,893
Consumer........................................................................ 917 4,290 169 5,376
- ------------------------------------------------------------------------------------------------------------------------------------
Total.................................................................... $ 40,624 $ 58,809 $ 168,632 $268,065
====================================================================================================================================
Demand loans, loans having no stated schedule of repayment and no stated
maturity, are included in under one year.
The following shows the amount of loans due after one year that have fixed,
variable or adjustable interest rates at December 31, 2004:
Loans with fixed predetermined interest rates $ 81,097
Loans with variable or adjustable interest rates $ 146,344
As mentioned previously, loan growth remains a major objective for 2005. Loan
growth is to be achieved through the use of a formal business development and
calling program encompassing lending personnel, branch personnel and senior
management. This program was strengthened in 2003 by the appointment of a
business development officer. The focus of this program is to both develop new
lending and deposit relationships, as well as to strengthen existing
relationships. This program has been successful as loans, net of unearned
income, increased $35,921,000 or 15.5 percent to $268,048,000 at December 31,
2004. This followed growth of $19,436,000 or 9.1 percent in 2003. Most of the
growth in loans in 2004 was centered in loans to small businesses, both
commercial and industrial, and loans secured by either commercial or residential
real estate, and home equity loans.
The Allowance For Loan Loss Allocation table on page 25 shows how the
composition of the loan portfolio has changed. The loan portfolio composition
changed slightly from year-end 2003 with commercial and industrial loans
increasing from 20.3 percent of the portfolio at year-end 2003 to 21.4 percent
of the portfolio at year-end 2004, and loans secured by residential properties
increasing from 36.1 percent of the portfolio to 37.3 percent. Most of the
growth in loans secured by residential properties is home equity loans. Consumer
loans as a percentage of loans continue to decrease as consumer loans,
especially auto loans, remain difficult to originate profitably because of the
zero rate or low rate loans offered by the automobile manufacturers.
For the second straight year, the commercial and industrial loan category
experienced strong growth, increasing $10,168,000, or 21.5 percent, to end the
year 2004 at $57,364,000. This followed growth of 19.3 percent in 2003. Although
a certain number of these loans are considered unsecured, the majority are
secured by non-real estate collateral such as equipment, vehicles, accounts
receivable and inventory. Loans secured by commercial real estate increased by
$11,690,000, or 13.5 percent, in 2004, following a 17.0 percent increase between
December 31, 2002 and 2003. QNB's commercial loans are not considered to be
concentrated within any one industry, except those loans to real estate
developers and investors that account for $52,046,000, or 19.4 percent, of the
loan portfolio at December 31, 2004. This is an increase from the $40,106,000,
or 17.3 percent, of the loan portfolio, at December 31, 2003. Concentration is
based upon Standard Industrial Classification codes used for bank regulatory
purposes and is considered to be 10.0 percent or more of total loans.
Diversification is achieved through lending to various industries located within
the market area. This diversification is believed to reduce risk associated with
changes in economic conditions.
23
Residential real estate loans increased $16,190,000, or 19.3 percent, to
$99,893,000 at December 31, 2004. Growth in variable rate home equity lines of
credit contributed $8,795,000 to the growth in this category. Home equity loans,
both term loans and lines, have been popular with consumers because they have
lower origination costs than residential mortgage loans. The variable line of
credit product indexed to the prime rate has been popular because of the low
interest rate environment. QNB anticipates some of these lines will be
refinanced into fixed rate loans as the prime rate increases. Residential
mortgage loans increased $2,139,000 to $22,443,000 at December 31, 2004. The
increase in this category was centered in adjustable rate mortgages.
NON-PERFORMING ASSETS
Non-performing assets include accruing loans past due 90 days or more,
non-accruing loans, restructured loans, other real estate owned and other
repossessed assets. The chart below shows the history of non-performing assets
over the past five years. Total non-performing assets were $469,000 at December
31, 2004, or .08 percent of total assets. This represents a decrease from the
December 31, 2003 balance of $829,000. Non-performing assets at December 31,
2003 represented .15 percent of total assets. Non-performing assets as a percent
of total assets remain at low levels both historically and compared to peer
groups.
Non-accrual loans are those on which the accrual of interest has ceased.
Commercial loans are placed on non-accrual status immediately if, in the opinion
of management, collection is doubtful, or when principal or interest is past due
90 days or more and collateral is insufficient to protect principal and
interest. Consumer loans are not automatically placed on non-accrual status when
principal or interest payments are 90 days past due, but, in most instances, are
charged-off when deemed uncollectible or after reaching 120 days past due.
Included in the loan portfolio are loans on non-accrual status of $373,000 and
$818,000 at December 31, 2004 and 2003, respectively.
There were no restructured loans as of December 31, 2004 or 2003, as defined in
the Financial Accounting Standards Board Statement 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 in non-accrual loans. There
was no other real estate owned or repossessed assets as of December 31, 2004 or
2003.
Loans not included in past due, non-accrual or restructured categories, but
where known information about possible credit problems causes management to be
uncertain as to the ability of the borrowers to comply with the present loan
repayment terms, totaled $4,328,000 and $5,348,000 at December 31, 2004 and
2003, respectively.
NON-PERFORMING ASSETS
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Loans past due 90 days or more not on non-accrual status
Commercial and industrial...................................... $ - $ - $ - $ - $ -
Agricultural................................................... - - - - -
Construction................................................... - - - - -
Real estate-commercial......................................... - - - - -
Real estate-residential........................................ 68 - - 305 -
Consumer....................................................... 28 11 7 11 4
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans past due 90 days or more and accruing............ 96 11 7 316 4
Loans accounted for on a non-accrual basis
Commercial and industrial...................................... 372 392 - - 42
Agricultural................................................... - - - - -
Construction................................................... - - - - -
Real estate-commercial......................................... - 17 - - -
Real estate-residential........................................ - 409 650 280 163
Consumer....................................................... 1 - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-accrual loans...................................... 373 818 650 280 205
Other real estate owned........................................... - - - - -
Repossessed assets................................................ - - 11 - -
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-performing assets.................................. $ 469 $829 $ 668 $ 596 $ 209
====================================================================================================================================
Total as a percent of total assets................................ .08% .15% .13% .13% .06%
24
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents management's best estimate of the known
and inherent losses in the existing loan portfolio. The determination of an
appropriate level of the allowance for loan losses is based upon an analysis of
the risks inherent in QNB's loan portfolio. Management uses various tools to
assess the appropriateness of the allowance for loan losses. One tool is a model
recommended by the Office of the Comptroller of the Currency, the Bank's primary
regulator. 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 commercial loan risk ratings, exceptions to QNB's loan
policy, and QNB's portfolio exposure to borrowers with large dollar
concentration. Other tools include ratio analysis and peer group analysis.
QNB utilizes a risk weighting system that assigns a risk code to every
commercial loan. This risk weighting system is supplemented with a program that
encourages account officers to identify potentially deteriorating loan
situations. The officer analysis program is used to complement the on-going
analysis of the loan portfolio performed during the loan review function. In
addition, QNB has a committee that meets quarterly to review the appropriateness
of the allowance for loan losses based on the current and projected status of
all relevant factors pertaining to the loan portfolio.
A loan is considered impaired, based on current information and events, if it is
probable that QNB will be unable to collect the scheduled payments of principal
or interest when due according to the contractual terms of the loan agreement.
The measurement of impaired loans is generally based on the present value of
expected future cash flows discounted at the effective interest rate, except
that all collateral-dependent loans are measured for impairment based on the
fair value of the collateral. At December 31, 2004 and 2003, the recorded
investment in loans for which impairment has been recognized totaled $372,000
and $796,000 of which $372,000 and $404,000 required no allowance for loan loss.
As of December 31, 2003, $392,000 of loans required an allowance for loan loss
of $100,000. Most of the loans identified as impaired are collateral-dependent.
QNB had net charge-offs of $317,000 and $9,000 in 2004 and 2003, respectively.
Included in net charge-offs in 2004 was a $350,000 charge-off related to the
relinquishment of assets by a borrower to the Bank as its secured creditor, and
the transfer of this loan to other assets as a repossessed asset. Part of this
charge-off was recovered in the fourth quarter of 2004 through the liquidation
of assets, which was recorded in non-interest income as a gain of $141,000. Net
charge-offs in 2003 were related primarily to consumer loans. QNB had net
recoveries of $93,000 during 2002. Most of this recovery relates to a loan
charged off in 2001.
The allowance for loan losses was $2,612,000 at December 31, 2004, which
represents .97 percent of total loans, compared to $2,929,000, or 1.26 percent,
of total loans at December 31, 2003. QNB did not add to the allowance for loan
losses, with a provision for loan losses, during any of the past five years
because of the continued low levels of non-performing assets, delinquent loans,
and charge-offs.
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. The allowance
for loan losses is dependent, to a great extent, on conditions beyond QNB's
control. It is therefore 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. These agencies may
require QNB to recognize additions to the allowance based on their judgments
using information available to them at the time of their examination.
ALLOWANCE FOR LOAN LOSS ALLOCATION
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
PERCENT PERCENT PERCENT PERCENT PERCENT
GROSS GROSS GROSS GROSS GROSS
AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at end of period applicable to:
Commercial and industrial..... $ 869 21.4% $ 685 20.3% $ 521 18.6% $ 531 19.8% $ 892 21.3%
Agricultural.................. - - - - 2 .1 32 1.3 41 1.6
Construction.................. 79 2.6 123 3.9 103 3.6 62 2.0 10 .2
Real estate-commercial........ 1,228 36.7 1,277 37.3 1,140 34.8 1,148 35.5 975 35.5
Real estate-residential....... 188 37.3 256 36.1 358 39.9 306 38.6 412 38.5
Consumer...................... 23 2.0 21 2.4 25 3.0 23 2.8 42 2.9
Unallocated................... 225 567 789 743 578
- ------------------------------------------------------------------------------------------------------------------------------------
Total....................... $2,612 100.0% $ 2,929 100.0% $ 2,938 100.0% $2,845 100.0% $2,950 100.0%
====================================================================================================================================
Gross loans represent loans before unamortized net loan fees. Percent gross
loans lists the percentage of each loan type to total loans.
25
ALLOWANCE FOR LOAN LOSSES
- ------------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses:
Balance, January 1........................................ $ 2,929 $ 2,938 $ 2,845 $ 2,950 $ 3,196
Charge-offs
Commercial and industrial.............................. 353 - - 86 163
Construction........................................... - - - - -
Real estate-commercial................................. 17 - - - 67
Real estate-residential................................ 10 - 6 32 27
Consumer............................................... 26 28 33 31 7
- ------------------------------------------------------------------------------------------------------------------------------------
Total charge-offs...................................... 406 28 39 149 264
Recoveries
Commercial and industrial.............................. - - 83 6 2
Construction........................................... - - - - -
Real estate-commercial................................. 17 - - 22 10
Real estate-residential................................ 54 1 35 8 4
Consumer............................................... 18 18 14 8 2
- ------------------------------------------------------------------------------------------------------------------------------------
Total recoveries....................................... 89 19 132 44 18
- ------------------------------------------------------------------------------------------------------------------------------------
Net (charge-offs) recoveries ............................ (317) (9) 93 (105) (246)
Provision for loan losses................................. - - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31...................................... $ 2,612 $ 2,929 $ 2,938 $ 2,845 $ 2,950
====================================================================================================================================
TOTAL LOANS (EXCLUDING LOANS HELD-FOR-SALE):
Average................................................ $ 250,042 $ 229,001 $207,238 $ 190,290 $ 177,678
Year-end............................................... 268,048 232,127 212,691 200,089 183,592
RATIOS:
Net charge-offs (recoveries) to:
Average loans.......................................... .13% - (.04)% .06% .14%
Loans at year-end...................................... .12 - (.04) .05 .13
Allowance for loan losses.............................. 12.14 .31% (3.17) 3.69 8.34
Provision for loan losses.............................. - - - - -
Allowance for loan losses to:
Average loans.......................................... 1.04% 1.28% 1.42% 1.50% 1.66%
Loans at year-end...................................... .97 1.26 1.38 1.42 1.61
Non-performing loans................................... 556.93 353.32 447.18 477.35 1411.48
DEPOSITS
QNB primarily attracts deposits from within its market area by offering various
deposit products including demand deposits, interest-bearing demand accounts,
money market accounts, savings accounts and certificates of deposit.
Total deposits increased $27,849,000, or 6.3 percent, to $466,488,000 at
December 31, 2004. While still considered healthy growth, it represents a
decline from the 12.8 percent growth rates achieved in both 2002 and 2003 and
the 17.3 percent growth rate in 2001. Similar to the growth obtained in 2003, a
significant portion of the growth in 2004 was a result of the ability of QNB to
increase its relationships with several school districts. Deposit growth in both
2002 and 2001 was more consumer driven and was aided by continued lackluster
performance in the stock market. Consumers were looking for the relative safety
of bank deposits despite the relatively low interest rate environment. Most of
the growth in 2004 was in money market and time deposits, while most of the
growth in 2003 was in non-interest bearing demand accounts and savings accounts.
QNB's "Free Checking" promotion, as well as the acquisition of new business
accounts were significant factors in the increase in non-interest bearing
deposits over the past three years. Non-interest bearing demand accounts
increased 4.2 percent in 2004 to $52,603,000. This compares to growth of 7.2
percent and 17.5 percent in 2003 and 2002.
Interest-bearing demand accounts decreased $12,528,000, or 11.6 percent, to
$95,120,000 at December 31, 2004. This followed growth of $37,170,000, or 52.7
percent, in 2003 and $15,395,000, or 27.9 percent, in 2002. Much of the growth
in 2002 and 2003 can be attributed to the development of relationships with
several school districts and municipalities. The decline in balances in 2004 is
related to a reduction in deposits of one of these school districts. Some of
this decline was offset by a 10.8 percent increase in personal interest bearing
demand accounts.
26
Money market balances increased $22,061,000, or 57.5 percent, to $60,434,000 at
December 31, 2004. The additional deposits of a school district account for
$15,000,000 of this increase. These deposits are anticipated to be withdrawn
during the second quarter of 2005. The additional growth in money market
accounts can be partially attributed to the Treasury Select Indexed Money Market
account which reprices monthly, based on a percentage of the average of the
91-day Treasury bill. This product should gain in popularity again as short-term
interest rates increase.
