QNB CORP - Annual Report: 2006 (Form 10-K)
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, 2006
|
| o |
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
for
the transition period from ____________________ to
____________________
|
Commission
file number 0-17706
(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 if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securites Act. YES
o NO
þ
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. YES o NO
þ
Note
-
Checking the box above will not relieve any registrant required to file reports
pursuant to Section 13 or 15(d) of the Exchange Act from their obligations
under
those Sections.
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 þ NO
o
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. o
Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large
accelerated filer o Accelerated
filer þ Non-accelerated
filer
o
Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). YES o NO
þ
As
of
March 1, 2007, 3,128,598 shares of Common Stock of the Registrant were
outstanding. As of June 30, 2006, the aggregate market value of the Common
Stock
of the Registrant held by nonaffiliates was approximately $72,223,588 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 for the annual meeting of its shareholders to be
held May 15, 2007 are incorporated by reference in Part III of this
report.
|
PAGE
|
||
|
3
|
||
|
7
|
||
|
10
|
||
|
10
|
||
|
10
|
||
|
10
|
||
|
11
|
||
|
13
|
||
|
13
|
||
|
38
|
||
|
41
|
||
|
65
|
||
|
65
|
||
|
66
|
||
|
67
|
||
|
67
|
||
|
67
|
||
|
67
|
||
|
67
|
||
|
68
|
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
a 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 are incorporated 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 the
forward-looking statements contained or incorporated by reference in this
document. These factors include, but are not limited, to the
following:
|
•
|
Volatility
in interest rates and shape of the yield
curve;
|
|
•
|
Increased
credit risk;
|
|
•
|
Operating,
legal and regulatory risks;
|
|
•
|
Economic,
political and competitive forces affecting the Corporation’s line of
business; and
|
|
•
|
The
risk that the analysis of these risks and forces could be incorrect,
and/or that the strategies developed to address them could be
unsuccessful.
|
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 actual results or circumstances for
future periods to differ materially from those anticipated or projected. Except
as required by law, QNB does not undertake, and specifically disclaims 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
was
incorporated under the laws of the Commonwealth of Pennsylvania on June 4,
1984.
QNB 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 Bank).
The
Bank
is a national banking association organized in 1877. The Bank is chartered
under
the National Banking Act and is subject to federal and state laws applicable
to
commercial banks. The Bank’s principal office is located in Quakertown, Bucks
County, Pennsylvania. The Bank also operates seven other full-service community
banking offices in Bucks, Montgomery and Lehigh counties in southeastern
Pennsylvania.
The
Bank
is engaged in the general commercial banking business and provides a full range
of banking 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.
At
December 31, 2006, QNB had total assets of $614,539,000, total loans of
$343,496,000, total deposits of $478,922,000 and total shareholders’ equity of
$50,410,000. For the year ended December 31, 2006, QNB reported net income
of
$5,420,000 compared to net income for the year ended December 31, 2005 of
$5,046,000, an increase of 7.4 percent.
At
March
1, 2007, the Bank had 138 full-time employees and 34 part-time employees. The
Bank’s 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 people in the
communities in which they serve, responding to changes in market conditions
and
customer requests in a timely manner.
Competition
and Market Area
The
banking business is highly competitive, and the profitability of QNB depends
principally upon the Bank’s ability to compete in its market area. QNB faces
intense competition within its 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, credit unions and on-line
banks. Some of QNB’s competitors offer products and services that QNB currently
does not offer, such as traditional trust and full-service insurance. However,
QNB has been able to compete effectively with other financial institutions
by
emphasizing the establishment of long-term relationships and customer loyalty.
A
strong focus on small-business solutions, providing fast local decision-making
on loans, exceptional personal customer service and up-to-date technology
solutions, including internet-banking and electronic bill pay, also enable
QNB
to compete successfully.
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 convenient locations
and
hours of operation, attractive rates, low fees, and alternative delivery
systems. One such delivery system is a courier service offered to businesses
to
assist in their daily banking needs without having to leave their workplace.
Successful loan origination tends to depend on being responsive and flexible
to
the customer’s needs, as well as the interest rate and terms of the loan. While
many competitors within the Bank’s primary market have substantially higher
legal lending limits, QNB often has the ability, through loan participations,
to
meet the larger lending needs of its customers.
QNB’s
success is dependent to a significant degree on economic conditions in eastern
Pennsylvania, especially upper Bucks, southern Lehigh and northern Montgomery
counties, which it defines as its primary market. The banking industry is
affected by general economic conditions, including the effects of inflation,
recession, unemployment, real estate values and trends in the national and
global economies, and other factors beyond QNB’s 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 subsidiary 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 (FDIA). In general, these statutes regulate the
corporate governance of the Bank and eligible business activities of QNB,
certain acquisition and merger restrictions, intercompany transactions, such
as
loans and dividends, and capital adequacy, among other restrictions. Other
corporate governance requirements are imposed on QNB by federal laws, including
the Sarbanes-Oxley Act, described later.
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 and the Business Corporation Law of 1988, as amended.
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 to commit its resources to
provide adequate capital funds to the Bank during periods of financial distress
or adversity.
Federal
Reserve approval may be required before QNB 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 the Bank. Under the National
Bank Act, the Bank is required to obtain the prior approval of the Office of
the
Comptroller of the Currency (OCC) for the payment of dividends, if 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, which is considered Tier
2
capital. At December 31, 2006, QNB’s Tier 1 capital and total (Tier 1 and Tier 2
combined) capital ratios were 13.15 percent and 13.91 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, 2006, QNB’s
leverage ratio was 8.42 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:
|
•
|
Total
risk-based capital ratio of 10 percent or
more,
|
|
•
|
Tier
1 risk-based capital ratio of 6 percent or
more,
|
|
•
|
Leverage
ratio of 5 percent or more, and
|
|
•
|
Not
subject to any order or written directive to meet and maintain a
specific
capital level
|
At
December 31, 2006, QNB 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 Bank are subject to federal and state statutes applicable
to
banks chartered under the banking laws of the United States, including the
National Bank Act, to members of the Federal Reserve System, and to banks whose
deposits are insured by the Federal Deposit Insurance Corporation (FDIC). These
operations are also subject to regulations of the OCC, the Federal Reserve,
and
the FDIC.
The
OCC,
which has primary supervisory authority over the Bank, regularly examines banks
in such areas as loans and the allowance for loan losses, investments,
management practices, regulatory compliance and other aspects of operations.
These examinations are designed for the protection of depositors rather than
QNB’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 FDIA, 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 Bank is subject to certain
restrictions imposed by the Federal Reserve Act on extensions of credit to
QNB
on investments in the stock or other securities of QNB, and on taking such
stock
or securities as collateral for loans.
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 and
loans, the rate of interest earned and paid and levels of liquidity and
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
Bank
is subject to deposit insurance assessments by the FDIC based on the risk
classification of the Bank. The Bank was not subject to any regular insurance
assessments by the FDIC in 2006. In 2006, the FDIC approved the reinstatement
of
regular insurance assessments effective January 1, 2007. The assessments will
be
determined using a risk-based system. Using the information currently available,
it is estimated that the assessment for the Bank will be approximately $.052
per
$100 of deposits in 2007. The FDIC is providing a credit to institutions that
paid assessments in the past which can be used to offset their regular insurance
assessments in future years. The Bank has an estimated credit of $340,000 which
should be sufficient to cover the 2007 assessment.
Insured
deposits are also assessed to fund debt service on certain related federal
government bonds. The total assessment paid by the Bank in 2006 to fund this
debt service was $57,000.
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
such institutions for, among other things:
|
•
|
Approval
of a branch or other deposit
facility;
|
|
•
|
An
office relocation or a merger; and
|
|
•
|
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. The Bank’s
most recent CRA rating was satisfactory.
Monetary
and Fiscal Policies
The
financial services industry, including QNB and the 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
The
USA
Patriot Act strengthens the 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
Bank must have procedures in place to:
|
•
|
Verify
the identity of persons applying to open an
account,
|
|
•
|
Ensure
adequate maintenance of the records used to verify a person’s identity,
and
|
|
•
|
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 USA Patriot Act.
Sarbanes-Oxley
Act of 2002
The
Sarbanes-Oxley Act is intended to bolster public confidence in the 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:
|
•
|
Corporate
Responsibility for Financial Reports - requires Chief Executive Officers
(CEOs) and Chief Financial Officers (CFOs) to personally certify
and be
accountable for their Company’s financial records and accounting and
internal controls.
|
|
•
|
Management
Assessment of Internal Controls - requires auditors to certify the
Company’s underlying controls and processes that are used to compile the
financial results.
|
|
•
|
Real-time
Issuer Disclosures - requires that companies provide real-time disclosures
of any events that may affect its stock price or financial performance,
generally within a 48-hour period.
|
|
•
|
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,
accounting standards, audit committee member independence and increased
authority, executive compensation, insider loans and whistleblower protection.
As a result of the Act, QNB adopted a Code of Business Conduct and Ethics
applicable to its CEO, CFO and Controller, which meets the requirements of
the
Act, to supplement its long-standing Code of Ethics, which applies to all
directors and employees.
QNB’s
Code of Business Conduct and Ethics can be found on the Corporation’s website at
www.qnb.com.
Additional
Information
QNB’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, that
file
electronically with the SEC which can be accessed at www.sec.gov.
QNB
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 the website is not a part of, and should not
be
incorporated into, this annual report on Form 10-K.
| ITEM 1A. |
RISK
FACTORS
|
The
following discusses risks that management believes are specific to our business
and could have a negative impact on QNB’s financial performance. When analyzing
an investment in QNB, the risks and uncertainties described below, together
with
all of the other information included or incorporated by reference in this
report should be carefully considered. This list should not be viewed as
comprehensive and may not include all risks that may affect the financial
performance of QNB:
Interest
Rate Risk
QNB’s
profitability is largely a function of the spread between the interest rates
earned on earning assets and the interest rates paid on deposits and other
interest-bearing liabilities. Like most financial institutions, QNB’s net
interest income and margin will be affected by general economic conditions
and
other factors, including fiscal and monetary policies of the federal government,
that influence market interest rates and QNB’s ability to respond to changes in
such rates. At any given time, QNB’s assets and liabilities may be such that
they are affected differently by a change in interest rates. As a result, an
increase or decrease in rates, the length of loan terms or the mix of
adjustable- and fixed- rate loans or investment securities in QNB’s portfolio
could have a positive or negative effect on its net income, capital and
liquidity. Although management believes it has implemented strategies and
guidelines to reduce the potential effects of adverse changes in interest rates
on results of operations, any substantial and prolonged change in market
interest rates could negatively affect operating results.
The
yield
curve for the various maturities of U. S. Treasury securities provides a
fundamental barometer that gauges the prevailing interest rate profile and,
simultaneously, acts as a guidepost for current loan and deposit pricing
constraints. The slope of the yield curve is driven primarily by expectations
for future interest rate increases and inflationary trends. A normal yield
curve
has a slope that reflects lower costs for shorter-term financial instruments,
accompanied by increases in costs for longer term instruments all along the
maturity continuum.
Short-term
interest rates are highly influenced by the monetary policy of the Federal
Reserve Bank. The Federal Open Market Committee, a committee of the Federal
Reserve Bank, targets the federal funds rate, the overnight rate at which banks
borrow or lend excess funds between financial institutions. This rate serves
as
a benchmark for the overnight money costs, and correspondingly influences the
pricing of a significant portion of a bank’s deposit funding sources.
Intermediate- and longer-term interest rates, unlike the federal funds rate,
are
more directly influenced by external market forces, including perceptions about
future interest rates and inflation. These trends, in turn, influence the
pricing on mid- and long-term loan commitments as well as deposits and bank
borrowings that have scheduled maturities.
Generally
speaking, a yield curve with a higher degree of slope provides more opportunity
to increase the spread between earning asset yields and funding costs. It should
be emphasized that while the yield curve is a critical benchmark in setting
prices for various monetary assets and liabilities in banks, its influence
is
not exerted in a vacuum. Credit risk, market risk, competitive issues, and
other
factors must all be considered in the pricing of financial
instruments.
A
steep
or highly-sloped yield curve may be a precursor of higher interest rates or
elevated inflation in the future, while a flat yield curve may be characteristic
of a Federal Reserve Bank policy designed to calm an overheated economy by
tightening credit availability via increases in short-term rates. If other
rates
along the maturity spectrum do not rise correspondingly, the yield curve can
be
expected to flatten. This scenario may reflect an economic outlook that has
little or no expectation of higher future interest rates or higher rates of
inflation. For banks, the presence of a flat yield curve for a prolonged or
sustained period could measurably lower expectations for expanding net interest
income.
An
inverted yield curve is the opposite of a normal yield curve and is
characterized by short-term rates that are higher than longer-term rates. The
presence of an inverted yield curve is considered to be an anomaly that is
almost counterintuitive to the core business of banking. Inverted yield curves
do not typically exist for more than a short period of time. In past economic
cycles, the presence of an inverted yield curve has frequently foreshadowed
a
recession. The possibility of recession may suppress future asset growth trends
and/or increase the influence of other forms of risk, such as credit risk,
which
could hamper opportunities for revenue expansion and earnings growth in the
near
term.
Credit
Risk
As
a
lender, QNB is exposed to the risk that its borrowers may be unable to repay
their loans and that any collateral securing the payment of their loans may
not
be sufficient to assure repayment in full. Credit losses are inherent in the
lending business and could have a material adverse effect on the operating
results of QNB. Adverse changes in the economy or business conditions, either
nationally or in QNB’s market areas, could increase credit-related losses and
expenses and/or limit growth. Substantially all of QNB’s loans are to businesses
and individuals in its limited geographic area and any economic decline in
this
market could impact QNB adversely. QNB makes various assumptions and judgments
about the collectibility of its loan portfolio and provides an allowance for
loan losses based on a number of factors. If these assumptions are incorrect,
the allowance for loan losses may not be sufficient to cover losses and may
cause QNB to increase the allowance in the future by increasing the provision
for loan losses, thereby having an adverse effect on operating results. QNB
has
adopted underwriting and credit monitoring procedures and credit policies that
management believes are appropriate to control these risks, however, such
policies and procedures may not prevent unexpected losses that could have a
material adverse affect on QNB’s financial condition or results of
operations.
Competition
The
financial services industry is highly competitive with competition for
attracting and retaining deposits and making loans coming from other banks
and
savings institutions, credit unions, mutual fund companies, insurance companies
and other non-bank businesses. Many of QNB’s competitors are much larger in
terms of total assets and market capitalization, have a higher lending limit,
have greater access to capital and funding, and offer a broader array of
financial products and services. In light of this, QNB’s ability to continue to
compete effectively is dependent upon its ability to maintain and build
relationships by delivering top quality service.
At
December 31, 2006, our lending limit per borrower was approximately $7,500,000,
or approximately 15 percent of our capital. Accordingly, the size of loans
that
we can offer to potential borrowers (without participation by other lenders)
is
less than the size of loans that many of our competitors with larger
capitalization are able to offer. Our legal lending limit also impacts the
efficiency of our lending operation because it tends to lower our average loan
size, which means we have to generate a higher number of transactions to achieve
the same portfolio volume. We may engage in loan participations with other
banks
for loans in excess of our legal lending limits. However, there can be no
assurance that such participations will be available at all or on terms which
are favorable to us and our customers.
Impairment
Risk
QNB
regularly purchases U.S. Government and U.S. Government agency debt securities,
U.S. Government agency issued mortgage-backed securities or collateralized
mortgage obligation securities (CMOs), corporate debt securities and equity
securities. QNB is exposed to the risk that the issuers of these securities
may
experience significant deterioration in credit quality which could impact the
market value of the issue. QNB periodically evaluates its investments to
determine if market value declines are other-than-temporary. Once a decline
is
determined to be other-than-temporary, the value of the security is reduced
and
a corresponding charge to earnings is recognized.
Third
Party Risk
Third
parties provide key components of the business infrastructure such as internet
connections and network access. Any disruption in internet, network access
or
other voice or data communication services provided by these third parties
or
any failure of these third parties to handle current or higher volumes of use
could adversely affect the ability to deliver products and services to clients
and otherwise to conduct business. Technological or financial difficulties
of a
third party service provider could adversely affect the business to the extent
those difficulties result in the interruption or discontinuation of services
provided by that party.
Technology
Risk
The
market for financial services is increasingly affected by advances in
technology, including developments in telecommunications, data processing,
computers, automation, Internet-based banking and telebanking. Our ability
to
compete successfully in our markets may depend on the extent to which we are
able to exploit such technological changes. However, we can provide no assurance
that we will be able properly or timely to anticipate or implement such
technologies or properly train our staff to use such technologies. Any failure
to adapt to new technologies could adversely affect our business, financial
condition or operating results.
Changes
in accounting standards
Our
accounting policies and methods are fundamental to how we record and report
our
financial condition and results of operations. From time to time the Financial
Accounting Standards Board (FASB) changes the financial accounting and reporting
standards that govern the preparation of our financial statements. These changes
can be hard to predict and can materially impact how we record and report our
financial condition and results of operations. In some cases, we could be
required to apply a new or revised standard retroactively, resulting in our
restating prior period financial statements.
Government
Regulation and Supervision
The
banking industry is heavily regulated under both federal and state law. Banking
regulations, designed primarily for the safety of depositors, may limit a
financial institution’s growth and the return to its investors, by restricting
such activities as the payment of dividends, mergers with or acquisitions by
other institutions, expansion of branch offices and the offering of securities.
QNB is also subject to capitalization guidelines established by federal law
and
could be subject to enforcement actions to the extent that its subsidiary bank
is found, by regulatory examiners, to be undercapitalized. It is difficult
to
predict what changes, if any, will be made to existing federal and state
legislation and regulations or the effect that such changes may have on QNB’s
future business and earnings prospects. Any substantial changes to applicable
laws or regulations could subject QNB to additional costs, limit the types
of
financial services and products it may offer, and inhibit its ability to compete
with other financial service providers.
Internal
and Controls and Procedures
Management
diligently reviews and updates its internal controls, disclosure controls and
procedures, and corporate governance policies and procedures. Our disclosure
controls and procedures are designed to reasonably assure that information
required to be disclosed by QNB in reports we file or submit under the Exchange
Act is accumulated and communicated to management, and recorded, processed,
summarized, and reported within the time periods specified in the SEC’s rules
and forms. We believe that any disclosure controls and procedures or internal
controls and procedures, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. Any undetected circumvention of these controls could have a
material adverse impact on QNB’s financial condition and results of
operations.
These
inherent limitations include the realities that judgments in decision-making
can
be faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people or by an unauthorized override
of
the controls. Accordingly, because of the inherent limitations in our control
system, misstatements due to error or fraud may occur and not be detected.
Attracting
and Retaining Skilled Personnel
Our
success depends upon the ability to attract and retain highly motivated,
well-qualified personnel. We face significant competition in the recruitment
of
qualified employees. Our ability to execute our business strategy and provide
high quality service may suffer if we are unable to recruit or retain a
sufficient number of qualified employees or if the costs of employee
compensation or benefits increase substantially. QNB currently has employment
agreements and change of control agreements with several of its senior
officers.
| ITEM 1B. |
UNRESOLVED
STAFF COMMENTS
|
None.
| 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 a computer facility. The Quakertown National Bank leases its
remaining five retail properties. The leases on the properties generally contain
renewal options. In management’s opinion, these properties are in good condition
and are currently adequate for QNB’s purposes.
The
following table details The Quakertown National Bank’s properties:
|
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 Avenue
|
|
|
|
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
|
| ITEM 3. |
LEGAL
PROCEEDINGS
|
Although
there is currently no litigation to which QNB is the subject, future litigation
that arises during the normal course of QNB’s business could be material and
have a negative impact on QNB’s earnings. Future litigation also could adversely
impact the reputation of QNB in the communities that it serves.
| ITEM 4. |
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY
HOLDERS
|
None.
| ITEM 5. |
MARKET
FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
|
Stock
Information
QNB
common stock is traded in the over-the-counter (OTC) market. Quotations for
QNB
common stock appear in the pink sheets published by the National Quotations
Bureau, Inc. QNB had approximately 1,160 shareholders of record as of March
1,
2007.
The
following table sets forth the high and low bid and ask stock prices for QNB
common stock on a quarterly basis during 2006 and 2005. These prices reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may
not
necessarily represent actual transactions.
|
|
Cash
|
|||||||||||||||
|
High
|
Low
|
Dividend
|
||||||||||||||
|
Bid
|
Ask
|
Bid
|
Ask
|
Per
Share
|
||||||||||||
|
2006
|
||||||||||||||||
|
First
Quarter
|
$
|
27.00
|
$
|
28.00
|
$
|
25.10
|
$
|
25.50
|
$
|
.21
|
||||||
|
Second
Quarter
|
26.35
|
29.00
|
25.85
|
26.00
|
.21
|
|||||||||||
|
Third
Quarter
|
26.50
|
29.00
|
24.35
|
24.50
|
.21
|
|||||||||||
|
Fourth
Quarter
|
26.75
|
27.50
|
24.40
|
25.25
|
.21
|
|||||||||||
|
2005
|
||||||||||||||||
|
First
Quarter
|
$
|
32.35
|
$
|
33.25
|
$
|
31.00
|
$
|
31.45
|
$
|
.195
|
||||||
|
Second
Quarter
|
31.25
|
31.80
|
30.50
|
30.70
|
.195
|
|||||||||||
|
Third
Quarter
|
30.50
|
31.40
|
28.00
|
28.05
|
.195
|
|||||||||||
|
Fourth
Quarter
|
28.00
|
28.75
|
27.00
|
27.60
|
.195
|
|||||||||||
QNB
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 “Capital Adequacy,” found on page 35 of
this Form 10-K filing, and Note 20 of the Notes to Consolidated Financial
Statements, found on page 63 of this Form 10-K filing, for the information
that
discusses and quantifies this regulatory restriction.
Stock
Performance Graph
Set
forth
on the following page is a performance graph comparing the yearly cumulative
total shareholder return on QNB’s common stock with:
| • |
the
yearly cumulative total shareholder return on stocks included in
the
NASDAQ Market Index, a broad market
index,
|
| • |
the
yearly cumulative total shareholder return on the SNL $500M to $1B
Bank
Index, a group encompassing 113 publicly traded banking companies
trading
on the NYSE, AMEX, or NASDAQ with assets between $500 million and
$1
billion,
|
| • |
the
yearly cumulative total shareholder return on the SNL Mid-Atlantic
Bank
Index, a group encompassing 94 publicly traded banking companies
trading
on the NYSE, AMEX, or NASDAQ headquartered in Delaware, District
of
Columbia, Maryland, New Jersey, New York, Pennsylvania, and Puerto
Rico.
|
All
of
these cumulative total returns are computed assuming the reinvestment of
dividends at the frequency with which dividends were paid during the applicable
years.
Comparison
of Five Year Cumulative Total Shareholder Return
QNB
Corp., SNL $500 M - $1B Bank Index & NASDAQ Market Index
|
Period
Ending
|
|||||||||||||||||||
|
Index
|
12/31/01
|
12/31/02
|
12/31/03
|
12/31/04
|
12/31/05
|
12/31/06
|
|||||||||||||
|
QNB
Corp.
|
100.00
|
141.79
|
219.75
|
218.27
|
183.31
|
178.71
|
|||||||||||||
|
NASDAQ
Composite
|
100.00
|
68.76
|
103.67
|
113.16
|
115.57
|
127.58
|
|||||||||||||
|
SNL
$500M-$1B Bank Index
|
100.00
|
127.67
|
184.09
|
208.62
|
217.57
|
247.44
|
|||||||||||||
|
SNL
Mid-Atlantic Bank Index
|
100.00
|
76.91
|
109.35
|
115.82
|
117.87
|
141.46
|
|||||||||||||
Source:
SNL Financial L.C. Charlottesville, VA
Equity
Compensation Plan Information
The
following table summarizes QNB’s equity compensation plan information as of
December 31, 2006. Information is included for both equity compensation plans
approved by QNB shareholders and equity compensation plans not approved by
QNB
shareholders.
|
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 shareholders
|
||||||||||
|
1998
Stock Option Plan
|
180,423
|
$
|
19.85
|
5,436
|
||||||
|
2005
Stock Option Plan
|
8,900
|
26.00
|
191,100
|
|||||||
|
2006
Employee Stock Purchase Plan
|
—
|
—
|
18,422
|
|||||||
|
Equity
compensation plans not approved by QNB shareholders
|
||||||||||
|
None
|
—
|
—
|
—
|
|||||||
|
Totals
|
189,323
|
$
|
20.14
|
214,958
|
||||||
| ITEM 6. |
SELECTED
FINANCIAL AND OTHER DATA (in
thousands, except share and per share
data)
|
|
Year
Ended December 31,
|
2006
|
2005
|
2004
|
2003
|
2002
|
|||||||||||
|
Income
and Expense
|
||||||||||||||||
|
Interest
income
|
$
|
32,002
|
$
|
28,272
|
$
|
25,571
|
$
|
25,139
|
$
|
27,191
|
||||||
|
Interest
expense
|
15,906
|
11,988
|
9,506
|
9,754
|
12,076
|
|||||||||||
|
Net
interest income
|
16,096
|
16,284
|
16,065
|
15,385
|
15,115
|
|||||||||||
|
Provision
for loan losses
|
345
|
—
|
—
|
—
|
—
|
|||||||||||
|
Non-interest
income
|
3,937
|
3,262
|
4,685
|
4,198
|
2,987
|
|||||||||||
|
Non-interest
expense
|
13,234
|
13,102
|
12,843
|
12,681
|
11,943
|
|||||||||||
|
Income
before income taxes
|
6,454
|
6,444
|
7,907
|
6,902
|
6,159
|
|||||||||||
|
Provision
for income taxes
|
1,034
|
1,398
|
1,704
|
1,254
|
1,204
|
|||||||||||
|
Net
income
|
$
|
5,420
|
$
|
5,046
|
$
|
6,203
|
$
|
5,648
|
$
|
4,955
|
||||||
|
Share
and Per Share Data*
|
||||||||||||||||
|
Net
income - basic
|
$
|
1.73
|
$
|
1.63
|
$
|
2.00
|
$
|
1.83
|
$
|
1.61
|
||||||
|
Net
income - diluted
|
1.71
|
1.59
|
1.95
|
1.79
|
1.59
|
|||||||||||
|
Book
value
|
16.11
|
15.00
|
14.78
|
14.03
|
13.28
|
|||||||||||
|
Cash
dividends
|
.84
|
.78
|
.74
|
.66
|
.60
|
|||||||||||
|
Average
common shares outstanding - basic
|
3,124,724
|
3,101,754
|
3,096,360
|
3,091,640
|
3,078,550
|
|||||||||||
|
Average
common shares outstanding - diluted
|
3,176,710
|
3,174,647
|
3,178,152
|
3,153,305
|
3,109,353
|
|||||||||||
|
Balance
Sheet at Year-end
|
||||||||||||||||
|
Investment
securities available-for-sale
|
$
|
219,818
|
$
|
233,275
|
$
|
267,561
|
$
|
260,631
|
$
|
211,156
|
||||||
|
Investment
securities held-to-maturity
|
5,021
|
5,897
|
6,203
|
12,012
|
29,736
|
|||||||||||
|
Non-marketable
equity securities
|
3,465
|
3,684
|
3,947
|
3,810
|
3,585
|
|||||||||||
|
Loans
held-for-sale
|
170
|
134
|
312
|
1,439
|
4,159
|
|||||||||||
|
Loans,
net of unearned income
|
343,496
|
301,349
|
268,048
|
232,127
|
212,691
|
|||||||||||
|
Other
earning assets
|
778
|
1,018
|
4,140
|
5,381
|
10,310
|
|||||||||||
|
Total
assets
|
614,539
|
582,205
|
583,644
|
550,831
|
503,430
|
|||||||||||
|
Deposits
|
478,922
|
458,670
|
466,488
|
438,639
|
388,913
|
|||||||||||
|
Borrowed
funds
|
82,113
|
74,596
|
68,374
|
65,416
|
69,485
|
|||||||||||
|
Shareholders’
equity
|
50,410
|
46,564
|
45,775
|
43,440
|
40,914
|
|||||||||||
|
Selected
Financial Ratios
|
||||||||||||||||
|
Net
interest margin
|
3.12
|
%
|
3.24
|
%
|
3.32
|
%
|
3.40
|
%
|
3.68
|
%
|
||||||
|
Net
income as a percentage of:
|
||||||||||||||||
|
Average
total assets
|
.91
|
.86
|
1.10
|
1.07
|
1.03
|
|||||||||||
|
Average
shareholders’ equity
|
10.89
|
10.83
|
14.43
|
14.38
|
13.88
|
|||||||||||
|
Average
shareholders’ equity to average total assets
|
8.37
|
7.98
|
7.64
|
7.46
|
7.45
|
|||||||||||
|
Dividend
payout ratio
|
48.45
|
47.96
|
36.95
|
36.15
|
37.29
|
|||||||||||
| * |
Adjusted
for October 14, 2003 two-for-one stock split distributed
|
| ITEM 7. |
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
Results
of Operations - Overview
QNB
Corp.
