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QNB CORP - Quarter Report: 2017 March (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended             March 31, 2017            

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from               to              

Commission file number 0-17706

 

QNB Corp.

(Exact Name of Registrant as Specified in Its Charter)

 

 

Pennsylvania

 

23-2318082

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

15 North Third Street, P.O. Box 9005 Quakertown, PA

 

18951-9005

(Address of Principal Executive Offices)

 

(Zip Code)

 

(215) 538-5600

Registrant's Telephone Number, Including Area Code

 

Not Applicable

Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report.

 

 

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      No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No  

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

Accelerated filer

Non-accelerated filer

 

Smaller Reporting Company

Emerging growth company

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at May 1, 2017

Common Stock, par value $0.625

 

3,424,756

 

 

 

 


 

QNB CORP. AND SUBSIDIARY

FORM 10-Q

QUARTER ENDED MARCH 31, 2017

INDEX

 

 

 

PART I - FINANCIAL INFORMATION

 

 

 

 

 

 

 

ITEM 1.

 

CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

PAGE

 

 

 

 

 

 

 

Consolidated Balance Sheets at March 31, 2017 and December 31, 2016

 

3

 

 

 

 

 

 

 

Consolidated Statements of Income for the Three Months Ended March 31, 2017 and 2016

 

4

 

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2017 and 2016

 

5

 

 

 

 

 

 

 

Consolidated Statement of Shareholders’ Equity for the Three Months Ended March 31, 2017 and 2016

 

6

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2017 and 2016

 

7

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements

 

8

 

 

 

 

 

ITEM 2.

 

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

38

 

 

 

 

 

ITEM 3.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

57

 

 

 

 

 

ITEM 4.

 

CONTROLS AND PROCEDURES

 

57

 

 

 

 

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

 

 

 

ITEM 1.

 

LEGAL PROCEEDINGS

 

58

 

 

 

 

 

ITEM 1A.

 

RISK FACTORS

 

58

 

 

 

 

 

ITEM 2.

 

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

58

 

 

 

 

 

ITEM 3.

 

DEFAULTS UPON SENIOR SECURITIES

 

58

 

 

 

 

 

ITEM 4.

 

MINE SAFETY DISCLOSURES

 

58

 

 

 

 

 

ITEM 5.

 

OTHER INFORMATION

 

58

 

 

 

 

 

ITEM 6.

 

EXHIBITS

 

59

 

 

 

 

 

SIGNATURES

 

 

 

 

 

 

 

CERTIFICATIONS

 

 

 

 

 

2


 

QNB Corp. and Subsidiary

 

CONSOLIDATED BALANCE SHEETS

 

 

 

(in thousands, except share data)

 

 

 

(current period unaudited)

 

 

 

March 31,

2017

 

 

December 31,

2016

 

Assets

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

13,787

 

 

$

8,897

 

Interest-bearing deposits in banks

 

 

6,755

 

 

 

1,824

 

Total cash and cash equivalents

 

 

20,542

 

 

 

10,721

 

 

 

 

 

 

 

 

 

 

Investment securities

 

 

 

 

 

 

 

 

Trading

 

 

2,358

 

 

 

3,596

 

Available-for-sale (amortized cost $387,489 and $396,168)

 

 

382,296

 

 

 

390,475

 

Restricted investment in bank stocks

 

 

910

 

 

 

1,017

 

Loans held-for-sale

 

 

903

 

 

 

789

 

Loans receivable

 

 

659,039

 

 

 

633,079

 

Allowance for loan losses

 

 

(7,719

)

 

 

(7,394

)

Net loans

 

 

651,320

 

 

 

625,685

 

Bank-owned life insurance

 

 

10,923

 

 

 

11,297

 

Premises and equipment, net

 

 

8,539

 

 

 

8,683

 

Accrued interest receivable

 

 

2,774

 

 

 

3,128

 

Net deferred tax assets

 

 

5,368

 

 

 

5,473

 

Other assets

 

 

3,074

 

 

 

2,277

 

Total assets

 

$

1,089,007

 

 

$

1,063,141

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

 

Demand, non-interest bearing

 

$

121,778

 

 

$

119,010

 

Interest-bearing demand

 

 

262,076

 

 

 

255,754

 

Money market

 

 

80,099

 

 

 

74,762

 

Savings

 

 

252,471

 

 

 

238,247

 

Time

 

 

129,199

 

 

 

131,370

 

Time of $100 or more

 

 

97,268

 

 

 

94,212

 

Total deposits

 

 

942,891

 

 

 

913,355

 

Short-term borrowings

 

 

45,265

 

 

 

52,660

 

Accrued interest payable

 

 

303

 

 

 

335

 

Other liabilities

 

 

4,505

 

 

 

3,224

 

Total liabilities

 

 

992,964

 

 

 

969,574

 

 

 

 

 

 

 

 

 

 

Shareholders' Equity

 

 

 

 

 

 

 

 

Common stock, par value $0.625 per share;

 

 

 

 

 

 

 

 

authorized 10,000,000 shares; 3,589,325 shares and 3,576,270

 

 

 

 

 

 

 

 

shares issued; 3,424,756 and 3,411,701 shares outstanding

 

 

2,243

 

 

 

2,235

 

Surplus

 

 

17,756

 

 

 

17,418

 

Retained earnings

 

 

81,948

 

 

 

80,147

 

Accumulated other comprehensive loss, net of tax

 

 

(3,428

)

 

 

(3,757

)

Treasury stock, at cost; 164,569 shares

 

 

(2,476

)

 

 

(2,476

)

Total shareholders' equity

 

 

96,043

 

 

 

93,567

 

Total liabilities and shareholders' equity

 

$

1,089,007

 

 

$

1,063,141

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

3


 

QNB Corp. and Subsidiary

CONSOLIDATED STATEMENTS OF INCOME

 

 

 

(in thousands, except per share data)

(unaudited)

 

Three months ended March 31,

 

2017

 

 

2016

 

Interest income

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

7,072

 

 

$

6,352

 

Interest and dividends on investment securities (AFS & HTM):

 

 

 

 

 

 

 

 

Taxable

 

 

1,563

 

 

 

1,356

 

Tax-exempt

 

 

465

 

 

 

516

 

Interest on trading securities

 

 

29

 

 

 

40

 

Interest on interest-bearing balances and other interest income

 

 

7

 

 

 

16

 

Total interest income

 

 

9,136

 

 

 

8,280

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

Interest on deposits

 

 

 

 

 

 

 

 

Interest-bearing demand

 

 

174

 

 

 

152

 

Money market

 

 

52

 

 

 

47

 

Savings

 

 

259

 

 

 

226

 

Time

 

 

368

 

 

 

373

 

Time of $100 or more

 

 

323

 

 

 

318

 

Interest on short-term borrowings

 

 

80

 

 

 

43

 

Total interest expense

 

 

1,256

 

 

 

1,159

 

Net interest income

 

 

7,880

 

 

 

7,121

 

Provision for loan losses

 

 

300

 

 

 

125

 

Net interest income after provision for loan losses

 

 

7,580

 

 

 

6,996

 

 

 

 

 

 

 

 

 

 

Non-interest income

 

 

 

 

 

 

 

 

Total other-than-temporary impairment loss on investment securities

 

 

 

 

 

(70

)

Less:  Portion of loss recognized in other comprehensive income (before taxes)

 

 

 

 

 

 

Net other-than temporary impairment losses on investment securities

 

 

 

 

 

(70

)

Net gain on sale of investment securities

 

 

749

 

 

 

389

 

Net gain on investment securities

 

 

749

 

 

 

319

 

Net gain on trading activities

 

 

17

 

 

 

34

 

Fees for services to customers

 

 

392

 

 

 

383

 

ATM and debit card

 

 

417

 

 

 

388

 

Retail brokerage and advisory

 

 

103

 

 

 

170

 

Bank-owned life insurance

 

 

71

 

 

 

71

 

Merchant

 

 

80

 

 

 

73

 

Net gain on sale of loans

 

 

50

 

 

 

49

 

Other

 

 

111

 

 

 

89

 

Total non-interest income

 

 

1,990

 

 

 

1,576

 

 

 

 

 

 

 

 

 

 

Non-interest expense

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

 

3,086

 

 

 

3,054

 

Net occupancy

 

 

451

 

 

 

441

 

Furniture and equipment

 

 

429

 

 

 

425

 

Marketing

 

 

229

 

 

 

196

 

Third party services

 

 

394

 

 

 

403

 

Telephone, postage and supplies

 

 

200

 

 

 

186

 

State taxes

 

 

193

 

 

 

180

 

FDIC insurance premiums

 

 

141

 

 

 

170

 

Other

 

 

465

 

 

 

464

 

Total non-interest expense

 

 

5,588

 

 

 

5,519

 

Income before income taxes

 

 

3,982

 

 

 

3,053

 

Provision for income taxes

 

 

1,122

 

 

 

788

 

Net income

 

$

2,860

 

 

$

2,265

 

Earnings per share - basic

 

$

0.84

 

 

$

0.67

 

Earnings per share - diluted

 

$

0.83

 

 

$

0.67

 

Cash dividends per share

 

$

0.31

 

 

$

0.30

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

4


 

QNB Corp. and Subsidiary

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

 

(in thousands - unaudited)

 

Three months ended March 31,

 

2017

 

 

2016

 

 

 

Before

tax

amount

 

 

Tax

expense

(benefit)

 

 

Net of

tax

amount

 

 

Before

tax

amount

 

 

Tax

expense

(benefit)

 

 

Net of

tax

amount

 

Net income

 

$

3,982

 

 

$

1,122

 

 

$

2,860

 

 

$

3,053

 

 

$

788

 

 

$

2,265

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net unrealized holding gains on securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized holding gains arising during

     the period

 

 

1,249

 

 

 

425

 

 

 

824

 

 

 

4,486

 

 

 

1,525

 

 

 

2,961

 

Reclassification adjustment for gains

     included in net income

 

 

(749

)

 

 

(254

)

 

 

(495

)

 

 

(319

)

 

 

(108

)

 

 

(211

)

Other comprehensive income

 

 

500

 

 

 

171

 

 

 

329

 

 

 

4,167

 

 

 

1,417

 

 

 

2,750

 

Total comprehensive income

 

$

4,482

 

 

$

1,293

 

 

$

3,189

 

 

$

7,220

 

 

$

2,205

 

 

$

5,015

 

 

The accompanying notes are an integral part of the consolidated financial statements

 

5


 

QNB Corp. and Subsidiary

 

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

Three months ended March 31, 2017 and 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Number of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

(unaudited)

 

Shares

 

 

Common

 

 

 

 

 

 

Retained

 

 

Comprehensive

 

 

Treasury

 

 

 

 

 

(in thousands, except share and per share data)

 

Outstanding

 

 

Stock

 

 

Surplus

 

 

Earnings

 

 

Income (Loss)

 

 

Stock

 

 

Total

 

Balance, December 31, 2016

 

 

3,411,701

 

 

$

2,235

 

 

$

17,418

 

 

$

80,147

 

 

$

(3,757

)

 

$

(2,476

)

 

$

93,567

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

2,860

 

 

 

 

 

 

 

 

 

2,860

 

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

329

 

 

 

 

 

 

329

 

Cash dividends declared ($0.31 per share)

 

 

 

 

 

 

 

 

 

 

 

 

(1,059

)

 

 

 

 

 

 

 

 

(1,059

)

Stock issued in connection with dividend

   reinvestment and stock purchase plan

 

 

6,656

 

 

 

4

 

 

 

238

 

 

 

 

 

 

 

 

 

 

 

 

242

 

Stock issued for options exercised

 

 

6,399

 

 

 

4

 

 

 

82

 

 

 

 

 

 

 

 

 

 

 

 

86

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

 

18

 

 

 

 

 

 

 

 

 

 

 

 

18

 

Balance, March 31, 2017

 

 

3,424,756

 

 

$

2,243

 

 

$

17,756

 

 

$

81,948

 

 

$

(3,428

)

 

$

(2,476

)

 

$

96,043

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Number of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

(unaudited)

 

Shares

 

 

Common

 

 

 

 

 

 

Retained

 

 

Comprehensive

 

 

Treasury

 

 

 

 

 

(in thousands, except share and per share data)

 

Outstanding

 

 

Stock

 

 

Surplus

 

 

Earnings

 

 

Income (Loss)

 

 

Stock

 

 

Total

 

Balance, December 31, 2015

 

 

3,359,794

 

 

$

2,203

 

 

$

15,973

 

 

$

75,289

 

 

$

(546

)

 

$

(2,476

)

 

$

90,443

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

2,265

 

 

 

 

 

 

 

 

 

2,265

 

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,750

 

 

 

 

 

 

2,750

 

Cash dividends declared ($0.30 per share)

 

 

 

 

 

 

 

 

 

 

 

 

(1,012

)

 

 

 

 

 

 

 

 

(1,012

)

Stock issued in connection with dividend

   reinvestment and stock purchase plan

 

 

8,657

 

 

 

5

 

 

 

241

 

 

 

 

 

 

 

 

 

 

 

 

246

 

Stock issued for options exercised

 

 

13,472

 

 

 

9

 

 

 

226

 

 

 

 

 

 

 

 

 

 

 

 

235

 

Tax benefit of stock options exercised

 

 

 

 

 

 

 

 

 

12

 

 

 

 

 

 

 

 

 

 

 

 

12

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

 

16

 

 

 

 

 

 

 

 

 

 

 

 

16

 

Balance, March 31, 2016

 

 

3,381,923

 

 

$

2,217

 

 

$

16,468

 

 

$

76,542

 

 

$

2,204

 

 

$

(2,476

)

 

$

94,955

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

 

6


 

QNB Corp. and Subsidiary

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

(in thousands, unaudited)

 

Three months ended March 31,

 

2017

 

 

2016

 

Operating Activities

 

 

 

 

 

 

 

 

Net income

 

$

2,860

 

 

$

2,265

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

202

 

 

 

222

 

Provision for loan losses

 

 

300

 

 

 

125

 

Net gain on investment securities available-for-sale

 

 

(749

)

 

 

(319

)

Net gain on sale of other real estate owned, repossessed assets and premises and equipment

 

 

(1

)

 

 

(1

)

Net gain on sale of loans

 

 

(50

)

 

 

(49

)

Proceeds from sales of residential mortgages held-for-sale

 

 

2,023

 

 

 

1,557

 

Origination of residential mortgages held-for-sale

 

 

(2,087

)

 

 

(611

)

Income on bank-owned life insurance

 

 

(71

)

 

 

(71

)

Stock-based compensation expense

 

 

18

 

 

 

16

 

Net decrease in trading securities

 

 

1,238

 

 

 

183

 

Deferred income tax provision

 

 

(67

)

 

 

(17

)

Net increase in income taxes payable

 

 

1,139

 

 

 

153

 

Net decrease (increase) in accrued interest receivable

 

 

354

 

 

 

(48

)

Amortization of mortgage servicing rights and change in valuation allowance

 

 

20

 

 

 

17

 

Net amortization of premiums and discounts on investment securities

 

 

414

 

 

 

482

 

Net (decrease) increase in accrued interest payable

 

 

(32

)

 

 

2

 

Increase in other assets

 

 

(817

)

 

 

(553

)

(Decrease) increase in other liabilities

 

 

(12

)

 

 

73

 

Net cash provided by operating activities

 

 

4,682

 

 

 

3,426

 

Investing Activities

 

 

 

 

 

 

 

 

Proceeds from payments, maturities and calls of investment securities available-for-sale

 

 

14,116

 

 

 

22,102

 

Proceeds from the sale of investment securities available-for-sale

 

 

13,996

 

 

 

24,616

 

Purchases of investment securities available-for-sale

 

 

(18,943

)

 

 

(26,740

)

Proceeds from redemption of investment in restricted bank stock

 

 

1,930

 

 

 

1,482

 

Purchase of restricted bank stock

 

 

(1,823

)

 

 

(1,482

)

Net (increase) decrease in loans

 

 

(25,935

)

 

 

13,461

 

Net purchases of premises and equipment

 

 

(58

)

 

 

(37

)

Redemption of bank-owned life insurance

 

 

446

 

 

 

 

Proceeds from sales of other real estate owned and repossessed assets

 

 

 

 

 

1

 

Net cash provided by (used in) investing activities

 

 

(16,271

)

 

 

33,403

 

Financing Activities

 

 

 

 

 

 

 

 

Net increase in non-interest bearing deposits

 

 

2,768

 

 

 

7,117

 

Net increase (decrease) in interest-bearing deposits

 

 

26,768

 

 

 

(31,543

)

Net (decrease) increase in short-term borrowings

 

 

(7,395

)

 

 

3,263

 

Tax benefit from exercise of stock options

 

 

 

 

 

12

 

Cash dividends paid, net of reinvestment

 

 

(928

)

 

 

(884

)

Proceeds from issuance of common stock

 

 

197

 

 

 

353

 

Net cash provided by financing activities

 

 

21,410

 

 

 

(21,682

)

Increase in cash and cash equivalents

 

 

9,821

 

 

 

15,147

 

Cash and cash equivalents at beginning of year

 

 

10,721

 

 

 

16,991

 

Cash and cash equivalents at end of period

 

$

20,542

 

 

$

32,138

 

Supplemental Cash Flow Disclosures

 

 

 

 

 

 

 

 

Interest paid

 

$

1,288

 

 

$

1,157

 

Income taxes paid

 

 

49

 

 

 

640

 

Non-cash transactions:

 

 

 

 

 

 

 

 

Unsettled trades to purchase securities

 

 

155

 

 

 

546

 

Unsettled trades to sell securities

 

 

 

 

 

(875

)

 

The accompanying notes are an integral part of the consolidated financial statements

 

 

 

7


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements include the accounts of QNB Corp. and its wholly-owned subsidiary, QNB Bank (the “Bank”). The consolidated entity is referred to herein as “QNB” or the “Company”. All significant intercompany accounts and transactions are eliminated in the consolidated financial statements.

These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in QNB's 2016 Annual Report incorporated in the Form 10-K. Operating results for the three month period ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.

The unaudited consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the results of operations for the period and are of a normal and recurring nature.

Tabular information, other than share and per share data, is presented in thousands of dollars.

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from such estimates.

The Company has evaluated events and transactions occurring subsequent to the balance sheet date of March 31, 2017, for items that should potentially be recognized or disclosed in these financial statements.

 

 

2. RECENT ACCOUNTING PRONOUNCEMENTS

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU was issued to help improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets. The ASU’s core principle is that a company will recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, this update specifies the accounting for certain costs to obtain or fulfill a contract with a customer and expands disclosure requirements for revenue recognition. This guidance does not apply to revenue associated with financial instruments, including loans, securities, and derivatives that are accounted for under other U.S. GAAP guidance. For that reason, we do not expect it to have a material impact on our consolidated results of operations for elements of the statement of income associated with financial instruments, including securities gains, interest income and interest expense. However, we do believe the new standard will result in new disclosure requirements. We are currently in the process of reviewing contracts to assess the impact of the new guidance on our service offerings that are in the scope of the guidance, included in non-interest income such as insurance commission fees, service charges, payment processing fees, trust services fees, and brokerage services fees. The Company is continuing to evaluate the effect of the new guidance on revenue sources other than financial instruments on our financial position and consolidated results of operations. The guidance is effective for the QNB’s financial statements beginning January 1, 2018. The guidance allows an entity to apply the new standard either retrospectively or through a cumulative effect adjustment as of January 1, 2018.

On January 5, 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This ASU was issued to enhance the reporting model for financial instruments to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. It will require the following:

 

Equity investments with readily determinable fair values must be measured at fair value with changes in fair value recognized in net income.

 

Equity investments without readily determinable fair values must be measured at either fair value or at cost adjusted for changes in observable prices minus impairment. Changes in value under either of these methods would be recognized in net income.

 

Entities that record financial liabilities at fair value due to a fair value option election must recognize changes in fair value in other comprehensive income if it is related to instrument-specific credit risk.

 

Entities must assess whether a valuation allowance is required for deferred tax assets related to available-for-sale debt securities.

8


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

This ASU is effective for public companies for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. If QNB had adopted this guidance on March 31, 2017 it would have resulted in a decrease in net income of approximately $6,000. There would have been no impact on shareholder’s equity as the equity securities held by QNB are currently recorded at fair value through accumulated other comprehensive income (loss).