Savings accounts continue to grow, increasing $3,503,000, or 6.7 percent, to
$55,511,000 at December 31, 2004. This followed growth of $6,670,000, or 14.7
percent, in 2003 and $8,178,000, or 22.0 percent, during 2002. It appears that
consumers are looking for the relative safety of bank deposits and the
flexibility of savings accounts despite the low interest rates.
The growth in time deposits picked up during 2004 as these accounts were the
primary beneficiary of rising interest rates; providing significantly better
interest rates than either savings and money market accounts. Total time deposit
accounts increased $12,678,000 or 6.7 percent to $202,820,000 at December 31,
2004. Total time deposits increased only 1.9 percent, or $3,465,000, to
$190,142,000 at December 31, 2003.
An analysis of the change in average deposits provides a more meaningful measure
of deposit change. Average total deposits increased 7.3 percent in 2004 and 12.7
percent in 2003. Average non-interest bearing deposits increased 7.2 percent to
$52,691,000 in 2004. This followed a 12.8 percent increase in 2003. Average
interest-bearing demand accounts increased 15.0 percent in 2004, to
$100,684,000, and 43.5 percent in 2003, to $87,570,000. Average money market
accounts increased 22.8 percent in 2004. This followed a 2.8 percent decrease in
2003. As mentioned previously, the growth in interest-bearing demand accounts in
both 2004 and 2003 and the growth in money market accounts in 2004 are primarily
the result of the additional deposits from the school districts and
municipalities. Average time deposits increased .9 percent in 2004 compared to
an increase of 3.9 percent in 2003. Much of the growth in time deposits in 2004
occurred later in the year as a result of the higher interest rates being
promoted.
[BAR CHART OMITTED, PLOT POINTS FOLLOWS]
2000 $292,273
2001 $312,509
2002 $371,718
2003 $419,098
2004 $449,743
Attracting and retaining deposits, while not a significant concern in any of the
past four years, may once again become an issue facing the banking industry. The
equity markets rebounded in 2003 and 2004 from three down years and may once
again be an attractive alternative to low rate bank deposits. To continue to
attract and retain deposits, QNB plans to be competitive with respect to rates
and to continue to deliver products that appeal to customers.
MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
- ------------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Three months or less............................................ $ 2,134 $ 11,004 $13,322
Over three months through six months............................ 2,785 4,949 7,074
Over six months through twelve months........................... 14,117 7,906 11,667
Over twelve months.............................................. 22,939 14,979 8,765
- ------------------------------------------------------------------------------------------------------------------------------------
Total...................................................... $41,975 $ 38,838 $40,828
====================================================================================================================================
AVERAGE DEPOSITS BY MAJOR CLASSIFICATION
- ------------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE RATE BALANCE RATE BALANCE RATE
- ------------------------------------------------------------------------------------------------------------------------------------
Non-interest bearing deposits....................... $ 52,691 - $ 49,164 - $ 43,569 -
Interest-bearing demand accounts.................... 100,684 .68% 87,570 .63% 61,006 .64%
Money market accounts............................... 44,364 .99 36,138 .83 37,171 1.51
Savings............................................. 54,613 .39 50,616 .64 41,764 1.19
Time ............................................... 156,511 2.65 152,321 2.96 141,854 4.12
Time deposits of $100,000 or more................... 40,880 2.42 43,289 2.49 46,354 3.48
- ------------------------------------------------------------------------------------------------------------------------------------
Total.......................................... $ 449,743 1.44% $ 419,098 1.61% $371,718 2.40%
====================================================================================================================================
27
LIQUIDITY
Liquidity represents an institution's ability to generate cash or otherwise
obtain funds at reasonable rates to satisfy commitments to borrowers and demands
of depositors. QNB manages its mix of cash, Federal funds sold, investment
securities and loans, in order to match the volatility, seasonality, interest
sensitivity and growth trends of its deposit funds. Liquidity is provided from
asset sources through maturities and repayments of loans and investment
securities, net interest income and fee income. The portfolio of investment
securities available-for-sale and QNB's policy of selling certain residential
mortgage originations in the secondary market also provide sources of liquidity.
Additional sources of liquidity are provided by the Bank's membership in the
Federal Home Loan Bank of Pittsburgh (FHLB) and a $10,000,000 unsecured Federal
funds line granted by a correspondent bank. The Bank has a maximum borrowing
capacity with the FHLB of approximately $230,210,000. At December 31, 2004,
QNB's outstanding borrowings under the FHLB credit facilities totaled
$55,000,000.
Cash and due from banks, Federal funds sold, available-for-sale securities and
loans held-for-sale totaled $290,058,000 at December 31, 2004 and $288,136,000
at December 31, 2003. These sources should be adequate to meet normal
fluctuations in loan demand or deposit withdrawals. For the most part, QNB has
been able to fund the growth in earning assets during 2004 and 2003 through
increased deposits. During the second quarter of 2004, QNB used overnight
borrowings from the FHLB and its Federal funds line to help fund the significant
loan growth at the end of the quarter. QNB could have sold investment securities
instead of using short-term borrowings to fund the loan growth, but decided it
made financial sense to use low cost funds as opposed to selling higher yielding
investment securities. In addition, the Federal funds line was used several
times during 2004 because of timing differences between the withdrawal of funds
by municipalities and the receipt of the proceeds from the securities matched
against these deposits.
Approximately $103,305,000 and $84,425,000 of available-for-sale securities at
December 31, 2004 and 2003 were pledged as collateral for repurchase agreements
and deposits of public funds. In addition, under terms of its agreement with the
FHLB, QNB maintains otherwise unencumbered qualifying assets (principally 1-4
family residential mortgage loans and U.S. Government and agency notes, bonds,
and mortgage-backed securities) in the amount of at least as much as its
advances from the FHLB. The significant increase in pledged amounts relates
primarily to the additional school district deposits received in 2004. These
deposits were used to purchase available-for-sale securities that were used to
pledge against the deposits of the municipalities.
QNB's near-term liquidity concern is the ability to meet the expected withdrawal
of $20,000,000 by a school district during the second quarter of 2005. These
funds are matched with callable agency securities with call dates that closely
match the anticipated withdrawal dates. The risk is interest rates increase
enough that these securities are not called. In that case, QNB could use its
credit facilities to fund the withdrawals, sell these callable securities,
probably at a loss, or sell other investment securities. A longer-term liquidity
concern is that the equity markets strengthen and the Bank suffers
disintermediation back to the equity market as it loses deposits that it
obtained during the years the equity markets were declining. During that time,
many customers preferred the safety of FDIC-insured deposits compared to the
uncertain equity market, despite historically low interest rates.
CAPITAL ADEQUACY
A strong capital position is fundamental to support continued growth and
profitability, to serve the needs of depositors, and to yield an attractive
return for shareholders. QNB's shareholders' equity at December 31, 2004 was
$45,775,000, or 7.84 percent of total assets, compared to shareholders' equity
of $43,440,000, or 7.89 percent of total assets, at December 31, 2003. At
December 31, 2004, shareholders' equity included a positive adjustment of
$691,000 related to the unrealized holding gain, net of taxes, on investment
securities available-for-sale, while shareholders' equity at December 31, 2003
included a positive adjustment of $2,341,000. Without these adjustments,
shareholders' equity to total assets would have been 7.72 percent and 7.46
percent at December 31, 2004 and 2003, respectively. The increase in the ratio
is a result of the rate of capital retention exceeding the rate of asset growth.
Total assets increased 6.0 percent between December 31, 2003 and December 31,
2004 while shareholders' equity, excluding the net unrealized holding gains,
increased 9.7 percent.
Average shareholders' equity and average total assets were $42,975,000 and
$562,582,000 during 2004, an increase of 9.4 percent and 6.8 percent,
respectively, compared to 2003. The ratio of average total equity to average
total assets was 7.64 percent for 2004, compared to 7.46 percent for 2003.
The Corporation is subject to restrictions on the payment of dividends to its
shareholders pursuant to the Pennsylvania Business Corporation Law as amended
(the "BCL"). The BCL operates generally to preclude dividend payments, if the
effect thereof would render the Corporation insolvent, as defined. As a
practical matter, the Corporation's payment of dividends is contingent upon its
ability to obtain funding in the form of dividends from the Bank. Payment of
dividends to the Corporation by the Bank is subject to the restrictions in the
National Bank Act. Generally, the National Bank Act permits the Bank to declare
dividends in 2005 of approximately $7,261,000, plus an amount equal to the net
profits of the Bank in 2005 up to the date of any such dividend declaration. QNB
Corp. paid dividends to its shareholders of $.74 per share in 2004, an increase
of 12.1 percent from the $.66 per share paid in 2003. Earnings retained in 2004
were 63.1 percent compared to 63.8 percent in 2003. These earnings are retained
in the form of capital to support future growth.
28
QNB is subject to various regulatory capital requirements as issued by Federal
regulatory authorities. Regulatory capital is defined in terms of Tier I capital
(shareholders' equity excluding unrealized gains or losses on available-for-sale
securities and intangible assets), Tier II capital which includes a portion of
the allowance for loan losses, and total capital (Tier I plus Tier II).
Risk-based capital ratios are expressed as a percentage of risk-weighted assets.
Risk-weighted assets are determined by assigning various weights to all assets
and off-balance sheet arrangements, such as letters of credit and loan
commitments, based on associated risk. Regulators have also adopted minimum Tier
I leverage ratio standards, which measure the ratio of Tier I capital to total
average assets. The minimum regulatory capital ratios are 4.00 percent for Tier
I, 8.00 percent for total risk-based capital and 4.00 percent for leverage.
CAPITAL ANALYSIS
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
TIER I
Shareholders' equity................................................................................ $ 45,775 $ 43,440
Net unrealized securities gains..................................................................... (691) (2,341)
Net unrealized losses equity securities............................................................. (1,019) (14)
Intangible assets................................................................................... (145) (208)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Tier I risk-based capital..................................................................... 43,920 40,877
TIER II
Allowable portion of the allowance
for loan losses................................................................................... $ 2,612 $ 2,929
- ------------------------------------------------------------------------------------------------------------------------------------
Total risk-based capital............................................................................ $ 46,532 $ 43,806
====================================================================================================================================
Risk-weighted assets................................................................................ $ 358,407 $ 327,243
====================================================================================================================================
CAPITAL RATIOS
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Tier I capital/risk-weighted assets................................................................ 12.25% 12.49%
Total risk-based capital/risk-weighted assets...................................................... 12.98 13.39
Tier I capital/average assets (leverage ratio)..................................................... 7.44 7.38
Based on the requirements, QNB has a Tier I capital ratio of 12.25 percent and
12.49 percent, a total risk-based ratio of 12.98 percent and 13.39 percent, and
a leverage ratio of 7.44 percent and 7.38 percent at December 31, 2004 and 2003,
respectively. The decline in both the Tier I capital ratio and total risk-based
ratio reflects the change in the balance sheet composition with growth in loans,
primarily commercial loans, outpacing the growth in investment securities. Loans
are usually assigned a higher risk weighting than investment securities. The
increase in net unrealized losses on equity securities in 2004 also had a
negative impact on both ratios. The total risk-based capital ratio was also
negatively impacted by the net charge-offs in 2004, which reduced the allowance
for loan losses included in Tier 2 capital.
The Federal Deposit Insurance Corporation Improvement Act of 1991 established
five capital level designations ranging from "well capitalized" to "critically
undercapitalized." At December 31, 2004 and 2003, QNB met the "well capitalized"
criteria, which requires minimum Tier I and total risk-based capital ratios of
6.00 percent and 10.00 percent, respectively, and a leverage ratio of 5.00
percent.
29
CONTRACTUAL OBLIGATIONS, COMMITMENTS, AND OFF-BALANCE SHEET ARRANGEMENTS
QNB has various financial obligations, including contractual obligations and
commitments, that may require future cash payments.
CONTRACTUAL OBLIGATIONS
The following table presents, as of December 31, 2004, significant contractual
obligations to third parties by payment date. Further discussion of the nature
of each obligation can be found in the notes to the consolidated financial
statements.
UNDER 1 YEAR 1 TO 3 YEARS 3 TO 5 YEARS OVER 5 YEARS TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
Time Deposits............................................. $ 103,405 $ 89,915 $ 9,454 $ 46 $ 202,820
Short-term borrowings..................................... 13,374 - - - 13,374
Federal Home Loan Bank advances........................... 2,000 3,000 26,500 23,500 55,000
Operating leases.......................................... 274 504 467 2,077 3,322
====================================================================================================================================
Total..................................................... $ 119,053 $ 93,419 $ 36,421 $ 25,623 $ 274,516
====================================================================================================================================
COMMITMENTS
The following table presents, as of December 31, 2004, the amounts and expected
maturities of significant commitments. Discussion of the obligations can be
found in the notes to the consolidated financial statements
UNDER 1 YEAR 1 TO 3 YEARS 3 TO 5 YEARS OVER 5 YEARS TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
Commitments to extend credit
Commercial............................................. $ 57,317 $ 1,081 $ - $ - $ 58,398
Residential real estate................................ 1,042 - - - 1,042
Other.................................................. - - - 22,348 22,348
Standby letters of credit................................. 2,569 1,068 - - 3,637
- ------------------------------------------------------------------------------------------------------------------------------------
Total..................................................... $ 60,928 $ 2,149 $ - $ 22,348 $ 85,425
====================================================================================================================================
Commitments to extend credit, inclulding loan commitments, standby letters of
credit, and commercial letters of credit do not necessarily represent future
cash requirements, as these commitments often expire without being drawn upon.
RECENTLY ISSUED ACCOUNTING STANDARDS
Refer to Note 1 of the Notes to Consolidated Financial Statements for discussion
of recently issued accounting standards.
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 U.S. generally accepted accounting principles (GAAP). The
preparation of these consolidated 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 plans 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-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 considers that the determination of the allowance for loan losses involves a
higher degree of judgment and complexity than its other significant accounting
policies. The allowance for loan losses is calculated with the objective of
maintaining a level believed by management to be sufficient 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.
30
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 collectibility. 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 expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date. A
valuation allowance is established against deferred tax assets when, in the
judgment of management, it is more likely than not that such deferred tax assets
will not become available. Because the judgment about the level of future
taxable income is dependent to a great extent on matters that may, at least in
part go beyond QNB's control, it is at least reasonably possible that
management's judgment about the need for a valuation allowance for deferred
taxes could change in the near term.