(QNB) earns its net income primarily, through its subsidiary, The Quakertown
National Bank (the Bank). Net interest income, or the spread between the
interest, dividends and fees earned on loans and investment securities and
the
expense incurred on deposits and other interest-bearing liabilities, is the
primary source of operating income for QNB. QNB seeks to achieve sustainable
and
consistent earnings growth while maintaining adequate levels of capital and
liquidity and limiting its exposure to credit and interest rate risk to Board
of
Directors approved levels. Due to its limited geographic area, comprised
principally of upper Bucks, southern Lehigh and northern Montgomery counties,
growth is pursued through expansion of existing customer relationships and
building new relationships by stressing a consistent high level of service
at
all points of contact.
Net
income for the year ended December 31, 2006 was $5,420,000, a 7.4 percent
increase from the $5,046,000 earned in 2005. In 2004, QNB reported net income
of
$6,203,000. These results represent basic net income per share of $1.73, $1.63
and $2.00 for the years 2006, 2005 and 2004, respectively. On a diluted basis,
net income per share was $1.71, $1.59 and $1.95 for the same three years,
respectively.
The
results for 2005 were significantly impacted by a $1,253,000 pre-tax unrealized
loss as an other-than-temporary impairment charge related to certain Fannie
Mae
(FNMA) and Freddie Mac (FHLMC) preferred stock issues recorded in accordance
with U.S. generally accepted accounting principles (GAAP). On an after-tax
basis, the charge was approximately $1,017,000, or $.32 per share diluted.
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 .91 percent and
10.89 percent, respectively, in 2006, compared with .86 percent and 10.83
percent, respectively, in 2005 and 1.10 percent and 14.43 percent, respectively,
in 2004.
2006
versus 2005
In
addition to the impairment charge recorded in 2005 as described above, the
results for 2006 compared with 2005 included the following significant
components:
Net
interest income decreased $188,000, or 1.2 percent to $16,096,000.
|
•
|
The
Federal Reserve Bank Board raised the federal funds target rate 4
more
times, taking the rate from 4.25 percent to 5.25 percent at June
30, 2006.
The target rate stayed at 5.25 percent for the remainder of 2006.
Short-term rates increased more than mid- and long-term interest
rates,
resulting in a further inversion of the yield
curve.
|
|
•
|
The
net interest margin declined 12 basis points to 3.12 percent. The
shape of
the yield curve, as well as rate competition for loans and deposits
resulted in the cost of funds increasing at a faster pace than the
rates
earned on loans and investment securities. The structure of QNB’s balance
sheet, which is comprised primarily of fixed-rate investments and
loans
and funding sources with relatively short-term repricing characteristics
also contributed to the decline in the net interest margin.
|
|
•
|
A
2.5 percent increase in average earning assets, along with the continued
shift in the balance sheet from lower yielding investment securities
to
higher yielding loans helped offset the decline in net interest income
and
the net interest margin.
|
|
•
|
Contributing
to the increase in average earning assets was QNB’s ability, at the end of
the second quarter of 2006, to reclassify some of its deposits for
reserve
calculation purposes. This reclassification enabled QNB to reduce
its
reserve requirements at the Federal Reserve Bank by approximately
$8,500,000. These funds went from a non-earning asset into federal
funds
sold and investment securities, thereby increasing interest
income.
|
|
•
|
The
average balance of loans increased by 16.2 percent while average
investment securities decreased by 12.7 percent. Average deposits
increased by .1 percent, while average short-term borrowings, primarily
commercial sweep accounts, increased $6,827,000, or 46.6 percent.
From
December 31, 2005 to December 31, 2006, total deposits increased
4.4
percent, reflecting strong growth in the fourth quarter of
2006.
|
QNB
recorded a provision for loan losses of $345,000, its first provision in six
years.
|
•
|
While
asset quality remains excellent, continued strong growth in the loan
portfolio, combined with small increases in net charge-offs, non-accrual
loans and delinquent loans prompted the increase in the allowance
for loan
losses through a charge to the provision for loan losses.
|
|
•
|
Total
non-performing loans were $425,000, or .12 percent of total loans,
at
December 31, 2006, compared with $14,000, or .005 percent of total
loans
at December 31, 2005.
|
Non-interest
income increased $675,000, or 20.7 percent, to $3,937,000.
|
•
|
QNB
reported a net gain on the sale of investment securities of $262,000
in
2006, compared to net gains of $526,000 in 2005, excluding the impairment
loss. Included in net gains in 2006 were net gains of $366,000 on
the sale
of equity securities from QNB’s portfolio and net losses of $104,000 from
the sale of debt and equity securities at the Bank. During the fourth
quarter of 2006, QNB repositioned the fixed-income investment portfolio
by
selling some lower-yielding securities at a loss of $250,000 and
reinvesting those proceeds into higher-yielding investment securities.
The
purpose of these transactions was to increase interest income in
the
future and improve the cash flow structure of the investment portfolio,
thereby strengthening the balance
sheet.
|
|
•
|
Non-interest
income in 2005 included the $1,253,000 impairment charge discussed
above.
|
|
•
|
Non-interest
income in 2005 included a $210,000 gain on the liquidation of assets
relinquished by a borrower in 2004, $62,000 in life insurance proceeds
and
$45,000 in a sales tax refund.
|
|
•
|
Net
gains on the sale of loans decreased by $81,000, to $64,000, reflecting
a
slow down in residential mortgage activity as rates increased and
the
housing market softened.
|
|
•
|
Debit
card income continued its strong growth increasing $67,000, or 13.6
percent, to $560,000, in 2006.
|
Non-interest
expense increased $132,000, or 1.0 percent, to $13,234,000.
|
•
|
Salary
expense increased $9,000, or .2 percent, in 2006 to $5,902,000. Included
in salary expense in 2006 was $118,000 of stock option expense associated
with the adoption of FASB No. 123R and $59,000 in incentive compensation,
while 2005 salary expense included $106,000 of severance costs. There
was
no incentive compensation paid in 2005. Excluding the impact of the
stock
option expense and incentive compensation in 2006 and the severance
costs
in 2005, salary expense decreased $62,000, or 1.1 percent. The number
of
full-time equivalent employees decreased by four when comparing 2006
to
2005.
|
|
•
|
Net
occupancy and furniture and fixture expense decreased $72,000, or
3.2
percent, as higher utility costs, building repairs and maintenance
expense, building taxes and equipment maintenance costs were offset
by a
decrease in depreciation and amortization expense on furniture and
equipment. During 2006, QNB opened its new loan center.
|
|
•
|
Marketing
expense increased $52,000, or 8.7 percent, in 2006 with advertising
expenditures increasing $35,000 and donations increasing
$21,000.
|
The
effective tax rate for 2006 was 16.0 percent, compared with 21.7 percent for
2005.
|
•
|
Included
in 2006 was the reversal of a $209,000 tax valuation allowance recorded
in
2005 related to impaired securities. Excluding the impact of the
valuation
allowance in both years, the effective tax rates were 19.3 percent
and
18.5 percent for 2006 and 2005,
respectively.
|
2005
versus 2004
In
addition to the impairment charge described above, the 2005 results compared
to
2004 included the following significant components:
Net
interest income increased $219,000, or 1.4 percent, to $16,284,000.
|
•
|
Contributing
to the increase in net interest income was a 4.0 percent increase
in
average earning assets. The average balance of loans increased by
11.3
percent while average investment securities decreased by 2.2
percent.
|
|
•
|
From
December 31, 2004 to December 31, 2005, total assets declined by
.2
percent, to $582,205,000, with total loans increasing by 12.4 percent,
or
$33,301,000, and total investments decreasing by $34,592,000, or
12.6
percent.
|
|
•
|
Increased
competition for deposits resulted in higher rates paid to attract
and
retain customers. While average deposits increased $14,845,000, or
3.3
percent, during 2005, total deposits from December 31, 2004 to December
31, 2005 declined by $7,818,000, to $458,670,000, primarily due to
the
decision not to aggressively seek to retain the short-term deposits
of a
school district.
|
|
•
|
The
Federal Reserve Bank Board raised the federal funds rate from 2.25
percent
to 4.25 percent during 2005. The yield curve flattened further and
inverted at some points along the curve as short-term rates increased
more
than mid- and long-term interest
rates.
|
|
•
|
The
shape of the yield curve, as well as the rate competition for loans
and
deposits, contributed to an 8 basis point decline in the net interest
margin to 3.24 percent.
|
Non-interest
income decreased $1,423,000, or 30.4 percent, to $3,262,000. Absent the
impairment write-down discussed above, non-interest income declined by $170,000,
or 3.6 percent.
|
•
|
Fees
for services to customers, primarily service charges on deposit accounts,
decreased $149,000. This decrease includes a $54,000 decline in service
charge income on non-interest bearing business checking accounts,
a
$32,000 decline from the elimination of a service charge on an
interest-bearing checking account product and a $62,000 reduction
in
collected overdraft charges.
|
|
•
|
Debit
card income increased $61,000, or 14.1 percent, as a result of the
increased reliance on the card as a means of paying for goods and
services
by both consumers and businesses.
|
|
•
|
Excluding
the impairment write-down, QNB reported a net gain on the sale of
investment securities of $526,000 in 2005, compared to net gains
of
$849,000 in 2004.
|
|
•
|
Non-interest
income in 2005 included a $210,000 gain from the liquidation of assets
relinquished by a borrower, compared with a $141,000 gain in
2004.
|
Non-interest
expense increased $259,000, or 2.0 percent, to $13,102,000.
|
•
|
Salary
and benefit expense increased by $151,000. Excluding the impact of
severance payments related to the reorganization of the lending department
in 2005 and incentive compensation paid in 2004, salary expense increased
by $250,000, or 4.5 percent.
|
|
•
|
Net
occupancy and furniture and fixture expense increased $100,000, or
4.6
percent, as a result of higher utility costs, building and equipment
maintenance costs and real estate taxes.
|
|
•
|
Marketing
expense increased $42,000, or 7.5 percent, in 2005 as a result of
the
decision to increase QNB’s visibility through the use of billboards,
television advertising and promotional giveaways. In addition, QNB
increased the amount of its donations to not-for-profit organizations,
clubs and community events.
|
|
•
|
The
effective tax rate was 21.7 percent for 2005, compared to 21.6 percent
for
2004. In addition, during 2005, the Bank recorded a valuation allowance
of
$209,000.
|
These
items, as well as others, will be explained more thoroughly in the next
sections.
Average
Balances, Rates, and Interest Income and Expense Summary (Tax-Equivalent
Basis)
|
2006
|
2005
|
2004
|
||||||||||||||||||||||||||
|
Average
|
Average
|
Average
|
Average
|
Average
|
Average
|
|||||||||||||||||||||||
|
Balance
|
Rate
|
Interest
|
Balance
|
Rate
|
Interest
|
Balance
|
Rate
|
Interest
|
||||||||||||||||||||
|
Assets
|
||||||||||||||||||||||||||||
|
Federal
funds sold
|
$
|
6,915
|
5.17
|
%
|
$
|
357
|
$
|
5,500
|
3.20
|
%
|
$
|
176
|
$
|
6,834
|
1.37
|
%
|
$
|
93
|
||||||||||
|
Investment
securities:
|
||||||||||||||||||||||||||||
|
U.S.
Treasury
|
5,856
|
3.95
|
231
|
6,169
|
2.29
|
141
|
6,536
|
1.97
|
129
|
|||||||||||||||||||
|
U.S.
Government agencies
|
31,660
|
4.88
|
1,544
|
35,003
|
3.81
|
1,334
|
35,239
|
3.65
|
1,286
|
|||||||||||||||||||
|
State
and municipal
|
43,425
|
6.62
|
2,874
|
52,641
|
6.50
|
3,423
|
51,548
|
6.54
|
3,369
|
|||||||||||||||||||
|
Mortgage-backed
and CMOs
|
123,676
|
4.32
|
5,339
|
136,479
|
4.20
|
5,728
|
141,464
|
4.25
|
6,012
|
|||||||||||||||||||
|
Other
|
21,576
|
6.31
|
1,361
|
28,681
|
5.73
|
1,643
|
29,890
|
5.33
|
1,594
|
|||||||||||||||||||
|
Total
investment securities
|
226,193
|
5.02
|
11,349
|
258,973
|
4.74
|
12,269
|
264,677
|
4.68
|
12,390
|
|||||||||||||||||||
|
Loans:
|
||||||||||||||||||||||||||||
|
Commercial
real estate
|
144,519
|
6.58
|
9,512
|
125,623
|
6.20
|
7,794
|
114,804
|
5.88
|
6,748
|
|||||||||||||||||||
|
Residential
real estate*
|
26,364
|
5.91
|
1,559
|
25,372
|
5.87
|
1,490
|
20,820
|
6.22
|
1,296
|
|||||||||||||||||||
|
Home
equity loans
|
66,933
|
6.36
|
4,255
|
60,865
|
5.94
|
3,616
|
54,910
|
5.71
|
3,134
|
|||||||||||||||||||
|
Commercial
and industrial
|
49,640
|
7.17
|
3,561
|
45,967
|
6.26
|
2,879
|
41,511
|
5.02
|
2,084
|
|||||||||||||||||||
|
Indirect
lease financing
|
9,931
|
9.16
|
910
|
2,564
|
9.23
|
237
|
—
|
—
|
—
|
|||||||||||||||||||
|
Consumer
loans
|
5,220
|
9.27
|
484
|
5,321
|
8.84
|
470
|
5,673
|
9.32
|
529
|
|||||||||||||||||||
|
Tax-exempt
loans
|
21,114
|
5.86
|
1,237
|
12,839
|
5.34
|
685
|
12,627
|
5.23
|
661
|
|||||||||||||||||||
|
Total
loans, net of unearned income
|
323,721
|
6.65
|
21,518
|
278,551
|
6.16
|
17,171
|
250,345
|
5.77
|
14,452
|
|||||||||||||||||||
|
Other
earning assets
|
4,612
|
4.65
|
214
|
4,688
|
2.81
|
132
|
4,866
|
1.63
|
80
|
|||||||||||||||||||
|
Total
earning assets
|
561,441
|
5.96
|
33,438
|
547,712
|
5.43
|
29,748
|
526,722
|
5.13
|
27,015
|
|||||||||||||||||||
|
Cash
and due from banks
|
15,606
|
19,476
|
20,074
|
|||||||||||||||||||||||||
|
Allowance
for loan losses
|
(2,549
|
)
|
(2,587
|
)
|
(2,843
|
)
|
||||||||||||||||||||||
|
Other
assets
|
20,077
|
18,983
|
18,629
|
|||||||||||||||||||||||||
|
Total
assets
|
$
|
594,575
|
$
|
583,584
|
$
|
562,582
|
||||||||||||||||||||||
|
Liabilities
and Shareholders’ Equity
|
||||||||||||||||||||||||||||
|
Interest-bearing
deposits:
|
||||||||||||||||||||||||||||
|
Interest-bearing
demand
|
$
|
100,973
|
2.30
|
%
|
2,322
|
$
|
95,487
|
1.29
|
%
|
1,229
|
$
|
100,684
|
.68
|
%
|
681
|
|||||||||||||
|
Money
market
|
50,800
|
2.92
|
1,484
|
52,080
|
1.76
|
917
|
44,364
|
.99
|
441
|
|||||||||||||||||||
|
Savings
|
48,377
|
.39
|
190
|
53,671
|
.39
|
211
|
54,613
|
.39
|
215
|
|||||||||||||||||||
|
Time
|
163,994
|
3.78
|
6,202
|
161,801
|
3.03
|
4,906
|
156,511
|
2.65
|
4,153
|
|||||||||||||||||||
|
Time
over $100,000
|
47,372
|
4.01
|
1,900
|
45,926
|
3.08
|
1,415
|
40,880
|
2.42
|
990
|
|||||||||||||||||||
|
Total
interest-bearing deposits
|
411,516
|
2.94
|
12,098
|
408,965
|
2.12
|
8,678
|
397,052
|
1.63
|
6,480
|
|||||||||||||||||||
|
Short-term
borrowings
|
21,473
|
3.43
|
736
|
14,646
|
2.21
|
323
|
11,938
|
1.03
|
124
|
|||||||||||||||||||
|
Federal
Home Loan Bank advances
|
54,901
|
5.60
|
3,072
|
55,000
|
5.43
|
2,987
|
55,000
|
5.28
|
2,902
|
|||||||||||||||||||
|
Total
interest-bearing liabilities
|
487,890
|
3.26
|
15,906
|
478,611
|
2.50
|
11,988
|
463,990
|
2.05
|
9,506
|
|||||||||||||||||||
|
Non-interest
bearing deposits
|
53,696
|
55,623
|
52,691
|
|||||||||||||||||||||||||
|
Other
liabilities
|
3,229
|
2,770
|
2,926
|
|||||||||||||||||||||||||
|
Shareholders’
equity
|
49,760
|
46,580
|
42,975
|
|||||||||||||||||||||||||
|
Total
liabilities and shareholders’ equity
|
$
|
594,575
|
$
|
583,584
|
$
|
562,582
|
||||||||||||||||||||||
|
Net
interest rate spread
|
2.70
|
%
|
2.93
|
%
|
3.08
|
%
|
||||||||||||||||||||||
|
Margin/net
interest income
|
3.12
|
%
|
$
|
17,532
|
3.24
|
%
|
$
|
17,760
|
3.32
|
%
|
$
|
17,509
|
||||||||||||||||
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.
|
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
31, 2006, 2005 and 2004.
Net
Interest Income
|
December
31,
|
2006
|
2005
|
2004
|
|||||||
|
Total
interest income
|
$
|
32,002
|
$
|
28,272
|
$
|
25,571
|
||||
|
Total
interest expense
|
15,906
|
11,988
|
9,506
|
|||||||
|
Net
interest income
|
16,096
|
16,284
|
16,065
|
|||||||
|
Tax
equivalent adjustment
|
1,436
|
1,476
|
1,444
|
|||||||
|
Net
interest income (fully taxable equivalent)
|
$
|
17,532
|
$
|
17,760
|
$
|
17,509
|
||||
Net
interest income is the primary source of operating income for QNB. Net interest
income is interest income, dividends, and fees on earning assets, less interest
expense incurred for funding sources. Earning assets primarily include loans,
investment securities and federal funds sold. Sources used to fund these assets
include deposits, borrowed funds and shareholders’ equity. Net interest income
is affected by changes in interest rates, the volume and mix of earning assets
and interest-bearing liabilities, and the amount of earning assets funded by
non-interest bearing deposits.
|
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 16. 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 2006 declined
$228,000, or 1.3 percent, to $17,532,000. Prior to 2006, the growth
in
earning assets over the past five years has offset the decline
in the net
interest margin. In 2006, the 2.5 percent increase in average earning
assets could not offset the impact of the 12 basis point decrease
in the
net interest margin. The interest rate environment over the past
two years
resulting from both changes in the shape of the yield curve as
well as the
competitive environment for loans and deposits has negatively impacted
net
interest margins and earnings growth for many financial institutions,
especially those which are heavily dependent on net interest income
as
their primary source of revenue.
|
 |
|
Over
the
past two years, short-term rates have increased to a much greater degree
than
mid- and long-term interest rates resulting in an inverted yield curve with
short-term rates being higher than mid- and long-term rates. The inverted
shape
of the yield curve, along with the increased competition for deposits and
loans,
are two factors which have resulted in funding costs for deposits and borrowed
money increasing to a greater degree than the rate earned on loans and
investment securities. The structure of QNB’s balance sheet, which is comprised
primarily of fixed-rate investments and loans and funding sources with
relatively short-term repricing characteristics, also has contributed to
the
decline in the net interest margin. The continued shift in the balance sheet
from lower yielding investment securities to higher yielding loans has helped
to
offset the decline in the margin resulting from higher funding
costs.
The
net
interest margin decreased to 3.12 percent in 2006 from 3.24 percent in 2005,
while the net interest rate spread decreased to 2.70 percent in 2006 from 2.93
percent in 2005.
The
interest rate graph above shows the trend in market interest rates for the
period 2004-2006.
During
2004, the Federal Reserve Board began tightening monetary policy after reducing
rates to 40-year lows. Using a “measured pace” strategy of tightening, the Board
raised the federal funds rate five times by 25 basis points, 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 ten-year bond fell by one basis point. During this time period, the yield
curve began to flatten. Because deposits and borrowings tend to be priced off
the short-end of the curve, while loans and investment securities tend to be
priced off the mid- and long- term part of the curve financial institutions,
including QNB, began to experience further net interest margin
pressure.
The
economy in 2005 was strong, with GDP growth of approximately 4.0 percent, steady
employment growth and a confident consumer. However, there were several issues,
including the impact of rapidly rising oil prices, the devastation caused by
several hurricanes, the fear of inflation and a potential housing bubble that
caused concern. The flattening of the yield curve continued during the year,
including several points of inversion by the end of 2005. The Federal Reserve
Board continued its “measured pace” strategy by raising the federal funds rate
eight times, or 200 basis points, bringing the overnight rate to 4.25 percent
at
the end of 2005. As the federal funds rate increased, the increase in other
short-term rates continued to outpace the increase in longer-term rates. The
rates on the two-year Treasury bond increased by about 130 basis points, to
4.41
percent, while the ten-year rate only increased by 12 basis points, to 4.39
percent.
2006
was
a year of unpredictability and an uncertain economic outlook. With a new
Chairman in place, the Federal Reserve raised its target rate four more times
by
the end of June, bringing the federal funds rate to 5.25 percent, its current
rate. Oil prices were volatile during the year, but ended 2006 about where
they
ended 2005. The housing market slowed significantly during 2006, but an increase
in activity at the end of the year may be an indication that this sector may
recover soon. Slower growth in GDP, along with the gradual easing of
inflationary pressures has shifted the market sentiment that the next Federal
Reserve move would be an easing of the federal funds rate, not a tightening.
However, the timing of any drop in the rate is uncertain. The yield curve
inversion which started at the end of 2005 worsened in 2006. While yields on
maturities less than six months increased by almost 100 basis points, the yields
on the two-year and ten-year Treasuries increased by only 41 basis points and
32
basis points, to close 2006 at 4.82 percent and 4.71 percent, respectively.
The
current inversion cycle is passing historic averages for duration and nearing
historic extremes for slope.
The
Rate-Volume Analysis table, as presented on a tax-equivalent basis on page
19,
highlights the impact of changing rates and volumes on total interest income
and
interest expense. Total interest income increased $3,690,000, or 12.4 percent,
in 2006, to $33,438,000. The increase in interest income was a result of an
increase in average earning assets, the shift in the mix of earning assets
from
investment securities to loans, as well as the impact of the rate increases
discussed above. The increases in interest income attributable to volume and
rate were $1,296,000 and $2,394,000, respectively. The yield on earning assets
on a tax-equivalent basis was 5.96 percent for 2006, compared to 5.43 percent
for 2005. Contributing to the increase in average earning assets and interest
income was QNB’s ability, at the end of the second quarter of 2006, to
reclassify some of its deposits for reserve calculation purposes. This
reclassification enabled QNB to reduce its reserve requirements at the Federal
Reserve Bank by approximately $8,500,000. These funds went from a non-earning
asset into federal funds sold and investment securities, thereby increasing
interest income.
Interest
income on federal funds sold increased $181,000 with higher interest rates
accounting for $136,000 of the increase. The average yield on federal funds
sold
increased from 3.20 percent for 2005 to 5.17 percent for 2006.
Interest
income on investment securities decreased $920,000 for 2006, as average balances
decreased $32,780,000, or 12.7 percent, resulting in a reduction in interest
income of $1,678,000. Partially offsetting the impact of lower volumes on
interest income was an increase in the average yield on the portfolio. The
average yield earned on the portfolio increased 28 basis points, to 5.02
percent, for 2006 contributing an additional $758,000 in interest income. QNB
purchased very few securities in the normal course of business over the past
two
years, a period of increased interest rates, because of the strong growth in
loans. Most of the increase in the yield on the portfolio has been the result
of
either purchase and sale transactions performed by management whereby lower
yielding securities were sold at a loss with the proceeds reinvested in higher
yielding securities or through the sale, maturity or repayment of lower yielding
securities with the proceeds used to fund loan growth. The purpose of the
purchase and sale transactions was to increase net interest income in the future
as well as to reposition the cash flow from the portfolio. During 2006, QNB
sold
its holdings of agency perpetual preferred securities that had been impaired
in
2005 as well as its holdings of corporate bonds in the automotive sector. These
sales had a negative impact on the yield of the portfolio since these bonds
had
a weighted average yield of 6.04 percent but the sale of these securities
removed some credit risk from the portfolio. Management will continue to look
at
trades that will enhance the structure and yield of the investment portfolio.
Interest
income on loans increased $4,347,000, or 25.3 percent, to $21,518,000 while
the
yield on loans improved 49 basis points, to 6.65 percent. The impact of higher
interest rates produced an increase in interest income from loans of $1,415,000,
while a 16.2 percent increase in average balances resulted in an increase in
interest income of $2,932,000. The portfolio of commercial loans secured by
real
estate contributed the largest increase with volume related income increasing
$1,172,000 and rate related income increasing $546,000. Average loans in this
category increased 15.0 percent while the average yield on the portfolio
increased 38 basis points, to 6.58 percent. Income from commercial and
industrial loans increased $682,000 with volume growth accounting for $230,000
of the increase and rate contributing $452,000. The yield on commercial and
industrial loans increased from 6.26 percent in 2005 to 7.17 percent in 2006.
The majority of commercial and industrial loans have adjustable-rates or
floating-rates indexed to prime, and therefore benefited from the increase
in
interest rates during 2005 and 2006. The average prime rate for 2006 was 7.96
percent, an increase of 177 basis points from the average for 2005.
Tax-exempt
loan income increased $552,000 with an increase in average balances contributing
$441,000. The average balance of tax-exempt loans increased $8,275,000 when
comparing the two years. A loan to a school district accounted for approximately
$5,700,000 of the average balance increase. The yield on tax-exempt loans
increased from 5.34 percent for 2005 to 5.86 percent for 2006. The impact of
both the origination of new loans at higher rates along with the repricing
of
existing loans at higher rates contributed to this increase in yield. Income
from indirect lease financing receivables increased $673,000 with volume
accounting for the entire increase. QNB began purchasing these loans during
the
second quarter of 2005. Average balances increased from $2,564,000 for 2005
to
$9,931,000 for 2006, while the average yield declined from 9.23 percent to
9.16
percent during the same time period.
Rate-Volume
Analysis of Changes in Net Interest Income (Tax-Equivalent
Basis)
|
2006
vs. 2005
|
2005
vs. 2004
|
||||||||||||||||||
|
Change
due to
|
Total
|
Change
due to
|
Total
|
||||||||||||||||
|
Volume
|
Rate
|
Change
|
Volume
|
Rate
|
Change
|
||||||||||||||
|
Interest
income:
|
|||||||||||||||||||
|
Federal
funds sold
|
$
|
45
|
$
|
136
|
$
|
181
|
$
|
(18
|
)
|
$
|
101
|
$
|
83
|
||||||
|
Investment
securities available-for-sale:
|
|||||||||||||||||||
|
U.S.