On February 25, 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This new standard on accounting for leases introduces a lessee model that brings most leases on the balance sheet, but recognizes expenses in the income statement similar to how items are recorded today. The new standard eliminates the requirement in current U.S. GAAP for an entity to use bright-line tests in determining lease classification. The ASU also eliminates the current real estate-specific provisions and changes the guidance on sale-leaseback transactions, initial direct costs and lease executory costs for all entities.  All entities will classify leases to determine how to recognize the related revenue and expense and this classification will affect amounts that lessors record on the balance sheet. The new guidance will be effective for public companies for annual periods beginning after December 15, 2018, and interim periods therein. Early adoption is permitted. QNB is evaluating the impact of this new standard on its consolidated financial statements.

On March 17, 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606), Principal versus Agent Considerations (Reporting Revenue Gross versus Net). This ASU amends the principal-versus agent implementation guidance and illustrations in the Board’s new revenue standard (ASU 2014-09). The FASB issued the ASU in response to concerns identified by stakeholders, including those related to (1) determining the appropriate unit of account under the revenue standard’s principal-versus-agent guidance and (2) applying the indicators of whether an entity is a principal or an agent in accordance with the revenue standard’s control principle. This ASU clarifies that an entity should evaluate whether it is the principal or the agent for each specified good or service promised in a contract with a customer. The ASU has the same effective date as the new revenue standard (as amended by the one-year deferral and the early adoption provisions in ASU 2015-14).

On March 30, 2016, the FASB issued ASU 2016-09, Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting. This ASU simplifies several aspects of the accounting for employee share-based payment transactions for both public and nonpublic entities, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. Entities will be required to recognize the income tax effects of awards in the income statement when awards vest or are settled which will eliminate additional-paid-in-capital or APIC pools. For public companies, the ASU is effective for annual reporting periods beginning after December 15, 2016, including interim periods within those annual reporting periods. QNB adopted this standard effective January 1, 2017. It did not have a material impact on its consolidated financial statements; however, the most significant impact relates to how tax benefits related to stock option exercises are recorded in the financial statements.

On June 16, 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326). The new guidance requires organizations to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts.

To that end, the new guidance:

 

Eliminates the probable initial recognition threshold in current U.S. GAAP and, instead, reflects an organization’s current estimate of all expected credit losses over the contractual term of its financial assets

 

Broadens the information an entity can consider when measuring credit losses to include forward-looking information

 

Increases usefulness of the financial statements by requiring timely inclusion of forecasted information in forming expectations of credit losses

 

Increases comparability of purchased financial assets with credit deterioration (PCD assets) with other purchased assets that do not have credit deterioration as well as originated assets because credit losses that are expected will be recorded through an allowance for credit losses for all assets

 

Increases users’ understanding of underwriting standards and credit quality trends by requiring additional information about credit quality indicators by year of origination (vintage)

 

For available-for-sale debt securities, aligns the income statement recognition of credit losses with the reporting period in which changes occur by recording credit losses (and subsequent changes in credit losses) through an allowance rather than a write down

The new guidance affects organizations that hold financial assets and net investments in leases that are not accounted for at fair value with changes in fair value reported in net income.  The new guidance affects loans, debt securities, trade receivables, net investments

9


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash.

For public business entities that are U.S. Securities and Exchange Commission (SEC) filers, the new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.  QNB is evaluating the impact of this new standard on its consolidated financial statements.

On March 30, 2017, the FASB issued ASU 2017-08, Premium Amortization on Purchased Callable Debt Securities. This ASU is intended to enhance the accounting for the amortization of premiums for purchased callable debt securities and will require premiums to be amortized to the earliest call date. For public companies, the ASU is effective for annual reporting periods beginning after December 15, 2018, including interim periods within those annual reporting periods. QNB does not anticipate this new standard will have a material impact on its consolidated financial statements as it already uses the earliest call date to amortize premiums on callable debt securities.

 

 

3. STOCK-BASED COMPENSATION AND SHAREHOLDERS’ EQUITY

QNB sponsors stock-based compensation plans, administered by a Board Committee, under which both qualified and non-qualified stock options may be granted periodically to certain employees. Compensation cost has been measured using the fair value of an award on the grant date and is recognized over the service period, which is usually the vesting period.

Stock-based compensation expense was $18,000 and $16,000 for the three months ended March 31, 2017 and 2016, respectively. As of March 31, 2017, there was approximately $150,000 of unrecognized compensation cost related to unvested share-based compensation award grants that is expected to be recognized over the next 35 months.

Options are granted to certain employees at prices equal to the market value of the stock on the date the options are granted. The 2005 Plan authorized the issuance of 200,000 shares. The time period during 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 five years after the date the option is awarded. The granted options vest after a three-year period. As of March 31, 2017, there were 184,200 options granted, 65,150 options forfeited, 79,075 options exercised, and 39,975 options outstanding under this Plan. The 2005 Plan expired on March 15, 2015.

The 2015 Plan authorizes the issuance of 300,000 shares. The terms of the 2015 Plan are identical to the 2005 Plan. There were 48,500 options granted and outstanding under this Plan as of March 31, 2017. There were no options forfeited or exercised as of March 31, 2017. The 2015 Plan expires on February 24, 2025.

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 highly subjective in nature.

The following assumptions were used in the option pricing model in determining the fair value of options granted during the period:

 

Three months ended March 31,

 

2017

 

 

2016

 

Risk free interest rate

 

 

1.48

%

 

 

1.14

%

Dividend yield

 

 

3.19

%

 

 

3.78

%

Volatility

 

 

17.89

%

 

 

22.62

%

Expected life (years)

 

 

4.20

 

 

 

4.20

 

 

The risk-free interest rate was selected based upon yields of U.S. Treasury issues with a term approximating 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 fair market value of options granted in the first three months of 2017 and 2016 was $3.88 and $3.79, respectively.

10


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Stock option activity during the three months ended March 31, 2017 and 2016 is as follows:

 

 

 

Number

of options

 

 

Weighted

average

exercise

price

 

 

Weighted

average

remaining

contractual term

(in years)

 

 

Aggregate

intrinsic value

 

Outstanding at December 31, 2016

 

 

73,950

 

 

$

27.14

 

 

 

 

 

 

 

 

 

Granted

 

 

25,000

 

 

 

37.60

 

 

 

 

 

 

 

 

 

Exercised

 

 

(10,375

)

 

 

22.21

 

 

 

 

 

 

 

 

 

Forfeited

 

 

(100

)

 

 

21.35

 

 

 

 

 

 

 

 

 

Outstanding at March 31, 2017

 

 

88,475

 

 

$

30.68

 

 

 

3.33

 

 

$

661

 

Exercisable at March 31, 2017

 

 

22,125

 

 

$

24.31

 

 

 

1.39

 

 

$

306

 

 

 

 

Number

of options

 

 

Weighted

average

exercise

price

 

 

Weighted

average

remaining

contractual term

(in years)

 

 

Aggregate

intrinsic value

 

Outstanding at December 31, 2015

 

 

82,875

 

 

$

24.33

 

 

 

 

 

 

 

 

 

Granted

 

 

23,500

 

 

 

30.40

 

 

 

 

 

 

 

 

 

Exercised

 

 

(17,900

)

 

 

20.65

 

 

 

 

 

 

 

 

 

Forfeited

 

 

(9,225

)

 

 

25.77

 

 

 

 

 

 

 

 

 

Outstanding at March 31, 2016

 

 

79,250

 

 

$

26.79

 

 

 

3.22

 

 

$

264

 

Exercisable at March 31, 2016

 

 

24,125

 

 

$

22.38

 

 

 

1.37

 

 

$

184

 

 

 

 

 

4. EARNINGS PER SHARE & SHARE REPURCHASE PLAN

The following sets forth the computation of basic and diluted earnings per share:

 

Three months ended March 31,

 

2017

 

 

2016

 

Numerator for basic and diluted earnings per share - net income

 

$

2,860

 

 

$

2,265

 

Denominator for basic earnings per share - weighted average

    shares outstanding

 

 

3,415,065

 

 

 

3,369,782

 

Effect of dilutive securities - employee stock options

 

 

14,165

 

 

 

8,154

 

Denominator for diluted earnings per share - adjusted

   weighted average shares outstanding

 

 

3,429,230

 

 

 

3,377,936

 

Earnings per share - basic

 

$

0.84

 

 

$

0.67

 

Earnings per share - diluted

 

 

0.83

 

 

 

0.67

 

 

There were 25,000 and 41,350 stock options that were anti-dilutive for the three-month periods ended March 31, 2017 and 2016, respectively. These stock options were not included in the above calculation.

 

The Board of Directors has authorized the repurchase of up to 100,000 shares of its common stock in open market or privately negotiated transactions. The repurchase authorization does not bear a termination date. There were no shares repurchased during the three months ended March 31, 2017 and 2016. As of March 31, 2017, 57,883 shares were repurchased under this authorization at an average price of $16.97 and a total cost of $982,000.

 

 

 

11


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

5. COMPREHENSIVE INCOME (LOSS)

The following shows the components of accumulated other comprehensive income (loss) at March 31, 2017 and December 31, 2016:

 

 

 

March 31,

 

 

December 31,

 

 

 

2017

 

 

2016

 

Unrealized net holding losses on available-for-sale

   securities

 

$

(5,079

)

 

$

(5,446

)

Unrealized losses on available-for-sale securities for which a

   portion of an other-than-temporary impairment loss has been

   recognized in earnings

 

 

(114

)

 

 

(247

)

Accumulated other comprehensive loss

 

 

(5,193

)

 

 

(5,693

)

Tax effect

 

 

1,765

 

 

 

1,936

 

Accumulated other comprehensive loss, net of tax

 

$

(3,428

)

 

$

(3,757

)

 

The following tables present amounts reclassified out of accumulated other comprehensive income (loss) for the three months ended March 31, 2017 and 2016:

 

Three months ended March 31,

 

Amount reclassified from

accumulated other

comprehensive income

 

 

 

Details about accumulated other comprehensive income

 

2017

 

 

2016

 

 

Affected line item in statement of income

Unrealized net holding gains on available-for-sale

   securities

 

$

749

 

 

$

389

 

 

Net gain on sale of investment

   securities

Other-than-temporary impairment losses on

     investment securities

 

 

 

 

 

(70

)

 

Net other-than-temporary

     impairment losses on

     investment securities

 

 

 

749

 

 

 

319

 

 

 

Tax effect

 

 

(254

)

 

 

(108

)

 

Provision for income taxes

Total reclass out of accumulated other comprehensive

    income, net of tax

 

$

495

 

 

$

211

 

 

Net of tax

 

 

 

6. INVESTMENT SECURITIES

QNB engages in trading activities for its own account. Municipal securities that are held principally for resale in the near term are recorded in the trading account at fair value with changes in fair value recorded in non-interest income. There were net realized and unrealized gains of $17,000 at March 31, 2017 and net realized and unrealized losses of $40,000 recorded at December 31, 2016. Unrealized gains on trading activity related to trading securities still held at March 31, 2017 and December 31, 2016 totaled $20,000 and $69,000, respectively. Interest and dividends are included in interest income.

Trading securities, at fair value, at March 31, 2017 and December 31, 2016 were as follows:

 

 

 

March 31,

 

 

December 31,

 

 

 

2017

 

 

2016

 

State and municipal securities

 

$

2,358

 

 

$

3,596

 

 

12


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The amortized cost and estimated fair values of investment securities available-for-sale at March 31, 2017 and December 31, 2016 were as follows:

 

 

 

 

 

 

 

Gross

 

 

Gross

 

 

 

 

 

 

 

 

 

 

 

unrealized

 

 

unrealized

 

 

 

 

 

 

 

Fair

 

 

holding

 

 

holding

 

 

Amortized

 

March 31, 2017

 

value

 

 

gains

 

 

losses

 

 

cost

 

U.S. Government agency

 

$

70,646

 

 

$

25

 

 

$

(1,847

)

 

$

72,468

 

State and municipal

 

 

75,728

 

 

 

714

 

 

 

(272

)

 

 

75,286

 

U.S. Government agencies and sponsored enterprises (GSEs):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed

 

 

142,230

 

 

 

448

 

 

 

(2,080

)

 

 

143,862

 

Collateralized mortgage obligations (CMOs)

 

 

77,106

 

 

 

67

 

 

 

(1,775

)

 

 

78,814

 

Pooled trust preferred

 

 

2,423

 

 

 

295

 

 

 

(748

)

 

 

2,876

 

Corporate debt

 

 

8,056

 

 

 

29

 

 

 

(40

)

 

 

8,067

 

Equity

 

 

6,107

 

 

 

181

 

 

 

(190

)

 

 

6,116

 

Total investment securities available-for-sale

 

$

382,296

 

 

$

1,759

 

 

$

(6,952

)

 

$

387,489

 

 

 

 

 

 

 

 

Gross

 

 

Gross

 

 

 

 

 

 

 

 

 

 

 

unrealized

 

 

unrealized

 

 

 

 

 

 

 

Fair

 

 

holding

 

 

holding

 

 

Amortized

 

December 31, 2016

 

value

 

 

gains

 

 

losses

 

 

cost

 

U.S. Government agency

 

$

76,650

 

 

$

36

 

 

$

(2,118

)

 

$

78,732

 

State and municipal

 

 

72,295

 

 

 

614

 

 

 

(398

)

 

 

72,079

 

U.S. Government agencies and sponsored enterprises (GSEs):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed

 

 

145,301

 

 

 

561

 

 

 

(2,241

)

 

 

146,981

 

Collateralized mortgage obligations (CMOs)

 

 

77,415

 

 

 

109

 

 

 

(1,846

)

 

 

79,152

 

Pooled trust preferred

 

 

2,281

 

 

 

263

 

 

 

(891

)

 

 

2,909

 

Corporate debt

 

 

8,030

 

 

 

16

 

 

 

(57

)

 

 

8,071

 

Equity

 

 

8,503

 

 

 

587

 

 

 

(328

)

 

 

8,244

 

Total investment securities available-for-sale

 

$

390,475

 

 

$

2,186

 

 

$

(7,879

)

 

$

396,168

 

 

The amortized cost and estimated fair value of securities available-for-sale by contractual maturity at March 31, 2017 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 and municipal securities that have been pre-refunded.

 

 

 

 

 

 

 

Amortized

 

March 31, 2017

 

Fair value

 

 

cost

 

Due in one year or less

 

$

8,664

 

 

$

8,589

 

Due after one year through five years

 

 

171,182

 

 

 

172,475

 

Due after five years through ten years

 

 

176,653

 

 

 

180,017

 

Due after ten years

 

 

19,690

 

 

 

20,292

 

Equity securities

 

 

6,107

 

 

 

6,116

 

Total investment securities available-for-sale

 

$

382,296

 

 

$

387,489

 

 

Proceeds from sales of investment securities available-for-sale were approximately $13,996,000 and $24,616,000 for the three months ended March 31, 2017 and 2016, respectively.

At March 31, 2017 and December 31, 2016, investment securities available-for-sale totaling approximately $167,022,000 and $166,628,000, respectively, were pledged as collateral for repurchase agreements and deposits of public funds.

13


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The following table presents information related to the Company’s gains and losses on the sales of equity and debt securities, and losses recognized for the other-than-temporary impairment (“OTTI”) of these investments. Gains and losses on available-for-sale securities are computed on the specific identification method and included in non-interest income. Gross realized losses on equity and debt securities are net of other-than-temporary impairment charges:

 

 

 

Three months ended March 31, 2017

 

 

Three months ended March 31, 2016

 

 

 

 

 

 

 

 

 

 

 

Other-than-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other-than-

 

 

 

 

 

 

 

Gross

 

 

Gross

 

 

temporary

 

 

 

 

 

 

Gross

 

 

Gross

 

 

temporary

 

 

 

 

 

 

 

realized

 

 

realized

 

 

impairment

 

 

 

 

 

 

realized

 

 

realized

 

 

impairment

 

 

 

 

 

 

 

gains

 

 

losses

 

 

losses

 

 

Net gains

 

 

gains

 

 

losses

 

 

losses

 

 

Net gains

 

Equity securities

 

$

725

 

 

$

 

 

$

 

 

$

725

 

 

$

382

 

 

$

 

 

$

(70

)

 

$

312

 

Debt securities

 

 

78

 

 

 

(54

)

 

 

 

 

 

24

 

 

 

80

 

 

 

(73

)

 

 

 

 

 

7

 

   Total

 

$

803

 

 

$

(54

)

 

$

 

 

$

749

 

 

$

462

 

 

$

(73

)

 

$

(70

)

 

$

319

 

 

 

The tax expense applicable to the net realized gains for the quarters and three-month periods ended March 31, 2017 and 2016 were $254,000 and $108,000, respectively.

QNB recognizes OTTI for debt securities classified as available-for-sale in accordance with FASB ASC 320, Investments – Debt and Equity Securities, which requires that we assess whether we intend to sell or it is more likely than not that the Company will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, the amount of the impairment is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows discounted at the security’s effective yield. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and, therefore, is not required to be recognized as a loss in the income statement, but is recognized in other comprehensive income. For equity securities, once a decline in value is determined to be other-than-temporary, the value of the equity security is reduced to fair value and a corresponding charge to earnings is recognized. QNB believes that we will fully collect the carrying value of securities on which we have recorded a non-credit related impairment in other comprehensive income.

The following table presents a roll forward of the credit loss component recognized in earnings. The credit loss component of the amortized cost represents the difference between the present value of expected future cash flows and the amortized cost basis of the security prior to considering credit losses. The beginning balance represents the credit loss component for debt securities for which OTTI occurred prior to the beginning of the year. Credit-impaired debt securities must be presented in two components based upon whether the current period is the first time the debt security was credit-impaired (initial credit impairment) or is not the first time the debt security was credit-impaired (subsequent credit impairments). No credit impairments were recognized on debt securities during first quarter of 2017 or 2016. The table presents a summary of the cumulative credit-related other-than-temporary impairment charges recognized as components of earnings for debt securities still held by QNB:

 

 

Three months ended March 31,

 

2017

 

 

2016

 

Balance, beginning of period

 

$

1,153

 

 

$

1,153

 

Additions:

 

 

 

 

 

 

 

 

Initial credit impairments

 

 

 

 

 

 

Subsequent credit impairments

 

 

 

 

 

 

Balance, end of period

 

$

1,153

 

 

$

1,153

 

 

14


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The following table indicates the length of time individual securities have been in a continuous unrealized loss position at March 31, 2017 and December 31, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less than 12 months

 

 

12 months or longer

 

 

Total

 

 

 

No. of

 

 

Fair

 

 

Unrealized

 

 

Fair

 

 

Unrealized

 

 

Fair

 

 

Unrealized

 

March 31, 2017

 

securities

 

 

value

 

 

losses

 

 

value

 

 

losses

 

 

value

 

 

losses

 

U.S. Government agency

 

 

50

 

 

$

66,631

 

 

$

(1,847

)

 

$

 

 

$

 

 

$

66,631

 

 

$

(1,847

)

State and municipal

 

 

66

 

 

 

26,959

 

 

 

(272

)

 

 

 

 

 

 

 

 

26,959

 

 

 

(272

)

U.S. Government agencies and sponsored enterprises (GSEs):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed

 

 

87

 

 

 

120,209

 

 

 

(2,080

)

 

 

 

 

 

 

 

 

120,209

 

 

 

(2,080

)

Collateralized mortgage obligations (CMOs)

 

 

70

 

 

 

59,295

 

 

 

(1,236

)

 

 

14,644

 

 

 

(539

)

 

 

73,939

 

 

 

(1,775

)

Pooled trust preferred

 

 

5

 

 

 

 

 

 

 

 

 

2,068

 

 

 

(748

)

 

 

2,068

 

 

 

(748

)

Corporate debt

 

 

4

 

 

 

4,015

 

 

 

(40

)

 

 

 

 

 

 

 

 

4,015

 

 

 

(40

)

Equity

 

 

8

 

 

 

2,004

 

 

 

(170

)

 

 

183

 

 

 

(20

)

 

 

2,187

 

 

 

(190

)

      Total

 

 

290

 

 

$

279,113

 

 

$

(5,645

)

 

$

16,895

 

 

$

(1,307

)

 

$

296,008

 

 

$

(6,952

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less than 12 months

 

 

12 months or longer

 

 

Total

 

 

 

No. of

 

 

Fair

 

 

Unrealized

 

 

Fair

 

 

Unrealized

 

 

Fair

 

 

Unrealized

 

December 31, 2016

 

securities

 

 

value

 

 

losses

 

 

value

 

 

losses

 

 

value

 

 

losses

 

U.S. Government agency

 

 

55

 

 

$

72,626

 

 

$

(2,118

)

 

$

 

 

$

 

 

$

72,626

 

 

$

(2,118

)

State and municipal

 

 

70

 

 

 

29,280

 

 

 

(398

)

 

 

 

 

 

 

 

 

29,280

 

 

 

(398

)

U.S. Government agencies and sponsored enterprises (GSEs):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed

 

 

88

 

 

 

123,087

 

 

 

(2,241

)

 

 

 

 

 

 

 

 

123,087

 

 

 

(2,241

)

Collateralized mortgage obligations (CMOs)

 

 

68

 

 

 

56,853

 

 

 

(1,269

)

 

 

15,426

 

 

 

(577

)

 

 

72,279

 

 

 

(1,846

)

Pooled trust preferred

 

 

5

 

 

 

 

 

 

 

 

 

1,952

 

 

 

(891

)

 

 

1,952

 

 

 

(891

)

Corporate debt

 

 

4

 

 

 

4,002

 

 

 

(57

)

 

 

 

 

 

 

 

 

4,002

 

 

 

(57

)

Equity

 

 

16

 

 

 

2,985

 

 

 

(268

)

 

 

888

 

 

 

(60

)

 

 

3,873

 

 

 

(328

)

Total

 

 

306

 

 

$

288,833

 

 

$

(6,351

)

 

$

18,266

 

 

$

(1,528

)

 

$

307,099

 

 

$

(7,879

)

 

Management evaluates debt securities, which are comprised of U.S. Government agencies, state and municipalities, mortgage-backed securities, CMOs and corporate debt securities, for other-than-temporary impairment and considers the current economic conditions, the length of time and the extent to which the fair value has been less than cost, interest rates and the bond rating of each security. The unrealized losses at March 31, 2017 in U.S. Government agency securities, state and municipal securities, mortgage-backed securities, CMOs and corporate debt securities are primarily the result of interest rate fluctuations. If held to maturity, these bonds will mature at par, and QNB will not realize a loss. The Company has the intent to hold the securities and does not believe it will be required to sell the securities before recovery occurs.

