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QNB CORP - Quarter Report: 2018 June (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             June 30, 2018            

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, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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 August 2, 2018

Common Stock, par value $0.625

 

3,466,504

 

 

 

 


 

QNB CORP. AND SUBSIDIARY

FORM 10-Q

QUARTER ENDED JUNE 30, 2018

INDEX

 

 

 

PART I - FINANCIAL INFORMATION

 

 

 

 

 

 

 

ITEM 1.

 

CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

PAGE

 

 

 

 

 

 

 

Consolidated Balance Sheets at June 30, 2018 and December 31, 2017

 

3

 

 

 

 

 

 

 

Consolidated Statements of Income for the Three and Six Months Ended June 30, 2018 and 2017

 

4

 

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2018 and 2017

 

5

 

 

 

 

 

 

 

Consolidated Statement of Shareholders’ Equity for the Six Months Ended June 30, 2018 and 2017

 

6

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017

 

7

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements

 

8

 

 

 

 

 

ITEM 2.

 

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

 

39

 

 

 

 

 

ITEM 3.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

58

 

 

 

 

 

ITEM 4.

 

CONTROLS AND PROCEDURES

 

58

 

 

 

 

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

 

 

 

ITEM 1.

 

LEGAL PROCEEDINGS

 

59

 

 

 

 

 

ITEM 1A.

 

RISK FACTORS

 

59

 

 

 

 

 

ITEM 2.

 

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

59

 

 

 

 

 

ITEM 3.

 

DEFAULTS UPON SENIOR SECURITIES

 

59

 

 

 

 

 

ITEM 4.

 

MINE SAFETY DISCLOSURES

 

59

 

 

 

 

 

ITEM 5.

 

OTHER INFORMATION

 

59

 

 

 

 

 

ITEM 6.

 

EXHIBITS

 

60

 

 

 

 

 

SIGNATURES

 

 

 

 

 

 

 

CERTIFICATIONS

 

 

 

 

 

2


 

QNB Corp. and Subsidiary

 

CONSOLIDATED BALANCE SHEETS

 

 

 

(in thousands, except share data)

 

 

 

(current period unaudited)

 

 

 

June 30,

2018

 

 

December 31,

2017

 

Assets

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

10,787

 

 

$

10,793

 

Interest-bearing deposits in banks

 

 

939

 

 

 

5,538

 

Total cash and cash equivalents

 

 

11,726

 

 

 

16,331

 

 

 

 

 

 

 

 

 

 

Investment debt securities

 

 

 

 

 

 

 

 

Available-for-sale (amortized cost $356,329 and $380,440)

 

 

344,194

 

 

 

374,570

 

Investment equity securities (cost of $10,127 and $5,296)

 

 

9,600

 

 

 

4,975

 

Restricted investment in stocks

 

 

2,668

 

 

 

1,501

 

Loans held-for-sale

 

 

404

 

 

 

 

Loans receivable

 

 

779,886

 

 

 

733,283

 

Allowance for loan losses

 

 

(8,192

)

 

 

(7,841

)

Net loans

 

 

771,694

 

 

 

725,442

 

Bank-owned life insurance

 

 

11,032

 

 

 

10,894

 

Premises and equipment, net

 

 

9,648

 

 

 

8,495

 

Accrued interest receivable

 

 

3,573

 

 

 

3,545

 

Net deferred tax assets

 

 

4,523

 

 

 

3,319

 

Other assets

 

 

3,812

 

 

 

3,265

 

Total assets

 

$

1,172,874

 

 

$

1,152,337

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

 

Demand, non-interest bearing

 

$

135,482

 

 

$

129,212

 

Interest-bearing demand

 

 

286,248

 

 

 

297,470

 

Money market

 

 

80,053

 

 

 

84,562

 

Savings

 

 

261,224

 

 

 

257,522

 

Time

 

 

120,303

 

 

 

124,485

 

Time of $100 or more

 

 

102,416

 

 

 

100,697

 

Total deposits

 

 

985,726

 

 

 

993,948

 

Short-term borrowings

 

 

85,646

 

 

 

55,756

 

Accrued interest payable

 

 

371

 

 

 

384

 

Other liabilities

 

 

3,313

 

 

 

3,679

 

Total liabilities

 

 

1,075,056

 

 

 

1,053,767

 

 

 

 

 

 

 

 

 

 

Shareholders' Equity

 

 

 

 

 

 

 

 

Common stock, par value $0.625 per share;

 

 

 

 

 

 

 

 

authorized 10,000,000 shares; 3,630,037 shares and 3,612,677

 

 

 

 

 

 

 

 

shares issued; 3,465,468 and 3,448,108 shares outstanding

 

 

2,269

 

 

 

2,258

 

Surplus

 

 

19,293

 

 

 

18,691

 

Retained earnings

 

 

88,319

 

 

 

84,183

 

Accumulated other comprehensive loss, net of tax

 

 

(9,587

)

 

 

(4,086

)

Treasury stock, at cost; 164,569 shares

 

 

(2,476

)

 

 

(2,476

)

Total shareholders' equity

 

 

97,818

 

 

 

98,570

 

Total liabilities and shareholders' equity

 

$

1,172,874

 

 

$

1,152,337

 

 

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)

 

Three months

ended June 30,

 

 

 

Six months

ended June 30,

 

(unaudited)

 

2018

 

 

2017

 

 

 

2018

 

 

2017

 

Interest income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

8,512

 

 

$

7,115

 

 

 

$

16,939

 

 

$

14,187

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

 

1,551

 

 

 

1,551

 

 

 

 

3,128

 

 

 

3,114

 

Tax-exempt

 

 

461

 

 

 

484

 

 

 

 

944

 

 

 

949

 

Interest on trading securities

 

 

 

 

 

16

 

 

 

 

 

 

 

45

 

Interest on interest-bearing balances and other interest income

 

 

38

 

 

 

26

 

 

 

 

60

 

 

 

33

 

Total interest income

 

 

10,562

 

 

 

9,192

 

 

 

 

21,071

 

 

 

18,328

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest on deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand

 

 

436

 

 

 

228

 

 

 

 

810

 

 

 

402

 

Money market

 

 

62

 

 

 

76

 

 

 

 

120

 

 

 

128

 

Savings

 

 

369

 

 

 

278

 

 

 

 

699

 

 

 

537

 

Time

 

 

379

 

 

 

372

 

 

 

 

757

 

 

 

740

 

Time of $100,000 or more

 

 

415

 

 

 

328

 

 

 

 

814

 

 

 

651

 

Interest on short-term borrowings

 

 

201

 

 

 

52

 

 

 

 

380

 

 

 

132

 

Total interest expense

 

 

1,862

 

 

 

1,334

 

 

 

 

3,580

 

 

 

2,590

 

Net interest income

 

 

8,700

 

 

 

7,858

 

 

 

 

17,491

 

 

 

15,738

 

Provision for loan losses

 

 

187

 

 

 

300

 

 

 

 

375

 

 

 

600

 

Net interest income after provision for loan losses

 

 

8,513

 

 

 

7,558

 

 

 

 

17,116

 

 

 

15,138

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-interest income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net gain on sales of  investment debt and equity securities

 

 

48

 

 

 

115

 

 

 

 

133

 

 

 

864

 

Unrealized gain (loss) on investment equity securities

 

 

41

 

 

 

 

 

 

 

(205

)

 

 

 

Net gain on trading activities

 

 

 

 

 

10

 

 

 

 

 

 

 

27

 

Fees for services to customers

 

 

408

 

 

 

421

 

 

 

 

829

 

 

 

813

 

ATM and debit card

 

 

487

 

 

 

449

 

 

 

 

917

 

 

 

866

 

Retail brokerage and advisory

 

 

105

 

 

 

104

 

 

 

 

208

 

 

 

207

 

Bank-owned life insurance

 

 

69

 

 

 

120

 

 

 

 

137

 

 

 

191

 

Merchant

 

 

82

 

 

 

92

 

 

 

 

156

 

 

 

172

 

Net gain on sale of loans

 

 

37

 

 

 

201

 

 

 

 

44

 

 

 

251

 

Other

 

 

177

 

 

 

103

 

 

 

 

302

 

 

 

214

 

Total non-interest income

 

 

1,454

 

 

 

1,615

 

 

 

 

2,521

 

 

 

3,605

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-interest expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

 

3,627

 

 

 

3,237

 

 

 

 

6,972

 

 

 

6,323

 

Net occupancy

 

 

448

 

 

 

425

 

 

 

 

919

 

 

 

876

 

Furniture and equipment

 

 

563

 

 

 

456

 

 

 

 

1,050

 

 

 

885

 

Marketing

 

 

221

 

 

 

307

 

 

 

 

531

 

 

 

536

 

Third party services

 

 

506

 

 

 

407

 

 

 

 

916

 

 

 

801

 

Telephone, postage and supplies

 

 

173

 

 

 

199

 

 

 

 

354

 

 

 

399

 

State taxes

 

 

164

 

 

 

155

 

 

 

 

335

 

 

 

348

 

FDIC insurance premiums

 

 

146

 

 

 

134

 

 

 

 

321

 

 

 

275

 

Other

 

 

685

 

 

 

622

 

 

 

 

1,313

 

 

 

1,087

 

Total non-interest expense

 

 

6,533

 

 

 

5,942

 

 

 

 

12,711

 

 

 

11,530

 

Income before income taxes

 

 

3,434

 

 

 

3,231

 

 

 

 

6,926

 

 

 

7,213

 

Provision for income taxes

 

 

572

 

 

 

845

 

 

 

 

1,129

 

 

 

1,967

 

Net income

 

$

2,862

 

 

$

2,386

 

 

 

$

5,797

 

 

$

5,246

 

Earnings per share - basic

 

$

0.83

 

 

$

0.70

 

 

 

$

1.68

 

 

$

1.53

 

Earnings per share - diluted

 

$

0.82

 

 

$

0.69

 

 

 

$

1.67

 

 

$

1.53

 

Cash dividends per share

 

$

0.32

 

 

$

0.31

 

 

 

$

0.64

 

 

$

0.62

 

 

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

 

4


 

QNB Corp. and Subsidiary

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

 

 

 

(in thousands - unaudited)

 

 

 

2018

 

 

2017

 

Three months ended June 30,

 

Before

tax

amount

 

 

Tax

expense

(benefit)

 

 

Net of

tax

amount

 

 

Before

tax

amount

 

 

Tax

expense

(benefit)

 

 

Net of

tax

amount

 

Net income

 

$

3,434

 

 

$

572

 

 

$

2,862

 

 

$

3,231

 

 

$

845

 

 

$

2,386

 

Other comprehensive (loss) income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net unrealized holding (losses) gains on securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized holding (losses) gains arising during the period

 

 

(1,217

)

 

 

(255

)

 

 

(962

)

 

 

1,682

 

 

 

572

 

 

 

1,110

 

Reclassification adjustment for gains included in net income

 

 

(2

)

 

 

(1

)

 

 

(1

)

 

 

(115

)

 

 

(40

)

 

 

(75

)

Other comprehensive (loss) income

 

 

(1,219

)

 

 

(256

)

 

 

(963

)

 

 

1,567

 

 

 

532

 

 

 

1,035

 

Total comprehensive income

 

$

2,215

 

 

$

316

 

 

$

1,899

 

 

$

4,798

 

 

$

1,377

 

 

$

3,421

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended June 30,

 

2018

 

 

2017

 

 

 

Before

tax

amount

 

 

Tax

expense

(benefit)

 

 

Net of

tax

amount

 

 

Before

tax

amount

 

 

Tax

expense

(benefit)

 

 

Net of

tax

amount

 

Net income

 

$

6,926

 

 

$

1,129

 

 

$

5,797

 

 

$

7,213

 

 

$

1,967

 

 

$

5,246

 

Other comprehensive (loss) income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net unrealized holding (losses) gains on securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized holding (losses) gains arising during the period

 

 

(6,263

)

 

 

(1,315

)

 

 

(4,948

)

 

 

2,931

 

 

 

997

 

 

 

1,934

 

Reclassification adjustment for gains included in net income

 

 

(3

)

 

 

(1

)

 

 

(2

)

 

 

(864

)

 

 

(294

)

 

 

(570

)

Other comprehensive income

 

 

(6,266

)

 

 

(1,316

)

 

 

(4,950

)

 

 

2,067

 

 

 

703

 

 

 

1,364

 

Total comprehensive (loss) income

 

$

660

 

 

$

(187

)

 

$

847

 

 

$

9,280

 

 

$

2,670

 

 

$

6,610

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tax rate of 21% for 2018 and 34% for 2017

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

 

5


 

QNB Corp. and Subsidiary

 

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

Six months ended June 30, 2018 and 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Number of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

(unaudited)

 

Shares

 

 

Common

 

 

 

 

 

 

Retained

 

 

Comprehensive

 

 

Treasury

 

 

 

 

 

(in thousands, except share and per share data)

 

Outstanding

 

 

Stock

 

 

Surplus

 

 

Earnings

 

 

Loss

 

 

Stock

 

 

Total

 

Balance, December 31, 2017

 

 

3,448,108

 

 

$

2,258

 

 

$

18,691

 

 

$

84,183

 

 

$

(4,086

)

 

$

(2,476

)

 

$

98,570

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

5,797

 

 

 

 

 

 

 

 

 

5,797

 

Other comprehensive loss, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(4,950

)

 

 

 

 

 

(4,950

)

Cash dividends declared ($0.64 per share)

 

 

 

 

 

 

 

 

 

 

 

 

(2,212

)

 

 

 

 

 

 

 

 

(2,212

)

Equity securities fair value reclassification (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(254

)

 

 

254

 

 

 

 

 

 

 

 

ASU 2018-02 stranded tax reclassification (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

805

 

 

 

(805

)

 

 

 

 

 

 

 

Stock issued in connection with dividend

   reinvestment and stock purchase plan

 

 

9,934

 

 

 

6

 

 

 

423

 

 

 

 

 

 

 

 

 

 

 

 

429

 

Stock issued for employee stock purchase

   plan

 

 

1,426

 

 

 

1

 

 

 

56

 

 

 

 

 

 

 

 

 

 

 

 

57

 

Stock issued for options exercised

 

 

6,000

 

 

 

4

 

 

 

65

 

 

 

 

 

 

 

 

 

 

 

 

69

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

 

58

 

 

 

 

 

 

 

 

 

 

 

 

58

 

Balance, June 30, 2018

 

 

3,465,468

 

 

$

2,269

 

 

$

19,293

 

 

$

88,319

 

 

$

(9,587

)

 

$

(2,476

)

 

$

97,818

 

(1) Refer to Note 2, ASU 2016-01

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2) Refer to Note 2, ASU 2018-02

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Number of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

(unaudited)

 

Shares

 

 

Common

 

 

 

 

 

 

Retained

 

 

Comprehensive

 

 

Treasury

 

 

 

 

 

(in thousands, except share and per share data)

 

Outstanding

 

 

Stock

 

 

Surplus

 

 

Earnings

 

 

Loss

 

 

Stock

 

 

Total

 

Balance, December 31, 2016

 

 

3,411,701

 

 

$

2,235

 

 

$

17,418

 

 

$

80,147

 

 

$

(3,757

)

 

$

(2,476

)

 

$

93,567

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

5,246

 

 

 

 

 

 

 

 

 

5,246

 

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,364

 

 

 

 

 

 

1,364

 

Cash dividends declared ($0.62 per share)

 

 

 

 

 

 

 

 

 

 

 

 

(2,122

)

 

 

 

 

 

 

 

 

(2,122

)

Stock issued in connection with dividend

   reinvestment and stock purchase plan

 

 

13,579

 

 

 

9

 

 

 

503

 

 

 

 

 

 

 

 

 

 

 

 

512

 

Stock issued for employee stock purchase

   plan

 

 

1,318

 

 

 

1

 

 

 

41

 

 

 

 

 

 

 

 

 

 

 

 

42

 

Stock issued for options exercised

 

 

6,642

 

 

 

4

 

 

 

86

 

 

 

 

 

 

 

 

 

 

 

 

90

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

 

51

 

 

 

 

 

 

 

 

 

 

 

 

51

 

Balance, June 30, 2017

 

 

3,433,240

 

 

$

2,249

 

 

$

18,099

 

 

$

83,271

 

 

$

(2,393

)

 

$

(2,476

)

 

$

98,750

 

 

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)

 

Six months ended June 30,

 

2018

 

 

2017

 

Operating Activities

 

 

 

 

 

 

 

 

Net income

 

$

5,797

 

 

$

5,246

 

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

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

436

 

 

 

403

 

Provision for loan losses

 

 

375

 

 

 

600

 

Net gain on sales of debt and equity securities

 

 

(133

)

 

 

(864

)

Net unrealized loss on equity securities

 

 

205

 

 

 

 

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

 

 

(1

)

 

 

(1

)

Net gain on sale of loan held for investment

 

 

 

 

 

(99

)

Net gain on sale of loans

 

 

(44

)

 

 

(152

)

Proceeds from sales of residential mortgages held-for-sale

 

 

1,949

 

 

 

4,675

 

Origination of residential mortgages held-for-sale

 

 

(2,309

)

 

 

(4,264

)

Income on bank-owned life insurance

 

 

(137

)

 

 

(191

)

Stock-based compensation expense

 

 

58

 

 

 

51

 

Net decrease in trading securities

 

 

 

 

 

3,596

 

Deferred income tax provision

 

 

110

 

 

 

130

 

Net increase in income taxes payable

 

 

(294

)

 

 

(601

)

Net (increase) decrease in accrued interest receivable

 

 

(28

)

 

 

622

 

Amortization of mortgage servicing rights and change in valuation allowance

 

 

31

 

 

 

47

 

Net amortization of premiums and discounts on investment securities

 

 

740

 

 

 

839

 

Net decrease in accrued interest payable

 

 

(13

)

 

 

(37

)

Increase in other assets

 

 

(388

)

 

 

(1,203

)

(Decrease) increase in other liabilities

 

 

(260

)

 

 

36

 

Net cash provided by operating activities

 

 

6,094

 

 

 

8,833

 

Investing Activities

 

 

 

 

 

 

 

 

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

 

 

22,380

 

 

 

27,255

 

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

 

 

4,159

 

 

 

19,358

 

Proceeds from the sale of equity securities

 

 

1,390

 

 

 

5,262

 

Purchases of debt securities available-for-sale

 

 

(3,166

)

 

 

(40,602

)

Purchases of equity securities

 

 

(6,090

)

 

 

(3,868

)

Proceeds from redemption of investment in restricted bank stock

 

 

4,505

 

 

 

2,977

 

Purchase of restricted stock

 

 

(5,672

)

 

 

(3,934

)

Proceeds from sale of loan held for investment

 

 

 

 

 

99

 

Net increase in loans

 

 

(46,627

)

 

 

(62,093

)

Net purchases of premises and equipment

 

 

(1,590

)

 

 

(241

)

Redemption of bank-owned life insurance

 

 

 

 

 

752

 

Proceeds from sales of other real estate owned and repossessed assets

 

 

1

 

 

 

1

 

Net cash used in investing activities

 

 

(30,710

)

 

 

(55,034

)

Financing Activities

 

 

 

 

 

 

 

 

Net increase in non-interest bearing deposits

 

 

6,270

 

 

 

1,359

 

Net (decrease) increase in interest-bearing deposits

 

 

(14,492

)

 

 

36,600

 

Net increase in short-term borrowings

 

 

29,890

 

 

 

14,247

 

Cash dividends paid, net of reinvestment

 

 

(1,927

)

 

 

(1,858

)

Proceeds from issuance of common stock

 

 

270

 

 

 

380

 

Net cash provided by financing activities

 

 

20,011

 

 

 

50,728

 

(Decrease) increase in cash and cash equivalents

 

 

(4,605

)

 

 

4,527

 

Cash and cash equivalents at beginning of year

 

 

16,331

 

 

 

10,721

 

Cash and cash equivalents at end of period

 

$

11,726

 

 

$

15,248

 

Supplemental Cash Flow Disclosures

 

 

 

 

 

 

 

 

Interest paid

 

$

3,593

 

 

$

2,627

 

Income taxes paid

 

 

1,313

 

 

 

2,434

 

Non-cash transactions:

 

 

 

 

 

 

 

 

Unsettled trades to purchase securities

 

 

 

 

 

(2,598

)

 

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 2017 Annual Report incorporated in the Form 10-K. Operating results for the six-month period ended June 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.