Treasury
|
(7
|
)
|
97
|
90
|
(7
|
)
|
19
|
12
|
|||||||||||
|
U.S.
Government agencies
|
(127
|
)
|
337
|
210
|
(9
|
)
|
57
|
48
|
|||||||||||
|
State
and municipal
|
(599
|
)
|
50
|
(549
|
)
|
72
(18
|
)
|
54
|
|||||||||||
|
Mortgage-backed
and CMOs
|
(538
|
)
|
149
|
(389
|
)
|
(212
|
)
|
(72
|
)
|
(284
|
)
|
||||||||
|
Other
|
(407
|
)
|
125
|
(282
|
)
|
(65
|
)
|
114
|
49
|
||||||||||
|
Loans:
|
|||||||||||||||||||
|
Commercial
real estate
|
1,172
|
546
|
1,718
|
636
|
410
|
1,046
|
|||||||||||||
|
Residential
real estate
|
58
|
11
|
69
|
283
|
(89
|
)
|
194
|
||||||||||||
|
Home
equity loans
|
360
|
279
|
639
|
340
|
142
|
482
|
|||||||||||||
|
Commercial
and industrial
|
230
|
452
|
682
|
224
|
571
|
795
|
|||||||||||||
|
Indirect
lease financing
|
680
|
(7
|
)
|
673
|
237
|
—
|
237
|
||||||||||||
|
Consumer
loans
|
(9
|
)
|
23
|
14
|
(33
|
)
|
(26
|
)
|
(59
|
)
|
|||||||||
|
Tax-exempt
loans
|
441
|
111
|
552
|
11
|
13
|
24
|
|||||||||||||
|
Other
earning assets
|
(3
|
)
|
85
|
82
|
(3
|
)
|
55
|
52
|
|||||||||||
|
Total
interest income
|
1,296
|
2,394
|
3,690
|
1,456
|
1,277
|
2,733
|
|||||||||||||
|
Interest
expense:
|
|||||||||||||||||||
|
Interest-bearing
demand
|
70
|
1,023
|
1,093
|
(35
|
)
|
583
|
548
|
||||||||||||
|
Money
market
|
(23
|
)
|
590
|
567
|
77
|
399
|
476
|
||||||||||||
|
Savings
|
(21
|
)
|
—
|
(21
|
)
|
(4
|
)
|
—
|
(4
|
)
|
|||||||||
|
Time
|
67
|
1,229
|
1,296
|
140
|
613
|
753
|
|||||||||||||
|
Time
over $100,000
|
44
|
441
|
485
|
122
|
303
|
425
|
|||||||||||||
|
Short-term
borrowings
|
151
|
262
|
413
|
28
|
171
|
199
|
|||||||||||||
|
Federal
Home Loan Bank advances
|
(6
|
)
|
91
|
85
|
—
|
85
|
85
|
||||||||||||
|
Total
interest expense
|
282
|
3,636
|
3,918
|
328
|
2,154
|
2,482
|
|||||||||||||
|
Net
interest income
|
$
|
1,014
|
$
|
(1,242
|
)
|
$
|
(228
|
)
|
$
|
1,128
|
$
|
(877
|
)
|
$
|
251
|
||||
Income
from residential mortgage loans increased $69,000 while income from home equity
loans increased $639,000. Residential mortgage origination slowed considerably
during 2006 as the housing market softened due to rising interest rates and
stabilization of home values. However, home equity loan activity remained
strong. Average home equity loans increased $6,068,000, or 10.0 percent, in
2006
while the average rate earned increased from 5.94 percent to 6.36 percent.
Home
equity loans tend to be less costly to the consumer to originate than mortgage
loans. In addition, consumers who had refinanced their mortgages when rates
were
at historic lows did not want to lose that low rate by refinancing again and
opted to borrow using home equity loans. Some of the increase in the yield
on
home equity loans relates to home equity lines of credit which are indexed
to
prime. As the prime rate increased many borrowers paid off their floating rate
lines with fixed rate home equity loans at lower rates.
While
total interest income increased $3,690,000 or 12.4 percent, in 2006, total
interest expense increased $3,918,000, or 32.7 percent, to $15,906,000. The
impact of higher interest rates contributed $3,636,000 of the total increase
in
interest expense. The rate paid on total interest-bearing liabilities increased
to 3.26 percent in 2006 from 2.50 percent in 2005, while the rate paid on
interest-bearing deposit accounts increased to 2.94 percent in 2006 from 2.12
percent in 2005. Interest expense on interest-bearing demand accounts increased
$1,093,000 with higher rates accounting for $1,023,000 of that increase. The
average rate paid on these accounts increased 101 basis points from 1.29 percent
to 2.30 percent. Approximately 45.5 percent of the average balances of
interest-bearing demand accounts for 2006 were municipal and school district
deposits compared with 38.6 percent in 2005. The rates paid on these accounts
are generally indexed to the federal funds rate so the rate paid on these
accounts has increased as the federal funds rate has increased over the past
two
years.
Interest
expense on money market accounts increased $567,000, and the rate paid increased
from 1.76 percent in 2005 to 2.92 percent in 2006. The increase in the rate
paid
was primarily the result of the majority of money market balances being in
QNB’s
Treasury Select product which carries a rate indexed to a percentage of the
91-day Treasury bill rate based on balances in the account. The rate on this
product has increased as short-term interest rates have increased. In addition,
in response to competition, QNB promoted a 4.00 percent minimum rate on this
product for new accounts with balances over $10,000 or for existing accounts
with additional deposits of $5,000. This 4.00 percent promotional rate was
offered for most of 2006 and was above the calculated rate under the terms
of
this product. In 2007, the Treasury Select money market account was changed
to
the Select money market account and the rate on this product will no longer
be
indexed to the 91-day Treasury bill but will be determined by QNB.
Interest
expense on time deposits increased $1,781,000, with the impact of higher rates
paid on time deposits contributing $1,670,000 of the increase. The average
rate
paid on time deposits increased from 3.04 percent in 2005 to 3.83 percent in
2006. Like fixed-rate loans and investment securities, time deposits reprice
over time and, therefore, have less of an immediate impact on costs in either
a
rising or falling rate environment. Unlike loans and investment securities,
the
maturity and repricing characteristics tend to be shorter. With interest rates
increasing over the past two years, customers have opted for shorter maturity
time deposits. Approximately 69.3 percent of time deposits at December 31,
2006
will reprice or mature during 2007. This compares to 45.4 percent of time
deposits that were scheduled to mature or reprice at December 31, 2005.
As
mentioned previously, the competition for deposits and especially time deposits
led to significantly higher rates paid on these products. Like other financial
institutions, QNB, as a result of consumer demand and the need to retain
deposits, offered relatively short maturity time deposits at attractive rates.
Most consumers were looking for short maturity time deposits in anticipation
of
short-term rates continuing to increase. It was very common to see time deposit
promotions with maturities less than one year at yields between 5.10 percent
and
5.50 percent. Given the short-term nature of QNB’s time deposits and the current
rates being offered, both the average rate paid and total interest expense
on
time deposits will likely increase in 2007.
Interest
expense on short-term borrowings increased $413,000 in 2006, to $736,000. Both
higher rates and an increase in balances resulted in the increase in interest
expense. The average rate paid on short-term borrowings increased from 2.21
percent in 2005 to 3.43 percent in 2006. Average short-term borrowings, mostly
repurchase agreements (a sweep product for commercial customers), increased
from
$14,646,000 in 2005 to $21,473,000 in 2006.
When
comparing 2005 to 2004, net interest income on a fully tax-equivalent basis
increased $251,000, or 1.4 percent, to $17,760,000. The increase in net interest
income was the result of the growth in average deposits and the investment
of
these deposits into profitable loans. Average earning assets increased 4.0
percent in 2005, while the net interest margin and net interest spread declined
by 8 basis points and 15 basis points, respectively. The net interest rate
margin decreased to 3.24 percent in 2005 from 3.32 percent in 2004, while the
net interest rate spread decreased to 2.93 percent in 2005 from 3.08 percent
in
2004.
Total
interest income increased $2,733,000, or 10.1 percent, in 2005, to $29,748,000.
The increase in interest income was a result of an increase in earning assets
and improving yields. The increase in interest income attributable to volume
was
$1,456,000, while the increase related to improving yields was $1,277,000.
The
yield on earning assets on a tax-equivalent basis was 5.43 percent for 2005
compared to 5.13 percent for 2004.
Interest
income on investment securities decreased $121,000 for 2005, as average balances
decreased 2.2 percent. The impact of lower volumes was offset by an increase
in
the average yield on the portfolio. The average yield earned increased 6 basis
points to 4.74 percent for 2005.
Interest
income on loans increased by $2,719,000 in 2005, with the yield on loans
increasing 39 basis points, to 6.16 percent. The impact of higher interest
rates
produced an increase in interest income from loans of $1,021,000, while an
11.3
percent increase in average balances resulted in an increase in interest income
of $1,698,000. The volume increase in loans was centered primarily in commercial
and industrial loans and home equity loans, many of which are indexed to the
prime rate.
Total
interest expense increased $2,482,000, or 26.1 percent, in 2005 to $11,988,000.
The impact of higher interest rates contributed $2,154,000 of the total increase
in interest expense. Volume growth resulted in interest expense increasing
by
$328,000.
The
average rate paid on total interest-bearing liabilities increased to 2.50
percent in 2005 from 2.05 percent in 2004. The rate paid on interest-bearing
deposit accounts increased to 2.12 percent in 2005 from 1.63 percent in 2004.
Higher rates paid on interest-bearing deposits, money market accounts and time
deposits increased interest expense by $583,000, $399,000 and $916,000,
respectively, in 2005. The average rate paid on these accounts increased 61
basis points, 77 basis points and 43 basis points, respectively.
Management
expects 2007 will be another challenging year with respect to net interest
income and the net interest margin. The extremely competitive environment for
loans and deposits, as well as the inverted yield curve, is expected to
continue. These factors combined with QNB’s current interest rate sensitivity
position which has funding sources repricing more quickly than earning assets
will likely put more pressure on the net interest margin. However, QNB’s
anticipated ability to continue to successfully increase loan balances is
expected to have a positive impact on the net interest margin and interest
income as loans tend to earn a higher yield than investment
securities.
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. While QNB’s asset quality remains strong, increases in
loan charge-offs, non-performing loans and delinquent loans combined with the
strong growth in the loan portfolio necessitated an increase in the allowance
for loan losses through a charge to the provision for loan losses. In 2006,
QNB
recorded a provision for loan losses of $345,000, the first provision expense
since 1999. Continued strong growth in the portfolio or deterioration in credit
quality could result in an increase in the provision in 2007.
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 $3,937,000 in 2006, compared to $3,262,000 in 2005,
an
increase of 20.7 percent. Excluding the gains and losses on investment
securities, loans, and repossessed assets in both years, non-interest income
declined $23,000, or .6 percent. Included in securities losses in 2005 was
a
$1,253,000 other-than-temporary impairment pre-tax loss related to certain
Fannie Mae (FNMA) and Freddie Mac (FHLMC) preferred stock issues. In addition,
other operating income in 2005 included a $210,000 gain on the liquidation
of
assets relinquished by a borrower in 2004, $62,000 in life insurance proceeds
and a $45,000 sales tax refund, all non-core operating activities.
When
comparing 2005 to 2004, non-interest income decreased 30.4 percent, from
$4,685,000 to $3,262,000. Adjusting for the same items noted above non-interest
income increased $93,000, or 2.6 percent, when comparing 2005 to
2004.
Fees
for
services to customers, the largest component of non-interest income, are
primarily comprised of service charges on deposit accounts. These fees increased
$16,000, or .9 percent, during 2006, to $1,867,000. Overdraft income increased
$63,000 as a result of an increase in the volume of overdrafts. This additional
income helped offset a decline in fee income on business checking accounts
and
internet bill pay. Fees on business checking accounts declined by $32,000,
while
internet bill pay income declined by $19,000 when comparing 2006 to 2005. The
decline in business checking account fees reflects the impact of a higher
earnings credit rate, resulting from the increases in short-term interest rates.
These credits are applied against service charges incurred. The decrease in
internet bill pay fees reflects a decision by QNB to eliminate the fee it
charged retail customers for the use of internet bill pay during the fourth
quarter of 2005.
When
comparing 2005 to 2004, fees for services to customers decreased $149,000,
or
7.5 percent, to $1,851,000 in 2005. Contributing to the decline in fee income
in
2005 was a $54,000 reduction in service charge income on non-interest bearing
business checking accounts resulting from a higher earnings credit rate as
discussed above. Also, negatively impacting service charge income was the
elimination of the monthly fee on an interest-bearing checking account product
that resulted in the reduction in fee income of approximately $32,000 in 2005.
Fees, primarily overdraft related, that were waived or charged-off as
uncollectible, increased 28.9 percent and accounted for $65,000 of the total
decrease in service charge income between 2004 and 2005.
ATM
and
debit card income is primarily comprised of income on debit cards, pin-based
transactions and ATM surcharge income for the use of QNB’s ATM machines by
non-QNB customers. ATM and debit card income was $772,000 for 2006, an increase
of $85,000, or 12.4 percent, from the amount recorded in 2005. This followed
an
increase of $89,000, or 14.9 percent, between 2004 and 2005. Debit card income
increased $67,000, or 13.6 percent, to $560,000, in 2006. Debit card income
was
$493,000 in 2005 and $432,000 in 2004. The increase in debit card income was
a
result of increased reliance on the card as a means of paying for goods and
services by both consumers and business cardholders. An increase in pin-based
transactions resulted in additional interchange income of $23,000 when comparing
2006 to 2005. This followed an increase of $34,000 in interchange income between
2004 and 2005. Partially offsetting these positive variances was a reduction
in
ATM surcharge income of $5,000 between 2005 and 2006 and $8,000 between 2004
and
2005. The proliferation of ATM machines, as well as the ability to get cash
back
during a pin-based transaction, has likely contributed to the decline in the
number of transactions by non-QNB customers at QNB’s ATM machines.
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 $291,000,
$288,000 and $300,000 for 2006, 2005 and 2004, respectively. The insurance
carriers reset the rates on these policies annually taking into consideration
the interest rate environment as well as mortality costs. The decline in income
between 2004 and 2005 reflects the lower interest rate environment at the time
of reset. The existing policies have rate floors which minimizes how low the
earnings rate can go. Some of these policies are currently at their
floor.
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 $98,000 in 2006, compared to $90,000 in 2005 and $112,000
in
2004. Included in mortgage servicing income in 2005 and 2004 were positive
fair
market value adjustments of $5,000 and $26,000, respectively. Positively
impacting mortgage servicing income over the period was a reduction in
amortization expense. Amortization expense related to the mortgage servicing
asset was $87,000 in 2006, $109,000 in 2005 and $122,000 in 2004. The higher
amortization expense in 2005 and 2004 was a result of early payoffs of mortgage
loans through refinancing. As mortgage interest rates have increased,
refinancing activity has slowed dramatically. The slowdown in mortgage activity
has also had a negative impact on the average balance of mortgages sold and
serviced as well as the fee income generated from these loans. The average
balance of mortgages serviced for others was $73,478,000 for 2006 compared
to
$77,461,000 and $82,577,000 for 2005 and 2004, respectively. The timing of
mortgage payments and delinquencies also impacts the amount of servicing fees
recorded. For additional information on intangible assets see Note 8 of the
Notes to Consolidated Financial Statements included as Item 8 of this
Report.
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 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.
Management continually reviews strategies that will result in an increase in
the
yield or improvement in the structure of the investment portfolio.
QNB
recorded a net gain on investment securities of $262,000 in 2006. Included
in
this amount were net gains of $366,000 on the sale of equity securities from
the
Corp.’s portfolio and net losses of $104,000 from the sale of debt and equity
securities at the Bank. During the first quarter of 2006, QNB entered into
several liquidity transactions through the sale of investment securities to
fund
the strong growth in loans. In addition, the Bank sold its preferred stock
holdings and recorded a gain of $451,000 on the carrying value of those issues
that had previously been impaired and a $300,000 loss on one issue that was
not
impaired in 2005. During the fourth quarter of 2006, QNB repositioned the
fixed-income investment portfolio by selling some lower-yielding securities
at a
loss of $250,000 and reinvesting those proceeds into higher-yielding investment
securities. The purpose of these transactions was to increase interest income
in
the future and improve the cash flow structure of the investment portfolio,
thereby strengthening the balance sheet.
QNB
recorded a net loss on investment securities of $727,000 in 2005. Included
in
this loss was the $1,253,000 write-down of the perpetual preferred stock of
FNMA
and FHLMC. During 2005, QNB realized net gains of $376,000 on the sale of equity
securities. In the fixed-income portfolio, QNB recorded net gains, excluding
the
impairment loss of $150,000 during 2005.
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 and
$236,000 in net gains from the fixed-income security portfolio.
The
net
gain on the sale of residential mortgage loans was $64,000, $145,000 and
$154,000 in 2006, 2005 and 2004, respectively. Residential mortgage loans to
be
sold are identified at origination. 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 decline in mortgage gains over
the three year period reflects the impact of rising interest rates which has
reduced both the volume of origination and sales activity and the amount of
gains recorded at the time of sale. Included in the gains on the sale of
residential mortgages in 2006, 2005 and 2004 were $31,000, $80,000 and $66,000,
respectively, related to the recognition of mortgage servicing assets. Proceeds
from the sale of residential mortgages were $4,129,000, $11,004,000 and
$9,162,000, respectively, during these same years. The lower amount of gains
in
2005 compared with 2004, despite the higher volume sold, reflects the impact
of
selling into a rising interest rate environment. QNB expects mortgage activity
to remain slow in 2007 due to a continued soft residential real estate
market.
Other
operating income was $583,000, $928,000 and $672,000 in 2006, 2005 and 2004,
respectively. When comparing 2006 to 2005 and 2005 to 2004, the non-core items
recorded in 2005 and mentioned earlier account for $317,000 of the changes.
Also
contributing to the decline between 2005 and 2006 was a $35,000 reduction in
trust income, a $43,000 reduction in retail brokerage income and a $20,000
reduction in income from QNB’s membership in Laurel Abstract Company LLC, a
title insurance company. QNB discontinued offering traditional trust services
at
the end of 2005. The decline in retail brokerage income primarily relates to
sales staffing issues while the decline in title insurance income relates to
the
slowdown in mortgage activity. Partially offsetting the decline in 2006 was
an
increase in official check income of $20,000 and an increase of $25,000 in
merchant income. The increase in official check income relates to higher
short-term interest rates, while the growth in merchant income is a result
of an
increase in the transaction volume of QNB’s merchant customers.
|
Change
from Prior Year
|
||||||||||||||||||||||
|
Non-Interest
Income Comparison
|
2006
|
2005
|
||||||||||||||||||||
|
2006
|
2005
|
2004
|
Amount
|
Percent
|
Amount
|
Percent
|
||||||||||||||||
|
Fees
for services to customers
|
$
|
1,867
|
$
|
1,851
|
$
|
2,000
|
$
|
16
.9
|
%
|
$
|
(149
|
)
|
(7.5
|
)%
|
||||||||
|
ATM
and debit card income
|
772
|
687
|
598
|
85
|
12.4
|
89
|
14.9
|
|||||||||||||||
|
Income
on bank-owned life insurance
|
291
|
288
|
300
|
3
|
1.0
|
(12
|
)
|
(4.0
|
)
|
|||||||||||||
|
Mortgage
servicing fees
|
98
|
90
|
112
|
8
|
8.9
|
(22
|
)
|
(19.6
|
)
|
|||||||||||||
|
Net
(loss) gain on investment securities
|
262
|
(727
|
)
|
849
|
989
|
(136.0
|
)
|
(1,576
|
)
|
(185.6
|
)
|
|||||||||||
|
Net
gain on sale of loans
|
64
|
145
|
154
|
(81
|
)
|
(55.9
|
)
|
(9
|
)
|
(5.8
|
)
|
|||||||||||
|
Other
operating income
|
583
|
928
|
672
|
(345
|
)
|
(37.2
|
)
|
256
|
38.1
|
|||||||||||||
|
Total
|
$
|
3,937
|
$
|
3,262
|
$
|
4,685
|
$
|
675
|
20.7
|
%
|
$
|
(1,423
|
)
|
(30.4
|
)%
|
|||||||
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 2006 increased $132,000,
or 1.0 percent, to $13,234,000, following an increase in non-interest expense
of
$259,000, or 2.0 percent, between 2004 and 2005. QNB’s overhead efficiency
ratio, which represents non-interest expense divided by net operating revenue
on
a tax-equivalent basis, improved from approximately 62.3 percent in 2005 to
61.6
percent in 2006. The efficiency ratio in 2004 was 57.9 percent. The difficulty
in improving this ratio stems not from the ability to control expense growth,
but from the difficulty in increasing revenue growth as a result of the pressure
on the net interest margin and net interest income.
Salaries
and benefits expense is the largest component of non-interest expense. Salaries
and benefits expense for 2006 was $7,320,000, an increase of $6,000, or .1
percent, over 2005. Salary expense increased $9,000, or .2 percent, in 2006
to
$5,902,000. Included in salary expense in 2006 was $118,000 of stock option
expense associated with the adoption of FASB No. 123R and $59,000 in incentive
compensation, while in 2005 salary expense included $106,000 of severance costs.
There was no incentive compensation paid in 2005. Excluding the impact of the
stock option expense and incentive compensation in 2006 and the severance costs
in 2005, salary expense decreased $62,000, or 1.1 percent. The number of
full-time equivalent employees decreased by four when comparing 2006 to 2005.
QNB monitors, through the use of various surveys, the competitive salary
information in its markets and makes adjustments where appropriate.
Benefits
expense decreased by $3,000, or .2 percent, to $1,418,000 in 2006. Medical
and
dental costs, net of employee contributions for cost sharing, increased $2,000,
or .4 percent, as the general increase in health care costs were offset by
a
reduction in the number of participants. State unemployment taxes decreased
$6,000 when comparing 2006 to 2005.
|
Salaries
and benefits expense for 2005 was $7,314,000, an increase of $151,000,
or
2.1 percent, over 2004. Salary expense increased $146,000, or 2.5
percent,
in 2005, to $5,893,000. In addition to the severance costs noted
above in
2005, 2004 salary expense included $210,000 of incentive compensation
expense. The Bank’s incentive compensation plan 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. Senior management
has a separate incentive compensation arrangement based on growth
in
earnings per share. Salary expense, excluding the severance and
incentive
payments, increased $250,000, or 4.5 percent, when comparing 2005
to
2004.
Benefits
expense increased by $5,000, or .4 percent, to $1,421,000 in 2005.
Medical
premiums increased $68,000, or 10.0 percent, as a result of the general
increase in medical insurance costs, while costs associated with
QNB’s
retirement plans increased $18,000, or 4.5 percent. These increases
were
offset by a decrease in dental premiums of $41,000 due to the Bank’s
decision to partially self-insure for dental costs and a $38,000
increase
in employee contributions to cost sharing for medical and dental
premiums.
Net
occupancy expense for 2006 was $1,161,000, an increase of $61,000,
or 5.5
percent, from the amount reported in 2005. An increase in gas, oil
and
electric costs resulted in an increase in utility expense of $15,000,
or
8.1 percent, in 2006. Repairs and maintenance to existing facilities
contributed an additional $20,000 to net occupancy expense in 2006.
Also,
contributing to the increase in net occupancy was higher costs related
to
depreciation, taxes, and branch rent expense. Some of these increases
were
a result of the renovation and opening of the loan center in June
2006.
Net
occupancy expense for 2005 was $1,100,000, an increase of $87,000,
or 8.6
percent, from the amount reported in 2004. An increase in utility
costs of
$33,000, or 21.7 percent, and building repairs and maintenance costs
of
$19,000 were the largest contributors to the increase in net occupancy
expense in 2005. Also contributing to the increase in net occupancy
expense were higher costs related to depreciation, taxes, and rent
expense. The addition of a supermarket branch, which opened late
June 2004
and the purchase in July of 2004 of a building now used as a loan
center,
contributed to these increases in net occupancy expense.
|
 |
Furniture
and equipment expense for 2006 was $1,026,000, a decrease of $133,000, or 11.5
percent, from the amount reported in 2005. Depreciation on furniture and
equipment and amortization of computer software decreased $69,000 and $91,000,
respectively. Hardware and software associated with the Bank’s core computer
system acquired in 2000 became fully depreciated in 2005. The rate of decline
in
depreciation and amortization expense slowed throughout 2006 as some hardware
associated with the computer system was replaced during the year and fixed
assets associated with the loan center were acquired and put into service.
Partially offsetting these savings were higher costs associated with equipment
repairs and maintenance contracts.
Marketing
expense increased $52,000, or 8.7 percent, in 2006, to $651,000. This followed
a
$42,000, or 7.5 percent, increase between 2004 and 2005. Advertising expense
increased $35,000 between 2005 and 2006 and $20,000 between 2004 and 2005.
QNB
has made a strategic decision to increase its visibility in the communities
it
serves through increased use of billboards, television advertising and
promotional giveaways to increase both product and brand recognition. In
addition, donations increased $21,000 when comparing 2006 and 2005 and $17,000
when comparing 2005 and 2004. QNB contributes to many not-for-profit
organizations, clubs and community events in the local communities it
serves.
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 correspondent banking services, statement printing and mailing,
investment security safekeeping and supply management services. Third party
services expense was $724,000 in 2006, compared to $701,000 in 2005 and $680,000
in 2004. The increase in costs between 2005 and 2006 relates to a $35,000
increase in legal expense, resulting principally from special projects. In
addition, with the elimination of the fee charged to customers for the use
of
internet bill pay services, QNB has experienced rapid growth in this service.
As
a result, the fees paid to the vendor who processes these payments have
increased by $15,000. Offsetting these increases was savings of $13,000 related
to payments to a third party vendor for trust services. QNB stopped offering
trust services at the end of 2005. In addition, costs paid to correspondent
banks decreased by $19,000, primarily a result of a higher earnings credit
rate
used to offset charges.
The
increase in third party costs between 2004 and 2005, primarily relates to the
use of consultants for entrance into the indirect equipment leasing business
and
strategic planning, as well as increased internal and external auditing costs
stemming from the internal control requirements of the Sarbanes-Oxley Act.
The
impact of these increases was partially offset by a reduction in expenses to
a
marketing firm that provided benefits to certain QNB deposit customers. This
contract ended in October 2004. These cost savings of $54,000 offset the loss
of
fee income described in the fees for services to customers.
Telephone,
postage and supplies expense increased $49,000, or 10.0 percent, to $537,000
in
2006. This followed a 6.3 percent decline in 2005. When comparing 2006 to 2005,
postage expense increased $14,000, or 7.4 percent, reflecting an increase in
both the volume of mailings, primarily statements and promotional pieces, as
well as the cost per mailing as the U.S. Postal service raised rates effective
January 2006. Supplies expense increased $28,000, or 16.8 percent, when
comparing the two years. Contributing to this increase were costs for ATM and
debit cards and costs related to supplies for the new loan center.
When
comparing 2005 to 2004, postage expense increased $23,000 reflecting an increase
in the volume of mail. This was offset by lower telephone expense and supplies
expense of $37,000 and $17,000, respectively. The reduction in telephone expense
primarily relates to refunds of overcharges incurred in late 2004 as well as
costs incurred in 2004 related to an additional line and costs associated with
the new branch.