The Company’s investment in marketable equity securities primarily consists of investments in large cap stock companies. These equity securities are analyzed for impairment on an ongoing basis. Management believes these equity securities will recover in the foreseeable future. QNB evaluated the near-term prospects of the issuers in relation to the severity and duration of the impairment. Based on that evaluation and the Company’s ability and intent to hold those securities for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these equity securities to be other-than-temporarily impaired.

QNB holds six pooled trust preferred securities as of March 31, 2017. These securities have a total amortized cost of approximately $2,876,000 and a fair value of $2,423,000. Five of the six securities have been in an unrealized loss position for more than twelve months. All of the pooled trust preferred securities are available-for-sale securities and are carried at fair value.

15


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The following table provides additional information related to pooled trust preferred securities (PreTSLs) as of March 31, 2017:

 

Deal

 

Class

 

 

Book

value

 

 

Fair

value

 

 

Unrealized

gains (losses)

 

 

Realized

OTTI

credit

loss

(YTD 2017)

 

 

Total

recognized

OTTI

credit

loss

 

 

Moody's

/Fitch

ratings

 

Current

number of

performing

banks

 

 

Current

number of

performing

insurance

companies

 

 

Actual

deferrals

and defaults

as a % of

total

collateral

 

 

Total

performing collateral

as a % of

outstanding

bonds

 

PreTSL IV

 

Mezzanine

*

 

$

242

 

 

$

188

 

 

$

(54

)

 

$

 

 

$

(1

)

 

B1/BB

 

 

5

 

 

 

 

 

 

18.0

%

 

 

141.6

%

PreTSL XVII

 

Mezzanine

 

 

 

588

 

 

 

486

 

 

 

(102

)

 

 

 

 

 

(222

)

 

C/CC

 

 

34

 

 

 

5

 

 

 

21.7

 

 

 

100.3

 

PreTSL XIX

 

Mezzanine

 

 

 

837

 

 

 

498

 

 

 

(339

)

 

 

 

 

 

 

 

Caa1/CC

 

 

41

 

 

 

12

 

 

 

6.9

 

 

 

103.1

 

PreTSL XXV

 

Mezzanine

 

 

 

766

 

 

 

541

 

 

 

(225

)

 

 

 

 

 

(222

)

 

Ca/C

 

 

44

 

 

 

5

 

 

 

24.2

 

 

 

89.9

 

PreTSL XXVI

 

Mezzanine

 

 

 

383

 

 

 

355

 

 

 

(28

)

 

 

 

 

 

(270

)

 

Caa3/C

 

 

44

 

 

 

7

 

 

 

18.2

 

 

 

98.1

 

PreTSL XXVI

 

Mezzanine

 

 

 

60

 

 

 

355

 

 

 

295

 

 

 

 

 

 

(438

)

 

Caa3/C

 

 

44

 

 

 

7

 

 

 

18.2

 

 

 

98.1

 

 

 

 

 

 

$

2,876

 

 

$

2,423

 

 

$

(453

)

 

$

 

 

$

(1,153

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mezzanine* - only class of bonds still outstanding (represents the senior-most obligation of the trust)

On January 14, 2014, Regulators released a final rule authorizing retention of pooled trust preferred securities backed primarily by bank-issued trust preferred securities which included the PreTSLs held by QNB. Due to the uncertainty invoked between the original release of the Volcker Rule and the final rule, there was a noticeable increase in trading activity. However, we believe most of these trades occurred under distress and do not represent trades made in an orderly market. Despite the trades that took place as discussed previously, the market for these securities at March 31, 2017 was not active and markets for similar securities also are not active. The new issue market is also inactive and the market values for these securities are depressed relative to historical levels. Lack of liquidity in the market for trust preferred collateralized debt obligations, credit rating downgrades and market uncertainties related to the financial industry are all factors contributing to the temporary impairment of these securities. Although these securities are classified as available-for-sale, the Company has the intent to hold the securities and does not believe it will be required to sell the securities before recovery occurs. As illustrated in the previous table, these securities are comprised mainly of securities issued by banks, and to a lesser degree, insurance companies. QNB owns the mezzanine tranches of these securities, except for PreTSL IV which represents the senior-most obligation of the trust.

On a quarterly basis we evaluate our debt securities for other-than-temporary impairment (OTTI), which involves the use of a third-party valuation firm to assist management with the valuation. When evaluating these investments a credit-related portion and a non-credit related portion of impairment are determined. The credit related portion is recognized in earnings and represents the expected shortfall in future cash flows. The non-credit related portion is recognized in other comprehensive income and represents the difference between the book value and the fair value of the security less any current quarter credit related impairment. For the first quarter of March 31, 2017 and 2016, no other-than-temporary impairment charges representing credit impairment were recognized on our pooled trust preferred collateralized debt obligations. A discounted cash flow analysis provides the best estimate of credit related OTTI for these securities. Additional information related to this analysis follows.

All of the pooled trust preferred collateralized debt obligations held by QNB are rated lower than AA and are measured for OTTI within the scope of ASC 325 (formerly known as EITF 99-20), Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to be Held by a Transferor in Securitized Financial Assets, and Amendments to the Impairment Guidance of EITF Issue No. 99-20 (formerly known as EITF 99-20-1). QNB performs a discounted cash flow analysis on all of its impaired debt securities to determine if the amortized cost basis of an impaired security will be recovered. In determining whether a credit loss exists, QNB uses its best estimate of the present value of cash flows expected to be collected from the debt security and discounts them at the effective yield implicit in the security at the date of acquisition or the prospective yield for those securities with prior OTTI charges. The discounted cash flow analysis is considered to be the primary evidence when determining whether credit related other-than-temporary impairment exists.

Results of a discounted cash flow test are significantly affected by other variables such as the estimate of future cash flows (including prepayments), credit worthiness of the underlying banks and insurance companies and determination of probability and severity of default of the underlying collateral. The following provides additional information for each of these variables:

 

Estimate of Future Cash Flows – Cash flows are constructed in an INTEXcalc valuation model. INTEX is a proprietary cash flow model recognized as the industry standard for analyzing all types of structured debt products. It includes each deal’s structural features updated with trustee information, including asset-by-asset detail, as it becomes available. The modeled

16


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

cash flows are then used to determine if all the scheduled principal and interest payments of the investments will be returned. For purposes of the cash flow analysis, relatively modest rates of prepayment of 1% were forecasted. In addition to the base prepayment assumption, due to the enactment of the Dodd-Frank Act’s revised Tier 1 capital treatment, additional prepayment analysis was performed. Trust preferred securities issued by banks with more than $15 billion in total assets at December 31, 2009 were identified. The current credit rating of these institutions was reviewed and it was assumed that any U.S. bank holding company with an investment grade credit rating and any foreign banking organization would prepay their issuance as soon as possible. For those institutions rated below investment grade we assumed that any holding company that could refinance for a cost savings of more than 2% when compared to the approximate cost of long-term funding given their rating and marketplace interest rates, will refinance as soon as possible. For issuers not impacted by the Tier 1 regulatory capital legislation enacted by the Dodd-Frank Act, the issuers that have shown a recent history of prepayment of both floating rate and fixed rate issues were identified and it was assumed these issuers will prepay as soon as possible.

 

Credit Analysis – A quarterly credit evaluation is performed for the companies comprising the collateral across the various pooled trust preferred securities. This credit evaluation considers any available evidence and focuses on capitalization, asset quality, profitability, liquidity, stock price performance, whether the institution has received TARP funding, whether the TARP funding was redeemed or resold through a Treasury Department auction at a premium or discount, and whether the institution has shown the ability to generate additional capital either internally or externally.

 

Probability of Default – A near-term probability of default is determined for each issuer based on its financial condition and is used to calculate the expected impact of future deferrals and defaults on the expected cash flows. Each issuer in the collateral pool is assigned a near-term probability of default based on individual performance and financial characteristics. Various studies suggest that the rate of bank failures between 1934 and 2015 were approximately 0.37%. Thus, in addition to the specific bank default assumptions used for the near term, for future defaults on the individual banks in the analysis for 2018 and beyond the rate used is calculated based on historic default averages and factoring that number based on a comparison of key financial ratios of active individual issuers without a short-term probability of default compared to all FDIC insured banks.  Default factors used in the cash flow analysis range from 0.23% to 0.47%.

 

Severity of Loss – In addition to the probability of default discussed above, a severity of loss (projected recovery) is determined in all cases. In the current analysis, the severity of loss ranges from 0% to 100% depending on the estimated credit worthiness of the individual issuer. Based on information from various published studies, a 95% severity of loss was utilized for defaults projected in 2018 and thereafter.

Based upon the analysis performed by management as of March 31, 2017, it is probable that we will collect all contractual principal and interest payments on one of our six pooled trust preferred securities, PreTSL XIX. The expected principal shortfall on the remaining pooled trust preferred securities has resulted in credit related other-than-temporary impairment charges in previous years. All of these pooled trust preferred securities held by QNB could be subject to additional write-downs in the future if additional deferrals and defaults occur.

 

 

7. LOANS & ALLOWANCE FOR LOAN LOSSES

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off 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 consists of residential mortgage loans that are carried at the lower of aggregate cost or fair value. Net unrealized losses, if any, are recognized through a valuation allowance charged to income. Gains and losses on residential mortgages held-for-sale are included in non-interest income.

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. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral

17


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

value) of the impaired loan is lower than the carrying value of that loan. 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 component covers pools of loans by loan class including commercial loans not considered impaired, as well as smaller balance homogeneous loans, such as residential real estate, home equity and other consumer loans. These pools of loans are evaluated for loss exposure based upon historical loss rates. These loss rates are based on a three year history of charge-offs and are more heavily weighted for recent experience for each of these categories of loans, adjusted for qualitative factors. These qualitative risk factors include:

 

1.

Lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices.

 

2.

Effect of external factors, such as legal and regulatory requirements.

 

3.

National, regional, and local economic and business conditions as well as the condition of various market segments, including the value of underlying collateral for collateral dependent loans.

 

4.

Nature and volume of the portfolio including growth.

 

5.

Experience, ability, and depth of lending management and staff.

 

6.

Volume and severity of past due, classified and nonaccrual loans.

 

7.

Quality of the Company’s loan review system, and the degree of oversight by the Company’s Board of Directors.

 

8.

Existence and effect of any concentrations of credit and changes in the level of such concentrations.

Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation.

An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

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 credit 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 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.

18


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Major classes of loans are as follows:

 

 

 

March 31

 

 

December 31,

 

 

 

2017

 

 

2016

 

Commercial:

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

120,344

 

 

$

110,233

 

Construction

 

 

40,244

 

 

 

39,268

 

Secured by commercial real estate

 

 

268,051

 

 

 

255,188

 

Secured by residential real estate

 

 

68,681

 

 

 

68,731

 

State and political subdivisions

 

 

35,523

 

 

 

35,260

 

Retail:

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

48,158

 

 

 

47,124

 

Home equity loans and lines

 

 

71,587

 

 

 

71,525

 

Consumer

 

 

6,317

 

 

 

5,670

 

Total loans

 

 

658,905

 

 

 

632,999

 

Net unearned costs

 

 

134

 

 

 

80

 

Loans receivable

 

$

659,039

 

 

$

633,079

 

 

Loans secured by commercial real estate 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.

Overdrafts are reclassified as loans and are included in consumer loans above and total loans on the balance sheet. At March 31, 2017 and December 31, 2016, overdrafts were approximately $118,000 and $171,000, respectively.

QNB generally lends in its trade area which is comprised of Quakertown and the surrounding communities. To a large extent, QNB makes loans collateralized at least in part by real estate. Its lending activities could be affected by changes in the general economy, the regional economy, or real estate values. Other than disclosed in the table above, at March 31, 2017, there were no concentrations of loans exceeding 10% of total loans.

The Company engages in a variety of lending activities, including commercial, residential real estate and consumer transactions. The Company focuses its lending activities on individuals, professionals and small to medium sized businesses. Risks associated with lending activities include economic conditions and changes in interest rates, which can adversely impact both the ability of borrowers to repay their loans and the value of the associated collateral.

Commercial and industrial loans, commercial real estate loans, construction loans and residential real estate loans with a business purpose are generally perceived as having more risk of default than residential real estate loans with a personal purpose and consumer loans. These types of loans involve larger loan balances to a single borrower or groups of related borrowers and are more susceptible to a risk of loss during a downturn in the business cycle. These loans may involve greater risk because the availability of funds to repay these loans depends on the successful operation of the borrower’s business. The assets financed are used within the business for its ongoing operation. Repayment of these kinds of loans generally comes from the cash flow of the business or the ongoing conversions of assets, such as accounts receivable and inventory, to cash. Typical collateral for commercial and industrial loans includes the borrower’s accounts receivable, inventory and machinery and equipment. Commercial real estate and residential real estate loans secured for a business purpose are originated primarily within the eastern Pennsylvania market area at conservative loan-to-value ratios and often backed by the individual guarantees of the borrowers or owners. Repayment of this kind of loan is dependent upon either the ongoing cash flow of the borrowing entity or the resale of or lease of the subject property. Commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers’ ability to repay their loans depends on successful development of their properties, as well as the factors affecting residential real estate borrowers.

Loans to state and political subdivisions are tax-exempt or taxable loans to municipalities, school districts and housing and industrial development authorities. These loans can be general obligations of the municipality or school district repaid through their taxing authority, revenue obligations repaid through the income generated by the operations of the authority, such as a water or sewer authority, or loans issued to a housing and industrial development agency, for which a private corporation is responsible for payments on the loans.

19


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Indirect lease financing receivables represent loans to small businesses that are collateralized by equipment. These loans tend to have higher risk characteristics but generally provide higher rates of return. These loans are originated by a third party and purchased by QNB based on criteria specified by QNB. In October 2016, the Company sold its interest in these third-party originated lease financing receivables.

The Company originates fixed-rate and adjustable-rate real estate-residential mortgage loans for personal purposes that are secured by first liens on the underlying 1-4 family residential properties. Credit risk exposure in this area of lending is minimized by the evaluation of the credit worthiness of the borrower, including debt-to-income ratios, credit scores and adherence to underwriting policies that emphasize conservative loan-to-value ratios of generally no more than 80%. Residential mortgage loans granted in excess of the 80% loan-to-value ratio criterion are generally insured by private mortgage insurance.

The real estate-home equity portfolio consists of fixed-rate home equity loans and variable-rate home equity lines of credit. Risks associated with loans secured by residential properties are generally lower than commercial loans and include general economic risks, such as the strength of the job market, employment stability and the strength of the housing market. Since most loans are secured by a primary or secondary residence, the borrower’s continued employment is the greatest risk to repayment.

The Company offers a variety of loans to individuals for personal and household purposes. Consumer loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or, if they are secured, the value of the collateral may be difficult to assess and is more likely to decrease in value than real estate. Credit risk in this portfolio is controlled by conservative underwriting standards that consider debt-to-income levels and the creditworthiness of the borrower and, if secured, collateral values.

The Company employs an eight (8) grade risk rating system related to the credit quality of commercial loans, loans to state and political subdivisions and indirect lease financing of which the first four categories are pass categories (credits not adversely rated). The following is a description of the internal risk ratings and the likelihood of loss related to each risk rating.

1 - Excellent - no apparent risk

2 - Good - minimal risk

3 - Acceptable - average risk

4 - Watch List - greater than average risk

5 - Special Mention - potential weaknesses

6 - Substandard - well defined weaknesses

7 - Doubtful - full collection unlikely

8 - Loss - considered uncollectible

The Company maintains a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential problem loans. Each loan officer assigns a rating to all loans in the portfolio at the time the loan is originated. Loans with risk ratings of one through three are reviewed annually based on the borrower’s fiscal year. Loans with risk ratings of four are reviewed every six to twelve months based on the dollar amount of the relationship with the borrower. Loans with risk ratings of five through eight are reviewed at least quarterly, and as often as monthly, at management’s discretion. The Company also utilizes an outside loan review firm to review the portfolio on a semi-annual basis to provide the Board of Directors and senior management an independent review of the Bank’s loan portfolio on an ongoing basis. These reviews are designed to recognize deteriorating credits in their earliest stages in an effort to reduce and control risk in the lending function as well as identifying potential shifts in the quality of the loan portfolio. The examinations by the outside loan review firm include the review of lending activities with respect to underwriting and processing new loans, monitoring the risk of existing loans and to provide timely follow-up and corrective action for loans showing signs of deterioration in quality. In addition, the outside firm reviews the methodology for the allowance for loan losses to determine compliance to policy and regulatory guidance.