OTHER-THAN-TEMPORARY INVESTMENT SECURITY IMPAIRMENT
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 prospect for a near-term recovery of value is
not necessarily favorable, or that there is a lack of evidence to support a
realizable value equal to or greater than the 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.
31
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a financial institution, the Corporation is subject to three primary risks.
o Credit risk
o Liquidity risk
o Interest rate risk
The Board of Directors has established an Asset Liability Committee (ALCO) to
measure, monitor and manage interest rate risk for the Bank. The Bank's Asset
Liability Policy has instituted guidelines covering the three primary risks.
For discussion on credit risk refer to the sections on non-performing assets,
allowance for loan losses, Note 5 and Note 6 of the Notes to Consolidated
Financial Statements.
For discussion on liquidity risk refer to the section on liquidity at page 28 in
Item 7 of this Form 10-K filing.
INTEREST RATE SENSITIVITY
- ------------------------------------------------------------------------------------------------------------------------------------
WITHIN 3 TO 6 6 MONTHS 1 TO 3 3 TO 5 AFTER
DECEMBER 31, 2004 3 MONTHS MONTHS TO 1 YEAR YEARS YEARS 5 YEARS TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
Assets
Interest-bearing balances..................$ 981 - - - - - $ 981
Federal funds sold......................... 3,159 - - - - - 3,159
Investment securities*..................... 13,392 $ 28,574 $ 21,190 $ 89,656 $ 55,799 $ 63,592 272,203
Non-marketable equity securities........... - - - - - 3,947 3,947
Loans, including loans held-for-sale....... 91,082 21,598 40,080 72,909 31,038 11,653 268,360
Bank-owned life insurance.................. - - 7,906 - - - 7,906
- ------------------------------------------------------------------------------------------------------------------------------------
Total rate sensitive assets................ 108,614 50,172 69,176 162,565 86,837 79,192 $556,556
Total cumulative assets....................$ 108,614 $158,786 $ 227,962 $ 390,527 $ 477,364 $ 556,556
====================================================================================================================================
Liabilities
Interest-bearing non-maturing deposits.....$ 92,174 $ 20,000 $ - $ 5,876 $ 13,560 $ 79,455 $211,065
Time deposits less than $100,000........... 13,519 25,353 51,791 63,355 6,801 26 160,845
Time deposits over $100,000................ 2,134 2,785 14,117 20,289 2,650 - 41,975
Short-term borrowings...................... 13,374 - - - - - 13,374
Federal Home Loan Bank advances............ 5,000 - - - 26,500 23,500 55,000
- ------------------------------------------------------------------------------------------------------------------------------------
Total rate sensitive liabilities........... 126,201 48,138 65,908 89,520 49,511 102,981 $482,259
Total cumulative liabilities...............$ 126,201 $174,339 $ 240,247 $ 329,767 $ 379,278 $ 482,259
====================================================================================================================================
Gap during period..........................$ (17,587) $ 2,034 $ 3,268 $ 73,045 $ 37,326 $ (23,789) $ 74,297
====================================================================================================================================
Cumulative gap.............................$ (17,587) $(15,553) $ (12,285) $ 60,760 $ 98,086 $ 74,297
====================================================================================================================================
Cumulative gap/rate sensitive assets....... (3.16)% (2.79)% (2.21)% 10.92% 17.62% 13.35%
====================================================================================================================================
Cumulative gap ratio....................... .86 .91 .95 1.18 1.26 1.15
====================================================================================================================================
* Excludes unrealized holding gain on available-for-sale securities of $1,561.
The table below summarizes estimated changes in net interest income over the
next twelve-month period, under various interest rate scenarios.
- ------------------------------------------------------------------------------------------------------------------------------------
CHANGE IN INTEREST RATES NET INTEREST INCOME DOLLAR CHANGE PERCENT CHANGE
====================================================================================================================================
DECEMBER 31, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
+300 Basis Points............................................... $ 15,632 $ (508) (3.15)%
+200 Basis Points............................................... 16,191 51 .32
+100 Basis Points............................................... 16,388 248 1.54
FLAT RATE....................................................... 16,140 - -
- -100 Basis Points............................................... 15,123 (1,017) (6.30)
====================================================================================================================================
DECEMBER 31, 2003
- ------------------------------------------------------------------------------------------------------------------------------------
+300 Basis Points............................................... $ 15,887 $ 146 .93%
+200 Basis Points............................................... 16,209 468 2.97
+100 Basis Points............................................... 16,182 441 2.80
FLAT RATE....................................................... 15,741 - -
- -100 Basis Points............................................... 13,890 (1,851) (11.76)
- ------------------------------------------------------------------------------------------------------------------------------------
32
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. 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 because 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 run-off. 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 December 31, 2004, interest earning assets scheduled to
mature or likely to be called, repriced or repaid in one year were $227,962,000.
Interest sensitive liabilities scheduled to mature or reprice within one year
were $240,247,000. The one-year cumulative gap, which reflects QNB's interest
sensitivity over a period of time, was a negative $12,285,000 at December 31,
2004. The cumulative one-year gap equals -2.21 percent of total rate sensitive
assets. This negative or liability sensitive gap will generally benefit QNB in a
falling interest rate environment, while rising interest rates could negatively
impact QNB.
QNB also uses a simulation model to assess the impact of changes in interest
rates on net interest income. The model reflects management's assumptions
related to asset yields and rates paid on liabilities, deposit sensitivity, and
the size, composition and maturity or repricing characteristics of the balance
sheet. The assumptions are based on what management believes, at that time, to
be the most likely interest rate environment. Management also evaluates the
impact of higher and lower interest rates by simulating the impact on net
interest income of changing rates. While management performs rate shocks of 100,
200 and 300 basis points, it believes, given the level of interest rates at
December 31, 2004, that it is unlikely that interest rates would decline by 200
or 300 basis points. The simulation results can be found in the chart on page
32.
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.
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 December 31, 2004, QNB did not have any
hedging transactions in place such as interest rate swaps, caps or floors.
QNB anticipates a rise in interest rates through 2005. Given this assumption,
the asset/liability strategy for 2005 is to achieve a positive gap position for
periods up to a year.
33
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following audited financial statements are set forth in this Annual
Report of Form 10-K on the following pages:
Independent Registered Public Accounting Firm's Report....Page 35
Independent Registered Public Accounting Firm's Report....Page 36
Consolidated Balance Sheet................................Page 37
Consolidated Income Statement.............................Page 38
Consolidated Statements of Shareholders' Equity...........Page 39
Consolidated Statements of Cash Flows.....................Page 40
Notes to Consolidated Financial Statements................Page 41
34
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS REPORT
The Board of Directors
QNB Corp:
We have audited the accompanying consolidated balance sheets of QNB Corp. and
subsidiary as of December 31, 2004 and the related consolidated statements of
income, shareholders' equity, and cash flows for the year then ended. These
consolidated financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit. The accompanying consolidated financial
statements of QNB Corp. and subsidiary as of December 31, 2003 and for each of
the years in the two-year period ended December 31, 2003, were audited by other
auditors whose report thereon dated February 20, 2004, expressed an unqualified
opinion on those statements.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the 2004 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of QNB Corp.
and subsidiary as of December 31, 2004, and the results of their operations and
their cash flows for the year then ended in conformity with U.S. generally
accepted accounting principles.
/s/ S.R. Snodgrass, A.C.
March 3, 2005
Wexford, Pennsylvania
35
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS REPORT
To the Shareholders and Board of Directors of QNB Corp.:
We have audited the accompanying consolidated balance sheet of QNB Corp. and
subsidiary (the "Company") as of December 31, 2003, and the related consolidated
statements of income, shareholders' equity, and cash flows for each of the years
in the two-year period ended December 31, 2003. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of QNB Corp. and
subsidiary as of December 31, 2003, and the results of their operations and
their cash flows for each of the years in the two-year period ended December 31,
2003 in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Philadelphia, Pennsylvania
February 20, 2004
36
Consolidated Balance Sheets
(in thousands, except share data)
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks................................................................................. $ 19,026 $ 21,534
Federal funds sold...................................................................................... 3,159 4,532
- ------------------------------------------------------------------------------------------------------------------------------------
Total cash and cash equivalents................................................................ 22,185 26,066
Investment securities
Available-for-sale (amortized cost $266,000 and $257,084).......................................... 267,561 260,631
Held-to-maturity (market value $6,432 and $12,334)................................................. 6,203 12,012
Non-marketable equity securities........................................................................ 3,947 3,810
Loans held-for-sale..................................................................................... 312 1,439
Total loans, net of unearned income .............................................................. 268,048 232,127
Allowance for loan losses............................................................................... (2,612) (2,929)
- ------------------------------------------------------------------------------------------------------------------------------------
Net loans...................................................................................... 265,436 229,198
Bank-owned life insurance............................................................................... 7,906 7,585
Premises and equipment, net............................................................................. 5,640 5,090
Accrued interest receivable ............................................................................ 2,531 2,823
Other assets............................................................................................ 1,923 2,177
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets............................................................................................ $ 583,644 $ 550,831
====================================================================================================================================
LIABILITIES
Deposits
Demand, non-interest-bearing....................................................................... $ 52,603 $ 50,468
Interest-bearing demand accounts................................................................... 95,120 107,648
Money market accounts.............................................................................. 60,434 38,373
Savings............................................................................................ 55,511 52,008
Time............................................................................................... 160,845 151,304
Time over $100,000................................................................................. 41,975 38,838
- ------------------------------------------------------------------------------------------------------------------------------------
Total deposits................................................................................. 466,488 438,639
Short-term borrowings................................................................................... 13,374 10,416
Federal Home Loan Bank advances......................................................................... 55,000 55,000
Accrued interest payable................................................................................ 1,179 1,285
Other liabilities....................................................................................... 1,828 2,051
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities....................................................................................... 537,869 507,391
- ------------------------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Common stock, par value $0.625 per share;
authorized 10,000,000 shares; 3,204,764 shares and 3,202,065 shares issued;
3,098,078 and 3,095,379 shares outstanding......................................................... 2,003 2,001
Surplus................................................................................................. 9,005 8,933
Retained earnings....................................................................................... 35,570 31,659
Accumulated other comprehensive income, net............................................................. 691 2,341
Treasury stock, at cost; 106,686 shares................................................................. (1,494) (1,494)
- ------------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity.............................................................................. 45,775 43,440
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity.............................................................. $ 583,644 $ 550,831
====================================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
37
Consolidated Statements of Income
(in thousands, except share data)
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Income
Interest and fees on loans..................................................................... $ 14,229 $ 14,208 $14,892
Interest and dividends on investment securities:
Taxable................................................................................... 8,945 8,603 10,060
Tax-exempt................................................................................ 2,224 2,112 1,979
Interest on Federal funds sold................................................................. 93 126 152
Interest on interest-bearing balances and other interest income................................ 80 90 108
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest income................................................................. 25,571 25,139 27,191
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Expense
Interest on deposits
Interest-bearing demand accounts.......................................................... 681 554 393
Money market accounts..................................................................... 441 298 559
Savings................................................................................... 215 324 497
Time...................................................................................... 4,153 4,511 5,843
Time over $100,000........................................................................ 990 1,080 1,614
Interest on short-term borrowings.............................................................. 124 106 264
Interest on Federal Home Loan Bank advances.................................................... 2,902 2,881 2,906
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest expense................................................................ 9,506 9,754 12,076
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income................................................................... 16,065 15,385 15,115
Provision for loan losses...................................................................... - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses................................... 16,065 15,385 15,115
- ------------------------------------------------------------------------------------------------------------------------------------
Non-Interest Income
Fees for services to customers................................................................. 2,000 1,849 1,634
ATM and debit card income...................................................................... 598 541 509
Income on bank-owned life insurance............................................................ 300 330 372
Mortgage servicing fees........................................................................ 112 12 97
Net gain (loss) on investment securities available-for-sale.................................... 849 (134) (779)
Net gain on sale of loans...................................................................... 154 923 676
Other operating income......................................................................... 674 679 480
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-interest income............................................................. 4,687 4,200 2,989
- ------------------------------------------------------------------------------------------------------------------------------------
Non-Interest Expense
Salaries and employee benefits................................................................. 7,163 7,195 6,531
Net occupancy expense.......................................................................... 1,013 859 861
Furniture and equipment expense................................................................ 1,148 1,111 1,060
Marketing expense.............................................................................. 557 536 598
Third party services........................................................................... 680 741 640
Telephone, postage and supplies expense........................................................ 521 556 545
State taxes.................................................................................... 375 331 335
Other expense.................................................................................. 1,388 1,354 1,375
- ------------------------------------------------------------------------------------------------------------------------------------
Total non-interest expense............................................................ 12,845 12,683 11,945
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes .............................................................. 7,907 6,902 6,159
Provision for income taxes..................................................................... 1,704 1,254 1,204
- ------------------------------------------------------------------------------------------------------------------------------------
Net Income................................................................................ $ 6,203 $ 5,648 $ 4,955
====================================================================================================================================
Net Income Per Share - Basic.............................................................. $ 2.00 $ 1.83 $ 1.61
====================================================================================================================================
Net Income Per Share - Diluted............................................................ $ 1.95 $ 1.79 $ 1.59
====================================================================================================================================
The accompanying notes are an integral part of the consolidated financial
statements.