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.

QNB has evaluated events and transactions occurring subsequent to the balance sheet date of June 30, 2018, for items that should potentially be recognized or disclosed in these consolidated financial statements.

 

2. RECENT ACCOUNTING PRONOUNCEMENTS 

QNB adopted ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, effective January 1, 2018. This ASU was issued by the Financial Accounting Standards Board (FASB) on January 5, 2016 to enhance the reporting model for financial instruments to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The FASB issued ASU 2018-03 in February 2018 which provides technical corrections and Improvements to ASU 2016-01.   QNB adopted the applicable requirements under these ASUs as follows:

 

Equity investments with readily determinable fair values are 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.  The Company chose to continue to measure equity investments without readily determinable fair value at cost adjusted for changes in observable prices minus impairment.  The Company will reassess at each reporting period whether these equity investments without readily determinable fair values qualify to be measured in accordance with the practical expedient to estimate fair value.  The Company can subsequently elect to measure these equity investments, if they qualify, at the estimated fair value under the practical expedient; but the election would be irrevocable.  Any gains or losses resulting from changes in the fair value would be recognized in net income.

 

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

 

QNB used the modified retrospective method for transition in which the cumulative effect will be recognized at the date of adoption with no restatement of comparative periods presented.  QNB reclassified a net loss of $254,000 from accumulated other comprehensive loss to retained earnings on January 1, 2018.  Based on an evaluation of our deferred tax asset and considering the effect of the new guidance, management believes that deferred tax assets related to AFS debt securities are realizable and no valuation allowance would be required.  Management believes the potential effect of using exit versus entry price is most relevant for fair value disclosures of loans, which considers the impact of credit risk on fair value.  

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (2017 Tax Reform Act) was enacted into law.  The 2017 Tax Reform Act made significant changes to U.S. corporate income tax laws including a decrease in the corporate income tax rate from 35% to 21% effective January 1, 2018.  The Company recorded less tax expense for the three and six months periods of 2018 than in the

8


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

comparable periods of 2017, with effective tax rates of 16.7% in 2018 compared to 26.2% in 2017 for the three months and 16.3% in 2018 compared to 27.3% in 2017 for the six months, primarily a result of the 2017 Tax Reform Act.  

QNB adopted ASU 2018-02, Income Statement—Reporting Comprehensive Income (Topic 202) during the first quarter of 2018.  The amendments in this ASU, issued by the FASB on February 2, 2018, affect any entity that is required to apply the provisions of Topic 220, Income Statement—Reporting Comprehensive Income, and has items of other comprehensive income for which the related tax effects are presented in other comprehensive income as required by GAAP.  The amendments in this ASU allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the 2017 Tax Reform Act and eliminates the stranded tax effects resulting from the 2017 Tax Reform Act.  The Company chose to early adopt the amendments in this update as permitted.  QNB reclassified $805,000 from accumulated other comprehensive loss to retained earnings in the consolidated statement of shareholders’ equity during the first quarter of 2018.

QNB adopted Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606) (ASC 606), effective January 1, 2018.  Under ASU 2014-09, revenue is recognized when a customer obtains control of promised services in an amount that reflects the consideration the entity expects to receive in exchange for those services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.  QNB applied the five-step method outlined in ASU 2014-09 to all revenue streams scoped-in by the ASU and elected the modified retrospective implementation method. Substantially all of QNB’s interest income and non-interest income were not impacted by the adoption of this ASU because either the revenue from those contracts with customers is covered by other guidance in U.S. GAAP or the revenue recognition outcomes were similar to our current revenue recognition practices. We reviewed non-interest sources of income and related contracts to document the impact of the new standard on our service offerings that are in the scope of the ASU including:  service charges on deposits; ATM and debit card income; retail brokerage and advisory fees; merchant income; credit card income; sale of checks to depositors; miscellaneous fees; and sale of OREOs.  Upon our analysis we concluded that the adoption of ASC 606 did not change the timing and pattern of revenue recognition related to scoped in non-interest income sources and only required additional disclosures.  In addition, we reviewed, and where necessary, enhanced our business processes, systems and controls to support recognition and disclosures under the new standard.

 

The implementation of the guidance had no material impact on the measurement or recognition of revenue of prior periods, however, additional disclosures have been added in accordance with the ASU which can be found in Note 12 – Revenue Recognition from Contracts with Customers.

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 does not expect the adoption of ASU 2016-02 to have a material impact on the consolidated 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

9


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

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 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 $36,000 and $33,000 for the three months ended June 30, 2018 and 2017, respectively. Stock-based compensation expense was $58,000 and $51,000 for the six months ended June 30, 2018 and 2017, respectively. As of June 30, 2018, there was approximately $161,000 of unrecognized compensation cost related to unvested share-based compensation award grants that is expected to be recognized over the next 32 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 June 30, 2018, there were 184,200 options granted, 65,850 options forfeited, 91,825 options exercised, and 26,525 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 73,500 options granted and outstanding under this Plan as of June 30, 2018. There were 1,100 options forfeited and no options exercised as of June 30, 2018. 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.

10


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

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

 

Six months ended June 30,

 

2018

 

 

2017

 

Risk free interest rate

 

 

2.15

%

 

 

1.48

%

Dividend yield

 

 

1.24

%

 

 

3.19

%

Volatility

 

 

18.12

%

 

 

17.89

%

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 six months of 2018 and 2017 was $5.29 and $3.88, respectively.

Stock option activity during the six months ended June 30, 2018 and 2017 is as follows:

 

 

 

Number

of options

 

 

Weighted

average

exercise

price

 

 

Weighted

average

remaining

contractual term

(in years)

 

 

Aggregate

intrinsic value

 

Outstanding at December 31, 2017

 

 

85,525

 

 

$

30.94

 

 

 

 

 

 

 

 

 

Granted

 

 

25,000

 

 

 

43.60

 

 

 

 

 

 

 

 

 

Exercised

 

 

(10,000

)

 

 

24.86

 

 

 

 

 

 

 

 

 

Forfeited

 

 

(1,600

)

 

 

32.52

 

 

 

 

 

 

 

 

 

Outstanding at June 30, 2018

 

 

98,925

 

 

$

34.73

 

 

 

2.99

 

 

$

1,180

 

Exercisable at June 30, 2018

 

 

26,525

 

 

$

27.46

 

 

 

1.14

 

 

$

509

 

 

 

 

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

 

 

(10,675

)

 

 

22.24

 

 

 

 

 

 

 

 

 

Forfeited

 

 

(100

)

 

 

21.35

 

 

 

 

 

 

 

 

 

Outstanding at June 30, 2017

 

 

88,175

 

 

$

30.71

 

 

 

3.09

 

 

$

849

 

Exercisable at June 30, 2017

 

 

21,825

 

 

$

24.33

 

 

 

1.15

 

 

$

349

 

 

11


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

4. EARNINGS PER SHARE & SHARE REPURCHASE PLAN

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

 

 

 

Three months

ended June 30,

 

 

Six months

ended June 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Numerator for basic and diluted earnings per share - net income

 

$

2,862

 

 

$

2,386

 

 

$

5,797

 

 

$

5,246

 

Denominator for basic earnings per share - weighted average shares outstanding

 

 

3,460,360

 

 

 

3,425,356

 

 

 

3,456,467

 

 

 

3,420,239

 

Effect of dilutive securities - employee stock options

 

 

20,952

 

 

 

17,852

 

 

 

20,407

 

 

 

16,027

 

Denominator for diluted earnings per share - adjusted weighted average shares outstanding

 

 

3,481,312

 

 

 

3,443,208

 

 

 

3,476,874

 

 

 

3,436,266

 

Earnings per share - basic

 

$

0.83

 

 

$

0.70

 

 

$

1.68

 

 

$

1.53

 

Earnings per share - diluted

 

 

0.82

 

 

 

0.69

 

 

 

1.67

 

 

 

1.53

 

 

There were 25,000  stock options that were anti-dilutive for both three- and six-month periods ended June 30, 2018 and 2017.     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 and six months ended June 30, 2018 and 2017. As of June 30, 2018, 57,883 shares were repurchased under this authorization at an average price of $16.97 and a total cost of $982,000.

 

 

5. COMPREHENSIVE INCOME (LOSS)

The following shows the components of accumulated other comprehensive income (loss) at June 30, 2018 and December 31, 2017:

 

 

 

June 30,

 

 

December 31,

 

 

 

2018

 

 

2017

 

Unrealized net holding losses on available-for-sale

   securities

 

$

(12,130

)

 

$

(6,165

)

Unrealized losses on available-for-sale securities

   for which a portion of an other-than-temporary

   impairment loss has been recognized in earnings

 

 

(5

)

 

 

(26

)

Accumulated other comprehensive loss

 

 

(12,135

)

 

 

(6,191

)

Tax effect

 

 

2,548

 

 

 

1,300

 

Stranded tax effect (1)

 

 

 

 

 

805

 

Accumulated other comprehensive loss, net of tax

 

$

(9,587

)

 

$

(4,086

)

(1) Refer to Note 2, ASU 2018-02

 

 

 

 

 

 

 

 

 

12


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The following tables present amounts reclassified out of accumulated other comprehensive income (loss) for the three and six months ended June 30, 2018 and 2017:

 

Three months ended June 30,

 

Amount reclassified from

accumulated other

comprehensive loss

 

 

 

Details about accumulated other comprehensive loss

 

2018

 

 

2017

 

 

Affected line item in statement of income

Unrealized net holding gains on available-for-sale

   securities

 

$

2

 

 

$

115

 

 

Net gain on sale of investment

   securities

Other-than-temporary impairment losses on

   investment securities

 

 

 

 

 

 

 

Net other-than-temporary impairment

   losses on investment securities

 

 

 

2

 

 

 

115

 

 

 

Tax effect

 

 

(1

)

 

 

(40

)

 

Provision for income taxes

Total reclass out of accumulated other

   comprehensive income, net of tax

 

$

1

 

 

$

75

 

 

Net of tax

 

 

Six months ended June 30,

 

Amount reclassified from

accumulated other

comprehensive loss

 

 

 

Details about accumulated other comprehensive loss

 

2018

 

 

2017

 

 

Affected line item in statement of income

Unrealized net holding gains on available-for-sale

   securities

 

$

3

 

 

$

864

 

 

Net gain on sale of investment

   securities

Other-than-temporary impairment losses on

     investment securities

 

 

 

 

 

 

 

Net other-than-temporary impairment

     losses on investment securities

 

 

 

3

 

 

 

864

 

 

 

Tax effect

 

 

(1

)

 

 

(294

)

 

Provision for income taxes

Total reclass out of accumulated other comprehensive

    income, net of tax

 

$

2

 

 

$

570

 

 

Net of tax

 

 

 

 

6. INVESTMENT SECURITIES

QNB engaged in trading activities for its own account. Municipal securities that were held principally for resale in the near term were recorded in the trading account at fair value with changes in fair value recorded in non-interest income. During the second quarter of 2017, QNB Bank redeemed the trading securities portfolio, as lack of volatility and the interest rate environment resulted in the declined performance of the portfolio.  The net realized gains were $27,000 for the six months ended June 30, 2017. Interest and dividends were included in interest income.

13


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The amortized cost and estimated fair values of investment debt securities available-for-sale and equity securities at June 30, 2018 and December 31, 2017 were as follows:

 

 

 

 

 

 

 

Gross

 

 

Gross

 

 

 

 

 

 

 

 

 

 

 

unrealized

 

 

unrealized

 

 

 

 

 

 

 

Fair

 

 

holding

 

 

holding

 

 

Amortized

 

June 30, 2018

 

value

 

 

gains

 

 

losses

 

 

cost

 

U.S. Government agency

 

$

69,495

 

 

$

 

 

$

(2,982

)

 

$

72,477

 

State and municipal

 

 

70,952

 

 

 

236

 

 

 

(662

)

 

 

71,378

 

U.S. Government agencies and sponsored

   enterprises (GSEs):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed

 

 

127,426

 

 

 

95

 

 

 

(5,214

)

 

 

132,545

 

Collateralized mortgage obligations (CMOs)

 

 

71,257

 

 

 

11

 

 

 

(3,525

)

 

 

74,771

 

Pooled trust preferred

 

 

118

 

 

 

 

 

 

(5

)

 

 

123

 

Corporate debt

 

 

4,946

 

 

 

14

 

 

 

(103

)

 

 

5,035

 

Equity

 

 

9,600

 

 

 

360

 

 

 

(887

)

 

 

10,127

 

Total investment debt securities available-for-sale

   and equity securities

 

$

353,794

 

 

$

716

 

 

$

(13,378

)

 

$

366,456

 

 

 

 

 

 

 

 

Gross

 

 

Gross

 

 

 

 

 

 

 

 

 

 

 

unrealized

 

 

unrealized

 

 

 

 

 

 

 

Fair

 

 

holding

 

 

holding

 

 

Amortized

 

December 31, 2017

 

value

 

 

gains

 

 

losses

 

 

cost

 

U.S. Government agency

 

$

70,524

 

 

$

 

 

$

(1,948

)

 

$

72,472

 

State and municipal

 

 

76,804

 

 

 

717

 

 

 

(113

)

 

 

76,200

 

U.S. Government agencies and sponsored

   enterprises (GSEs):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed

 

 

142,703

 

 

 

195

 

 

 

(2,401

)

 

 

144,909

 

Collateralized mortgage obligations (CMOs)

 

 

76,302

 

 

 

29

 

 

 

(2,292

)

 

 

78,565

 

Pooled trust preferred

 

 

215

 

 

 

 

 

 

(26

)

 

 

241

 

Corporate debt

 

 

8,022

 

 

 

6

 

 

 

(37

)

 

 

8,053

 

Equity

 

 

4,975

 

 

 

28

 

 

 

(349

)

 

 

5,296

 

Total investment debt securities available-for-sale

   and equity securities

 

$

379,545

 

 

$

975

 

 

$

(7,166

)

 

$

385,736

 

 

The amortized cost and estimated fair value of debt securities available-for-sale by contractual maturity at June 30, 2018 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

 

June 30, 2018

 

Fair value

 

 

cost

 

Due in one year or less

 

$

6,938

 

 

$

6,922

 

Due after one year through five years

 

 

185,003

 

 

 

191,920

 

Due after five years through ten years

 

 

131,117

 

 

 

135,913

 

Due after ten years

 

 

21,136

 

 

 

21,574

 

Total investment debt securities available-for-sale

 

$

344,194

 

 

$

356,329

 

 

14


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Proceeds from sales of investment debt securities available-for-sale were approximately $1,756,000 and $9,872,000 for the three months ended June 30, 2018 and 2017, respectively. Proceeds from sales of investment equity securities were approximately $678,000 and $752,000 for the three months ended June 30, 2018 and 2017, respectively.  Proceeds from sales of investment debt securities available-for-sale were approximately $4,159,000 and $19,358,000 for the six months ended June 30, 2018 and 2017, respectively. Proceeds from sales of investment equity securities were approximately $1,390,000 and $5,262,000 for the six months ended June 30, 2018 and 2017, respectively.

At June 30, 2018 and December 31, 2017, investment debt securities available-for-sale totaling approximately $187,915,000 and $202,887,000, respectively, were pledged as collateral for repurchase agreements and deposits of public funds.

