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QNBC > SEC Filings for QNBC > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for QNB CORP

Form 10-Q for QNB CORP


14-Nov-2012

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

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

QNB Corp. (herein referred to as "QNB" or the "Company") is a bank holding company headquartered in Quakertown, Pennsylvania. The Company, through its wholly-owned subsidiary, QNB Bank (the Bank), has been serving the residents and businesses of upper Bucks, northern Montgomery and southern Lehigh counties in Pennsylvania since 1877. The Bank is a locally managed community bank that provides a full range of commercial 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 2011 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 the Company's line of business;

The risk that the Federal Deposit Insurance Corporation (FDIC) could levy additional insurance assessments on all insured institutions in order to replenish the Deposit Insurance Fund based on the level of bank failures in the future; 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.

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QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

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 determination of impairment of restricted bank stock, the valuation of deferred tax assets, stock-based compensation and income taxes. QNB bases its estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Other-Than-Temporary Investment Security Impairment

Securities are evaluated periodically to determine whether a decline in their value is other-than-temporary. Management utilizes criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other-than-temporary. The term "other-than-temporary" is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. For equity securities, once a decline in value is determined to be other-than-temporary, the value of the equity security is reduced and a corresponding charge to earnings is recognized.

The Company follows accounting guidance related to the recognition and presentation of other-than-temporary impairment that specifies (a) if a company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss. When an entity does not intend to sell the security, and it is more likely than not, the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment is amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.

There were no credit-related other-than-temporary impairment charges during the first nine months of 2012. During the third quarter and first nine months of 2011 QNB recorded credit related other-than temporary impairment charges of $97,000. These charges relate to losses in the equity securities portfolio.

Allowance for Loan Losses

QNB considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance for loan losses is calculated with the objective of maintaining a level believed by management to be sufficient to absorb probable known and inherent losses in the outstanding loan portfolio. The allowance is reduced by actual credit losses and is increased by the provision for loan losses and recoveries of previous losses. The provisions for loan losses are charged to earnings to bring the total allowance for loan losses to a level considered necessary by management.

The allowance for loan losses is based on management's 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. 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.

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QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

CRITICAL ACCOUNTING POLICIES AND ESTIMATES (Continued)

Allowance for Loan Losses (continued)

Management emphasizes loan quality and close monitoring of potential problem credits. Credit risk identification and review processes are utilized in order to assess and monitor the degree of risk in the loan portfolio. QNB's lending and credit administration staff are charged with reviewing the loan portfolio and identifying changes in the economy or in a borrower's circumstances which may affect the ability to repay debt or the value of pledged collateral. A loan classification and review system exists that identifies those loans with a higher than normal risk of uncollectibility. Each commercial loan is assigned a grade based upon an assessment of the borrower's financial capacity to service the debt and the presence and value of collateral for the loan. An independent loan review group tests risk assessments and evaluates the adequacy of the allowance for loan losses. Management meets monthly to review the credit quality of the loan portfolio and quarterly to review the allowance for loan losses.

In addition, various regulatory agencies, as an integral part of their examination process, periodically review QNB's allowance for loan losses. Such agencies may require QNB to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

Management believes that it uses the best information available to make determinations about the adequacy of the allowance and that it has established its existing allowance for loan losses in accordance with GAAP. If circumstances differ substantially from the assumptions used in making determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be affected. Because future events affecting borrowers and collateral cannot be predicted with certainty, increases to the allowance may be necessary should the quality of any loans deteriorate as a result of the factors discussed above.

Foreclosed Assets

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

Stock-Based Compensation

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

Income Taxes

QNB accounts for income taxes under the asset/liability method in accordance with income tax accounting guidance, ASC 740, Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established against deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become available. Because the judgment about the level of future taxable income is dependent to a great extent on matters that may, at least in part, be beyond QNB's control, it is at least reasonably possible that management's judgment about the need for a valuation allowance for deferred tax assets could change in the near term.

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QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS - OVERVIEW

QNB reported net income for the third quarter of 2012 of $2,074,000, or $0.64 per share on a diluted basis. This compares to net income of $2,322,000, or $0.73 per share on a diluted basis, for the same period in 2011.

For the nine month period ended September 30, 2012, QNB reported net income of $7,050,000, or $2.20 per share on a diluted basis. This compares favorably to the $6,968,000, or $2.21 per share on a diluted basis, reported for the nine month period ended September 30, 2011.

Net income expressed as an annualized rate of return on average assets and average shareholders' equity was 0.90% and 11.59%, respectively, for the quarter ended September 30, 2012 compared with 1.07% and 14.31%, respectively, for the quarter ended September 30, 2011. For the nine month periods the annualized rate of return on average assets and average shareholders' equity was 1.06% and 13.58%, respectively, for the period ended September 30, 2012 compared with 1.12% and 14.88%, respectively, for the period ended September 30, 2011.

Net Interest Income and Net Interest Margin

Net interest income for the quarter ended September 30, 2012 totaled $6,723,000, a decrease of $357,000, or 5.0%, over the same period in 2011. On a linked quarter basis, net interest income decreased by $53,000, or 0.8%. Net interest income continues to be negatively impacted by declining yields on earning assets resulting from the prolonged low interest rate environment and the low level of loan demand by both businesses and consumers. Partially offsetting the impact of declining asset yields on net interest income was the significant growth in earning assets, primarily investment securities.