20


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The following tables present the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company’s internal risk rating system as of March 31, 2017 and December 31, 2016:

 

March 31, 2017

 

Pass

 

 

Special

mention

 

 

Substandard

 

 

Doubtful

 

 

Total

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

110,818

 

 

$

4,598

 

 

$

4,928

 

 

$

 

 

$

120,344

 

Construction

 

 

40,237

 

 

 

 

 

 

7

 

 

 

 

 

 

40,244

 

Secured by commercial real estate

 

 

252,137

 

 

 

5,131

 

 

 

10,783

 

 

 

 

 

 

268,051

 

Secured by residential real estate

 

 

65,903

 

 

 

229

 

 

 

2,549

 

 

 

 

 

 

68,681

 

State and political subdivisions

 

 

35,523

 

 

 

 

 

 

 

 

 

 

 

 

35,523

 

Total

 

$

504,618

 

 

$

9,958

 

 

$

18,267

 

 

$

 

 

$

532,843

 

 

December 31, 2016

 

Pass

 

 

Special

mention

 

 

Substandard

 

 

Doubtful

 

 

Total

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

102,396

 

 

$

686

 

 

$

7,151

 

 

$

 

 

$

110,233

 

Construction

 

 

39,259

 

 

 

 

 

 

9

 

 

 

 

 

 

39,268

 

Secured by commercial real estate

 

 

238,290

 

 

 

5,185

 

 

 

11,713

 

 

 

 

 

 

255,188

 

Secured by residential real estate

 

 

65,169

 

 

 

231

 

 

 

3,331

 

 

 

 

 

 

68,731

 

State and political subdivisions

 

 

35,260

 

 

 

 

 

 

 

 

 

 

 

 

35,260

 

Total

 

$

480,374

 

 

$

6,102

 

 

$

22,204

 

 

$

 

 

$

508,680

 

 

For retail loans, the Company evaluates credit quality based on the performance of the individual credits. The following tables present the recorded investment in the retail classes of the loan portfolio based on payment activity as of March 31, 2017 and December 31, 2016:

 

March 31, 2017

 

Performing

 

 

Non-performing

 

 

Total

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

$

47,418

 

 

$

740

 

 

$

48,158

 

Home equity loans and lines

 

 

71,517

 

 

 

70

 

 

 

71,587

 

Consumer

 

 

6,226

 

 

 

91

 

 

 

6,317

 

Total

 

$

125,161

 

 

$

901

 

 

$

126,062

 

 

December 31, 2016

 

Performing

 

 

Non-performing

 

 

Total

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

$

46,858

 

 

$

266

 

 

$

47,124

 

Home equity loans and lines

 

 

71,436

 

 

 

89

 

 

 

71,525

 

Consumer

 

 

5,577

 

 

 

93

 

 

 

5,670

 

Total

 

$

123,871

 

 

$

448

 

 

$

124,319

 

 

21


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The performance and credit quality of the loan portfolio is also monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the past due status as of March 31, 2017 and December 31, 2016:

 

March 31, 2017

 

30-59 days

past due

 

 

60-89 days

past due

 

 

90 days or

more past

due

 

 

Total past

due loans

 

 

Current

 

 

Total loans

receivable

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

5,758

 

 

 

 

 

 

 

 

$

5,758

 

 

$

114,586

 

 

$

120,344

 

Construction

 

 

 

 

 

 

 

 

 

 

 

 

 

 

40,244

 

 

 

40,244

 

Secured by commercial real estate

 

 

705

 

 

 

 

 

$

93

 

 

 

798

 

 

 

267,253

 

 

 

268,051

 

Secured by residential real estate

 

 

179

 

 

 

 

 

 

158

 

 

 

337

 

 

 

68,344

 

 

 

68,681

 

State and political subdivisions

 

 

76

 

 

 

 

 

 

 

 

 

76

 

 

 

35,447

 

 

 

35,523

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

875

 

 

 

 

 

 

481

 

 

 

1,356

 

 

 

46,802

 

 

 

48,158

 

Home equity loans and lines

 

 

168

 

 

$

50

 

 

 

35

 

 

 

253

 

 

 

71,334

 

 

 

71,587

 

Consumer

 

 

29

 

 

 

11

 

 

 

 

 

 

40

 

 

 

6,277

 

 

 

6,317

 

Total

 

$

7,790

 

 

$

61

 

 

$

767

 

 

$

8,618

 

 

$

650,287

 

 

$

658,905

 

 

December 31, 2016

 

30-59 days

past due

 

 

60-89 days

past due

 

 

90 days or

more past

due

 

 

Total past

due loans

 

 

Current

 

 

Total loans

receivable

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

463

 

 

 

 

 

 

 

 

$

463

 

 

$

109,770

 

 

$

110,233

 

Construction

 

 

214

 

 

 

 

 

 

 

 

 

214

 

 

 

39,054

 

 

 

39,268

 

Secured by commercial real estate

 

 

64

 

 

$

395

 

 

$

1,596

 

 

 

2,055

 

 

 

253,133

 

 

 

255,188

 

Secured by residential real estate

 

 

 

 

 

 

 

 

285

 

 

 

285

 

 

 

68,446

 

 

 

68,731

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

35,260

 

 

 

35,260

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

1,459

 

 

 

323

 

 

 

 

 

 

1,782

 

 

 

45,342

 

 

 

47,124

 

Home equity loans and lines

 

 

107

 

 

 

15

 

 

 

 

 

 

122

 

 

 

71,403

 

 

 

71,525

 

Consumer

 

 

14

 

 

 

2

 

 

 

 

 

 

16

 

 

 

5,654

 

 

 

5,670

 

Total

 

$

2,321

 

 

$

735

 

 

$

1,881

 

 

$

4,937

 

 

$

628,062

 

 

$

632,999

 

 

The following tables disclose the recorded investment in loans receivable that are either on non-accrual status or past due 90 days or more and still accruing interest as of March 31, 2017 and December 31, 2016:

 

March 31, 2017

 

90 days or more past

due (still accruing)

 

 

Non-accrual

 

Commercial:

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

 

 

$

4,670

 

Construction

 

 

 

 

 

 

Secured by commercial real estate

 

 

 

 

 

2,215

 

Secured by residential real estate

 

 

 

 

 

1,812

 

State and political subdivisions

 

 

 

 

 

 

Retail:

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

 

 

 

740

 

Home equity loans and lines

 

 

 

 

 

70

 

Consumer

 

 

 

 

 

91

 

Total

 

$

 

 

$

9,598

 

 

22


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

December 31, 2016

 

90 days or more past

due (still accruing)

 

 

Non-accrual

 

Commercial:

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

 

 

$

4,798

 

Construction

 

 

 

 

 

 

Secured by commercial real estate

 

 

 

 

 

3,007

 

Secured by residential real estate

 

 

 

 

 

1,866

 

State and political subdivisions

 

 

 

 

 

 

Retail:

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

 

 

 

266

 

Home equity loans and lines

 

 

 

 

 

89

 

Consumer

 

 

 

 

 

93

 

Total

 

$

 

 

$

10,119

 

 

Activity in the allowance for loan losses for the three months ended March 31, 2017 and 2016 are as follows:

 

Three months ended March 31, 2017

 

Balance,

beginning of

period

 

 

Provision for

(credit to)

loan losses

 

 

Charge-offs

 

 

Recoveries

 

 

Balance, end

of period

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

1,459

 

 

$

507

 

 

 

 

 

$

12

 

 

$

1,978

 

Construction

 

 

449

 

 

 

14

 

 

 

 

 

 

 

 

 

463

 

Secured by commercial real estate

 

 

2,646

 

 

 

(71

)

 

 

 

 

 

2

 

 

 

2,577

 

Secured by residential real estate

 

 

1,760

 

 

 

(436

)

 

$

(3

)

 

 

23

 

 

 

1,344

 

State and political subdivisions

 

 

123

 

 

 

1

 

 

 

 

 

 

 

 

 

124

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

-

 

1-4 family residential mortgages

 

 

366

 

 

 

49

 

 

 

 

 

 

 

 

 

415

 

Home equity loans and lines

 

 

353

 

 

 

(14

)

 

 

 

 

 

3

 

 

 

342

 

Consumer

 

 

76

 

 

 

13

 

 

 

(21

)

 

 

9

 

 

 

77

 

Unallocated

 

 

162

 

 

 

237

 

 

N/A

 

 

N/A

 

 

 

399

 

Total

 

$

7,394

 

 

$

300

 

 

$

(24

)

 

$

49

 

 

$

7,719

 

 

Three months ended March 31, 2016

 

Balance,

beginning of

period

 

 

Provision for

(credit to)

loan losses

 

 

Charge-offs

 

 

Recoveries

 

 

Balance, end

of period

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

1,521

 

 

$

(56

)

 

$

(140

)

 

$

9

 

 

$

1,334

 

Construction

 

 

286

 

 

 

66

 

 

 

 

 

 

 

 

 

352

 

Secured by commercial real estate

 

 

2,411

 

 

 

(121

)

 

 

 

 

 

2

 

 

 

2,292

 

Secured by residential real estate

 

 

1,812

 

 

 

(140

)

 

 

 

 

 

18

 

 

 

1,690

 

State and political subdivisions

 

 

222

 

 

 

(26

)

 

 

 

 

 

 

 

 

196

 

Indirect lease financing

 

 

164

 

 

 

53

 

 

 

(9

)

 

 

 

 

 

208

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

350

 

 

 

2

 

 

 

 

 

 

 

 

 

352

 

Home equity loans and lines

 

 

428

 

 

 

(81

)

 

 

 

 

 

5

 

 

 

352

 

Consumer

 

 

76

 

 

 

1

 

 

 

(17

)

 

 

9

 

 

 

69

 

Unallocated

 

 

284

 

 

 

427

 

 

N/A

 

 

N/A

 

 

 

711

 

Total

 

$

7,554

 

 

$

125

 

 

$

(166

)

 

$

43

 

 

$

7,556

 

 

 

As previously discussed, the Company maintains a loan review system, which includes a continuous review of the loan portfolio by internal and external parties to aid in the early identification of potential impaired loans. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining

23


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial loans, loans to state and political subdivisions and indirect lease financing loans by using either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential mortgage loans for impairment disclosures, unless such loans are part of a larger relationship that is impaired, or are classified as a troubled debt restructuring.

An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of the majority of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral.

For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.

For commercial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable agings or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.

From time to time, QNB may extend, restructure, or otherwise modify the terms of existing loans, on a case-by-case basis, to remain competitive and retain certain customers, as well as assist other customers that may be experiencing financial difficulties. A loan is considered to be a troubled debt restructuring (“TDR”) loan when the Company grants a concession to the borrower because of the borrower’s financial condition that it would not otherwise consider. Such concessions include the reduction of interest rates, forgiveness of principal or interest, or other modifications of interest rates to less than the current market rate for new obligations with similar risk. Loans classified as TDRs are considered non-performing and are also designated as impaired.

The concessions made for TDRs involve lowering the monthly payments on loans through periods of interest only payments, a reduction in interest rate below a market rate or an extension of the term of the loan without a corresponding adjustment to the risk premium reflected in the interest rate, or a combination of these three methods. The restructurings rarely result in the forgiveness of principal or accrued interest. If the borrower has demonstrated performance under the previous terms and our underwriting process shows the borrower has the capacity to continue to perform under the restructured terms, the loan will continue to accrue interest. Non-accruing restructured loans may be returned to accrual status when there has been a sustained period of repayment performance (generally six consecutive months of payments) and both principal and interest are deemed collectible. TDR loans that are in compliance with their modified terms and that yield a market rate may be removed from the TDR status after a period of performance.

Performing TDRs (not reported as non-accrual or past due 90 days or more and still accruing) totaled $1,425,000 and $1,819,000 as of March 31, 2017 and December 31, 2016, respectively. Non-performing TDRs totaled $3,531,000 and $3,555,000 as of March 31, 2017 and December 31, 2016, respectively. All TDRs are included in impaired loans.

24


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The following table illustrates the specific reserve for loan losses allocated to loans modified as TDRs. These specific reserves are included in the allowance for loan losses for loans individually evaluated for impairment.

 

 

 

March 31, 2017

 

 

December 31, 2016

 

 

 

Unpaid

principal

balance

 

 

Related

allowance

 

 

Unpaid

principal

balance

 

 

Related

allowance

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

TDRs with no specific allowance recorded

 

$

3,653

 

 

 

 

 

$

3,992

 

 

 

 

TDRs with an allowance recorded

 

 

1,303

 

 

$

395

 

 

 

1,382

 

 

$

761

 

Total

 

$

4,956

 

 

$

395

 

 

$

5,374

 

 

$

761

 

 

There were no newly identified TDRs during the three months ended March 31, 2017. As of March 31, 2017 and December 31, 2016, QNB had commitments of $925,000 and $30,000, respectively, to lend additional funds to customers with loans whose terms have been modified in troubled debt restructurings. There were net charge-offs of $3,000 and $0 during the three months ended March 31, 2017 and 2016, respectively, resulting from loans previously modified as TDRs.

The following tables present loans, by loan class, modified as TDRs during the three months ended March 31, 2017 and 2016. The pre-modification and post-modification outstanding recorded investments disclosed in the tables below, represent carrying amounts immediately prior to the modification and as of the period end indicated.

 

Three months ended March 31,

 

2017

 

 

2016

 

 

 

Number of

contracts

 

 

Pre-modification

outstanding

recorded

investment

 

 

Post-modification

outstanding

recorded

investment

 

 

Number of

contracts

 

 

Pre-modification

outstanding

recorded

investment

 

 

Post-modification

outstanding

recorded

investment

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

 

 

$

 

 

$

 

 

 

6

 

 

$

1,074

 

 

$

1,050

 

Secured by residential real estate

 

 

 

 

 

 

 

 

 

 

 

3

 

 

 

483

 

 

 

479

 

Total

 

 

 

 

$

 

 

$

 

 

 

9

 

 

$

1,557

 

 

$

1,529

 

 

 

There were no loans modified as TDRs within 12 months prior to March 31, 2017 and 2016 for which there was a payment default (60 days or more past due) during the three months ended March 31, 2017 and 2016.

The Company has three consumer mortgage loans secured by residential real estate for which foreclosure proceedings are in process at March 31, 2017. The recorded investment is $516,000.

25


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The following tables present the balance in the allowance for loan losses at March 31, 2017 and December 31, 2016 disaggregated on the basis of the Company’s impairment method by class of loans receivable along with the balance of loans receivable by class, excluding unearned fees and costs, disaggregated on the basis of the Company’s impairment methodology:

 

 

 

Allowance for Loan Losses

 

 

Loans Receivable

 

March 31, 2017

 

Balance

 

 

Balance related

to loans

individually

evaluated for

impairment

 

 

Balance related

to loans

collectively

evaluated for

impairment

 

 

Balance

 

 

Balance

individually

evaluated for

impairment

 

 

Balance

collectively

evaluated for

impairment

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

1,978

 

 

$

841

 

 

$

1,137

 

 

$

120,344

 

 

$

4,877

 

 

$

115,467

 

Construction

 

 

463

 

 

 

 

 

 

463

 

 

 

40,244

 

 

 

7

 

 

 

40,237

 

Secured by commercial real estate

 

 

2,577

 

 

 

52

 

 

 

2,525

 

 

 

268,051

 

 

 

5,532

 

 

 

262,519

 

Secured by residential real estate

 

 

1,344

 

 

 

176

 

 

 

1,168

 

 

 

68,681

 

 

 

2,249

 

 

 

66,432

 

State and political subdivisions

 

 

124

 

 

 

 

 

 

124

 

 

 

35,523

 

 

 

 

 

 

35,523

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

415

 

 

 

4

 

 

 

411

 

 

 

48,158

 

 

 

1,081

 

 

 

47,077

 

Home equity loans and lines

 

 

342

 

 

 

 

 

 

342

 

 

 

71,587

 

 

 

92

 

 

 

71,495

 

Consumer

 

 

77

 

 

 

 

 

 

77

 

 

 

6,317

 

 

 

91

 

 

 

6,226

 

Unallocated

 

 

399

 

 

N/A

 

 

N/A

 

 

N/A

 

 

N/A

 

 

N/A

 

Total

 

$

7,719

 

 

$

1,073

 

 

$

6,247

 

 

$

658,905

 

 

$

13,929

 

 

$

644,976

 

 

 

 

Allowance for Loan Losses

 

 

Loans Receivable

 

December 31, 2016

 

Balance

 

 

Balance related

to loans

individually

evaluated for

impairment

 

 

Balance related

to loans

collectively

evaluated for

impairment

 

 

Balance

 

 

Balance

individually

evaluated for

impairment

 

 

Balance

collectively

evaluated for

impairment

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

1,459

 

 

$

696

 

 

$

763

 

 

$

110,233

 

 

$

5,134

 

 

$

105,099

 

Construction

 

 

449

 

 

 

 

 

 

449

 

 

 

39,268

 

 

 

224

 

 

 

39,044

 

Secured by commercial real estate

 

 

2,646

 

 

 

 

 

 

2,646

 

 

 

255,188

 

 

 

6,383

 

 

 

248,805

 

Secured by residential real estate

 

 

1,760

 

 

 

494

 

 

 

1,266

 

 

 

68,731

 

 

 

2,313

 

 

 

66,418

 

State and political subdivisions

 

 

123

 

 

 

 

 

 

123

 

 

 

35,260

 

 

 

 

 

 

35,260

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

366

 

 

 

8

 

 

 

358

 

 

 

47,124

 

 

 

748

 

 

 

46,376

 

Home equity loans and lines

 

 

353

 

 

 

 

 

 

353

 

 

 

71,525

 

 

 

111

 

 

 

71,414

 

Consumer

 

 

76

 

 

 

 

 

 

76

 

 

 

5,670

 

 

 

93

 

 

 

5,577

 

Unallocated

 

 

162

 

 

N/A

 

 

N/A

 

 

N/A

 

 

N/A

 

 

N/A

 

Total

 

$

7,394

 

 

$

1,198

 

 

$

6,034

 

 

$

632,999

 

 

$

15,006

 

 

$

617,993

 

 

26


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The following tables summarize additional information in regards to impaired loans by loan portfolio class as of March 31, 2017 and December 31, 2016:

 

 

 

March 31, 2017

 

 

December 31, 2016

 

 

 

Recorded

investment

(after

charge-offs)

 

 

Unpaid

principal

balance

 

 

Related

allowance

 

 

Recorded

investment

(after

charge-offs)

 

 

Unpaid

principal

balance

 

 

Related

allowance

 

With no specific allowance recorded:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

2,313

 

 

$

2,659

 

 

$

 

 

$

2,482

 

 

$

2,862

 

 

$

 

Construction

 

 

7

 

 

 

7

 

 

 

 

 

 

224

 

 

 

234

 

 

 

 

Secured by commercial real estate

 

 

5,422

 

 

 

5,929

 

 

 

 

 

 

6,383

 

 

 

6,367

 

 

 

 

Secured by residential real estate

 

 

1,020

 

 

 

1,430

 

 

 

 

 

 

1,046

 

 

 

1,438

 

 

 

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

908

 

 

 

928

 

 

 

 

 

 

570

 

 

 

589

 

 

 

 

Home equity loans and lines

 

 

92

 

 

 

132

 

 

 

 

 

 

111

 

 

 

174

 

 

 

 

Consumer

 

 

91

 

 

 

93

 

 

 

 

 

 

93

 

 

 

95

 

 

 

 

Total

 

$

9,853

 

 

$

11,178

 

 

$

 

 

$

10,909

 

 

$

11,759

 

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

With an allowance recorded:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

2,564

 

 

$

2,742

 

 

$

841

 

 

$

2,652

 

 

$

2,812

 

 

$

696

 

Construction

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial real estate

 

 

110

 

 

 

112

 

 

 

52

 

 

 

 

 

 

 

 

 

 

Secured by residential real estate

 

 

1,229

 

 

 

1,360

 

 

 

176

 

 

 

1,267

 

 

 

1,435

 

 

 

494

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

173

 

 

 

190

 

 

 

4

 

 

 

178

 

 

 

193

 

 

 

8

 

Home equity loans and lines

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

4,076

 

 

$

4,404

 

 

$

1,073

 

 

$

4,097

 

 

$

4,440

 

 

$

1,198

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

4,877

 

 

$

5,401

 

 

$

841

 

 

$

5,134

 

 

$

5,674

 

 

$

696

 

Construction

 

 

7

 

 

 

7

 

 

 

 

 

 

224

 

 

 

234

 

 

 

 

Secured by commercial real estate

 

 

5,532

 

 

 

6,041

 

 

 

52

 

 

 

6,383

 

 

 

6,367

 

 

 

 

Secured by residential real estate

 

 

2,249

 

 

 

2,790

 

 

 

176

 

 

 

2,313

 

 

 

2,873

 

 

 

494

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

1,081

 

 

 

1,118

 

 

 

4

 

 

 

748

 

 

 

782

 

 

 

8

 

Home equity loans and lines

 

 

92

 

 

 

132

 

 

 

 

 

 

111

 

 

 

174

 

 

 

 

Consumer

 

 

91

 

 

 

93

 

 

 

 

 

 

93

 

 

 

95

 

 

 

 

Total

 

$

13,929

 

 

$

15,582

 

 

$

1,073

 

 

$

15,006

 

 

$

16,199

 

 

$

1,198

 

 

27


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Three Months Ended March 31,

 

2017

 

 

2016

 

 

 

Average

recorded

investment

 

 

Interest income

recognized

 

 

Average

recorded

investment

 

 

Interest income

recognized

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

4,995

 

 

$

5

 

 

$

4,570

 

 

$

19

 

Construction

 

 

146

 

 

 

2

 

 

 

382

 

 

 

4

 

Secured by commercial real estate

 

 

6,128

 

 

 

40

 

 

 

6,554

 

 

 

34

 

Secured by residential real estate

 

 

2,278

 

 

 

7

 

 

 

2,070

 

 

 

4

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

Indirect lease financing

 

 

 

 

 

 

 

 

129

 

 

 

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

829

 

 

 

4

 

 

 

580

 

 

 

3

 

Home equity loans and lines

 

 

101

 

 

 

 

 

 

145

 

 

 

 

Consumer

 

 

92

 

 

 

 

 

 

 

 

 

 

Total

 

$

14,569

 

 

$

58

 

 

$

14,430

 

 

$

64

 

 

 

8. FAIR VALUE MEASUREMENTS AND DISCLOSURES

Financial Accounting Standards Board (FASB) ASC 820, Fair Value Measurements and Disclosures, defines fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (fair values are not adjusted for transaction costs). ASC 820 also establishes a framework (fair value hierarchy) for measuring fair value under GAAP, and expands disclosures about fair value measurements.

ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:

 

Level 1:

Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

 

Level 2:

Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.