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 June 30, 2018

 

 

Three months ended June 30, 2017

 

 

 

 

 

 

 

 

 

 

 

Other-than-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other-than-

 

 

 

 

 

 

 

Gross

 

 

Gross

 

 

temporary

 

Gross

 

 

Gross

 

 

 

 

 

 

Gross

 

 

Gross

 

 

temporary

 

 

 

 

 

 

 

realized

 

 

realized

 

 

impairment

 

unrealized

 

 

unrealized

 

 

Net

 

 

realized

 

 

realized

 

 

impairment

 

 

Net

 

 

 

gains

 

 

losses

 

 

losses

 

gains

 

 

losses

 

 

gains

 

 

gains

 

 

losses

 

 

losses

 

 

gains/(losses)

 

Equity securities

 

$

44

 

 

$

 

 

$

 

$

375

 

 

$

(334

)

 

$

85

 

 

$

131

 

 

$

 

 

$

 

 

$

131

 

Debt securities available-for-sale

 

 

4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

4

 

 

 

431

 

 

 

(447

)

 

 

 

 

 

(16

)

Total

 

$

48

 

 

$

 

 

$

 

$

375

 

 

$

(334

)

 

$

89

 

 

$

562

 

 

$

(447

)

 

$

 

 

$

115

 

 

 

 

Six months ended June 30, 2018

 

 

Six months ended June 30, 2017

 

 

 

 

 

 

 

 

 

 

 

Other-than-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other-than-

 

 

 

 

 

 

 

Gross

 

 

Gross

 

 

temporary

 

Gross

 

 

Gross

 

 

 

 

 

 

Gross

 

 

Gross

 

 

temporary

 

 

 

 

 

 

 

realized

 

 

realized

 

 

impairment

 

unrealized

 

 

unrealized

 

 

Net

 

 

realized

 

 

realized

 

 

impairment

 

 

Net

 

 

 

gains

 

 

losses

 

 

losses

 

gains

 

 

losses

 

 

gains/(losses)

 

 

gains

 

 

losses

 

 

losses

 

 

gains

 

Equity securities

 

$

130

 

 

$

 

 

$

 

$

349

 

 

$

(554

)

 

$

(75

)

 

$

856

 

 

$

 

 

$

 

 

$

856

 

Debt securities available-for-sale

 

 

25

 

 

 

(22

)

 

 

 

 

 

 

 

 

 

 

3

 

 

 

509

 

 

 

(501

)

 

 

 

 

 

8

 

Total

 

$

155

 

 

$

(22

)

 

$

 

$

349

 

 

$

(554

)

 

$

(72

)

 

$

1,365

 

 

$

(501

)

 

$

 

 

$

864

 

 

 

Tax expense applicable to the net realized gains for the three-month periods ended June 30, 2018 and 2017 were a credit of $14,000 and $48,000, respectively.  Tax expense applicable to the net realized gains for the six-month periods ended June 30, 2018 and 2017 were $38,000 and $350,000, 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

15


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

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 six months of 2018 or 2017. 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:

 

 

Six months ended June 30,

 

2018

 

 

2017

 

Balance, beginning of period

 

$

1

 

 

$

1,153

 

Reductions:  sale, collaterized debt obligation

 

 

 

 

 

(1,152

)

Additions:

 

 

 

 

 

 

 

 

Initial credit impairments

 

 

 

 

 

 

Subsequent credit impairments

 

 

 

 

 

 

Balance, end of period

 

$

1

 

 

$

1

 

 

The following table indicates the length of time individual securities have been in a continuous unrealized loss position at June 30, 2018 and December 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less than 12 months

 

 

12 months or longer

 

 

Total

 

 

 

No. of

 

 

Fair

 

 

Unrealized

 

 

Fair

 

 

Unrealized

 

 

Fair

 

 

Unrealized

 

June 30, 2018

 

securities

 

 

value

 

 

losses

 

 

value

 

 

losses

 

 

value

 

 

losses

 

U.S. Government agency

 

 

53

 

 

$

8,731

 

 

$

(258

)

 

$

60,764

 

 

$

(2,724

)

 

$

69,495

 

 

$

(2,982

)

State and municipal

 

 

99

 

 

 

35,507

 

 

 

(492

)

 

 

5,604

 

 

 

(170

)

 

 

41,111

 

 

 

(662

)

U.S. Government agencies and

   sponsored enterprises (GSEs):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed

 

 

108

 

 

 

53,757

 

 

 

(1,795

)

 

 

71,300

 

 

 

(3,419

)

 

 

125,057

 

 

 

(5,214

)

Collateralized mortgage obligations

   (CMOs)

 

 

77

 

 

 

21,839

 

 

 

(712

)

 

 

48,757

 

 

 

(2,813

)

 

 

70,596

 

 

 

(3,525

)

Pooled trust preferred

 

 

1

 

 

 

 

 

 

 

 

 

118

 

 

 

(5

)

 

 

118

 

 

 

(5

)

Corporate debt

 

 

4

 

 

 

2,963

 

 

 

(68

)

 

 

969

 

 

 

(35

)

 

 

3,932

 

 

 

(103

)

Equity

 

 

19

 

 

 

4,128

 

 

 

(550

)

 

 

832

 

 

 

(337

)

 

 

4,960

 

 

 

(887

)

Total

 

 

361

 

 

$

126,925

 

 

$

(3,875

)

 

$

188,344

 

 

$

(9,503

)

 

$

315,269

 

 

$

(13,378

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less than 12 months

 

 

12 months or longer

 

 

Total

 

 

 

No. of

 

 

Fair

 

 

Unrealized

 

 

Fair

 

 

Unrealized

 

 

Fair

 

 

Unrealized

 

December 31, 2017

 

securities

 

 

value

 

 

losses

 

 

value

 

 

losses

 

 

value

 

 

losses

 

U.S. Government agency

 

 

53

 

 

$

10,828

 

 

$

(155

)

 

$

59,696

 

 

$

(1,793

)

 

$

70,524

 

 

$

(1,948

)

State and municipal

 

 

37

 

 

 

10,577

 

 

 

(49

)

 

 

4,446

 

 

 

(64

)

 

 

15,023

 

 

 

(113

)

U.S. Government agencies and

   sponsored enterprises (GSEs):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed

 

 

99

 

 

 

61,069

 

 

 

(705

)

 

 

72,318

 

 

 

(1,696

)

 

 

133,387

 

 

 

(2,401

)

Collateralized mortgage obligations

   (CMOs)

 

 

70

 

 

 

21,660

 

 

 

(349

)

 

 

52,833

 

 

 

(1,943

)

 

 

74,493

 

 

 

(2,292

)

Pooled trust preferred

 

 

1

 

 

 

 

 

 

 

 

 

215

 

 

 

(26

)

 

 

215

 

 

 

(26

)

Corporate debt

 

 

4

 

 

 

3,018

 

 

 

(20

)

 

 

988

 

 

 

(17

)

 

 

4,006

 

 

 

(37

)

Equity

 

 

11

 

 

 

2,727

 

 

 

(277

)

 

 

275

 

 

 

(72

)

 

 

3,002

 

 

 

(349

)

Total

 

 

275

 

 

$

109,879

 

 

$

(1,555

)

 

$

190,771

 

 

$

(5,611

)

 

$

300,650

 

 

$

(7,166

)

 

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 June 30, 2018 in U.S. Government agency securities, state and municipal securities, mortgage-backed securities,

16


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

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 one pooled trust preferred security as of June 30, 2018. This security has a total amortized cost of approximately $123,000 and a fair value of $118,000.   The pooled trust preferred security is available-for-sale securities and is carried at fair value.

The following table provides additional information related to the pooled trust preferred security (PreTSL) as of June 30, 2018:

 

Deal

 

Class

 

 

Book

value

 

 

Fair

value

 

 

Unrealized

gains (losses)

 

 

Realized

OTTI

credit

loss

(YTD 2018)

 

 

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

*

 

$

123

 

 

$

118

 

 

$

(5

)

 

$

 

 

$

(1

)

 

Ba1/BB

 

 

4

 

 

 

 

 

 

0.00

%

 

 

185.4

%

 

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

In June 2017, QNB Bank sold five non-performing pooled trust preferred securities, with $2,235,000 carrying value, recording a loss on sale of $15,000, included in non-interest income in the quarter ended June 30, 2017 consolidated statement of income.  Several years ago, QNB had recorded $1,152,000 in OTTI for four of these five bonds, and subsequently applied any cashflow received to the balance of these non-performing, nonaccrual assets. Improvement in market prices for these securities during the second quarter 2017 reduced realized losses, and the reduction of approximately $19,000,000 in risk-based assets required for the bonds drove the decision to redeem these debt securities.

On a quarterly basis we evaluate our debt securities for 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 quarter and six months ended June 30, 2018 and 2017, 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.

PreTSL IV is rated lower than AA and 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). In addition to discounted cash-flows, QNB considers trends in the financial performance ratios of the bond’s underlying issuers, as well as the bond’s structure (QNB holds the senior-most obligation of the trust for PreTSL IV), determining there is little likelihood of default. 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.  Lack of liquidity in the market for trust preferred collateralized debt obligations contributed to the temporary impairment of this security. Although classified as available-for-sale, the Company has the intent to hold PreTSL IV and does not believe it will be required to sell it before recovery occurs.  QNB could be subject to additional write-downs in the future if additional deferrals and defaults occur.  

 

 

 

 

 

17


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

7. RESTRICTED INVESTMENT IN STOCK

 

Restricted investment in stock includes Federal Home Loan Bank of Pittsburgh (FHLB) with a carrying cost of $2,656,000, Atlantic Community Bankers Bank (ACBB) stock with a carrying cost of $12,000 and VISA Class B stock with a carrying cost of $0 at June 30, 2018. FHLB and ACBB stock was issued to the Bank as a requirement to facilitate the Bank’s participation in borrowing and other banking services.  The Bank’s investment in FHLB stock may fluctuate, as it is based on the member banks’ use of FHLB’s services.

 

The Bank owns 6,502 shares of Visa Class B stock, which was necessary to participate in Visa services in support of the Bank’s credit card, debit card, and related payment programs (permissible activities under banking regulations) as a member institution.  Following the resolution of Visa’s covered litigation, shares of Visa’s Class B stock will be converted to Visa Class A shares using a conversion factor (1.6298 as of June 30, 2018), which is periodically adjusted to reflect VISA’s ongoing litigation costs. There is a very limited market for this stock, as only current owners of Class B shares are permitted to transact in Class B.  Due to the lack of orderly trades and public information of such trades, Visa Class B does not have a readily determinable fair value.

 

These restricted investments are carried at cost and evaluated for OTTI periodically. As of June 30, 2018, there was no OTTI associated with these shares.

 

 

8. 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 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.

18


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

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 firm reviews risk assessment 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.

Major classes of loans are as follows:

 

 

 

June 30,

 

 

December 31,

 

 

 

2018

 

 

2017

 

Commercial:

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

160,281

 

 

$

147,190

 

Construction

 

 

52,143

 

 

 

51,157

 

Secured by commercial real estate

 

 

304,865

 

 

 

286,867

 

Secured by residential real estate

 

 

69,995

 

 

 

71,703

 

State and political subdivisions

 

 

47,405

 

 

 

38,087

 

Retail:

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

63,681

 

 

 

55,818

 

Home equity loans and lines

 

 

74,346

 

 

 

75,576

 

Consumer

 

 

6,955

 

 

 

6,680

 

Total loans

 

 

779,671

 

 

 

733,078

 

Net unearned costs

 

 

215

 

 

 

205

 

Loans receivable

 

$

779,886

 

 

$

733,283

 

 

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 June 30, 2018 and December 31, 2017, overdrafts were approximately $122,000 and $126,000, 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 June 30, 2018, there was a concentration of loans to lessors or residential buildings and dwellings of 15.6% of total loans and to lessors of nonresidential buildings of 18.6% of total loans,

19


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

compared with 15.7% and of 17.3% of total loans, respectively, at December 31, 2017.  These concentrations were primarily within the commercial real estate categories.

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.

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 a ten-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 - lower risk

 

4

- Acceptable - average risk

20


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

5

- Acceptable – high risk

 

6

- Pass watch

 

7

- Special Mention - potential weaknesses

 

8

- Substandard - well defined weaknesses

 

9

- Doubtful - full collection unlikely

 

10

- 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 five are reviewed annually based on the borrower’s fiscal year. Loans with risk ratings of six are reviewed every six to twelve months based on the dollar amount of the relationship with the borrower. Loans with risk ratings of seven through ten 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.

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 June 30, 2018 and December 31, 2017:

 

June 30, 2018

 

Pass

 

 

Special

mention

 

 

Substandard

 

 

Doubtful

 

 

Total

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

154,058

 

 

$

183

 

 

$

6,040

 

 

$

 

 

$

160,281

 

Construction

 

 

52,143

 

 

 

 

 

 

 

 

 

 

 

 

52,143

 

Secured by commercial real estate

 

 

286,441

 

 

 

8,320

 

 

 

10,104

 

 

 

 

 

 

304,865

 

Secured by residential real estate

 

 

67,940

 

 

 

 

 

 

2,055

 

 

 

 

 

 

69,995

 

State and political subdivisions

 

 

47,405

 

 

 

 

 

 

 

 

 

 

 

 

47,405

 

Total

 

$

607,987

 

 

$

8,503

 

 

$

18,199

 

 

$

 

 

$

634,689

 

 

December 31, 2017

 

Pass

 

 

Special

mention

 

 

Substandard

 

 

Doubtful

 

 

Total

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

139,820

 

 

$

863

 

 

$

6,507

 

 

$

 

 

$

147,190

 

Construction

 

 

51,156

 

 

 

 

 

 

1

 

 

 

 

 

 

51,157

 

Secured by commercial real estate

 

 

268,069

 

 

 

10,569

 

 

 

8,229

 

 

 

 

 

 

286,867

 

Secured by residential real estate

 

 

69,571

 

 

 

222

 

 

 

1,910

 

 

 

 

 

 

71,703

 

State and political subdivisions

 

 

38,087

 

 

 

 

 

 

 

 

 

 

 

 

38,087

 

Total

 

$

566,703

 

 

$

11,654

 

 

$

16,647

 

 

$

 

 

$

595,004

 

 

21


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

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 June 30, 2018 and December 31, 2017:

 

June 30, 2018

 

Performing

 

 

Non-performing

 

 

Total

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

$

62,704

 

 

$

977

 

 

$

63,681

 

Home equity loans and lines

 

 

74,200

 

 

 

146

 

 

 

74,346

 

Consumer

 

 

6,851

 

 

 

104

 

 

 

6,955

 

Total

 

$

143,755

 

 

$

1,227

 

 

$

144,982

 

 

December 31, 2017

 

Performing

 

 

Non-performing

 

 

Total

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

$

54,936

 

 

$

882

 

 

$

55,818

 

Home equity loans and lines

 

 

75,433

 

 

 

143

 

 

 

75,576

 

Consumer

 

 

6,595

 

 

 

85

 

 

 

6,680

 

Total

 

$

136,964

 

 

$

1,110

 

 

$

138,074

 

 

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 June 30, 2018 and December 31, 2017:

 

June 30, 2018

 

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

 

$

58

 

 

$

247

 

 

$

1,361

 

 

$

1,666

 

 

$

158,615

 

 

$

160,281

 

Construction

 

 

 

 

 

 

 

 

 

 

 

 

 

 

52,143

 

 

 

52,143

 

Secured by commercial real estate

 

 

736

 

 

 

86

 

 

 

647

 

 

 

1,469

 

 

 

303,396

 

 

 

304,865

 

Secured by residential real estate

 

 

372

 

 

 

50

 

 

 

199

 

 

 

621

 

 

 

69,374

 

 

 

69,995

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

47,405

 

 

 

47,405

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

 

 

 

119

 

 

 

494

 

 

 

613

 

 

 

63,068

 

 

 

63,681

 

Home equity loans and lines

 

 

63

 

 

 

47

 

 

 

65

 

 

 

175

 

 

 

74,171

 

 

 

74,346

 

Consumer

 

 

19

 

 

 

28

 

 

 

23

 

 

 

70

 

 

 

6,885

 

 

 

6,955

 

Total

 

$

1,248

 

 

$

577

 

 

$

2,789

 

 

$

4,614

 

 

$

775,057

 

 

$

779,671

 

 

December 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

 

$

25

 

 

$

429

 

 

$

57

 

 

$

511

 

 

$

146,679

 

 

$

147,190

 

Construction

 

 

 

 

 

 

 

 

 

 

 

 

 

 

51,157

 

 

 

51,157

 

Secured by commercial real estate

 

 

899

 

 

 

 

 

 

730

 

 

 

1,629

 

 

 

285,238

 

 

 

286,867

 

Secured by residential real estate

 

 

24

 

 

 

 

 

 

210

 

 

 

234

 

 

 

71,469

 

 

 

71,703

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

38,087

 

 

 

38,087

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

744

 

 

 

152

 

 

 

504

 

 

 

1,400

 

 

 

54,418

 

 

 

55,818

 

Home equity loans and lines

 

 

251

 

 

 

44

 

 

 

119

 

 

 

414

 

 

 

75,162

 

 

 

75,576

 

Consumer

 

 

23

 

 

 

8

 

 

 

 

 

 

31

 

 

 

6,649

 

 

 

6,680

 

Total

 

$

1,966

 

 

$

633

 

 

$

1,620

 

 

$

4,219

 

 

$

728,859

 

 

$

733,078

 

 

22


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

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 June 30, 2018 and December 31, 2017:

 

June 30, 2018

 

90 days or more past

due (still accruing)

 

 

Non-accrual

 

Commercial:

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

 

 

$

2,678

 

Construction

 

 

 

 

 

 

Secured by commercial real estate

 

 

 

 

 

1,651

 

Secured by residential real estate

 

 

 

 

 

1,198

 

State and political subdivisions

 

 

 

 

 

 

Retail:

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

 

 

 

977

 

Home equity loans and lines

 

 

 

 

 

146

 

Consumer

 

 

23

 

 

 

81

 

Total

 

$

23

 

 

$

6,731

 

 

December 31, 2017

 

90 days or more past

due (still accruing)

 

 

Non-accrual

 

Commercial:

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

 

 

$

3,367

 

Construction

 

 

 

 