38
Consolidated Statements of Shareholders' Equity
- ------------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED
OTHER
NUMBER COMPREHENSIVE COMPREHENSIVE COMMON RETAINED TREASURY
(in thousands, except share data) OF SHARES INCOME INCOME (LOSS) STOCK SURPLUS EARNINGS STOCK TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001............... 3,072,718 - $ 1,099 $ 1,987 $8,681 $ 24,946 $(1,494) $35,219
- ------------------------------------------------------------------------------------------------------------------------------------
Net income............................... - $4,955 - - - 4,955 - 4,955
Other comprehensive income, net of tax
Unrealized holding gains on
investment securities
available-for-sale................ - 1,990 - - - - - -
Reclassification adjustment for
losses included in net income..... - 514 - - - - - -
------
Other comprehensive income.......... - 2,504 2,504 - - - - 2,504
------
Comprehensive income..................... - $7,459 - - - - - -
======
Cash dividends paid
($.60 per share).................... - - - - - (1,848) - (1,848)
Stock issue - Employee stock purchase plan 3,304 - - 2 50 - - 52
Stock issued for options exercised....... 5,572 - - 4 28 - - 32
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2002............... 3,081,594 - 3,603 1,993 8,759 28,053 (1,494) 40,914
====================================================================================================================================
Net income............................... - $5,648 - - - 5,648 - 5,648
Other comprehensive income, net of tax
Unrealized holding losses on
investment securities
available-for-sale................ - (1,350) - - - - - -
Reclassification adjustment for
losses included in net income..... - 88 - - - - - -
------
Other comprehensive income.......... - (1,262) (1,262) - - - - (1,262)
------
Comprehensive income..................... - $4,386 - - - - - -
======
Cash dividends paid
($.66 per share).................... - - - - - (2,042) - (2,042)
Stock issue - Employee stock purchase plan 3,415 - - 2 62 - - 64
Stock issued for options exercised....... 10,370 - - 6 72 - - 78
Tax benefits from stock plans............ - - - - 40 - - 40
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2003............... 3,095,379 - 2,341 2,001 8,933 31,659 (1,494) 43,440
====================================================================================================================================
Net income............................... - $6,203 - - - 6,203 - 6,203
Other comprehensive income, net of tax
Unrealized holding losses on
investment securities
available-for-sale................ - (1,090) - - - - - -
Reclassification adjustment for
gains included in net income...... - (560) - - - - - -
------
Other comprehensive income.......... - (1,650) (1,650) - - - - (1,650)
------
Comprehensive income..................... - $4,553 - - - - - -
======
Cash dividends paid
($.74 per share).................... - - - - - (2,292) - (2,292)
Stock issue - Employee stock purchase plan 2,679 - - 2 72 - - 74
Stock issued for options exercised....... 20 - - - - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2004............... 3,098,078 - $ 691 $ 2,003 $9,005 $35,570 $(1,494) $45,775
====================================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
39
Consolidated Statements of Cash Flows
(in thousands)
- ------------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income.................................................................................... $ 6,203 $ 5,648 $ 4,955
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization............................................................... 907 873 835
Securities (gains) losses .................................................................. (849) 134 779
Net gain on sale of repossessed assets...................................................... (141) - -
Proceeds from sale of repossessed assets.................................................... 1,167 - -
Net gain on sale of loans................................................................... (154) (923) (676)
Loss on disposal of premises and equipment.................................................. 3 13 2
Loss on equity investment in title company.................................................. 26 - -
Proceeds from sales of residential mortgages................................................ 9,162 41,904 24,472
Originations of residential mortgages held-for-sale......................................... (8,055) (39,244) (27,276)
Proceeds from sales of student loans........................................................ - 403 1,896
Originations of student loans............................................................... - (160) (1,121)
Income on bank-owned life insurance......................................................... (300) (330) (372)
Life insurance (premiums) proceeds/net...................................................... (21) 142 (27)
Deferred income tax provision............................................................... 299 (2) (79)
Change in income taxes payable.............................................................. 282 (121) (132)
Net decrease (increase) in accrued interest receivable...................................... 292 (113) (213)
Net amortization of premiums and discounts.................................................. 933 1,447 901
Net decrease in accrued interest payable.................................................... (106) (270) (588)
(Increase) decrease in other assets ........................................................ (67) 45 69
(Decrease) increase in other liabilities................................................... (280) 206 (1,336)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities................................................... 9,301 9,652 2,089
- ------------------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Proceeds from maturities and calls of investment securities
available-for-sale.......................................................................... 55,334 87,380 63,296
held-to-maturity............................................................................ 5,811 17,706 18,877
Proceeds from sales of investment securities
available-for-sale.......................................................................... 66,715 54,591 17,245
Purchase of investment securities
available-for-sale.......................................................................... (130,878) (194,743) (123,909)
held-to-maturity............................................................................ - - (5,955)
Net increase in loans......................................................................... (37,156) (19,050) (11,934)
Net change in non-marketable securities....................................................... (137) (225) (845)
Net purchases of premises and equipment....................................................... (1,460) (479) (720)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities....................................................... (41,771) (54,820) (43,945)
- ------------------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net increase in non-interest-bearing deposits................................................. 2,135 3,389 7,001
Net increase in interest-bearing non-maturity deposits........................................ 13,036 42,872 27,315
Net increase in time deposits................................................................. 12,678 3,465 9,866
Net increase (decrease) in short-term borrowings.............................................. 2,958 (4,069) 1,034
Proceeds from Federal Home Loan Bank advances................................................. - - 2,000
Cash dividends paid........................................................................... (2,292) (2,042) (1,848)
Proceeds from issuance of common stock........................................................ 74 142 84
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities .................................................. 28,589 43,757 45,452
- ------------------------------------------------------------------------------------------------------------------------------------
(Decrease) increase in cash and cash equivalents............................................ (3,881) (1,411) 3,596
Cash and cash equivalents at beginning of year.............................................. 26,066 27,477 23,881
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year.................................................... $ 22,185 $ 26,066 $ 27,477
====================================================================================================================================
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid................................................................................. $ 9,612 $ 10,024 $ 12,664
Income taxes paid............................................................................. 1,042 1,368 1,400
Non-Cash Transactions
Change in net unrealized holding gains, net of taxes, on investment securities.............. (1,650) (1,262) 2,504
Transfer of loans to repossessed assets....................................................... 1,026 - -
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
- --------------------------------------------------------------------------------
QNB Corp. (the Corporation), through its wholly-owned subsidiary, The Quakertown
National Bank (the Bank), has been serving the residents and businesses of upper
Bucks, southern Lehigh, and northern Montgomery 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
Bank encounters vigorous competition for market share in the communities it
serves from bank holding companies, other community banks, thrift institutions,
credit unions and other non-bank financial organizations such as mutual fund
companies, insurance companies and brokerage companies. QNB Corp. manages its
business as a single operating segment.
The Corporation and the Bank are subject to regulations of certain state and
Federal agencies. These regulatory agencies periodically examine the Corporation
and the Bank for adherence to laws and regulations.
USE OF ESTIMATES
- --------------------------------------------------------------------------------
The consolidated financial statements include the accounts of the Corporation
and its wholly-owned subsidiary, the Bank. The consolidated entity is referred
to herein as "QNB". These statements are prepared in accordance with U.S.
generally accepted accounting principles (GAAP) and predominant practices within
the banking industry. The preparation of these consolidated 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 plans 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.
All significant inter-company accounts and transactions have been eliminated in
the consolidated financial statements. Tabular information other than share data
is presented in thousands of dollars. Certain previously reported amounts have
been reclassified to conform to current presentation standards. These
reclassifications had no effect on net income.
STOCK SPLIT
- --------------------------------------------------------------------------------
On August 19, 2003, the Board of Directors authorized a two-for-one split of the
Corporation's common stock, effected by a distribution on October 14, 2003 of
one share for each one share held of record at the close of business on
September 30, 2003. All earnings per share and common stock information is
presented as if the stock split occurred prior to the earliest year included in
these financial statements.
INVESTMENT SECURITIES
- --------------------------------------------------------------------------------
Investment securities that QNB has the positive intent and ability to hold to
maturity are classified as held-to-maturity securities and reported at amortized
cost. Debt and equity securities that are bought and held principally for the
purpose of selling in the near term are classified as trading securities and
reported at fair value, with unrealized gains and losses included in earnings.
Debt and equity securities not classified as either held-to-maturity securities
or trading securities are classified as available-for-sale securities and
reported at fair value, with unrealized gains and losses, net of tax, excluded
from earnings and reported as accumulated other comprehensive income or loss, a
separate component of shareholders' equity. Management determines the
appropriate classification of securities at the time of purchase.
Available-for-sale securities include securities that management intends to use
as part of its asset/liability management strategy and that may be sold in
response to changes in market interest rates and related changes in the
securities' prepayment risk or to meet liquidity needs.
Premiums and discounts on debt securities are recognized in interest income
using a constant yield method. Gains and losses on sales of investment
securities are computed on the specific identification method and included in
non-interest income.
NON-MARKETABLE EQUITY SECURITIES
- --------------------------------------------------------------------------------
Non-marketable equity securities are comprised of restricted stock of the
Federal Home Loan Bank of Pittsburgh (FHLB), the Federal Reserve Bank, and
Atlantic Central Bankers Bank. These restricted securities are carried at cost.
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
LOANS
- --------------------------------------------------------------------------------
Loans are stated at the principal amount outstanding, net of deferred loan fees
and costs. Interest income is accrued on the principal amount outstanding. Loan
origination and commitment fees and related direct costs are deferred and
amortized to income over the term of the respective loan and loan commitment
period as a yield adjustment.
Loans held-for-sale consist of residential mortgage loans and are carried at the
lower of aggregate cost or market value. Gains and losses on residential
mortgages held-for-sale are included in non-interest income.
NON-PERFORMING ASSETS
- --------------------------------------------------------------------------------
Non-performing assets are comprised of non-accrual loans and other real estate
owned. Non-accrual loans are those on which the accrual of interest has ceased.
Commercial loans are placed on non-accrual status immediately if, in the opinion
of management, collection is doubtful, or when principal or interest is past due
90 days or more and collateral is insufficient to cover principal and interest.
Interest accrued, but not collected at the date a loan is placed on non-accrual
status, is reversed and charged against interest income. Subsequent cash
receipts are applied either to the outstanding principal or recorded as interest
income, depending on management's assessment of the ultimate collectibility of
principal and interest. Loans are returned to an accrual status when the
borrower's ability to make periodic principal and interest payments has returned
to normal (i.e. brought current with respect to principal or interest or
restructured) and the paying capacity of the borrower and/or the underlying
collateral is deemed sufficient to cover principal and interest. Consumer loans
are not automatically placed on non-accrual status when principal or interest
payments are 90 days past due, but in most instances, are charged-off when
deemed uncollectible or after reaching 120 days past due.
Accounting for impairment in the performance of a loan is required when it is
probable that all amounts, including both principal and interest, will not be
collected in accordance with the loan agreement. Impaired loans are measured
based on the present value of expected future cash flows discounted at the
loan's effective interest rate or, as a practical expedient, at the loan's
observable market price or the fair value of the collateral if the loans are
collateral dependent. Impairment criteria are applied to the loan portfolio
exclusive of smaller homogeneous loans such as residential mortgage and consumer
loans which are evaluated collectively for impairment.
Other real estate owned is comprised of properties acquired through foreclosure
proceedings or acceptance of a deed in lieu of foreclosure. Other real estate
owned is recorded at the lower of the carrying value of the loan or the fair
value of the property less disposal costs. Loan losses arising from the
acquisition of such properties are charged against the allowance for loan
losses. Holding expenses related to the operation and maintenance of properties
are expensed as incurred. Gains and losses upon disposition are reflected in
earnings as realized.
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.
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 using 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.
TRANSFERS AND SERVICING OF FINANCIAL ASSETS
- --------------------------------------------------------------------------------
QNB continues to carry servicing assets, relating to mortgage loans it has sold.
Such servicing assets are recorded based on the relative fair values of the
servicing assets and loans sold at the date of transfer. The servicing asset is
amortized in proportion to and over the period of net servicing income.
Servicing assets are assessed for impairment based on their disaggregated fair
value.
PREMISES AND EQUIPMENT
- --------------------------------------------------------------------------------
Premises and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization are calculated principally on an
accelerated or straight-line basis over the estimated useful lives of the assets
as follows: buildings--10 to 40 years, and equipment--3 to 10 years.
Expenditures for maintenance and repairs are charged to operations as incurred.
Gains or losses upon disposition are reflected in earnings as realized.
BANK-OWNED LIFE INSURANCE
- --------------------------------------------------------------------------------
The Bank invests in bank-owned life insurance (BOLI) as a source of funding for
employee benefit expenses. BOLI involves the purchasing of life insurance by the
Bank on a chosen group of employees. The Bank is the owner and beneficiary of
the policies. Income from the increase in cash surrender value of the policies
is included on the income statement.
STOCK-BASED COMPENSATION
- --------------------------------------------------------------------------------
At December 31, 2004, QNB had a stock-based employee compensation plan, which is
described more fully in Note 14. QNB accounts for this plan under the
recognition and measurement principles of APB Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations. No stock-based employee
compensation cost is reflected in net income, as all options granted under this
plan had an exercise price equal to the market value of the underlying common
stock on the date of grant. The following table illustrates the effect of net
income and earnings per share if the Corporation had applied the fair value
recognition provisions of FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to stock-based employee compensation.
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Net income, as reported............................................................................ $6,203 $5,648 $4,955
Deduct: Total stock-based employee compensation expense determined under
fair value based method for all awards, net of related tax effects................................. 95 104 91
- ------------------------------------------------------------------------------------------------------------------------------------
Pro forma net income............................................................................... $6,108 $5,544 $4,864
====================================================================================================================================
Earnings per share
Basic - as reported............................................................................. $ 2.00 $ 1.83 $ 1.61
====================================================================================================================================
Basic - pro forma............................................................................... $ 1.97 $ 1.79 $ 1.58
====================================================================================================================================
Diluted - as reported........................................................................... $ 1.95 $ 1.79 $ 1.59
====================================================================================================================================
Diluted - pro forma............................................................................. $ 1.92 $ 1.76 $ 1.57
====================================================================================================================================
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SFAS No. 123 provides an alternative method of accounting for stock-based
compensation arrangements. This method is based on fair value of the stock-based
compensation determined by an option pricing model utilizing various assumptions
regarding the underlying attributes of the options and QNB's stock, rather than
the existing method of accounting for stock-based compensation which is provided
in Accounting Principles Board Opinion No. 25 (APB No. 25), "Accounting for
Stock Issued to Employees." The Financial Accounting Standards Board encourages
entities to adopt the fair value based method, but does not require the adoption
of this method. QNB applies APB No. 25 and related Interpretations in accounting
for the Plan.
For purposes of computing pro forma results, QNB estimated the fair value of
stock options on the date of the grant using the Black-Scholes option pricing
model. The model requires the use of numerous assumptions, many of which are
highly subjective in nature. Therefore, the pro forma results are, of necessity,
estimates of results of operations as if compensation expense had been
recognized for all stock-based compensation plans and are not indicative of the
impact on future periods. The following assumptions were used in the option
pricing model for purposes of estimating pro forma results.