 

Level 3:

Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The measurement of fair value should be consistent with one of the following valuation techniques: market approach, income approach, and/or cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). For example, valuation techniques consistent with the market approach often use market multiples derived from a set of comparables. Multiples might lie in ranges with a different multiple for each comparable. The selection of where within the range the appropriate multiple falls requires judgment, considering factors specific to the measurement (qualitative and quantitative). Valuation techniques consistent with the market approach include matrix pricing. Matrix pricing is a mathematical technique used principally to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the security’s relationship to other benchmark quoted securities.

28


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The following table sets forth QNB’s financial assets measured at fair value on a recurring and nonrecurring basis and the fair value measurements by level within the fair value hierarchy as of March 31, 2017:

 

March 31, 2017

 

Quoted prices

in active

markets

for identical

assets

(Level 1)

 

 

Significant

other

observable

input

(Level 2)

 

 

Significant

unobservable

inputs

(Level 3)

 

 

Balance at end

of period

 

Recurring fair value measurements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trading Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

State and municipal securities

 

$

 

 

$

2,358

 

 

$

 

 

$

2,358

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government agency securities

 

 

 

 

$

70,646

 

 

 

 

 

$

70,646

 

State and municipal securities

 

 

 

 

 

75,728

 

 

 

 

 

 

75,728

 

U.S. Government agencies and sponsored enterprises (GSEs):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

 

 

 

 

142,230

 

 

 

 

 

 

142,230

 

Collateralized mortgage obligations (CMOs)

 

 

 

 

 

77,106

 

 

 

 

 

 

77,106

 

Pooled trust preferred securities

 

 

 

 

 

 

 

$

2,423

 

 

 

2,423

 

Corporate debt securities

 

 

 

 

 

8,056

 

 

 

 

 

 

8,056

 

Equity securities

 

$

6,107

 

 

 

 

 

 

 

 

 

6,107

 

Total securities available-for-sale

 

$

6,107

 

 

$

373,766

 

 

$

2,423

 

 

$

382,296

 

Total recurring fair value measurements

 

$

6,107

 

 

$

376,124

 

 

$

2,423

 

 

$

384,654

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonrecurring fair value measurements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impaired loans

 

$

 

 

$

 

 

$

3,003

 

 

$

3,003

 

Mortgage servicing rights

 

 

 

 

 

 

 

 

43

 

 

 

43

 

Total nonrecurring fair value measurements

 

$

 

 

$

 

 

$

3,046

 

 

$

3,046

 

 

There were no transfers in and out of Level 1 and Level 2 fair value measurements during the three months ended March 31, 2017. There were also no transfers in or out of level 3 for the same period. There were no losses included in earnings attributable to the change in unrealized gains or losses relating to the available-for-sale securities above with fair value measurements utilizing significant unobservable inputs for the three-month period ended March 31, 2017.

29


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The following table sets forth QNB’s financial assets measured at fair value on a recurring and nonrecurring basis, the fair value measurements by level within the fair value hierarchy as of December 31, 2016:

 

December 31, 2016

 

Quoted prices

in active

markets

for identical

assets

(Level 1)

 

 

Significant

other

observable

input

(Level 2)

 

 

Significant

unobservable

inputs

(Level 3)

 

 

Balance at end

of period

 

Recurring fair value measurements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trading Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

State and municipal securities

 

$

 

 

$

3,596

 

 

$

 

 

$

3,596

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government agency securities

 

 

 

 

$

76,650

 

 

 

 

 

$

76,650

 

State and municipal securities

 

 

 

 

 

72,295

 

 

 

 

 

 

72,295

 

U.S. Government agencies and sponsored enterprises (GSEs):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

 

 

 

 

145,301

 

 

 

 

 

 

145,301

 

Collateralized mortgage obligations (CMOs)

 

 

 

 

 

77,415

 

 

 

 

 

 

77,415

 

Pooled trust preferred securities

 

 

 

 

 

 

 

$

2,281

 

 

 

2,281

 

Corporate debt securities

 

 

 

 

 

8,030

 

 

 

 

 

 

8,030

 

Equity securities

 

$

8,503

 

 

 

 

 

 

 

 

 

8,503

 

Total securities available-for-sale

 

$

8,503

 

 

$

379,691

 

 

$

2,281

 

 

$

390,475

 

Total recurring fair value measurements

 

$

8,503

 

 

$

383,287

 

 

$

2,281

 

 

$

394,071

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonrecurring fair value measurements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impaired loans

 

$

 

 

$

 

 

$

2,899

 

 

$

2,899

 

Mortgage servicing rights

 

 

 

 

 

 

 

 

58

 

 

 

58

 

Total nonrecurring fair value measurements

 

$

 

 

$

 

 

$

2,957

 

 

$

2,957

 

 

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which QNB has utilized Level 3 inputs to determine fair value:

 

 

 

Quantitative information about Level 3 fair value measurements

March 31, 2017

 

Fair value

 

 

Valuation

techniques

 

 

Unobservable

input

 

 

Value or range

of values

Impaired loans

 

$

1,281

 

 

Appraisal of collateral

(1)

 

Appraisal adjustments

(2)

 

-10% to -80%

 

 

 

 

 

 

 

 

 

Liquidation expenses

(3)

 

-10%

Impaired loans

 

 

24

 

 

Used commercial vehicle and equipment guides

 

 

Guide value discounts

(4)

 

0% to -25%

Impaired loans

 

 

1,698

 

 

Financial statement values for UCC collateral

 

 

Financial statement value discounts

(5)

 

-20% to -50%

Mortgage servicing rights

 

 

43

 

 

Discounted cash flow

 

 

Remaining term

 

 

2 to 27 yrs

 

 

 

 

 

 

 

 

 

Discount rate

 

 

14% to 16%

 

30


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

 

Quantitative information about Level 3 fair value measurements

December 31, 2016

 

Fair value

 

 

Valuation

techniques

 

 

Unobservable

input

 

 

Value or range

of values

Impaired loans

 

$

938

 

 

Appraisal of collateral

(1)

 

Appraisal adjustments

(2)

 

-10% to -80%

 

 

 

 

 

 

 

 

 

Liquidation expenses

(3)

 

-10%

Impaired loans

 

 

76

 

 

Used commercial vehicle and equipment guides

 

 

Guide value discounts

(4)

 

0% to -25%

Impaired loans

 

 

1,880

 

 

Financial statement values for UCC collateral

 

 

Financial statement value discounts

(5)

 

-20% to -50%

Impaired loans

 

 

5

 

 

Agreement of sale

(6)

 

 

 

 

 

Mortgage servicing rights

 

 

58

 

 

Discounted cash flow

 

 

Remaining term

 

 

2 to 27 yrs

 

 

 

 

 

 

 

 

 

Discount rate

 

 

14% to 16%

 

(1)

Fair value is primarily determined through appraisals of the underlying collateral by independent parties, which generally includes various level 3 inputs which are not always identifiable.

(2)

Appraisals may be adjusted by management for qualitative factors such as economic conditions and the age of the appraisal. The range is presented as a percent of the initial appraised value.

(3)

Appraisals and pending agreements of sale are adjusted by management for estimated liquidation expenses. The range is presented as a percent of the initial appraised value.

(4)

If lendable value (lower than wholesale) is utilized then no additional discounts are taken. If lendable value is not provided, additional discounts are applied.

(5)

Values obtained from financial statements for UCC collateral (fixed assets and inventory) are discounted to estimated realizable liquidation value.

(6)

Fair value is determined by the net amount due.

The following table presents additional information about the securities available-for-sale measured at fair value on a recurring basis and for which QNB utilized significant unobservable inputs (Level 3 inputs) to determine fair value for the three months ended March 31, 2017 and 2016:

 

 

 

Fair value measurements using significant unobservable inputs

(Level 3)

 

 

 

2017

 

 

2016

 

Balance, January 1,

 

$

2,281

 

 

$

2,653

 

Payments received

 

 

(34

)

 

 

(71

)

Total gains or losses (realized/unrealized)

 

 

 

 

 

 

 

 

Included in earnings

 

 

 

 

 

 

Included in other comprehensive income

 

 

176

 

 

 

73

 

Transfers in and/or out of Level 3

 

 

 

 

 

 

Balance, March 31,

 

$

2,423

 

 

$

2,655

 

 

The Level 3 securities consist of six collateralized debt obligation securities, PreTSL securities, which are backed by trust preferred securities issued by banks, thrifts, and insurance companies. As discussed in Note 7, despite the fact that there were some trades over the past few years, the market for these securities at March 31, 2017 was not active and markets for similar securities also are not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which PreTSLs trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive and there are currently very few market participants who are willing and or able to transact for these securities.

31


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Given conditions in the debt markets today and the absence of observable transactions in the secondary and new issue markets, we determined:

 

The few observable transactions and market quotations that are available are not reliable for purposes of determining fair value at March 31, 2017;

 

An income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than the market approach valuation technique used at prior measurement dates; and

 

PreTSLs will be classified within Level 3 of the fair value hierarchy because significant adjustments are required to determine fair value at the measurement date.

The Bank is aware of several factors indicating that recent transactions of PreTSL securities are not orderly including an increased spread between bid/ask prices, lower sales transaction volumes for these types of securities, and a lack of new issuances. As a result, the Bank engaged an independent third party to value the securities using a discounted cash flow analysis. The estimated cash flows are based on specific assumptions about defaults, deferrals and prepayments of the trust preferred securities underlying each PreTSL. The resulting collateral cash flows are allocated to the bond waterfall using the INTEXcalc valuation model.  Default rates are calculated based upon a comparison of key financial ratios of active individual issuers without a short-term probability of default compared to all FDIC insured banks.  The base loss severity assumption and long-term loss severity assumptions are modeled at 95%. The severity factor for near-term default is vectored to reflect the relative expected performance of the institutions modeled to default, with lower forecasted severities used for the higher quality institutions.  Prepayments are modeled to take into account the disruption in the asset-backed securities marketplace and the lack of new pooled trust preferred issuances.  For those institutions rated below investment grade the holding companies’ approximate cost of long-term funding given their rating and marketplace interest rate was estimated. The following assumption was made; any holding company that could refinance for a cost savings of more than 2% will refinance and will do so as soon as possible. Finally, for issuers not impacted by the Tier 1 regulatory capital legislation enacted by the Dodd-Frank Act, the issuers that have shown a recent history of prepayment of both floating rate and fixed rate issues were identified and it was assumed these issuers will prepay as soon as possible.

The internal rate of return is the pre-tax yield used to discount the best estimate of future cash flows after credit losses. The cash flows have been discounted using estimated market discount rates of 3-month LIBOR plus spreads ranging from 5.18% to 7.72%. The determination of appropriate market discount rates involved the consideration of the following:

 

the time value of money

 

the price for bearing uncertainty in cash flows

 

other factors that would be considered by market participants

The analysis of discount rates involved the review of corporate bond spreads for banks, U.S. Treasury yields, credit default swap rates for financial companies (utilized as a proxy for credit), the swap/LIBOR yield curve and the characteristics of the individual securities being valued. For a further discussion of PreTSL valuation, see Note 6, Investment Securities.

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of QNB’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between QNB’s disclosures and those of other companies may not be meaningful.

The following methods and assumptions were used to estimate the fair values of each major classification of financial instrument and non-financial asset at March 31, 2017 and December 31, 2016:

Cash and cash equivalents, accrued interest receivable and accrued interest payable (carried at cost):  The carrying amounts reported in the balance sheet approximate those assets’ fair value.

Investment securities - trading (carried at fair value), available for sale (carried at fair value) and held-to-maturity (carried at amortized cost):  The fair value of securities are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other

32


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

benchmark quoted prices. Level 2 debt securities are valued by a third-party pricing service commonly used in the banking industry. Level 2 fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution date, market consensus prepayment speeds, credit information and the security’s terms and conditions, among other things. For certain securities which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3). In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) were used to support fair values of certain Level 3 investments.

Restricted investment in bank stocks (carried at cost):  The fair value of stock in Atlantic Community Bankers Bank and the Federal Home Loan Bank is the carrying amount, based on redemption provisions, and considers the limited marketability of such securities.

Loans Held-for-Sale (carried at lower of cost or fair value):  The fair value of loans held for sale is determined, when possible, using quoted secondary market prices. If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan.

Loans Receivable (carried at cost): The fair values of loans are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.

Impaired Loans (generally carried at fair value):  Impaired loans are loans, in which the Company has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements. .

Mortgage Servicing Rights (carried at lower of cost or fair value):  The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The mortgage servicing rights are stratified into tranches based on predominant characteristics, such as interest rate, loan type and investor type. The valuation incorporates assumptions that market participants would use in estimating future net servicing income.

Deposit liabilities (carried at cost):  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 (carried at cost):  The carrying amount of short-term borrowings approximates their fair values.

Off-balance-sheet instruments (disclosed at cost):  The fair values for the Bank’s off-balance sheet instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing.

Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in sales transaction on the dates indicated. The estimated fair value amounts have been measured as of the respective period ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period end.

33


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The estimated fair values and carrying amounts of the Company’s financial and off-balance sheet instruments are summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

Fair value measurements

 

March 31, 2017

 

Carrying

amount

 

 

Fair value

 

 

Quoted

prices in

active

markets for

identical

assets

(Level 1)

 

 

Significant

other

observable

inputs

(Level 2)

 

 

Significant

unobservable

inputs

(Level 3)

 

Financial assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

20,542

 

 

$

20,542

 

 

$

20,542

 

 

 

 

 

 

 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trading

 

 

2,358

 

 

 

2,358

 

 

 

 

 

$

2,358

 

 

 

 

Available-for-sale

 

 

382,296

 

 

 

382,296

 

 

 

6,107

 

 

 

373,766

 

 

$

2,423

 

Restricted investment in bank stocks

 

 

910

 

 

 

910

 

 

 

 

 

 

910

 

 

 

 

Loans held-for-sale

 

 

903

 

 

 

925

 

 

 

 

 

 

925

 

 

 

 

Net loans

 

 

651,320

 

 

 

649,870

 

 

 

 

 

 

 

 

 

649,870

 

Mortgage servicing rights

 

 

494

 

 

 

595

 

 

 

 

 

 

 

 

 

595

 

Accrued interest receivable

 

 

2,774

 

 

 

2,774

 

 

 

 

 

 

2,774

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits with no stated maturities

 

$

716,424

 

 

$

716,424

 

 

$

716,424

 

 

 

 

 

$

 

Deposits with stated maturities

 

 

226,467

 

 

 

225,847

 

 

 

 

 

$

225,847

 

 

 

 

Short-term borrowings

 

 

45,265

 

 

 

45,265

 

 

 

45,265

 

 

 

 

 

 

 

Accrued interest payable

 

 

303

 

 

 

303

 

 

 

 

 

 

303

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Off-balance sheet instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commitments to extend credit

 

$

 

 

$

 

 

$

 

 

$

 

 

$

 

Standby letters of credit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

34


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

Fair value measurements

 

December 31, 2016

 

Carrying

amount

 

 

Fair value

 

 

Quoted

prices in

active

markets for

identical

assets

(Level 1)

 

 

Significant

other

observable

inputs

(Level 2)

 

 

Significant

unobservable

inputs

(Level 3)

 

Financial assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

10,721

 

 

$

10,721

 

 

$

10,721

 

 

 

 

 

 

 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trading

 

 

3,596

 

 

 

3,596

 

 

 

 

 

$

3,596

 

 

 

 

Available-for-sale

 

 

390,475

 

 

 

390,475

 

 

 

8,503

 

 

 

379,691

 

 

$

2,281

 

Restricted investment in bank stocks

 

 

1,017

 

 

 

1,017

 

 

 

 

 

 

1,017

 

 

 

 

Loans held-for-sale

 

 

789

 

 

 

789

 

 

 

 

 

 

789

 

 

 

 

Net loans

 

 

625,685

 

 

 

626,052

 

 

 

 

 

 

 

 

 

626,052

 

Mortgage servicing rights

 

 

498

 

 

 

579

 

 

 

 

 

 

 

 

 

579

 

Accrued interest receivable

 

 

3,128

 

 

 

3,128

 

 

 

 

 

 

3,128

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits with no stated maturities

 

$

687,773

 

 

$

687,773

 

 

$

687,773

 

 

 

 

 

$

 

Deposits with stated maturities

 

 

225,582

 

 

 

225,403

 

 

 

 

 

$

225,403

 

 

 

 

Short-term borrowings

 

 

52,660

 

 

 

52,660

 

 

 

52,660

 

 

 

 

 

 

 

Accrued interest payable

 

 

335

 

 

 

335

 

 

 

 

 

 

335

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Off-balance sheet instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commitments to extend credit

 

$

 

 

$

 

 

$

 

 

$

 

 

$

 

Standby letters of credit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9. OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS AND GUARANTEES

In the normal course of business there are various legal proceedings, commitments, and contingent liabilities which are not reflected in the consolidated 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. 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.

A summary of the Bank's financial instrument commitments is as follows:

 

 

 

March 31,

 

 

December 31,

 

 

 

2017

 

 

2016

 

Commitments to extend credit and unused lines of credit

 

$

277,444

 

 

$

277,216

 

Standby letters of credit

 

 

14,207

 

 

 

16,490

 

Total financial instrument commitments

 

$

291,651

 

 

$

293,706

 

 

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 by the Bank to guarantee the financial or performance obligation of a customer to a third party. QNB’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in

35


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

making conditional obligations as it does for on-balance sheet instruments. These standby letters of credit expire within three years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending other loan commitments. The Bank requires collateral and personal guarantees supporting these letters of credit as deemed necessary. Management believes that the proceeds obtained through a liquidation of such collateral and the enforcement of personal guarantees would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees. The amount of the liability as of March 31, 2017 and December 31, 2016 for guarantees under standby letters of credit issued is not material.

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.

 

 

10. REGULATORY RESTRICTIONS

Dividends payable by the Company and the Bank are subject to various limitations imposed by statutes, regulations and policies adopted by bank regulatory agencies. Under Pennsylvania banking law, the Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. Under Federal Reserve regulations, the Bank is limited as to the amount it may lend affiliates, including QNB Corp., unless such loans are collateralized by specific obligations.

Both the Company 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 Company 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 March 31, 2017, that the Company and the Bank met capital adequacy requirements to which they were subject.

As of the most recent notification, the primary regulator of the Bank considered it 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 Company and the Bank must maintain minimum ratios as set forth in the following table below.

The Company and the Bank’s actual capital amounts and ratios are presented as follows:

 

 

Capital levels

 

 

 

Actual

 

 

Adequately capitalized

 

 

Well capitalized

 

As of March 31, 2017

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

Total risk-based capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

$

107,237

 

 

 

12.77

%

 

$

67,195

 

 

 

8.00

%

 

$

83,993

 

 

 

10.00

%

Bank

 

 

98,389

 

 

11.98

 

 

 

65,682

 

 

8.00

 

 

 

82,103

 

 

10.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier I capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

99,459

 

 

11.84

 

 

 

50,396

 

 

6.00

 

 

 

50,396

 

 

6.00

 

Bank

 

 

90,611

 

 

11.04

 

 

 

49,262

 

 

6.00

 

 

 

65,682

 

 

8.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common equity tier 1 capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

99,459

 

 

11.84

 

 

 

37,797

 

 

4.50

 

 

N/A

 

 

N/A

 

Bank

 

 

90,611

 

 

11.04

 

 

 

36,946

 

 

4.50

 

 

 

53,367

 

 

6.50

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier I capital (to average assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

99,459

 

 

9.24

 

 

 

43,036

 

 

4.00

 

 

N/A

 

 

N/A

 

Bank

 

 

90,611

 

 

8.49

 

 

 

42,683

 

 

4.00

 

 

 

53,353

 

 

5.00

 

36


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

 

Capital levels

 

 

 

Actual

 

 

Adequately capitalized

 

 

Well capitalized

 

As of December 31, 2016

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

Total risk-based capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

$

104,820

 

 

 

12.75

%

 

$

65,777

 

 

 

8.00

%

 

$

82,221

 

 

 

10.00

%

Bank

 

 

96,478

 

 

12.10

 

 

 

63,792

 

 

8.00

 

 

 

79,740

 

 

10.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier I capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

97,320

 

 

11.84

 

 

 

49,333

 

 

6.00

 

 

 

49,333

 

 

6.00

 

Bank

 

 

89,025

 

 

11.16

 

 

 

47,844

 

 

6.00

 

 

 

63,792

 

 

8.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common equity tier 1 capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

97,320

 

 

11.84

 

 

 

36,999

 

 

4.50

 

 

N/A

 

 

N/A

 

Bank

 

 

89,025

 

 

11.16

 

 

 

35,883

 

 

4.50

 

 

 

51,831

 

 

6.50

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier I capital (to average assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

97,320

 

 

9.16

 

 

 

42,479

 

 

4.00

 

 

N/A

 

 

N/A

 

Bank

 

 

89,025

 

 

8.45

 

 

 

42,144

 

 

4.00

 

 

 

52,680

 

 

5.00

 

 

 

 

37


QNB CORP. AND SUBSIDIARY

 

 

 

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

QNB Corp. is a bank holding company headquartered in Quakertown, Pennsylvania. QNB Corp., through its wholly-owned subsidiary, the Bank, has been serving the residents and businesses of upper Bucks, northern Montgomery and southern Lehigh counties in Pennsylvania since 1877. Due to its limited geographic area, 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.  The Bank is a locally managed community bank that provides a full range of commercial and retail banking and retail brokerage services.