 

 

Secured by commercial real estate

 

 

 

 

 

1,987

 

Secured by residential real estate

 

 

 

 

 

1,458

 

State and political subdivisions

 

 

 

 

 

 

Retail:

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

 

 

 

882

 

Home equity loans and lines

 

 

 

 

 

142

 

Consumer

 

 

 

 

 

85

 

Total

 

$

 

 

$

7,921

 

 

Activity in the allowance for loan losses for the three and six months ended June 30, 2018 and 2017 are as follows:

 

Three months ended June 30, 2018

 

Balance,

beginning of

period

 

 

Provision for

(credit to)

loan losses

 

 

Charge-offs

 

 

Recoveries

 

 

Balance, end

of period

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

2,829

 

 

$

4

 

 

$

 

 

$

7

 

 

$

2,840

 

Construction

 

 

557

 

 

 

16

 

 

 

 

 

 

 

 

 

573

 

Secured by commercial real estate

 

 

2,431

 

 

 

278

 

 

 

 

 

 

1

 

 

 

2,710

 

Secured by residential real estate

 

 

835

 

 

 

(72

)

 

 

 

 

 

18

 

 

 

781

 

State and political subdivisions

 

 

121

 

 

 

69

 

 

 

 

 

 

 

 

 

190

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

512

 

 

 

(3

)

 

 

 

 

 

 

 

 

509

 

Home equity loans and lines

 

 

381

 

 

 

(27

)

 

 

(44

)

 

 

1

 

 

 

311

 

Consumer

 

 

61

 

 

 

21

 

 

 

(23

)

 

 

8

 

 

 

67

 

Unallocated

 

 

310

 

 

 

(99

)

 

N/A

 

 

N/A

 

 

 

211

 

Total

 

$

8,037

 

 

$

187

 

 

$

(67

)

 

$

35

 

 

$

8,192

 

 

23


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Three months ended June 30, 2017

 

Balance,

beginning of

period

 

 

Provision for

(credit to)

loan losses

 

 

Charge-offs

 

 

Recoveries

 

 

Balance, end

of period

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

1,978

 

 

$

191

 

 

$

 

 

$

8

 

 

$

2,177

 

Construction

 

 

463

 

 

 

53

 

 

 

 

 

 

 

 

 

516

 

Secured by commercial real estate

 

 

2,577

 

 

 

61

 

 

 

 

 

 

2

 

 

 

2,640

 

Secured by residential real estate

 

 

1,344

 

 

 

(156

)

 

 

 

 

 

12

 

 

 

1,200

 

State and political subdivisions

 

 

124

 

 

 

(1

)

 

 

 

 

 

 

 

 

123

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

415

 

 

 

24

 

 

 

 

 

 

 

 

 

439

 

Home equity loans and lines

 

 

342

 

 

 

(25

)

 

 

 

 

 

2

 

 

 

319

 

Consumer

 

 

77

 

 

 

9

 

 

 

(18

)

 

 

10

 

 

 

78

 

Unallocated

 

 

399

 

 

 

144

 

 

N/A

 

 

N/A

 

 

 

543

 

Total

 

$

7,719

 

 

$

300

 

 

$

(18

)

 

$

34

 

 

$

8,035

 

 

Six months ended June 30, 2018

 

Balance,

beginning of

period

 

 

Provision for

(credit to)

loan losses

 

 

Charge-offs

 

 

Recoveries

 

 

Balance, end

of period

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

2,711

 

 

$

107

 

 

$

 

 

$

22

 

 

$

2,840

 

Construction

 

 

563

 

 

 

10

 

 

 

 

 

 

 

 

 

573

 

Secured by commercial real estate

 

 

2,410

 

 

 

298

 

 

 

 

 

 

2

 

 

 

2,710

 

Secured by residential real estate

 

 

816

 

 

 

(55

)

 

 

 

 

 

20

 

 

 

781

 

State and political subdivisions

 

 

114

 

 

 

76

 

 

 

 

 

 

 

 

 

190

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

444

 

 

 

65

 

 

 

 

 

 

 

 

 

509

 

Home equity loans and lines

 

 

357

 

 

 

(7

)

 

 

(44

)

 

 

5

 

 

 

311

 

Consumer

 

 

57

 

 

 

39

 

 

 

(49

)

 

 

20

 

 

 

67

 

Unallocated

 

 

369

 

 

 

(158

)

 

N/A

 

 

N/A

 

 

 

211

 

Total

 

$

7,841

 

 

$

375

 

 

$

(93

)

 

$

69

 

 

$

8,192

 

 

Six months ended June 30, 2017

 

Balance,

beginning of

period

 

 

Provision for

(credit to)

loan losses

 

 

Charge-offs

 

 

Recoveries

 

 

Balance, end

of period

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

1,459

 

 

$

698

 

 

$

 

 

$

20

 

 

$

2,177

 

Construction

 

 

449

 

 

 

67

 

 

 

 

 

 

 

 

 

516

 

Secured by commercial real estate

 

 

2,646

 

 

 

(10

)

 

 

 

 

 

4

 

 

 

2,640

 

Secured by residential real estate

 

 

1,760

 

 

 

(592

)

 

 

(3

)

 

 

35

 

 

 

1,200

 

State and political subdivisions

 

 

123

 

 

 

 

 

 

 

 

 

 

 

 

123

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

366

 

 

 

73

 

 

 

 

 

 

 

 

 

439

 

Home equity loans and lines

 

 

353

 

 

 

(39

)

 

 

 

 

 

5

 

 

 

319

 

Consumer

 

 

76

 

 

 

22

 

 

 

(39

)

 

 

19

 

 

 

78

 

Unallocated

 

 

162

 

 

 

381

 

 

N/A

 

 

N/A

 

 

 

543

 

Total

 

$

7,394

 

 

$

600

 

 

$

(42

)

 

$

83

 

 

$

8,035

 

 

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 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

24


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

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 $1,233,000 and $1,321,000 as of June 30, 2018 and December 31, 2017, respectively. Non-performing TDRs totaled $2,444,000 and $2,994,000 as of June 30, 2018 and December 31, 2017, respectively. All TDRs are included in impaired loans.

25


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.

 

 

 

June 30, 2018

 

 

December 31, 2017

 

 

 

Unpaid

principal

balance

 

 

Related

allowance

 

 

Unpaid

principal

balance

 

 

Related

allowance

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

TDRs with no specific allowance recorded

 

$

3,398

 

 

$

 

 

$

3,448

 

 

$

 

TDRs with an allowance recorded

 

 

279

 

 

 

190

 

 

 

867

 

 

 

235

 

Total

 

$

3,677

 

 

$

190

 

 

$

4,315

 

 

$

235

 

 

There was one newly identified TDR during the six months ended June 30, 2018. The TDR concession involved extension of a maturity date and lower monthly payments.  As of June 30, 2018 and December 31, 2017, QNB had no commitments to lend additional funds to customers with loans whose terms have been modified in troubled debt restructurings. There were net charge-offs of $0 and $3,000 during the six months ended June 30, 2018 and 2017, respectively, resulting from loans previously modified as TDRs.

The following tables present loans, by loan class, modified as TDRs during the three and six months ended June 30, 2018 and 2017. 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 June 30,

 

2018

 

 

2017

 

 

 

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

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Home equity loans and lines

 

 

 

 

$

 

 

$

 

 

 

 

 

$

 

 

$

 

Total

 

 

 

 

$

 

 

$

 

 

 

 

 

$

 

 

$

 

 

Six months ended June 30,

 

2018

 

 

2017

 

 

 

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

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Home equity loans and lines

 

 

1

 

 

$

47

 

 

$

57

 

 

 

 

 

$

 

 

$

 

Total

 

 

1

 

 

$

47

 

 

$

57

 

 

 

 

 

$

 

 

$

 

 

There were no loans modified as TDRs within 12 months prior to June 30, 2018 for which there was a payment default (60 days or more past due) during the six months ended June 30, 2018.  There was one loan with an outstanding balance of $21,000 that was  modified as TDRs within 12 months prior to June 30, 2017 for which there was a payment default (60 days or more past due) during the six months ended June 30, 2017.

The Company has four consumer mortgage loans secured by residential real estate for which foreclosure proceedings are in process at June 30, 2018. The recorded investment is $559,000.

26


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The following tables present the balance in the allowance for loan losses at June 30, 2018 and December 31, 2017 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

 

June 30, 2018

 

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

 

$

2,840

 

 

$

1,125

 

 

$

1,715

 

 

$

160,281

 

 

$

5,079

 

 

$

155,202

 

Construction

 

 

573

 

 

 

 

 

 

573

 

 

 

52,143

 

 

 

 

 

 

52,143

 

Secured by commercial real estate

 

 

2,710

 

 

 

 

 

 

2,710

 

 

 

304,865

 

 

 

3,781

 

 

 

301,084

 

Secured by residential real estate

 

 

781

 

 

 

61

 

 

 

720

 

 

 

69,995

 

 

 

1,573

 

 

 

68,422

 

State and political subdivisions

 

 

190

 

 

 

 

 

 

190

 

 

 

47,405

 

 

 

 

 

 

47,405

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

509

 

 

 

9

 

 

 

500

 

 

 

63,681

 

 

 

1,309

 

 

 

62,372

 

Home equity loans and lines

 

 

311

 

 

 

13

 

 

 

298

 

 

 

74,346

 

 

 

166

 

 

 

74,180

 

Consumer

 

 

67

 

 

 

 

 

 

67

 

 

 

6,955

 

 

 

81

 

 

 

6,874

 

Unallocated

 

 

211

 

 

N/A

 

 

N/A

 

 

N/A

 

 

N/A

 

 

N/A

 

Total

 

$

8,192

 

 

$

1,208

 

 

$

6,773

 

 

$

779,671

 

 

$

11,989

 

 

$

767,682

 

 

 

 

Allowance for Loan Losses

 

 

Loans Receivable

 

December 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

 

$

2,711

 

 

$

1,260

 

 

$

1,451

 

 

$

147,190

 

 

$

6,498

 

 

$

140,692

 

Construction

 

 

563

 

 

 

 

 

 

563

 

 

 

51,157

 

 

 

1

 

 

 

51,156

 

Secured by commercial real estate

 

 

2,410

 

 

 

 

 

 

2,410

 

 

 

286,867

 

 

 

3,874

 

 

 

282,993

 

Secured by residential real estate

 

 

816

 

 

 

84

 

 

 

732

 

 

 

71,703

 

 

 

1,744

 

 

 

69,959

 

State and political subdivisions

 

 

114

 

 

 

 

 

 

114

 

 

 

38,087

 

 

 

 

 

 

38,087

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

444

 

 

 

8

 

 

 

436

 

 

 

55,818

 

 

 

1,218

 

 

 

54,600

 

Home equity loans and lines

 

 

357

 

 

 

40

 

 

 

317

 

 

 

75,576

 

 

 

164

 

 

 

75,412

 

Consumer

 

 

57

 

 

 

 

 

 

57

 

 

 

6,680

 

 

 

85

 

 

 

6,595

 

Unallocated

 

 

369

 

 

N/A

 

 

N/A

 

 

N/A

 

 

N/A

 

 

N/A

 

Total

 

$

7,841

 

 

$

1,392

 

 

$

6,080

 

 

$

733,078

 

 

$

13,584

 

 

$

719,494

 

 

27


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The following table summarizes additional information, in regards to impaired loans by loan portfolio class, as of June 30, 2018 and December 31, 2017:

 

 

 

June 30, 2018

 

 

December 31, 2017

 

 

 

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

 

$

3,789

 

 

$

3,998

 

 

 

 

 

 

$

5,070

 

 

$

5,461

 

 

 

 

 

Construction

 

 

 

 

 

 

 

 

 

 

 

 

1

 

 

 

1

 

 

 

 

 

Secured by commercial real estate

 

 

3,781

 

 

 

4,336

 

 

 

 

 

 

 

3,874

 

 

 

4,464

 

 

 

 

 

Secured by residential real estate

 

 

1,408

 

 

 

1,712

 

 

 

 

 

 

 

914

 

 

 

1,239

 

 

 

 

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

1,150

 

 

 

1,191

 

 

 

 

 

 

 

1,057

 

 

 

1,108

 

 

 

 

 

Home equity loans and lines

 

 

126

 

 

 

177

 

 

 

 

 

 

 

124

 

 

 

168

 

 

 

 

 

Consumer

 

 

81

 

 

 

87

 

 

 

 

 

 

 

85

 

 

 

90

 

 

 

 

 

Total

 

$

10,335

 

 

$

11,501

 

 

 

 

 

 

$

11,125

 

 

$

12,531

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

With an allowance recorded:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

1,290

 

 

$

2,535

 

 

$

1,125

 

 

$

1,428

 

 

$

2,593

 

 

$

1,260

 

Construction

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial real estate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured by residential real estate

 

 

165

 

 

 

185

 

 

 

61

 

 

 

830

 

 

 

879

 

 

 

84

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

159

 

 

 

185

 

 

 

9

 

 

 

161

 

 

 

163

 

 

 

8

 

Home equity loans and lines

 

 

40

 

 

 

41

 

 

 

13

 

 

 

40

 

 

 

41

 

 

 

40

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

1,654

 

 

$

2,946

 

 

$

1,208

 

 

$

2,459

 

 

$

3,676

 

 

$

1,392

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

5,079

 

 

$

6,533

 

 

$

1,125

 

 

$

6,498

 

 

$

8,054

 

 

$

1,260

 

Construction

 

 

 

 

 

 

 

 

 

 

 

1

 

 

 

1

 

 

 

 

Secured by commercial real estate

 

 

3,781

 

 

 

4,336

 

 

 

 

 

 

3,874

 

 

 

4,464

 

 

 

 

Secured by residential real estate

 

 

1,573

 

 

 

1,897

 

 

 

61

 

 

 

1,744

 

 

 

2,118

 

 

 

84

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

1,309

 

 

 

1,376

 

 

 

9

 

 

 

1,218

 

 

 

1,271

 

 

 

8

 

Home equity loans and lines

 

 

166

 

 

 

218

 

 

 

13

 

 

 

164

 

 

 

209

 

 

 

40

 

Consumer

 

 

81

 

 

 

87

 

 

 

 

 

 

85

 

 

 

90

 

 

 

 

Total

 

$

11,989

 

 

$

14,447

 

 

$

1,208

 

 

$

13,584

 

 

$

16,207

 

 

$

1,392

 

 


28


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The following table presents additional information regarding the average recorded investment and interest income recognized on impaired loans:

 

Six Months Ended June 30,

 

2018

 

 

2017

 

 

 

Average

recorded

investment

 

 

Interest income

recognized

 

 

Average

recorded

investment

 

 

Interest income

recognized

 

Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

$

6,208

 

 

$

121

 

 

$

4,879

 

 

$

8

 

Construction

 

 

 

 

 

 

 

 

86

 

 

 

2

 

Secured by commercial real estate

 

 

3,752

 

 

 

49

 

 

 

5,838

 

 

 

78

 

Secured by residential real estate

 

 

1,696

 

 

 

9

 

 

 

2,252

 

 

 

13

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential mortgages

 

 

1,222

 

 

 

6

 

 

 

955

 

 

 

7

 

Home equity loans and lines

 

 

186

 

 

 

1

 

 

 

102

 

 

 

1

 

Consumer

 

 

83

 

 

 

 

 

 

91

 

 

 

 

Total

 

$

13,147

 

 

$

186

 

 

$

14,203

 

 

$

109

 

 

 

9. FAIR VALUE MEASUREMENTS AND DISCLOSURES

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.

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 and the fair value measurements by level within the fair value hierarchy as of June 30, 2018:

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

$

9,600

 

 

$

 

 

$

 

 

$

9,600

 

Debt securities available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government agency securities

 

 

 

 

 

69,495

 

 

 

 

 

 

69,495

 

State and municipal securities

 

 

 

 

 

70,952

 

 

 

 

 

 

70,952

 

U.S. Government agencies and sponsored

   enterprises (GSEs):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

 

 

 

 

127,426

 

 

 

 

 

 

127,426

 

Collateralized mortgage obligations (CMOs)

 

 

 

 

 

71,257

 

 

 

 

 

 

71,257

 

Pooled trust preferred securities

 

 

 

 

 

 

 

 

118

 

 

 

118

 

Corporate debt securities

 

 

 

 

 

4,946

 

 

 

 

 

 

4,946

 

Total debt securities available-for-sale

 

 

 

 

 

344,076

 

 

 

118

 

 

 

344,194

 

Total recurring fair value measurements

 

$

9,600

 

 

$

344,076

 

 

$

118

 

 

$

353,794

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonrecurring fair value measurements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impaired loans

 

$

 

 

$

 

 

$

446

 

 

$

446

 

Mortgage servicing rights

 

 

 

 

 

 

 

 

6

 

 

 

6

 

Total nonrecurring fair value measurements

 

$

 

 

$

 

 

$

452

 

 

$

452

 

 

There were no transfers in and out of Level 1 and Level 2 fair value measurements during the three or six months ended June 30, 2018. There were also no transfers in or out of level 3 for the same periods. 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- or six-month periods ended June 30, 2018.