State
tax
expense represents the payment of the Pennsylvania Shares Tax, which is based
primarily on the equity of the Bank, Pennsylvania sales and use tax and the
Pennsylvania capital stock tax. State tax expense was $453,000, $423,000 and
$375,000 for the years 2006, 2005 and 2004, respectively. The Pennsylvania
Shares Tax increased $36,000 in each of the three years, reflecting higher
equity levels. The Pennsylvania Shares Tax for 2006 was $433,000. The capital
stock tax decreased $7,000 when comparing 2006 to 2005 and increased $14,000
when comparing 2005 to 2004.
|
Change
from Prior Year
|
||||||||||||||||||||||
|
Non-Interest
Expense Comparison
|
2006
|
2005
|
||||||||||||||||||||
|
2006
|
2005
|
2004
|
Amount
|
Percent
|
Amount
|
Percent
|
||||||||||||||||
|
Salaries
and employee benefits
|
$
|
7,320
|
$
|
7,314
|
$
|
7,163
|
$
|
6
|
.1
|
%
|
$
|
151
|
2.1
|
%
|
||||||||
|
Net
occupancy expense
|
1,161
|
1,100
|
1,013
|
61
|
5.5
|
87
|
8.6
|
|||||||||||||||
|
Furniture
and equipment expense
|
1,026
|
1,159
|
1,146
|
(133
|
)
|
(11.5
|
)
|
13
|
1.1
|
|||||||||||||
|
Marketing
expense
|
651
|
599
|
557
|
52
|
8.7
|
42
|
7.5
|
|||||||||||||||
|
Third
party services
|
724
|
701
|
680
|
23
|
3.3
|
21
|
3.1
|
|||||||||||||||
|
Telephone,
postage and supplies
|
537
|
488
|
521
|
49
|
10.0
|
(33
|
)
|
(6.3
|
)
|
|||||||||||||
|
State
taxes
|
7.1
|
453
|
423
|
375
|
30
|
48
|
12.8
|
|||||||||||||||
|
Other
expense
|
1,362
|
1,318
|
1,388
|
44
|
3.3
|
(70
|
)
|
(5.0
|
)
|
|||||||||||||
|
Total
|
$
|
13,234
|
$
|
13,102
|
$
|
12,843
|
$
|
132
|
1.0
|
%
|
$
|
259
|
2.0
|
%
|
||||||||
Income
Taxes
Applicable
income taxes and effective tax rates were $1,034,000, or 16.0 percent, for
2006
compared to $1,398,000, or 21.7 percent, for 2005, and $1,704,000, or 21.6
percent, for 2004. The lower effective tax rate in 2006 compared to both 2005
and 2004 was primarily the result of the reversal of the $209,000 valuation
allowance, established in 2005. This valuation allowance was initially recorded
in connection with the recognition of the impairment of equity security values,
while the reversal was the ability to recognize tax benefits due to realized
and
unrealized capital gains in the equity portfolio. 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 are challenged to demonstrate they can generate
sustainable and consistent earnings growth in an increasingly competitive
environment. Managing the balance sheet in this extremely competitive business
environment, along with the interest rate environment of the past several years,
has been a major challenge. The flattening of the yield curve that began in
2004, as the Federal Reserve began to raise short-term interest rates, continued
into 2005, with the yield curve inverting at points late in the year. This
yield
curve inversion continued throughout 2006 as the Federal Reserve raised interest
rates four more times through June 2006. After its seventeenth consecutive
25
basis point increase in June, the Federal Reserve held at its target rate of
5.25 percent. As of the end of 2006, the current inversion cycle was passing
historical averages for duration and nearing historical extremes for slope.
As
mentioned earlier, this phenomenon has resulted in funding costs increasing
more
than the yield on earning assets, thereby reducing the net interest margin.
This
phenomenon also has resulted in a change in balance sheet structure as deposit
customers have opted for higher paying money market accounts and short-term
time
deposits over longer maturity time deposits and lower costing savings accounts.
On the loan side, customers have shifted their preferences to fixed-rate loans
over variable- or adjustable-rate loans.
QNB
operates in an attractive, but highly competitive, market for financial
services. QNB’s “Sincere Interest in Your Success”operating motto is achieved by
offering a broad range of high quality financial products and services. QNB
has
established internal standards of service excellence and trains all employees
on
those standards so the customer experiences a consistently high level of service
at all points of contact with the Bank.
The
financial services market in which QNB operates continues to change. In addition
to competition from other local community banks and regional and nationwide
financial institutions moving into QNB’s market area, other forms of competition
have emerged, such as internet banks. The internet has enabled customers to
“rate shop” financial institutions throughout the nation. Deposit growth
remained a challenge in 2006 as the stock market continued to perform well
and
the pricing of deposits became more competitive, with many institutions offering
high short-term 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. Loan growth has been strong but the price
competition for loans has increased as well. The multiple increases in the
prime
rate over the past two years has resulted in an increased demand for fixed-rate
loans over floating- or adjustable-rate loans, thereby minimizing the potential
positive impact of the increase in short-term rates.
Total
assets at year-end 2006 were $614,539,000, compared with $582,205,000 at
December 31, 2005, an increase of $32,334,000, or 5.6 percent. This followed
a
slight decline during 2005 of .2 percent. Average total assets increased 1.9
percent, or $10,991,000, in 2006 to $594,575,000, and 3.7 percent, or
$21,002,000, in 2005. The stronger year-end over year-end growth when comparing
2006 to 2005 versus the average growth rate reflects the amount of funding
growth that occurred at the end of 2006. Funding sources, which include deposits
and borrowed money, increased 6.4 percent from year-end 2005 to year-end 2006.
This followed a decrease of .3 percent from year-end 2004 to year-end 2005.
The
deposit growth at the end of 2006 was a result of both aggressive deposit
promotion in the fourth quarter as well as large temporary funding from business
customers. Some of this temporary funding was withdrawn early in 2007. A
significant portion of the funding growth in 2006 was in the form of repurchase
agreements included in short-term borrowings which represent deposit sweep
products for commercial customers. Average funding sources increased 1.4 percent
in 2006 and 3.4 percent in 2005.
This
growth in deposits and short-term borrowings along with the proceeds from the
investment portfolio helped fund the growth in the loan portfolio. Total loans
increased $42,147,000 or 14.0 percent during 2006. This followed growth of
12.4
percent and 15.5 percent in 2005 and 2006, respectively. Average total loans
increased 16.2 percent in 2006 compared to 11.3 percent in 2005 and 8.6 percent
in 2004.
The
following discussion will further detail QNB’s financial condition during 2006
and 2005.
Investment
Securities and Other Short-Term Investments
Total
investment securities at December 31, 2006 and 2005 were $224,839,000 and
$239,172,000, respectively. For the same periods, approximately 69.9 percent
and
62.8 percent, respectively, of QNB’s investment securities were either U.S.
Government, U.S. Government agency debt securities, U.S. Government agency
issued mortgage-backed securities or collateralized mortgage obligation
securities (CMOs). As of December 31, 2006, 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.
As
mentioned previously, the proceeds from the investment portfolio sales were
primarily used to fund loan growth and deposit withdrawals in 2005 and 2006.
The
6.0 percent decrease in the balance of the portfolio between 2005 and 2006
followed a 12.6 percent decrease between 2004 and 2005. Average investment
securities decreased $32,780,000, or 12.7 percent, to $226,193,000 in 2006,
compared with a $5,704,000, or 2.2 percent, decrease in 2005. The differences
in
the percentage change when comparing average balances to year-end balances
was a
function of timing. A significant portion of the loan growth as well as the
deposit withdrawals occurred in the third and fourth quarters of 2005 and the
first quarter of 2006.
QNB
had
federal funds sold of $11,664,000 at December 31, 2006. There were no federal
funds sold at December 31, 2005. Average federal funds sold increased
$1,415,000, or 25.7 percent, to $6,915,000, in 2006, compared to a $1,334,000,
or 19.5 percent, decrease in average federal funds sold in 2005. The higher
level of federal funds sold in 2006 reflects QNB’s desire to have more liquidity
in light of the increase in short-term deposits and repurchase agreements and
the potential for loan growth. In addition, with federal funds earning
approximately 5.25 percent, there was not much additional benefit from investing
in securities.
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 considering liquidity needs and interest
rate risk. During the first quarter of 2006, QNB entered into several liquidity
transactions through the sale of investment securities to fund the strong growth
in loans. One such trade involved the sale of $7,000,000 of tax-exempt municipal
securities at a yield of 5.53 percent. The proceeds were used to fund a
tax-exempt loan to a school district at a yield of 5.61 percent. In addition,
to
the slight improvement in yield, the average life of the loan is about half
the
average life of the municipal securities. Also during 2006, QNB sold its
preferred stock holdings, including those that were written down as impaired,
and its holdings of corporate bonds in the automobile sector, thereby improving
the credit quality of the portfolio. During the fourth quarter of 2006, QNB
repositioned the fixed-income investment portfolio by selling some
lower-yielding securities at a loss of $250,000 and reinvesting those proceeds
into higher-yielding investment securities. The purpose of these transactions
was to increase interest income in the future and improve the cash flow
structure of the investment portfolio, thereby strengthening the balance sheet.
Proceeds
from the sale of investments were $46,490,000 in 2006 compared to $45,105,000
and $66,715,000 during 2005 and 2004, respectively. In addition, proceeds from
maturities, calls and prepayments of securities were $25,465,000 in 2006,
compared with $37,020,000 and $61,145,000, respectively, in 2005 and 2004.
These
proceeds were used to purchase $57,069,000 in securities during 2006, an
increase of 8.8 percent from the $52,442,000 purchased in 2005 and a decline
of
56.4 percent from the $130,878,000 purchased in 2004. Approximately $8,500,000
of the purchases in 2006 was a result of QNB’s ability to reclassify some of its
deposits for reserve calculation purposes. This reclassification enabled QNB
to
reduce its reserve requirements at the Federal Reserve Bank and convert a
non-earning asset into an investment security, thereby increasing interest
income.
As
a
result of the aforementioned transactions, the composition of the portfolio
changed significantly between December 31, 2005 and December 31, 2006. U.S.
Government agency securities and mortgage-backed securities increased to 14.8
percent and 30.0 percent, respectively, of the portfolio from 10.0 percent
and
24.1 percent, respectively, of the portfolio, while tax-exempt state and
municipal securities and CMOs decreased to 18.3 percent and 26.3 percent,
respectively, of the portfolio from 22.3 percent and 29.9 percent, respectively,
of the portfolio. Other debt, which includes corporate bonds and pooled trust
preferred securities, and equity securities decreased to 8.4 percent of the
portfolio at December 31, 2006 from 11.2 percent of the portfolio at December
31, 2005.
Investment
Portfolio History
|
December
31,
|
2006
|
2005
|
2004
|
|||||||
|
Investment
Securities Available-for-Sale
|
||||||||||
|
U.S.
Treasuries
|
$
|
4,984
|
$
|
6,002
|
$
|
6,114
|
||||
|
U.S.
Government agencies
|
33,244
|
23,824
|
46,478
|
|||||||
|
State
and municipal securities
|
36,121
|
47,530
|
45,992
|
|||||||
|
Mortgage-backed
securities
|
67,471
|
57,733
|
67,510
|
|||||||
|
Collateralized
mortgage obligations (CMOs)
|
59,033
|
71,475
|
70,789
|
|||||||
|
Other
debt securities
|
14,373
|
18,252
|
21,972
|
|||||||
|
Equity
securities
|
4,592
|
8,459
|
8,706
|
|||||||
|
Total
investment securities available-for-sale
|
$
|
219,818
|
$
|
233,275
|
$
|
267,561
|
||||
|
Investment
Securities Held-to-Maturity
|
||||||||||
|
State
and municipal securities
|
$
|
5,021
|
$
|
5,897
|
$
|
6,203
|
||||
|
Total
investment securities held-to-maturity
|
$
|
5,021
|
$
|
5,897
|
$
|
6,203
|
||||
|
Total
investment securities
|
$
|
224,839
|
$
|
239,172
|
$
|
273,764
|
||||
Investment
Portfolio Weighted Average Yields
|
Under
|
1-5
|
5-10
|
Over
10
|
|||||||||||||
|
December
31, 2006
|
1
Year
|
Years
|
Years
|
Years
|
Total
|
|||||||||||
|
Investment
Securities Available-for-Sale
|
||||||||||||||||
|
U.S.
Treasuries:
|
||||||||||||||||
|
Fair
value
|
$
|
4,484
|
$
|
500
|
—
|
—
|
$
|
4,984
|
||||||||
|
Weighted
average yield
|
4.66
|
%
|
4.63
|
%
|
—
|
—
|
4.66
|
%
|
||||||||
|
U.S.
Government agencies:
|
||||||||||||||||
|
Fair
value
|
—
|
$
|
12,972
|
$
|
20,272
|
—
|
$
|
33,244
|
||||||||
|
Weighted
average yield
|
—
|
5.35
|
%
|
5.58
|
%
|
—
|
5.49
|
%
|
||||||||
|
State
and municipal securities:
|
||||||||||||||||
|
Fair
value
|
$
|
572
|
$
|
5,447
|
$
|
15,204
|
$
|
14,898
|
$
|
36,121
|
||||||
|
Weighted
average yield
|
9.70
|
%
|
4.53
|
%
|
6.69
|
%
|
6.36
|
%
|
6.26
|
%
|
||||||
|
Mortgage-backed
securities:
|
||||||||||||||||
|
Fair
value
|
—
|
$
|
48,732
|
$
|
18,739
|
—
|
$
|
67,471
|
||||||||
|
Weighted
average yield
|
—
|
4.76
|
%
|
5.40
|
%
|
—
|
4.94
|
%
|
||||||||
|
Collateralized
mortgage obligations (CMOs):
|
||||||||||||||||
|
Fair
value
|
$
|
5,969
|
$
|
51,984
|
$
|
1,080
|
—
|
$
|
59,033
|
|||||||
|
Weighted
average yield
|
4.45
|
%
|
4.18
|
%
|
3.84
|
%
|
—
|
4.20
|
%
|
|||||||
|
Other
debt securities:
|
||||||||||||||||
|
Fair
value
|
$
|
3,824
|
$
|
9,518
|
$
|
1,031
|
—
|
$
|
14,373
|
|||||||
|
Weighted
average yield
|
7.42
|
%
|
6.93
|
%
|
9.04
|
%
|
—
|
7.20
|
%
|
|||||||
|
Equity
securities:
|
||||||||||||||||
|
Fair
value
|
—
|
—
|
—
|
$
|
4,592
|
$
|
4,592
|
|||||||||
|
Weighted
average yield
|
—
|
—
|
—
|
2.45
|
%
|
2.45
|
%
|
|||||||||
|
Total
fair value
|
$
|
14,849
|
$
|
129,153
|
$
|
56,326
|
$
|
19,490
|
$
|
219,818
|
||||||
|
Weighted
average yield
|
5.48
|
%
|
4.72
|
%
|
5.83
|
%
|
5.50
|
%
|
5.12
|
%
|
||||||
|
Investment
Securities Held-to-Maturity
|
||||||||||||||||
|
State
and municipal securities:
|
||||||||||||||||
|
Amortized
cost
|
$
|
636
|
$
|
563
|
$
|
759
|
$
|
3,063
|
$
|
5,021
|
||||||
|
Weighted
average yield
|
7.30
|
%
|
6.26
|
%
|
6.67
|
%
|
6.93
|
%
|
6.86
|
%
|
||||||
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 .20 percent. Weighted average yields on investment securities
available-for-sale are based on historical cost.
Management
anticipates minimal purchases in the investment portfolio during 2007 given
the
expectation that loan growth will outpace deposit growth, resulting in less
funds to invest in securities. Based on projections, QNB estimates that
approximately $37,000,000 of investment securities at a book yield of 4.76
percent will be available from cash flow from the portfolio for reinvestment
in
either loans or securities. Based on current interest rates, reinvestment of
these funds should be into higher yielding investment securities or loans.
At
December 31, 2006 and 2005, investment securities totaling $75,793,000 and
$68,917,000, respectively, were pledged as collateral for repurchase agreements
and public deposits. The increase in pledged balances was a result of the
increase in repurchase agreement balances.
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, 2006 or
2005.
Investments
Available-For-Sale
Available-for-sale
investment securities include securities that management intends to use as
part
of its liquidity and 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, 2006, the fair value of investment securities available-for-sale was
$219,818,000, or $1,235,000 below the amortized cost of $221,053,000. This
compared to a fair value of $233,275,000, or $1,912,000 below the amortized
cost
of $235,187,000, at December 31, 2005. An unrealized holding loss of $815,000
was recorded as a decrease to shareholders’ equity as of December 31, 2006,
while an unrealized holding loss of $1,262,000 was recorded as a decrease to
shareholders’ equity as of December 31, 2005. The available-for-sale portfolio,
excluding equity securities, had a weighted average maturity of approximately
4
years, 1 month at December 31, 2006 and 4 years, 5 months at December 31, 2005.
The weighted average tax-equivalent yield was 5.12 percent and 4.87 percent
at
December 31, 2006 and 2005, respectively.
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
38
reflects the repricing term of the securities portfolio based upon estimated
call dates and anticipated cash flows assuming an unchanged, as well as a
simulated, 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, 2006 and 2005,
the
amortized cost of investment securities held-to-maturity was $5,021,000 and
$5,897,000, respectively, and the fair value was $5,168,000 and $6,082,000,
respectively. The held-to-maturity portfolio had a weighted average maturity
of
approximately 3 years, 11 months at December 31, 2006, and 3 years, 10 months
at
December 31, 2005. The weighted average tax-equivalent yield was 6.86 percent
and 6.78 percent at December 31, 2006 and 2005, respectively.
Loans
QNB’s
primary business is to accept deposits and to make loans to meet the credit
needs of the communities it serves. Loans are the most 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
commercial loan, retail loan and indirect lease financing originations
and
the 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.
QNB
manages the risk associated with commercial loans, which generally
have
balances larger than retail loans, by having lenders work in tandem
with
credit analysts while maintaining independence between personnel.
In
addition, a Bank loan committee and a committee of the Board of
Directors
review and approve certain loan requests on a weekly basis. At
December
31, 2006, there were no concentrations of loans exceeding 10 percent
of
total loans other than disclosed in the table on page 29.
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. Tax-exempt loans to qualified municipalities, school
districts, and other not-for-profit entities, not secured by real
estate,
are also classified as commercial and industrial loans. 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 investment purpose loans.
Indirect
lease financing receivables represent loans to small businesses
that are
collateralized by equipment. These loans are originated by a third
party
and purchased by QNB based on criteria specified by QNB. The criteria
include minimum credit scores of the borrower, term of the lease,
type and
age of equipment financed and geographic area. The geographic area
primarily represents states contiguous to Pennsylvania. QNB is
not the
lessor and does not service these
loans.
|
|
Loan
Portfolio
|
||||||||||||||||
|
December
31,
|
2006
|
2005
|
2004
|
2003
|
2002
|
|||||||||||
|
Commercial
and industrial
|
$
|
72,718
|
$
|
64,812
|
$
|
57,372
|
$
|
47,210
|
$
|
39,722
|
||||||
|
Construction
|
10,503
|
7,229
|
7,027
|
9,056
|
7,687
|
|||||||||||
|
Real
estate-commercial
|
118,166
|
104,793
|
98,397
|
86,707
|
74,125
|
|||||||||||
|
Real
estate-residential
|
123,531
|
112,920
|
99,893
|
83,703
|
84,907
|
|||||||||||
|
Consumer
|
5,044
|
5,080
|
5,376
|
5,604
|
6,513
|
|||||||||||
|
Indirect
lease financing
|
13,405
|
6,451
|
—
|
—
|
—
|
|||||||||||
|
Total
loans
|
343,367
|
301,285
|
268,065
|
232,280
|
212,954
|
|||||||||||
|
Unearned
costs (income)
|
129
|
64
|
(17
|
)
|
(153
|
)
|
(263
|
)
|
||||||||
|
Total
loans, net of unearned costs (income)
|
$
|
343,496
|
$
|
301,349
|
$
|
268,048
|
$
|
232,127
|
$
|
212,691
|
||||||
|
Loan
Maturities and Interest Sensitivity
|
|||||||||||||
|
Under
|
1-5
|
Over
|
|||||||||||
|
December
31, 2006
|
1
Year
|
Years
|
5
Years
|
Total
|
|||||||||
|
Commercial
and industrial
|
$
|
2,940
|
$
|
49,103
|
$
|
20,675
|
$
|
72,718
|
|||||
|
Construction
|
5,867
|
2,276
|
2,360
|
10,503
|
|||||||||
|
Real
estate-commercial
|
3,135
|
8,797
|
106,234
|
118,166
|
|||||||||
|
Real
estate-residential
|
9,633
|
13,160
|
100,738
|
123,531
|
|||||||||
|
Consumer
|
869
|
3,869
|
306
|
5,044
|
|||||||||
|
Indirect
lease financing
|
84
|
13,292
|
29
|
13,405
|
|||||||||
|
Total
|
$
|
22,528
|
$
|
90,497
|
$
|
230,342
|
$
|
343,367
|
|||||
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, 2006:
|
Loans
with fixed predetermined interest rates
|
$
|
122,377
|
||
|
Loans
with variable or adjustable interest rates
|
$
|
198,462
|
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, 2006 and 2005, real estate residential loans held-for-sale were $170,000
and
$134,000, respectively. These loans are carried at the lower of aggregate cost
or market.
Total
loans, excluding loans held-for-sale, at December 31, 2006 were $343,496,000,
an
increase of $42,147,000, or 14.0 percent, from December 31, 2005. This followed
a $33,301,000, or 12.4 percent, increase from December 31, 2004 to December
31,
2005. Average total loans increased 16.2 percent in 2006 and 11.3 percent in
2005. This loan growth was achieved despite the extremely competitive
environment for both commercial and consumer loans. A key financial ratio is
the
loan to deposit ratio. With the strong growth in loans in 2006 this ratio
improved to 71.7 percent at December 31, 2006, compared with 65.7 percent,
at
December 31, 2005. At December 31, 2001, the loan to deposit ratio was 54.7
percent. Despite the improvement in this ratio over the past five years, it
remains below the local peer group. Continued loan growth remains one of the
primary goals of QNB in 2007.
The
Allowance for Loan Loss Allocation table on page 31 shows the percentage
composition of the loan portfolio. Despite the significant growth in the loan
portfolio, the composition of the portfolio remained relatively unchanged from
December 31, 2005. Real estate loans secured by residential properties continued
to be the largest sector representing 36.0 percent of the portfolio at December
31, 2006, down slightly from 37.5 percent at December 31, 2005. Real estate
loans secured by residential properties increased $10,611,000, or 9.4 percent,
to $123,531,000 at December 31, 2006. Included in this increase were home equity
loan balances which increased $5,274,000, or 8.3 percent, with fixed-rate term
loans increasing $7,974,000 and variable-rate home equity lines declining
$2,700,000. Home equity loans, both term loans and lines, have been popular
with
consumers because they typically have lower origination costs than residential
mortgage loans. In addition, rates on fixed-rate home equity loans have
increased only marginally because mid-term and longer-term interest rates have
not increased significantly and competition for these types of loans remains
strong. As the prime rate has increased from 4.00 percent to 8.25 percent,
customers have refinanced their variable-rate home equity lines of credit into
fixed-rate term loans. Residential mortgage loans increased $579,000, to
$27,035,000, at December 31, 2006. With the increase in interest rates over
the
past two years and the softening of the housing market residential mortgage
origination has slowed considerably. The remaining $4,758,000 of growth in
this
category relates to commercial purpose loans that are secured by residential
real estate.
Loans
secured by commercial real estate, while still the second largest sector of
the
portfolio, declined to 34.4 percent of the portfolio at year-end 2006, from
34.8
percent at year-end 2005. Loans secured by commercial real estate increased
by
$13,373,000, or 12.8 percent, to $118,166,000 at December 31, 2006, following
a
6.5 percent increase between December 31, 2004 and 2005. While loans secured
by
commercial real estate represent a significant portion of the total portfolio,
the collateral is diversified including investment properties, manufacturing
facilities, office buildings, warehouses and owner occupied facilities.
The
commercial and industrial loan category continued to experience strong growth,
increasing $7,906,000, or 12.2 percent, to end the year 2006 at $72,718,000.
This followed growth of 13.0 percent in 2005. Most of the growth in this
category during 2006 can be attributed to a $6,600,000 tax-exempt loan to a
school district. Although a certain number of commercial and industrial loans
are considered unsecured, the majority are secured by non-real estate collateral
such as equipment, vehicles, accounts receivable and inventory.
At
December 31, 2006, indirect lease financing receivables represent approximately
3.9 percent of the portfolio compared to 2.1 percent of the portfolio at
December 31, 2005. QNB began purchasing these receivables during the second
quarter of 2005. Total balances at December 31, 2006 and 2005 were $13,405,000
and $6,451,000, respectively. These loans tend to have slightly higher risk
characteristics but generally provide higher returns and have maturities with
full payout in three to five years.
Construction
loans increased $3,274,000, to $10,503,000, at December 31, 2006 and represented
approximately 3.0 percent of the loan portfolio. These loans are to developers
and builders for the construction of residential units or commercial buildings
or to individuals for construction of their homes. Construction loans are
generally made only on projects that have township approval. These loans usually
have short maturities and are paid off through a commercial or residential
mortgage after construction is complete.
Over
the
past year the repricing and maturity characteristics of the loan portfolio
have
changed. Loans that mature or reprice over five years increased from
$198,481,000, or 65.9 percent of the portfolio, at December 31, 2005, to
$230,342,000, or 67.1 percent of the portfolio, at December 31, 2006. In
addition, loans with fixed interest rates due after one year increased to
$122,377,000, or 38.1 percent of the portfolio, at December 31, 2006 from
$96,676,000, or 34.6 percent of the portfolio, at December 31, 2005. These
changes reflect customers’ demand for longer term fixed rate loans given the
current interest rate environment. This analysis does not consider cash flow
or
prepayments of these loans. The interest rate sensitivity analysis on page
38
reflects the anticipated cash flows assuming an unchanged, as well as a
simulated, interest rate environment.
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 on page 31 shows the history of non-performing assets over the past five
years. Total non-performing assets were $466,000 at December 31, 2006, or .08
percent, of total assets which represents an increase from the December 31,
2005
balance of $14,000. Non-performing assets at December 31, 2005 represented
.002
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
and indirect financing leases 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
are charged-off when deemed uncollectible or, in most instances, after reaching
120 days past due. Included in the loan portfolio are loans on non-accrual
status of $416,000 at December 31, 2006. There were no loans on non-accrual
status at December 31, 2005. Included in the balance of non-accrual loans at
December 31, 2006, was an indirect financing lease of $290,000 which was
subsequently paid off in January 2007 by the originator.
There
were no restructured loans as of December 31, 2006 or 2005, 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 as of December 31, 2006 or 2005. Repossessed assets
at
December 31, 2006 amounted to $41,000 and included equipment or vehicles related
to the lease portfolio. There were no repossessed assets as of December 31,
2005.
