QNB CORP
10-Ks and 10-Qs
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
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x
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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for the fiscal year ended
December 31, 2010
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¨
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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for the transition period from ________________ to ________________ .
Commission file number
0-17706
(Exact name of registrant as specified in its charter)
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Pennsylvania
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23-2318082
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State or other jurisdiction of
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(I.R.S. Employer Identification No.)
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incorporation or organization
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15 North Third Street, Quakertown, PA
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18951-9005
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(Address of principal executive offices)
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(Zip Code)
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Registrant’s telephone number, including area code:
(215) 538-5600
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Securities registered pursuant to Section 12(b) of the Act: None.
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Name of each exchange on which registered
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N/A
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Securities registered pursuant to Section 12(g) of the Act:
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Title of class
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Common Stock, $0.625 par value
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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
YES
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NO
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Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
YES
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NO
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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES
þ
NO
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Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES
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NO
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K
þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
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Accelerated filer
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Non-accelerated filer
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Smaller reporting company
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Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES
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NO
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As of February 28, 2011, 3,134,405 shares of common stock of the registrant were outstanding. As of June 30, 2010, the aggregate market value of the common stock of the registrant held by nonaffiliates was approximately $52,929,000 based upon the average bid and asked prices of the common stock as reported on the OTC BB.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of registrant’s Proxy Statement for the annual meeting of its shareholders to be held May 24, 2011 are incorporated by reference in Part III of this report.
FORM 10-K INDEX
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PAGE
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PART I
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Item 1
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Business
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3
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Item 1A
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Risk Factors
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10
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Item 1B
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Unresolved Staff Comments
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14
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Item 2
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Properties
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15
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Item 3
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Legal Proceedings
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15
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Item 4
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[Removed and Reserved]
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15
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PART II
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Item 5
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Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
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16
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Item 6
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Selected Financial Data
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18
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Item 7
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Management’s Discussion and Analysis of Financial Condition and Results of Operations
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18
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Item 7A
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Quantitative and Qualitative Disclosures about Market Risk
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45
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Item 8
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Financial Statements and Supplementary Data
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45
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Item 9
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Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
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81
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Item 9A
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Controls and Procedures
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81
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Item 9B
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Other Information
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81
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PART III
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Item 10
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Directors, Executive Officers and Corporate Governance
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82
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Item 11
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Executive Compensation
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82
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Item 12
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Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
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82
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Item 13
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Certain Relationships and Related Transactions, and Director Independence
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83
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Item 14
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Principal Accounting Fees and Services
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83
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PART IV
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Item 15
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Exhibits, Financial Statement Schedules
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83
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2
FORWARD-LOOKING STATEMENTS
In addition to historical information, this document contains forward-looking statements. Forward-looking statements are typically identified by words or phrases such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project” and variations of such words and similar expressions, or future or conditional verbs such as “will,” “would,” “should,” “could,” “may” or similar expressions. The U.S. Private Securities Litigation Reform Act of 1995 provides a safe harbor in regard to the inclusion of forward-looking statements in this document and documents incorporated by reference.
Shareholders should note that many factors, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference, could affect the future financial results of QNB Corp. 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:
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Volatility in interest rates and shape of the yield curve;
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Credit risk;
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Liquidity risk;
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Operating, legal and regulatory risks;
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Economic, political and competitive forces affecting QNB Corp.’s line of business;
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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
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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.
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QNB Corp. (herein referred to as QNB or the Company) 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 Annual Report on Form 10-K, 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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ITEM 1.
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BUSINESS
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Overview
QNB was incorporated under the laws of the Commonwealth of Pennsylvania on June 4, 1984. QNB is registered with the Board of Governors of the Federal Reserve System as a bank holding company under the Bank Holding Company Act of 1956 and conducts its business through its wholly-owned subsidiary, QNB Bank (the Bank).
Prior to December 28, 2007, the Bank was a national banking association organized in 1877 as Quakertown National Bank and was chartered under the National Banking Act and was subject to Federal and state laws applicable to national banks. Effective December 28, 2007, the Bank became a Pennsylvania chartered commercial bank and changed its name to QNB Bank. The Bank’s principal office is located in Quakertown, Bucks County, Pennsylvania. The Bank also operates eight other full-service community banking offices in Bucks, Montgomery and Lehigh counties in southeastern Pennsylvania.
The Bank is engaged in the general commercial banking business and provides a full range of banking services to its customers. These banking services consist of, among other things, attracting deposits and using these funds in making commercial loans, residential mortgage loans, consumer loans, and purchasing investment securities. These deposits are in the form of time, demand and savings accounts. Time deposits include certificates of deposit and individual retirement accounts. The Bank’s demand and savings accounts include money market accounts, interest-bearing demand accounts including a high-yield checking account, club accounts, traditional statement savings accounts, and a high-yield online savings account.
At December 31, 2010, QNB had total assets of $809,260,000, total loans of $482,182,000, total deposits of $694,977,000 and total shareholders’ equity of $61,090,000. For the year ended December 31, 2010, QNB reported net income of $7,217,000 compared to net income for the year ended December 31, 2009 of $4,227,000.
At February 28, 2011, the Bank had 148 full-time employees and 24 part-time employees. The Bank’s employees have a customer-oriented philosophy, a strong commitment to service and a “sincere interest” in their customers’ success. They maintain close contact with both the residents and local business people in the communities in which they serve, responding to changes in market conditions and customer requests in a timely manner.
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Competition and Market Area
The banking business is highly competitive, and the profitability of QNB depends principally upon the Bank’s ability to compete in its market area. QNB faces intense competition within its market, both in making loans and attracting deposits. The upper Bucks, southern Lehigh, and northern Montgomery counties have a high concentration of financial institutions, including large national and regional banks, community banks, savings institutions and credit unions. Some of QNB’s competitors offer products and services that QNB currently does not offer, such as traditional trust services and full-service insurance. In addition, as a result of consolidation in the banking industry, some of QNB’s competitors may enjoy advantages such as greater financial resources, a wider geographic presence, more favorable pricing alternatives and lower origination and operating costs. However, QNB has been able to compete effectively with other financial institutions by emphasizing the establishment of long-term relationships and customer loyalty. A strong focus on small-business solutions, providing fast local decision-making on loans, exceptional personal customer service and technology solutions, including internet-banking and electronic bill pay, also enable QNB to compete successfully.
Competition for loans and deposits comes principally from commercial banks, savings institutions, credit unions and non-bank financial service providers. Factors in successfully competing for deposits include providing excellent customer service, convenient locations and hours of operation, attractive rates, low fees, and alternative delivery systems. One such delivery system is a courier service offered to businesses to assist in their daily banking needs without having to leave their workplace. Successful loan origination tends to depend on being responsive and flexible to the customers’ needs, as well as the interest rate and terms of the loan. While many competitors within the Bank’s primary market have substantially higher legal lending limits, QNB often has the ability, through loan participations, to meet the larger lending needs of its customers.
QNB’s success is dependent to a significant degree on economic conditions in southeastern Pennsylvania, especially upper Bucks, southern Lehigh and northern Montgomery counties, which it defines as its primary market. The banking industry is affected by general economic conditions, including the effects of recession, unemployment, declining real estate values, inflation, trends in the national and global economies, and other factors beyond QNB’s control.
MONETARY POLICY AND ECONOMIC CONDITIONS
The business of financial institutions is affected not only by general economic conditions, but also by the policies of various governmental regulatory agencies, including the Federal Reserve Board. The Federal Reserve Board regulates money, credit conditions and interest rates to influence general economic conditions primarily through open market operations in U.S. government securities, changes in the discount rate on bank borrowings and changes in the reserve requirements against depository institutions’ deposits. These policies and regulations significantly affect the overall growth and distribution of loans, investments and deposits, as well as the interest rates charged on loans and the interest rates paid on deposits.
The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of financial institutions in the past and are expected to continue to have significant effects in the future. In view of the changing conditions in the economy and the financial markets in addition to the activities of monetary and fiscal authorities, the prediction of future changes in interest rates, credit availability or deposit levels is very challenging.
The recession, which economists suggest began in October 2007, became a major force over the past several years in the United States of America (U.S.) and around the world. In the U.S., the Government provided support for financial institutions that requested it in order to strengthen capital, increase liquidity and ease the credit markets. In the U.S., these actions provided capital for some banks and other financial institutions and generally increased regulations and oversight on virtually all banks. QNB has not requested or received any capital provided by the U.S. Government under these programs.
SUPERVISION AND REGULATION
Banks and bank holding companies operate in a highly regulated environment and are regularly examined by Federal and state regulatory authorities. Federal statutes that apply to QNB and its subsidiary include the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Gramm-Leach-Bliley Act (GLBA), the Bank Holding Company Act of 1956 (BHCA), the Federal Reserve Act and the Federal Deposit Insurance Act (FDIA). In general, these statutes regulate the corporate governance of the Bank and eligible business activities of QNB, certain merger and acquisition restrictions, intercompany transactions, such as loans and dividends, and capital adequacy, among other restrictions. Other corporate governance requirements are imposed on QNB by Federal laws, including the Sarbanes-Oxley Act, described later.
The Company is under the jurisdiction of the Securities and Exchange Commission and of state securities commissions for matters relating to the offering and sale of its securities. In addition, the Company is subject to the Securities and Exchange Commission’s rules and regulations relating to periodic reporting, proxy solicitation and insider trading.
To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by references to the particular statutory or regulatory provisions themselves. Proposals to change banking laws and regulations are frequently introduced in Congress, the state legislatures, and before the various bank regulatory agencies. QNB cannot determine the likelihood of passage or timing of any such proposals or legislation or the impact they may have on QNB and its subsidiary. A change in law, regulations or regulatory policy may have a material effect on QNB and its subsidiary.
4
Bank Holding Company Regulation
QNB is registered as a bank holding company and is subject to the regulations of the Board of Governors of the Federal Reserve System (the Federal Reserve) under the BHCA. In addition, QNB Corp., as a Pennsylvania business corporation, is also subject to the provisions of Section 115 of the Pennsylvania Banking Code of 1965 and the Pennsylvania Business Corporation Law of 1988, as amended.
Bank holding companies are required to file periodic reports with, and are subject to examination by, the Federal Reserve. The Federal Reserve’s regulations require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the Federal Reserve, pursuant to its “source of strength” regulations, may require QNB to commit its resources to provide adequate capital funds to the Bank during periods of financial distress or adversity.
Federal Reserve approval may be required before QNB may begin to engage in any non-banking activity and before any non-banking business may be acquired by QNB.
Regulatory Restrictions on Dividends
Dividend payments made by the Bank to the Company are subject to the Pennsylvania Banking Code, the Federal Deposit Insurance Act, and the regulations of the FDIC. Under the Banking Code, no dividends may be paid except from “accumulated net earnings” (generally retained earnings). The Federal Reserve Board and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions. Under the FDIA, the Bank is prohibited from paying any dividends, making other distributions or paying any management fees if, after such payment, it would fail to satisfy its minimum capital requirements. The Pennsylvania Banking Code restricts the availability of capital funds for payment of dividends by the Bank generally to its accumulated net earnings. See also “Supervision and Regulation – Bank Regulation”.