Average earning assets for the third quarter of 2012 were $884,863,000, an increase of $54,309,000, or 6.5%, compared with the same period in 2011 and an increase of $43,302,000, or 5.2%, from the second quarter of 2012. Average investment securities for the third quarter of 2012 were $379,398,000, an increase of $46,919,000, or 14.1%, from the third quarter of 2011 and an increase of $34,007,000, or 9.8%, from the second quarter of 2012. In comparison, average loans for the third quarter of 2012 were $483,431,000, an increase of $7,882,000, or 1.7%, from the third quarter of 2011 and an increase of $3,079,000, or 0.6%, from the second quarter of 2012.

Funding this growth in earning assets was an increase in deposits. Average deposits for the third quarter of 2012 were $811,180,000, an increase of $66,561,000, or 8.9%, from the corresponding quarter in 2011 and an increase of $40,954,000, or 5.3%, from the second quarter of 2012. QNB has developed significant relationships with many of the school districts and municipalities in the communities it serves. During the third quarter of each year these entities deposit tax receipts resulting in seasonal growth in QNB's deposit balances. Average interest-bearing municipal demand accounts increased $20,868,000, or 29.3%, to $92,025,000 for the third quarter of 2012 compared to the same period in 2011 and increased $36,391,000, or 65.4%, when compared to the second quarter of 2012. Also contributing to the growth in average deposits when comparing the third quarters of 2012 and 2011 was a $37,999,000, or 24.2%, increase in average savings account balances, primarily QNB's eSavings product which pays a very competitive rate of interest. Average interest-bearing demand accounts and average money market accounts increased $10,644,000, or 12.2%, and $6,662,000, or 9.6%, respectively when comparing the two quarters. Offsetting a portion of this growth in funding was a decline in average time deposits of $12,972,000, or 4.4%, and a reduction in average borrowed funds of $16,219,000, or 34.1%, comparing the third quarter 2012 with the same period in 2011. During the second quarter of 2012 the Company paid off $15,000,000 of repurchase agreements with a cost of 4.75%.

The net interest margin for the third quarter of 2012 was 3.26% compared to 3.63% for the third quarter of 2011 and 3.49% for the linked quarter. The historically low interest rate environment of the past few years combined with the change in the mix of earning assets to be more dependent upon investment securities, which generally earn a lower yield than loans, resulted in a decline in the net interest margin. During the beginning of this interest rate cycle, funding costs declined at a faster pace and to a greater degree than rates on earning assets resulting in an increasing net interest margin. However, since the second quarter of 2011 this trend has reversed as funding costs have approached bottom while yields on earning assets continue to reprice lower resulting in a decline in the net interest margin. The growth in municipal balances and the investment of these deposits into short-term agency securities during the third quarter of 2012 also impacted the margin, as these transactions while increasing incremental net interest income do so at a significantly tighter interest rate spread.

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QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS - OVERVIEW (Continued)

The yield on earning assets declined 63 basis points from 4.59% for the third quarter of 2011 to 3.96% for the third quarter of 2012. When comparing the change in the yield on earning assets between the two quarters, loans and investment securities declined from 5.61% and 3.45%, respectively, for the third quarter of 2011 to 5.09% and 2.74%, respectively, for the third quarter of 2012, a decline of 52 basis points and 71 basis points, respectively.

The cost of interest-bearing liabilities declined by 29 basis points from 1.09% for the third quarter of 2011 to 0.80% for the third quarter of 2012. The interest rate paid on interest-bearing deposits declined by 22 basis points to 0.78% for the third quarter of 2012 compared to the third quarter of 2011.

For the nine-month period ended September 30, 2012 net interest income was $20,305,000, a decrease of $883,000, or 4.2%, from the $21,188,000 reported for the first nine months of 2011. The factors that were discussed in the analysis of the quarterly comparison above are also the primary factors in the year-to-date net interest income comparison; strong deposit growth, change in the mix of earning assets with investment securities representing a larger portion of earning assets and a lower net interest margin.

For the nine-month period ended September 30, 2012 average earning assets increased by $51,044,000, or 6.4%, with average loans increasing $5,565,000, or 1.2%, and average investment securities increasing $45,448,000, or 14.7%. Over this same period average funding sources increased $47,085,000, or 6.2%, with average total deposits increasing $59,687,000, or 8.3% and average borrowed funds decreasing $12,602,000.

The net interest margin for the first nine months of 2012 was 3.42%, a decrease of 36 basis points from the 3.78% reported for the same period in 2011. When comparing the nine-month periods ended September 30, 2011 and 2012, the average rate earned on earning assets declined 60 basis points from 4.81% to 4.21%, respectively, with the yield on loans

and investment securities declining by 49 basis points and 65 basis points, respectively. In comparison, the interest rate paid on total average interest-bearing liabilities declined 28 basis points from 1.18% for the first nine months of 2011 to

0.90% for the first nine months of 2012 with the average rate paid on interest-bearing deposits declining 23 basis points from 1.08% to 0.85% comparing the same periods. The decline in the yield on earning assets as well as in the cost of deposits reflects the impact of a long period of historically low interest rates.