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 $1,609,000 and $2,634,000 at December 31, 2006 and 2005,
respectively.
| Non-Performing Assets | ||||||||||||||||
|
December
31,
|
2006
|
2005
|
2004
|
2003
|
2002
|
|||||||||||
|
Loans
past due 90 days or more not on non-accrual status
|
||||||||||||||||
|
Commercial
and industrial
|
$
|
—
|
$
|
—
|
$
|
—
|
$
|
—
|
$
|
—
|
||||||
|
Construction
|
—
|
—
|
—
|
—
|
—
|
|||||||||||
|
Real
estate-commercial
|
—
|
—
|
—
|
—
|
—
|
|||||||||||
|
Real
estate-residential
|
5
|
—
|
68
|
—
|
—
|
|||||||||||
|
Consumer
|
4
|
14
|
28
|
11
|
7
|
|||||||||||
|
Indirect
lease financing
|
—
|
—
|
—
|
—
|
—
|
|||||||||||
|
Total
loans past due 90 days or more and accruing
|
9
|
14
|
96
|
11
|
7
|
|||||||||||
|
Loans
accounted for on a non-accrual basis
|
||||||||||||||||
|
Commercial
and industrial
|
—
|
—
|
372
|
392
|
—
|
|||||||||||
|
Construction
|
—
|
—
|
—
|
—
|
—
|
|||||||||||
|
Real
estate-commercial
|
113
|
—
|
—
|
17
|
—
|
|||||||||||
|
Real
estate-residential
|
13
|
—
|
—
|
409
|
650
|
|||||||||||
|
Consumer
|
—
|
—
|
1
|
—
|
—
|
|||||||||||
|
Indirect
lease financing
|
290
|
—
|
—
|
—
|
—
|
|||||||||||
|
Total
non-accrual loans
|
416
|
—
|
373
|
818
|
650
|
|||||||||||
|
Other
real estate owned
|
—
|
—
|
—
|
—
|
—
|
|||||||||||
|
Repossessed
assets
|
41
|
—
|
—
|
—
|
11
|
|||||||||||
|
Total
non-performing assets
|
$
|
466
|
$
|
14
|
$
|
469
|
$
|
829
|
$
|
668
|
||||||
|
Total
as a percent of total assets
|
.08
|
%
|
.002
|
%
|
.08
|
%
|
.15
|
%
|
.13
|
%
|
||||||
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. 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 U.S. generally accepted accounting principles (GAAP). 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 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.
|
Allowance
for Loan Loss Allocation
|
|||||||||||||||||||||||||||||||
|
December
31,
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||||||||||||||||
|
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
|
$
|
623
|
21.2
|
%
|
$
|
695
|
21.5
|
%
|
$
|
869
|
21.4
|
%
|
$
|
685
|
20.3
|
%
|
$
|
523
|
18.7
|
%
|
|||||||||||
|
Construction
|
138
|
3.0
|
108
|
2.4
|
79
|
2.6
|
123
|
3.9
|
103
|
3.6
|
|||||||||||||||||||||
|
Real
estate-commercial
|
1,214
|
34.4
|
1,258
|
34.8
|
1,228
|
36.7
|
1,277
|
37.3
|
1,140
|
34.8
|
|||||||||||||||||||||
|
Real
estate-residential
|
378
|
36.0
|
262
|
37.5
|
188
|
37.3
|
256
|
36.1
|
358
|
39.9
|
|||||||||||||||||||||
|
Consumer
|
61
|
1.5
|
23
|
1.7
|
23
|
2.0
|
21
|
2.4
|
25
|
3.0
|
|||||||||||||||||||||
|
Indirect
lease financing
|
214
|
3.9
|
29
|
2.1
|
—
|
—
|
—
|
—
|
—
|
—
|
|||||||||||||||||||||
|
Unallocated
|
101
|
151
|
225
|
567
|
789
|
||||||||||||||||||||||||||
|
Total
|
$
|
2,729
|
100.0
|
%
|
$
|
2,526
|
100.0
|
%
|
$
|
2,612
|
100.0
|
%
|
$
|
2,929
|
100.0
|
%
|
$
|
2,938
|
100.0
|
%
|
|||||||||||
Gross
loans represent loans before unamortized net loan fees and costs. Percent gross
loans lists the percentage of each loan type to total loans.
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, 2006, the recorded investment
in
loans for which impairment has been recognized totaled $403,000 of which none
required an allowance for loan loss. There were no loans considered impaired
at
December 31, 2005. The loans that have been identified as impaired are
collateral-dependent.
QNB
had
net loan charge-offs of $142,000 and $86,000 in 2006 and 2005, respectively.
Consumer loans accounted for $104,000 of the net charge-offs with overdrawn
deposit accounts contributing $56,000 of this total. Other consumer charge-offs
related primarily to motorcycle loans and unsecured lines of credit. Indirect
lease financing charge-offs were $37,000 for 2006 and relate principally to
one
borrower. QNB has recovered $3,000 on this loan as the borrower has resumed
making payments in 2007.
The
allowance for loan losses was $2,729,000 at December 31, 2006, which represents
.79 percent of total loans, compared to $2,526,000, or .84 percent of total
loans, at December 31, 2005. QNB’s management determined a $345,000 provision
for loan losses was appropriate in 2006. During the fourth quarter of 2006,
QNB
added $240,000 of the $345,000 provision. While QNB’s asset quality remains
strong, loan charge-offs, non-performing loans and delinquent loans, which
includes loans past due more than 30 days but less than 90 days, increased
during the fourth quarter. These factors coupled with the continued growth
in
loans and the analysis described below resulted in the additional provision
for
loan losses and an allowance for loan losses that management believes is
adequate in relation to the estimate of known and inherent losses in the
portfolio. There was no provision for loan losses recorded in 2005. The ratio,
at .79 percent was at a level below peers but which QNB believed was adequate
based on its analysis.
|
Allowance
for Loan Losses
|
||||||||||||||||
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
Allowance
for loan losses:
|
||||||||||||||||
|
Balance,
January 1
|
$
|
2,526
|
$
|
2,612
|
$
|
2,929
|
$
|
2,938
|
$
|
2,845
|
||||||
|
Charge-offs
|
||||||||||||||||
|
Commercial
and industrial
|
5
|
7
|
353
|
—
|
—
|
|||||||||||
|
Construction
|
—
|
—
|
—
|
—
|
—
|
|||||||||||
|
Real
estate-commercial
|
—
|
—
|
17
|
—
|
—
|
|||||||||||
|
Real
estate-residential
|
—
|
6
|
10
|
—
|
6
|
|||||||||||
|
Consumer
|
145
|
102
|
26
|
28
|
33
|
|||||||||||
|
Indirect
lease financing
|
37
|
—
|
—
|
—
|
—
|
|||||||||||
|
Total
charge-offs
|
187
|
115
|
406
|
28
|
39
|
|||||||||||
|
Recoveries
|
||||||||||||||||
|
Commercial
and industrial
|
2
|
—
|
—
|
—
|
83
|
|||||||||||
|
Construction
|
—
|
—
|
—
|
—
|
—
|
|||||||||||
|
Real
estate-commercial
|
—
|
—
|
17
|
—
|
—
|
|||||||||||
|
Real
estate-residential
|
2
|
—
|
54
|
1
|
35
|
|||||||||||
|
Consumer
|
41
|
29
|
18
|
18
|
14
|
|||||||||||
|
Indirect
lease financing
|
—
|
—
|
—
|
—
|
-
|
|||||||||||
|
Total
recoveries
|
45
|
29
|
89
|
19
|
132
|
|||||||||||
|
Net
(charge-offs) recoveries
|
(142
|
)
|
(86
|
)
|
(317
|
)
|
(9
|
)
|
93
|
|||||||
|
Provision
for loan losses
|
345
|
—
|
—
|
—
|
—
|
|||||||||||
|
Balance,
December 31
|
$
|
2,729
|
$
|
2,526
|
$
|
2,612
|
$
|
2,929
|
$
|
2,938
|
||||||
|
Total
loans (excluding loans held-for-sale):
|
||||||||||||||||
|
Average
|
$
|
323,578
|
$
|
278,221
|
$
|
250,042
|
$
|
229,001
|
$
|
207,238
|
||||||
|
Year-end
|
343,496
|
301,349
|
268,048
|
232,127
|
212,691
|
|||||||||||
|
Ratios:
|
||||||||||||||||
|
Net
charge-offs (recoveries) to:
|
||||||||||||||||
|
Average
loans
|
.04
|
%
|
.03
|
%
|
.13
|
%
|
-
|
%
|
(.04)%
|
|||||||
|
Loans
at year-end
|
.04
|
.03
|
.12
|
—
|
(.04
|
)
|
||||||||||
|
Allowance
for loan losses
|
5.20
|
3.40
|
12.14
|
.31
|
(3.17
|
)
|
||||||||||
|
Provision
for loan losses
|
41.16
|
—
|
—
|
—
|
—
|
|||||||||||
|
Allowance
for loan losses to:
|
||||||||||||||||
|
Average
loans
|
.84
|
%
|
.91
|
%
|
1.04
|
%
|
1.28
|
%
|
1.42
|
%
|
||||||
|
Loans
at year-end
|
.79
|
.84
|
.97
|
1.26
|
1.38
|
|||||||||||
It
is
possible that management’s estimates of the allowance for loan losses and actual
results could differ in the near term, due to conditions beyond QNB’s control.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review QNB’s allowance for loan losses. 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.
Deposits
QNB
primarily attracts deposits from within its market area by offering various
deposit products, including demand deposit accounts, interest-bearing demand
accounts, money market accounts, savings accounts and time deposit
accounts.
Total
deposits increased $20,252,000, or 4.4 percent, to $478,922,000 at December
31,
2006. This compares to a decline of 1.7 percent in 2005. Average deposits
increased only $624,000, or .1 percent, when comparing 2006 to 2005. The
competition for deposits from local, regional and national financial
institutions as well as from internet banks grew stronger in 2006. In addition,
customers through the use of information gathered from the internet have become
better informed about alternative products and rates offered by financial
service providers throughout the nation and are willing to move funds around
the
country over small differences in rate. Strong performance in the stock market
also provides competition for financial resources. Most of the decline in
deposits in 2005 was a result of the decision to not aggressively seek to retain
the short-term deposits of a school district by paying high short-term rates.
The
mix
of deposits, continued to be impacted by the reaction of customers to changes
in
interest rates on various products and by rates paid by the competition.
Interest rates on time deposits and money market accounts continued to show
the
greatest sensitivity, as short-term Treasury rates increased during the first
half of 2006. Most customers were looking for the highest rate for the shortest
term. In contrast, the interest rates paid on interest-bearing demand accounts
and savings accounts did not react as significantly to the increases in market
interest rates. These accounts tend to be less interest rate
sensitive.
|
At
year-end 2006, non-interest bearing demand accounts declined
10.1 percent
to $50,740,000. This decrease compares to growth of 7.3 percent
and 4.2
percent at year-end 2005 and 2004, respectively. Average non-interest
bearing demand accounts declined $1,927,000 or 3.5 percent to
$53,696,000
when comparing 2006 to 2005. These deposits are primarily comprised
of
business checking accounts and are volatile depending on the
timing of
deposits and withdrawals. In addition, business customers are
migrating to
sweep accounts that transfer excess balances not used to cover
daily
activity to interest bearing accounts. This trend could result
in a higher
cost of funds as the use of this product increases.
Interest-bearing
demand accounts declined $3,450,000, or 3.4 percent, to $98,164,000
at
December 31, 2006, compared to an increase in interest-bearing
demand
account of $6,494,000, or 6.8 percent, in 2005. Similar to non-interest
bearing demand accounts, the balances in these accounts can be
volatile on
a daily basis. The volatility in this product is principally
a result of
the movement of balances by school districts and municipalities.
In 2006,
the decline in interest-bearing demand accounts was primarily
a result of
the reduction in balances of a school district. Average interest-bearing
demand accounts increased 5.7 percent in 2006 compared with a
decline of
5.2 percent in 2005. Once again, these variances are principally
the
result of swings in balances in the school district and municipal
accounts.
Money
market accounts increased $12,686,000, or 32.4 percent, at December
31,
2006. This compares to a decrease of $21,264,000, or 35.2 percent,
in
2005. The growth in 2006 was the result of a 4.00 percent money
market
promotion. This promotion was used to compete with the other local
financial institutions and internet banks offering attractive rates
on
money market balances. With the higher rate on this product and
the
ability to immediately access funds, some customers moved money
from their
other lower paying demand and savings accounts to this money market
product. The large decline in balances from 2004 to 2005 was a
result of
the decision to not aggressively seek to retain the short-term
deposits of
a school district by paying high short-term rates. Given the shape
of the
yield curve at the time and the rate that would have been paid
on these
deposits versus what could have been earned in an investment security,
these funds would not have added significant incremental net interest
income and would have further eroded the net interest margin. Total
savings accounts declined $4,966,000, or 9.9 percent, as some customers
sought out the higher yielding money market accounts and short-term
time
deposits.
|
 |
|
Maturity
of Time Deposits of $100,000 or More
|
||||||||||
|
Year
Ended December 31,
|
2006
|
2005
|
2004
|
|||||||
|
Three
months or less
|
$
|
11,702
|
$
|
6,966
|
$
|
2,134
|
||||
|
Over
three months through six months
|
9,713
|
2,721
|
2,785
|
|||||||
|
Over
six months through twelve months
|
16,442
|
14,322
|
14,117
|
|||||||
|
Over
twelve months
|
20,318 |
26,907
|
22,939
|
|||||||
|
Total
|
$
|
58,175
|
$
|
50,916
|
$
|
41,975
|
||||
|
Average
Deposits by Major Classification
|
|||||||||||||||||||
|
2006
|
2005
|
2004
|
|||||||||||||||||
|
Balance
|
Rate
|
Balance
|
Rate
|
Balance
|
Rate
|
||||||||||||||
|
Non-interest
bearing deposits
|
$
|
53,696
|
—
|
$
|
55,623
|
—
|
$
|
52,691
|
—
|
||||||||||
|
Interest-bearing
demand
|
100,973
|
2.30
|
%
|
95,487
|
1.29
|
%
|
100,684
|
.68
|
%
|
||||||||||
|
Money
market
|
50,800
|
2.92
|
52,080
|
1.76
|
44,364
|
.99
|
|||||||||||||
|
Savings
|
48,377
|
.39
|
53,671
|
.39
|
54,613
|
.39
|
|||||||||||||
|
Time
|
163,994
|
3.78
|
161,801
|
3.03
|
156,511
|
2.65
|
|||||||||||||
|
Time
deposits of $100,000 or more
|
47,372
|
4.01
|
45,926
|
3.08
|
40,880
|
2.42
|
|||||||||||||
|
Total
|
$
|
465,212
|
2.60
|
%
|
$
|
464,588
|
1.87
|
%
|
$
|
449,743
|
1.44
|
%
|
|||||||
Total
time deposit accounts increased $21,703,000, or 10.3 percent, to $232,832,000
at
December 31, 2006. This growth in total time deposits in 2006 followed an
increase of $8,309,000, or 4.1 percent, between December 31, 2004 and December
31, 2005. Average time deposits increased 1.8 percent in 2006 and 7.1 percent
in
2005. Most of the growth in time deposits in 2006 occurred in the fourth quarter
and in the maturity range of greater than six months through 12 months, which
QNB promoted heavily in response to customers’ preferences and competitors’
offerings. Most customers and potential customers were looking for the highest
rate for the shortest term because of the belief that short-term interest rates
would continue to rise. Continuing to increase time deposit balances will be
a
challenge in 2007 because of the strong rate competition. Matching or beating
competitors’ rates could have a negative impact on the net interest
margin.
Attracting
and retaining deposits, while not a significant concern in the years 2001 to
2004, has become an issue facing the banking industry. The equity markets
continue to perform well, loan demand remains strong and the competition for
deposits has become extremely aggressive. To continue to attract and retain
deposits, QNB plans to be competitive with respect to rates and to continue
to
deliver products with terms and features that appeal to customers.
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 and investment
securities in an attempt to match the volatility, seasonality, interest
sensitivity and growth trends of its loans and deposits. Liquidity is provided
from asset sources through maturities and repayments of loans and investment
securities. 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 FHLB and two unsecured federal funds
lines granted by correspondent banks totaling $21,000,000. The Bank has a
maximum borrowing capacity with the FHLB of approximately $241,946,000. At
December 31, 2006, QNB’s outstanding borrowings under the FHLB credit facilities
totaled $52,000,000.
Cash
and
due from banks, federal funds sold, available-for-sale securities and loans
held-for-sale totaled $244,091,000 at December 31, 2006 and $254,216,000 at
December 31, 2005. These sources should be adequate to meet normal fluctuations
in loan demand or deposit withdrawals. During both 2005 and 2006, QNB used
its
federal funds line of credit and overnight borrowings with the FHLB to
temporarily help fund deposit withdrawals and loan growth. In addition, during
both the fourth quarter of 2005 and the first quarter of 2006, QNB entered
into
several investment sales transactions for the purpose of providing liquidity.
There were no federal funds purchased at December 31, 2006. Federal funds
purchased totaled $1,490,000 at December 31, 2005. Average federal funds sold
and overnight borrowings were $1,351,000 and $345,000 for 2006 and 2005,
respectively.
Approximately
$75,793,000 and $68,917,000 of available-for-sale securities at December 31,
2006 and 2005, respectively, 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 increase in pledged amounts relates
primarily to the increase in repurchase agreement balances.
Capital
Adequacy
A
strong
capital position is fundamental to support continued growth and profitability
and to serve the needs of depositors. QNB’s shareholders’ equity at December 31,
2006 was $50,410,000, or 8.20 percent of total assets, compared to shareholders’
equity of $46,564,000, or 8.00 percent of total assets, at December 31, 2005.
At
December 31, 2006, shareholders’ equity included a negative adjustment of
$815,000 related to the unrealized holding loss, net of taxes, on investment
securities available-for-sale, while shareholders’ equity at December 31, 2005
included a negative adjustment of $1,262,000 related to the unrealized holding
loss. Without these adjustments, shareholders’ equity to total assets would have
been 8.34 percent and 8.21 percent at December 31, 2006 and 2005, respectively.
The increase in the ratio is a result of the rate of capital retention and
generation exceeding the rate of asset growth. QNB retained 51.6 percent and
52.0 percent of net income in 2006 and 2005, respectively, while generating
$421,000 and $112,000 of equity through the issuance of stock. Total assets
increased 5.6 percent between December 31, 2005 and December 31, 2006, while
shareholders’ equity, excluding the net unrealized holding losses, increased 7.1
percent.
Average
shareholders’ equity and average total assets were $49,760,000 and $594,575,000
during 2006, an increase of 6.8 percent and 1.9 percent, respectively, from
2005. The ratio of average total equity to average total assets was 8.37 percent
for 2006, compared to 7.98 percent for 2005.
QNB
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 QNB insolvent, as defined. As a practical matter, the QNB’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 Coporation 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 2007 of approximately
$5,201,000, plus an amount equal to the net profits of the Bank in 2007 up
to
the date of any such dividend declaration. QNB paid dividends to its
shareholders of $.84 per share in 2006, an increase of 7.7 percent from the
$.78
per share paid in 2005.
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 disallowed intangible assets), Tier II capital which includes
the
allowance for loan losses and a portion of the unrealized gains on equity
securities, 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 and 4.00 percent for leverage. Under the requirements, QNB
has
a Tier I capital ratio of 13.15 percent and 13.04 percent, a total risk-based
ratio of 13.91 percent and 13.77 percent, and a leverage ratio of 8.42 percent
and 8.15 percent at December 31, 2006 and 2005, respectively. The Federal
Deposit Insurance Corporation Improvement Act of 1991 established five capital
level designations ranging from “well capitalized” to “critically
undercapitalized.” At December 31, 2006 and 2005, 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.
|
Capital
Analysis
|
|||||||
|
December
31,
|
2006
|
2005
|
|||||
|
Tier
I
|
|||||||
|
Shareholders’
equity
|
$
|
50,410
|
$
|
46,564
|
|||
|
Net
unrealized securities losses
|
815
|
1,262
|
|||||
|
Intangible
assets
|
(43
|
)
|
(94
|
)
|
|||
|
Total
Tier I risk-based capital
|
51,182
|
47,732
|
|||||
|
Tier
II
|
|||||||
|
Allowable
portion: Allowance for loan losses
|
$
|
2,729
|
$
|
2,526
|
|||
|
Unrealized
gains on equity securities
|
222
|
126
|
|||||
|
Total
risk-based capital
|
$
|
54,133
|
$
|
50,384
|
|||
|
Risk-weighted
assets
|
$
|
389,192
|
$
|
365,931
|
|||
|
Capital
Ratios
|
|||||||
|
December
31,
|
2006
|
2005
|
|||||
|
Tier
I capital/risk-weighted assets
|
13.15
|
%
|
13.04
|
%
|
|||
|
Total
risk-based capital/risk-weighted assets
|
13.91
|
13.77
|
|||||
|
Tier
I capital/average assets (leverage ratio)
|
8.42
|
8.15
|
|||||
Contractual
Obligations, Commitments, and Off-Balance Sheet
Arrangements
QNB
has
various financial obligations, including contractual obligations and
commitments, which may require future cash payments.
Contractual
Obligations
The
following table presents, as of December 31, 2006, significant contractual
obligations to third parties by payment date. Further discussion of the nature
of each obligation can be found in the Notes to Consolidated Financial
Statements.
|
Under
1 Year
|
1
to 3 years
|
3
to 5 Years
|
Over
5 Years
|
Total
|
||||||||||||
|
Time
Deposits
|
$
|
160,119
|
$
|
62,125
|
$
|
10,558
|
$
|
30
|
$
|
232,832
|
||||||
|
Short-term
borrowings
|
30,113
|
—
|
—
|
—
|
30,113
|
|||||||||||
|
Federal
Home Loan Bank advances
|
2,000
|
26,500
|
23,500
|
—
|
52,000
|
|||||||||||
|
Operating
leases
|
304
|
574
|
539
|
1,728
|
3,145
|
|||||||||||
|
Total
|
$
|
192,536
|
$
|
89,199
|
$
|
34,597
|
$
|
1,758
|
$
|
318,090
|
||||||
Commitments
and Off-Balance Sheet Arrangements
The
following table presents, as of December 31, 2006, the amounts and expected
maturities of significant commitments. Discussion of the obligations can be
found in the Notes to Consolidated Financial Statements
|
Under
1 Year
|
1
to 3 years
|
3
to 5 Years
|
Over
5 Years
|
Total
|
||||||||||||
|
Commitments
to extend credit
|
||||||||||||||||
|
Commercial
|
$
|
43,642
|
$
|
2,112
|
$
|
—
|
$
|
—
|
$
|
45,754
|
||||||
|
Residential
real estate
|
617
|
—
|
—
|
—
|
617
|
|||||||||||
|
Other
|
—
|
—
|
—
|
23,555
|
23,555
|
|||||||||||
|
Standby
letters of credit
|
3,026
|
396
|
—
|
—
|
3,422
|
|||||||||||
|
Total
|
$
|
47,285
|
$
|
2,508
|
$
|
—
|
$
|
23,555
|
$
|
73,348
|
||||||
Commitments
to extend credit, including 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 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.
The
allowance for loan losses is based on management’s continuous review and
evaluation of the loan portfolio. The level of the allowance is determined
by
assigning specific reserves to individually identified problem credits and
general reserves to all other loans. The portion of the allowance that is
allocated to internally criticized and non-accrual loans is determined by
estimating the inherent loss on each credit after giving consideration to the
value of underlying collateral. The general reserves are based on the
composition and risk characteristics of the loan portfolio, including the nature
of the loan portfolio, credit concentration trends, historic and anticipated
delinquency and loss experience, as well as other qualitative factors such
as
current economic trends.
Management
emphasizes loan quality and close monitoring of potential problem credits.
Credit risk identification and review processes are utilized in order to assess
and monitor the degree of risk in the loan portfolio. QNB’s lending and loan
administration staff are charged with reviewing the loan portfolio and
identifying changes in the economy or in a borrower’s circumstances which may
affect the ability to repay debt or the value of pledged collateral. A loan
classification and review system exists that identifies those loans with a
higher than normal risk of uncollectibility. Each commercial loan is assigned
a
grade based upon an assessment of the borrower’s financial capacity to service
the debt and the presence and value of collateral for the loan. An independent
loan review group tests risk assessments and evaluates the adequacy of the
allowance for loan losses. Management meets monthly to review the credit quality
of the loan portfolio and quarterly to review the allowance for loan
losses.
In
addition, various regulatory agencies, as an integral part of their examination
process, periodically review QNB’s allowance for loan losses. 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, increases to the allowance may
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, be 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.
| ITEM 7A. |
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
|
As
a
financial institution, QNB is subject to three primary risks.
|
•
|
Credit
risk;
|
|
•
|
Liquidity
risk; and
|
|
•
|
Interest
rate risk.
|
The
Board
of Directors has established an Asset Liability Committee (ALCO) to measure,
monitor and manage interest rate risk for QNB. QNB’s Asset Liability and Loan
Policies have instituted guidelines covering the three primary
risks.
For
discussion on credit risk refer to the sections on non-performing assets and
the
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 34 in Item 7 of this Form 10-K filing.
Interest
Rate Sensitivity
Since
the
assets and liabilities of QNB have diverse repricing characteristics that
influence net interest income, management analyzes interest sensitivity through
the use of gap analysis and simulation models. Interest rate sensitivity
management seeks to minimize the effect of interest rate changes on net interest
margins and interest rate spreads and to provide growth in net interest income
through periods of changing interest rates. The 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 stated maturities or repricing
terms and can be withdrawn or repriced at any time. This may impact QNB’s margin
if more expensive alternative sources of deposits are required to fund loans
or
deposit runoff. Management projects the repricing characteristics of these
accounts based on historical performance and assumptions that it believes
reflect their rate sensitivity. The Treasury Select Indexed Money Market account
reprices monthly, based on a percentage of the average of the 91-day Treasury
bill.
A
positive gap results when the amount of interest rate sensitive assets exceeds
interest rate sensitive liabilities. A negative gap results when the amount
of
interest rate sensitive liabilities exceeds interest rate sensitive
assets.
QNB
primarily focuses on the management of the one-year interest rate sensitivity
gap. At December 31, 2006, interest earning assets scheduled to mature or likely
to be called, repriced or repaid in one year were $192,116,000. Interest
sensitive liabilities scheduled to mature or reprice within one year were
$301,660,000. The one-year cumulative gap, which reflects QNB’s interest
sensitivity over a period of time, was a negative $109,544,000 at December
31,
2006. The cumulative one-year gap equals -18.44 percent of total rate sensitive
assets. This position compares to a negative gap position of $39,123,000, or
-7.04 percent, of total rate sensitive assets, at December 31, 2005. The
increase in the negative gap position in the one-year time frame was primarily
the result of changes in the repricing and maturity structure of the Bank’s
interest sensitive liabilities. The amount of time deposits maturing or
repricing in less than one year increased significantly. At December 31, 2006,
$161,358,000, or 69.3 percent, of total time deposits were scheduled to reprice
or mature in the next twelve months level compared to $95,840,000, or 45.4
percent, of total time deposits at December 31, 2005. In addition, balances
in
the Treasury Select Money Market account increased by $16,160,000 between
December 31, 2005 and December 31, 2006. Both of these events reflect consumers
desire to invest in shorter term investments whose rates have increased
significantly and which could increase further if market rates continue to
increase. Also contributing to the increase in interest sensitive liabilities
was a $10,518,000 increase in short-term borrowings, primarily consisting of
commercial sweep accounts set up as repurchase agreements. On the asset side,
the amount of assets maturing or repricing increased by $12,784,000 from
December 31, 2005 to December 31, 2006. This increase was primarily the result
of the $11,664,000 increase in federal funds sold. This negative gap position
has contributed to the decline in the net interest margin as interest rates
have
increased on a greater amount of liabilities than earning assets and to a
greater magnitude.
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 the interest rate environment at period end. 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, 2006, that it is unlikely that interest rates
would decline by 300 basis points. The simulation results can be found in the
chart on page 40.
The
decline in net interest income in a rising rate environment is consistent with
the gap analysis and reflects the fixed-rate nature of the investment and loan
portfolio and the increased expense associated with higher costing deposits
and
short-term borrowings. Also impacting net interest income in a rising rate
environment would be the conversion of some of the borrowings from the FHLB
from
a fixed-rate to a variable-rate tied to LIBOR. If converted, QNB has the option
to return the borrowings to the FHLB without penalty. Net interest income
increases slightly if rates were to decline by 100 basis points. However, in
the
200 basis point down scenario, net interest income declines slightly which
indicates the current interest pricing on interest-bearing transaction accounts,
regular money market accounts and savings accounts are at their hypothetical
floors. Interest rates on these products do not have the ability to decline
to
the degree that rates on earning assets can. In addition, in a lower rate
environment the cash flow from both the loan and investment portfolios would
increase and be reinvested at lower rates. These results are inconsistent with
the gap analysis and identify some of the weaknesses of gap analysis which
does
not take into consideration the magnitude of the rate change on different
instruments or the timing of the rate change.