In addition to the dividend restrictions described above, the banking regulators have the authority to prohibit or to limit the payment of dividends by the Bank if, in the banking regulator’s opinion, payment of a dividend would constitute an unsafe or unsound practice in light of the financial condition of the Bank.
Under Pennsylvania law, QNB may not pay a dividend, if, after giving effect thereto, it would be unable to pay its debts as they become due in the usual course of business and, after giving effect to the dividend, the total assets of QNB would be less than the sum of its total liabilities plus the amount that would be needed, if QNB were to be dissolved at the time of distribution, to satisfy the preferential rights upon dissolution of shareholders whose rights are superior to those receiving the dividend.
It is also the policy of the Federal Reserve that a bank holding company generally only pay dividends on common stock out of net income available to common shareholders over the past year and only if the prospective rate of earnings retention appears consistent with a bank holding company’s capital needs, asset quality, and overall financial condition. In the current financial and economic environment, the Federal Reserve has indicated that bank holding companies should carefully review their dividend policy and has discouraged dividend pay-out ratios at the 100% level unless both asset quality and capital are very strong. A bank holding company also should not maintain a dividend level that places undue pressure on the capital of such institution’s subsidiaries, or that may undermine the bank holding company’s ability to serve as a source of strength for such subsidiaries.
Under these policies and subject to the restrictions applicable to the Bank, to remain “well-capitalized,” the Bank had approximately $6,658,000 available for payment of dividends to the Company at December 31, 2010.
Capital Adequacy
Bank holding companies are required to comply with the Federal Reserve’s risk-based capital guidelines. The required minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least half of total capital must be Tier 1 capital. Tier 1 capital consists principally of common shareholders’ equity, plus retained earnings, less certain intangible assets. The remainder of total capital may consist of the allowance for loan losses, which is considered Tier 2 capital. At December 31, 2010, QNB’s Tier 1 capital and total capital (Tier 1 and Tier 2 combined) ratios were 10.52% and 11.82%, respectively.
In addition to the risk-based capital guidelines, the Federal Reserve requires a bank holding company to maintain a minimum leverage ratio. This requires a minimum level of Tier 1 capital (as determined under the risk-based capital rules) to average total consolidated assets of 4% for those bank holding companies that have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. The Federal Reserve expects all other bank holding companies to maintain a ratio of at least 1% to 2% above the stated minimum. At December 31, 2010, QNB’s leverage ratio was 7.42%.
5
Pursuant to the prompt corrective action provisions of the FDIA, the Federal banking agencies have specified, by regulation, the levels at which an insured institution is considered well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, or critically undercapitalized. Under these regulations, an institution is considered well capitalized if it satisfies each of the following requirements:
• Total risk-based capital ratio of 10% or more,
• Tier 1 risk-based capital ratio of 6% or more,
• Leverage ratio of 5% or more, and
• Not subject to any order or written directive to meet and maintain a specific capital level
At December 31, 2010, the Bank qualified as well capitalized under these regulatory standards. See Note 19 of the Notes to Consolidated Financial Statements included at Item 8 of this Report.
Bank Regulation
As a Pennsylvania chartered, insured commercial bank, the Bank is subject to extensive regulation and examination by the Pennsylvania Department of Banking (the Department) and by the FDIC, which insures its deposits to the maximum extent permitted by law.
The Federal and state laws and regulations applicable to banks regulate, among other things, the scope of their business, their investments, the reserves required to be kept against deposits, the timing of the availability of deposited funds, the nature and amount of collateral for certain loans, the activities of a bank with respect to mergers and consolidations, and the establishment of branches. The laws and regulations governing the Bank generally have been promulgated to protect depositors and not for the purpose of protecting QNB’s shareholders. This regulatory structure also gives the Federal and state banking agencies extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulation, whether by the Department, the FDIC or the United States Congress, could have a material impact on the Company, the Bank and their operations.
As a subsidiary bank of a bank holding company, the Bank is subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to QNB, on investments in the stock or other securities of QNB, and on taking such stock or securities as collateral for loans.
FDIC Insurance Assessments
The Bank’s deposits are insured to the applicable limits as determined by the FDIC, which is currently $250,000 per depositor, with the exception of non-interest bearing transaction accounts which have unlimited coverage through December 31, 2013.
The FDIC has adopted a risk-based premium system that provides for quarterly assessments based on an insured institution’s ranking in one of four risk categories based on their examination ratings and capital ratios. Well-capitalized institutions with the CAMELS ratings of 1 or 2 are grouped in Risk Category I. Deposit insurance premiums are billed quarterly and in arrears. For the quarter beginning January 1, 2009, the FDIC raised the base annual assessment rate for institutions in Risk Category I to between 12 and 14 basis points while the base annual assessment rates for institutions in Risk Categories II, III and IV were increased to 17, 35 and 50 basis points, respectively. For the quarter beginning April 1, 2009 the FDIC set the base annual assessment rate for institutions in Risk Category I to between 12 and 16 basis points and the base annual assessment rates for institutions in Risk Categories II, III and IV at 22, 32 and 45 basis points, respectively. An institution’s assessment rate could be adjusted for several factors: ratio of its long-term unsecured debt to deposits, ratio of certain amounts of Tier 1 capital to adjusted assets, high levels of brokered deposits, high levels of asset growth (other than through acquisitions) and a ratio of brokered deposits to deposits in excess of 10%. An institution’s base assessment rate would also be increased if an institution’s ratio of secured liabilities (including FHLB advances and repurchase agreements) to deposits exceeds 25%.
On May 22, 2009, the FDIC Board of Directors took further action to strengthen the DIF by adopting a final rule imposing a special assessment on insured institutions of 5 basis points on June 30, 2009 (payable at the end of September 2009). The amount of this special assessment for QNB was $332,000. On September 29, 2009, the FDIC adopted an Amended Restoration Plan to allow the DIF to return to a reserve ratio of 1.15% within eight years as mandated by statute, and simultaneously adopted higher annual risk-based assessment rates effective January 1, 2011. In 2009, the DIF’s liquid assets have been used to protect depositors of failed institutions. Because of bank failures and projected bank failures, the FDIC determined that it needed more liquidity to protect depositors. Pursuant to this Amended Plan, the FDIC amended its assessment regulations to require all institutions to prepay, on December 30, 2009, their estimated risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012, as estimated by the FDIC. The assessment paid by the Bank at that time was $3,407,000, of which $2,219,000 remains in a prepaid asset account at December 31, 2010. It will be expensed monthly during the years of 2011 through 2012 based on actual FDIC assessment rate calculations.
Beginning with the second quarter of 2011, as mandated by the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the assessment base that the FDIC will use to calculate assessment premiums will be a bank’s average assets minus average tangible equity. As the asset base of the banking industry is larger than the deposit base, the range of assessment rates will change to a low of 2.5 basis points to a high of 45 basis points, per $100 of assets; however, the dollar amount of the actual premiums is expected to be roughly the same.
6
The FDIC is required under the Dodd-Frank Act to establish assessment rates that will allow the Deposit Insurance Fund to achieve a reserve ratio of 1.35% of Insurance Fund insured deposits by September 2020. In addition, the FDIC has established a “designated reserve ratio” of 2.0%, a target ratio that, until it is achieved, will not likely result in the FDIC reducing assessment rates. In attempting to achieve the mandated 1.35% ratio, the FDIC is required to implement assessment formulas that charge banks over $10 billion in asset size more than banks under that size. Those new formulas begin in the second quarter of 2011, but do not affect the Bank. Under the Dodd-Frank Act, the FDIC is authorized to make reimbursements from the insurance fund to banks if the reserve ratio exceeds 1.50%, but the FDIC has adopted the “designated reserve ratio” of 2.0% and has announced that any reimbursements from the fund are indefinitely suspended.
For the years ended December 31, 2010 and 2009, the Bank recorded $974,000 and $1,151,000, respectively, in FDIC deposit insurance premium expense.
In addition, all insured institutions of the FDIC are required to pay assessments to fund interest payments on Financing Corporation (FICO) bonds. The Financing Corporation was created by Congress to issue bonds to finance the resolution of failed thrift institutions. Prior to 1997, only thrift institutions were subject to assessments to raise funds to pay the FICO bonds; however, beginning in 2000, commercial banks and thrifts are subject to the same assessment for FICO bonds. The FDIC has the authority to set the Financing Corporation assessment rate every quarter. The expense for 2010 and 2009 recorded by QNB was $67,000 and $60,000, respectively. These assessments will continue until the Financing Corporation bonds mature in 2017.
FDIC Temporary Liquidity Guarantee Program
On October 13, 2008, the FDIC established a Temporary Liquidity Guarantee Program under which the FDIC will fully guarantee all non-interest bearing transaction accounts until December 31, 2009 (the “Transaction Account Guarantee Program”) and certain senior unsecured debt of insured depository institutions or their qualified holding companies issued between October 14, 2008 and June 30, 2009 (the “Debt Guarantee Program”). After being extended, the Transaction Account Guarantee Program expired on December 31, 2010. In March 2009, the FDIC extended the Debt Program until October 31, 2009. Further, for any senior debt issued on or after April 1, 2009, the Debt Program will extend the FDIC guarantee until December 31, 2012. The FDIC also adopted new surcharges on debt issued under the Debt Program that have a maturity of one year or more and are issued on or after April 1, 2009. These surcharges will be deposited in the DIF.
All eligible institutions participated in the program without cost for the first 30 days of the program. After November 12, 2008, institutions were assessed at the rate of 10 basis points for transaction account balances in excess of $250,000 and at the rate of between 50 and 100 basis points of the amount of debt issued. Beginning in January 2010, institutions that did not opt out of the Transaction Account Guarantee Program paid an increased assessment rate of 15 basis points for transaction account balances in excess of $250,000. QNB continued to participate in the Transaction Account Guarantee Program, but opted out of participation in the Debt Guarantee Program. Although the Transaction Account Guarantee Program was originally scheduled to expire on December 31, 2009, the FDIC implemented a final rule, effective as of October 1, 2009, extending the Transaction Account Guarantee Program by six months until June 30, 2010 (subject to the option of participating institutions to opt out of such six-month extension). QNB did not choose to opt out of the six-month extension. On April 19, 2010, the FDIC further extended the Transaction Account Guarantee Program through December 31, 2010. QNB continued to participate in the program throughout 2010. Included in the FDIC insurance premium expense noted above are premiums related to this program of $10,000 for 2010 and $7,000 for 2009.
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB), which is one of 12 regional Federal Home Loan Banks. Each Federal Home Loan Bank serves as a reserve or central bank for members within its assigned region. It is funded primarily from funds deposited by member institutions and proceeds from the sale of consolidated obligations of the Federal Home Loan Bank System. It makes loans to members (i.e. advances) in accordance with policies and procedures established by the board of directors of the Federal Home Loan Bank. At December 31, 2010, the Bank had no FHLB advances outstanding.