30


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, 2017:

 

December 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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

$

4,975

 

 

$

 

 

$

 

 

$

4,975

 

Debt securities available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government agency securities

 

 

 

 

 

70,524

 

 

 

 

 

 

70,524

 

State and municipal securities

 

 

 

 

 

76,804

 

 

 

 

 

 

76,804

 

U.S. Government agencies and sponsored

   enterprises (GSEs):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed securities

 

 

 

 

 

142,703

 

 

 

 

 

 

142,703

 

Collateralized mortgage obligations (CMOs)

 

 

 

 

 

76,302

 

 

 

 

 

 

76,302

 

Pooled trust preferred securities

 

 

 

 

 

 

 

 

215

 

 

 

215

 

Corporate debt securities

 

 

 

 

 

8,022

 

 

 

 

 

 

8,022

 

Total debt securities available-for-sale

 

 

 

 

 

374,355

 

 

 

215

 

 

 

374,570

 

Total recurring fair value measurements

 

$

4,975

 

 

$

374,355

 

 

$

215

 

 

$

379,545

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonrecurring fair value measurements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impaired loans

 

$

 

 

$

 

 

$

1,067

 

 

$

1,067

 

Mortgage servicing rights

 

 

 

 

 

 

 

 

34

 

 

 

34

 

Total nonrecurring fair value measurements

 

$

 

 

$

 

 

$

1,101

 

 

$

1,101

 

 

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

 

June 30, 2018

 

Fair value

 

 

Valuation

techniques

 

 

Unobservable

input

 

 

Value or range

of values

 

Impaired loans

 

$

299

 

 

Appraisal of collateral

(1)

 

Appraisal adjustments

(2)

 

-20% to -80%

 

 

 

 

 

 

 

 

 

 

Liquidation expenses

(3)

 

-10%

 

Impaired loans

 

 

147

 

 

Financial statement values for UCC collateral

 

 

Financial statement value discounts

(4)

 

-20% to -50%

 

Mortgage servicing rights

 

 

6

 

 

Discounted cash flow

 

 

Remaining term

 

 

2 to 27 years

 

 

 

 

 

 

 

 

 

 

Discount rate

 

 

 

12.50

%

 

 

 

Quantitative information about Level 3 fair value measurements

December 31, 2017

 

Fair value

 

 

Valuation

techniques

 

 

Unobservable

input

 

 

Value or range

of values

Impaired loans

 

$

943

 

 

Appraisal of collateral

(1)

 

Appraisal adjustments

(2)

 

-15% to -90%

 

 

 

 

 

 

 

 

 

Liquidation expenses

(3)

 

-10%

Impaired loans

 

 

124

 

 

Financial statement values for UCC collateral

 

 

Financial statement value discounts

(4)

 

-25% to -50%

Mortgage servicing rights

 

 

34

 

 

Discounted cash flow

 

 

Remaining term

 

 

2 to 26 years

 

 

 

 

 

 

 

 

 

Discount rate

 

 

13% to 15%

 

(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.

31


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

(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)

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

 

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 six months ended June 30, 2018 and 2017:

 

 

 

Fair value measurements

using significant

unobservable inputs

(Level 3)

 

 

 

2018

 

 

2017

 

Balance, January 1,

 

$

215

 

 

$

2,281

 

Payments received

 

 

(119

)

 

 

(55

)

Sale of securities

 

 

 

 

 

(2,026

)

Total gains or losses (realized/unrealized)

 

 

 

 

 

 

 

 

Included in earnings

 

 

 

 

 

(15

)

Included in other comprehensive income

 

 

22

 

 

 

27

 

Transfers in and/or out of Level 3

 

 

 

 

 

 

Balance, June 30,

 

$

118

 

 

$

212

 

 

The Level 3 securities consist of one collateralized debt obligation security, PreTSL security, which is backed by trust preferred securities issued by banks, thrifts, and insurance companies. As discussed in Note 6, the market for these securities at June 30, 2018 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 the 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.

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 June 30, 2018;

 

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 used an independent third party to value this security using a discounted cash flow analysis. Based on management’s review of the bond’s five underlying issuers, there are no expected credit losses or prepayments; cashflows used were contractual based on the Bloomberg YA screen.  The assumed cashflows have been discounted using and estimated market discount rate based on the 30-year swap rate.  The 30-year is used as the reference rate since it is indicative of market expectation for short-term rates in the future.  This is consistent with the 30-year nature of PreTSL securities, which are priced using the 3-month LIBOR as a reference rate.  The discount rate of 5.74% includes the risk-free rate, a credit component and a spread for illiquidity.  

 

32


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

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 June 30, 2018 and December 31, 2017:

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 - available for sale (carried at fair value):  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 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 stocks (carried at cost):  The fair value of stock in Atlantic Community Bankers Bank, the Federal Home Loan Bank and VISA Class B is the carrying amount, based on redemption provisions, and considers the limited marketability of and restrictions on 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 liquidity, 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.

33


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

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.

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

 

 

 

 

 

 

 

 

 

 

 

Fair value measurements

 

June 30, 2018

 

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

 

$

11,726

 

 

$

11,726

 

 

$

11,726

 

 

$

 

 

$

 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equities

 

 

9,600

 

 

 

9,600

 

 

 

9,600

 

 

 

 

 

 

 

Available-for-sale

 

 

344,194

 

 

 

344,194

 

 

 

 

 

 

344,076

 

 

 

118

 

Restricted investment in stocks

 

 

2,668

 

 

 

2,668

 

 

 

 

 

 

2,668

 

 

 

 

Loans held-for-sale

 

 

404

 

 

 

415

 

 

 

 

 

 

415

 

 

 

 

Net loans

 

 

771,694

 

 

 

774,814

 

 

 

 

 

 

 

 

 

774,814

 

Mortgage servicing rights

 

 

466

 

 

 

609

 

 

 

 

 

 

 

 

 

609

 

Accrued interest receivable

 

 

3,573

 

 

 

3,573

 

 

 

 

 

 

3,573

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits with no stated maturities

 

$

763,007

 

 

$

763,007

 

 

$

763,007

 

 

$

 

 

$

 

Deposits with stated maturities

 

 

222,719

 

 

 

218,800

 

 

 

 

 

 

218,800

 

 

 

 

Short-term borrowings

 

 

85,646

 

 

 

85,646

 

 

 

85,646

 

 

 

 

 

 

 

Accrued interest payable

 

 

371

 

 

 

371

 

 

 

 

 

 

371

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Off-balance sheet instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commitments to extend credit

 

$

 

 

$

 

 

$

 

 

$

 

 

$

 

Standby letters of credit

 

 

 

 

 

 

 

 

 

 

 

65

 

 

 

 

 

34


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

Fair value measurements

 

December 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

 

$

16,331

 

 

$

16,331

 

 

$

16,331

 

 

$

 

 

$

 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equities

 

 

4,975

 

 

 

4,975

 

 

 

4,975

 

 

 

 

 

 

 

Available-for-sale

 

 

374,570

 

 

 

374,570

 

 

 

 

 

 

374,355

 

 

 

215

 

Restricted investment in stocks

 

 

1,501

 

 

 

1,501

 

 

 

 

 

 

1,501

 

 

 

 

Net loans

 

 

725,442

 

 

 

727,341

 

 

 

 

 

 

 

 

 

727,341

 

Mortgage servicing rights

 

 

483

 

 

 

585

 

 

 

 

 

 

 

 

 

585

 

Accrued interest receivable

 

 

3,545

 

 

 

3,545

 

 

 

 

 

 

3,545

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits with no stated maturities

 

$

768,766

 

 

$

768,766

 

 

$

768,766

 

 

$

 

 

$

 

Deposits with stated maturities

 

 

225,182

 

 

 

223,325

 

 

 

 

 

 

223,325

 

 

 

 

Short-term borrowings

 

 

55,756

 

 

 

55,756

 

 

 

55,756

 

 

 

 

 

 

 

Accrued interest payable

 

 

384

 

 

 

384

 

 

 

 

 

 

384

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Off-balance sheet instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commitments to extend credit

 

$

 

 

$

 

 

$

 

 

$

 

 

$

 

Standby letters of credit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10. 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:

 

 

 

June 30,

 

 

December 31,

 

 

 

2018

 

 

2017

 

Commitments to extend credit and unused lines of credit

 

$

293,857

 

 

$

313,541

 

Standby letters of credit

 

 

18,774

 

 

 

15,211

 

Total financial instrument commitments

 

$

312,631

 

 

$

328,752

 

 

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 making conditional obligations as it does for on-balance sheet instruments. Standby letters of credit of $17,708,000 will expire within

35


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

one year. 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 June 30, 2018 and December 31, 2017 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.

 

 

11. REGULATORY RESTRICTIONS

 

On May 24, 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) was enacted into law, which provides certain modifications to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which will provide regulatory relief for smaller and certain regional banking organizations.  In addition, the legislation establishes new consumer protections and amends various securities- and investment company-related requirements.  In addition to the sections that reduce the regulator burden on the Bank, the following sections of EGRRCPA will impact or potentially impact QNB’s financial statements:  

 

Section 201 requires the Federal banking agencies to promulgate a rule establishing a new “Community Bank Leverage Ratio” of 8%-10% for depository institutions and depository institution holding companies, including banks and bank holding companies, with less than $10 billion in total consolidated assets.  If such a depository institution or holding company maintains tangible equity in excess of this leverage ratio, it would be deemed to be in compliance with (1) the leverage and risk-based capital requirements promulgated by the Federal banking agencies; (2) in the case of a depository institution, the capital ratio requirements to be considered “well capitalized” under the Federal banking agencies’ “prompt corrective action” regime; and (3) “any other capital or leverage requirements” to which the depository institution or holding company is subject, in each case unless the appropriate Federal banking agency determines otherwise based on the particular institution’s risk profile.  In carrying out these requirements, the Federal banking agencies are required to consult with State banking regulators and notify the applicable State banking regulator of any qualifying community bank that exceeds or no longer exceeds the Community Bank Leverage Ratio.

 

 

Section 214 statutorily prescribes that the Federal banking agencies may only require depository institutions to apply a heightened risk-weight to exposures that are “high volatility commercial real estate” (HVCRE) if the exposures meet the definition of a HVCRE Acquisition, Development or Construction (ADC) loan as set forth in that section.  The new definition applies to a narrower scope of exposures.  The new definition of HVCRE ADC loan excludes loans made prior to January 1, 2015, amends the loan-to-value/capital contribution exemption, specifies the loan must primarily finance the property, has the purpose of providing financing to acquire, develop or improve such real property in income-producing property and is dependent upon future income or sales proceeds or refinancing of such property to repay the loan.  Once the property sufficiently produces cash-flows to support the debt service and expenses in accordance with the bank’s underwriting criteria for permanent financing, the loan meets the exemption as a HVCRE ADC loan.  The new definition is applicable for QNB’s reporting of its Regulatory Capital Ratios in Note 11 and had a positive impact of approximately five basis points to the ratios.  

 

 

Section 217 requires a reduction of the Federal Reserve Bank’s combined surplus fund from $7.5 billion to $6.825 billion.  This surplus fund was decreased earlier this year from $10 billion to $7.5 billion as part of the Bipartisan Budget Act of 2018.  This will impact the calculation of QNB’s Deposit Insurance.

 

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 Federal and 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

36


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

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 June 30, 2018, 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 June 30, 2018

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

$

115,662

 

 

 

12.70

%

 

$

72,861

 

 

 

8.00

%

 

$

91,077

 

 

 

10.00

%

Bank

 

 

106,129

 

 

 

12.03

 

 

 

70,572

 

 

8.00

 

 

 

88,215

 

 

10.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier I capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

107,397

 

 

 

11.79

 

 

 

54,646

 

 

6.00

 

 

 

54,646

 

 

6.00

 

Bank

 

 

97,864

 

 

 

11.09

 

 

 

52,929

 

 

6.00

 

 

 

70,572

 

 

8.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common equity tier 1 capital (to risk-weighted

   assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

107,397

 

 

 

11.79

 

 

 

40,985

 

 

4.50

 

 

N/A

 

 

N/A

 

Bank

 

 

97,864

 

 

 

11.09

 

 

 

39,697

 

 

4.50

 

 

 

57,339

 

 

6.50

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier I capital (to average assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

107,397

 

 

 

9.20

 

 

 

46,655

 

 

4.00

 

 

N/A

 

 

N/A

 

Bank

 

 

97,864

 

 

 

8.46

 

 

 

46,262

 

 

4.00

 

 

 

57,827

 

 

5.00

 

 

 

 

Capital levels

 

 

 

Actual

 

 

Adequately capitalized

 

 

Well capitalized

 

As of December 31, 2017

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

 

Amount

 

 

Ratio

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

$

110,352

 

 

 

12.52

%

 

$

70,520

 

 

 

8.00

%

 

$

88,150

 

 

 

10.00

%

Bank

 

 

101,040

 

 

 

11.67

 

 

 

69,277

 

 

8.00

 

 

 

86,596

 

 

10.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier I capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

102,438

 

 

 

11.62

 

 

 

52,890

 

 

6.00

 

 

 

52,890

 

 

6.00

 

Bank

 

 

93,126

 

 

 

10.75

 

 

 

51,957

 

 

6.00

 

 

 

69,277

 

 

8.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common equity tier 1 capital (to risk-weighted

   assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

102,438

 

 

 

11.62

 

 

 

39,668

 

 

4.50

 

 

N/A

 

 

N/A

 

Bank

 

 

93,126

 

 

 

10.75

 

 

 

38,968

 

 

4.50

 

 

 

56,287

 

 

6.50

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier I capital (to average assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

102,438

 

 

 

8.88

 

 

 

46,149

 

 

4.00

 

 

N/A

 

 

N/A

 

Bank

 

 

93,126

 

 

 

8.14

 

 

 

45,761

 

 

4.00

 

 

 

57,201

 

 

5.00

 

 

 

 

 

37


QNB CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

12.  REVENUE RECOGNITION FROM CONTRACTS WITH CUSTOMERS

 

The Company generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.  The main types of revenue contracts included in non-interest income within the consolidated statements of operations are as follows:

 

Fees for services to customers—fees include service charges on deposits which are included as liabilities in the consolidated statement of financial position and consist of transaction-based fees, stop payment fees, Automated Clearing House (ACH) fees, account maintenance fees, and overdraft services fees for various retail and business checking customers.  These fees are charged as earned on the day of the transaction or within the month of the service, with the exception of Enhanced Account Analysis Fees, which are calculated on the previous month’s activity and assessed on the following month.  The Enhanced Account Analysis Fees are currently being accrued; the revenue is currently being recorded in the month it is earned.   Service charges on deposits are withdrawn directly from the customer’s account balance.

 

ATM and debit card – fees are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer’s request.

 

Retail brokerage and advisory—fee income and related expenses are accrued monthly to properly record the revenues in the month they are earned.  Advisory fees are collected in advance on a quarterly basis.  These advisory fees and recorded in the first month of the quarter for which the service is being performed.     Fees that are transaction based are recognized at the point in time that the transaction is executed (i.e. trade date).

 

Merchant – QNB earns interchange fees from credit/debit cardholder transactions conducted through VISA/MasterCard payment networks.  Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized monthly, concurrently with the transaction processing services provided to the cardholder within the month.

 

Other—includes credit card fees, sales of checks to depositors, miscellaneous fees and gain/losses on sale of OREO.

 

Credit card fees are recognized monthly, concurrently with the transaction processing services provided to the cardholder within the month.

 

Sales of checks to depositors are commissions earned from a third-party who provides checks to QNB’s customers.  There is a pre-paid incentive with the third party which is recognized over the term of the contact.  Other commissions on the sales of checks are recorded weekly.

 

Miscellaneous fees, such as wire, cashier check and garnishment fees, are charged as earned on the day of the transaction.

 

Gain (loss) on sales of OREO – QNB records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the QNB finances the sale of OREO to the buyer, QNB assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable.  Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer.  In determining the gain or loss on the sale, QNB adjusts the transaction prices and related gain (loss) on sale if a significant financing component is present.

 

 

 

 

 

 

 

 

38


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 2017 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.

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.

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.

39


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

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.  There were no other-than-temporary impairment charges recorded during the quarter or six months ended June 30, 2018 and 2017, respectively.

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. There were no credit-related other-than-temporary impairment charges in the quarter or six months ended June 30, 2018 or 2017, respectively.

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.

40


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

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 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 second quarter of 2018 of $2,862,000, or $0.82 per share on a diluted basis, compared to net income of $2,386,000, or $0.69 per share on a diluted basis, for the same period in 2017.  For the six-month period ended June 30, 2018, QNB reported net income of $5,797,000, or $1.67 per share on a diluted basis, compared to net income of $5,246,000, or $1.53 per share on a diluted basis, for the same period in 2017.

Net income expressed as an annualized rate of return on average assets and average shareholders’ equity was 0.98% and 10.70%, respectively, for the quarter ended June 30, 2018 compared with 0.87% and 9.52%, respectively, for the quarter ended June 30, 2017.  For the six months ended June 30, 2018, the annualized rate of return on average assets and average shareholders’ equity was 1.00% and 11.02%, respectively, compared with 0.97% and 10.62%, for the same period in 2017.

Total assets as of June 30, 2018 were $1,172,874,000, compared with $1,152,337,000 at December 31, 2017. Loans receivable at June 30, 2018 were $779,886,000, compared with $733,283,000 at December 31, 2017, an increase of $46,603,000, or 6.4%, with commercial lending as the largest contributor to the growth. Total deposits of $985,726,000 at June 30, 2018 decreased $8,222,000, or 0.8%, compared with total deposits of $993,948,000 at December 31, 2017.

Results for the three and six months ended June 30, 2018 include the following significant components:

 

Net interest income increased $842,000, or 10.7%, to $8,700,000 and $1,753,000, or 11.1%, to $17,491,000 for the three and six months ended June 30, 2018 respectively.

 

Net interest margin on a tax-equivalent basis increased five basis points for the quarter and two basis points year-to-date, to 3.15% and 3.18%, respectively.

 

QNB recorded $187,000 in provision for loan losses for the quarter and $375,000 for the six months ended June 30, 2018, compared with $300,000 and $600,000 for the same periods in 2017, respectively.

41


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

 

Non-interest income decreased $161,000, or 10.0%, to $1,454,000 for the second quarter and $1,084,000, or 30.1%, to $2,521,000 for year-to-date 2018, compared with the same periods in 2017.

 

Non-interest expense increased $591,000, or 9.9%, to $6,533,000 for the second quarter and $1,181,000, or 10.2%, to $12,711,000 for year-to-date 2018, compared to the same periods in 2017.