Tabular information presented throughout management’s discussion and analysis, other than share and per share data, is presented in thousands of dollars.

FORWARD-LOOKING STATEMENTS

In addition to historical information, this document contains forward-looking statements. Forward-looking statements are typically identified by words or phrases such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project” and variations of such words and similar expressions, or future or conditional verbs such as “will,” “would,” “should,” “could,” “may” or similar expressions. The U.S. Private Securities Litigation Reform Act of 1995 provides safe harbor in regard to the inclusion of forward-looking statements in this document and documents incorporated by reference.

Shareholders should note that many factors, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference, and including the risk factors identified in Item 1A of QNB’s 2016 Form 10-K, could affect the future financial results of the Company 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;

 

Credit risk;

 

Liquidity risk;

 

Operating, legal and regulatory risks;

 

Economic, political and competitive forces affecting QNB’s 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.

38


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

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 of this report on Form 10-Q, even if subsequently made available by QNB on its website or otherwise, 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.

QNB uses the current statutory tax rate of 34% to value its deferred tax assets and liabilities. Proposed comprehensive tax reform, announced April 26, 2017, included a reduction in the U.S. corporate income tax rate to 15%. If corporate tax rates were reduced, management expects the Company would be required to record an initial charge against earnings to lower the carrying amount of its net deferred tax asset, and then, going forward, would record lower tax provisions. The proposal is at the beginning stages of negotiations and will need to be addressed by both houses of Congress. It is too early in the process to determine if any of the proposals are actionable. Accordingly, management cannot assess the effect a change in the corporate tax rate would have on Company's operating results or financial position.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The discussion and analysis of the financial condition and results of operations are based on the consolidated financial statements of QNB, which are prepared in accordance with U.S. generally accepted accounting principles (GAAP) 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 determination of the allowance for loan losses, the determination of the valuation of other real estate owned and foreclosed assets, other-than-temporary impairments on investment securities, the valuation of deferred tax assets, stock-based compensation 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.

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. For equity securities, once a decline in value is determined to be other-than-temporary, the value of the equity security is reduced and a corresponding charge to earnings is recognized. As a result of prolonged declines in some equity securities’ fair values, $70,000 of other-than-temporary impairment charges were recorded during the first quarter of 2016.  There were no other-than-temporary impairment charges recorded during the first quarter of 2017.

The Company follows accounting guidance related to the recognition and presentation of other-than-temporary impairment that specifies (a) if a company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss. When an entity does not intend to sell the security, and it is more likely than not, the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment is amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security. There were no credit-related other-than-temporary impairment charges in the first quarters ended March 31, 2017 or 2016, respectively.

39


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

Allowance for Loan Losses

The determination of the allowance for loan losses involves a higher degree of judgment and complexity than the Company’s 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 continual 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 impaired loans is determined by estimating the inherent loss on each credit after giving consideration to the value of underlying collateral or present value of future estimated cash flows. 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, 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 to assess and monitor the degree of risk in the loan portfolio. QNB’s lending and credit 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 collection. 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.

Foreclosed Assets

Assets acquired through, or in lieu of, loan foreclosure are held-for-sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses and changes in the valuation allowance are included in net expenses from foreclosed assets.

Stock-Based Compensation

QNB sponsors stock-based compensation plans, administered by a Board committee, under which both qualified and non-qualified stock options may be granted periodically to certain employees. QNB accounts for all awards granted under stock-based compensation plans in accordance with ASC 718, Compensation-Stock Compensation. Compensation cost has been measured using the fair value of an award on the grant date and is recognized over the service period, which is usually the vesting period. 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 estimates the fair value of stock options on the date of the grant using the Black-Scholes option pricing model. The model requires the use of numerous assumptions, many of which are highly subjective in nature.

Income Taxes

QNB accounts for income taxes under the asset/liability method in accordance with income tax accounting guidance, ASC 740, Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the

40


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

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 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 tax assets could change in the near term.

RESULTS OF OPERATIONS - OVERVIEW

QNB reported net income for the first quarter of 2017 of $2,860,000, or $0.83 per share on a diluted basis, compared to net income of $2,265,000, or $0.67 per share on a diluted basis, for the same period in 2016.

Net income expressed as an annualized rate of return on average assets and average shareholders’ equity was 1.08% and 11.76%, respectively, for the quarter March 31, 2017 compared with 0.91% and 9.88%, respectively, for the quarter ended March 31, 2016.

Total assets as of March 31, 2017 were $1,089,007,000, compared with $1,063,141,000 at December 31, 2016. Loans receivable at March 31, 2017 were $659,039,000, compared with $633,079,000 at December 31, 2016, an increase of $25,960,000, or 4.1%, with commercial lending as the largest contributor to the growth. Total deposits of $942,891,000 at March 31, 2017 increased $29,536,000, or 3.2%, compared with total deposits of $913,355,000 at December 31, 2016.

Results for the three months ended March 31, 2017 include the following significant components:

 

Net interest income increased $759,000, or 10.7%, to $7,880,000 for the three months ended March 31, 2017.

 

Net interest margin on a tax-equivalent basis increased eight basis points for the quarter to 3.22%.

 

QNB recorded $300,000 in provision for loan losses for the quarter ended March 31, 2017, compared with $125,000 for the same period in 2016.

 

Non-interest income increased $414,000, or 26.3%, to $1,990,000 for the first quarter of 2017 compared with the same period in 2016.

 

Non-interest expense increased $69,000, or 1.3%, to $5,588,000 for the first quarter of 2017, compared to the same period in 2016.

 

Total non-performing loans were $11,023,000, or 1.67% of loans receivable at March 31, 2017, compared to $11,938,000, or 1.89% of loans receivable at December 31, 2016. Loans on non-accrual status were $9,598,000 at March 31, 2017 compared with $10,119,000 at December 31, 2016. Net recoveries for the three months ended March 31, 2017 were $25,000, or -0.02% annualized of average total loans, compared with net charge-offs of $123,000, or 0.08% annualized of average total loans for the same period in 2016.

These items, as well as others, will be explained more thoroughly in the next sections.

NET INTEREST INCOME

QNB Corp. earns its net income primarily through its subsidiary, 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. Management 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 levels approved by the Board of Directors.

41


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

The following table presents the adjustment to convert net interest income to net interest income on a fully taxable-equivalent basis for the three month periods ended March 31, 2017 and 2016.

 

Three months ended March 31,

 

2017

 

 

2016

 

Total interest income

 

$

9,136

 

 

$

8,280

 

Total interest expense

 

 

1,256

 

 

 

1,159

 

Net interest income

 

 

7,880

 

 

 

7,121

 

Tax-equivalent adjustment

 

 

387

 

 

 

436

 

Net interest income (fully taxable-equivalent)

 

$

8,267

 

 

$

7,557

 

 

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, interest bearing balances at the Federal Reserve Bank (Fed) and Federal funds sold. Sources used to fund these assets include deposits and borrowed funds. 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 tables that appear above. 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 rate margin, which includes interest-free sources of funds, is net interest income expressed as a percentage of average interest-earning assets. The Asset/Liability and Investment Management Committee works to manage and maximize the net interest margin for the Company.

 

42


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

Average Balances, Rate, and Interest Income and Expense Summary (Tax-Equivalent Basis)

 

 

 

Three Months Ended

 

 

 

March 31, 2017

 

 

March 31, 2016

 

 

 

Average

 

 

Average

 

 

 

 

 

 

Average

 

 

Average

 

 

 

 

 

 

 

Balance

 

 

Rate

 

 

Interest

 

 

Balance

 

 

Rate

 

 

Interest

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trading securities

 

$

2,806

 

 

 

6.32

%

 

$

44

 

 

$

3,866

 

 

 

6.30

%

 

$

61

 

Investment securities (AFS & HTM):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government agencies

 

 

76,090

 

 

 

1.75

 

 

 

333

 

 

 

57,028

 

 

 

1.83

 

 

 

262

 

State and municipal

 

 

72,006

 

 

 

3.91

 

 

 

704

 

 

 

76,221

 

 

 

4.11

 

 

 

782

 

Mortgage-backed and CMOs

 

 

223,965

 

 

 

2.05

 

 

 

1,148

 

 

 

200,424

 

 

 

2.01

 

 

 

1,005

 

Pooled trust preferred securities

 

 

2,907

 

 

 

0.27

 

 

 

2

 

 

 

3,285

 

 

 

0.19

 

 

 

2

 

Corporate debt securities

 

 

8,069

 

 

 

1.90

 

 

 

38

 

 

 

9,081

 

 

 

1.60

 

 

 

36

 

Equities

 

 

6,838

 

 

 

3.37

 

 

 

57

 

 

 

7,523

 

 

 

3.67

 

 

 

69

 

Total investment securities

 

 

389,875

 

 

 

2.34

 

 

 

2,282

 

 

 

353,562

 

 

 

2.44

 

 

 

2,156

 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

 

375,188

 

 

 

4.73

 

 

 

4,380

 

 

 

325,189

 

 

 

4.45

 

 

 

3,602

 

Residential real estate

 

 

47,536

 

 

 

3.85

 

 

 

458

 

 

 

43,123

 

 

 

3.84

 

 

 

414

 

Home equity loans

 

 

66,389

 

 

 

3.85

 

 

 

630

 

 

 

62,067

 

 

 

3.80

 

 

 

586

 

Commercial and industrial

 

 

113,010

 

 

 

4.66

 

 

 

1,299

 

 

 

115,322

 

 

 

4.19

 

 

 

1,200

 

Indirect lease financing

 

 

-

 

 

-

 

 

 

-

 

 

 

10,409

 

 

 

9.27

 

 

 

241

 

Consumer loans

 

 

6,258

 

 

 

5.11

 

 

 

79

 

 

 

4,385

 

 

 

5.32

 

 

 

58

 

Tax-exempt loans

 

 

35,309

 

 

 

3.94

 

 

 

343

 

 

 

40,313

 

 

 

3.81

 

 

 

382

 

Total loans, net of unearned income*

 

 

643,690

 

 

 

4.53

 

 

 

7,189

 

 

 

600,808

 

 

 

4.34

 

 

 

6,483

 

Other earning assets

 

 

6,045

 

 

 

0.52

 

 

 

8

 

 

 

10,474

 

 

 

0.64

 

 

 

16

 

Total earning assets

 

 

1,042,416

 

 

 

3.71

 

 

 

9,523

 

 

 

968,710

 

 

 

3.62

 

 

 

8,716

 

Cash and due from banks

 

 

12,098

 

 

 

 

 

 

 

 

 

 

 

11,438

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

 

(7,443

)

 

 

 

 

 

 

 

 

 

 

(7,608

)

 

 

 

 

 

 

 

 

Other assets

 

 

28,833

 

 

 

 

 

 

 

 

 

 

 

28,649

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,075,904

 

 

 

 

 

 

 

 

 

 

$

1,001,189

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders' Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand

 

$

161,928

 

 

 

0.20

%

 

 

80

 

 

$

145,026

 

 

 

0.19

%

 

 

70

 

Municipals

 

 

87,312

 

 

 

0.43

 

 

 

94

 

 

 

94,987

 

 

 

0.35

 

 

 

82

 

Money market

 

 

77,990

 

 

 

0.27

 

 

 

52

 

 

 

70,130

 

 

 

0.27

 

 

 

47

 

Savings

 

 

241,042

 

 

 

0.44

 

 

 

259

 

 

 

225,071

 

 

 

0.40

 

 

 

226

 

Time

 

 

130,699

 

 

 

1.14

 

 

 

368

 

 

 

134,670

 

 

 

1.12

 

 

 

373

 

Time of $100,000 or more

 

 

95,522

 

 

 

1.37

 

 

 

323

 

 

 

93,404

 

 

 

1.37

 

 

 

318

 

Total interest-bearing deposits

 

 

794,493

 

 

 

0.60

 

 

 

1,176

 

 

 

763,288

 

 

 

0.59

 

 

 

1,116

 

Short-term borrowings

 

 

60,560

 

 

 

0.54

 

 

 

80

 

 

 

43,067

 

 

 

0.40

 

 

 

43

 

Total interest-bearing liabilities

 

 

855,053

 

 

 

0.60

 

 

 

1,256

 

 

 

806,355

 

 

 

0.58

 

 

 

1,159

 

Non-interest-bearing deposits

 

 

117,861

 

 

 

 

 

 

 

 

 

 

 

98,951

 

 

 

 

 

 

 

 

 

Other liabilities

 

 

4,361

 

 

 

 

 

 

 

 

 

 

 

3,632

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

 

98,629

 

 

 

 

 

 

 

 

 

 

 

92,251

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders' equity

 

$

1,075,904

 

 

 

 

 

 

 

 

 

 

$

1,001,189

 

 

 

 

 

 

 

 

 

Net interest rate spread

 

 

 

 

 

 

3.11

%

 

 

 

 

 

 

 

 

 

 

3.04

%

 

 

 

 

Margin/net interest income

 

 

 

 

 

 

3.22

%

 

$

8,267

 

 

 

 

 

 

 

3.14

%

 

$

7,557

 

 

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 and investment securities are included in earning assets.

* Includes loans held-for-sale

43


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

Rate/Volume Analysis. The following table shows the fully taxable equivalent effect of changes in volumes and rates on interest income and interest expense. Changes in net interest income that could not be specifically identified as either a rate or volume change were allocated to changes in volume.

 

 

 

Three months ended

 

 

 

March 31, 2017 compared

 

 

 

to March 31, 2016

 

 

 

Total

 

 

Due to change in:

 

 

 

Change

 

 

Volume

 

 

Rate

 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

Trading securities

 

$

(17

)

 

$

(17

)

 

$

 

Investment securities (AFS & HTM):

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government agencies

 

 

71

 

 

 

87

 

 

 

(16

)

State and municipal

 

 

(78

)

 

 

(43

)

 

 

(35

)

Mortgage-backed and CMOs

 

 

143

 

 

 

118

 

 

 

25

 

Pooled trust preferred securities

 

 

-

 

 

 

(1

)

 

 

1

 

Corporate debt securities

 

 

2

 

 

 

(4

)

 

 

6

 

Equities

 

 

(12

)

 

 

(7

)

 

 

(5

)

Total Investment securities (AFS & HTM)

 

 

126

 

 

 

150

 

 

 

(24

)

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

 

778

 

 

 

519

 

 

 

259

 

Residential real estate

 

 

44

 

 

 

43

 

 

 

1

 

Home equity loans

 

 

44

 

 

 

35

 

 

 

9

 

Commercial and industrial

 

 

99

 

 

 

(34

)

 

 

133

 

Indirect lease financing

 

 

(241

)

 

 

(241

)

 

 

-

 

Consumer loans

 

 

21

 

 

 

24

 

 

 

(3

)

Tax-exempt loans

 

 

(39

)

 

 

(50

)

 

 

11

 

Total Loans

 

 

706

 

 

 

296

 

 

 

410

 

Other earning assets

 

 

(8

)

 

 

(6

)

 

 

(2

)

Total interest income

 

 

807

 

 

 

423

 

 

 

384

 

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits:

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand

 

 

10

 

 

 

8

 

 

 

2

 

Municipals

 

 

12

 

 

 

(7

)

 

 

19

 

Money market

 

 

5

 

 

 

5

 

 

 

-

 

Savings

 

 

33

 

 

 

14

 

 

 

19

 

Time

 

 

(5

)

 

 

(13

)

 

 

8

 

Time of $100,000 or more

 

 

5

 

 

 

4

 

 

 

1

 

Total interest-bearing deposits

 

 

60

 

 

 

11

 

 

 

49

 

Short-term borrowings

 

 

37

 

 

 

16

 

 

 

21

 

Total interest expense

 

 

97

 

 

 

27

 

 

 

70

 

Net interest income

 

$

710

 

 

$

396

 

 

$

314

 

 

Average earning assets for the first quarter of 2017 were $1,042,416,000, an increase of $73,706,000, or 7.6% from the first quarter of 2016, with average loans increasing $42,882,000, or 7.1%, and average investment securities increasing $35,253,000, or 9.9%, over the same period. Growth in the loan portfolio mitigates the impact of the low rate environment on net interest income and the net interest margin as loans generally earn a higher yield than investment securities. Average loans as a percent of average earning assets were 61.7% for the first quarter of 2017, compared with 62.0% for the first quarter of 2016. On the funding side, average deposits increased $50,115,000, or 5.8%, to $912,354,000 for the first quarter of 2017 with growth in all categories except for municipal deposits and time deposits. Customers continue to reinvest funds into non-time deposits, as the yield in time deposits remains low and customers prefer to keep their funds liquid to capitalize on rising rates. Average borrowed funds for the first quarter of 2017 increased $17,493,000, to $60,560,000, which consisted of average commercial repurchase agreements of $40,043,000 and average overnight

44


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

borrowings of $20,517,000.  For the same period in 2016, borrowings consisted of average commercial repurchase agreements of $38,652,000 and average overnight borrowings of $4,415,000.

The net interest margin for the first quarter of 2017 was 3.22% compared with 3.14% for same period in 2016.    The increase in margin was due to $416,000 of interest collected at payoff on a non-accrual loan. Without the additional interest recognized, the net interest margin would have been 3.05% compared with 2.97% for the fourth quarter of 2016.  Competition for quality loans in our local market continues to negatively impact rates and compressed the net interest margin.  

The Rate-Volume Analysis tables, as presented on a tax-equivalent basis, highlight the impact of changing rates and volumes on interest income and interest expense. Total interest income on a tax-equivalent basis increased $807,000, or 9.3%, to $9,523,000 for the first quarter of 2017; total interest expense increased 8.4% to $1,256,000. Growth in earning assets contributed to the increase in interest income, as well as the additional interest income referenced above.  All categories of interest-bearing deposits except money market deposits and time deposits of $100,000 or more experienced higher rates in the first quarter of 2017 compared to first quarter of 2016, due to rate increases for municipal deposits indexed to Fed Funds, and a five basis point rate increase to the eSavings and Rewards checking product in late 2016.

 

The yield on earning assets on a tax-equivalent basis increased nine basis points from 3.62% for the first quarter of 2016, to 3.71% for the first quarter of 2017.  Excluding the additional interest income referenced above, the yield on earning assets was 3.55%, a seven basis point decline when compared with the first quarter of 2016.  The cost of interest-bearing liabilities was 0.60% for the first quarter ended March 31, 2017, compared with 0.58% for the same period in 2016.

Interest income on investment securities (trading, available-for-sale and held-to-maturity) increased $109,000 when comparing the quarters ended March 31, 2017 and 2016. The average yield on the investment portfolio was 2.37% for the first quarter of 2017 compared with 2.48% for the first quarter of 2016. Investment opportunities in the current rate environment provide a yield comparable to the overall portfolio yield.

Income on U.S. Government agency securities increased $71,000, as the $19,062,000, or 33.4%, increase in average balances contributed to an increase in interest income by $87,000. This was offset by a $16,000 decrease in interest income due to an eight basis point decrease in the yield from 1.83% for the first quarter of 2016 to 1.75% for the same period in 2017.

Tax-exempt municipal securities experienced a decrease in average balances of $4,215,000, which, coupled with a 20 basis point reduction in average yield, resulted in a decrease of interest income of $78,000.  QNB had purchased many municipal securities when rates were significantly higher. Many of these bonds have either reached maturity or their call dates and are being replaced with municipal bonds with lower yields. Typically, QNB purchases municipal bonds with 10-15 year maturities with call dates between 2-5 years. The yield on this portfolio is expected to continue to decline as additional higher yielding municipal bonds are expected to be called or mature during 2017. The current yield on replacement bonds is well below the yield of the bonds being called or maturing.

Interest income on mortgage-backed securities and CMOs increased $143,000 with a four basis point increase in average yield, plus the $23,541,000 increase in average balances contributing to the increase.  This portfolio generally provides higher yields relative to agency bonds and also provides monthly cash flow which can be used for liquidity purposes or can be reinvested when interest rates eventually increase. Mortgage refinancing activity over the past three years was significant resulting in an increase in prepayments on these securities. Since most of these securities were purchased at a premium, prepayments result in a shorter amortization period of this premium and therefore a reduction in income.