As a member, the Bank is required to purchase and maintain stock in the FHLB in an amount equal to the greater of 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 5% of its outstanding advances from the FHLB. On October 28, 2010 the FHLB announced their decision to have a limited excess capital stock repurchase. QNB received $115,000 on October 29, 2010. Further repurchases will be evaluated quarterly by the FHLB. At December 31, 2010, the Bank had $2,164,000 in stock of the FHLB which was well in excess of the amount needed to be in compliance with this requirement.
In December 2008, the FHLB notified member banks that it was suspending dividend payments and the repurchase of capital stock to preserve capital. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB. Management believes no impairment charge is necessary related to the FHLB restricted stock as of December 31, 2010.
7
Emergency Economic Stabilization Act of 2008
On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (EESA) was signed into law. EESA, among other measures, authorizes the U.S. Treasury to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies, under a troubled asset relief program, or “TARP.” The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. Under the TARP Capital Purchase Program, the U.S. Treasury purchased equity securities from participating institutions. EESA also temporarily increased federal deposit insurance on most deposit accounts from $100,000 to $250,000. This temporary increase was scheduled to expire on December 31, 2013; however, has been extended indefinitely due to the passage of the Dodd-Frank Act.
Community Reinvestment Act
Under the Community Reinvestment Act (CRA), as amended, the FDIC is required to assess all financial institutions that it regulates to determine whether these institutions are meeting the credit needs of the communities that they serve. The act focuses specifically on low and moderate income neighborhoods. An institution’s record is considered during the evaluation of any application made by such institutions for, among other things:
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Approval of a branch or other deposit facility;
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An office relocation or a merger; and
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Any acquisition of bank shares.
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The CRA, as amended, also requires that the regulatory agency make publicly available the evaluation of the Bank’s record of meeting the credit needs of its entire community, including low and moderate income neighborhoods. This evaluation includes a descriptive rating of either outstanding, satisfactory, needs to improve, or substantial noncompliance, and a statement describing the basis for the rating. The Bank’s most recent CRA rating was satisfactory.
USA Patriot Act
The USA Patriot Act strengthens the anti-money laundering provisions of the Bank Secrecy Act. The Act requires financial institutions to establish certain procedures to be able to identify and verify the identity of its customers. Specifically the Bank must have procedures in place to:
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•
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Verify the identity of persons applying to open an account;
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•
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Ensure adequate maintenance of the records used to verify a person’s identity; and
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•
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Determine whether a person is on any U.S. government agency list of known or suspected terrorists or a terrorist organization.
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Check 21
In October 2003, the Check Clearing for the 21st Century Act, also known as Check 21, became law. Check 21 gives “substitute checks,” such as a digital image of a check and copies made from that image, the same legal standing as the original paper check. Some major provisions of Check 21 include:
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•
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Allowing check truncation without making it mandatory;
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•
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Demanding that every financial institution communicate to account holders in writing a description of its substitute check processing program and their rights under the law;
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•
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Legalizing substitutions for and replacements of paper checks without agreement from consumers;
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•
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Retaining in place the previously mandated electronic collection and return of checks between financial institutions only when individual agreements are in place;
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•
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Requiring that when account holders request verification, financial institutions produce the original check (or a copy that accurately represents the original) and demonstrate that the account debit was accurate and valid; and
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•
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Requiring recrediting of funds to an individual’s account on the next business day after a consumer proves the financial institution has erred.
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Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act is intended to bolster public confidence in the nation’s capital markets by imposing new duties and penalties for non-compliance on public companies and their executives, directors, auditors, attorneys and securities analysts. Some of the more significant aspects of the Act include:
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•
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Corporate Responsibility for Financial Reports - requires Chief Executive Officers (CEOs) and Chief Financial Officers (CFOs) to certify certain matters relating to a company’s financial records and accounting and internal controls.
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•
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Management Assessment of Internal Controls - requires auditors to certify the company’s underlying controls and processes that are used to compile the financial results for companies that are accelerated filers.
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•
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Real-time Issuer Disclosures - requires that companies provide real-time disclosures of any events that may affect its stock price or financial performance, generally within a 48-hour period.
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•
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Criminal Penalties for Altering Documents - provides severe penalties for “whoever knowingly alters, destroys, mutilates” any record or document with intent to impede an investigation. Penalties include monetary fines and prison time.
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The Act also imposes requirements for corporate governance, auditor independence, accounting standards, audit committee member independence and increased authority, executive compensation, insider loans and whistleblower protection. As a result of the Act, QNB adopted a Code of Business Conduct and Ethics applicable to its CEO, CFO and Controller, which meets the requirements of the Act, to supplement its long-standing Code of Ethics, which applies to all directors and employees.
8
QNB’s Code of Business Conduct and Ethics can be found on the Bank’s website at www.qnb.com.
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act)
The Dodd-Frank Act was enacted on July 21, 2010. This new law will significantly change the current bank regulatory structure and affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies.
The Dodd-Frank Act requires various Federal agencies to adopt a broad range of new rules and regulations, and to prepare various studies and reports for Congress. The Federal agencies are given significant discretion in drafting such rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for some time.
Certain provisions of the Dodd-Frank Act are expected to have a near term impact on the Company. For example, effective July 21, 2011, a provision of the Dodd-Frank Act eliminates the Federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse impact on the Company’s interest expense.
The Dodd-Frank Act also broadens the base for Federal Deposit Insurance Corporation insurance assessments. Under the Act, the assessment base will no longer be an institution’s deposit base, but rather its average consolidated total assets less its average tangible equity during the assessment period. The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2013.
Bank and thrift holding companies with assets of less than $15 billion as of December 31, 2009, such as the Company, will be permitted to include trust preferred securities that were issued before May 19, 2010, as Tier 1 capital; however, trust preferred securities issued by a bank or thrift holding company (other than those with assets of less than $500 million) after May 19, 2010, will no longer count as Tier 1 capital. Trust preferred securities still will be entitled to be treated as Tier 2 capital.
The Dodd-Frank Act will require publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” arrangements, and may allow greater access by shareholders to the company’s proxy material by authorizing the SEC to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded.
The Dodd-Frank Act creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets such as the Bank will continue to be examined for compliance with the consumer laws by their primary bank regulators. The Dodd-Frank Act also weakens the Federal preemption rules that have been applicable for national banks and Federal savings associations, and gives state attorneys general the ability to enforce Federal consumer protection laws.
At this time it is difficult to predict the specific impact the Dodd-Frank Act and the yet-to-be written implementing rules and regulations will have on community banks at this time. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on financial institutions’ operations is presently unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.
Possible Future Legislation
Congress is often considering some financial industry legislation, and the Federal banking agencies routinely propose new regulations. The Company cannot predict the future effect any new legislation, or new rules adopted by Federal or state banking agencies will have on the business of the Company and its subsidiaries. Given that the financial industry remains under stress and severe scrutiny, and given that the U.S. economy has not yet fully recovered to pre-crisis levels of activity, the Company expects that there will be significant legislation and regulatory actions that may materially effect the banking industry for the foreseeable future.
9
Additional Information
QNB’s principal executive offices are located at 320 West Broad Street, Quakertown, Pennsylvania. Its telephone number is (215) 538-5600.
This annual report, including the exhibits and schedules filed as part of the annual report on Form 10-K, may be inspected at the public reference facility maintained by the Securities and Exchange Commission (SEC) at its public reference room at 100 F Street, NE, Washington, DC 20549 and copies of all, or any part thereof, may be obtained from that office upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference room, and you can request copies of the documents upon payment of a duplicating fee by writing to the SEC. In addition, the SEC maintains a website that contains reports, proxy and information statements and other information regarding registrants, including QNB, that file electronically with the SEC which can be accessed at www.sec.gov.
QNB also makes its periodic and current reports available, free of charge, on its website, www.qnb.com, as soon as reasonably practicable after such material is electronically filed with the SEC. Information available on the website is not a part of, and should not be incorporated into, this annual report on Form 10-K.
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ITEM 1A.
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RISK FACTORS
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The following discusses risks that management believes are specific to our business and could have a negative impact on QNB’s financial performance. When analyzing an investment in QNB, the risks and uncertainties described below, together with all of the other information included or incorporated by reference in this report, should be carefully considered. This list should not be viewed as comprehensive and may not include all risks that may affect the financial performance of QNB.
Economic and Market Risk
As discussed in the section “Supervision and Regulation,” the Board of Governors of the Federal Reserve System, the U.S. Congress, the U.S. Treasury, the FDIC, the SEC and others have taken numerous actions to address the liquidity and credit crisis that has followed the subprime mortgage meltdown that commenced in 2007. These measures include homeowner relief that encourage loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the Federal funds rate; significant purchases of longer-term Treasury securities; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector.
The purpose of these legislative and regulatory actions is to stabilize the U.S. banking system. EESA and the other regulatory initiatives described above may not have their desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen, our business, financial condition, results of operations and cash flows could be materially and adversely affected.
Dramatic declines in the U.S. housing market over the past several years, with decreasing home prices and increasing delinquencies and foreclosures, may have a negative impact on the credit performance of mortgage, consumer, commercial and construction loan portfolios resulting in significant write-downs of assets by many financial institutions. In addition, the values of real estate collateral supporting many loans have declined and may continue to decline. General downward economic trends, reduced availability of commercial credit and increasing unemployment may negatively impact the credit performance of commercial and consumer credit, resulting in additional write-downs.
Concerns over the stability of the financial markets and the economy have resulted in decreased lending by some financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets may adversely affect our business, financial condition, results of operations and stock price. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the industry. In particular, we may face the following risks in connection with these events:
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•
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We expect to face increased regulation of our industry. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities.
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•
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Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our credit exposure is made more complex by these difficult market and economic conditions.
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•
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We also may be required to pay higher FDIC premiums because financial institution failures resulting from the depressed market conditions have depleted and may continue to deplete the deposit insurance fund and reduce its ratio of reserves to insured deposits.
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•
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Our ability to borrow from other financial institutions or the FHLB could be adversely affected by disruptions in the capital markets or other events.
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•
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We may experience increases in foreclosures, delinquencies and customer bankruptcies.
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10
Interest Rate Risk
QNB’s profitability is largely a function of the spread between the interest rates earned on earning assets and the interest rates paid on deposits and other interest-bearing liabilities. Like most financial institutions, QNB’s net interest income and margin will be affected by general economic conditions and other factors, including fiscal and monetary policies of the Federal government, that influence market interest rates and QNB’s ability to respond to changes in such rates. At any given time, QNB’s assets and liabilities may be such that they are affected differently by a change in interest rates. As a result, an increase or decrease in rates, the length of loan terms or the mix of adjustable- and fixed-rate loans or investment securities in QNB’s portfolio could have a positive or negative effect on its net income, capital and liquidity. Although management believes it has implemented strategies and guidelines to reduce the potential effects of adverse changes in interest rates on results of operations, any substantial and prolonged change in market interest rates could affect operating results negatively.