 

Total non-performing loans were $7,987,000, or 1.02% of loans receivable at June 30, 2018, compared to $9,242,000, or 1.26% of loans receivable at December 31, 2017. Loans on non-accrual status were $6,731,000 at June 30, 2018 compared with $7,921,000 at December 31, 2017. Net charge-offs for the six months ended June 30, 2018 were $24,000, compared with net recoveries of $41,000 for the 2017 period.

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.

The following table presents the adjustment to convert net interest income to net interest income on a fully taxable-equivalent basis for the three- and six-month periods ended June 30, 2018 and 2017.  The tax-equivalent adjustments are based on the marginal Federal corporate tax rate of 21% and 34% for three and six months ended June 30, 2018 and 2017, respectively.

 

 

 

Three months

ended June 30,

 

 

Six months

ended June 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Total interest income

 

$

10,562

 

 

$

9,192

 

 

$

21,071

 

 

$

18,328

 

Total interest expense

 

 

1,862

 

 

 

1,334

 

 

 

3,580

 

 

 

2,590

 

Net interest income

 

 

8,700

 

 

 

7,858

 

 

 

17,491

 

 

 

15,738

 

Tax-equivalent adjustment

 

 

201

 

 

 

390

 

 

 

402

 

 

 

777

 

Net interest income (fully taxable-equivalent)

 

$

8,901

 

 

$

8,248

 

 

$

17,893

 

 

$

16,515

 

 

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

 

 

 

June 30, 2018

 

 

June 30, 2017

 

 

 

Average

 

 

Average

 

 

 

 

 

 

Average

 

 

Average

 

 

 

 

 

 

 

Balance

 

 

Rate

 

 

Interest

 

 

Balance

 

 

Rate

 

 

Interest

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trading securities

 

$

 

 

 

0.00

%

 

$

 

 

$

1,985

 

 

 

4.78

%

 

$

24

 

Investment securities (AFS & Equity):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government agencies

 

 

72,476

 

 

 

1.79

 

 

 

324

 

 

 

73,007

 

 

 

1.78

 

 

 

325

 

State and municipal

 

 

71,528

 

 

 

3.26

 

 

 

584

 

 

 

75,620

 

 

 

3.88

 

 

 

733

 

Mortgage-backed and CMOs

 

 

212,076

 

 

 

2.12

 

 

 

1,124

 

 

 

221,045

 

 

 

2.04

 

 

 

1,130

 

Pooled trust preferred securities

 

 

123

 

 

 

4.53

 

 

 

2

 

 

 

2,846

 

 

 

2.27

 

 

 

16

 

Corporate debt securities

 

 

6,538

 

 

 

2.39

 

 

 

39

 

 

 

8,064

 

 

 

1.98

 

 

 

40

 

Equities

 

 

10,109

 

 

 

2.87

 

 

 

72

 

 

 

6,923

 

 

 

3.18

 

 

 

55

 

Total investment securities

 

 

372,850

 

 

 

2.30

 

 

 

2,145

 

 

 

387,505

 

 

 

2.37

 

 

 

2,299

 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

 

427,120

 

 

 

4.61

 

 

 

4,904

 

 

 

387,959

 

 

 

4.41

 

 

 

4,270

 

Residential real estate

 

 

60,830

 

 

 

3.82

 

 

 

580

 

 

 

49,196

 

 

 

3.84

 

 

 

472

 

Home equity loans

 

 

66,298

 

 

 

4.46

 

 

 

736

 

 

 

65,822

 

 

 

3.78

 

 

 

621

 

Commercial and industrial

 

 

155,505

 

 

 

4.98

 

 

 

1,930

 

 

 

124,363

 

 

 

4.63

 

 

 

1,437

 

Consumer loans

 

 

7,105

 

 

 

5.95

 

 

 

106

 

 

 

6,494

 

 

 

5.38

 

 

 

87

 

Tax-exempt loans

 

 

40,686

 

 

 

3.21

 

 

 

325

 

 

 

34,927

 

 

 

3.97

 

 

 

346

 

Total loans, net of unearned income*

 

 

757,544

 

 

 

4.54

 

 

 

8,581

 

 

 

668,761

 

 

 

4.34

 

 

 

7,233

 

Other earning assets

 

 

2,890

 

 

 

5.12

 

 

 

37

 

 

 

9,018

 

 

 

1.18

 

 

 

26

 

Total earning assets

 

 

1,133,284

 

 

 

3.81

 

 

 

10,763

 

 

 

1,067,269

 

 

 

3.60

 

 

 

9,582

 

Cash and due from banks

 

 

11,657

 

 

 

 

 

 

 

 

 

 

 

13,213

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

 

(8,103

)

 

 

 

 

 

 

 

 

 

 

(7,766

)

 

 

 

 

 

 

 

 

Other assets

 

 

29,545

 

 

 

 

 

 

 

 

 

 

 

29,228

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,166,383

 

 

 

 

 

 

 

 

 

 

$

1,101,944

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders' Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand

 

$

186,532

 

 

 

0.23

%

 

 

108

 

 

$

171,584

 

 

 

0.21

%

 

 

88

 

Municipals

 

 

99,001

 

 

 

1.33

 

 

 

328

 

 

 

92,188

 

 

 

0.61

 

 

 

140

 

Money market

 

 

77,903

 

 

 

0.32

 

 

 

62

 

 

 

92,866

 

 

 

0.33

 

 

 

76

 

Savings

 

 

263,365

 

 

 

0.56

 

 

 

369

 

 

 

253,524

 

 

 

0.44

 

 

 

278

 

Time

 

 

121,392

 

 

 

1.25

 

 

 

379

 

 

 

128,394

 

 

 

1.16

 

 

 

372

 

Time of $100,000 or more

 

 

105,353

 

 

 

1.58

 

 

 

415

 

 

 

94,741

 

 

 

1.39

 

 

 

328

 

Total interest-bearing deposits

 

 

853,546

 

 

 

0.78

 

 

 

1,661

 

 

 

833,297

 

 

 

0.62

 

 

 

1,282

 

Short-term borrowings

 

 

67,841

 

 

 

1.19

 

 

 

201

 

 

 

44,365

 

 

 

0.46

 

 

 

52

 

Total interest-bearing liabilities

 

 

921,387

 

 

 

0.81

 

 

 

1,862

 

 

 

877,662

 

 

 

0.61

 

 

 

1,334

 

Non-interest-bearing deposits

 

 

133,454

 

 

 

 

 

 

 

 

 

 

 

118,895

 

 

 

 

 

 

 

 

 

Other liabilities

 

 

4,241

 

 

 

 

 

 

 

 

 

 

 

4,846

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

 

107,301

 

 

 

 

 

 

 

 

 

 

 

100,541

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders' equity

 

$

1,166,383

 

 

 

 

 

 

 

 

 

 

$

1,101,944

 

 

 

 

 

 

 

 

 

Net interest rate spread

 

 

 

 

 

 

3.00

%

 

 

 

 

 

 

 

 

 

 

2.99

%

 

 

 

 

Margin/net interest income

 

 

 

 

 

 

3.15

%

 

$

8,901

 

 

 

 

 

 

 

3.10

%

 

$

8,248

 

43


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

 

 

 

 

Six Months Ended

 

 

 

June 30, 2018

 

 

June 30, 2017

 

 

 

Average

 

 

Average

 

 

 

 

 

 

Average

 

 

Average

 

 

 

 

 

 

 

Balance

 

 

Rate

 

 

Interest

 

 

Balance

 

 

Rate

 

 

Interest

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trading securities

 

$

-

 

 

 

0.00

%

 

$

-

 

 

$

2,393

 

 

 

5.69

%

 

$

68

 

Investment securities (AFS & Equity):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government agencies

 

 

72,475

 

 

 

1.79

 

 

 

649

 

 

 

74,540

 

 

 

1.76

 

 

 

657

 

State and municipal

 

 

73,127

 

 

 

3.27

 

 

 

1,196

 

 

 

73,823

 

 

 

3.89

 

 

 

1,438

 

Mortgage-backed and CMOs

 

 

215,753

 

 

 

2.11

 

 

 

2,274

 

 

 

222,497

 

 

 

2.05

 

 

 

2,278

 

Pooled trust preferred securities

 

 

179

 

 

 

4.07

 

 

 

4

 

 

 

2,876

 

 

 

1.26

 

 

 

18

 

Corporate debt securities

 

 

7,290

 

 

 

2.30

 

 

 

84

 

 

 

8,067

 

 

 

1.94

 

 

 

78

 

Equities

 

 

9,231

 

 

 

2.91

 

 

 

133

 

 

 

6,881

 

 

 

3.27

 

 

 

112

 

Total investment securities

 

 

378,055

 

 

 

2.30

 

 

 

4,340

 

 

 

388,684

 

 

 

2.36

 

 

 

4,581

 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

 

424,032

 

 

 

4.65

 

 

 

9,768

 

 

 

381,609

 

 

 

4.57

 

 

 

8,650

 

Residential real estate

 

 

58,958

 

 

 

3.84

 

 

 

1,132

 

 

 

48,370

 

 

 

3.85

 

 

 

930

 

Home equity loans

 

 

66,253

 

 

 

4.35

 

 

 

1,430

 

 

 

66,104

 

 

 

3.82

 

 

 

1,251

 

Commercial and industrial

 

 

155,068

 

 

 

5.08

 

 

 

3,904

 

 

 

118,717

 

 

 

4.65

 

 

 

2,736

 

Consumer loans

 

 

7,010

 

 

 

5.89

 

 

 

205

 

 

 

6,377

 

 

 

5.25

 

 

 

166

 

Tax-exempt loans

 

 

39,567

 

 

 

3.23

 

 

 

634

 

 

 

35,117

 

 

 

3.95

 

 

 

689

 

Total loans, net of unearned income*

 

 

750,888

 

 

 

4.59

 

 

 

17,073

 

 

 

656,294

 

 

 

4.43

 

 

 

14,422

 

Other earning assets

 

 

4,223

 

 

 

2.86

 

 

 

60

 

 

 

7,540

 

 

 

0.92

 

 

 

34

 

Total earning assets

 

 

1,133,166

 

 

 

3.82

 

 

 

21,473

 

 

 

1,054,911

 

 

 

3.65

 

 

 

19,105

 

Cash and due from banks

 

 

11,486

 

 

 

 

 

 

 

 

 

 

 

12,658

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

 

(8,086

)

 

 

 

 

 

 

 

 

 

 

(7,605

)

 

 

 

 

 

 

 

 

Other assets

 

 

28,790

 

 

 

 

 

 

 

 

 

 

 

29,032

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,165,356

 

 

 

 

 

 

 

 

 

 

$

1,088,996

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders' Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand

 

$

183,323

 

 

 

0.22

%

 

 

203

 

 

$

166,783

 

 

 

0.20

%

 

 

168

 

Municipals

 

 

100,775

 

 

 

1.21

 

 

 

607

 

 

 

89,764

 

 

 

0.53

 

 

 

234

 

Money market

 

 

79,938

 

 

 

0.30

 

 

 

120

 

 

 

85,469

 

 

 

0.30

 

 

 

128

 

Savings

 

 

261,266

 

 

 

0.54

 

 

 

699

 

 

 

247,317

 

 

 

0.44

 

 

 

537

 

Time

 

 

122,641

 

 

 

1.25

 

 

 

757

 

 

 

129,540

 

 

 

1.15

 

 

 

740

 

Time of $100,000 or more

 

 

106,555

 

 

 

1.54

 

 

 

814

 

 

 

95,129

 

 

 

1.38

 

 

 

651

 

Total interest-bearing deposits

 

 

854,498

 

 

 

0.76

 

 

 

3,200

 

 

 

814,002

 

 

 

0.61

 

 

 

2,458

 

Short-term borrowings

 

 

69,637

 

 

 

1.10

 

 

 

380

 

 

 

52,418

 

 

 

0.51

 

 

 

132

 

Total interest-bearing liabilities

 

 

924,135

 

 

 

0.78

 

 

 

3,580

 

 

 

866,420

 

 

 

0.60

 

 

 

2,590

 

Non-interest-bearing deposits

 

 

130,835

 

 

 

 

 

 

 

 

 

 

 

118,381

 

 

 

 

 

 

 

 

 

Other liabilities

 

 

4,313

 

 

 

 

 

 

 

 

 

 

 

4,605

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

 

106,073

 

 

 

 

 

 

 

 

 

 

 

99,590

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders' equity

 

$

1,165,356

 

 

 

 

 

 

 

 

 

 

$

1,088,996

 

 

 

 

 

 

 

 

 

Net interest rate spread

 

 

 

 

 

 

3.04

%

 

 

 

 

 

 

 

 

 

 

3.05

%

 

 

 

 

Margin/net interest income

 

 

 

 

 

 

3.18

%

 

$

17,893

 

 

 

 

 

 

 

3.16

%

 

$

16,515

 

 

Tax-exempt securities and loans were adjusted to a tax-equivalent basis and are based on the marginal Federal corporate tax rate of 21 percent and 34 percent for three and six months ended June 30, 2018 and 2017, respectively. Non-accrual loans and investment securities are included in earning assets.

* Includes loans held-for-sale

44


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

 

 

Six months ended

 

 

 

June 30, 2018 compared

 

 

June 30, 2018 compared

 

 

 

to June 30, 2017

 

 

to June 30, 2017

 

 

 

Total

 

 

Due to change in:

 

 

Total

 

 

Due to change in:

 

 

 

Change

 

 

Volume

 

 

Rate

 

 

Change

 

 

Volume

 

 

Rate

 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trading securities

 

$

(24

)

 

$

(24

)

 

$

 

 

$

(68

)

 

$

(68

)

 

$

 

Investment securities (AFS & Equity):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government agencies

 

 

(1

)

 

 

(3

)

 

 

2

 

 

 

(8

)

 

 

(18

)

 

 

10

 

State and municipal

 

 

(149

)

 

 

(39

)

 

 

(110

)

 

 

(242

)

 

 

(13

)

 

 

(229

)

Mortgage-backed and CMOs

 

 

(6

)

 

 

(46

)

 

 

40

 

 

 

(4

)

 

 

(69

)

 

 

65

 

Pooled trust preferred securities

 

 

(14

)

 

 

(15

)

 

 

1

 

 

 

(14

)

 

 

(17

)

 

 

3

 

Corporate debt securities

 

 

(1

)

 

 

(8

)

 

 

7

 

 

 

6

 

 

 

(7

)

 

 

13

 

Equities

 

 

17

 

 

 

25

 

 

 

(8

)

 

 

21

 

 

 

37

 

 

 

(16

)

Total Investment securities (AFS & Equity)

 

 

(154

)

 

 

(86

)

 

 

(68

)

 

 

(241

)

 

 

(87

)

 

 

(154

)

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

 

634

 

 

 

431

 

 

 

203

 

 

 

1,118

 

 

 

961

 

 

 

157

 

Residential real estate

 

 

108

 

 

 

112

 

 

 

(4

)

 

 

202

 

 

 

203

 

 

 

(1

)

Home equity loans

 

 

115

 

 

 

4

 

 

 

111

 

 

 

179

 

 

 

3

 

 

 

176

 

Commercial and industrial

 

 

493

 

 

 

360

 

 

 

133

 

 

 

1,168

 

 

 

838

 

 

 

330

 

Consumer loans

 

 

19

 

 

 

9

 

 

 

10

 

 

 

39

 

 

 

17

 

 

 

22

 

Tax-exempt loans

 

 

(21

)

 

 

56

 

 

 

(77

)

 

 

(55

)

 

 

87

 

 

 

(142

)

Total Loans

 

 

1,348

 

 

 

972

 

 

 

376

 

 

 

2,651

 

 

 

2,109

 

 

 

542

 

Other earning assets

 

 

11

 

 

 

(17

)

 

 

28

 

 

 

26

 

 

 

(15

)

 

 

41

 

Total interest income

 

 

1,181

 

 

 

845

 

 

 

336

 

 

 

2,368

 

 

 

1,939

 

 

 

429

 

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand

 

 

20

 

 

 

8

 

 

 

12

 

 

 

35

 

 

 

17

 

 

 

18

 

Municipals

 

 

188

 

 

 

11

 

 

 

177

 

 

 

373

 

 

 

29

 

 

 

344

 

Money market

 

 

(14

)

 

 

(12

)

 

 

(2

)

 

 

(8

)

 

 

(7

)

 

 

(1

)

Savings

 

 

91

 

 

 

11

 

 

 

80

 

 

 

162

 

 

 

31

 

 

 

131

 

Time

 

 

7

 

 

 

(20

)

 

 

27

 

 

 

17

 

 

 

(40

)

 

 

57

 

Time of $100,000 or more

 

 

87

 

 

 

35

 

 

 

52

 

 

 

163

 

 

 

78

 

 

 

85

 

Total interest-bearing deposits

 

 

379

 

 

 

33

 

 

 

346

 

 

 

742

 

 

 

108

 

 

 

634

 

Short-term borrowings

 

 

149

 

 

 

27

 

 

 

122

 

 

 

248

 

 

 

43

 

 

 

205

 

Total interest expense

 

 

528

 

 

 

60

 

 

 

468

 

 

 

990

 

 

 

151

 

 

 

839

 

Net interest income

 

$

653

 

 

$

785

 

 

$

(132

)

 

$

1,378

 

 

$

1,788

 

 

$

(410

)

 

Net Interest Income and Net Interest Margin – Quarterly Comparison

 

Average earning assets for the second quarter of 2018 were $1,133,284,000, an increase of $66,015,000, or 6.2%, from the second quarter of 2017, with average loans increasing $88,783,000, or 13.3%, and average investment securities decreasing $16,640,000, or 4.3%, over the same period. Growth in the loan portfolio supports 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 66.8% for the second quarter of 2018, compared with 62.7% for the second quarter of 2017. On the funding side, average deposits increased $34,808,000, or 3.7%, to $987,000,000 for the second quarter of 2018 with growth in all categories except money markets and time deposits less than $100,000. 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 second quarter of 2018 increased $23,476,000, to $67,841,000, which consisted of average commercial repurchase agreements of $37,484,000 and average overnight borrowings of

45


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

$30,357,000.  For the same period in 2017, borrowings consisted of average commercial repurchase agreements of $40,216,000 and average overnight borrowings of $4,149,000.