- ------------------------------------------------------------------------------------------------------------------------------------
Year ended December 31, 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Risk free interest rate............................................................... 4.39% 3.97% 4.83%
Dividend yield........................................................................ 2.20 3.30 3.72
Volatility............................................................................ 13.61 24.53 21.63
Expected life......................................................................... 10 yrs. 10 yrs. 10 yrs.
====================================================================================================================================
The weighted average fair value per share of options granted during 2004, 2003
and 2002 was $7.18, $4.67 and $3.43, respectively.
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 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.
NET INCOME PER SHARE
- --------------------------------------------------------------------------------
Basic earnings per share excludes any dilutive effects of options and is
computed by dividing net income by the weighted average number of shares
outstanding during the period. Diluted earnings per share gives effect to all
dilutive potential common shares that were outstanding during the period. For
the purpose of earnings per share, share and per share data, for all periods
presented, have been restated to reflect the two-for-one stock split distributed
October 14, 2003.
COMPREHENSIVE INCOME
- --------------------------------------------------------------------------------
Comprehensive income is defined as the change in equity of a business entity
during a period due to transactions and other events and circumstances,
excluding those resulting from investments by and distributions to owners. For
QNB, the primary component of other comprehensive income is the unrealized
holding gains or losses on available-for-sale investment securities.
RECENT ACCOUNTING PRONOUNCEMENTS
- --------------------------------------------------------------------------------
STOCK-BASED COMPENSATION
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 123(R), "Share-Based Payment." Statement No. 123(R) replaces
Statement No. 123, "Accounting for Stock-Based Compensation," and supersedes APB
Opinion No. 25, "Accounting for Stock Issued to Employees." Statement No. 123(R)
requires compensation costs related to share-based payment transactions to be
recognized in the financial statements over the period that an employee provides
service in exchange for the award. Public companies are required to adopt the
new standard using a modified prospective method and may elect to restate prior
periods using the modified retrospective method. Under the modified prospective
method, companies are required to record compensation costs for new and modified
awards over the related vesting period of such awards prospectively and record
compensation costs prospectively for the unvested portion, at the date of
adoption, of previously issued and outstanding awards over the remaining vesting
period of such awards. No change to prior periods presented is permitted under
the modified prospective method. Under the modified retrospective method,
companies record compensation costs for prior periods retroactively through
restatement of such periods using the exact pro forma amounts disclosed in the
companies' footnotes. Also, in the period of adoption and after, companies
record compensation cost based on the modified prospective method. Statement No.
123(R) is effective for periods beginning after June 15, 2005. The Corporation
is currently examining the effects of this statement and has not yet determined
the method of adoption.
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
LOANS OR CERTAIN DEBT SECURITIES ACQUIRED IN A TRANSFER
In December 2003, the Accounting Standards Executive Committee issued Statement
of Position 03-3 (SOP 03-3), "Accounting for Certain Loans or Debt Securities
Acquired in a Transfer." SOP 03-3 addresses accounting for differences between
contractual cash flows and cash flows expected to be collected from an
investor's initial investment in loans or debt securities acquired in a
transfer, including business combinations, if those differences are
atttibutable, at least in part, to credit quality. SOP 03-3 is effective for
loans for debt securities acquired in fiscal years beginning after December 15,
2004. The Corporation intends to adopt the provisions of SOP 03-3 effective
January 1, 2005, and does not expect the initial implementation to have a
material effect on the Corporation's consolidated financial statements.
LOAN COMMITMENTS
In March 2004, the SEC released Staff Accounting Bulletin (SAB) No. 105,
"Application of Accounting Principles to Loan Commitments." SAB No. 105 provides
guidance about the measurements of loan commitments recognized at fair value
under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SAB No. 105 also requires companies to disclose their accounting
policy for those loan commitments including methods and assumptions used to
estimate fair value and associated hedging strategies. SAB No. 105 is effective
for all loan commitments accounted for as derivatives that are entered into
after March 31, 2004. The adoption of SAB No. 105 did not have a material effect
on the consolidated financial statements.
OTHER-THAN-TEMPORARY IMPAIRMENT OF INVESTMENT SECURITIES
In December 2003, the FASB's Emerging Issues Task Force (EITF) issued EITF 03-1,
"The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments." The EITF addresses disclosure requirements regarding information
about temporarily impaired investments. The requirements are effective for
fiscal years ending after December 15, 2003 for all entities that have debt or
marketable equity securities with market values below carrying values. The
requirements apply to investments in debt and marketable equity securities that
are accounted for under SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." The requirements apply only to annual financial
statements. As of December 31, 2004, QNB has included the required disclosures
in their financial statements.
In March 2004, the EITF reached a consensus on EITF 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments."
EITF 03-1 provides guidance regarding the meaning of other-than-temporary
impairment and its application to investments classified as either
available-for-sale or held-to-maturity under FASB Statement No. 115, "Accounting
for Certain Investments in Debt and Equity Securities," and to equity securities
accounted for under the cost method. Included in EITF 03-1 is guidance on how to
account for impairments that are solely due to interest rate changes, including
changes resulting from increases in sector credit spreads. This guidance was to
become effective for reporting periods beginning after June 15, 2005. However,
on September 30, 2004, the FASB issued a Staff Position that delays the
effective date for the recognition and measurement guidance of EITF 03-1 until
additional clarifying guidance is issued. Management is not able to assess the
impact of the adoption of EITF 03-1 until final guidance is issued.
STATEMENT OF CASH FLOWS
- --------------------------------------------------------------------------------
Cash and cash equivalents for purposes of this statement consist of cash on
hand, cash items in process of collection, amounts due from banks, interest
earning deposits in other financial institutions and Federal funds sold.
NOTE 2 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share (share and per share data have been restated to reflect the two-for-one
stock split paid October 14, 2003 and are not in thousands):
- ------------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Numerator for basic and diluted earnings per share - net income................................... $6,203 $5,648 $4,955
====================================================================================================================================
Denominator for basic earnings per share - weighted average shares outstanding..................... 3,096,360 3,091,640 3,078,550
Effect of dilutive securities - employee stock options............................................. 81,792 61,665 30,803
- ------------------------------------------------------------------------------------------------------------------------------------
Denominator for diluted earnings per share - adjusted weighted average shares outstanding.......... 3,178,152 3,153,305 3,109,353
====================================================================================================================================
Earnings per share - basic......................................................................... $2.00 $1.83 $1.61
Earnings per share - diluted....................................................................... 1.95 1.79 1.59
- ------------------------------------------------------------------------------------------------------------------------------------
There were 20,000 stock options that were anti-dilutive as of December 31, 2004.
These stock options were not included in the above calculation.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - CASH AND DUE FROM BANKS
Included in cash and due from banks are reserves in the form of deposits with
the Federal Reserve Bank of $8,445,000 and $9,165,000 to satisfy Federal
regulatory requirements as of December 31, 2004 and 2003.
NOTE 4 - INVESTMENT SECURITIES AVAILABLE-FOR-SALE
The amortized cost and estimated fair values of investment securities
available-for-sale at December 31, 2004 and 2003 were as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003
GROSS GROSS GROSS GROSS
AGGREGATE UNREALIZED UNREALIZED AGGREGATE UNREALIZED UNREALIZED
FAIR HOLDING HOLDING AMORTIZED FAIR HOLDING HOLDING AMORTIZED
VALUE GAINS LOSSES COST VALUE GAINS LOSSES COST
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. Treasury........................$ 6,114 $ - $ 53 $ 6,167 $ 6,792 $ 19 $ 1 $ 6,774
U.S. Government agencies............. 46,478 40 65 46,503 43,279 339 67 43,007
State and municipal securities....... 45,992 1,162 137 44,967 41,076 1,162 217 40,131
Mortgage-backed securities........... 67,510 566 185 67,129 66,476 835 159 65,800
Collateralized mortgage obligations
(CMOs)............................. 70,789 127 865 71,527 68,761 364 1,086 69,483
Other debt securities................ 21,972 2,000 - 19,972 25,214 2,379 - 22,835
Equity securities.................... 8,706 698 1,727 9,735 9,033 951 972 9,054
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment securities
available-for-sale................$ 267,561 $ 4,593 $ 3,032 $ 266,000 $ 260,631 $6,049 $ 2,502 $257,084
====================================================================================================================================
The amortized cost and estimated fair value of securities available-for-sale by
contractual maturity at December 31, 2004 are shown in the following table.
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.
- ------------------------------------------------------------------------------------------------------------------------------------
Aggregate Amortized
DECEMBER 31, 2004 fair value cost
- ------------------------------------------------------------------------------------------------------------------------------------
Due in one year or less................................................................................. $ 3,042 $ 3,060
Due after one year through five years................................................................... 45,160 44,723
Due after five years through ten years.................................................................. 54,596 52,774
Due after ten years..................................................................................... 156,057 155,708
Equity securities....................................................................................... 8,706 9,735
- ------------------------------------------------------------------------------------------------------------------------------------
Total securities available-for-sale .................................................................... $ 267,561 $ 266,000
====================================================================================================================================
Proceeds from sales of investment securities available-for-sale are as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Proceeds....................................................................................... $ 66,715 $ 54,591 $17,245
Gross gains.................................................................................... 1,207 455 165
Gross losses................................................................................... 358 589 944
There were no other-than-temporary impairment charges in 2004. Included in gross
losses for 2003 and 2002 were other-than-temporary impairment charges of
$126,000 and $702,000, respectively.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HELD-TO-MATURITY
The amortized cost and estimated fair values of investment securities
held-to-maturity at December 31, 2004 and 2003 were as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003
GROSS GROSS GROSS GROSS
UNREALIZED UNREALIZED AGGREGATE UNREALIZED UNREALIZED AGGREGATE
AMORTIZED HOLDING HOLDING FAIR AMORTIZED HOLDING HOLDING FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
State and municipal securities....... $ 6,203 $ 229 $ - $ 6,432 $11,180 $ 317 $ - $11,497
Collateralized mortgage obligations
(CMOs)............................. - - - - 832 5 - 837
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment securities
held-to-maturity.................. $ 6,203 $ 229 $ - $ 6,432 $12,012 $ 322 $ - $12,334
====================================================================================================================================
The amortized cost and estimated fair values of securities held-to-maturity by
contractual maturity at December 31, 2004, are shown in the following table.
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without penalties.
- ------------------------------------------------------------------------------------------------------------------------------------
AGGREGATE AMORTIZED
DECEMBER 31, 2004 FAIR VALUE COST
- ------------------------------------------------------------------------------------------------------------------------------------
Due in one year or less................................................................................. $ 304 $ 300
Due after one year through five years.................................................................. 1,159 1,113
Due after five years through ten years................................................................. - -
Due after ten years..................................................................................... 4,969 4,790
- ------------------------------------------------------------------------------------------------------------------------------------
Total securities held-to-maturity....................................................................... $ 6,432 $ 6,203
====================================================================================================================================
There were no sales of investment securities classified as held-to-maturity
during 2004, 2003 or 2002. At December 31, 2004 and 2003, investment securities
totaling $103,305,000 and $84,425,000 were pledged as collateral for repurchase
agreements and deposits of public funds.
The table below indicates the length of time individual securities have been in
a continuous unrealized loss position at December 31, 2004:
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES VALUE LOSSES
- ------------------------------------------------------------------------------------------------------------------------------------
U.S. Treasury............................................. $ 6,114 $ 53 $ - $ - $ 6,114 $ 53
U.S. Government agencies.................................. 24,875 45 980 20 25,855 65
State and municipal securities............................ 10,152 137 - - 10,152 137
Mortgage-backed securities................................ 21,834 157 1,517 28 23,351 185
Collateralized mortgage obligations (CMOs)................ 34,099 368 18,355 497 52,454 865
Equity securities......................................... 1,365 255 4,028 1,472 5,393 1,727
- ------------------------------------------------------------------------------------------------------------------------------------
Total ................................................... $ 98,439 $ 1,015 $ 24,880 $ 2,017 $ 123,319 $3,032
====================================================================================================================================
The unrealized losses in QNB's investment holdings are related to the dynamic
nature of interest rates. One of QNB's prime objectives with the investment
portfolio is to invest excess liquidity that is not needed to fund loans. As a
result, QNB adds new investments throughout the year as they become available
through deposit inflows or roll-off from loans and securities. The unrealized
losses in certain holdings are the result of these being purchased when market
interest rates were lower than at year end. As interest rates increase, fixed
rate securities generally fall in market price to reflect the higher market
yield. If held to maturity, all of the bonds will mature at par, and QNB will
not realize a loss.
A portion of the unrealized losses is also related to four adjustable rate
Fannie Mae and Freddie Mac preferred stocks. The dividend on these holdings
resets at regular intervals at a specific spread to a predetermined index (such
as the two year Treasury yield). The dividend is also eligible for the dividend
received deduction (DRD), which exempts 70 percent of the dividend from Federal
taxes. As interest rates fell sharply and the dividends on these decreased, the
benefit of the DRD decreased as well. As a result, the market price fell to
compensate buyers for the decreased tax benefit. As interest rates rise and the
tax benefit widens, we expect the market price of these stocks to rise as well.
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - LOANS
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial and industrial.................................................................................. $ 57,364 $ 47,196
Agricultural............................................................................................... 8 14
Construction............................................................................................... 7,027 9,056
Real estate-commercial..................................................................................... 98,397 86,707
Real estate-residential.................................................................................... 99,893 83,703
Consumer................................................................................................... 5,376 5,604
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans................................................................................................ 268,065 232,280
Less unearned income....................................................................................... 17 153
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans, net of unearned income ....................................................................... $ 268,048 $232,127
====================================================================================================================================
Real estate commercial loans include all loans collateralized at least in part
by commercial real estate. These loans may not be for the expressed purpose of
conducting commercial real estate transactions.
At December 31, 2004 and 2003, the recorded investment in loans for which
impairment has been recognized totaled $372,000 and $796,000 of which $372,000
and $404,000 required no allowance for loan loss. As of December 31, 2003,
$392,000 of loans required an allowance for loan loss of $100,000. Most of the
loans identified as impaired are collateral-dependent. For the years ended
December 31, 2004, 2003 and 2002, the average recorded investment in impaired
loans was approximately $507,000, $508,000 and $699,000, respectively. QNB
recognized $111,000, $56,000 and $68,000 of interest income on these loans in
2004, 2003 and 2002, respectively.