The yield curve for the various maturities of U.S. Treasury securities provides a fundamental barometer that gauges the prevailing interest rate profile and, simultaneously, acts as a guidepost for current loan and deposit pricing constraints. The slope of the yield curve is driven primarily by expectations for future interest rate increases and inflationary trends. A normal yield curve has a slope that reflects lower costs for shorter-term financial instruments, accompanied by increases in costs for longer term instruments all along the maturity continuum.
Short-term interest rates are highly influenced by the monetary policy of the Federal Reserve. The Federal Open Market Committee, a committee of the Federal Reserve, targets the Federal funds rate, the overnight rate at which banks borrow or lend excess funds between financial institutions. This rate serves as a benchmark for the overnight money costs, and correspondingly influences the pricing of a significant portion of a bank’s deposit funding sources. Intermediate and longer-term interest rates, unlike the Federal funds rate, are more directly influenced by external market forces, including perceptions about future interest rates and inflation. These trends, in turn, influence the pricing on mid- and long-term loan commitments as well as deposits and bank borrowings that have scheduled maturities.
Generally speaking, a yield curve with a higher degree of slope provides more opportunity to increase the spread between earning asset yields and funding costs. It should be emphasized that while the yield curve is a critical benchmark in setting prices for various monetary assets and liabilities in banks, its influence is not exerted in a vacuum. Credit risk, market risk, competitive issues, and other factors must all be considered in the pricing of financial instruments.
A steep or highly-sloped yield curve may be a precursor of higher interest rates or elevated inflation in the future, while a flat yield curve may be characteristic of a Federal Reserve policy designed to calm an overheated economy by tightening credit availability via increases in short-term rates. If other rates along the maturity spectrum do not rise correspondingly, the yield curve can be expected to flatten. This scenario may reflect an economic outlook that has little or no expectation of higher future interest rates or higher rates of inflation. For banks, the presence of a flat yield curve for a prolonged or sustained period could measurably lower expectations for expanding the net interest margin.
An inverted yield curve is the opposite of a normal yield curve and is characterized by short-term rates that are higher than longer-term rates. The presence of an inverted yield curve is considered to be an anomaly that is almost counterintuitive to the core business of banking. Inverted yield curves do not typically exist for more than a short period of time. In past economic cycles, the presence of an inverted yield curve has frequently foreshadowed a recession. The recent recession may suppress future asset growth trends and/or increase the influence of other forms of risk, such as credit risk, which could hamper opportunities for revenue expansion and earnings growth in the near term.
Credit Risk
As a lender, QNB is exposed to the risk that its borrowers may be unable to repay their loans and that the current market value of any collateral securing the payment of their loans may not be sufficient to assure repayment in full. Credit losses are inherent in the lending business and could have a material adverse effect on the operating results of QNB. Adverse changes in the economy or business conditions, either nationally or in QNB’s market areas, could increase credit-related losses and expenses and/or limit growth. Substantially all of QNB’s loans are to businesses and individuals in its limited geographic area and any economic decline in this market could impact QNB adversely. QNB makes various assumptions and judgments about the collectability of its loan portfolio and provides an allowance for loan losses based on a number of factors. If these assumptions are incorrect, the allowance for loan losses may not be sufficient to cover losses and may cause QNB to increase the allowance in the future by increasing the provision for loan losses, thereby having an adverse effect on operating results. QNB has adopted underwriting and credit monitoring procedures and credit policies that management believes are appropriate to control these risks; however, such policies and procedures may not prevent unexpected losses that could have a material adverse effect on QNB’s financial condition or results of operations.
Competition
The financial services industry is highly competitive with competition for attracting and retaining deposits and making loans coming from other banks and savings institutions, credit unions, mutual fund companies, insurance companies and other non-bank businesses. Many of QNB’s competitors are much larger in terms of total assets and market capitalization, have a higher lending limit, have greater access to capital and funding, and offer a broader array of financial products and services. In light of this, QNB’s ability to continue to compete effectively is dependent upon its ability to maintain and build relationships by delivering top quality service.
11
At December 31, 2010, our lending limit per borrower was approximately $9,720,000. Accordingly, the size of loans that we may offer to potential borrowers (without participation by other lenders) is less than the size of loans that many of our competitors with larger capitalization are able to offer. Our legal lending limit also impacts the efficiency of our lending operation because it tends to lower our average loan size, which means we have to generate a higher number of transactions to achieve the same portfolio volume. We may engage in loan participations with other banks for loans in excess of our legal lending limit. However, there can be no assurance that such participations will be available or on terms which are favorable to us and our customers.
Impairment Risk
QNB purchases U.S. Government and U.S. Government agency debt securities, U.S. Government agency issued mortgage-backed securities or collateralized mortgage obligation securities, corporate debt securities and equity securities. QNB is exposed to the risk that the issuers of these securities may experience significant deterioration in credit quality which could impact the market value of the issue. QNB periodically evaluates its investments to determine if market value declines are other-than-temporary. Once a decline is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized for the credit related portion of the impairment.
The Bank holds eight pooled trust preferred securities with an amortized cost of $3,640,000 and a fair value as of December 31, 2010 of $1,866,000. All of the trust preferred securities are available-for-sale securities and are carried at fair value. Currently, the market for these securities is 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 pooled trust preferred securities trade and then by a significant decrease in the volume of trades relative to historical levels. There are currently very few market participants who are willing and or able to transact for these securities. The market values for these securities are very depressed relative to historical levels. These securities are comprised mainly of securities issued by banks, and to a lesser degree, insurance companies. The Bank owns the mezzanine tranches of these securities.
On a quarterly basis, we evaluate our debt securities for other-than-temporary impairment (OTTI), which involves the use of a third-party valuation firm to assist management with the valuation. When evaluating these investments a credit related portion and a non-credit related portion of OTTI are determined. All of the pooled trust preferred collateralized debt obligations held by QNB are rated lower than AA and are measured for OTTI within the scope of The FASB Accounting Standards Codification (ASC) 325 (formerly known as EITF 99-20-1). QNB performs a discounted cash flow analysis on all of its impaired debt securities to determine if the amortized cost basis of an impaired security will be recovered. In determining whether a credit loss exists, QNB uses its best estimate of the present value of cash flows expected to be collected from the debt security and discounts them at the effective yield implicit in the security at the date of acquisition or the prospective yield for those securities with prior OTTI charges. The discounted cash flow analysis is considered to be the primary evidence when determining whether credit related other-than-temporary impairment exists. 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 fair value of the security and the amount of credit related impairment. During 2010 and 2009, charges representing credit impairment were recognized on our investment in pooled trust preferred collateralized debt obligations of $277,000 and $1,002,000, respectively.
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. As a result of declines in some equity values, $33,000 and $521,000 of other-than-temporary impairment charges were taken in 2010 and 2009, respectively. QNB had five equity securities with unrealized losses of $43,000 at December 31, 2010. The severity and duration of the impairment is consistent with current stock market developments. Management believes these equity securities in an unrealized loss position 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.
The Bank is a member of the FHLB and is required to purchase and maintain stock in the FHLB in an amount equal to the greater of 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 5% of its outstanding advances from the FHLB. At December 31, 2010, the Bank had $2,164,000 in stock of the FHLB which was in compliance with this requirement. These equity securities are restricted in that they can only be sold back to the respective institutions or another member institution at par. Therefore, they are less liquid than other tradable equity securities, their fair value is equal to amortized cost, and no impairment write-downs have been recorded on these securities.
Third-Party Risk
Third parties provide key components of the business infrastructure such as Internet connections and network access. Any disruption in Internet, network access or other voice or data communication services provided by these third parties or any failure of these third parties to handle current or higher volumes of use could affect adversely the ability to deliver products and services to clients and otherwise to conduct business. Technological or financial difficulties of a third-party service provider could affect adversely the business to the extent those difficulties result in the interruption or discontinuation of services provided by that party.
12
Technology Risk
The market for financial services is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, Internet-based banking and mobile banking. Our ability to compete successfully in our markets may depend on the extent to which we are able to exploit such technological changes. However, we can provide no assurance that we will be able to properly or timely anticipate or implement such technologies or properly train our staff to use such technologies. Any failure to adapt to new technologies could adversely affect our business, financial condition or operating results.
Changes in accounting standards
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time the Financial Accounting Standards Board (FASB) changes the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements. Management believes the current financial statements are prepared in accordance with U.S. generally accepted accounting principles.
Government Regulation and Supervision
The banking industry is heavily regulated under both Federal and state law. Banking regulations, designed primarily for the safety of depositors, may limit a financial institution’s growth and the return to its investors, by restricting such activities as the payment of dividends, mergers with or acquisitions by other institutions, expansion of branch offices and the offering of securities. QNB is also subject to capitalization guidelines established by Federal law and could be subject to enforcement actions to the extent that its subsidiary bank is found, by regulatory examiners, to be undercapitalized. It is difficult to predict what changes, if any, will be made to existing Federal and state legislation and regulations or the effect that such changes may have on QNB’s future business and earnings prospects.
In response to the financial crisis that commenced in 2008, Congress has taken actions that are intended to strengthen confidence and encourage liquidity in financial institutions, and the FDIC has taken actions to increase insurance coverage on deposit accounts. The recently enacted Dodd-Frank Act provides for the creation of a consumer protection division at the Board of Governors of the Federal Reserve System that will have broad authority to issue regulations governing the services and products we provide consumers. This additional regulation could increase our compliance costs and otherwise adversely impact our operations. That legislation also contains provisions that, over time, could result in higher regulatory capital requirements and loan loss provisions for the Bank, and may increase interest expense due to the ability in July 2011 to pay interest on all demand deposits. In addition, there have been proposals made by members of Congress and others that would reduce the amount delinquent borrowers are otherwise contractually obligated to pay under their mortgage loans and limit an institution’s ability to foreclose on mortgage collateral. These proposals could result in credit losses or increased expense in pursuing our remedies as a creditor. Recent regulatory changes impose limits on our ability to charge overdraft fees, which may decrease our non-interest income as compared to recent prior periods.
The potential exists for additional Federal or state laws and regulations, or changes in policy, affecting many aspects of our operations, including capital levels, lending and funding practices, and liquidity standards. New laws and regulations may increase our costs of regulatory compliance and of doing business and otherwise affect our operations, and may significantly affect the markets in which we do business, the markets for and value of our loans and investments, the fees we can charge and our ongoing operations, costs and profitability.
FDIC Insurance Premiums
Since 2008, higher levels of bank failures have dramatically increased the claims against the deposit insurance fund. In addition, the FDIC instituted two temporary programs to further insure customer deposits at FDIC insured banks: deposit accounts are now insured up to $250,000 per customer (up from $100,000) and noninterest-bearing transactional accounts are fully insured (unlimited coverage). These programs have placed additional stress on the deposit insurance fund. In order to maintain a strong funding position and restore reserve ratios of the deposit insurance fund, the FDIC has increased assessment rates of insured institutions. In addition, on November 12, 2009, the FDIC adopted a rule requiring banks to prepay three years of estimated deposit insurance premiums. The Company is generally unable to control the amount of premiums that the Bank is required to pay for FDIC insurance. If there are additional bank failures, or the cost of resolving prior failures exceeds expectations, the Bank may be required to pay even higher FDIC premiums than the recently increased levels. These announced increases and any future increases or required prepayments of FDIC insurance premiums may adversely impact the Company’s earnings and financial condition.