The net interest margin for the second quarter of 2018 increased five basis points to 3.15% compared to the same period in 2017.  While competition for quality loans in our local market continues to exert pressure on the net interest margin, three increases in the prime lending rate since June 30, 2017 have provided increased interest income on variable rate loans, and moderate competitive pricing pressure on deposits.  

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 $1,181,000, or 12.3%, to $10,763,000 for the second quarter of 2018; total interest expense increased $528,000, or 39.6%, to $1,862,000. The increase in interest income was due to growth in loans.  All categories of interest-bearing deposits, except money markets, experienced higher rates in the second quarter of 2018 compared to second quarter of 2017, due to rate increases for municipal deposits indexed to Fed Funds, and a 15-basis point rate increase to the eSavings and Rewards checking products since June 30, 2017.

The yield on earning assets on a tax-equivalent basis increased 21 basis points from 3.60% for the second quarter of 2017 to 3.81% for the second quarter of 2018.  The cost of interest-bearing liabilities was 0.81% for the second quarter ended June 30, 2018, compared with 0.61% for the same period in 2017.

Interest income on investment securities (available-for-sale and equity) decreased $154,000 when comparing the quarters ended June 30, 2018 and 2017. The average yield on the investment portfolio was 2.30% for the first quarter of 2018 compared with 2.37% for the second quarter of 2017. Proceeds from sales, payments, calls and maturities, net of purchases, were utilized to grow the loan portfolio at higher yields than the investment portfolio.  

Interest income on trading securities decreased $24,000, as the portfolio was sold in 2017, reducing the $1,985,000 second quarter 2017 average balance to $0 in 2018.  Decreased interest income on U.S. Government agencies of $1,000 was primarily due to a decrease in volume of $531,000.

Tax-exempt municipal securities experienced a decrease in yield due to the 2017 Tax Reform Act of approximately 62 basis points and is the primary contributing factor to the $149,000 decline in interest income; also contributing was a decrease in average balances of $4,092,000.  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 2018.  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 decreased $6,000 with an eight-basis point increase in average yield which partially offset the $8,969,000 decrease in average balances.  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.

Dividends on equity securities increased $17,000, as the average balance increased $3,186,000, or 46.0%, more than offset the decrease in yield of 31 basis points when comparing the quarters ended June 30, 2018 and 2017.  

Income on loans increased $1,348,000 to $8,581,000 when comparing the second quarters of 2018 and 2017, with a 13.3% growth in average balances contributing an increase in interest income of $972,000. Despite increases in the prime rate in June and December of 2017 and March and June of 2018, competitive pressures result in new loans being originated at lower 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 $634,000 primarily due to the 10.1% increase in average balances. Average balances increased $39,161,000, to $427,120,000 for the quarter ended June 30, 2018 compared with the same quarter in 2017. The yield on commercial real estate loans increased 20 basis points from 4.41% in 2017 to 4.61% in 2018.  

46


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

Income on commercial and industrial loans increased $493,000. Average balances increased $31,142,000, or 25.0%, to $155,505,000 for the second quarter of 2018 resulting in a $360,000 increase in income. The average yield on these loans increased 35 basis points to 4.98% resulting in an increase in income of $133,000. Many of the loans in this category are indexed to the prime interest rate, which increased by 75 basis points since June 30, 2017.

Tax-exempt loan income was $325,000 for the second quarter of 2018, a decrease of $21,000 from the same period in 2017. As with municipal marketable securities, there was a decrease in yield due to the 2017 Tax Reform Act.  The yield on municipal loans decreased 76 basis points, to 3.21% for the second quarter of 2018, compared with the same period in 2017, resulting in decrease of $77,000 in interest income.  This was partially offset by an increase in average balances of $5,759,000, or 16.5%, to $40,686,000 for the second quarter of 2018, resulting in an increase of $56,000 in income.

QNB desires to become the “local consumer lender of choice” and to effect 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 overall retail lending: residential mortgage, home equity and consumer loans.  Average residential mortgage loans secured by first lien 1-4 family residential mortgages increased by $11,634,000, or 23.6%, to $60,830,000 for the second quarter of 2018 compared to the same period in 2017. Over this same timeframe, the average yield on the portfolio decreased two basis points to 3.82% for the second quarter of 2018. The combined result was a net increase in interest income of $108,000. Average home equity loans increased slightly by $476,000, or 0.7%, to $66,298,000 while the average yield increased 68 basis points to 4.46% resulting in an increase in interest income of $115,000. Average consumer loans increased $611,000, or 9.4%, to $7,105,000 and the yield on the portfolio increased 57 basis points to 5.95% for the second quarter of 2018 resulting in a combined $19,000 increase in interest income.

Earning assets are funded by deposits and borrowed funds.  Interest expense increased $528,000, when comparing the second quarter of 2018 to the same period in 2017.  The growth in average deposits continues to be centered in accounts with greater liquidity, such as non-interest and interest-bearing demand and savings deposits. Average non-interest-bearing demand accounts increased $14,559,000, or 12.2%, to $133,454,000 for the second quarter of 2018. QNB has been successful in increasing both personal and business checking accounts.  Average interest-bearing demand accounts increased $14,948,000, or 8.7%, to $186,532,000 for the second quarter of 2018. Interest expense on interest-bearing demand accounts increased $20,000 to $108,000 for the same period, as the average rate paid increased two basis points to 0.23% for the second quarter of 2018. Included in this category is QNB-Rewards checking, a higher-rate checking account product that pays 1.25% on balances up to $25,000 and 0.40% 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 second quarter of 2018, the average balance in this product was $56,627,000 and the related interest expense was $85,000 for an average yield of 0.60%. In comparison, the average balance of the QNB-Rewards accounts for the second quarter of 2017 was $51,815,000 with a related interest expense of $70,000 and an average rate paid of 0.54%. 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 $119,769,000 for the second quarter of 2017 to $129,905,000 for the second quarter of 2018. The average rate paid on these balances was 0.07% for the 2018 quarter compared to 0.06% for the same period in 2017.

Interest expense on municipal interest-bearing demand accounts increased $188,000 to $328,000 for the second quarter of 2018. The average balance of municipal interest-bearing demand accounts increased $6,813,000, or 7.4%, to $99,001,000, with the average interest rate paid on these accounts increasing 72 basis points to 1.33% for the second quarter of 2018.  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 decreased $14,963,000, or 16.1%, to $77,903,000 for the second quarter of 2018 compared with the same period in 2017. Interest expense on money market accounts decreased $14,000 to $62,000, while the average interest rate paid on money market accounts decreased one basis point to 0.32% for the second quarter of 2018.  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 $91,000 when comparing the second quarter of 2018 to the second quarter of 2017, and the average rate increased 12 basis points to 0.56% when comparing both periods. When comparing these same periods, average savings accounts increased $9,841,000, or 3.9%, to $263,365,000 for the second quarter of 2018 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

47


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

deposits, with average balances for the second quarter of 2018 of $190,063,000. This product has grown successfully since its introduction in the third quarter of 2009. The average yield paid on these accounts was 0.71% for the first quarter of 2018 and 0.55% for the same period in 2017. 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 $4,439,000, or 6.4%, when comparing the first quarter of 2018 average to the same period in 2017.

Total interest expense on total time deposits totaled $794,000 for the second quarter of 2018 compared to $700,000 in 2017. Average total time deposits increased by $3,610,000 to $226,745,000 for the second quarter of 2018. 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 total time deposits increased 14 basis points from 1.26% to 1.40% when comparing the second quarter of 2017 to the same period in 2018.

Approximately $92,217,000, or 41%, of time deposits at June 30, 2018 will mature over the next 12 months. The average rate paid on these time deposits is approximately 0.92%. 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 primarily comprised of sweep accounts structured as repurchase agreements with our commercial customers and overnight FHLB borrowings. Interest expense on short-term borrowings increased $149,000 for the second quarter of 2018 to $201,000 when compared to the same period in 2017. When comparing these same periods, average balances increased from $23,476,000 to $67,841,000, primarily due to an increase in average FHLB borrowings of $26,199,000, while the average rate paid increased 73 basis points to 1.19% for the second quarter of 2018.

 

Net Interest Income and Net Interest Margin – Six-Month Comparison

 

For the six-month period ending June 30, 2018 average earning assets increased $78,255,000, or 7.4%, to $1,133,166,000, with average loans increasing 14.4% and average investment securities decreasing 3.3%. Average total deposits increased $52,950,000, or 5.7%, to $985,333,000 for the six-month period ended June 30, 2018 compared to the same period in 2017. The net interest margin on a tax-equivalent basis was 3.18% for the six-month period ended June 30, 2018, a two-basis point increase from the same period in 2017.

 

Total interest income on a tax-equivalent basis increased $2,368,000, or 12.4%, from $19,105,000 to $21,473,000, when comparing the six-month periods ended June 30, 2017 and June 30, 2018 due to the additional interest income generated from the growth in earning assets combined with the impact of improved yields on some of those assets. Interest income increased $1,939,000 as a result of volume increases, and $429,000 as a result of better yields. The analysis of the six-month comparison periods is similar to what was described in the quarterly analysis.

 

The yield on earning assets increased from 3.65% to 3.82% for the six-month periods with the yield on loans up 16 basis points to 4.59%. QNB continues to experience pressure on yields due to historically low levels of interest rates over the past several years and competitive pressures on loan pricing. The yield on investments, including trading securities, decreased eight basis points from 2.38% to 2.30% when comparing the six-month periods.

 

Total interest expense increased $990,000 for the six-month period ended June 30, 2018 compared with the same period in 2017, attributable to the increase in deposits into higher-earning interest-bearing DDA, as well as rate increases in the eSavings, Rewards checking, and municipal deposits, which are correlated to changes in the Fed Funds target rate. The average rate paid on interest bearing deposits increased 15 basis point to 0.76% for the six-month period ended June 30, 2018 versus the first half of 2017.  QNB Bank funded short-term cash needs with increased Federal Home Loan Bank borrowings in the first half of 2018 compared with the same period in 2017; the total short-term borrowing rate increased 59 basis points, which also contributed to the increase in interest expense.  The yield on interest-bearing liabilities rose 18 basis points to 0.78% for the first half of 2018.

 

48


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

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 $187,000 and $375,000 in provision for loan losses in the second quarter and first six months of 2018, compared with $300,000 and $600,000 for the same periods in 2017, respectively.  QNB's allowance for loan losses of $8,192,000 represents 1.05% of loans receivable at June 30, 2018 compared with an allowance for loan losses of $7,841,000, or 1.07% of loans receivable, at December 31, 2017, and $8,035,000, or 1.16% of loans receivable at June 30, 2017. Management believes the allowance for loan losses at June 30, 2018 is adequate as of that date based on its analysis of known and inherent losses in the portfolio.

Net charge-offs were $32,000 and $24,000 for the three and six months ended June 30, 2018, respectively, compared with net recoveries of $16,000 and $41,000, respectively, for the same periods in 2017.  Annualized net charge-offs as a percentage of average loans receivable were 0.02% and 0.01% for the three and six months ended June 30, 2018, respectively, compared with annualized recoveries as a percentage of loans receivable of 0.01% for the same periods in 2017.

Non-performing assets of $7,987,000 at June 30, 2018 compares favorably with $9,242,000 as of December 31, 2017 and $10,846,000 as of June 30, 2017.  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 1.02% of loans receivable at June 30, 2018 compared with 1.26% of loans receivable at December 31, 2017.  At June 30, 2017, non-performing loans totaled $10,846,000, or 1.56% of loans receivable. 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 June 30, 2018, $3,512,000, or approximately 52%, of the loans classified as non-accrual are current or past due less than 30 days. Loans classified as substandard or doubtful totaled $18,199,000, an increase of $1,552,000, or 9.3%, from the $16,647,000 reported at December 31, 2017 and a increase of $643,000, or 3.7%, from the $17,556,000 reported at June 30, 2017.

QNB had $23,000 in loans past due 90 days or more and still accruing interest at June 30, 2018, compared to $0 at December 31, 2017 and June 30, 2017. Total loans 30 days or more past due, which includes non-accrual loans by actual number of days delinquent, represented 0.59% of loans receivable at June 30, 2018 compared with 0.58% at December 31, 2017 and 0.30% at June 30, 2017.  The majority of the increase in the ratio of delinquent to total loans is due to one commercial relationship.

Troubled debt restructured loans, not classified as non-accrual loans or loans past due 90 days or more and accruing, were $1,233,000 at June 30, 2018, compared with $1,321,000 at December 31, 2017, and $1,393,000 at June 30, 2017. There was one newly identified troubled debt restructuring in the six months ended June 30, 2018, a non-accruing home equity loan. QNB had no other real estate owned or repossessed assets as of June 30, 2018, December 31, 2017, or June 30, 2017.  

 

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

49


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

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:

 

 

 

June 30,

 

 

December 31,

 

 

June 30,

 

 

 

2018

 

 

2017

 

 

2017

 

Non-accrual loans

 

$

6,731

 

 

$

7,921

 

 

$

9,453

 

Loans past due 90 days or more and still accruing interest

 

 

23

 

 

 

 

 

 

 

Troubled debt restructured loans (not already included above)

 

 

1,233

 

 

 

1,321

 

 

 

1,393

 

Total non-performing loans

 

 

7,987

 

 

 

9,242

 

 

 

10,846

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

Average total loans (YTD)

 

$

750,828

 

 

$

682,292

 

 

$

656,026

 

Total loans

 

 

779,886

 

 

 

733,283

 

 

 

695,213

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

 

8,192

 

 

 

7,841

 

 

 

8,035

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses to:

 

 

 

 

 

 

 

 

 

 

 

 

Non-performing loans

 

 

102.57

%

 

 

84.84

%

 

 

74.09

%

Total loans (excluding held-for-sale)

 

 

1.05

%

 

 

1.07

%

 

 

1.16

%

Average total loans

 

 

1.09

%

 

 

1.15

%

 

 

1.22

%

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

1.02

%

 

 

1.26

%

 

 

1.56

%

Non-performing assets / total assets

 

 

0.68

%

 

 

0.80

%

 

 

0.97

%

 

An analysis of net loan recoveries for the three and six months ended June 30, 2018 compared to 2017 is as follows:

 

 

 

Three months

ended June 30,

 

 

Six months

ended June 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Net recoveries

 

$

32

 

 

$

(16

)

 

$

24

 

 

$

(41

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net annualized recoveries charge-offs to:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans

 

 

0.02

%

 

 

(0.01

%)

 

 

0.01

%

 

 

(0.01

%)

Average total loans excluding held-for-sale

 

 

0.02

%

 

 

(0.01

%)

 

 

0.01

%

 

 

(0.01

%)

Allowance for loan losses

 

 

1.57

%

 

 

(0.81

%)

 

 

0.59

%

 

 

(1.03

%)

50


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

At June 30, 2018 and December 31, 2017, the recorded investment in loans for which impairment has been identified totaled $11,989,000 and $13,584,000 of which $10,335,000 and $11,125,000, respectively, required no specific allowance for loan loss. The recorded investment in impaired loans requiring an allowance for loan losses was $1,654,000 and $2,459,000 at June 30, 2018 and December 31, 2017, respectively, and the related allowance for loan losses associated with these loans was $1,208,000 and $1,392,000, respectively. Most of the loans that have been identified as impaired are collateral-dependent. See Note 8 to the Notes to Consolidated Financial Statements for additional detail of impaired loans.

NON-INTEREST INCOME

 

Non-Interest Income Comparison

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months

 

 

Change from

 

 

Six months

 

 

Change from

 

 

 

ended June 30,

 

 

prior year

 

 

ended June 30,

 

 

prior year

 

 

 

2018

 

 

2017

 

 

Amount

 

 

Percent

 

 

2018

 

 

2017

 

 

Amount

 

 

Percent

 

Net gain on sales of investment securities

 

$

48

 

 

$

115

 

 

$

(67

)

 

 

-58.3

%

 

$

133

 

 

$

864

 

 

$

(731

)

 

 

-84.6

%

Unrealized gain (loss) on investment equity securities

 

 

41

 

 

 

 

 

 

41

 

 

N/M

 

 

 

(205

)

 

 

 

 

 

(205

)

 

N/M

 

Net gain on trading activity

 

 

 

 

 

10

 

 

 

(10

)

 

N/M

 

 

 

 

 

 

27

 

 

 

(27

)

 

N/M

 

Fees for services to customers

 

 

408

 

 

 

421

 

 

 

(13

)

 

 

(3.1

)

 

 

829

 

 

 

813

 

 

 

16

 

 

 

2.0

 

ATM and debit card

 

 

487

 

 

 

449

 

 

 

38

 

 

 

8.5

 

 

 

917

 

 

 

866

 

 

 

51

 

 

 

5.9

 

Retail brokerage and advisory

 

 

105

 

 

 

104

 

 

 

1

 

 

 

1.0

 

 

 

208

 

 

 

207

 

 

 

1

 

 

 

0.5

 

Bank-owned life insurance

 

 

69

 

 

 

120

 

 

 

(51

)

 

 

(42.5

)

 

 

137

 

 

 

191

 

 

 

(54

)

 

 

(28.3

)

Merchant

 

 

82

 

 

 

92

 

 

 

(10

)

 

 

(10.9

)

 

 

156

 

 

 

172

 

 

 

(16

)

 

 

(9.3

)

Net gain on sale of loans

 

 

37

 

 

 

201

 

 

 

(164

)

 

 

(81.6

)

 

 

44

 

 

 

251

 

 

 

(207

)

 

 

(82.5

)

Other

 

 

177

 

 

 

103

 

 

 

74

 

 

 

71.8

 

 

 

302

 

 

 

214

 

 

 

88

 

 

 

41.1

 

Total

 

$

1,454

 

 

$

1,615

 

 

$

(161

)

 

 

-10.0

%

 

$

2,521

 

 

$

3,605

 

 

$

(1,084

)

 

 

-30.1

%

Quarter to Quarter Comparison

Total non-interest income for the second quarter of 2018 was $1,454,000, a decrease of $161,000, compared to $1,615,000 for the second quarter of 2017. Excluding net gains on investment securities, trading activities and sale of loans for both periods, total non-interest income increased 3.0% to $1,328,000 for the second quarter of 2018 compared to $1,289,000 for the second quarter of 2017.