Income on loans increased $706,000 to $7,189,000 when comparing the first quarters of 2017 and 2016, with a 7.1% growth in average balances contributing an increase in interest income of $296,000.  While the yield on loans, at 4.53%, was nineteen basis points higher than the first quarter of 2016, excluding the additional interest income referenced above, yield on loans for the first quarter of 2017 was 4.27%, seven basis points lower than the 4.34% in first quarter of 2016.   Despite increases in the Fed funds rate in December 2016 and March 2017, competitive pressures result in new loans being originated at low rates. Mitigating competitive pricing, variable rate loans have repriced higher.

The largest category of the loan portfolio is commercial real estate loans. This category of loans includes commercial purpose loans secured by either commercial properties such as office buildings, factories, warehouses, medical facilities and retail establishments, or residential real estate, usually the residence of the business owner. The category also includes construction and land development loans. Income on commercial real estate loans increased $778,000 due in part to the 15.4% increase in average balances. Average balances increased $49,999,000, to $375,188,000 for the quarter ended March 31, 2017 compared with the same quarter in 2016. The

45


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

yield on commercial real estate loans increased 28 basis points from 4.45% in 2016 to 4.73% in 2017.  The positive impact of the loan payoff in this category was approximately $342,000, or 27 basis points.

Income on commercial and industrial loans increased $99,000. Average balances decreased $2,312,000, or 2.0%, to $113,010,000 for the first quarter of 2017 resulting in a $34,000 decrease in income. The average yield on these loans increased 47 basis points to 4.66% resulting in an increase in income of $133,000. The positive impact of the loan payoff in this category was approximately $74,000, or 26 basis points.  Many of the loans in this category are indexed to the prime interest rate, which increased by one quarter of one percent in late December 2016 and in mid-March 2017.

Tax-exempt loan income was $343,000 for the first quarter of 2017, a decrease of $39,000 from the same period in 2016. As with municipal marketable securities, many municipalities have refinanced existing loans. While QNB has been successful in winning some of these bids, average balances have decreased $5,004,000, or 12.4%, to $35,309,000 for the first quarter of 2017, resulting in a decrease of $50,000 in income. The yield on municipal loans improved 13 basis points, to 3.94% for the first quarter of 2017, compared with the same period in 2016, resulting in an additional $11,000 in interest income.

In October 2016, QNB sold its interest in third-party originated indirect lease financing contracts.  This portfolio provided $241,000 in interest income during the first quarter of 2016.

QNB desires to become the “local consumer lender of choice” and to affect this QNB refocused its retail lending efforts, adding new product offerings and increasing marketing and promotion.  The positive impact of this focus has been year-over-year growth in balances in all three categories of retail lending: residential mortgage, home equity and consumer loans.  Average residential mortgage loans secured by first lien 1-4 family residential mortgages increased by $4,413,000, or 10.2%, to $47,536,000 for the first quarter of 2017 compared to the same period in 2016. Over this same timeframe, the average yield on the portfolio increased one basis point to 3.85% for the first quarter of 2017. The net result was an increase in interest income of $44,000. Average home equity loans increased $4,322,000, or 7.0%, to $66,389,000 while the average yield increased five basis points to 3.85% resulting in an increase in interest income of $44,000. Average consumer loans increased $1,873,000, or 42.7%, to $6,258,000 while the yield on the portfolio decreased 21 basis points to 5.11% for the first quarter of 2017 resulting in a $21,000 increase in interest income.

Earning assets are funded by deposits and borrowed funds.  Interest expense increased $97,000, when comparing the first quarter of 2017 to the same period in 2016.  The growth in average deposits continues to be centered in accounts with greater liquidity, such as non-interest and interest-bearing demand, money market, and savings deposits. Average non-interest-bearing demand accounts increased $18,910,000, or 19.1%, to $117,861,000 for the first quarter of 2017. QNB has been successful in increasing business checking accounts as average balances in these accounts have increased by $17,050,000, or 21.6%, to $95,872,000 when comparing the quarters. Average interest-bearing demand accounts increased $16,902,000, or 11.7%, to $161,928,000 for the first quarter of 2017. Interest expense on interest-bearing demand accounts increased $10,000 to $80,000 for the same period, as the average rate paid increased one basis point to 0.20% for the first quarter of 2017. Included in this category is QNB-Rewards checking, a higher-rate checking account product that pays 1.05% on balances up to $25,000 and 0.25% for balances over $25,000. In order to receive the high rate a customer must receive an electronic statement, have one direct deposit or other ACH transaction and have at least 12 check card purchase transactions post and clear per statement cycle. For the first quarter of 2017, the average balance in this product was $49,186,000 and the related interest expense was $64,000 for an average yield of 0.53%. In comparison, the average balance of the QNB-Rewards accounts for the first quarter of 2016 was $43,230,000 with a related interest expense of $55,000 and an average rate paid of 0.51%. This product also generates fee income through the use of the check card. The average balance of other interest-bearing demand accounts included in this category increased from $101,796,000 for the first quarter of 2016 to $112,742,000 for the first quarter of 2017. The average rate paid on these balances was 0.06% for both periods.

Interest expense on municipal interest-bearing demand accounts increased $12,000 to $94,000 for the first quarter of 2017. The average balance of municipal interest-bearing demand accounts decreased $7,675,000, or 8.1%, to $87,312,000, with the average interest rate paid on these accounts increasing eight basis points to 0.43% for the first quarter of 2017.  Many of these accounts are indexed to the Federal funds rate with rate floors between 0.25% and 0.50%, therefore the increases in the Federal funds rate affected the yield of these deposits. Municipal deposits are seasonal in nature and are received during the third quarter as tax receipts are collected and are withdrawn over the course of the next year.

Average money market accounts increased $7,860,000, or 11.2%, to $77,990,000 for the first quarter of 2017 compared with the same period in 2016. Interest expense on money market accounts increased $5,000 to $52,000, while the average interest rate paid on

46


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

money market accounts was 0.27% for the first quarters of 2017 and 2016. Most of balances in this category are in a product that pays a tiered rate based on account balances.

Interest expense on savings accounts increased $33,000 when comparing the first quarter of 2017 to the first quarter of 2016, and the average rate increased four basis points to 0.44% when comparing both periods. When comparing these same periods, average savings accounts increased $15,971,000, or 7.1%, to $241,042,000 for the first quarter of 2017 with both the statement savings and e-Savings products accounting for the growth in savings balances. QNB’s online e-Savings product is the largest category of savings deposits, with average balances for the first quarter of 2017 of $176,331,000. This product has grown successfully since its introduction in the third quarter of 2009. The average yield paid on these accounts was 0.55% for the first quarter of 2017 and 0.50% for the same period in 2016. Traditional statement savings accounts, passbook savings and club accounts are also included in the savings category and average balances in these types of savings accounts increased $6,130,000, or 10.5%, when comparing the first quarter of 2017 average to the same period in 2016.

Total interest expense on time deposits totaled $691,000 for the first quarters of 2017 and 2016. Average total time deposits decreased by $1,853,000 to $226,221,000 for the first quarter of 2017. As with 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, however, the maturity and repricing characteristics of time deposits tend to be shorter. The average rate paid on time deposits increased two basis points from 1.22% to 1.24% when comparing the first quarter of 2016 to the same period in 2017.

Approximately $93,000,000, or 42%, of time deposits at March 31, 2017 will mature over the next 12 months. The average rate paid on these time deposits is approximately 0.69%. The yield on the time deposit portfolio may change slightly in the next quarter as short-term time deposits reprice. However, given the short-term nature of these deposits, interest expense may increase if short-term time deposit rates were to increase suddenly or if customers select higher paying longer-term time deposits.

Short-term borrowings are comprised of sweep accounts structured as repurchase agreements with our commercial customers and overnight FHLB borrowings. Interest expense on short-term borrowings increased $37,000 for the first quarter of 2017 to $80,000 when compared to the same period in 2016. When comparing these same periods, average balances increased from $43,067,000 to $60,560,000, due to an increase in average FHLB borrowings of $16,081,000, while the average rate paid increased fourteen basis points to 0.54% for the first quarter of 2017.

PROVISION FOR LOAN LOSSES AND ALLOWANCE FOR LOAN LOSSES

The provision for loan losses represents management's determination of the amount necessary to be charged to operations to bring the allowance for loan losses to a level that represents management’s best estimate of the known and inherent losses in the existing loan portfolio. 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 for the allowance for loan losses is based upon an analysis of the risks inherent in QNB’s loan portfolio. Management, in determining the allowance for loan losses, makes significant estimates and assumptions. Since the allowance for loan losses is dependent, to a great extent, on conditions that may be beyond QNB’s control, it is at least reasonably possible that management’s estimates of the allowance for loan losses and actual results could differ. In addition, various regulatory agencies, as an integral part of their examination process, periodically review QNB’s allowance for losses on loans. Such agencies may require QNB to recognize changes to the allowance based on their judgments about information available to them at the time of their examination. Actual loan losses, net of recoveries, serve to reduce the allowance.

Management closely monitors the quality of its loan portfolio and performs a quarterly analysis of the appropriateness of the allowance for loan losses. This analysis considers several relevant factors including: specific impairment reserves, historical loan loss experience, general economic conditions, levels of and trends in delinquent and non-performing loans, levels of classified loans, trends in the growth rate of loans and concentrations of credit.

Based on this analysis, QNB recorded $300,000 in provision for loan losses in the first quarter of 2017, compared with $125,000 for the same period in 2016. QNB's allowance for loan losses of $7,719,000 represents 1.17% of loans receivable at March 31, 2017 compared with an allowance for loan losses of $7,394,000, or 1.17% of loans receivable, at December 31, 2016, and $7,556,000, or 1.26% of loans receivable at March 31, 2016. Management believes the allowance for loan losses at March 31, 2017 is adequate as of that date based on its analysis of known and inherent losses in the portfolio.

47


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

Net recoveries were $25,000 for the first quarter of 2017, compared with net loan charge-offs of $123,000 for the first quarter of 2016.

Charge-offs of approximately $25,000 during the quarter ended March 31, 2017 consisted almost exclusively of overdrafts.  These were offset by $18,000 in recoveries related to sale of collateral for previously charged-off loans, and $18,000 in repayments from borrowers of previously charged-off credits, and $9,000 related to overdraft recoveries.  For the quarter ended March 31, 2017 annualized net recoveries as a percent of average loans were -0.02%, compared with 0.08% of average loans for the same period in 2016.

Non-performing assets of $13,446,000 at March 31, 2017 compares favorably with $14,219,000 as of December 31, 2016 and is slightly higher than $12,765,000 as of March 31, 2016. Included in this classification are non-performing loans, and non-accrual pooled trust preferred securities. Total non-performing loans, which represent loans on non-accrual status, loans past due 90 days or more and still accruing interest and restructured loans, were $11,023,000, or 1.67% of loans receivable at March 31, 2017 compared with $11,938,000, or 1.89% of loans receivable at December 31, 2016, and $10,110,000, or 1.68% of loans receivable at March 31, 2016. In cases where there is a collateral shortfall on non-accrual loans, specific impairment reserves have been established based on updated collateral values even if the borrower continues to pay in accordance with the terms of the agreement. At March 31, 2017, $8,077,000, or approximately 84% of the loans classified as non-accrual are current or past due less than 30 days. Loans classified as substandard or doubtful totaled $18,267,000, a reduction of $3,937,000, or 17.7%, from the $22,204,000 reported at December 31, 2016 and a $7,703,000 decline from the $25,970,000 reported at March 31, 2016.

QNB had no loans past due 90 days or more and still accruing interest at March 31, 2017 or December 31, 2016 compared with $8,000 at March 31, 2016. Total loans 30 days or more past due, which includes non-accrual loans by actual number of days delinquent, represented 1.31% of loans receivable at March 31, 2017 compared with 0.78% at December 31, 2016 and 0.66% at March 31, 2016.  The majority of the increase in the ratio of delinquent to total loans is due to a single past-due credit that is now current.

Troubled debt restructured loans, not classified as non-accrual loans or loans past due 90 days or more and accruing, were $1,425,000 at March 31, 2017, compared with $1,819,000 at December 31, 2016, and $1,268,000 at March 31, 2016. There were no newly identified troubled debt restructures in the three months ended March 31, 2017. QNB had no other real estate owned or repossessed assets as of March 31, 2017, December 31, 2016, or March 31, 2016.  Non-accrual pooled trust preferred securities are carried at fair value of $2,423,000, $2,281,000, and $2,655,000 at March 31, 2017, December 31, 2016 and March 31, 2016, respectively. The change in the carrying value of these securities reflects a combination of payments received and changes in their fair value.


48


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

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. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and shortfalls on a case-by-case basis, taking into consideration all the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral, if the loan is collateral dependent.

The following table shows detailed information and ratios pertaining to the Company’s loan and asset quality:

 

 

 

March 31,

 

 

December 31,

 

 

March 31,

 

 

 

2017

 

 

2016

 

 

2016

 

Non-accrual loans

 

$

9,598

 

 

$

10,119

 

 

$

8,834

 

Loans past due 90 days or more and still accruing interest

 

 

 

 

 

 

 

 

8

 

Troubled debt restructured loans (not already included

   above)

 

 

1,425

 

 

 

1,819

 

 

 

1,268

 

Total non-performing loans

 

 

11,023

 

 

 

11,938

 

 

 

10,110

 

Non-accrual investment securities

 

 

2,423

 

 

 

2,281

 

 

 

2,655

 

Total non-performing assets

 

$

13,446

 

 

$

14,219

 

 

$

12,765

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans (excluding loans held-for-sale):

 

 

 

 

 

 

 

 

 

 

 

 

Average total loans (YTD)

 

$

643,327

 

 

$

604,757

 

 

$

600,631

 

Total loans

 

 

659,039

 

 

 

633,079

 

 

 

601,686

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

 

7,719

 

 

 

7,394

 

 

 

7,556

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses to:

 

 

 

 

 

 

 

 

 

 

 

 

Non-performing loans

 

 

70.02

%

 

 

61.94

%

 

 

74.73

%

Total loans (excluding held-for-sale)

 

 

1.17

%

 

 

1.17

%

 

 

1.26

%

Average total loans

 

 

1.20

%

 

 

1.22

%

 

 

1.26

%

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-performing loans / total loans (excluding held-for-sale)

 

 

1.67

%

 

 

1.89

%

 

 

1.68

%

Non-performing assets / total assets

 

 

1.23

%

 

 

1.34

%

 

 

1.27

%

 

An analysis of net loan (recoveries) charge-offs for the three months ended March 31, 2017 compared to 2016 is as follows:

 

Three months ended March 31,

 

2017

 

 

2016

 

Net (recoveries) charge-offs

 

$

(25

)

 

$

123

 

 

 

 

 

 

 

 

 

 

Net annualized (recoveries) charge-offs to:

 

 

 

 

 

 

 

 

Total loans

 

 

(0.02

%)

 

 

0.08

%

Average total loans excluding held-for-sale

 

 

(0.02

%)

 

 

0.08

%

Allowance for loan losses

 

 

(1.31

%)

 

 

6.60

%

49


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

At March 31, 2017 and December 31, 2016, the recorded investment in loans for which impairment has been identified totaled $13,929,000 and $15,006,000 of which $9,853,000 and $10,909,000, respectively, required no specific allowance for loan loss. The recorded investment in impaired loans requiring an allowance for loan losses was $4,076,000 and $4,097,000 at March 31, 2017 and December 31, 2016, respectively, and the related allowance for loan losses associated with these loans was $1,073,000 and $1,198,000, respectively. Most of the loans that have been identified as impaired are collateral-dependent. See Note 7 to the Notes to Consolidated Financial Statements for additional detail of impaired loans.

NON-INTEREST INCOME

 

Non-Interest Income Comparison

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months

 

 

Change from

 

 

 

ended March 31,

 

 

prior year

 

 

 

2017

 

 

2016

 

 

Amount

 

 

Percent

 

Net gain on investment securities

 

$

749

 

 

$

319

 

 

$

430

 

 

 

134.8

%

Net gain on trading activity

 

 

17

 

 

 

34

 

 

 

(17

)

 

 

-50.0

%

Fees for services to customers

 

 

392

 

 

 

383

 

 

 

9

 

 

 

2.3

%

ATM and debit card

 

 

417

 

 

 

388

 

 

 

29

 

 

 

7.5

%

Retail brokerage and advisory

 

 

103

 

 

 

170

 

 

 

(67

)

 

 

-39.4

%

Bank-owned life insurance

 

 

71

 

 

 

71

 

 

 

-

 

 

 

0.0

%

Merchant

 

 

80

 

 

 

73

 

 

 

7

 

 

 

9.6

%

Net gain on sale of loans

 

 

50

 

 

 

49

 

 

 

1

 

 

 

2.0

%

Other

 

 

111

 

 

 

89

 

 

 

22

 

 

 

24.7

%

Total

 

$

1,990

 

 

$

1,576

 

 

$

414

 

 

 

26.3

%

Quarter to Quarter Comparison

Total non-interest income for the first quarter of 2017 was $1,990,000, an increase of $414,000, compared to $1,576,000 for the first quarter of 2016. Excluding net gains on investment securities, trading activities and sale of loans for both periods, total non-interest income was $1,174,000 for both the first quarters of 2017 and 2016.

Net gains on investment securities increased $430,000 from $319,000 in first quarter of 2016 to $749,000 in first quarter of 2017.  Gain on investments are primarily derived from sale of equities.  Market conditions in the equities market for the quarter ended March 31, 2017 versus the same period in 2016 resulted in better opportunities for sales.

QNB originates residential mortgage loans for sale in the secondary market.  Net gain on sale of loans increased slightly to $50,000 when comparing the two periods.  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.  Residential mortgage loans to be sold are identified at origination.  Proceeds from the sale of residential mortgages were $2,023,000 and $1,557,000 for the first quarters of 2017 and 2016, respectively.

ATM and debit card income increased $29,000, or 7.5%, to $417,000 for the first quarter of 2017, compared to the same period in 2016, due to increases in card-based transactions and expansion of checking account households.  

Other non-interest income increased $22,000, or 24.7%, due to increased credit card fees, letter of credit income, title insurance income, and sale of checks to depositors.  Fees for services to customers increased $9,000, or 2.3%, to $392,000 at March 31, 2017, due primarily to an increase in net overdraft income.

These increases in non-interest income were offset in part by a $67,000, or 39.4%, decrease in retail brokerage and advisory income.  While assets under management have grown over 39% since March 31, 2016, to $106,000,000 at March 31, 2017, the asset growth has been in products with more trailing income than up-front income.  Trading income for the first quarter of 2017 decreased $17,000, compared with the same period in 2016.

50


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

NON-INTEREST EXPENSE

 

Non-Interest Expense Comparison

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months

 

 

Change from

 

 

 

ended March 31,

 

 

prior year

 

 

 

2017

 

 

2016

 

 

Amount

 

 

Percent

 

Salaries and employee benefits

 

$

3,086

 

 

$

3,054

 

 

$

32

 

 

 

1.0

%

Net occupancy

 

 

451

 

 

 

441

 

 

 

10

 

 

 

2.3

%

Furniture and equipment

 

 

429

 

 

 

425

 

 

 

4

 

 

 

0.9

%

Marketing

 

 

229

 

 

 

196

 

 

 

33

 

 

 

16.8

%

Third-party services

 

 

394

 

 

 

403

 

 

 

(9

)

 

 

-2.2

%

Telephone, postage and supplies

 

 

200

 

 

 

186

 

 

 

14

 

 

 

7.5

%

State taxes

 

 

193

 

 

 

180

 

 

 

13

 

 

 

7.2

%

FDIC insurance premiums

 

 

141

 

 

 

170

 

 

 

(29

)

 

 

-17.1

%

Other

 

 

465

 

 

 

464

 

 

 

1

 

 

 

0.2

%

Total

 

$

5,588

 

 

$

5,519

 

 

$

69

 

 

 

1.3

%

 

Quarter to Quarter Comparison

Total non-interest expense was $5,588,000 for the first quarter of 2017, an increase of $69,000, or 1.3%, compared to the first quarter of 2016.

Salaries and benefits comprise the largest component of non-interest expense. QNB monitors, through the use of various surveys, the competitive salary and benefit information in its markets and makes adjustments when appropriate. Salaries and benefits expense increased $32,000, or 1.0%, to $3,086,000 when comparing the two quarters.  Salary expense and related payroll taxes increased $106,000, or 4.1%, to $2,702,000 during the first quarter of 2017 compared to the same period in 2016, while medical premiums and post-retirement life insurance declined $42,000 and $35,000, respectively.