13
Internal Controls and Procedures
Management diligently reviews and updates its internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Our disclosure controls and procedures are designed to reasonably assure that information required to be disclosed by QNB in reports filed or submitted under the Exchange Act is accumulated and communicated to management, and recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Management believes that any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Any undetected circumvention of these controls could have a material adverse impact on QNB’s financial condition and results of operations.
These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by an unauthorized override of the controls. Accordingly, because of the inherent limitations in our control system, misstatements due to error or fraud may occur and not be detected.
Attracting and Retaining Skilled Personnel
Our success depends upon the ability to attract and retain highly motivated, well-qualified personnel. We face significant competition in the recruitment of qualified employees. Our ability to execute our business strategy and provide high quality service may suffer if we are unable to recruit or retain a sufficient number of qualified employees or if the costs of employee compensation or benefits increase substantially. QNB currently has employment agreements and change of control agreements with three of its senior officers.
As a “smaller reporting company” as defined in Item 10 of Regulation S-K, the Company is not required to respond to this item.
14
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ITEM 2.
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PROPERTIES
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QNB Bank and QNB Corp.’s principal office is located at 15 North Third Street, Quakertown, Pennsylvania. QNB Bank conducts business from its principal office and eight other retail offices located in upper Bucks, southern Lehigh, and northern Montgomery counties in Pennsylvania. QNB Bank owns its principal office, two retail locations, its operations facility and a computer facility. QNB Bank leases its remaining six retail properties. The leases on the properties generally contain renewal options. In management’s opinion, these properties are in good condition and are currently adequate for QNB’s purposes.
The following table details QNB Bank’s properties:
Location
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Quakertown, PA
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-
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Downtown Office
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Owned
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15 North Third Street
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Quakertown, PA
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-
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Towne Bank Center
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Owned
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320-322 West Broad Street
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Quakertown, PA
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-
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Computer Center
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Owned
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121 West Broad Street
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Quakertown, PA
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-
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Country Square Office
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Leased
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240 South West End Boulevard
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Quakertown, PA
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-
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Quakertown Commons Branch
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Leased
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901 South West End Boulevard
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Dublin, PA
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-
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Dublin Branch
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Leased
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161 North Main Street
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Pennsburg, PA
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-
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Pennsburg Square Branch
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Leased
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410-420 Pottstown Avenue
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Coopersburg, PA
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-
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Coopersburg Branch
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Owned
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51 South Third Street
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Perkasie, PA
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-
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Perkasie Branch
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Owned
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607 Chestnut Street
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Souderton, PA
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-
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Souderton Branch
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Leased
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750 Route 113
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Wescosville, PA
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-
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Wescosville Branch
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Leased
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950 Mill Creek Road
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ITEM 3.
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LEGAL PROCEEDINGS
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Although there is currently no material proceedings to which QNB is the subject, future litigation that arises during the normal course of QNB’s business could be material and have a negative impact on QNB’s earnings. Future litigation also could adversely impact the reputation of QNB in the communities that it serves.
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ITEM 4.
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[REMOVED AND RESERVED]
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15
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ITEM 5.
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MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
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Stock Information
QNB common stock is quoted on the over-the-counter bulletin board (OTCBB). QNB had approximately 1,350 shareholders of record as of February 28, 2011.
The following table sets forth the high and low bid and ask stock prices for QNB common stock on a quarterly basis during 2010 and 2009. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
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Cash
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High
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Low
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Dividend
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Bid
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Ask
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Bid
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Ask
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Per Share
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2010
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First Quarter
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$ | 18.90 | $ | 19.03 | $ | 16.75 | $ | 17.05 | $ | 0.24 | ||||||||||
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Second Quarter
|
20.55 | 21.20 | 17.80 | 19.00 | 0.24 | |||||||||||||||
|
Third Quarter
|
20.50 | 21.30 | 19.35 | 19.70 | 0.24 | |||||||||||||||
|
Fourth Quarter
|
21.00 | 22.00 | 19.60 | 20.00 | 0.24 | |||||||||||||||
|
2009
|
||||||||||||||||||||
|
First Quarter
|
$ | 18.00 | $ | 20.00 | $ | 15.55 | $ | 16.00 | $ | 0.24 | ||||||||||
|
Second Quarter
|
18.40 | 19.30 | 16.25 | 16.85 | 0.24 | |||||||||||||||
|
Third Quarter
|
17.06 | 18.25 | 16.05 | 16.15 | 0.24 | |||||||||||||||
|
Fourth Quarter
|
18.00 | 18.90 | 16.20 | 16.50 | 0.24 | |||||||||||||||
QNB has traditionally paid quarterly cash dividends on the last Friday of each quarter. The Company expects to continue the practice of paying quarterly cash dividends to its shareholders; however, future dividends are dependent upon future earnings, financial condition, appropriate legal restrictions, and other factors relevant at the time the board of directors considers declaring a dividend. Certain laws restrict the amount of dividends that may be paid to shareholders in any given year. See “Capital Adequacy” section of this Form 10-K filing, and Note 19 of the Notes to Consolidated Financial Statements of this Form 10-K filing, for the information that discusses and quantifies this regulatory restriction.
The following table provides information on repurchases by QNB of its common stock in each month of the quarter ended December 31, 2010.
|
Total
|
Total Number of Shares
|
Maximum Number
|
||||||||||||||
|
Number
|
Average
|
Purchased as Part of
|
of Shares that may
|
|||||||||||||
|
of Shares
|
Price Paid
|
Publicly Announced
|
yet be Purchased
|
|||||||||||||
|
Period
|
Purchased
|
per Share
|
Plan
|
Under the Plan
|
||||||||||||
|
October 1, 2010 through October 31, 2010
|
– | N/A | – | 42,117 | ||||||||||||
|
November 1, 2010 through November 30, 2010
|
– | N/A | – | 42,117 | ||||||||||||
|
December 1, 2010 through December 31, 2010
|
– | N/A | – | 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 number of shares approved for repurchase under QNB’s current stock repurchase plan is 100,000 as of the filing of this Form 10-K.
(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.
16
Stock Performance Graph
Set forth below is a performance graph comparing the yearly cumulative total shareholder return on QNB’s common stock with:
|
•
|
the yearly cumulative total shareholder return on stocks included in the NASDAQ Market Index, a broad market index;
|
|
•
|
|
•
|
the yearly cumulative total shareholder return on the SNL Mid-Atlantic Bank Index, a group encompassing publicly traded banking companies trading on the NYSE, AMEX, or NASDAQ headquartered in Delaware, District of Columbia, Maryland, New Jersey, New York, Pennsylvania, and Puerto Rico.
|
All of these cumulative total returns are computed assuming the reinvestment of dividends at the frequency with which dividends were paid during the applicable years.
QNB Corp.
|
Period Ending
|
||||||||||||||||||||||||
|
Index
|
12/31/05
|
12/31/06
|
12/31/07
|
12/31/08
|
12/31/09
|
12/31/10
|
||||||||||||||||||
|
QNB Corp.
|
100.00 | 97.49 | 97.16 | 72.84 | 74.77 | 92.39 | ||||||||||||||||||
|
NASDAQ Composite
|
100.00 | 110.39 | 122.15 | 73.32 | 106.57 | 125.91 | ||||||||||||||||||
|
SNL $500M-$1B Bank Index
|
100.00 | 113.73 | 91.14 | 58.40 | 55.62 | 60.72 | ||||||||||||||||||
|
SNL Mid-Atlantic Bank Index
|
100.00 | 120.02 | 90.76 | 50.00 | 52.63 | 61.40 | ||||||||||||||||||
Source : SNL Financial LC, Charlottesville, VA
17
|
Year Ended December 31,
|
2010
|
2009
|
2008
|
2007
|
2006
|
|||||||||||||||
|
Income and Expense
|
||||||||||||||||||||
|
Interest income
|
$ | 36,183 | $ | 35,368 | $ | 35,285 | $ | 35,305 | $ | 32,002 | ||||||||||
|
Interest expense
|
10,270 | 13,667 | 15,319 | 17,738 | 15,906 | |||||||||||||||
|
Net interest income
|
25,913 | 21,701 | 19,966 | 17,567 | 16,096 | |||||||||||||||
|
Provision for loan losses
|
3,800 | 4,150 | 1,325 | 700 | 345 | |||||||||||||||
|
Non-interest income
|
4,339 | 3,885 | 3,300 | 907 | 3,937 | |||||||||||||||
|
Non-interest expense
|
17,401 | 16,586 | 14,628 | 14,441 | 13,234 | |||||||||||||||
|
Income before income taxes
|
9,051 | 4,850 | 7,313 | 3,333 | 6,454 | |||||||||||||||
|
Provision for income taxes
|
1,834 | 623 | 1,560 | 286 | 1,034 | |||||||||||||||
|
Net income
|
$ | 7,217 | $ | 4,227 | $ | 5,753 | $ | 3,047 | $ | 5,420 | ||||||||||
|
Share and Per Share Data
|
||||||||||||||||||||
|
Net income - basic
|
$ | 2.32 | $ | 1.37 | $ | 1.83 | $ | 0.97 | $ | 1.73 | ||||||||||
|
Net income - diluted
|
2.32 | 1.36 | 1.82 | 0.96 | 1.71 | |||||||||||||||
|
Book value
|
19.52 | 18.24 | 17.21 | 16.99 | 16.11 | |||||||||||||||
|
Cash dividends
|
0.96 | 0.96 | 0.92 | 0.88 | 0.84 | |||||||||||||||
|
Average common shares outstanding - basic
|
3,105,565 | 3,094,624 | 3,135,608 | 3,130,179 | 3,124,724 | |||||||||||||||
|
Average common shares outstanding - diluted
|
3,114,722 | 3,103,433 | 3,161,326 | 3,174,873 | 3,176,710 | |||||||||||||||
|
Balance Sheet at Year-end
|
||||||||||||||||||||
|
Federal funds sold
|
– | – | $ | 4,541 | – | $ | 11,664 | |||||||||||||
|
Investment securities available-for-sale
|
$ | 290,564 | $ | 256,862 | 219,597 | $ | 191,552 | 219,818 | ||||||||||||
|
Investment securities held-to-maturity
|
2,667 | 3,347 | 3,598 | 3,981 | 5,021 | |||||||||||||||
|
Restricted investment in bank stocks
|
2,176 | 2,291 | 2,291 | 954 | 3,465 | |||||||||||||||
|
Loans held-for-sale
|
228 | 534 | 120 | 688 | 170 | |||||||||||||||
|
Loans receivable
|
482,182 | 449,421 | 403,579 | 381,016 | 343,496 | |||||||||||||||
|
Allowance for loan losses
|
(8,955 | ) | (6,217 | ) | (3,836 | ) | (3,279 | ) | (2,729 | ) | ||||||||||
|
Other earning assets
|
6,414 | 22,158 | 1,314 | 579 | 778 | |||||||||||||||
|
Total assets
|
809,260 | 762,426 | 664,394 | 609,813 | 614,539 | |||||||||||||||
|
Deposits
|
694,977 | 634,103 | 549,790 | 494,124 | 478,922 | |||||||||||||||
|
Borrowed funds
|
50,094 | 63,433 | 56,663 | 58,990 | 82,113 | |||||||||||||||
|
Shareholders’ equity
|
61,090 | 56,426 | 53,909 | 53,251 | 50,410 | |||||||||||||||
|
Selected Financial Ratios
|
||||||||||||||||||||
|
Net interest margin
|
3.72 | % | 3.42 | % | 3.56 | % | 3.32 | % | 3.12 | % | ||||||||||
|
Net income as a percentage of:
|
||||||||||||||||||||
|
Average total assets
|
0.93 | 0.59 | 0.91 | 0.51 | 0.91 | |||||||||||||||
|
Average shareholders’ equity
|
12.53 | 7.73 | 10.76 | 5.94 | 10.89 | |||||||||||||||
|
Average shareholders’ equity to average total assets
|
7.42 | 7.70 | 8.47 | 8.51 | 8.37 | |||||||||||||||
|
Dividend payout ratio
|
41.32 | 70.31 | 50.17 | 90.42 | 48.45 | |||||||||||||||
|
ITEM 7.