Net gains on investment securities decreased $67,000 from $115,000 in second quarter of 2017 to $48,000 in second quarter of 2018.  Gain on investments are primarily derived from sale of equity securities.  Market conditions in the equities market for the quarter ended June 30, 2018 versus the same period in 2017 resulted in fewer opportunities for profitable sales.  The adoption of Accounting Standard Update 2016-01 (ASU 2016-01) effective January 1, 2018 requires the Company to record unrealized gains or losses on equity securities through earnings, rather than in other comprehensive income (loss), a component of shareholders’ equity.  Unrealized gains on equity securities were $41,000 for the second quarter of 2018.  The Bank redeemed the trading investment portfolio in its entirety during the second quarter of 2017, therefore no income in 2018 compared with the same period in 2017.

QNB originates residential mortgage loans for sale in the secondary market.  Net gain on sale of residential mortgage loans decreased $65,000 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 $1,344,000 and $2,652,000 for the second quarters of 2018 and 2017, respectively.  QNB recognized a $99,000 gain on sale of a non-performing loan during the second quarter of 2017.

Fees for services to customers decreased $13,000, or 3.1%, to $408,000 at June 30, 2018, due primarily to an decrease in net overdraft income.  ATM and debit card income increased $38,000, or 8.5%, to $487,000 for the second quarter of 2018, compared to the same period in 2017, due to increases in card-based transactions and expansion of checking account households.

Bank-owned life insurance included a life insurance benefit of $51,000 in the second quarter of 2017.  Other non-interest income increased $74,000, or 71.8%, due to a sales tax refund of $57,000 in 2018, increased letter of credit income and mortgage servicing fees.  

Six-Month Comparison

51


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

Total non-interest income for the six-month periods ended June 30, 2018 and 2017 was $2,521,000 and $3,605,000, respectively, a decrease of $1,084,000, or 30.1%. Excluding net gains on investment securities, trading activities and loans for both periods total non-interest income was $2,549,000 and $2,463,000, an increase of $86,000.

Net investment securities gains decreased $731,000 to $133,000 for the six months ended June 30, 2018 compared to $864,000 for the comparable six months in 2017. Market conditions in the equities market for the six months ended June 30, 2018 versus the same period in 2017 resulted in fewer opportunities for profitable sales.   Under ASU 2016-01, QNB recorded unrealized losses on equity securities of $205,000 for the six months ended June 30, 2018.

Excluding the $99,000 gain on note sale during 2017, net gains on the sale of loans decreased $108,000 to $44,000, when comparing the six months ended June 30, 2018 to the same period in 2017.  Proceeds from the sale of residential mortgages were $1,949,000 and $4,675,000 for the six-month periods ended June 30, 2018 and 2017, respectively.

ATM and debit card income, and fees for services to customers increased for the first six months of 2018 compared to 2017, for reasons detailed in the quarterly comparison.

NON-INTEREST EXPENSE

 

Non-Interest Expense Comparison

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months

 

 

Change from

 

 

Six months

 

 

Change from

 

 

 

ended June 30,

 

 

prior year

 

 

ended June 30,

 

 

prior year

 

 

 

2018

 

 

2017

 

 

Amount

 

 

Percent

 

 

2018

 

 

2017

 

 

Amount

 

 

Percent

 

Salaries and employee benefits

 

$

3,627

 

 

$

3,237

 

 

$

390

 

 

 

12.0

%

 

$

6,972

 

 

$

6,323

 

 

$

649

 

 

 

10.3

%

Net occupancy

 

 

448

 

 

 

425

 

 

 

23

 

 

 

5.4

 

 

 

919

 

 

 

876

 

 

 

43

 

 

 

4.9

 

Furniture and equipment

 

 

563

 

 

 

456

 

 

 

107

 

 

 

23.5

 

 

 

1,050

 

 

 

885

 

 

 

165

 

 

 

18.6

 

Marketing

 

 

221

 

 

 

307

 

 

 

(86

)

 

 

(28.0

)

 

 

531

 

 

 

536

 

 

 

(5

)

 

 

(0.9

)

Third-party services

 

 

506

 

 

 

407

 

 

 

99

 

 

 

24.3

 

 

 

916

 

 

 

801

 

 

 

115

 

 

 

14.4

 

Telephone, postage and supplies

 

 

173

 

 

 

199

 

 

 

(26

)

 

 

(13.1

)

 

 

354

 

 

 

399

 

 

 

(45

)

 

 

(11.3

)

State taxes

 

 

164

 

 

 

155

 

 

 

9

 

 

 

5.8

 

 

 

335

 

 

 

348

 

 

 

(13

)

 

 

(3.7

)

FDIC insurance premiums

 

 

146

 

 

 

134

 

 

 

12

 

 

 

9.0

 

 

 

321

 

 

 

275

 

 

 

46

 

 

 

16.7

 

Other

 

 

685

 

 

 

622

 

 

 

63

 

 

 

10.1

 

 

 

1,313

 

 

 

1,087

 

 

 

226

 

 

 

20.8

 

Total

 

$

6,533

 

 

$

5,942

 

 

$

591

 

 

 

9.9

%

 

$

12,711

 

 

$

11,530

 

 

$

1,181

 

 

 

10.2

%

 

Quarter to Quarter Comparison

Total non-interest expense was $6,533,000 for the second quarter of 2018, an increase of $591,000, or 9.9%, compared to the second quarter of 2017.

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 $390,000, or 12.0%, to $3,627,000 when comparing the two quarters.  Salary expense and related payroll taxes increased $167,000, or 5.9%, to $2,989,000 during the second quarter 2018 compared to the same period in 2017 due to additions to staff.  Benefits expense increased $223,000, or 53.7%, to $638,000, due primarily to increased medical insurance claims comparing the two quarters.

Net occupancy and furniture and equipment expense increased $130,000, or 14.8%, to $1,011,000, due to the relocation of the Warminster loan facility to a new full-service branch, as well as, the renovation of the operations center.  Building and equipment maintenance expense increased $54,000, depreciation expense increased $19,000, and computer software amortization and maintenance expense increased $43,000, when comparing the two quarters.  Marketing expense decreased $86,000, or 28.0%, to $221,000 for the quarter ended June 30, 2018. This was due to the timing of sponsorships and donations made in the first quarter of 2018 versus in the second quarter of 2017.

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

52


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

services, IT services, statement printing and mailing, investment security safekeeping and supply management services. Third party services expense increased $99,000 when comparing the two periods, due primarily to legal fees and IT services.

Telephone and postage and supplies expenses decreased $26,000, or 13.1%, due to decreased data line cost and costs related to debit card conversion in 2017.  FDIC insurance premiums increased $12,000, or 9.0%, due to the change in the assessment rate for the quarter. Other non-interest expense increased $63,000, or 10.1%, due to training and check card expense.  

Six-Month Comparison

Total non-interest expense was $12,711,000 for the six-month period ended June 30, 2018, an increase of $1,181,000, or 10.2%, compared to the first half of 2017.

Salaries and benefits expense increased $649,000 to $6,972,000 for the six months ended June 30, 2018 compared to the same period in 2017, for the same reasons described in the quarter comparison. Salary and related payroll tax expense increased $316,000, or 5.7%, during the period, to $5,840,000 while benefits expense increased $333,000, to $1,132,000, related to increased medical premiums and post-retirement life insurance expense.

Net occupancy and furniture and equipment expense increased $208,000, or 1.8%, to $1,969,000, and third-party services increased $115,000, or 14.4%, to $916,000 for the six months ended June 30, 2018, for the same reasons described in the quarter comparison.

Telephone, postage and supplies expenses decreased in the first six months of 2018 compared to 2017, and FDIC insurance premiums and other non-interest expense increased for the first six months ended June 30, 2017, due to the reasons described in the quarter comparison.  

INCOME TAXES

QNB utilizes an asset and liability approach for financial accounting and reporting of income taxes. As of June 30, 2018, QNB’s net deferred tax asset was $4,523,000. The primary components of deferred taxes are deferred tax assets of $1,720,000 relating to the allowance for loan losses, $2,548,000 related to unrealized losses on available for sale securities, and $324,000 related to non-accrual interest income. As of December 31, 2017, QNB’s net deferred tax asset was $3,319,000. The primary difference in the balance of net deferred tax assets when comparing June 30, 2018 to December 31, 2017 is the increase in deferred tax asset due to increased unrealized losses on available for sale securities.

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 $572,000 for the quarter and $1,129,000 for the six months ended June 30, 2018, compared to $845,000 and $1,967,000 for the same periods in 2018. The effective tax rate for second quarter and year-to-date 2018 was 16.7% and 16.3%, respectively, compared with 26.2% and 27.3% for the same periods in 2017. This decrease in effective tax rate in 2018 is due primarily to a reduced corporate tax rate from 34% to 21%, resulting from the Tax Cuts and Jobs Act, effective January 1, 2018.

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 2018. It is also anticipated that the rate competition for attracting and retaining deposits will continue to increase in 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.

53


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

Total assets at June 30, 2018 were $1,172,874,000 compared with $1,152,337,000 at December 31, 2017.  Cash and cash equivalents decreased $4,605,000 from $16,331,000 at December 31, 2017 to $11,726,000 at June 30, 2018, due primarily to growth in loans.

The composition of the investment portfolio is essentially unchanged since December 31, 2017.  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 one CDO in the form of a pooled trust preferred security, with a fair value of $118,000. PreTSL IV represents the senior-most obligation of the trust.

Loans receivable grew $46,603,000, or 6.4%, with commercial loans increasing $39,685,000, or 6.7%, to $634,689,000 at June 30, 2018, compared with $595,004,000 at year-end 2017.  Retail loan balances grew $6,908,000, to $144,982,000, when comparing June 30, 2018 to December 31, 2017.

Deposits declined $8,222,000 to $985,726,000 at June 30, 2018. Municipal interest-bearing demand balances decreased $21,056,000, or 17.8%, to $97,108,000.  Municipal deposits can be volatile depending on the timing of deposits and withdrawals, and the cash flow needs of the school districts or municipalities.  Interest-bearing demand balances, excluding municipal deposits, grew $9,834,000, or 5.5%, to $189,140,000, with the Rewards checking and Select 50 products providing $8,162,000 of the growth. Savings balances increased $3,702,000 from December 31, 2017 to June 30, 2018.  Non-interest-bearing demand balances increased $6,270,000 to $135,482,000 at June 30, 2018, due to both personal and business deposits.  Money market balances declined $4,509,000, or 5.3%, to $80,053,000 as depositors moved to high-yielding savings accounts.  Time deposits decreased $2,463,000 from December 31, 2017 to June 30, 2018.  It is anticipated that total deposits will increase during the third quarter as tax money received from the local school districts flows in during September, then declines 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 increased 53.6%, from $55,756,000 at December 31, 2017 to $85,646,000 at June 30, 2018. Commercial sweep accounts decreased $2,650,000, as these funds may be volatile based on businesses’ receipt and disbursement of funds.  Overnight borrowings from FHLB increased $32,540,000 to $46,451,000 to support loan growth.

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 June 30, 2018, the Bank had a maximum borrowing capacity with the FHLB of approximately $259,700,000, net of the $46,451,000 in overnight borrowings and a $350,000 letter of credit at June 30, 2018. 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 June 30, 2018, there were no outstanding borrowings under these lines.  During the second quarter of 2018, 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, available-for-sale and equity investment securities, and loans held-for-sale have decreased $29,952,000 since December 31, 2017, totaling $365,924,000 at June 30, 2018. Proceeds from sales, call and maturities of debt securities available-for-sale and the issuance of short-term borrowings have 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 or mature and cash flow on

54


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

mortgage-backed and CMO securities continues to be steady, although cash flow available from the investment portfolio decreased in 2018 compared to 2017, as a result of interest rates rising.

Approximately $187,915,000 and $202,887,000 of available-for-sale debt securities at June 30, 2018 and December 31, 2017, 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 June 30, 2018 was $97,818,000, or 8.34% of total assets, compared with shareholders' equity of $98,570,000, or 8.55% of total assets, at December 31, 2017. Shareholders’ equity at June 30, 2018 and December 31, 2017 included a negative adjustment of $9,587,000 and $4,086,000, 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 9.08% and 8.88% at June 30, 2018 and December 31, 2017, respectively.

Average shareholders' equity and average total assets were $106,073,000 and $1,165,356,000 for the six months ended June 30, 2018, an increase of 4.5% and 4.3%, respectively, from the averages for the year ended December 31, 2017. The ratio of average total equity to average total assets was 9.1% for both the six months ended June 30, 2018 and for all 2017. 

Retained earnings at June 30, 2018 were impacted by six months of net income totaling $5,797,000 partially offset by dividends declared and paid of $2,212,000 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 $429,000 to capital during the six months ended June 30, 2018.  

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 June 30, 2018, 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 capital. 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 of the 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.

On May 24, 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act was enacted into law. which provides certain modifications to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which will provide

55


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

regulatory relief for smaller and certain regional banking organizations.  Section 214 statutorily prescribes that the Federal banking agencies may only require depository institutions to apply a heightened risk-weight to exposures that are “high volatility commercial real estate” (HVCRE) if the exposures meet the definition of a HVCRE Acquisition, Development or Construction (ADC) loan as set forth in that section.  The new definition applies to a narrower scope of exposures.  The new definition of HVCRE ADC loan excludes loans made prior to January 1, 2015, amends the loan-to-value/capital contribution exemption, the loan must primarily finance the property, have the purpose of providing financing to acquire, develop or improve such real property in income-producing property and is dependent upon future income or sales proceeds or refinancing of such property to repay the loan.  Once the property sufficiently produces cash-flows to support the debt service and expenses in accordance with the bank’s underwriting criteria for permanent financing, the loan it meets the exemption as a HVCRE ADC loan.  Under the new definition, QNB’s was able to move certain HVCRE loans from the 150% to the 100% risk-weighted category as of June 30, 2018; resulting in a favorable increase to its regulatory capital ratios of approximately 5 basis points.  

The following table sets forth consolidated information for QNB Corp.

 

 

 

June 30,

 

 

December 31,

 

Capital Analysis

 

2018

 

 

2017

 

Regulatory Capital

 

 

 

 

 

 

 

 

Shareholders' equity

 

$

97,818

 

 

$

98,570

 

Net unrealized securities losses, net of tax

 

 

9,587

 

 

 

4,086

 

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

   net of tax

 

 

 

 

 

(212

)

Disallowed intangible assets

 

 

(8

)

 

 

(6

)

Common equity tier I capital

 

 

107,397

 

 

 

102,438

 

 

 

 

 

 

 

 

 

 

Tier I capital

 

 

107,397

 

 

 

102,438

 

Allowable portion: Allowance for loan losses and reserve

   for unfunded commitments

 

 

8,265

 

 

 

7,914

 

Unrealized gains on equity securities, net of tax

 

 

 

 

 

 

Total regulatory capital

 

$

115,662

 

 

$

110,352

 

Risk-weighted assets

 

$

910,768

 

 

$

881,503

 

Quarterly average assets for leverage capital purposes

 

$

1,166,375

 

 

$

1,153,721

 

 

 

 

June 30,

 

 

December 31,

 

Capital Ratios

 

2018

 

 

2017

 

Common equity tier I capital / risk-weighted assets

 

 

11.79

%

 

 

11.62

%

Tier I capital / risk-weighted assets

 

 

11.79

%

 

 

11.62

%

Total regulatory capital / risk-weighted assets

 

 

12.70

%

 

 

12.52

%

Tier I capital / average assets (leverage ratio)

 

 

9.21

%

 

 

8.88

%

 

At June 30, 2018, common equity Tier I, Tier I capital, total regulatory capital and leverage ratios improved slightly from December 31, 2017. The Company remains well-capitalized by all applicable regulatory requirements as of June 30, 2018.

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.

56


QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

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  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 June 30, 2018 is liability sensitive. Management expects that market interest rates will continue with gradual increases 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 June 30, 2018 and 2017 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

 

June 30,

 

(in basis points)

 

2018

 

 

2017

 

+300

 

 

(10.08

%)

 

 

(8.81

%)

+200

 

 

(6.60

%)

 

 

(5.77

%)

+100

 

 

(3.15

%)

 

 

(2.69

%)

-100

 

 

(0.02

%)

 

 

(5.78

%)

 

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.

QNB is not subject to foreign currency exchange or commodity price risk. At June 30, 2018, QNB did not have any hedging transactions in place such as interest rate swaps, caps or floors.

 

 

 

57


 

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.

 

 

58


 

QNB CORP. AND SUBSIDIARY

PART II. OTHER INFORMATION

JUNE 30, 2018

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, 2017.

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 June 30, 2018. 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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

April 1, 2018 through April 30, 2018

 

 

 

 

 

 

 

 

 

 

 

42,117

 

May 1, 2018 through May 31, 2018

 

 

 

 

 

 

 

 

 

 

 

42,117

 

June 1, 2018 through June 30, 2018

 

 

 

 

 

 

 

 

 

 

 

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.

 

 

59


 

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.

 

 

60


 

SIGNATURES

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

 

 

QNB Corp.

 

 

 

 

Date:         August 8, 2018          

By:

 

/s/ David W. Freeman

 

 

 

David W. Freeman

 

 

 

Chief Executive Officer

 

 

 

 

Date:         August 8, 2018          

By:

 

/s/ Janice McCracken Erkes

 

 

 

Janice McCracken Erkes

 

 

 

Chief Financial Officer

 

 

 

 

Date:         August 8, 2018          

By:

 

/s/ Mary E. Liddle

 

 

 

Mary E. Liddle

 

 

 

Chief Accounting Officer, QNB Bank