Management
will continue to look for ways to reduce the impact of rising interest rates
on
net interest income. One step that has been taken was changing the Treasury
Select money market product by removing the automatic index feature and setting
the rate at the discretion of QNB’s Management. QNB will also attempt to shorten
the repricing characteristics of the loan portfolio and lengthen the maturity
of
the time deposit portfolio. Both of these will be difficult to achieve if the
yield curve stays inverted and the competition continues to offer high rate
short-term time deposits and money market deposits and low fixed rate loans.
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.
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, 2006, QNB did not have any
hedging transactions in place such as interest rate swaps, caps or
floors.
The
table
below summarizes estimated changes in net interest income over the next
twelve-month period, under various interest rate scenarios.
|
Interest
Rate Sensitivity
|
||||||||||||||||||||||
|
Within
|
3
to 6
|
6
months
|
1
to 3
|
3
to 5
|
After
|
|||||||||||||||||
|
December
31, 2006
|
3
months
|
months
|
to
1 year
|
years
|
years
|
5
years
|
Total
|
|||||||||||||||
|
Assets
|
||||||||||||||||||||||
|
Interest-bearing
balances
|
$
|
778
|
$
|
—
|
$
|
—
|
$
|
—
|
$
|
—
|
$
|
—
|
$
|
778
|
||||||||
|
Federal
funds sold
|
11,664
|
—
|
—
|
—
|
—
|
—
|
11,664
|
|||||||||||||||
|
Investment
securities*
|
13,965
|
9,272
|
18,356
|
73,560
|
55,263
|
55,658
|
226,074
|
|||||||||||||||
|
Non-marketable
equity securities
|
3,375
|
—
|
—
|
—
|
—
|
90
|
3,465
|
|||||||||||||||
|
Loans,
including loans held-for-sale
|
72,970
|
15,935
|
37,386
|
110,200
|
72,149
|
35,026
|
343,666
|
|||||||||||||||
|
Bank-owned
life insurance
|
—
|
—
|
8,415
|
—
|
—
|
—
|
8,415
|
|||||||||||||||
|
Total
rate sensitive assets
|
102,752
|
25,207
|
64,157
|
183,760
|
127,412
|
90,774
|
$
|
594,062
|
||||||||||||||
|
Total
cumulative assets
|
$
|
102,752
|
$
|
127,959
|
$
|
192,116
|
$
|
375,876
|
$
|
503,288
|
$
|
594,062
|
||||||||||
|
Liabilities
|
||||||||||||||||||||||
|
Interest-bearing
non-maturing deposits
|
$
|
108,189
|
$
|
—
|
$
|
—
|
$
|
4,806
|
$
|
11,286
|
$
|
71,069
|
$
|
195,350
|
||||||||
|
Time
deposits less than $100,000
|
45,996
|
24,790
|
52,344
|
43,886
|
7,641
|
—
|
174,657
|
|||||||||||||||
|
Time
deposits over $100,000
|
12,174
|
9,713
|
16,341
|
17,031
|
2,916
|
—
|
58,175
|
|||||||||||||||
|
Short-term
borrowings
|
30,113
|
—
|
—
|
—
|
—
|
—
|
30,113
|
|||||||||||||||
|
Federal
Home Loan Bank advances
|
2,000
|
—
|
—
|
26,500
|
23,500
|
—
|
52,000
|
|||||||||||||||
|
Total
rate sensitive liabilities
|
198,472
|
34,503
|
68,685
|
92,223
|
45,343
|
71,069
|
$
|
510,295
|
||||||||||||||
|
Total
cumulative liabilities
|
$
|
198,472
|
$
|
232,975
|
$
|
301,660
|
$
|
393,883
|
$
|
439,226
|
$
|
510,295
|
||||||||||
|
Gap
during period
|
$
|
(95,720
|
)
|
$
|
(9,296
|
)
|
$
|
(4,528
|
)
|
$
|
91,537
|
$
|
82,069
|
$
|
19,705
|
$
|
83,767
|
|||||
|
Cumulative
gap
|
$
|
(95,720
|
)
|
$
|
(105,016
|
)
|
$
|
(109,544
|
)
|
$
|
(18,007
|
)
|
$
|
64,062
|
$
|
83,767
|
||||||
|
Cumulative
gap/rate sensitive assets
|
(16.11
|
)%
|
(17.68
|
)%
|
(18.44
|
)%
|
(
3.03
|
)%
|
10.78
|
%
|
14.10
|
%
|
||||||||||
|
Cumulative
gap ratio
|
.52
|
.55
|
.64
|
.95
|
1.15
|
1.16
|
||||||||||||||||
| * |
Excludes
unrealized holding loss on available-for-sale securities of
$1,235.
|
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, 2006
|
||||||||||
|
+300
Basis Points
|
$
|
13,700
|
$
|
(3,190
|
)
|
(18.89
|
)%
|
|||
|
+200
Basis Points
|
14,715
|
(2,175
|
)
|
(12.88
|
)
|
|||||
|
+100
Basis Points
|
15,920
|
(970
|
)
|
(5.74
|
)
|
|||||
|
FLAT
RATE
|
16,890
|
—
|
—
|
|||||||
|
-100
Basis Points
|
17,075
|
185
|
1.10
|
|||||||
|
-200
Basis Points
|
16,737
|
(153
|
)
|
(.91
|
)
|
|||||
|
December
31, 2005
|
||||||||||
|
+300
Basis Points
|
$
|
14,820
|
$
|
(1,036
|
)
|
(6.53
|
)%
|
|||
|
+200
Basis Points
|
15,280
|
(576
|
)
|
(3.63
|
)
|
|||||
|
+100
Basis Points
|
15,738
|
(118
|
)
|
(.74
|
)
|
|||||
|
FLAT
RATE
|
15,856
|
—
|
—
|
|||||||
|
-100
Basis Points
|
15,744
|
(112
|
)
|
(.71
|
)
|
|||||
|
-200
Basis Points
|
14,634
|
(1,222
|
)
|
(7.71
|
)
|
|||||
| 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 Report
|
Page
42
|
|
Consolidated
Balance Sheets
|
Page
43
|
|
Consolidated
Statements of Income
|
Page
44
|
|
Consolidated
Statements of Shareholders’ Equity
|
Page
45
|
|
Consolidated
Statements of Cash Flows
|
Page
46
|
|
Notes
to Consolidated Financial Statements
|
Page
47
|
INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM REPORT
The
Board
of Directors
QNB
Corp:
We
have
audited the consolidated balance sheets of QNB Corp. and subsidiary as of
December 31, 2006, and 2005, and the related consolidated statements of income,
shareholders’ equity, and cash flows for each of the years in the three-year
period ended December 31, 2006. These consolidated financial statements are
the
responsibility of the Corporation’s management. Our responsibility is to express
an opinion on these 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 provides 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, 2006 and 2005, and the consolidated results of their operations
and their cash flows for each of the years in the three-year period ended
December 31, 2006, in conformity with U.S. generally accepted accounting
principles.
We
also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of QNB Corp.’s internal
control over financial reporting as of December 31, 2006, based on criteria
established in “Internal Control - Integrated Framework” issued by the Committee
of Sponsoring Organizations of the Treadway Commission and our report dated
March 7, 2007 expressed an unqualified opinion on management’s assessment of the
effectiveness of QNB Corp.’s internal control over financial reporting and an
unqualified opinion on the effectiveness of QNB Corp.’s internal control over
financial reporting.
Wexford,
Pennsylvania
March
7,
2007
CONSOLIDATED
BALANCE SHEETS
|
(in
thousands, except share data)
|
|||||||
|
December
31,
|
2006
|
2005
|
|||||
|
Assets
|
|||||||
|
Cash
and due from banks
|
$
|
12,439
|
$
|
20,807
|
|||
|
Federal
funds sold
|
11,664
|
—
|
|||||
|
Total
cash and cash equivalents
|
24,103
|
20,807
|
|||||
|
Investment
securities
|
|||||||
|
Available-for-sale
(amortized cost $221,053 and $235,187)
|
219,818
|
233,275
|
|||||
|
Held-to-maturity
(market value $5,168 and $6,082)
|
5,021
|
5,897
|
|||||
|
Non-marketable
equity securities
|
3,465
|
3,684
|
|||||
|
Loans
held-for-sale
|
170
|
134
|
|||||
|
Total
loans, net of unearned costs
|
343,496
|
301,349
|
|||||
|
Allowance
for loan losses
|
(2,729
|
)
|
(2,526
|
)
|
|||
|
Net
loans
|
340,767
|
298,823
|
|||||
|
Bank-owned
life insurance
|
8,415
|
8,103
|
|||||
|
Premises
and equipment, net
|
6,442
|
5,400
|
|||||
|
Accrued
interest receivable
|
2,874
|
2,572
|
|||||
|
Other
assets
|
3,464
|
3,510
|
|||||
|
Total
assets
|
$
|
614,539
|
$
|
582,205
|
|||
|
Liabilities
|
|||||||
|
Deposits
|
|||||||
|
Demand,
non-interest bearing
|
$
|
50,740
|
$
|
56,461
|
|||
|
Interest-bearing
demand
|
98,164
|
101,614
|
|||||
|
Money
market
|
51,856
|
39,170
|
|||||
|
Savings
|
45,330
|
50,296
|
|||||
|
Time
|
174,657
|
160,213
|
|||||
|
Time
over $100,000
|
58,175
|
50,916
|
|||||
|
Total
deposits
|
478,922
|
458,670
|
|||||
|
Short-term
borrowings
|
30,113
|
19,596
|
|||||
|
Federal
Home Loan Bank advances
|
52,000
|
55,000
|
|||||
|
Accrued
interest payable
|
2,240
|
1,512
|
|||||
|
Other
liabilities
|
854
|
863
|
|||||
|
Total
liabilities
|
564,129
|
535,641
|
|||||
|
Shareholders’
Equity
|
|||||||
|
Common
stock, par value $0.625 per share;
|
|||||||
|
authorized
10,000,000 shares; 3,235,284 shares and 3,210,762 shares
issued;
|
|||||||
|
3,128,598
and 3,104,076 shares outstanding
|
2,022
|
2,007
|
|||||
|
Surplus
|
9,707
|
9,117
|
|||||
|
Retained
earnings
|
40,990
|
38,196
|
|||||
|
Accumulated
other comprehensive loss, net
|
(815
|
)
|
(1,262
|
)
|
|||
|
Treasury
stock, at cost; 106,686 shares
|
(1,494
|
)
|
(1,494
|
)
|
|||
|
Total
shareholders’ equity
|
50,410
|
46,564
|
|||||
|
Total
liabilities and shareholders’ equity
|
$
|
614,539
|
$
|
582,205
|
|||
The
accompanying notes are an integral part of the consolidated financial
statements.
CONSOLIDATED
STATEMENTS OF INCOME
|
(in
thousands, except share data)
|
||||||||||
|
Year
Ended December 31,
|
2006
|
2005
|
2004
|
|||||||
|
Interest
Income
|
||||||||||
|
Interest
and fees on loans
|
$
|
21,097
|
$
|
16,938
|
$
|
14,229
|
||||
|
Interest
and dividends on investment securities:
|
||||||||||
|
Taxable
|
8,437
|
8,767
|
8,945
|
|||||||
|
Tax-exempt
|
1,897
|
2,259
|
2,224
|
|||||||
|
Interest
on federal funds sold
|
357
|
176
|
93
|
|||||||
|
Interest
on interest-bearing balances and other interest income
|
214
|
132
|
80
|
|||||||
|
Total
interest income
|
32,002
|
28,272
|
25,571
|
|||||||
|
Interest
Expense
|
||||||||||
|
Interest
on deposits
|
||||||||||
|
Interest-bearing
demand
|
2,322
|
1,229
|
681
|
|||||||
|
Money
market
|
1,484
|
917
|
441
|
|||||||
|
Savings
|
190
|
211
|
215
|
|||||||
|
Time
|
6,202
|
4,906
|
4,153
|
|||||||
|
Time
over $100,000
|
1,900
|
1,415
|
990
|
|||||||
|
Interest
on short-term borrowings
|
736
|
323
|
124
|
|||||||
|
Interest
on Federal Home Loan Bank advances
|
3,072
|
2,987
|
2,902
|
|||||||
|
Total
interest expense
|
15,906
|
11,988
|
9,506
|
|||||||
|
Net
interest income
|
16,096
|
16,284
|
16,065
|
|||||||
|
Provision
for loan losses
|
345
|
—
|
—
|
|||||||
|
Net
interest income after provision for loan losses
|
15,751
|
16,284
|
16,065
|
|||||||
|
Non-Interest
Income
|
||||||||||
|
Fees
for services to customers
|
1,867
|
1,851
|
2,000
|
|||||||
|
ATM
and debit card income
|
772
|
687
|
598
|
|||||||
|
Income
on bank-owned life insurance
|
291
|
288
|
300
|
|||||||
|
Mortgage
servicing fees
|
98
|
90
|
112
|
|||||||
|
Net
gain (loss) on investment securities available-for-sale
|
262
|
(727
|
)
|
849
|
||||||
|
Net
gain on sale of loans
|
64
|
145
|
154
|
|||||||
|
Other
operating income
|
583
|
928
|
672
|
|||||||
|
Total
non-interest income
|
3,937
|
3,262
|
4,685
|
|||||||
|
Non-Interest
Expense
|
||||||||||
|
Salaries
and employee benefits
|
7,320
|
7,314
|
7,163
|
|||||||
|
Net
occupancy expense
|
1,161
|
1,100
|
1,013
|
|||||||
|
Furniture
and equipment expense
|
1,026
|
1,159
|
1,146
|
|||||||
|
Marketing
expense
|
651
|
599
|
557
|
|||||||
|
Third
party services
|
724
|
701
|
680
|
|||||||
|
Telephone,
postage and supplies expense
|
537
|
488
|
521
|
|||||||
|
State
taxes
|
453
|
423
|
375
|
|||||||
|
Other
expense
|
1,362
|
1,318
|
1,388
|
|||||||
|
Total
non-interest expense
|
13,234
|
13,102
|
12,843
|
|||||||
|
Income
before income taxes
|
6,454
|
6,444
|
7,907
|
|||||||
|
Provision
for income taxes
|
1,034
|
1,398
|
1,704
|
|||||||
|
Net
Income
|
$
|
5,420
|
$
|
5,046
|
$
|
6,203
|
||||
|
Earnings
Per Share - Basic
|
$
|
1.73
|
$
|
1.63
|
$
|
2.00
|
||||
|
Earnings
Per Share - Diluted
|
$
|
1.71
|
$
|
1.59
|
$
|
1.95
|
||||
The
accompanying notes are an integral part of the consolidated financial
statements.
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, 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 loss, net of tax benefit
|
|||||||||||||||||||||||||
|
Unrealized
holding losses on investment securities available-for-sale
|
—
|
(1,090
|
)
|
—
|
—
|
—
|
—
|
—
|
—
|
||||||||||||||||
|
Reclassification
adjustment for gains included in net income
|
—
|
(560
|
)
|
—
|
—
|
—
|
—
|
—
|
—
|
||||||||||||||||
|
Other
comprehensive loss
|
—
|
(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
|
||||||||||||||||
|
Net
income
|
—
|
$
|
5,046
|
—
|
—
|
—
|
5,046
|
—
|
5,046
|
||||||||||||||||
|
Other
comprehensive loss, net of tax benefit
|
|||||||||||||||||||||||||
|
Unrealized
holding losses on investment securities available-for-sale
|
—
|
(2,627
|
)
|
—
|
—
|
—
|
—
|
—
|
—
|
||||||||||||||||
|
Reclassification
adjustment for losses included in net income
|
—
|
674
|
—
|
—
|
—
|
—
|
—
|
—
|
|||||||||||||||||
|
Other
comprehensive loss
|
—
|
(1,953
|
)
|
(1,953
|
)
|
—
|
—
|
—
|
—
|
(1,953
|
)
|
||||||||||||||
|
Comprehensive
income
|
—
|
$
|
3,093
|
—
|
—
|
—
|
—
|
—
|
—
|
||||||||||||||||
|
Cash
dividends paid ($.78 per share)
|
—
|
—
|
—
|
—
|
—
|
(2,420
|
)
|
—
|
(2,420
|
)
|
|||||||||||||||
|
Stock
issue - Employee stock purchase plan
|
2,794
|
—
|
—
|
2
|
72
|
—
|
—
|
74
|
|||||||||||||||||
|
Stock
issued for options exercised
|
3,204
|
—
|
—
|
2
|
36
|
—
|
—
|
38
|
|||||||||||||||||
|
Tax
benefits from stock plans
|
—
|
—
|
—
|
—
|
4
|
—
|
—
|
4
|
|||||||||||||||||
|
Balance,
December 31, 2005
|
3,104,076
|
—
|
(1,262
|
)
|
2,007
|
9,117
|
38,196
|
(1,494
|
)
|
46,564
|
|||||||||||||||
|
Net
income
|
—
|
$
|
5,420
|
—
|
—
|
—
|
5,420
|
—
|
5,420
|
||||||||||||||||
|
Other
comprehensive income, net of taxes
|
|||||||||||||||||||||||||
|
Unrealized
holding gains on investment securities available-for-sale
|
—
|
620
|
—
|
—
|
—
|
—
|
—
|
—
|
|||||||||||||||||
|
Reclassification
adjustment for gains included in net income
|
—
|
(173
|
)
|
—
|
—
|
—
|
—
|
—
|
—
|
||||||||||||||||
|
Other
comprehensive income
|
—
|
447
|
447
|
—
|
—
|
—
|
—
|
447
|
|||||||||||||||||
|
Comprehensive
income
|
—
|
$
|
5,867
|
—
|
—
|
—
|
—
|
—
|
—
|
||||||||||||||||
|
Cash
dividends paid ($.84 per share)
|
—
|
—
|
—
|
—
|
—
|
(2,626
|
)
|
—
|
(2,626
|
)
|
|||||||||||||||
|
Stock
issue - Employee stock purchase plan
|
3,071
|
—
|
—
|
2
|
70
|
—
|
—
|
72
|
|||||||||||||||||
|
Stock
issued for options exercised
|
21,451
|
—
|
—
|
13
|
336
|
—
|
—
|
349
|
|||||||||||||||||
|
Tax
benefits from stock plans
|
—
|
—
|
—
|
—
|
66
|
—
|
—
|
66
|
|||||||||||||||||
|
Stock-based
compensation expense
|
—
|
—
|
—
|
—
|
118
|
—
|
—
|
118
|
|||||||||||||||||
|
Balance,
December 31, 2006
|
3,128,598
|
—
|
$
|
(815
|
)
|
$
|
2,022
|
$
|
9,707
|
$
|
40,990
|
$
|
(1,494
|
)
|
$
|
50,410
|
|||||||||
The
accompanying notes are an integral part of the consolidated financial
statements.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
(in
thousands)
|
||||||||||
|
Year
Ended December 31,
|
2006
|
2005
|
2004
|
|||||||
|
Operating
Activities
|
||||||||||
|
Net
income
|
$
|
5,420
|
$
|
5,046
|
$
|
6,203
|
||||
|
Adjustments
to reconcile net income to net cash provided by operating
activities
|
||||||||||
|
Depreciation
and amortization
|
744
|
890
|
907
|
|||||||
|
Provision
for loan losses
|
345
|
—
|
—
|
|||||||
|
Securities
gains, net
|
(313
|
)
|
(526
|
)
|
(849
|
)
|
||||
|
Impairment
write-down of securities
|
51
|
1,253
-
|
||||||||
|
Net
gain on sale of repossessed assets
|
—
|
(210
|
)
|
(141
|
)
|
|||||
|
Proceeds
from sale of repossessed assets
|
9
|
210
|
1,167
|
|||||||
|
Net
gain on sale of loans
|
(64
|
)
|
(145
|
)
|
(154
|
)
|
||||
|
Loss
on disposal of premises and equipment
|
3
|
1
|
3
|
|||||||
|
Loss
on equity investment in title company
|
—
|
—
|
26
|
|||||||
|
Proceeds
from sales of residential mortgages
|
4,129
|
11,004
|
9,162
|
|||||||
|
Originations
of residential mortgages held-for-sale
|
(4,148
|
)
|
(10,857
|
)
|
(8,055
|
)
|
||||
|
Income
on bank-owned life insurance
|
(291
|
)
|
(288
|
)
|
(300
|
)
|
||||
|
Life
insurance (premiums)/proceeds net
|
(21
|
)
|
91
(21
|
)
|
||||||
|
Stock-based
compensation expense
|
118
|
—
|
—
|
|||||||
|
Deferred
income tax (benefit) provision
|
(183
|
)
|
(81
|
)
|
299
|
|||||
|
Net
(decrease) increase in income taxes payable
|
—
|
(338
|
)
|
282
|
||||||
|
Net
(increase) decrease in accrued interest receivable
|
(302
|
)
|
(41
|
)
|
292
|
|||||
|
Net
amortization of premiums and discounts
|
524
|
869
|
933
|
|||||||
|
Net
increase (decrease) in accrued interest payable
|
728
|
333
|
(106
|
)
|
||||||
|
Increase
in other assets
|
(67
|
)
|
(135
|
)
|
(67
|
)
|
||||
|
Decrease
in other liabilities
|
(9
|
)
|
(551
|
)
|
(280
|
)
|
||||
|
Net
cash provided by operating activities
|
6,673
|
6,525
|
9,301
|
|||||||
|
Investing
Activities
|
||||||||||
|
Proceeds
from maturities and calls of investment securities
|
||||||||||
|
available-for-sale
|
24,595
|
36,720
|
55,334
|
|||||||
|
held-to-maturity
|
870
|
300
|
5,811
|
|||||||
|
Proceeds
from sales of investment securities
|
||||||||||
|
available-for-sale
|
46,490
|
45,105
|
66,715
|
|||||||
|
Purchase
of investment securities
|
||||||||||
|
available-for-sale
|
(57,069
|
)
|
(52,442
|
)
|
(130,878
|
)
|
||||
|
Proceeds
from sales of non-marketable equity securities
|
1,700
|
751
|
259
|
|||||||
|
Purchase
of non-marketable equity securities
|
(1,481
|
)
|
(488
|
)
|
(396
|
)
|
||||
|
Net
increase in loans
|
(42,323
|
)
|
(33,294
|
)
|
(37,156
|
)
|
||||
|
Net
purchases of premises and equipment
|
(1,789
|
)
|
(651
|
)
|
(1,460
|
)
|
||||
|
Net
cash used by investing activities
|
(29,007
|
)
|
(3,999
|
)
|
(41,771
|
)
|
||||
|
Financing
Activities
|
||||||||||
|
Net
(decrease) increase in non-interest bearing deposits
|
(5,721
|
)
|
3,858
|
2,135
|
||||||
|
Net
increase (decrease) in interest-bearing non-maturity deposits
|
4,270
|
(19,985
|
)
|
13,036
|
||||||
|
Net
increase in time deposits
|
21,703
|
8,309
|
12,678
|
|||||||
|
Net
increase in short-term borrowings
|
10,517
|
6,222
|
2,958
|
|||||||
|
Repayment
of Federal Home Loan Bank advances
|
(3,000
|
)
|
—
|
—
|
||||||
|
Tax
benefit from exercise of stock options
|
66
|
—
|
—
|
|||||||
|
Cash
dividends paid
|
(2,626
|
)
|
(2,420
|
)
|
(2,292
|
)
|
||||
|
Proceeds
from issuance of common stock
|
421
|
112
|
74
|
|||||||
|
Net
cash provided by (used by) financing activities
|
25,630
|
(3,904
|
)
|
28,589
|
||||||
|
Increase
(decrease) in cash and cash equivalents
|
3,296
|
(1,378
|
)
|
(3,881
|
)
|
|||||
|
Cash
and cash equivalents at beginning of year
|
20,807
|
22,185
|
26,066
|
|||||||
|
Cash
and cash equivalents at end of year
|
$
|
24,103
|
$
|
20,807
|
$
|
22,185
|
||||
|
Supplemental
Cash Flow Disclosures
|
||||||||||
|
Interest
paid
|
$
|
15,178
|
$
|
11,655
|
$
|
9,612
|
||||
|
Income
taxes paid
|
1,134
|
1,802
|
1,042
|
|||||||
|
Non-Cash
Transactions
|
||||||||||
|
Change
in net unrealized holding gains, net of taxes, on investment securities
447
|
(1,953
|
)
|
(1,650
|
)
|
||||||
|
Transfer
of loans to repossessed assets
|
50
|
—
|
1,026
|
|||||||
The
accompanying notes are an integral part of the consolidated financial
statements.
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 retail brokerage 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. The Corporation 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.
Misstatements
On
September 13, 2006 the Securities and Exchange Commission (SEC) Staff issued
Statement of Accounting Bulletin No. 108,
Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements
(SAB
108). SAB 108 addresses how errors, built up over time in the balance sheet,
should be considered from a materiality perspective and corrected. SAB 108
provides interpretive guidance on how the effects of the carryover or reversal
of prior year misstatements should be considered in quantifying a current year
misstatement. The SEC Staff believes that companies should quantify errors
using
both a balance sheet and an income statement approach and evaluate whether
either of these approaches results in quantifying a misstatement that, when
all
relevant quantitative and qualitative factors are considered, is material.
SAB
108 also describes the circumstances where it would be appropriate for a
registrant to record a one-time cumulative effect adjustment to correct errors
existing in prior years that previously had been considered immaterial as well
as the required disclosures to investors. During 2006, the Corporation has
not
identified a situation for which it must apply SAB 108 for 2006, 2005 or 2004.
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.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
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 the Atlantic Central
Bankers Bank. These restricted securities are carried at cost.
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 accruing loans past due 90 days or more, non-accrual
loans, other real estate owned and repossessed assets. Non-accrual loans are
those on which the accrual of interest has ceased. Commercial loans and indirect
lease financing 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, 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.
Allowance
for Loan Losses
QNB maintains an allowance for loan losses, which is
intended
to absorb probable known and inherent losses in the outstanding loan portfolio.
The allowance is reduced by actual credit losses and is increased by the
provision for loan losses and recoveries of previous losses. The provisions
for
loan losses are charged to earnings to bring the total allowance for loan
losses
to a level considered necessary by management.
The
allowance for loan losses is based on management’s continuing review and
evaluation of the loan portfolio. The level of the allowance is determined
by
assigning specific reserves to individually identified problem credits and
general reserves to all other loans. The portion of the allowance that is
allocated to internally criticized and non-accrual loans is determined by
estimating the inherent loss on each credit after giving consideration to the
value of underlying collateral. The general reserves are based on the
composition and risk characteristics of the loan portfolio, including the nature
of the loan portfolio, credit concentration trends, historic and anticipated
delinquency and loss experience, as well as other qualitative factors such
as
current economic trends.
Management
emphasizes loan quality and close monitoring of potential problem credits.
Credit risk identification and review processes are utilized in order to assess
and monitor the degree of risk in the loan portfolio. QNB’s lending and loan
administration staff are charged with reviewing the loan portfolio and
identifying changes in the economy or in a borrower’s circumstances which may
affect the ability to repay debt or the value of pledged collateral. A loan
classification and review system exists that identifies those loans with a
higher than normal risk of uncollectibility. Each commercial loan is assigned
a
grade based upon an assessment of the borrower’s financial capacity to service
the debt and the presence and value of collateral for the loan. An independent
loan review group tests risk assessments and evaluates the adequacy of the
allowance for loan losses. Management meets monthly to review the credit quality
of the loan portfolio and quarterly to review the allowance for loan
losses.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
In
addition, various regulatory agencies, as an integral part of their examination
process, periodically review QNB’s allowance for loan losses. 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, 2006, QNB sponsored stock-based compensation plans, administered
by
a committee, under which both qualified and non-qualified stock options may
be
granted periodically to certain employees. QNB accounted for all awards granted
between January 1, 2002 and December 31, 2005 under the “fair value” approach
under Financial Accounting Standards Board (FASB) Statement No. 123,
Accounting
for Stock-Based Compensation.