Asset Quality, Provision for Loan Loss and Allowance for Loan Loss

QNB closely monitors the quality of its loan portfolio and considers many factors when performing a quarterly analysis of the appropriateness of the allowance for loan losses and calculating the required provision for loan losses. This analysis considers a number of 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.

QNB recorded a provision for loan losses of $300,000 in the third quarter of 2012 compared to no provision for the second quarter of 2012 and $650,000 in the third quarter of 2011. For the nine month periods ended September 30, 2012 and 2011 the provision for loan losses was $600,000 and $1,750,000, respectively. Net loan charge-offs were $51,000 for the third quarter of 2012, or 0.04% annualized of total average loans, compared with net recoveries of $12,000 for the second quarter of 2012, or -0.01% annualized of total average loans, and net loan charge-offs of $633,000 for the third quarter of 2011, or 0.53% annualized of total average loans. For the nine-month periods ended September 30, 2012 and 2011 net loan charge-offs were $124,000, or 0.03% annualized, and $1,838,000, or 0.52% annualized, respectively.

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QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS - OVERVIEW (Continued)

QNB's allowance for loan losses of $9,717,000 represents 2.03% of total loans at September 30, 2012 compared to an allowance for loan losses of $9,241,000, or 1.89% of total loans, at December 31, 2011 and $8,867,000, or 1.87% of total loans, at September 30, 2011.

Asset quality has stabilized over the past year. Total non-performing assets were $24,359,000 at September 30, 2012 compared with $24,145,000 at December 31, 2011 and $24,718,000 at September 30, 2011. Included in this classification are non-performing loans, other real estate owned (OREO) and repossessed assets, and non-accrual pooled trust preferred securities. Total non-performing loans, which represent loans on non-accrual status, loans past due 90 days or more and still accruing interest and troubled debt restructured loans were $21,211,000, or 4.43% of total loans, at September 30, 2012 compared with $21,390,000, or 4.36% of total loans, at December 31, 2011 and $21,956,000, or 4.64% of total loans, at September 30, 2011. Loans on non-accrual status were $18,582,000 at September 30, 2012 compared with $18,597,000 at December 31, 2011 and $19,219,000 at September 30, 2011. 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. Of the total amount of non-accrual loans at September 30, 2012, $14,980,000, or more than 80% of the loans classified as non-accrual, are current or past due less than 30 days as of the end of the quarter.

QNB had other real estate owned and other repossessed assets of $1,187,000 as of September 30, 2012 compared with $826,000 at December 31, 2011 and $884,000 at September 30, 2011. Non-accrual pooled trust preferred securities are carried at fair value which was $1,961,000, $1,929,000, and $1,878,000 at September 30, 2012, December 31, 2011 and September 30, 2011, respectively. The increase in the balance of non-accrual pooled trust preferred securities reflects an improvement in the fair value of these securities.

Non-Interest Income

Total non-interest income was $1,125,000 for the third quarter of 2012, an increase of $43,000 compared with the same period in 2011. Fees for services to customers increased $31,000, or 8.5%, and gains on the sale of residential mortgage loans increased $62,000, or 50.0%, when comparing the three month periods. The increase in fees for services to customers primarily reflects the positive impact of the introduction of an overdraft protection program on net overdraft income, as well as the timing of receipt of real estate tax collection fees. The increase in gains on the sale of loans is a result of historically low mortgage rates which contributed to a significant increase in refinancing activity as well as the amount of gains recorded on the sale of these mortgages. Other non-interest income declined by $63,000 when comparing the three months ended September 30, 2012 with the same period in 2011. Mortgage servicing income declined by $15,000 when comparing the two quarters due to mortgage refinancing activity contributing to a reduction in the value of mortgage servicing assets as well as an increase in the amortization of this asset. During the third quarter of 2012 there was a $39,000 loss recognized on the sale of a property held in other real estate owned. In addition, letter of credit fees declined $22,000 in comparison to the third quarter of prior year.

Total non-interest income for the nine month period ended September 30, 2012 was $4,017,000, an increase of $925,000, or 29.9%, from the amount recorded in 2011. The largest contributor to the overall increase compared to 2011 was gains recognized on the sale of residential mortgage loans which increased $463,000, or 255.8%, to $644,000 due to the amount of refinance activity in 2012 as discussed previously. Net gains on investment securities were $493,000 for the first nine months of 2012 compared with net losses of $21,000 in 2011. For the 2012 period, the net investment gains were primarily related to the sale of equity securities. In 2011, net gains of $76,000 on the sale of investments, primarily equity securities, were offset by other-than-temporary impairment charges of $97,000 on several equity securities. Partially offsetting these increases was a $156,000 decrease in other non-interest income related to mortgage servicing income, letter of credit fees and a loss recognized on the sale of a property held in other real estate owned.

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QNB CORP. AND SUBSIDIARY

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS - OVERVIEW (Continued) . . .

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