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
Results of Operations – Overview
QNB Corp. (QNB or the Company) earns its net income primarily through its subsidiary, QNB Bank (the Bank). Net interest income, or the spread between the interest, dividends and fees earned on loans and investment securities and the expense incurred on deposits and other interest-bearing liabilities, is the primary source of operating income for QNB. QNB seeks to achieve sustainable and consistent earnings growth while maintaining adequate levels of capital and liquidity and limiting its exposure to credit and interest rate risk levels approved by the Board of Directors. Due to its limited geographic area, comprised principally of upper Bucks, southern Lehigh and northern Montgomery counties, growth is pursued through expansion of existing customer relationships and building new relationships by stressing a consistent high level of service at all points of contact.
Tabular information, other than share and per share data, is presented in thousands of dollars.
Net income for the year ended December 31, 2010 was $7,217,000, or $2.32 per share on a diluted basis, and represents a record year for the Company. In 2009, the Company reported net income of $4,227,000, or $1.36 per share on a diluted basis.
Two important measures of profitability in the banking industry are an institution’s return on average assets and return on average shareholders’ equity. Return on average assets was 0.93% and 0.59% in 2010 and 2009, respectively, and return on average shareholders’ equity was 12.53% and 7.73% during those same periods.
18
The core functions of the Bank, gathering deposits and making loans, continued to show strength and contributed positively to the results for both 2010 and 2009. QNB took advantage of disruptions in its local banking market to grow both loans and deposits. This growth when combined with a declining cost of funds resulted in significant improvement in net interest income and the net interest margin and helped the Company to achieve record net income for 2010. However, the challenging economic environment and the continued uncertainty in the financial markets negatively impacted QNB’s earnings performance during these same periods as QNB had to record a higher than normal level of provision for loan losses and recognize credit related other-than-temporary impairment charges (OTTI) on investment securities. In addition, the results for 2009 were impacted by higher industry-wide FDIC insurance premiums plus a special industry-wide FDIC assessment. These FDIC actions were a result of bank failures which significantly impacted the level of the Deposit Insurance Fund.
2010 versus 2009
The results for 2010 include the following significant components:
Net interest income increased $4,212,000, or 19.4%, to $25,913,000 for 2010.
|
•
|
Average earning assets increased $64,261,000, or 9.4%, to $747,453,000 for 2010 with average loans increasing $39,139,000, or 9.1%, to $467,063,000, and average investment securities increasing $20,203,000, or 8.3%, to $263,307,000. The growth in loans was primarily real estate secured commercial loans and to a lesser degree commercial and industrial loans and tax-exempt state and municipal loans.
|
|
•
|
Funding the growth in earning assets was an increase in average total deposits of $71,585,000, or 12.0%, to $665,913,000 for 2010. The growth is a result of increases in core deposits, including checking, savings and money market accounts. The growth in deposit balances reflects the positive response to two of QNB’s high yielding deposit products, QNB Rewards Checking and Online eSavings, as well as customer’s desire to do business with a strong institution that believes in community bank principles.
|
|
•
|
While the economy has shown signs of improvement, issues in the residential and commercial real estate markets persist as do high levels of unemployment and low levels of inflation. In response to these factors the Federal Reserve Open Market Committee maintained its position of an exceptionally low level for the Federal funds rate throughout 2010. As detailed below, Treasury yields were volatile during 2010 and declined to historically low levels in the fourth quarter of 2010 before rebounding towards the end of the year. A low level of interest rates have been in place since 2008 and have resulted in lower yields earned on both loans and investment securities as well as lower rates paid on deposits and borrowed funds.
|
|
December 31,
|
Low
|
High
|
||||||||||||||
|
2009
|
2010
|
during 2010
|
during 2010
|
|||||||||||||
|
3 month Treasury
|
0.07 | % | 0.12 | % | 0.03 | % | 0.18 | % | ||||||||
|
2 year Treasury
|
1.15 | 0.60 | 0.33 | 1.17 | ||||||||||||
|
5 year Treasury
|
2.69 | 2.01 | 1.03 | 2.74 | ||||||||||||
|
10 year Treasury
|
3.88 | 3.30 | 2.39 | 3.99 | ||||||||||||
|
•
|
The net interest margin for 2010 was 3.72% compared to 3.42% for 2009 with lower deposit costs being a significant factor in the improvement. The interest rate paid on interest-bearing deposits declined by 73 basis points from 2.20% for 2009 to 1.47% for 2010. The decline in the rate paid on deposits largely resulted from the repricing of time deposits at lower market rates. The average rate paid on time deposits declined from 3.15% for 2009 to 2.12% for 2010.
|
|
•
|
Lower interest rates also had a negative impact on the yields on earning assets, especially investment securities. The average rate on earning assets declined 32 basis points when comparing the two years with the average rate earned on investment securities falling 73 basis points from 4.80% for 2009 to 4.07% for 2010. The extended period of low interest rates resulted in an increase in the amount of cash flow that was reinvested into lower yielding securities. Helping to minimize the impact of lower securities yields on the yield on earning assets was the minimal decline in the average rate earned on the loan portfolio. The average rate earning on loans declined only seven basis points from 5.92% for 2009 to 5.85% for 2010.
|
|
•
|
Contributing to the increase in both net interest income and the net interest margin was a reduction in interest expense on long-term debt resulting from the maturity and repayment of $15,000,000 in borrowings at an average cost of 3.61%.
|
QNB recorded a provision for loan losses of $3,800,000 for 2010, a slight decrease from the $4,150,000 recorded in 2009. As a result of an increase in specific reserves for impaired loans, loan growth, increases in non-performing, delinquent and classified loans and continued concerns related to current economic conditions, QNB increased the allowance for loan losses to reflect these conditions.
|
•
|
The allowance for loan losses of $8,955,000 represents 1.86% of total loans at December 31, 2010 compared to $6,217,000, or 1.38% of total loans at December 31, 2009.
|
|
•
|
Net charge-offs for 2010 were $1,062,000, or 0.23% of average total loans, as compared with $1,769,000, or 0.41% of average total loans for 2009.
|
|
•
|
Total non-performing loans, which represent loans on non-accrual status, loans past due more than 90 days and still accruing interest, and restructured loans, were $9,872,000, or 2.05% of total loans at December 31, 2010, compared to $6,102,000, or 1.36% of total loans at December 31, 2009.
|
|
•
|
Total delinquent loans, which includes loans past due more than 30 days, increased to 2.82% of total loans at December 31, 2010 compared with 2.17% of total loans at December 31, 2009.
|
|
•
|
QNB’s non-performing loan ratio of 2.05%, while elevated, continues to compare favorably with the average for Pennsylvania commercial banks with assets between $500 million and $1 billion, as reported by the FDIC. The total non-performing loan ratio for these Pennsylvania commercial banks was 3.14% of total loans as of December 31, 2010.
|
Non-interest income increased $454,000 to $4,339,000 for 2010
|
•
|
Net losses on investment securities were $1,000 in 2010 compared with net losses of $454,000 in 2009. The net loss on investment securities for 2010 was comprised of credit related OTTI charges of $310,000 which was almost entirely offset by net gains on the sale of securities of $309,000. The net loss for 2009 was comprised of credit related OTTI charges on pooled trust preferred securities and equity securities of $1,523,000 and net gains on the sales of securities of $1,069,000.
|
19
|
•
|
Gains on the sale of residential mortgages decreased from $633,000 in 2009 to $494,000 in 2010, largely a result of a decline in mortgage activity and the volume of mortgages sold.
|
|
•
|
Fees for services to customers declined $172,000 when comparing the two years. Overdraft income, which represents approximately 73% of total fees for services to customers in 2010, declined by $217,000, or 16.0%, when comparing 2010 to 2009. The decline in overdraft income is a result of the implementation of new rules under Regulation E and a reduction in the per item fee charged to customers.
|
|
•
|
ATM and debit card income increased $212,000, or 20.9%, to $1,228,000 for 2010 as a result of the continued acceptance and use by consumers and business cardholders.
|
|
•
|
Net losses on other real estate owned and repossessed assets declined from $134,000 in 2009 to $2,000 for 2010.
|
Non-interest expense increased $815,000, or 4.9%, to $17,401,000 for 2010.
|
•
|
Salary and benefit expense increased $474,000, or 5.6%, when comparing 2010 and 2009. A company-wide incentive compensation expense contributed $211,000 to the increase. There was no incentive compensation expense in 2009. Payroll tax and retirement plan expense increased $56,000, principally a function of higher salary expense, while medical and dental premiums increased $44,000 compared to 2009.
|
|
•
|
Net occupancy expense increased $192,000 with the majority of the increase related to lease expense for the new permanent Wescosville branch as well as increased expenses for utilities, building repairs and maintenance and security.
|
|
•
|
Marketing expense increased $90,000 to $737,000 for 2010. The majority of the increase relates to a $56,000 increase in donations and a $15,000 increase in public relations expense.
|
|
•
|
FDIC insurance premiums decreased $170,000, or 14.0%, to $1,041,000 for 2010. The 2009 expense included a special assessment levied on all insured institutions by the FDIC during the second quarter of 2009. The special assessment contributed $332,000 to the total FDIC costs in 2009. There was no similar special assessment in 2010. Partially offsetting this reduction in 2010 was the impact on the premiums resulting from significant growth in deposits combined with a slightly higher assessment rate in 2010 compared with 2009.
|
|
•
|
Expenses in connection with foreclosed real estate and repossessed assets increased $89,000, with the majority of the increase related to costs associated with maintaining a property the Bank owns that is classified as other real estate owned (OREO).
|
These items, as well as others, will be explained more thoroughly in the next sections.