Effective January 1, 2006, QNB adopted FASB Statement No. 123 (revised 2004),
Share-Based
Payment (FASB
No.
123r), using the modified prospective application method. The modified
prospective application method applies to new awards, to any outstanding
liability awards, and to awards modified, repurchased, or cancelled after
January 1, 2006. For all awards granted prior to January 1, 2006, unrecognized
compensation cost, on the date of adoption, will be recognized as an expense
in
future periods. The results for prior periods have not been
restated.
The
adoption of FASB No. 123r reduced net income by approximately $118,000 for
year
ended December 31, 2006. The following table illustrates the effect on net
income and earnings per share if QNB had applied the fair value recognition
provisions to stock-based employee compensation during the period presented.
For
purposes of this pro forma disclosure, the value of the options is estimated
using the Black-Scholes option-pricing model and amortized to expense over
the
options’ vesting period.
|
December
31,
|
2005
|
2004
|
|||||
|
Net
income, as reported
|
$
|
5,046
|
$
|
6,203
|
|||
|
Deduct:
Total stock-based employee compensation expense determined under
fair
value based method for all awards, net of related tax effects
|
101
|
95
|
|||||
|
Pro
forma net income
|
$
|
4,945
|
$
|
6,108
|
|||
|
Earnings
per share
|
|||||||
|
Basic
- as reported
|
$
|
1.63
|
$
|
2.00
|
|||
|
Basic
- pro forma
|
$
|
1.59
|
$
|
1.97
|
|||
|
Diluted
- as reported
|
$
|
1.59
|
$
|
1.95
|
|||
|
Diluted
- pro forma
|
$
|
1.56
|
$
|
1.92
|
|||
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The
fair
value of each option is amortized into compensation expense on a straight-line
basis between the grant date for the option and each vesting date. 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 subjective in nature. The following assumptions were used in the
option pricing model in determining the fair value of options granted during
the
periods presented.
|
Year
ended December 31,
|
2006
|
2005
|
2004
|
|||||||
|
Risk
free interest rate
|
4.27
|
%
|
4.18
|
%
|
4.39
|
%
|
||||
|
Dividend
yield
|
3.23
|
2.40
|
2.20
|
|||||||
|
Volatility
|
13.28
|
14.05
|
13.61
|
|||||||
|
Expected
life
|
5
yrs.
|
10
yrs.
|
10
yrs.
|
|||||||
The
risk-free interest rate was selected based upon yields of U.S. Treasury issues
with a term equal to the expected life of the option being valued. Historical
information was the primary basis for the selection of the expected dividend
yield, expected volatility and expected lives of the options.
The
weighted average fair value per share of options granted during 2006, 2005
and
2004 was $3.13, $6.46 and $7.18, 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, be 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.
Earnings
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.
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
Accounting
for Certain Hybrid Instruments
In
February 2006, the FASB issued FASB Statement No. 155 (FASB No. 155),
Accounting
for Certain Hybrid Instruments, as an amendment of FASB Statements No. 133
and
140.
FASB
No. 155 allows financial instruments that have embedded derivatives to be
accounted for as a whole (eliminating the need to bifurcate the derivative
from
its host) if the holder elects to account for the whole instrument on a fair
value basis. This statement is effective for all financial instruments acquired
or issued after the beginning of an entity’s first fiscal year that begins after
September 15, 2006. The adoption of this standard is not expected to have a
material effect on the QNB’s results of operations or financial
position.
Accounting
for Servicing of Financial Assets
In
March
2006, the FASB issued FASB Statement No. 156 (FASB No. 156), Accounting
for Servicing of Financial Assets.
This
Statement, which is an amendment to FASB No. 140, will simplify the accounting
for servicing assets and liabilities, such as those common with mortgage
securitization activities. Specifically, FASB No. 156 addresses the recognition
and measurement of separately recognized servicing assets and liabilities and
provides an approach to simplify efforts to obtain hedge-like (offset)
accounting. FASB No. 156 also clarifies when an obligation to service financial
assets should be separately recognized as a servicing asset or a servicing
liability, requires that a separately recognized servicing asset or servicing
liability be initially measured at fair value, if practicable, and permits
an
entity with a separately recognized servicing asset or servicing liability
to
choose either of the amortization or fair value methods for subsequent
measurement. The provisions of FASB No. 156 are effective as of the beginning
of
the first fiscal year that begins after September 15, 2006. The adoption of
this
standard is not expected to have a material effect on QNB’s results of
operations or financial position.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Fair
Value Measurements
In
September 2006, the FASB issued FASB Statement No. 157 (FASB No. 157),
Fair
Value Measurements,
which
provides enhanced guidance for using fair value to measure assets and
liabilities. The standard applies whenever other standards require or permit
assets or liabilities to be measured at fair value. The Standard does not expand
the use of fair value in any new circumstances. FASB No. 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007
and interim periods within those fiscal years. Early adoption is permitted.
The
adoption of this standard is not expected to have a material effect on QNB’s
results of operations or financial position.
Accounting
for Uncertainty in Income Taxes
In
June
2006, the FASB issued FASB Interpretation No. 48 (FIN 48), Accounting
for Uncertainty in Income Taxes.
FIN 48
is an interpretation of FASB No. 109, Accounting
for Income Taxes,
and it
seeks to reduce the diversity in practice associated with certain aspects of
measurement and recognition in accounting for income taxes. In addition, FIN
48
requires expanded disclosure with respect to the uncertainty in income taxes
and
is effective for fiscal years beginning after December 15, 2006. The adoption
of
this standard is not expected to have a material effect on QNB’s results of
operations
Accounting
for Deferred Compensation
In
September 2006, the FASB reached consensus on the guidance provided by Emerging
Issues Task Force Issue 06-4 (EITF 06-4), Accounting
for Deferred Compensation and Postretirement Benefit Aspects of Endorsement
Split-Dollar Life Insurance Arrangements.
The
guidance is applicable to endorsement split-dollar life insurance arrangements,
whereby the employer owns and controls the insurance policy, that are associated
with a postretirement benefit. EITF 06-4 requires that for a split-dollar life
insurance arrangement within the scope of the Issue, an employer should
recognize a liability for future benefits in accordance with FASB No. 106 (if,
in substance, a postretirement benefit plan exists) or Accounting Principles
Board Opinion No. 12 (if the arrangement is, in substance, an individual
deferred compensation contract) based on the substantive agreement with the
employee. EITF 06-4 is effective for fiscal years beginning after December
15,
2007. QNB is currently evaluating the impact the adoption of the standard will
have on its results of operations and financial position.
Accounting
for Purchases of Life Insurance
In
September 2006, the FASB reached consensus on the guidance provided by Emerging
Issues Task Force Issue 06-5 (EITF 06-5), Accounting
for Purchases of Life Insurance—Determining the Amount That Could Be Realized in
Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases
of
Life Insurance.
EITF
06-5 states that a policyholder should consider any additional amounts included
in the contractual terms of the insurance policy other than the cash surrender
value in determining the amount that could be realized under the insurance
contract. EITF 06-5 also states that a policyholder should determine the amount
that could be realized under the life insurance contract assuming the surrender
of an individual-life by individual-life policy (or certificate by certificate
in a group policy). EITF 06-5 is effective for fiscal years beginning after
December 15, 2006. QNB is currently evaluating the impact the adoption of the
standard will have on its results of operations and financial position.
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:
|
2006
|
2005
|
2004
|
||||||||
|
Numerator
for basic and diluted earnings per share - net income
|
$
|
5,420
|
$
|
5,046
|
$
|
6,203
|
||||
|
Denominator
for basic earnings per share - weighted average shares
outstanding
|
3,124,724
|
3,101,754
|
3,096,360
|
|||||||
|
Effect
of dilutive securities - employee stock options
|
51,986
|
72,893
|
81,792
|
|||||||
|
Denominator
for diluted earnings per share - adjusted weighted average shares
outstanding
|
3,176,710
|
3,174,647
|
3,178,152
|
|||||||
|
Earnings
per share - basic
|
$
|
1.73
|
$
|
1.63
|
$
|
2.00
|
||||
|
Earnings
per share - diluted
|
1.71
|
1.59
|
1.95
|
|||||||
There
were 52,300 and 40,000 stock options that were anti-dilutive as of December
31,
2006 and 2005, respectively. These stock options were not included in the above
calculation.
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 $225,000 and $8,807,000 to satisfy federal regulatory
requirements as of December 31, 2006 and 2005, respectively.
Note
4 - Investment Securities Available-For-Sale
The
amortized cost and estimated fair values of investment securities
available-for-sale at December 31, 2006 and 2005 were as
follows:
|
December
31,
|
2006
|
2005
|
|||||||||||||||||||||||
|
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
|
$
|
4,984
|
$
|
—
|
$
|
9
|
$
|
4,993
|
$
|
6,002
|
$
|
—
|
$
|
39
|
$
|
6,041
|
|||||||||
|
U.S.
Government agencies
|
33,244
|
96
|
91
|
33,239
|
23,824
|
1
|
326
|
24,149
|
|||||||||||||||||
|
State
and municipal securities
|
36,121
|
784
|
123
|
35,460
|
47,530
|
1,073
|
226
|
46,683
|
|||||||||||||||||
|
Mortgage-backed
securities
|
67,471
|
36
|
1,227
|
68,662
|
57,733
|
29
|
1,241
|
58,945
|
|||||||||||||||||
|
Collateralized
mortgage obligations (CMOs)
|
59,033
|
—
|
1,777
|
60,810
|
71,475
|
6
|
2,169
|
73,638
|
|||||||||||||||||
|
Other
debt securities
|
14,373
|
587
|
5
|
13,791
|
18,252
|
1,043
|
344
|
17,553
|
|||||||||||||||||
|
Equity
securities
|
4,592
|
515
|
21
|
4,098
|
8,459
|
744
|
463
|
8,178
|
|||||||||||||||||
|
Total
investment securities available-for-sale
|
$
|
219,818
|
$
|
2,018
|
$
|
3,253
|
$
|
221,053
|
$
|
233,275
|
$
|
2,896
|
$
|
4,808
|
$
|
235,187
|
|||||||||
The
amortized cost and estimated fair value of securities available-for-sale by
contractual maturity at December 31, 2006 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. Securities are assigned to categories based on contractual
maturity except for mortgage-backed securities and CMOs which are based on
the
estimated average life of these securities.
|
Aggregate
|
Amortized
|
||||||
|
December
31, 2006
|
fair
value
|
cost
|
|||||
|
Due
in one year or less
|
$
|
14,849
|
$
|
14,884
|
|||
|
Due
after one year through five years
|
129,153
|
131,518
|
|||||
|
Due
after five years through ten years
|
56,326
|
56,009
|
|||||
|
Due
after ten years
|
14,898
|
14,544
|
|||||
|
Equity
securities
|
4,592
|
4,098
|
|||||
|
Total
securities available-for-sale
|
$
|
219,818
|
$
|
221,053
|
|||
Proceeds
from sales of investment securities available-for-sale were as
follows:
|
2006
|
2005
|
2004
|
||||||||
|
Proceeds
|
$
|
46,490
|
$
|
45,105
|
$
|
66,715
|
||||
|
Gross
gains
|
1,309
|
812
|
1,207
|
|||||||
|
Gross
losses
|
1,047
|
1,539
|
358
|
|||||||
Included
in gross losses for 2006, 2005 and 2004 were other-than-temporary impairment
charges of $51,000, $1,253,000 and $0, respectively.
Held-To-Maturity
The
amortized cost and estimated fair values of investment securities
held-to-maturity at December 31, 2006 and 2005 were as follows:
|
December
31,
|
2006
|
2005
|
|||||||||||||||||||||||
|
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
|
$
|
5,021
|
$
|
147
|
$
|
—
|
$
|
5,168
|
$
|
5,897
|
$
|
185
|
$
|
—
|
$
|
6,082
|
|||||||||
The
amortized cost and estimated fair values of securities held-to-maturity by
contractual maturity at December 31, 2006, 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, 2006
|
fair
value
|
cost
|
|||||
|
Due
in one year or less
|
$
|
639
|
$
|
636
|
|||
|
Due
after one year through five years
|
573
|
563
|
|||||
|
Due
after five years through ten years
|
786
|
759
|
|||||
|
Due
after ten years
|
3,170
|
3,063
|
|||||
|
Total
securities held-to-maturity
|
$
|
5,168
|
$
|
5,021
|
|||
There
were no sales of investment securities classified as held-to-maturity during
2006, 2005 or 2004.
At
December 31, 2006 and 2005, investment securities available-for-sale totaling
$75,793,000 and $68,917,000 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, 2006 and
2005:
|
Less
than 12 months
|
12
months or longer
|
Total
|
|||||||||||||||||
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
||||||||||||||
|
As
of December 31, 2006
|
value
|
losses
|
value
|
losses
|
value
|
losses
|
|||||||||||||
|
U.S.
Treasury
|
$
|
1,998
|
$
|
2
|
$
|
1,990
|
$
|
7
|
$
|
3,988
|
$
|
9
|
|||||||
|
U.S.
Government agencies
|
12,966
|
28
|
5,782
|
63
|
18,748
|
91
|
|||||||||||||
|
State
and municipal securities
|
683
|
1
|
4,926
|
122
|
5,609
|
123
|
|||||||||||||
|
Mortgage-backed
securities
|
17,609
|
104
|
45,083
|
1,123
|
62,692
|
1,227
|
|||||||||||||
|
Collateralized
mortgage obligations (CMOs)
|
775
|
1
|
58,258
|
1,776
|
59,033
|
1,777
|
|||||||||||||
|
Other
debt securities
|
2,001
|
5
|
—
|
—
|
2,001
|
5
|
|||||||||||||
|
Equity
securities
|
638
|
11
|
87
|
10
|
725
|
21
|
|||||||||||||
|
Total
|
$
|
36,670
|
$
|
153
|
$
|
116,126
|
$
|
3,101
|
$
|
152,796
|
$
|
3,253
|
|||||||
|
Less
than 12 months
|
12
months or longer
|
Total
|
|||||||||||||||||
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
||||||||||||||
|
As
of December 31, 2005
|
value
|
losses
|
value
|
losses
|
value
|
losses
|
|||||||||||||
|
U.S.
Treasury
|
$
|
2,999
|
$
|
7
|
$
|
3,003
|
$
|
32
|
$
|
6,002
|
$
|
39
|
|||||||
|
U.S.
Government agencies
|
17,046
|
211
|
5,777
|
115
|
22,823
|
326
|
|||||||||||||
|
State
and municipal securities
|
9,317
|
57
|
4,647
|
169
|
13,964
|
226
|
|||||||||||||
|
Mortgage-backed
securities
|
43,780
|
882
|
12,762
|
359
|
56,542
|
1,241
|
|||||||||||||
|
Collateralized
mortgage obligations (CMOs)
|
27,558
|
397
|
42,967
|
1,772
|
70,525
|
2,169
|
|||||||||||||
|
Other
debt securities
|
2,214
|
344
|
—
|
—
|
2,214
|
344
|
|||||||||||||
|
Equity
securities
|
1,030
|
73
|
1,923
|
390
|
2,953
|
463
|
|||||||||||||
|
Total
|
$
|
103,944
|
$
|
1,971
|
$
|
71,079
|
$
|
2,837
|
$
|
175,023
|
$
|
4,808
|
|||||||
QNB
has
150 securities in an unrealized loss position at December 31, 2006. 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.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
5 - Loans
|
December
31,
|
2006
|
2005
|
|||||
|
Commercial
and industrial
|
$
|
72,718
|
$
|
64,812
|
|||
|
Construction
|
10,503
|
7,229
|
|||||
|
Real
estate-commercial
|
118,166
|
104,793
|
|||||
|
Real
estate-residential
|
123,531
|
112,920
|
|||||
|
Consumer
|
5,044
|
5,080
|
|||||
|
Indirect
lease financing
|
13,405
|
6,451
|
|||||
|
Total
loans
|
343,367
|
301,285
|
|||||
|
Unearned
costs
|
129
|
64
|
|||||
|
Total
loans, net of unearned costs (income)
|
$
|
343,496
|
$
|
301,349
|
|||
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, 2006, the recorded investment in loans for which impairment has
been recognized totaled $403,000 of which none required an allowance for loan
loss. At December 31, 2005, there were no loans identified for impairment.
Most
of the loans identified as impaired are collateral-dependent. For the years
ended December 31, 2006, 2005 and 2004, the average recorded investment in
impaired loans was approximately $44,000, $11,000 and $507,000, respectively.
QNB recognized $13,000, $38,000 and $111,000 of interest income on these loans
in 2006, 2005 and 2004, respectively.
At
December 31, 2006 there were $416,000 of loans on non-accrual status. There
were
no non-accrual loans at December 31, 2005. Some of 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, 2006,
2005 and 2004, would have increased approximately $8,000, $0 and $21,000,
respectively. The amount of interest income on these loans that was included
in
net income in 2006 was $9,000. There was no interest income recognized on
non-accrual loans in 2005 or 2004.
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.
At
December 31, 2006, there were no concentrations of loans exceeding 10 percent
of
total loans other than disclosed in the table above.
Note
6 - Allowance For Loan Losses
Activity
in the allowance for loan losses is shown below:
|
December
31,
|
2006
|
2005
|
2004
|
|||||||
|
Balance
at beginning of year
|
$
|
2,526
|
$
|
2,612
|
$
|
2,929
|
||||
|
Charge-offs
|
(187
|
)
|
(115
|
)
|
(406
|
)
|
||||
|
Recoveries
|
45
|
29
|
89
|
|||||||
|
Net
charge-offs
|
(142
|
)
|
(86
|
)
|
(317
|
)
|
||||
|
Provision
for loan losses
|
345
|
—
|
—
|
|||||||
|
Balance
at end of year
|
$
|
2,729
|
$
|
2,526
|
$
|
2,612
|
||||
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,
|
2006
|
2005
|
|||||
|
Land
and buildings
|
$
|
6,719
|
$
|
5,812
|
|||
|
Furniture
and equipment
|
8,733
|
7,987
|
|||||
|
Leasehold
improvements
|
1,655
|
1,655
|
|||||
|
Book
value
|
17,107
|
15,454
|
|||||
|
Accumulated
depreciation and amortization
|
(10,665
|
)
|
(10,054
|
)
|
|||
|
Net
book value
|
$
|
6,442
|
$
|
5,400
|
|||
Depreciation
and amortization expense on premises and equipment amounted to $744,000,
$890,000 and $907,000 for the years ended December 31, 2006, 2005 and 2004,
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 deposit premium intangible was
$43,000 and $94,000 at December 31, 2006 and 2005, respectively. Amortization
expense for core deposit intangibles for each of the years ended December 31,
2006, 2005 and 2004 was $51,000.
The
following table reflects the components of mortgage servicing rights as of
the
periods indicated:
|
Years
Ended December 31,
|
2006
|
2005
|
2004
|
|||||||
|
Mortgage
servicing rights beginning balance
|
$
|
528
|
$
|
552
|
$
|
582
|
||||
|
Mortgage
servicing rights capitalized
|
31
|
80
|
66
|
|||||||
|
Mortgage
servicing rights amortized
|
(87
|
)
|
(109
|
)
|
(122
|
)
|
||||
|
Fair
market value adjustments
|
—
|
5
|
26
|
|||||||
|
Mortgage
servicing rights ending balance
|
$
|
472
|
$
|
528
|
$
|
552
|
||||
|
Mortgage
loans serviced for others
|
$
|
70,816
|
$
|
77,196
|
$
|
78,904
|
||||
|
Amortization
expense of intangible assets for the years ended December
31
|
138
|
160
|
173
|
|||||||
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,
2007
|
$
|
134
|
||
|
for
the year ended December 31, 2008
|
79
|
|||
|
for
the year ended December 31, 2009
|
65
|
|||
|
for
the year ended December 31, 2010
|
53
|
|||
|
for
the year ended December 31, 2011
|
43
|
Note
9 - Time Deposits
The
aggregate amount of time deposits including deposits in denominations of
$100,000 or more was $232,832,000 and $211,129,000 at December 31, 2006 and
2005, respectively. The scheduled maturities of time deposits as of December
31,
2006 for the years 2007 through 2011 and thereafter are approximately
$160,119,000, $29,093,000, $33,032,000, $8,248,000, $2,310,000 and $30,000,
respectively.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
10 - Short-Term Borrowings
|
Securities
Sold under
|
Other
|
||||||
|
December
31,
|
Agreements
to Repurchase
(a)
|
Short-term
Borrowings (b)
|
|||||
|
2006
|
|||||||
|
Balance
|
$
|
29,513
|
$
|
600
|
|||
|
Maximum
indebtedness at any month end
|
29,513
|
5,061
|
|||||
|
Daily
average indebtedness outstanding
|
19,755
|
1,718
|
|||||
|
Average
rate paid for the year
|
3.29
|
%
|
5.02
|
%
|
|||
|
Average
rate on period-end borrowings
|
3.43
|
5.04
|
|||||
|
2005
|
|||||||
|
Balance
|
$
|
17,506
|
$
|
2,090
|
|||
|
Maximum
indebtedness at any month end
|
20,287
|
2,090
|
|||||
|
Daily
average indebtedness outstanding
|
13,959
|
687
|
|||||
|
Average
rate paid for the year
|
2.13
|
%
|
3.80
|
%
|
|||
|
Average
rate on period-end borrowings
|
2.53
|
4.14
|
|||||
| (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 $29,992,000
and $21,453,000 and a fair value of $29,332,000 and $20,907,000 at
December 31, 2006 and 2005, 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.
|
The
Bank
has two unsecured federal funds lines granted by correspondent banks totaling
$21,000,000. Federal funds purchased totaled $1,490,000 at December 31,
2005.
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
$3,375,000 and $3,594,000 at December 31, 2006 and 2005, respectively, is also
pledged to secure these advances.
QNB
has a
maximum borrowing capacity with the FHLB of approximately $241,946,000. At
December 31, 2006 and 2005, there were $52,000,000 and $55,000,000,
respectively, in outstanding advances with a weighted average interest rate
of
5.55 percent and 5.47 percent, respectively. Advances are made pursuant to
several different credit programs offered by the FHLB. At December 31, 2006,
$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, 2006 mature as follows:
|
Loans
maturing in 2007 with a rate of 5.45%
|
$
|
2,000
|
||
|
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
|
$
|
52,000
|
||
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
12 - Income Taxes
The
components of the provision for income taxes are as follows:
|
Year
Ended December 31,
|
2006
|
2005
|
2004
|
|||||||
|
Current
federal income taxes
|
$
|
1,217
|
$
|
1,479
|
$
|
1,405
|
||||
|
Deferred
federal income taxes
|
(183
|
)
|
(81
|
)
|
299
|
|||||
|
Net
provision
|
$
|
1,034
|
$
|
1,398
|
$
|
1,704
|
||||
At
December 31, 2006 and 2005, the tax effects of temporary differences that
represent the significant portion of deferred tax assets and liabilities are
as
follows:
|
Year
Ended December 31,
|
2006
|
2005
|
|||||
|
Deferred
tax assets
|
|||||||
|
Allowance
for loan losses
|
$
|
928
|
$
|
750
|
|||
|
Impaired
equity securities
|
52
|
384
|
|||||
|
Capital
loss carryover
|
77
|
—
|
|||||
|
Net
unrealized holding losses on investment securities available for
sale
|
420
|
650
|
|||||
|
Deferred
compensation
|
64
|
74
|
|||||
|
Deposit
premium
|
53
|
47
|
|||||
|
Other
|
7
|
13
|
|||||
|
Total
deferred tax assets
|
1,601
|
1,918
|
|||||
|
Valuation
allowance
|
—
|
(209
|
)
|
||||
|
Net
deferred tax assets
|
1,601
|
1,709
|
|||||
|
Deferred
tax liabilities
|
|||||||
|
Depreciation
|
32
|
60
|
|||||
|
Mortgage
servicing rights
|
161
|
180
|
|||||
|
Other
|
103
|
117
|
|||||
|
Total
deferred tax liabilities
|
296
|
357
|
|||||
|
Net
deferred tax asset
|
$
|
1,305
|
$
|
1,352
|
|||
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 $209,000 was established during the year
ended December 31, 2005 to offset a portion of the tax benefits associated
with
certain impaired securities that management believed may not be realizable.
During 2006, QNB was able to recognize tax benefits due to realized and
unrealized capital gains which allowed for the reversal of the entire valuation
allowance. Based upon these and other factors, management believes it is more
likely than not that QNB will realize the benefits of these remaining deferred
tax assets. The net deferred tax asset is included in other assets on the
consolidated balance sheet. As of December 31, 2006, QNB has a capital loss
carryover of $228,000 that will expire on December 31, 2011, if not
utilized.
A
reconciliation of the tax provision on income before taxes computed at the
statutory rate of 34 percent and the actual tax provision was as
follows:
|
Year
Ended December 31,
|
2006
|
2005
|
2004
|
|||||||
|
Provision
at statutory rate
|
$
|
2,194
|
$
|
2,191
|
$
|
2,688
|
||||
|
Tax-exempt
interest and dividend income
|
(830
|
)
|
(882
|
)
|
(879
|
)
|
||||
|
Bank-owned
life insurance
|
(99
|
)
|
(98
|
)
|
(102
|
)
|
||||
|
Life
insurance proceeds
|
—
|
(21
|
)
|
—
|
||||||
|
Stock-based
compensation expense
|
40
|
—
|
—
|
|||||||
|
Change
in valuation allowance
|
(209
|
)
|
209
|
—
|
||||||
|
Other
|
(62
|
)
|
(1
|
)
|
(3
|
)
|
||||
|
Total
provision
|
$
|
1,034
|
$
|
1,398
|
$
|
1,704
|
||||
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
13 - Employee Benefit Plans
The
Quakertown National Bank Retirement Savings 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
2006, 2005 and 2004, QNB contributed $145,656, $145,825 and $140,131,
respectively, as a matching contribution and $276,789, $275,908 and $259,981,
respectively, 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 2001 Plan expired on June 1, 2006. The 2001 Plan
authorized the issuance of 42,000 shares. As of December 31, 2006, 15,399 shares
were issued under the 2001 Plan. The 2006 Plan authorizes the issuance of 20,000
shares. As of December 31, 2006, 1,578 shares were issued under the 2006 Plan.
The 2006 Plan expires May 31, 2011.
Shares
issued pursuant to the Plan were as follows:
|
Year
Ended December 31,
|
Shares
|
Price
per Share
|
|||||
|
2006
|
3,071
|
|
$
23.40 and
$ 23.63
|
||||
|
2005
|
2,794
|
24.98
and 27.90
|
|||||
|
2004
|
2,679
|
27.45
and 27.45
|
|||||
Note
14 - Stock Option Plan
QNB
has
stock option plans (the Plans) administered by a committee which consists of
three or more members of QNB’s Board of Directors. The Plans provide for the
granting of either (i) Non-Qualified Stock Options (NQSOs) or (ii) Incentive
Stock Options (ISOs). The exercise price of an option, as defined by the Plans,
is the fair market value of QNB’s common stock at the date of grant. The Plans
provide for the exercise either in cash or in securities of the Corporation
or
in any combination thereof.
The
1998
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 after the date of grant or
continue beyond the expiration of ten years after the date the option is
awarded. As of December 31, 2006, there were 225,058 options granted, 9,994
options cancelled, 34,641 options exercised and 180,423 options outstanding
under this Plan.
The
2005
Plan authorizes the issuance of 200,000 shares. The terms of the 2005 Plan
are
identical to the 1998 Plan except the options expire five years after the grant
date. As of December 31, 2006, there were 8,900 options granted and outstanding
under this Plan.
As
of
December 31, 2006, there was approximately $91,000 of unrecognized compensation
cost related to unvested share-based compensation awards granted. That cost
is
expected to be recognized over the next two years.