Included within the loan portfolio are loans on non-accrual status of $373,000
and $818,000 at December 31, 2004 and 2003, respectively. These loans are
included in the impaired loan total above. If interest on non-accrual loans had
been accrued throughout the period, interest income for the years ended December
31, 2004, 2003 and 2002, would have increased approximately $21,000, $40,000 and
$19,000, respectively. The amount of interest income on these loans that was
included in net income in 2004, 2003 and 2002 was $0, $55,000 and $31,000,
respectively.
QNB generally lends in its trade area which is comprised of Quakertown and the
surrounding communities. To a large extent, QNB makes loans collateralized at
least in part by real estate. Its lending activities could be affected by
changes in the general economy, the regional economy, or real estate values.
QNB's commercial loans are not considered to be concentrated within any one
industry, except those loans to real estate developers and investors which
account for $52,046,000 or 19.4 percent of the loan portfolio at December 31,
2004. This is an increase from the $40,106,000, or 17.3 percent, at December 31,
2003. Concentration is based upon Standard Industrial Classification codes used
for bank regulatory purposes and is considered to be 10 percent or more of total
loans.
NOTE 6 - ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses is shown below:
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at beginning of year................................................................. $ 2,929 $2,938 $2,845
- ------------------------------------------------------------------------------------------------------------------------------------
Charge-offs.................................................................................. (406) (28) (39)
Recoveries................................................................................... 89 19 132
- ------------------------------------------------------------------------------------------------------------------------------------
Net (charge-offs) recoveries................................................................. (317) (9) 93
Provision for loan losses.................................................................... - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at end of year....................................................................... $ 2,612 $ 2,929 $2,938
====================================================================================================================================
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - PREMISES AND EQUIPMENT
Premises and equipment, stated at cost less accumulated depreciation and
amortization, are summarized below:
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Land and buildings.......................................................................................... $ 5,543 $ 4,928
Furniture and equipment..................................................................................... 7,648 7,162
Leasehold improvements...................................................................................... 1,655 1,593
- ------------------------------------------------------------------------------------------------------------------------------------
Book value.................................................................................................. 14,846 13,683
Accumulated depreciation and amortization................................................................... (9,206) (8,593)
- ------------------------------------------------------------------------------------------------------------------------------------
Net book value.............................................................................................. $ 5,640 $ 5,090
====================================================================================================================================
Depreciation and amortization expense on premises and equipment amounted to
$907,000, $873,000 and $835,000, for the years ended December 31, 2004, 2003 and
2002, respectively.
NOTE 8 - INTANGIBLE ASSETS
As a result of the purchase of deposits in 1997, QNB recorded a deposit premium
of $511,000. This premium is being amortized, for book purposes, over ten years
and is reviewed annually for impairment. The net accumulated amortization was
$145,000 and $196,000 at December 31, 2004 and 2003, respectively. Amortization
expense for core deposit intangibles for each of the years ended December 31,
2004, 2003 and 2002 was $51,000.
The following table reflects the components of mortgage servicing rights as of
the periods indicated:
- ------------------------------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Mortgage servicing rights beginning balance...................................................... $ 582 $ 429 $ 240
Mortgage servicing rights capitalized............................................................ 66 345 246
Mortgage servicing rights amortized.............................................................. (122) (174) (91)
Fair market value adjustments.................................................................... 26 (18) 34
- ------------------------------------------------------------------------------------------------------------------------------------
Mortgage servicing rights ending balance.................................................... $ 552 $ 582 $ 429
====================================================================================================================================
Mortgage loans serviced for others $ 78,904 $ 74,857 $71,621
Amortization expense of intangible assets for the years ended December 31 173 225 142
The annual estimated amortization expense of intangible assets for each of the
five succeeding fiscal years is as follows:
Estimated annual amortization expense for the year ended December 31, 2005 $159
for the year ended December 31, 2006 144
for the year ended December 31, 2007 119
for the year ended December 31, 2008 62
for the year ended December 31, 2009 50
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - TIME DEPOSITS
The aggregate amount of time deposits including deposits in denominations of
$100,000 or more was $202,820,000 and $190,142,000 at December 31, 2004 and
2003, respectively. The scheduled maturities of time deposits as of December 31,
2004 for the years 2005 through 2009 and thereafter are approximately
$103,405,000, $48,221,000, $41,694,000, $4,510,000, $4,944,000 and $46,000,
respectively.
NOTE 10 - SHORT-TERM BORROWINGS
- ------------------------------------------------------------------------------------------------------------------------------------
SECURITIES SOLD UNDER OTHER
DECEMBER 31, AGREEMENTS TO REPURCHASE (A) SHORT-TERM BORROWINGS (B)
- ------------------------------------------------------------------------------------------------------------------------------------
2004
Balance............................................................................... $ 12,774 $ 600
Maximum indebtedness at any month end................................................. 14,033 8,549
Daily average indebtedness outstanding................................................ 10,735 1,203
Average rate paid for the year........................................................ .99% 1.42%
Average rate on period-end borrowings................................................. 1.47 2.03
- ------------------------------------------------------------------------------------------------------------------------------------
2003
Balance............................................................................... $ 9,816 $ 600
Maximum indebtedness at any month end................................................. 11,550 600
Daily average indebtedness outstanding................................................ 9,802 424
Average rate paid for the year........................................................ 1.04% 1.10%
Average rate on period-end borrowings................................................. .85 .73
- ------------------------------------------------------------------------------------------------------------------------------------
(a) Securities sold under agreements to repurchase mature within 30 days. The
repurchase agreements were collateralized by U.S. Government agency securities,
mortgage-backed securities and CMOs with an amortized cost of $15,287,000 and
$14,827,000 and a fair value of $15,210,000 and $14,814,000 at December 31, 2004
and 2003, respectively. These securities are held in safekeeping at the Federal
Reserve Bank.
(b) Other short-term borrowings include Federal funds purchased, overnight
borrowings from FHLB and Treasury tax and loan notes.
NOTE 11 - FHLB ADVANCES
Under terms of its agreement with the FHLB, QNB maintains otherwise unencumbered
qualifying assets (principally 1-4 family residential mortgage loans and U.S.
Government and agency notes, bonds, and mortgage-backed securities) in the
amount of at least as much as its advances from the FHLB. QNB's FHLB stock of
$3,857,100 and $3,720,000 at December 31, 2004 and 2003, respectively, is also
pledged to secure these advances.
At December 31, 2004 and 2003, there were $55,000,000 in outstanding advances
with a weighted average rate of 5.29 percent and 5.16 percent, respectively.
Advances are made pursuant to several different credit programs offered by the
FHLB. At December 31, 2004, $35,000,000 of these advances are convertible,
whereby the FHLB has the option at a predetermined time to convert the fixed
interest rate to an adjustable rate tied to LIBOR. QNB then has the option to
prepay these advances if the FHLB converts the interest rate.
Outstanding borrowings as of December 31, 2004 mature as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
Loans maturing in 2005 with a rate of 2.64% ............................................................................. $ 2,000
Loans maturing in 2006 with a rate of 2.61%.............................................................................. 3,000
2007..................................................................................................................... -
2008..................................................................................................................... -
Loans maturing in 2009 with rates ranging from 5.05% to 5.97%............................................................ 26,500
Loans maturing in 2010 with rates ranging from 5.86% to 6.02%............................................................ 9,500
Loans maturing in 2011 with rates ranging from 4.99% to 6.04%............................................................ 14,000
- ------------------------------------------------------------------------------------------------------------------------------------
Total FHLB advances...................................................................................................... $55,000
====================================================================================================================================
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - INCOME TAXES
The components of the provision for income taxes are as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Current:
Federal income taxes............................................................................ $1,405 $1,256 $1,283
Deferred Federal income taxes...................................................................... 299 (2) (79)
- ------------------------------------------------------------------------------------------------------------------------------------
Net provision...................................................................................... $1,704 $1,254 $1,204
====================================================================================================================================
At December 31, 2004 and 2003, the tax effects of temporary differences that
represent the significant portion of deferred tax assets and liabilities are as
follows:
- ------------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
DEFERRED TAX ASSETS
Allowance for loan losses................................................................................... $ 697 $ 750
Impaired equity securities.................................................................................. 52 272
Deferred compensation....................................................................................... 199 202
Deposit premium............................................................................................. 42 36
Other....................................................................................................... 14 35
- ------------------------------------------------------------------------------------------------------------------------------------
Total deferred tax assets................................................................................. 1,004 1,295
- ------------------------------------------------------------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES
Depreciation................................................................................................ 158 138
Mortgage servicing rights................................................................................... 188 198
Net unrealized holding gains on
investment securities available-for-sale.................................................................. 870 1,206
Other....................................................................................................... 37 39
- ------------------------------------------------------------------------------------------------------------------------------------
Total deferred tax liabilities............................................................................ 1,253 1,581
- ------------------------------------------------------------------------------------------------------------------------------------
Net deferred tax liabilities................................................................................ $ (249) $ (286)
====================================================================================================================================
The realizability of deferred tax assets is dependent upon a variety of factors,
including the generation of future taxable income, the existence of taxes paid
and recoverable, the reversal of deferred tax liabilities and tax planning
strategies. A valuation allowance of $95,000 was established during the year
ended December 31, 2002 to offset a portion of the tax benefits associated with
certain impaired securities that management believed may not be realizable. This
valuation allowance was reversed during 2003 as a result of the ability to
realize tax benefits associated with certain impaired securities, due to the
increase in unrealized gains of certain equity securities. Based upon these and
other factors, management believes it is more likely than not that QNB will
realize the benefits of these remaining deferred tax assets. The net deferred
tax liability is included in other liabilities on the consolidated balance
sheet.
A reconciliation between the statutory and effective tax rate for net income was
as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Provision at statutory rate........................................................................ $2,688 $2,347 $2,094
Tax-exempt interest income......................................................................... (879) (843) (840)
Bank-owned life insurance.......................................................................... (102) (112) (126)
Life insurance proceeds............................................................................ - (37) -
Change in valuation allowance...................................................................... - (95) 95
Other.............................................................................................. (3) (6) (19)
- ------------------------------------------------------------------------------------------------------------------------------------
Total provision.................................................................................... $1,704 $1,254 $1,204
====================================================================================================================================
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - EMPLOYEE BENEFIT PLANS
Until December 31, 2002, QNB maintained a money purchase defined contribution
plan which covered all employees who met the age and service requirements. QNB
made contributions to the money purchase plan equivalent to 5 percent of total
compensation (as defined by the plan). QNB contributed and expensed $217,039 to
this plan in 2002. QNB also had a 401(k) profit sharing plan pursuant to the
provisions of 401(k) of the Internal Revenue Code. The plan covered
substantially all employees who met the age and service requirements. The 401(k)
plan provided for elective employee contributions up to 9 percent of
compensation and a matching company contribution limited to 3 percent. QNB made
contributions to the profit sharing plan as directed by its Board of Directors.
For 2002, QNB contributed and expensed $119,063 to the 401(k) profit sharing
plan.
Effective January 1, 2003, these two plans were merged and restated into The
Quakertown National Bank Retirement Savings Plan. The plan provides for elective
employee contributions up to 20 percent of compensation and a matching company
contribution limited to 3 percent. In addition, the plan provides for safe
harbor nonelective contributions of 5 percent of total compensation by QNB. For
2004 and 2003, QNB contributed $140,131 and $141,597 as a matching contribution
and $259,981 and $257,927 as a safe harbor contribution to the plan.
QNB's Employee Stock Purchase Plan (the "Plan") offers eligible employees an
opportunity to purchase shares of QNB Corp. Common Stock at a 10 percent
discount from the lesser of fair market value on the first or last day of each
offering period (as defined by the plan). The Plan authorizes the issuance of
42,000 shares. As of December 31, 2004, 11,112 shares were issued under the
plan.
Shares issued pursuant to the Plan, were as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, SHARES PRICE PER SHARE
- ------------------------------------------------------------------------------------------------------------------------------------
2004.......................................................................................... 2,679 $ 27.45 and $ 27.45
2003.......................................................................................... 3,415 18.00 and 19.82
2002.......................................................................................... 3,304 14.85 and 17.10
- ------------------------------------------------------------------------------------------------------------------------------------
NOTE 14 - STOCK OPTION PLAN
QNB has a stock option plan (the "Plan") administered by a committee which
consists of three or more members of QNB's Board of Directors. The Plan provides
for the granting of either (i) Non-Qualified Stock Options (NQSOs) or (ii)
Incentive Stock Options (ISOs). The exercise price of an option is the fair
market value of QNB's common stock at the date of grant, as defined by the Plan.
The Plan provides for the exercise either in cash or in securities of the
Corporation or in any combination thereof.
The Plan authorizes the issuance of 220,500 shares. The time period by which any
option is exercisable under the Plan is determined by the Committee but shall
not commence before the expiration of six months or continue beyond the
expiration of ten years after the date the option is awarded. As of December 31,
2004, there were 196,558 options granted and 182,392 options outstanding under
the Plan.
Changes in total options outstanding during 2004, 2003 and 2002, were as
follows:
NUMBER OF OPTIONS EXERCISE PRICE PER OPTION AVERAGE EXERCISE PRICE
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2001 137,960 $ 13.09 - $ 16.70 $14.53
Exercised (28,100) 13.09 - 16.70 14.58
Expired (1,654) 13.30 13.30
Granted 40,000 16.13 16.13
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2002 148,206 13.09 - 16.70 14.97
Exercised (25,794) 13.09 - 16.70 15.30
Granted 40,000 20.00 20.00
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2003 162,412 13.09 - 20.00 16.15
Exercised (20) 13.09 13.09
Granted 20,000 33.25 33.25
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 2004 182,392 $ 13.09 - $ 33.25 $18.03
====================================================================================================================================
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes information about stock options outstanding at
December 31, 2004:
EXERCISABLE
-------------------------------------------------------
EXERCISE PRICE RANGE OPTIONS AVERAGE LIFE1 AVERAGE EXERCISE PRICE
- ------------------------------------------------------------------------------------------------------------------------------------
$ 13.09 - $ 13.30 56,378 5.58 $ 13.20
16.13 - 20.00 106,014 6.70 17.73
33.25 20,000 9.34 33.25
- ------------------------------------------------------------------------------------------------------------------------------------
Total 182,392 6.64 $ 18.03
====================================================================================================================================
1 Average contractual life remaining in years
NOTE 15 - RELATED PARTY TRANSACTIONS
The following table presents activity in the amounts due from directors,
principal officers, and their related interests. All of these transactions were
made in the ordinary course of business on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with other persons. Also, they did not involve a more
than normal risk of collectibility or present any other unfavorable features.