Net Interest Income
The following table presents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the years ended December 31, 2010 and 2009.
|
Net Interest Income
|
||||||||
|
Year Ended December 31,
|
2010
|
2009
|
||||||
|
Total interest income
|
$ | 36,183 | $ | 35,368 | ||||
|
Total interest expense
|
10,270 | 13,667 | ||||||
|
Net interest income
|
25,913 | 21,701 | ||||||
|
Tax-equivalent adjustment
|
1,907 | 1,658 | ||||||
|
Net interest income (tax-equivalent basis)
|
$ | 27,820 | $ | 23,359 | ||||
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 table that appears 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 margin, which includes interest-free sources of funds, is net interest income expressed as a percentage of average interest-earning assets.
Net interest income increased $4,212,000, or 19.4%, to $25,913,000 for 2010. On a tax-equivalent basis, net interest income for 2010 increased $4,461,000, or 19.1%, to $27,820,000. Several factors contributed to the significant increase in net interest income. Continued strong growth in deposits and the deployment of these deposits into loans and investment securities was one contributing factor. Total average deposits increased $71,585,000, or 12.0%, to $665,913,000 when comparing 2010 and 2009. Over this same time period total average loans increased $39,139,000, or 9.2%, and total average investment securities increased $20,203,000, or 8.3%. An even more significant factor was the decrease in interest expense resulting from a change in the mix of deposit types, the pricing of new and reinvested time deposits and money market accounts at lower market rates and a reduction in higher cost long-term debt. As a result of these factors the net interest margin improved to 3.72% for 2010 compared with 3.42% for 2009.
While the economy has shown signs of improvement, issues in the residential and commercial real estate markets persist as do high levels of unemployment and extremely low levels of inflation. As a result of these factors, as well as actions by the Fed, both actual and anticipated, interest rates on Treasury securities declined during 2010 to historically low levels. These low levels of interest rates have been in place since 2008 and have resulted in lower yields earned on both loans and investment securities as well as lower rates paid on deposits and borrowed funds.
20
|
Average Balances, Rates, and Interest Income and Expense Summary
(Tax-Equivalent Basis
)
|
|||||||||||||||||||||||||||||||||||
|
2010
|
2009
|
2008
|
|||||||||||||||||||||||||||||||||
|
Average
|
Average
|
Average
|
Average
|
Average
|
|||||||||||||||||||||||||||||||
|
Balance
|
Rate
|
Interest
|
Balance
|
Rate
|
Interest
|
Balance
|
Rate
|
Interest
|
|||||||||||||||||||||||||||
|
Assets
|
|||||||||||||||||||||||||||||||||||
|
Federal funds sold
|
– | – | – | $ | 992 | 0.15 | % | $ | 2 | $ | 6,281 | 2.20 | % | $ | 138 | ||||||||||||||||||||
|
Investment securities:
|
|||||||||||||||||||||||||||||||||||
|
U.S. Treasury
|
$ | 3,924 | 0.56 | % | $ | 22 | 5,075 | 1.41 | 71 | 5,152 | 3.46 | 178 | |||||||||||||||||||||||
|
U.S. Government agencies
|
58,050 | 2.88 | 1,671 | 47,717 | 3.97 | 1,892 | 37,391 | 5.03 | 1,881 | ||||||||||||||||||||||||||
|
State and municipal
|
59,141 | 6.22 | 3,676 | 50,921 | 6.50 | 3,308 | 43,394 | 6.51 | 2,826 | ||||||||||||||||||||||||||
|
Mortgage-backed and CMOs
|
134,859 | 3.85 | 5,192 | 126,883 | 4.89 | 6,200 | 107,069 | 5.50 | 5,894 | ||||||||||||||||||||||||||
|
Corporate bonds (fixed and variable)
|
4,313 | 1.24 | 54 | 5,839 | 1.36 | 79 | 12,689 | 6.11 | 776 | ||||||||||||||||||||||||||
|
Money market mutual funds
|
– | – | – | 3,461 | 0.68 | 23 | 865 | 2.62 | 23 | ||||||||||||||||||||||||||
|
Equities
|
3,020 | 3.66 | 111 | 3,208 | 3.15 | 101 | 4,177 | 2.57 | 107 | ||||||||||||||||||||||||||
|
Total investment securities
|
263,307 | 4.07 | 10,726 | 243,104 | 4.80 | 11,674 | 210,737 | 5.54 | 11,685 | ||||||||||||||||||||||||||
|
Loans:
|
|||||||||||||||||||||||||||||||||||
|
Commercial real estate
|
252,604 | 5.95 | 15,041 | 219,991 | 6.16 | 13,544 | 183,212 | 6.68 | 12,242 | ||||||||||||||||||||||||||
|
Residential real estate*
|
24,468 | 5.74 | 1,405 | 24,710 | 5.95 | 1,471 | 21,737 | 6.13 | 1,332 | ||||||||||||||||||||||||||
|
Home equity loans
|
60,192 | 5.02 | 3,023 | 64,918 | 5.14 | 3,338 | 68,249 | 5.83 | 3,977 | ||||||||||||||||||||||||||
|
Commercial and industrial
|
82,074 | 5.27 | 4,327 | 74,343 | 5.09 | 3,786 | 67,542 | 5.98 | 4,042 | ||||||||||||||||||||||||||
|
Indirect lease financing
|
13,910 | 8.97 | 1,248 | 14,735 | 8.62 | 1,270 | 13,372 | 9.79 | 1,309 | ||||||||||||||||||||||||||
|
Consumer loans
|
3,163 | 13.78 | 436 | 3,986 | 10.71 | 427 | 4,524 | 11.49 | 520 | ||||||||||||||||||||||||||
|
Tax-exempt loans
|
30,652 | 6.02 | 1,844 | 25,241 | 5.91 | 1,491 | 24,362 | 6.05 | 1,475 | ||||||||||||||||||||||||||
|
Total loans, net of unearned income
|
467,063 | 5.85 | 27,324 | 427,924 | 5.92 | 25,327 | 382,998 | 6.50 | 24,897 | ||||||||||||||||||||||||||
|
Other earning assets
|
17,083 | 0.23 | 40 | 11,172 | 0.21 | 23 | 2,430 | 2.33 | 56 | ||||||||||||||||||||||||||
|
Total earning assets
|
747,453 | 5.10 | 38,090 | 683,192 | 5.42 | 37,026 | 602,446 | 6.10 | 36,776 | ||||||||||||||||||||||||||
|
Cash and due from banks
|
10,157 | 9,815 | 10,716 | ||||||||||||||||||||||||||||||||
|
Allowance for loan losses
|
(7,129 | ) | (4,668 | ) | (3,425 | ) | |||||||||||||||||||||||||||||
|
Other assets
|
26,118 | 22,241 | 21,955 | ||||||||||||||||||||||||||||||||
|
Total assets
|
$ | 776,599 | $ | 710,580 | $ | 631,692 | |||||||||||||||||||||||||||||
|
Liabilities and Shareholders’ Equity
|
|||||||||||||||||||||||||||||||||||
|
Interest-bearing deposits:
|
|||||||||||||||||||||||||||||||||||
|
Interest-bearing demand
|
$ | 83,546 | 0.65 | % | 545 | $ | 70,398 | 0.57 | % | 403 | $ | 57,883 | 0.27 | % | 156 | ||||||||||||||||||||
|
Municipals
|
40,242 | 0.91 | 366 | 33,077 | 1.08 | 357 | 39,738 | 2.06 | 818 | ||||||||||||||||||||||||||
|
Money market
|
75,128 | 0.76 | 568 | 60,535 | 1.16 | 703 | 48,027 | 1.83 | 879 | ||||||||||||||||||||||||||
|
Savings
|
93,576 | 0.79 | 739 | 51,245 | 0.37 | 189 | 43,859 | 0.39 | 169 | ||||||||||||||||||||||||||
|
Time
|
211,867 | 2.09 | 4,420 | 218,047 | 3.13 | 6,829 | 198,500 | 4.10 | 8,143 | ||||||||||||||||||||||||||
|
Time of $100,000 or more
|
105,482 | 2.19 | 2,306 | 107,764 | 3.18 | 3,424 | 77,765 | 4.09 | 3,179 | ||||||||||||||||||||||||||
|
Total interest-bearing deposits
|
609,841 | 1.47 | 8,944 | 541,066 | 2.20 | 11,905 | 465,772 | 2.86 | 13,344 | ||||||||||||||||||||||||||
|
Short-term borrowings
|
27,658 | 0.97 | 269 | 21,817 | 1.14 | 248 | 22,197 | 2.12 | 471 | ||||||||||||||||||||||||||
|
Long-term debt
|
22,077 | 4.72 | 1,057 | 35,000 | 4.27 | 1,514 | 34,535 | 4.28 | 1,504 | ||||||||||||||||||||||||||
|
Total interest-bearing liabilities
|
659,576 | 1.56 | 10,270 | 597,883 | 2.29 | 13,667 | 522,504 | 2.93 | 15,319 | ||||||||||||||||||||||||||
|
Non-interest bearing deposits
|
56,072 | 53,262 | 51,170 | ||||||||||||||||||||||||||||||||
|
Other liabilities
|
3,362 | 4,725 | 4,532 | ||||||||||||||||||||||||||||||||
|
Shareholders’ equity
|
57,589 | 54,710 | 53,486 | ||||||||||||||||||||||||||||||||
|
Total liabilities and
shareholders’ equity
|
$ | 776,599 | $ | 710,580 | $ | 631,692 | |||||||||||||||||||||||||||||
| 3.54 | % | 3.13 | % | 3.17 | % | ||||||||||||||||||||||||||||||
|
Margin/net interest income
|
3.72 | % | $ | 27,820 | 3.42 | % | $ | 23,359 | 3.56 | % | $ | 21,457 | |||||||||||||||||||||||
Tax-exempt securities and loans were adjusted to a tax-equivalent basis and are based on the marginal Federal corporate tax rate of 34 percent.
Non-accrual loans and investment securities are included in earning assets.
* Includes loans held-for-sale.