Net occupancy and furniture and equipment expense increased $14,000, or 1.6%, to $880,000 for the first quarter of 2017, with maintenance cost increases of $30,000 partially offset by a $16,000 decrease in leasehold and equipment depreciation expense.  Marketing expense increased $33,000, or 16.8%, to $229,000 for the quarter ended March 31, 2017. The increase is due to additional sponsorships and donations for the first quarter of 2017 compared to the same period in 2016.

Third party services are comprised of professional services, including legal, accounting, 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 decreased slightly when comparing the two periods. Telephone and postage and supplies expenses increased $14,000, or 7.5%, due to increased data line capacity, and costs related to debit card conversion and the increase in new deposits and loans.  State taxes are based on the Bank’s equity, and the $13,000 increase is due to increased net worth of the Bank as well as a higher rate in effect for 2017.  FDIC insurance premiums decreased $29,000, or 17.1%, due to the change in the FDIC insurance premium calculation, implemented starting in late 2016.

INCOME TAXES

QNB utilizes an asset and liability approach for financial accounting and reporting of income taxes. As of March 31, 2017, QNB’s net deferred tax asset was $5,368,000. The primary components of deferred taxes are deferred tax assets of $2,625,000 relating to the allowance for loan losses, $1,766,000 related to unrealized losses on available for sale securities, $455,000 related to non-accrual interest income, $222,000 related to deferred fees and rent, $41,000 generated by OTTI charges on equity securities and $392,000 related to OTTI charges on trust preferred securities. As of December 31, 2016, QNB’s net deferred tax asset was $5,473,000. The primary difference in the balance of net deferred tax assets when comparing March 31, 2017 to December 31, 2016 is the decrease in deferred tax asset due to decreased unrealized losses on available for sale securities.

51


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

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. 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.

Applicable income tax expense was $1,122,000 for the quarter ended March 31, 2017 compared to $788,000 for the same period in 2016. The effective tax rate for first quarter of 2017 was 28.2% compared with 25.8% for the first quarter of 2016. This increase in effective tax rate in 2017 is due to the decreased proportion of tax-free income to total income, primarily municipal securities and municipal loan interest income.

FINANCIAL CONDITION ANALYSIS

Financial service organizations are challenged to demonstrate they can generate sustainable and consistent earnings growth in a dynamic operating environment.  Rate competition for quality loans is anticipated to continue through 2017. It is also anticipated that the rate competition for attracting and retaining deposits may increase in 2017 and into 2018 as short-term interest rates increase, which could result in a lower net interest margin and a decline in net interest income.

QNB’s primary business is accepting deposits and making loans to meet the credit needs of the communities it serves. Loans are the most significant component of earning assets and growth in loans to small businesses and residents of these communities has been a primary focus of QNB. Inherent within the lending function is the evaluation and acceptance of credit risk and interest rate risk. QNB manages credit risk associated with its lending activities through portfolio diversification, underwriting policies and procedures and loan monitoring practices. QNB is committed to make credit available to its customers.

Total assets at March 31, 2017 were $1,089,007,000 compared with $1,063,141,000 at December 31, 2016.  Cash and cash equivalents increased $9,821,000 from $10,721,000 at December 31, 2016 to $20,542,000 at March 31, 2017, due primarily to growth in deposit balances and paydowns of amortizing mortgage-backed securities during the quarter.

The composition of the investment portfolio is essentially unchanged since December 31, 2016.  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 to take advantage of changes in the shape of the yield curve and changes in spread relationships in different sectors and for liquidity purposes. Management continually reviews strategies that will result in an increase in the yield or improvement in the structure of the investment portfolio, including monitoring credit and concentration risk in the portfolio.

QNB owns CDOs in the form of pooled trust preferred securities. These securities are comprised mainly of securities issued by banks or bank holding companies, and to a lesser degree, insurance companies. QNB owns the mezzanine tranches of these securities, with except for PreTSL IV, that now represents the senior-most obligation of the trust. These securities are structured so that the senior and mezzanine tranches are protected from defaults by over-collateralization and cash flow default protection provided by subordinated tranches.   The company received principal and interest payments totaling $35,000 during the first quarter of 2017.   The payments were recorded as a reduction to the amortized cost for four of these securities.  For PreTSL IV, $2,000 was recorded to interest income on a cash basis.  There was no credit-related other-than-temporary impairment charge during the quarter ended March 31, 2017 or 2016. It is possible that future calculations could require recording additional other-than-temporary impairment charges through earnings. For additional detail on these securities see Note 6 Investment Securities and Note 8 Fair Value Measurements and Disclosures.

Loans receivable grew $25,960,000, or 4.1%, with commercial loans increasing $24,217,000, or 4.8% to $532,977,000 at March 31, 2017, compared with $508,760,000 at year-end 2016.  Retail loan balances grew $1,743,000, or 1.4% to $126,062,000, when comparing March 31, 2017 to December 31, 2016.  QNB has experienced growth in part due to market disruption created by bank mergers in its footprint throughout 2016.

Deposit growth was led by savings balances, which increased $14,224,000, or 6.0%, to $252,471,000 from December 31, 2016 to March 31, 2017. Interest-bearing demand balances, excluding municipal deposits, grew $11,258,000, or 6.9%, to $174,245,000, with Rewards checking providing $6,275,000 of the growth.  Money market balances grew $5,337,000, or 7.1%, to $80,099,000 and non-interest bearing demand balances increased $2,768,000 to $121,778,000 at March 31, 2017, due primarily to business deposits.  Municipal deposit balances decreased $4,936,000, or 5.3%, to $87,831,000.  Municipal deposits can be volatile depending on the timing of deposits and withdrawals, and the cash flow needs of the school districts or municipalities. Time deposits increased

52


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

$885,000 from December 31, 2016 to March 31, 2017. It is anticipated that total deposits will decrease during the second quarter as tax money received from the local school districts during September flows out for the subsequent twelve months as the schools use the funds for operations. These deposits provide incremental income as they are invested in short-term investment securities but will further reduce the net interest margin as the spread earned is significantly less than the current net interest margin.

Short-term borrowings decreased 14.0%, from $52,660,000 at December 31, 2016 to $45,265,000 at March 31, 2017. Commercial sweep accounts decreased $1,505,000, as these funds may be volatile based on businesses’ receipt and disbursement of funds.  Overnight borrowings from FHLB decreased $5,890,000 to $1,431,000.

LIQUIDITY

Liquidity represents an institution’s ability to generate cash or otherwise obtain funds at reasonable rates to satisfy demand for loans and deposit withdrawals. QNB attempts to manage its mix of cash and interest-bearing balances, Federal funds sold and investment securities to match the volatility, seasonality, interest sensitivity and growth trends of its loans and deposits. The Company manages its liquidity risk by measuring and monitoring its liquidity sources and estimated funding needs. Liquidity is provided from asset sources through repayments and maturities of loans and investment securities. The portfolio of investment securities classified as available for sale and QNB's policy of selling certain residential mortgage originations in the secondary market also provide sources of liquidity. Core deposits and cash management repurchase agreements have historically been the most significant funding source for QNB. These deposits and repurchase agreements are generated from a base of consumers, businesses and public funds primarily located in the Company’s market area.

Additional sources of liquidity are provided by the Bank’s membership in the FHLB. At March 31, 2017, the Bank had a maximum borrowing capacity with the FHLB of approximately $254,206,000, net of the $1,431,000 in overnight borrowings at March 31, 2017. The maximum borrowing depends upon qualifying collateral assets and QNB’s asset quality and capital adequacy.  In addition, the Bank maintains unsecured Federal funds lines with three correspondent banks totaling $46,000,000. At March 31, 2017, there were no outstanding borrowings under these lines.  During the first quarter of 2017, QNB borrowed from the FHLB to fund short-term liquidity needs. Future availability under these lines is subject to the policies of the granting banks and may be withdrawn.

Liquid sources of funds, including cash, trading and available-for-sale investment securities and loans held-for-sale have increased $518,000 since December 31, 2016, totaling $406,099,000 at March 31, 2017. Growth in deposits since year-end 2016 has been used to fund loans. Management expects these liquid sources will be adequate to meet normal fluctuations in loan demand or deposit withdrawals. The investment portfolio is expected to continue to provide sufficient liquidity, even in a rising rate environment, as municipal bonds are called and cash flow on mortgage-backed and CMO securities continues to be steady. As interest rates rise, the cash flow available from the investment portfolio may decrease.

Approximately $167,022,000 and $166,628,000 of available-for-sale securities at March 31, 2017 and December 31, 2016, respectively, were pledged as collateral for repurchase agreements and deposits of public funds. The level of pledged securities corresponds with the municipal deposit and repurchase agreement balances.

QNB is a member of the Certificate of Deposit Account Registry Services (CDARS) program offered by the Promontory Interfinancial Network, LLC. CDARS is a funding and liquidity management tool used by banks to access funds and manage their balance sheet. It enables financial institutions to provide customers with full FDIC insurance on time deposits over $250,000 that are placed in the program. QNB also has available Insured Cash Sweep (ICS), another program through Promontory Interfinancial Network, LLC, which is a product similar to CDARS, but one that provides liquidity like a money market or savings account.

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 March 31, 2017 was $96,043,000, or 8.82% of total assets, compared with shareholders' equity of $93,567,000, or 8.80% of total assets, at December 31, 2016. Shareholders’ equity at March 31, 2017 and December 31, 2016 included a negative adjustment of $3,428,000 and $3,757,000, respectively, related to unrealized holding losses, net of taxes, on investment securities available-for-sale. Without these adjustments, shareholders' equity to total assets would have been 9.11% and 9.12% at March 31, 2017 and December 31, 2016, respectively.

53


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

Average shareholders' equity and average total assets were $98,629,000 and $1,075,904,000 for the quarter ended March 31, 2017, an increase of 4.4% and 4.3%, respectively, from the averages for the year ended December 31, 2016. The ratio of average total equity to average total assets was 9.17% for the quarter ended March 31, 2017 compared to 9.16% for all 2016

Retained earnings at March 31, 2017 were impacted by three months of net income totaling $2,860,000 partially offset by dividends declared and paid of $1,059,000 for the same period.  QNB offers a Dividend Reinvestment and Stock Purchase Plan (the “Plan”) to provide participants a convenient and economical method for investing cash dividends paid on the Company’s common stock in additional shares at a discount. The Plan also allows participants to make additional cash purchases of stock at a discount. Stock purchases under the Plan contributed $242,000 and $246,000 to capital during the quarters ended March 31, 2017 and 2016, respectively.

The Board of Directors has authorized the repurchase of up to 100,000 shares of its common stock in open market or privately negotiated transactions. The repurchase authorization does not bear a termination date. As of March 31, 2017, 57,883 shares were repurchased under this authorization at an average price of $16.97 and a total cost of $982,000.  There have been no additional shares repurchased under the plan since the first quarter of 2009.

QNB and the Bank are subject to various regulatory capital requirements as issued by Federal regulatory authorities. Regulatory capital is defined in terms of Tier 1 capital and Tier 2. 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. The final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (“Basel III”) became effective for QNB on January 1, 2015, with full compliance with all the of final rule’s requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019.

Under the final rules, minimum requirements increased for both the quantity and quality of capital. The rules included a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, required a minimum ratio of Total Capital to risk-weighted assets of 8.0%, and required a minimum Tier 1 leverage ratio of 4.0%.  A new capital conservation buffer, comprised of common equity Tier 1 capital, is also established above the regulatory minimum capital requirements. This capital conservation buffer was phased in beginning January 1, 2016, at 0.625% of risk-weighted assets and will increase each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019.  Strict eligibility criteria for regulatory capital instruments were also implemented.  The final rules also revised the definition and calculation of Tier 1 capital, Total Capital, and risk-weighted assets. QNB continues to monitor the effect of these new rules on the business, operations and capital levels of the Company and the Bank.

The following table sets forth consolidated information for QNB Corp.

 

 

 

March 31,

 

 

December 31,

 

Capital Analysis

 

2017

 

 

2016

 

Regulatory Capital

 

 

 

 

 

 

 

 

Shareholders' equity

 

$

96,043

 

 

$

93,567

 

Net unrealized securities losses, net of tax

 

 

3,428

 

 

 

3,757

 

Net unrealized losses on available-for-sale equity securities,

   net of tax

 

 

(6

)

 

 

 

Disallowed intangible assets

 

 

(6

)

 

 

(4

)

Common equity tier I capital

 

 

99,459

 

 

 

97,320

 

 

 

 

 

 

 

 

 

 

Tier I capital

 

 

99,459

 

 

 

97,320

 

Allowable portion: Allowance for loan losses and reserve

   for unfunded commitments

 

 

7,778

 

 

 

7,453

 

Unrealized gains on equity securities, net of tax

 

 

 

 

 

47

 

Total regulatory capital

 

$

107,237

 

 

$

104,820

 

Risk-weighted assets

 

$

839,933

 

 

$

822,210

 

Quarterly average assets for leverage capital purposes

 

$

1,075,898

 

 

$

1,061,976

 

 

54


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

 

 

March 31,

 

 

December 31,

 

Capital Ratios

 

2017

 

 

2016

 

Common equity tier I capital / risk-weighted assets

 

 

11.84

%

 

 

11.84

%

Tier I capital / risk-weighted assets

 

 

11.84

%

 

 

11.84

%

Total regulatory capital / risk-weighted assets

 

 

12.77

%

 

 

12.75

%

Tier I capital / average assets (leverage ratio)

 

 

9.24

%

 

 

9.16

%

 

At March 31, 2017, common equity tier I and tier I capital ratios remain unchanged from December 31, 2016, while total regulatory capital and leverage ratios improved slightly. The Company remains well-capitalized by all applicable regulatory requirements as of March 31, 2017.

MARKET RISK MANAGEMENT

Market risk reflects the risk of economic loss resulting from changes in interest rates and market prices.  QNB’s primary market risk exposure is interest rate risk and liquidity risk.  QNB’s liquidity position was discussed in a prior section.

QNB’s largest source of revenue is net interest income, which is subject to changes in market interest rates.  Interest rate risk 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. QNB’s Asset/Liability and Investment Management Committee (ALCO) is responsible for managing interest rate risk and for evaluating the impact of changing interest rate conditions on net interest income.

QNB uses computer simulation analysis to measure the sensitivity of projected earnings to changes in interest rates.  Simulation considers current balance sheet volumes and the scheduled repricing dates, instrument level optionality, and maturities of assets and liabilities.  It incorporates assumptions for growth, changes in the mix of assets and liabilities, prepayments, and average rates earned and paid.  Based on this information, management uses the model to project net interest income under multiple interest rate scenarios.

A balance sheet is considered liability sensitive when its liabilities (deposits and borrowings) reprice faster or than its earning assets (loans and securities). A liability sensitive balance sheet will produce relatively less net interest income when interest rates rise and more net interest income when they decline. Based on our simulation analysis, management believes QNB’s interest sensitivity position at March 31, 2017 is liability sensitive. Management expects that market interest rates may gradually increase in the next 12 months, based on the economic environment and policy of the Board of Governors of the Federal Reserve System.

The following table shows the estimated impact of changes in interest rates on net interest income as of March 31, 2017 and 2016 assuming instantaneous rate shocks, and consistent levels of assets and liabilities.  Net interest income for the subsequent twelve months is projected to decrease when interest rates are higher than current rates.

 

Estimated Change in Net Interest Income

 

Changes in Interest rates

 

March 31,

 

(in basis points)

 

2017

 

 

2016

 

+300

 

 

-8.24

%

 

 

-5.18

%

+200

 

 

-5.49

%

 

 

-3.36

%

+100

 

 

-2.65

%

 

 

-1.55

%

-100

 

*N/A

 

 

*N/A

 

 

* Certain short-term interest rates are below 1%

Computations of future effects of hypothetical interest rate changes are based on numerous assumptions and should not be relied upon as indicative of actual results. Assets and liabilities may react differently than projected to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while rates on other types of assets and liabilities may lag changes in market interest rates.  Interest rate shifts may not be parallel.

Changes in interest rates can cause substantial changes in the amount of prepayments of loans and mortgage-backed securities, which may in turn affect QNB’s interest rate sensitivity position. Additionally, credit risk may rise if an interest rate increase adversely affects the ability of borrowers to service their debt.

55


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

QNB is not subject to foreign currency exchange or commodity price risk. At March 31, 2017 QNB did not have any hedging transactions in place such as interest rate swaps, caps or floors.

 

 

 

56


 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.

The information required in response to this item is set forth in Item 2, above.

ITEM 4. CONTROLS AND PROCEDURES

We maintain a system of controls and procedures designed to provide reasonable assurance as to the reliability of the consolidated financial statements and other disclosures included in this report, as well as to safeguard assets from unauthorized use or disposition. We evaluated the effectiveness of the design and operation of our disclosure controls and procedures under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of the end of the period covered by this report. No changes were made to our internal control over financial reporting during the fiscal quarter covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

57


 

QNB CORP. AND SUBSIDIARY

PART II. OTHER INFORMATION

MARCH 31, 2017

Item 1. Legal Proceedings

No material proceedings.

Item 1A. Risk Factors

There were no material changes to the Risk Factors described in Item 1A in QNB’s Annual Report on Form 10-K for the period ended December 31, 2016.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

QNB did not repurchase any shares of its common stock during the quarter ended March 31, 2017. The following provides certain information relating to QNB's stock repurchase plan.

 

Period

 

Total Number of

Shares Purchased

 

 

Average Price

Paid per Share

 

 

Total Number of

Shares

Purchased as

Part of Publicly

Announced

Plan

 

 

Maximum

Number of

Shares that

may yet be

Purchased

Under the Plan

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

January 1, 2017 through January 31, 2017

 

 

 

 

 

 

 

 

 

 

 

42,117

 

February 1, 2017 through February 28, 2017

 

 

 

 

 

 

 

 

 

 

 

42,117

 

March 1, 2017 through March 31, 2017

 

 

 

 

 

 

 

 

 

 

 

42,117

 

Total

 

 

 

 

 

 

 

 

 

 

 

42,117

 

 

(1)

Transactions are reported as of settlement dates.

(2)

QNB’s current stock repurchase plan was approved by its Board of Directors and announced on January 24, 2008 and subsequently increased on February 9, 2009.

(3)

The total number of shares approved for repurchase under QNB’s current stock repurchase plan is 100,000.

(4)

QNB’s current stock repurchase plan has no expiration date.

(5)

QNB has no stock repurchase plan that it has determined to terminate or under which it does not intend to make further purchases.

Item 3. Default Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

 

 

58


 

Item 6. Exhibits

 

 

Exhibit 3.1

Articles of Incorporation of Registrant, as amended. (Incorporated by reference to Exhibit 3(i) of Registrant’s Annual Report on Form 10-K, SEC File No. 0-17706, filed with the Commission on March 13, 2015).

 

 

 

 

Exhibit 3.2

Bylaws of Registrant, as amended. (Incorporated by reference to Exhibit 3(ii) of Registrant’s Annual Report on Form 10-K, SEC File No. 0-17706, filed with the Commission on March 13, 2015).

 

 

 

 

Exhibit 31.1

Section 302 Certification of Chief Executive Officer

 

 

 

 

Exhibit 31.2

Section 302 Certification of Chief Financial Officer

 

 

 

 

Exhibit 32.1

Section 906 Certification of Chief Executive Officer

 

 

 

 

Exhibit 32.2

Section 906 Certification of Chief Financial Officer

 

 

 

 

 

 

 

The following Exhibits are being furnished* as part of this report:

 

No.

 

Description

101.INS

 

XBRL Instance Document.*

101.SCH

 

XBRL Taxonomy Extension Schema Document.*

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document.*

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document.*

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document.*

101.DEF

 

XBRL Taxonomy Extension Definitions Linkbase Document.*

 

 

 

 

 

*

These interactive data files are being furnished as part of this Quarterly Report, and, in accordance with Rule 402 of Regulation S-T, shall not be deemed filed for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability under those sections.

 

 

59


 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

QNB Corp.

 

 

 

 

Date:         May 8, 2017          

By:

 

/s/ David W. Freeman

 

 

 

David W. Freeman

 

 

 

Chief Executive Officer

 

 

 

 

Date:         May 8, 2017          

By:

 

/s/ Janice McCracken Erkes

 

 

 

Janice McCracken Erkes

 

 

 

Chief Financial Officer

 

 

 

 

Date:         May 8, 2017          

By:

 

/s/ Phillip N. Geiger

 

 

 

Phillip N. Geiger

 

 

 

Chief Accounting Officer, QNB Bank