Stock
option activity during 2006, 2005 and 2004, was as follows:
|
Weighted
Average
|
|||||||||||||
|
Weighted
|
Remaining
|
Aggregate
Intrinsic
|
|||||||||||
|
Number
of Options
|
Average
Exercise Price
|
Contractual
Term (in yrs)
|
Value
|
||||||||||
|
Outstanding
at December
31, 2003
|
162,412
|
$
|
16.15
|
7.29
|
|||||||||
|
Exercised
|
(20
|
)
|
13.09
|
||||||||||
|
Granted
|
20,000
|
33.25
|
|||||||||||
|
Outstanding
at December 31, 2004
|
182,392
|
18.03
|
6.64
|
||||||||||
|
Exercised
|
(3,918
|
)
|
15.21
|
||||||||||
|
Granted
|
20,000
|
32.35
|
|||||||||||
|
Cancelled
|
(5,100
|
)
|
32.79
|
||||||||||
|
Outstanding
December 31, 2005
|
193,374
19.18
|
5.93
|
|||||||||||
|
Exercised
|
(21,451
|
)
|
16.27
|
||||||||||
|
Granted
|
17,400
|
26.00
|
|||||||||||
|
Outstanding
at December 31, 2006
|
189,323
|
20.14
|
4.92
|
$
|
1,279
|
||||||||
|
Exercisable
at December 31, 2006
|
137,023
|
$
|
16.16
|
4.33
|
$
|
1,279
|
|||||||
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The
cash
proceeds, tax benefits and intrinsic value related to total stock options
exercised during 2006, 2005 and 2004 are as follows:
|
2006
|
2005
|
2004
|
||||||||
|
Proceeds
from stock options exercised
|
$
|
349
|
$
|
38
|
$
|
—
|
||||
|
Tax
benefits related to stock options exercised
|
66
|
4
|
—
|
|||||||
|
Intrinsic
value of stock options exercised
|
196
|
64
|
—
|
|||||||
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, 2005
|
$
|
3,154
|
||
|
New
loans
|
3,030
|
|||
|
Repayments
|
2,394
|
|||
|
Balance,
December 31, 2006
|
$
|
3,790
|
||
QNB
allowed its directors to defer a portion of their compensation. The amount
of
deferred compensation accrued as of December 31, 2006 and 2005, was $188,000
and
$219,000, respectively.
On
September 22, 2005, the Bank approved and entered into an agreement with Eugene
T. Parzych, Inc. to act as the general contractor for the renovation of its
property at 322 W. Broad Street, Quakertown, Pennsylvania to be used as the
loan
center. The bids for this project were submitted through a formal bidding
process and reviewed by the Board of Directors. Mr. Gary S. Parzych is the
president of Eugene T. Parzych, Inc. and is also a director of QNB Corp.
Management and the Board of Directors of QNB Corp. and the Bank believe this
is
an arms-length transaction. The total paid to Eugene T. Parzych Inc. during
2006
and 2005, was $1,032,000 and $214,000, respectively.
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 $3,422,000 and $5,095,000, and commitments to extend credit
and unused lines of credit totaled $69,926,000 and $81,154,000 at December
31,
2006 and 2005, 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.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Other
commitments:
QNB
has
committed to various operating leases for several of their branch and office
facilities. Some of these leases include renewal options as well as specific
provisions relating to rent increases. The minimum annual rental commitments
under these leases outstanding at December 31, 2006 are as
follows:
|
Minimum
Lease Payments
|
||||
|
2007
|
$
|
304
|
||
|
2008
|
297
|
|||
|
2009
|
277
|
|||
|
2010
|
274
|
|||
|
2011
|
265
|
|||
|
Thereafter
|
1,728
|
|||
Rent
expense under leases for each of the years ended December 31, 2006, 2005 and
2004, was $317,000, $307,000 and $299,000, respectively.
Note
17 - Other Comprehensive Income (Loss)
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, 2006
|
||||||||||
|
Unrealized
gains on securities
|
||||||||||
|
Unrealized
holding gains arising during the period
|
$
|
939
|
$
|
(319
|
)
|
$
|
620
|
|||
|
Reclassification
adjustment for gains included in net income
|
(262
|
)
|
89
|
(173
|
)
|
|||||
|
Other
comprehensive income (loss)
|
$
|
677
|
$
|
(230
|
)
|
$
|
447
|
|||
|
Year
Ended December 31, 2005
|
||||||||||
|
Unrealized
losses on securities
|
||||||||||
|
Unrealized
holding losses arising during the period
|
$
|
(4,200
|
)
|
$
|
1,573
|
$
|
(2,627
|
)
|
||
|
Reclassification
adjustment for losses included in net income
|
727
|
(53
|
)
|
674
|
||||||
|
Other
comprehensive income (loss)
|
$
|
(3,473
|
)
|
$
|
1,520
|
$
|
(1,953
|
)
|
||
|
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 (loss)
|
$
|
(1,986
|
)
|
$
|
336
|
$
|
(1,650
|
)
|
||
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.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The
estimated fair values and carrying amounts are summarized as
follows:
|
December
31,
|
2006
|
2005
|
|||||||||||
|
Carrying
Amount
|
Estimated
Fair Value
|
Carrying
Amount
|
Estimated
Fair Value
|
||||||||||
|
Financial
Assets
|
|||||||||||||
|
Cash
and due from banks
|
$
|
12,439
|
$
|
12,439
|
$
|
20,807
|
$
|
20,807
|
|||||
|
Federal
funds sold
|
11,664
|
11,664
|
—
|
—
|
|||||||||
|
Investment
securities available-for-sale
|
219,818
|
219,818
|
233,275
|
233,275
|
|||||||||
|
Investment
securities held-to-maturity
|
5,021
|
5,168
|
5,897
|
6,082
|
|||||||||
|
Non-marketable
equity securities
|
3,465
|
3,465
|
3,684
|
3,684
|
|||||||||
|
Loans
held-for-sale
|
170
|
168
|
134
|
137
|
|||||||||
|
Net
loans
|
340,767
|
332,539
|
298,823
|
293,851
|
|||||||||
|
Bank-owned
life insurance
|
8,415
|
8,415
|
8,103
|
8,103
|
|||||||||
|
Mortgage
servicing rights
|
472
|
680
|
528
|
727
|
|||||||||
|
Accrued
interest receivable
|
2,874
|
2,874
|
2,572
|
2,572
|
|||||||||
|
Financial
Liabilities
|
|||||||||||||
|
Deposits
with no stated maturities
|
246,090
|
246,090
|
247,541
|
247,541
|
|||||||||
|
Deposits
with stated maturities
|
232,832
|
231,007
|
211,129
|
208,024
|
|||||||||
|
Short-term
borrowings
|
30,113
|
30,113
|
19,596
|
19,596
|
|||||||||
|
Federal
Home Loan Bank advances
|
52,000
|
52,741
|
55,000
|
56,441
|
|||||||||
|
Accrued
interest payable
|
2,240
|
2,240
|
1,512
|
1,512
|
|||||||||
The
estimated fair value of QNB’s off-balance sheet financial instruments is as
follows:
|
December
31,
|
2006
|
2005
|
|||||||||||
|
Notional
Amount
|
Estimated
Fair Value
|
Notional
Amount
|
Estimated
Fair Value
|
||||||||||
|
Commitments
to extend credit
|
$
|
69,926
|
—
|
$
|
81,154
|
—
|
|||||||
|
Standby
letters of credit
|
3,422
|
—
|
5,095
|
—
|
|||||||||
The
following methods and assumptions were used to estimate the fair value of each
major classification of financial instruments at December 31, 2006 and
2005.
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.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
19 - Parent Company Financial Information
Condensed
financial statements of QNB Corp. only:
|
Balance
Sheets
|
|||||||
|
December
31,
|
2006
|
2005
|
|||||
|
Assets
|
|||||||
|
Cash
and cash equivalents
|
$
|
8
|
$
|
8
|
|||
|
Investment
securities available-for-sale
|
4,592
|
4,069
|
|||||
|
Investment
in subsidiary
|
45,915
|
42,527
|
|||||
|
Other
assets
|
11
|
49
|
|||||
|
Total
assets
|
$
|
50,526
|
$
|
46,653
|
|||
|
Liabilities
|
|||||||
|
Other
liabilities
|
$
|
116
|
$
|
89
|
|||
|
Shareholders’
equity
|
|||||||
|
Common
stock
|
2,022
|
2,007
|
|||||
|
Surplus
|
9,707
|
9,117
|
|||||
|
Retained
earnings
|
40,990
|
38,196
|
|||||
|
Accumulated
other comprehensive loss, net
|
(815
|
)
|
(1,262
|
)
|
|||
|
Treasury
stock
|
(1,494
|
)
|
(1,494
|
)
|
|||
|
Total
shareholders’ equity
|
50,410
|
46,564
|
|||||
|
Total
liabilities and shareholders’ equity
|
$
|
50,526
|
$
|
46,653
|
|||
|
Statements
of Income
|
||||||||||
|
Year
Ended December 31,
|
2006
|
2005
|
2004
|
|||||||
|
Dividends
from subsidiary
|
$
|
2,385
|
$
|
2,691
|
$
|
2,182
|
||||
|
Interest
and dividend income
|
70
|
57
|
48
|
|||||||
|
Securities
gains
|
366
|
376
|
613
|
|||||||
|
Total
income
|
2,821
|
3,124
|
2,843
|
|||||||
|
Expenses
|
345
|
221
|
203
|
|||||||
|
Income
before applicable income taxes and equity in undistributed income
of
subsidiary
|
2,476
|
2,903
|
2,640
|
|||||||
|
Income
taxes
|
55
|
59
|
144
|
|||||||
|
Income
before equity in undistributed income of subsidiary
|
2,421
|
2,844
|
2,496
|
|||||||
|
Equity
in undistributed income of subsidiary
|
2,999
|
2,202
|
3,707
|
|||||||
|
Net
income
|
$
|
5,420
|
$
|
5,046
|
$
|
6,203
|
||||
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
|
Statements
of Cash Flows
|
||||||||||
|
Year
Ended December 31,
|
2006
|
2005
|
2004
|
|||||||
|
Operating
Activities
|
||||||||||
|
Net
income
|
$
|
5,420
|
$
|
5,046
|
$
|
6,203
|
||||
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||||
|
Equity
in undistributed income from subsidiary
|
(2,999
|
)
|
(2,202
|
)
|
(3,707
|
)
|
||||
|
Securities
gains, net
|
(366
|
)
|
(376
|
)
|
(613
|
)
|
||||
|
Tax
benefit from exercise of stock options
|
66
|
4
|
—
|
|||||||
|
Stock-based
compensation expense
|
118
|
—
|
—
|
|||||||
|
Decrease
(increase) in other assets
|
38
|
(37
|
)
|
165
|
||||||
|
(Decrease)
increase in other liabilities
|
(1
|
)
|
(75
|
)
|
71
|
|||||
|
Deferred
income tax provision
|
(2
|
)
|
2
|
147
|
||||||
|
Net
cash provided by operating activities
|
2,274
|
2,362
|
2,266
|
|||||||
|
Investing
Activities
|
||||||||||
|
Purchase
of investment securities
|
(2,672
|
)
|
(1,652
|
)
|
(1,623
|
)
|
||||
|
Proceeds
from sale of investment securities
|
2,603
|
1,600
|
1,555
|
|||||||
|
Net
cash used by operating activities
|
(69
|
)
|
(52
|
)
|
(68
|
)
|
||||
|
Financing
Activities
|
||||||||||
|
Cash
dividends paid
|
(2,626
|
)
|
(2,420
|
)
|
(2,292
|
)
|
||||
|
Proceeds
from issuance of common stock
|
421
|
112
|
74
|
|||||||
|
Net
cash used by financing activities
|
(2,205
|
)
|
(2,308
|
)
|
(2,218
|
)
|
||||
|
Increase
(decrease) in cash and cash equivalents
|
—
|
2
|
(20
|
)
|
||||||
|
Cash
and cash equivalents at beginning of year
|
8
|
6
|
26
|
|||||||
|
Cash
and cash equivalents at end of year
|
$
|
8
|
$
|
8
|
$
|
6
|
||||
|
Supplemental
Cash Flow Disclosure
|
||||||||||
|
Non-Cash
Transactions
|
||||||||||
|
Change
in net unrealized holding gains or losses, net of taxes on investment
securities
|
$
|
58
|
$
|
(150
|
)
|
$
|
(207
|
)
|
||
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 2007 to the Corporation totaling $5,201,000, plus
additional amounts equal to the net profit earned by the Bank for the period
from January 1, 2007, through the date of declaration, less dividends previously
declared in 2007.
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, 2006, that the
Corporation and the Bank met capital adequacy requirements to which they were
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:
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
|
Capital
Levels
|
|||||||||||||||||||
|
Actual
|
Adequately
Capitalized
|
Well
Capitalized
|
|||||||||||||||||
|
As
of December 31, 2006
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
|||||||||||||
|
Total
risk-based capital (to risk weighted assets):1
|
|||||||||||||||||||
|
Consolidated
|
$
|
54,133
|
13.91
|
%
|
$
|
31,135
|
8.00
|
%
|
$
|
38,919
|
10.00
|
%
|
|||||||
|
Bank
|
49,742
|
12.92
|
30,789
|
8.00
|
38,486
|
10.00
|
|||||||||||||
|
Tier
I capital (to risk weighted assets):1
|
|||||||||||||||||||
|
Consolidated
|
51,182
|
13.15
|
15,568
|
4.00
|
23,352
|
6.00
|
|||||||||||||
|
Bank
|
47,013
|
12.22
|
15,394
|
4.00
|
23,092
|
6.00
|
|||||||||||||
|
Tier
I capital (to average assets):1
|
|||||||||||||||||||
|
Consolidated
|
51,182
|
8.42
|
24,301
|
4.00
|
30,377
|
5.00
|
|||||||||||||
|
Bank
|
47,013
|
7.79
|
24,134
|
4.00
|
30,167
|
5.00
|
|||||||||||||
|
Capital
Levels
|
|||||||||||||||||||
|
Actual
|
Adequately
Capitalized
|
Well
Capitalized
|
|||||||||||||||||
|
As
of December 31, 2005
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
|||||||||||||
|
Total
risk-based capital (to risk weighted assets):1
|
|||||||||||||||||||
|
Consolidated
|
$
|
50,384
|
13.77
|
%
|
$
|
29,274
|
8.00
|
%
|
$
|
36,593
|
10.00
|
%
|
|||||||
|
Bank
|
46,406
|
12.82
|
28,964
|
8.00
|
36,206
|
10.00
|
|||||||||||||
|
Tier
I capital (to risk weighted assets):1
|
|||||||||||||||||||
|
Consolidated
|
47,732
|
13.04
|
14,637
|
4.00
|
21,956
|
6.00
|
|||||||||||||
|
Bank
|
43,880
|
12.12
|
14,482
|
4.00
|
21,723
|
6.00
|
|||||||||||||
|
Tier
I capital (to average assets):1
|
|||||||||||||||||||
|
Consolidated
|
47,732 |
8.15
|
23,421
|
4.00
|
29,277
|
5.00
|
|||||||||||||
|
Bank
|
43,880
|
7.54
|
23,270
|
4.00
|
29,088
|
5.00
|
|||||||||||||
| 1 |
As
defined by the regulators
|
Note
21 - Consolidated Quarterly Financial Data
The
unaudited quarterly results of operations for the years ended 2006 and 2005
are
in the following table:
|
Quarters
Ended 2006
|
Quarters
Ended 2005
|
||||||||||||||||||||||||
|
March
31
|
June
30
|
Sept.
30
|
Dec.
31
|
March
31
|
June
30
|
Sept.
30
|
Dec.
31
|
||||||||||||||||||
|
Interest
income
|
$
|
7,427
|
$
|
7,828
|
$
|
8,278
|
$
|
8,469
|
$
|
6,759
|
$
|
6,956
|
$
|
7,143
|
$
|
7,414
|
|||||||||
|
Interest
expense
|
3,441
|
3,798
|
4,238
|
4,429
|
2,674
|
2,845
|
3,125
|
3,344
|
|||||||||||||||||
|
Net
interest income
|
3,986
|
4,030
|
4,040
|
4,040
|
4,085
|
4,111
|
4,018
|
4,070
|
|||||||||||||||||
|
Provision
for loan losses
|
—
|
45
|
60
|
240
|
—
|
—
|
—
|
—
|
|||||||||||||||||
|
Non-interest
income
|
1,208
|
951
|
1,147
|
631
|
1,669
|
(172
|
)
|
938
|
827
|
||||||||||||||||
|
Non-interest
expense
|
3,236
|
3,282
|
3,254
|
3,462
|
3,236
|
3,316
|
3,140
|
3,410
|
|||||||||||||||||
|
Income
before income taxes
|
1,958
|
1,654
|
1,873
|
969
|
2,518
|
623
|
1,816
|
1,487
|
|||||||||||||||||
|
Provision
for income taxes
|
280
|
352
|
356
|
46
|
599
|
140
|
385
|
274
|
|||||||||||||||||
|
Net
Income
|
$
|
1,678
|
$
|
1,302
|
$
|
1,517
|
$
|
923
|
$
|
1,919
|
$
|
483
|
$
|
1,431
|
$
|
1,213
|
|||||||||
|
Earnings
Per Share - basic
|
$
|
.54
|
$
|
.42
|
$
|
.48
|
$
|
.30
|
$
|
.62
|
$
|
.16
|
$
|
.46
|
$
|
.39
|
|||||||||
|
Earnings
Per Share - diluted
|
$
|
.53
|
$
|
.41
|
$
|
.48
|
$
|
.29
|
$
|
.60
|
$
|
.15
|
$
|
.45
|
$
|
.38
|
|||||||||
| ITEM 9. |
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
|
None.
| ITEM 9A. |
CONTROLS
AND PROCEDURES
|
| (a) |
Management’s
Report on Internal Control Over Financial
Reporting
|
Management
is responsible for the preparation, integrity, and fair presentation of the
consolidated financial statements included in this annual report. The
consolidated financial statements and notes included in this annual report
have
been prepared in conformity with U.S. generally accepted accounting principles,
and as such, include some amounts that are based on management’s best estimates
and judgments.
The
Corporation’s management is responsible for establishing and maintaining
effective internal control over financial reporting. The system of internal
control over financial reporting, as it relates to the financial statements,
is
evaluated for effectiveness by management and tested for reliability through
a
program of internal audits and management testing and review. Actions are taken
to correct potential deficiencies as they are identified. Any system of internal
control, no matter how well designed, has inherent limitations, including the
possibility that a control can be circumvented or overridden and misstatements
due to error or fraud may occur and not be detected. Also, because of changes
in
conditions, internal control effectiveness may vary over time. Accordingly,
even
an effective system of internal control will provide only a reasonable assurance
with respect to financial statement preparation.
Management
assessed the effectiveness of the Corporation’s internal control over financial
reporting as of December 31, 2006. In making this assessment, it used the
criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) in Internal
Control — Integrated Framework.
Based on
our assessment, management concluded that, as of December 31, 2006, the
Corporation’s internal control over financial reporting is effective and meets
the criteria of the Internal
Control — Integrated Framework.
The
Corporation’s independent registered public accounting firm, S.R. Snodgrass,
A.C., has issued an attestation report on management’s assessment of the
Corporation’s internal control over financial reporting.
| (b) |
Report
of Independent Registered Public Accounting
Firm
|
Board
of
Directors and Shareholders
QNB
Corp.
We
have
audited management’s assessment, included in the accompanying Report on
Management’s Assessment of Internal Control Over Financial Reporting, that QNB
Corp. (the Corporation) maintained effective internal control over financial
reporting as of December 31, 2006, based on criteria established in “Internal
Control—Integrated Framework” issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Corporation’s management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management’s
assessment and an opinion on the effectiveness of the Corporation’s internal
control over financial reporting based on our audit.
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 effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control
over
financial reporting, evaluating management’s assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing
such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain
to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors
of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In
our
opinion, management’s assessment that QNB Corp. maintained effective internal
control over financial reporting as of December 31, 2006, is fairly stated,
in
all material respects, based on the COSO criteria. Also in our opinion, QNB
Corp. maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2006, based on the COSO
criteria.
We
have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of QNB Corp.
and subsidiary as of December 31, 2006, and the related consolidated statements
of income, shareholders’ equity, and cash flows for the years then ended, and
our report dated March 7, 2007, expressed an unqualified opinion.
Wexford,
Pennsylvania
March
7,
2007
| (c) |
Internal
Controls and 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, 2006, 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 subsidiary would be made known to them
by
others within those entities.
There
were no changes in QNB’s internal control over financial reporting that occurred
during the fourth quarter of 2006 that have materially affected, or are
reasonably likely to materially affect, QNB’s internal control over financial
reporting.
| ITEM 9B. |
OTHER
INFORMATION
|
None.
| ITEM 10. |
DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
|
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 2007 Annual Meeting of Shareholders under the captions
| • |
“Election
of Directors”
|
| • |
“Governance
of the Company - Code of Ethics”
|
| • |
“Section
16(a) Beneficial Ownership
Compliance”
|
| • |
“Meetings
and Committees of the Board of Directors of QNB and the
Bank”
|
| • |
“Executive
Officers of QNB and/or the Bank”
|
The
Corporation has adopted a Code of Business Conduct and Ethics applicable to
its
CEO, CFO and Controller as well as its long-standing Code of Ethics which
applies to all directors and employees. The codes are available on the
Corporation’s website at www.qnb.com.
| 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 2007 Annual Meeting of Shareholders under the captions
| • |
“Compensation
Committee Report”
|
| • |
“Compensation
Discussion and Analysis”
|
| • |
“Executive
Compensation”
|
| • |
“Director
Compensation”
|
| • |
“Compensation
Tables”
|
| ITEM 12. |
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
|
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 2007 Annual Meeting of Shareholders under the captions
| • |
“Security
Ownership of Certain Beneficial Owners and
Management”
|
| • |
“Equity
Compensation Plan Information”
|
| ITEM 13. |
CERTAIN
RELATIONSHIPS AND RELATED PARTY TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
|
The
information required by Item 13 is incorporated by reference to the information
appearing in QNB Corp.’s definitive proxy statement to be used in connection
with the 2007 Annual Meeting of Shareholders under the captions
| • |
“Certain
Relationships and Related Party
Transactions”
|
| • |
“Governance
of the Company - Director
Independence”
|
| ITEM 14. |
PRINCIPAL
ACCOUNTANT 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 2007 Annual Meeting of Shareholders under the captions
| • |
“Audit
Committee Pre-Approval of Audit and Permissible Non-Audit Services
of
Independent Auditors”
|
| • |
“Audit
Fees, Audit Related Fees, Tax Fees, and All Other
Fees”
|
| ITEM 15. |
EXHIBITS
AND 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 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 DEF 14-A filed with the Commission on
April 15, 2005.)
|
|
3(ii)
|
- |
By-laws
of Registrant, as amended. (Incorporated by reference to Exhibit
3(ii) of
Registrant’s Form 8-K filed with the Commission on January 23,
2006.)
|
|
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 10.5 of Registrant’s
Form 10-Q filed with the Commission on November 8, 2005.)
|
|
10.6
|
- |
Change
of Control Agreement between Registrant and Bret H. Krevolin.
(Incorporated by reference to Exhibit 10.6 of Registrant’s
Form 10-Q filed with the Commission on November 8,
2005.)
|
|
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).
|
|
10.8
|
- |
QNB
Corp. 2005 Stock Incentive Plan (Incorporated by referrence to Exhibit
99.1 to Registration Statement No. 333-125998 on Form
S-8, filed with the Commission on June 21, 2005).
|
|
10.9
|
- |
QNB
Corp. 2006 Employee Stock Purchase Plan (Incorporated by reference
to
Exhibit 99.1 to Registration Statement No. 333-135408
on
Form S-8, filed with the Commission on June 28,
2006).
|
|
11
|
- |
Statement
re: Computation of Earnings per Share as found on page 50 of Form
10-K,
which is included herein.
|
|
12
|
- |
Statement
re: Computation of Ratios as found on page 12 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
|
- |
Consent
of S.R. Snodgrass, A.C., Independent Registered Public Accounting
Firm
|
|
31.1
|
- |
Section
302 Certification of the President and CEO.
|
|
31.2
|
- |
Section
302 Certification of the Chief Financial Officer.
|
| 32.1 | - | Section 906 Certification of the President and CEO. |
| 32.2 | - | Section 906 Certification of the Chief Financial Officer. |
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
14,
2007
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 Officer and Director
|
March
14, 2007
|
||
|
Thomas
J. Bisko
|
||||
|
/s/
Bret H. Krevolin
|
Chief
Financial Officer and Principal Financial and Accounting
Officer
|
March
14, 2007
|
||
|
Bret
H. Krevolin
|
||||
|
/s/
Norman L. Baringer
|
Director
|
March
14, 2007
|
||
|
Norman
L. Baringer
|
||||
|
/s/
Kenneth F. Brown, Jr.
|
Director
|
March
14, 2007
|
||
|
Kenneth
F. Brown, Jr.
|
||||
|
/s/
Dennis Helf
|
Director,
Chairman
|
March
14, 2007
|
||
|
Dennis
Helf
|
||||
|
/s/
G. Arden Link
|
Director
|
March
14, 2007
|
||
|
G.
Arden Link
|
||||
|
/s/
Charles M. Meredith, III
|
Director
|
March
14, 2007
|
||
|
Charles
M. Meredith, III
|
||||
|
/s/
Anna Mae Papso
|
Director
|
March
14 2007
|
||
|
Anna
Mae Papso
|
||||
|
/s/
Gary S. Parzych
|
Director
|
March
14, 2007
|
||
|
Gary
S. Parzych
|
||||
|
/s/
Henry L. Rosenberger
|
Director
|
March
14, 2007
|
||
|
Henry
L. Rosenberger
|
||||
|
/s/
Edgar L. Stauffer
|
Director
|
March
14, 2007
|
||
|
Edgar
L. Stauffer
|
QNB
CORP.
FORM
10-K
FOR
YEAR
ENDED DECEMBER 31, 2006
EXHIBIT
INDEX
|
Exhibit
|
||
|
3(i)
|
- |
Articles
of Incorporation of Registrant, as amended. (Incorporated by reference
to
Exhibit 3(i) of Registrant’s Form DEF 14-A filed with the Commission on
April 15, 2005.)
|
|
3(ii)
|
- |
By-laws
of Registrant, as amended. (Incorporated by reference to Exhibit
3(ii) of
Registrant’s Form 8-K filed with the Commission on January 23,
2006.)
|
|
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 10.5 of Registrant’s Form 10-Q filed
with the Commission on November 8, 2005.)
|
|
10.6
|
- |
Change
of Control Agreement between Registrant and Bret H. Krevolin.
(Incorporated by reference to Exhibit 10.6 of Registrant’s Form 10-Q filed
with the Commission on November 8, 2005.)
|
|
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).
|
|
10.8
|
- |
QNB
Corp. 2005 Stock Incentive Plan (Incorporated by referrence to Exhibit
99.1 to Registration Statement No. 333-125998 on Form S-8, filed
with the
Commission on June 21, 2005).
|
|
10.9
|
- |
QNB
Corp. 2006 Employee Stock Purchase Plan (Incorporated by reference
to
Exhibit 99.1 to Registration Statement No. 333-135408 on Form S-8,
filed
with the Commission on June 28, 2006).
|
|
11
|
- |
Statement
re: Computation of Earnings per Share as found on page 50 of Form
10-K,
which is included herein.
|
|
12
|
- |
Statement
re: Computation of Ratios as found on page 12 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
|
- |
Consent
of S.R. Snodgrass, A.C., Independent Registered Public Accounting
Firm
|
|
31.1
|
- |
Section
302 Certification of the President and CEO.
|
|
31.2
|
- |
Section
302 Certification of the Chief Financial Officer.
|
|
32.1
|
- |
Section
906 Certification of the President and CEO.
|
|
32.2
|
- |
Section
906 Certification of the Chief Financial
Officer.
|
-71-