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2003................................................................................................ $1,740
New loans................................................................................................................. 2,909
Repayments................................................................................................................ 3,214
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2004................................................................................................ $1,435
====================================================================================================================================
QNB allowed its directors to defer a portion of their compensation. The amount
of deferred compensation accrued as of December 31, 2004 and 2003, was $584,000
and $593,000, respectively.
During 2003, QNB entered into an agreement with a Director for the renovation of
the Bank's operation center. This agreement was approved by the Board of
Directors. The total paid during 2003 was $62,000.
On July 21, 2004, the Bank entered into an agreement with a director of QNB
Corp. for the purchase by the Bank of a two story building for a purchase price
of $600,000. The price was determined through an independent third party
appraisal. Management of QNB Corp. and the Bank believe that the transaction
reflects arm's-length negotiated terms. The Bank intends to use the acquired
property for additional office space.
NOTE 16 - COMMITMENTS AND CONTINGENCIES
Financial instruments with off-balance-sheet risk:
In the normal course of business there are various legal proceedings,
commitments, and contingent liabilities which are not reflected in the financial
statements. Management does not anticipate any material losses as a result of
these transactions and activities. They include, among other things, commitments
to extend credit and standby letters of credit. Outstanding standby letters of
credit amounted to $3,637,000 and $5,632,000, and commitments to extend credit
and unused lines of credit totaled $81,788,000 and $59,406,000 at December 31,
2004 and 2003, respectively. The maximum exposure to credit loss, which
represents the possibility of sustaining a loss due to the failure of the other
parties to a financial instrument to perform according to the terms of the
contract, is represented by the contractual amount of these instruments. QNB
uses the same lending standards and policies in making credit commitments as it
does for on-balance sheet instruments. The activity is controlled through credit
approvals, control limits, and monitoring procedures.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require the payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. QNB evaluates each customer's
creditworthiness on a case-by-case basis.
Standby letters of credit are conditional commitments issued to guarantee the
performance of a customer to a third party. The credit risk and collateral
policy involved in issuing letters of credit are essentially the same as those
involved in extending loan commitments.
The amount of collateral obtained for letters of credit and commitments to
extend credit is based on management's credit evaluation of the customer.
Collateral varies, but may include real estate, accounts receivable, marketable
securities, pledged deposits, inventory or equipment.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Other commitments:
QNB has committed to various operating leases for several of their branch and
office facilities. The minimum annual rental commitments under these leases
outstanding at December 31, 2004 are as follows:
Minimum Lease Payments
- ------------------------------------------------------------------------------------------------------------------------------------
2005..................................................................................................................... $ 274
2006..................................................................................................................... 260
2007..................................................................................................................... 244
2008..................................................................................................................... 244
2009..................................................................................................................... 223
Thereafter............................................................................................................... 2,077
- ------------------------------------------------------------------------------------------------------------------------------------
Rent expense under leases for each of the years ended December 31, 2004, 2003
and 2002, was $299,000, $264,000 and $273,000, respectively.
NOTE 17 - OTHER COMPREHENSIVE INCOME
The tax effects allocated to each component of other comprehensive income are as
follows:
- ------------------------------------------------------------------------------------------------------------------------------------
BEFORE-TAX AMOUNT TAX EXPENSE (BENEFIT) NET-OF-TAX AMOUNT
- ------------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2004
- ----------------------------
Unrealized losses on securities
Unrealized holding losses arising during the period............ $(1,137) $ 47 $(1,090)
Reclassification adjustment for gains included in net income...... (849) 289 (560)
- ------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income........................................ $(1,986) $ 336 $(1,650)
====================================================================================================================================
YEAR ENDED DECEMBER 31, 2003
- ----------------------------
Unrealized losses on securities
Unrealized holding losses arising during the period............ $(2,111) $ 761 $(1,350)
Reclassification adjustment for losses included in net income.. 134 (46) 88
- ------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income........................................ $(1,977) $ 715 $(1,262)
====================================================================================================================================
YEAR ENDED DECEMBER 31, 2002
- ----------------------------
Unrealized gains on securities
Unrealized holding gains arising during the period............. $ 3,079 $ (1,089) $ 1,990
Reclassification adjustment for losses included in net income.. 779 (265) 514
- ------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income........................................ $ 3,858 $ (1,354) $ 2,504
====================================================================================================================================
NOTE 18 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
All entities are required to disclose estimated fair values for their financial
instruments, whether or not recognized in the balance sheet. For QNB, as for
most financial institutions, substantially all of its assets and liabilities are
considered financial instruments.
Estimates of fair value are made at a specific point in time, based upon, where
available, relevant market prices and information about the financial
instrument. Such estimates do not include any premium or discount that could
result from offering for sale at one time QNB's entire holdings of a particular
financial instrument. For a substantial portion of QNB's financial instruments,
no quoted market exists. Therefore, estimates of fair value are necessarily
based on a number of significant assumptions regarding the amount and timing of
estimated future cash flows, which are discounted to reflect varying degrees of
risk. Given the uncertainties surrounding these assumptions, the reported fair
values may not represent actual values of financial instruments that could have
been realized as of year-end or that will be realized in the future. Use of
different assumptions or methodologies is likely to result in significantly
different fair value estimates.
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The estimated fair values and carrying amounts are summarized as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
CARRYING AMOUNT ESTIMATED FAIR VALUE CARRYING AMOUNT ESTIMATED FAIR VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
Financial Assets
Cash and due from banks....................... $ 19,026 $ 19,026 $ 21,534 $ 21,534
Federal funds sold............................ 3,159 3,159 4,532 4,532
Investment securities available-for-sale...... 267,561 267,561 260,631 260,631
Investment securities held-to-maturity........ 6,203 6,432 12,012 12,334
Non-marketable equity securities.............. 3,947 3,947 3,810 3,810
Loans held-for-sale........................... 312 305 1,439 1,462
Net loans..................................... 265,436 265,810 229,198 232,404
Bank-owned life insurance..................... 7,906 7,906 7,585 7,585
Mortgage servicing rights..................... 552 637 582 582
Accrued interest receivable................... 2,531 2,531 2,823 2,823
Financial Liabilities
Deposits with no stated maturities............ 263,668 263,668 248,497 248,497
Deposits with stated maturities............... 202,820 203,152 190,142 193,253
Short-term borrowings......................... 13,374 13,374 10,416 10,416
Federal Home Loan Bank advances............... 55,000 58,656 55,000 58,751
Accrued interest payable...................... 1,179 1,179 1,285 1,285
The estimated fair value of QNB's off-balance sheet financial instruments is as
follows:
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
NOTIONAL AMOUNT ESTIMATED FAIR VALUE NOTIONAL AMOUNT ESTIMATED FAIR VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
Commitments to extend credit........................... $81,788 - $58,770 -
Standby letters of credit.............................. 3,637 - 5,632 -
The following methods and assumptions were used to estimate the fair value of
each major classification of financial instruments at December 31, 2004 and
2003.
CASH AND DUE FROM BANKS, FEDERAL FUNDS SOLD, BANK-OWNED LIFE INSURANCE, ACCRUED
INTEREST RECEIVABLE AND ACCRUED INTEREST PAYABLE: Current carrying amounts
approximate estimated fair value.
INVESTMENT SECURITIES: Quoted market prices were used to determine fair value.
NON-MARKETABLE EQUITY SECURITIES: The fair value of stock in Atlantic Central
Bankers Bank, the Federal Reserve Bank and the Federal Home Loan Bank is the
carrying amount.
LOANS AND MORTGAGE SERVICING RIGHTS: The fair value for loans and mortgage
servicing rights is estimated by discounting contractual cash flows and
adjusting for prepayment estimates. Discount rates are based upon rates
generally charged for such loans with similar characteristics.
DEPOSIT LIABILITIES: The fair value of deposits with no stated maturity (e.g.
demand deposits, interest-bearing demand accounts, money market accounts and
savings accounts) are by definition, equal to the amount payable on demand at
the reporting date (i.e. their carrying amounts). This approach to estimating
fair value excludes the significant benefit that results from the low-cost
funding provided by such deposit liabilities, as compared to alternative sources
of funding. Deposits with a stated maturity (time deposits) have been valued
using the present value of cash flows discounted at rates approximating the
current market for similar deposits.
SHORT-TERM BORROWINGS AND FEDERAL HOME LOAN BANK ADVANCES: Short-term borrowings
and advances from the Federal Home Loan Bank have been valued using the present
value of cash flows discounted at rates approximating the current market for
similar liabilities.
OFF-BALANCE-SHEET INSTRUMENTS: Off-balance-sheet instruments are primarily
comprised of loan commitments which are generally priced at market at the time
of funding. Fees on commitments to extend credit and standby letters of credit
are deemed to be immaterial and these instruments are expected to be settled at
face value or expire unused. It is impractical to assign any fair value to these
instruments.
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 - PARENT COMPANY FINANCIAL INFORMATION
Condensed financial statements of QNB Corp. only:
BALANCE SHEETS
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Assets
Cash and due from banks................................................................................. $ 6 $ 26
Investment securities available-for-sale................................................................ 3,869 3,501
Investment in subsidiary ............................................................................... 42,127 39,864
Other assets............................................................................................ 8 173
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets............................................................................................ $ 46,010 $43,564
====================================================================================================================================
Liabilities
Other liabilities....................................................................................... $ 235 $ 124
Shareholders' equity
Common stock ........................................................................................... 2,003 2,001
Surplus................................................................................................. 9,005 8,933
Retained earnings....................................................................................... 35,570 31,659
Accumulated other comprehensive income.................................................................. 691 2,341
Treasury stock.......................................................................................... (1,494) (1,494)
- ------------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity.............................................................................. 45,775 43,440
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity.............................................................. $ 46,010 $43,564
====================================================================================================================================
STATEMENTS OF INCOME
- ------------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Dividends from subsidiary............................................................. $ 2,182 $ 2,050 $ 1,913
Interest and dividend income.......................................................... 48 39 40
Securities gains (losses) ............................................................ 613 23 (663)
- ------------------------------------------------------------------------------------------------------------------------------------
Total income....................................................................... 2,843 2,112 1,290
Expenses........................................................................... 203 153 149
- ------------------------------------------------------------------------------------------------------------------------------------
Income before applicable income taxes and equity in undistributed income of subsidiary 2,640 1,959 1
Income taxes (benefit)................................................................ 144 (135) (197)
- ------------------------------------------------------------------------------------------------------------------------------------
Income before equity in undistributed income of subsidiary ........................... 2,496 2,094 1,338
Equity in undistributed income of subsidiary.......................................... 3,707 3,554 3,617
- ------------------------------------------------------------------------------------------------------------------------------------
Net income......................................................................... $ 6,203 $ 5,648 $ 4,955
====================================================================================================================================
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
STATEMENTS OF CASH FLOWS
- ------------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2004 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Net income......................................................................... $ 6,203 $ 5,648 $ 4,955
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed income from subsidiary................................... (3,707) (3,554) (3,617)
Securities (gains) losses ..................................................... (613) (23) 663
Decrease (increase) in other assets.............................................. 165 (173) -
Increase (decrease) in other liabilities......................................... 71 (9) (61)
Deferred income tax provision.................................................... 147 50 (136)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities...................................... 2,266 1,939 1,804
- ------------------------------------------------------------------------------------------------------------------------------------
Investing Activities
Purchase of investment securities.................................................. (1,623) (744) (695)
Proceeds from sale of investment securities........................................ 1,555 699 686
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities.......................................... (68) (45) (9)
- ------------------------------------------------------------------------------------------------------------------------------------
Financing Activities
Cash dividends paid................................................................ (2,292) (2,042) (1,848)
Stock issue........................................................................ 74 142 84
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used by financing activities.......................................... (2,218) (1,900) (1,764)
- ------------------------------------------------------------------------------------------------------------------------------------
(Decrease) increase in cash and cash equivalents............................... (20) (6) 31
Cash and cash equivalents at beginning of year................................. 26 32 1,141
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year....................................... $ 6 $ 26 $ 32
====================================================================================================================================
Supplemental Cash Flow Disclosure
Non-Cash Transactions
Change in net unrealized holding gains or losses,
net of taxes on investment securities $ (207) $ 596 $ (51)
NOTE 20 - REGULATORY RESTRICTIONS
Dividends payable by the Corporation and the Bank are subject to various
limitations imposed by statutes, regulations and policies adopted by bank
regulatory agencies. Under current regulations regarding dividend availability,
the Bank may declare dividends in 2005 to the Corporation totaling $7,261,000,
plus additional amounts equal to the net profit earned by the Bank for the
period from January 1, 2005, through the date of declaration, less dividends
previously declared in 2005.
Both the Corporation and the Bank are subject to regulatory capital requirements
administered by Federal banking agencies. Failure to meet minimum capital
requirements can initiate actions by regulators that could have an effect on the
financial statements. Under the framework for prompt corrective action, both the
Corporation and the Bank must meet capital guidelines that involve quantitative
measures of their assets, liabilities, and certain off-balance-sheet items. The
capital amounts and classification are also subject to qualitative judgments by
the regulators. Management believes, as of December 31, 2004, that the
Corporation and the Bank meet all capital adequacy requirements to which it is
subject.
As of the most recent notification, the Federal Reserve Bank and the Comptroller
of the Currency considered the Corporation and the Bank to be "well capitalized"
under the regulatory framework. There are no conditions or events since that
notification that management believes have changed the classification. To be
categorized as well capitalized, the Corporation and the Bank must maintain
minimum ratios set forth in the table below. The Corporation and the Bank's
actual capital amounts and ratios are presented as follows:
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPITAL LEVELS
- ------------------------------------------------------------------------------------------------------------------------------------
ACTUAL ADEQUATELY CAPITALIZED WELL CAPITALIZED
AS OF DECEMBER 31, 2004 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ------------------------------------------------------------------------------------------------------------------------------------
Total risk-based capital (to risk weighted assets):1
Consolidated.................................... $46,532 12.98% $ 28,673 8.00% $35,841 10.00%
Bank............................................ 42,885 12.10 28,362 8.00 35,453 10.00
Tier I capital (to risk weighted assets):1
Consolidated.................................... 43,920 12.25 14,336 4.00 21,504 6.00
Bank............................................ 40,273 11.36 14,181 4.00 21,272 6.00
Tier I capital (to average assets):1
Consolidated.................................... 43,920 7.44 23,614 4.00 29,517 5.00
Bank............................................ 40,273 6.86 23,481 4.00 29,351 5.00
- ------------------------------------------------------------------------------------------------------------------------------------
CAPITAL LEVELS
- ------------------------------------------------------------------------------------------------------------------------------------
ACTUAL ADEQUATELY CAPITALIZED WELL CAPITALIZED
AS OF DECEMBER 31, 2003 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ------------------------------------------------------------------------------------------------------------------------------------
Total risk-based capital (to risk weighted assets):1
Consolidated.................................... $43,806 13.39% $ 26,179 8.00% $32,724 10.00%
Bank............................................ 40,230 12.43 25,885 8.00 32,356 10.00
Tier I capital (to risk weighted assets):1
Consolidated.................................... 40,877 12.49 13,090 4.00 19,635 6.00
Bank............................................ 37,301 11.53 12,943 4.00 19,414 6.00
Tier I capital (to average assets):1
Consolidated.................................... 40,877 7.38 22,169 4.00 27,711 5.00
Bank............................................ 37,301 6.77 22,045 4.00 27,556 5.00
- ------------------------------------------------------------------------------------------------------------------------------------
1 As defined by the regulators
NOTE 21 - CONSOLIDATED QUARTERLY FINANCIAL DATA
The unaudited quarterly results of operations for the years ended 2004 and 2003
are in the following table:
- ------------------------------------------------------------------------------------------------------------------------------------
QUARTERS ENDED 2004 QUARTERS ENDED 2003
MARCH 31 JUNE 30 SEPT. 30 DEC. 31 MARCH 31 JUNE 30 SEPT. 30 DEC. 31
- ------------------------------------------------------------------------------------------------------------------------------------
Interest income........................... $ 6,136 $ 6,172 $ 6,519 $ 6,744 $6,333 $6,241 $6,203 $6,362
Interest expense.......................... 2,210 2,219 2,425 2,652 2,505 2,471 2,405 2,373
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income....................... 3,926 3,953 4,094 4,092 3,828 3,770 3,798 3,989
Provision for loan losses................. - - - - - - - -
Non-interest income....................... 1,370 1,173 991 1,153 1,238 1,426 938 598
Non-interest expense...................... 3,078 3,181 3,246 3,340 3,079 3,077 3,206 3,321
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes ............... 2,218 1,945 1,839 1,905 1,987 2,119 1,530 1,266
Provision for income taxes ............... 496 426 386 396 456 489 118 191
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME................................ $ 1,722 $ 1,519 $ 1,453 $ 1,509 $1,531 $1,630 $1,412 $1,075
====================================================================================================================================
NET INCOME PER SHARE - BASIC.............. $ .56 $ .49 $ .47 $ .49 $ .50 $ .53 $ .46 $ .35
====================================================================================================================================
NET INCOME PER SHARE - DILUTED............ $ .54 $ .48 $ .46 $ .47 $ .49 $ .52 $ .45 $ .34
====================================================================================================================================
58
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On August 16, 2004, QNB Corp. (QNB) retained S.R. Snodgrass, A.C. (Snodgrass) as
its new independent accountants to audit QNB's financial statements for the
fiscal year ended December 31, 2004. KPMG LLP (KPMG) was dismissed on August 16,
2004. The decision to change independent accountants was recommended and
approved by the Audit Committee of QNB.
During each of the fiscal years ended December 31, 2002 and 2003, none of KPMG's
reports on the financial statements of QNB contained an adverse opinion or a
disclaimer of opinion or was qualified or modified as to uncertainty, audit
scope or accounting principle and there were no disagreements between QNB and
KPMG on any matter of accounting principles and practices, financial statement
disclosure, or audit scope or procedure, which disagreement, if not resolved to
the satisfaction of KPMG would have caused it to make reference to the subject
matter of the disagreement in connection with its reports. There were no
"reportable events" as that term is defined in Item 304 (a) (1) (v) of
Regulation S-K occurring within QNB in the two most recent fiscal years.
During QNB's two most recent fiscal years, QNB has not consulted with Snodgrass
regarding any of the matters or events set forth in Item 304 (a) (2) of
Regulation S-K.
QNB provided KPMG with a copy of the foregoing disclosures and requested that
KPMG review such disclosures. KPMG provided a letter addressed to the Securities
and Exchange Commission stating that they agree with such statements.
ITEM 9A. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
QNB's principal executive officer and principal financial officer, after
evaluating, together with management, the effectiveness of the design and
operation of QNB's disclosure controls and procedures (as defined in Exchange
Act Rules 13a-15(e) and 15d-15(e)) as of December 31, 2004, the end of the
period covered by this report, have concluded that, as of such date, QNB's
disclosure controls and procedures were adequate and effective to ensure that
material information relating to QNB and our consolidated subsidiaries would be
made known to them by others within those entities.
QNB expects to conclude its testing and evaluation of internal controls over
financial reporting and management's assessment of such control prior to filing
its amended annual report on Form 10-K/A with the 45-day period provided by the
exemptive order issued by the Securities and Exchange Commission on November 30,
2004. The Form 10-K/A will include a management report and auditor report on the
Company's internal control over financial reporting.
INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no changes in QNB's internal control over financial reporting that
occurred during the fourth quarter of 2004 that have materially affected, or are
reasonably likely to materially affect, QNB's internal control over financial
reporting.
ITEM 9B. OTHER INFORMATION
None.
59
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is incorporated by reference to information
appearing in QNB Corp.'s definitive proxy statement to be used in connection
with the 2005 Annual Meeting of Shareholders under the captions
o "Election of Directors"
o "Governance of the Company"
o "Section 16(a) Beneficial Ownership Compliance"
o "Meetings and Committees of the Board of Directors of QNB and the
Bank"
o "Executive Officers of QNB and/or the Bank"
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated by reference to the
information appearing in QNB Corp.'s definitive proxy statement to be used in
connection with the 2005 Annual Meeting of Shareholders under the captions
o "Compensation of the Board of Directors"
o "Executive Compensation"
o "Compensation Committee Interlocks and Insider Participation"
o "Stock Performance Graph"
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated by reference to the
information appearing in QNB Corp.'s definitive proxy statement to be used in
connection with the 2005 Annual Meeting of Shareholders under the captions
o "Security Ownership of Management"
o "Equity Compensation Plan Information"
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
The information required by Item 13 is incorporated by reference to the
information appearing under the caption "Certain Relationships and Related Party
Transactions" in QNB Corp.'s definitive proxy statement to be used in connection
with the 2005 Annual Meeting of Shareholders.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by Item 14 is incorporated by reference to the
information appearing in QNB Corp.'s definitive proxy statement to be used in
connection with the 2005 Annual Meeting of Shareholders under the captions
o "Audit Committee Pre-Approval of Audit and Permissible Non-Audit
Services of Independent Auditors"
o "Audit Fees, Audit Related Fees, Tax Fees, and All Other Fees"
60
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) 1. Financial Statements
The following financial statements are included by reference in Part II,
Item 8 hereof.
Independent Registered Public Accounting Firm's Report
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Cash Flows
Consolidated Statements of Changes in Shareholders' Equity
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
The financial statement schedules required by this Item are omitted
because the information is either inapplicable, not required or is in the
consolidated financial statements as a part of this Report.
3. The following exhibits are incorporated by reference herein or
annexed to this Form 10-K:
3(i)- Articles of Incorporation of Registrant, as amended. (Incorporated
by reference to Exhibit 3(i) of Registrant's Form 10-K filed with
the Commission on March 30, 2004.)
3(ii)- By-laws of Registrant, as amended. (Incorporated by reference to
Exhibit 3(ii) of Registrant's Form 10-K filed with the Commission
on March 30, 2004.)
10.1- Employment Agreement between the Registrant and Thomas J. Bisko.
(Incorporated by reference to Exhibit 10.1 of Registrant's Form
10-Q filed with the Commission on November 15, 2004.)
10.2- Salary Continuation Agreement between the Registrant and Thomas J.
Bisko. (Incorporated by reference to Exhibit 10.2 of Registrant's
Form 10-Q filed with the Commission on November 15, 2004.)
10.3- QNB Corp. 1998 Stock Incentive Plan. (Incorporated by reference to
Exhibit 4.3 to Registration Statement No. 333-91201 on Form S-8,
filed with the Commission on November 18, 1999.)
10.4- The Quakertown National Bank Retirement Savings Plan. (Incorporated
by reference to Exhibit 10.4 of Registrant's Form 10-Q filed with
the Commission on August 14, 2003.)
10.5- Change of Control Agreement between Registrant and Robert C.
Werner. (Incorporated by reference to Exhibit 10.7 of Registrant's
Form 10-Q filed with the Commission on November 13, 2000.)
10.6- Change of Control Agreement between Registrant and Bret H.
Krevolin. (Incorporated by reference to Exhibit 10.7 of
Registrant's Form 10-Q filed with the Commission on November 13,
2000.)
10.7- QNB Corp. 2001 Employee Stock Purchase Plan. (Incorporated by
reference to Exhibit 99.1 to Registration Statement No. 333- 67588
on Form S-8, filed with the Commission on August 15, 2001).
61
11- Statement re: Computation of Earnings per Share as found on page 45
of Form 10-K, which is included herein.
12- Statement re: Computation of Ratios as found on page 10 of Form
10-K, which is included herein.
14- Registrant's Code of Ethics. (Incorporated by reference to Exhibit
14 of Registrant's Form 10-K filed with the Commission on March 30,
2004.)
21- Subsidiaries of the Registrant.
23.1- Consent of S.R. Snodgrass, A.C., Independent Registered Public
Accounting Firm
23.2- Consent of KPMG LLP, Independent Registered Public Accounting Firm
31.1- Rule 13a-14(a)/15d-14(a) Certification of the CEO.
31.2- Rule 13a-14(a)/15d-14(a) Certification of the CFO.
32.1- ss.1350 Certification of Principal Executive Officer.
32.2- ss.1350 Certification of Principal Financial Officer.
62
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
QNB Corp.
March 15, 2005
BY: /s/ Thomas J. Bisko
-------------------
Thomas J. Bisko
President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report is signed below by the following persons on behalf of the Registrant
and in the capacities and on the dates indicated.
/s/ Thomas J. Bisko President, Chief Executive March 15, 2005
------------------- Officer and Director
Thomas J. Bisko
/s/ Robert C. Werner Vice President March 15, 2005
--------------------
Robert C. Werner
/s/ Bret H. Krevolin Chief Financial Officer March 15, 2005
-------------------- and Principal Accounting Officer
Bret H. Krevolin
/s/ Norman L. Baringer Director March 15, 2005
----------------------
Norman L. Baringer
/s/ Kenneth F. Brown Jr. Director March 15, 2005
--------------------------
Kenneth F. Brown Jr.
/s/ Dennis Helf Director, Chairman March 15, 2005
---------------
Dennis Helf
/s/ G. Arden Link Director March 15, 2005
-----------------
G. Arden Link
Charles M. Meredith, III Director
/s/ Anna Mae Papso Director March 15, 2005
------------------
Anna Mae Papso
/s/ Gary S. Parzych Director March 15, 2005
-------------------
Gary S. Parzych
/s/ Henry L. Rosenberger Director March 15, 2005
------------------------
Henry L. Rosenberger
/s/ Edgar L. Stauffer Director March 15, 2005
-----------------------
Edgar L. Stauffer
63
QNB CORP.
FORM 10-K
FOR YEAR ENDED DECEMBER 31, 2004
EXHIBIT INDEX
Exhibit
3(i)- Articles of Incorporation of Registrant, as amended. (Incorporated
by reference toExhibit 3(i) of Registrant's Form 10-K filed with
the Commission on March 30, 2004.)
3(ii)- By-laws of Registrant, as amended. (Incorporated by reference to
Exhibit 3(ii) of Registrant's Form 10-K filed with the Commission
on March 30, 2004.)
10.1- Employment Agreement between the Registrant and Thomas J. Bisko.
(Incorporated by reference to Exhibit 10.1 of Registrant's Form
10-Q filed with the Commission on November 15, 2004.)
10.2- Salary Continuation Agreement between the Registrant and Thomas J.
Bisko. (Incorporated by reference to Exhibit 10.2 of Registrant's
Form 10-Q filed with the Commission on November 15, 2004.)
10.3- QNB Corp. 1998 Stock Incentive Plan. (Incorporated by reference to
Exhibit 4.3 to Registration Statement No. 333-91201 on Form S-8,
filed with the Commission on November 18, 1999.)
10.4- The Quakertown National Bank Retirement Savings Plan. (Incorporated
by reference to Exhibit 10.4 of Registrants Form 10-Q filed with
the Commission on August 14, 2003)
10.5- Change of Control Agreement between Registrant and Robert C.
Werner. (Incorporated by reference to Exhibit 10.7 of Registrant's
Form 10-Q filed with the Commission on November 13, 2000.)
10.6- Change of Control Agreement between Registrant and Bret H.
Krevolin. (Incorporated by reference to Exhibit 10.7 of
Registrant's Form 10-Q filed with the Commission on November 13,
2000.)
10.7- QNB Corp. 2001 Employee Stock Purchase Plan. (Incorporated by
reference to Exhibit 99.1 to Registration Statement No. 333- 67588
on Form S-8, filed with the Commission on August 15, 2001).
11- Statement re: Computation of Earnings per Share as found on page 45
of Form 10-K, which is included herein.
12- Statement re: Computation of Ratios as found on page 10 of Form
10-K, which is included herein.
14- Registrant's Code of Ethics. (Incorporated by reference to Exhibit
14 of Registrant's Form 10-K filed with the Commission on March 30,
2004.)
21- Subsidiaries of the Registrant.
23.1- Consent of S.R. Snodgrass, A.C., Independent Registered Public
Accounting Firm
23.2- Consent of KPMG LLP, Independent Registered Public Accounting Firm
31.1- Rule 13a-14(a)/15d-14(a) Certification of the CEO.
31.2- Rule 13a-14(a)/15d-14(a) Certification of the CFO.
32.1- ss.1350 Certification of Principal Executive Officer.
32.2- ss.1350 Certification of Principal Financial Officer.
64