21
|
Rate-Volume Analysis of Changes in Net Interest Income
(
1
) (
2
) (
3
)
|
|||||||||||||||||||||||||
|
2010 vs. 2009
|
2009 vs. 2008
|
||||||||||||||||||||||||
|
Change due to
|
Total
|
Change due to
|
Total
|
||||||||||||||||||||||
|
Volume
|
Rate
|
Change
|
Volume
|
Rate
|
Change
|
||||||||||||||||||||
|
Interest income:
|
|||||||||||||||||||||||||
|
Federal funds sold
|
$ | (2 | ) | – | $ | (2 | ) | $ | (116 | ) | $ | (20 | ) | $ | (136 | ) | |||||||||
|
Investment securities:
|
|||||||||||||||||||||||||
|
U.S. Treasury
|
(16 | ) | $ | (33 | ) | (49 | ) | (3 | ) | (104 | ) | (107 | ) | ||||||||||||
|
U.S. Government agencies
|
410 | (631 | ) | (221 | ) | 519 | (508 | ) | 11 | ||||||||||||||||
|
State and municipal
|
533 | (165 | ) | 368 | 490 | (8 | ) | 482 | |||||||||||||||||
|
Mortgage-backed and CMOs
|
390 | (1,398 | ) | (1,008 | ) | 1,090 | (784 | ) | 306 | ||||||||||||||||
|
Corporate bonds (fixed and variable)
|
(20 | ) | (5 | ) | (25 | ) | (419 | ) | (278 | ) | (697 | ) | |||||||||||||
|
Money market mutual funds
|
(23 | ) | – | (23 | ) | 67 | (67 | ) | – | ||||||||||||||||
|
Equities
|
(6 | ) | 16 | 10 | (24 | ) | 18 | (6 | ) | ||||||||||||||||
|
Loans:
|
|||||||||||||||||||||||||
|
Commercial real estate
|
2,008 | (511 | ) | 1,497 | 2,457 | (1,155 | ) | 1,302 | |||||||||||||||||
|
Residential real estate
|
(14 | ) | (52 | ) | (66 | ) | 182 | (43 | ) | 139 | |||||||||||||||
|
Home equity loans
|
(243 | ) | (72 | ) | (315 | ) | (194 | ) | (445 | ) | (639 | ) | |||||||||||||
|
Commercial and industrial
|
394 | 147 | 541 | 407 | (663 | ) | (256 | ) | |||||||||||||||||
|
Indirect lease financing
|
(71 | ) | 49 | (22 | ) | 134 | (173 | ) | (39 | ) | |||||||||||||||
|
Consumer loans
|
(88 | ) | 97 | 9 | (62 | ) | (31 | ) | (93 | ) | |||||||||||||||
|
Tax-exempt loans
|
319 | 34 | 353 | 53 | (37 | ) | 16 | ||||||||||||||||||
|
Other earning assets
|
13 | 4 | 17 | 203 | (236 | ) | (33 | ) | |||||||||||||||||
|
Total interest income
|
3,584 | (2,520 | ) | 1,064 | 4,784 | (4,534 | ) | 250 | |||||||||||||||||
|
Interest expense:
|
|||||||||||||||||||||||||
|
Interest-bearing demand
|
76 | 66 | 142 | 34 | 213 | 247 | |||||||||||||||||||
|
Municipals
|
77 | (68 | ) | 9 | (138 | ) | (323 | ) | (461 | ) | |||||||||||||||
|
Money market
|
170 | (305 | ) | (135 | ) | 229 | (405 | ) | (176 | ) | |||||||||||||||
|
Savings
|
156 | 394 | 550 | 29 | (9 | ) | 20 | ||||||||||||||||||
|
Time
|
(194 | ) | (2,215 | ) | (2,409 | ) | 802 | (2,116 | ) | (1,314 | ) | ||||||||||||||
|
Time of $100,000 or more
|
(73 | ) | (1,045 | ) | (1,118 | ) | 1,227 | (982 | ) | 245 | |||||||||||||||
|
Short-term borrowings
|
67 | (46 | ) | 21 | (8 | ) | (215 | ) | (223 | ) | |||||||||||||||
|
Long-term debt
|
(559 | ) | 102 | (457 | ) | 16 | (6 | ) | 10 | ||||||||||||||||
|
Total interest expense
|
(280 | ) | (3,117 | ) | (3,397 | ) | 2,191 | (3,843 | ) | (1,652 | ) | ||||||||||||||
|
Net interest income
|
$ | 3,864 | $ | 597 | $ | 4,461 | $ | 2,593 | $ | (691 | ) | $ | 1,902 | ||||||||||||
(
1
) Loan fees have been included in the change in interest income totals presented. Non-accrual loans and investment securities have been included in average balances.
(
2
) Changes due to both volume and rates have been allocated in proportion to the relationship of the dollar amount change in each.
(
3
) Interest income on loans and securities is presented on a tax-equivalent basis.
The Rate-Volume Analysis table, as presented on a tax-equivalent basis, highlights the impact of changing rates and volumes on interest income and interest expense. Total interest income on a tax-equivalent basis increased $1,064,000, or 2.9%, in 2010, to $38,090,000, while total interest expense decreased $3,397,000, or 24.9%, to $10,270,000. The increase in interest income was the result of the growth in earning assets outpacing the impact of the decline in interest rates. Volume growth contributed an additional $3,584,000 of interest income offsetting the decline in interest income of $2,520,000 resulting from lower interest rates. With regard to interest expense, lower funding costs resulted in a decline in interest expense of $3,117,000.
The yield on earning assets on a tax-equivalent basis decreased 32 basis points from 5.42% for 2009 to 5.10% for 2010. The yield on earning assets has held up fairly well as a result of the ability to grow loans at reasonable returns. This has been offset in part by the decline in the yield on the investment portfolio due to the call or prepayment of a significant amount of higher yielding securities the proceeds of which were reinvested at much lower rates. In comparison, the rate paid on interest-bearing liabilities decreased 73 basis points from 2.29% for 2009 to 1.56% for 2010.
Interest income on investment securities decreased $948,000 when comparing the two years as the $20,203,000, or 8.3%, increase in average balances could only partially offset the 73 basis point decline in the average yield of the portfolio. The average yield on the investment portfolio was 4.07% for 2010 compared with 4.80% for 2009. As noted previously, the decline in the yield on the investment portfolio is primarily the result of the extended period of low interest rates which has resulted in an increase in cash flow from the investment portfolio as prepayment speeds on mortgage-backed securities and CMOs ramped-up as did the amount of calls of agency and municipal securities. The reinvestment of these funds was generally in securities that had lower yields than what they replaced. The growth in the investment portfolio was primarily in high quality U.S. Government agency issued mortgage-backed and CMO securities as well as in tax-exempt state and municipal bonds.
22
|
Income on Government agency securities decreased $221,000, as the yield declined 109 basis points from 3.97% for 2009 to 2.88% for 2010, with lower yields reducing interest income by $631,000. Most of the bonds in the agency portfolio have call features ranging from three months to five years, many of which were exercised as a result of the low interest rate environment. The proceeds from these called bonds were reinvested in securities with significantly lower yields. The average balance of Government agency securities increased $10,333,000, or 21.7% and contributed $410,000 in additional income. The growth in this sector is primarily the result of an increase in deposits of a local school district. Agency bonds were purchased to match the cash flow needs of the school district over the course of the year. Since these bonds were very short-term their average yields were low, also contributing to the decline in the overall yield of the agency portfolio.
|
|
Interest income on mortgage-backed securities and CMOs decreased $1,008,000 with lower yields being the primary factor. The yield on the mortgage-backed portfolio decreased 104 basis points from 4.89% to 3.85% when comparing 2009 and 2010. With the historically low interest rate environment mortgage refinancing activity 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. The impact on income of lower yields was partially offset by a $7,976,000, or 6.3%, increase in average balances which resulted in additional income of $390,000.
Interest on tax-exempt municipal securities increased $368,000 with higher balances accounting for $533,000 of additional income. Average balances of tax-exempt municipal securities increased $8,220,000, or 16.1%, to $59,141,000 for 2010. As a result of credit concerns in the municipal market arising from issues with the insurance companies that insure the bonds during 2009 and concerns over the general health of state and municipal governments because of declining revenues and budget issues resulting from economic conditions in 2010, municipal bond yields declined but not to the same degree as yields on other types of securities. As a result QNB expanded its purchase of municipal bonds, primarily general obligation bonds of issuers with strong underlying credit ratings. The yield on the state and municipal portfolio decreased 28 basis points from 6.50% for 2009 to 6.22% for 2010. As of
December 31, 2010 the balance in this category was $66,255,000 with a tax-equivalent yield of 5.84%.
With the issues in the economy and low levels of inflation the Federal Reserve Open Market Committee has indicated it will continue to keep its target rate at between 0.0% and 0.25% for an extended period of time and will continue its purchases of Treasury securities through its quantitative easing program. Therefore, Treasury yields, despite coming off their historic lows at the end of 2010 will likely remain at fairly low levels. When combined with spread tightening on agency bonds, mortgage securities and municipal securities, yields on investment securities are anemic. As a result the yield on the total investment portfolio is anticipated to continue to decline as cash flow from the portfolio, as well as excess liquidity, is invested at current market rates which are significantly below the projected portfolio yield at December 31, 2010 of 3.79%.
Income on loans increased $1,997,000 to $27,324,000 comparing 2010 to 2009 as the impact of declining interest rates was offset by the growth in the portfolio. Average loans increased $39,139,000, or 9.1%, and this volume increase contributed an additional $2,305,000 in interest income. The yield on loans decreased only seven basis points, to 5.85% when comparing the same periods, resulting in a reduction in interest income of $308,000. Reducing the impact of the decline in interest rates on loans is the structure of the loan portfolio, which has a significant portion of fixed-rate and adjustable-rate loans with fixed-rate terms for three to ten years. Also helping to stabilize the yield was the implementation of interest rate floors on some variable-rate commercial loans and home equity lines of credit. The rate earned on loans has not fallen to the degree that the rate earned on investment securities, which are more closely tied to the Treasury yield curve. Most variable-rate loans are indexed to the Prime lending rate which did not change during 2010.
QNB took advantage of disruptions in its local banking market during 2009 and 2010 to grow its loan portfolio, particularly the commercial loan portfolio. Most of the growth in the loan portfolio, both in terms of balances and interest income, was in the category of 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. This category also includes construction and land development loans. Income on commercial real estate loans increased $1,497,000, with average balances increasing $32,613,000, or 14.8%, to $252,604,000, for 2010. The growth in this category resulted in an additional $2,008,000 in interest income. The yield on commercial real estate loans was 5.95% for 2010, a decline of 21 basis points from the 6.16% reported for 2009. The decline in the yield on the portfolio reduced interest income by $511,000.
Interest on commercial and industrial loans, the second largest category, increased $541,000 with a positive impact from both the growth in balances and the increase in the yield. Average commercial and industrial loans increased $7,731,000, or 10.4%, to $82,074,000 for 2010, contributing an additional $394,000 in interest income. The average yield on these loans increased 18 basis points to 5.27% resulting in an increase in interest income of $147,000. The implementation of interest rate floors on some loans in this category, primarily lines of credit indexed to the Prime lending rate, was a major factor in the improvement in the yield.
23
|
Another strong growth area has been loans to tax-exempt municipalities and organizations. This category of loans increased $5,411,000, or 21.4%, when comparing the average balances for 2010 and 2009. This growth in balances along with an increase in the yield on the portfolio from 5.91% for 2009 to 6.02% for 2010 resulted in an increase in interest income of $353,000.
Income on home equity loans declined by $315,000 when comparing the two years. During this same time period average home equity loans decreased $4,726,000, or 7.3%, to $60,192,000, while the yield on the home equity portfolio decreased 12 basis points to 5.02%. The demand for home equity loans has declined as home values have fallen eliminating some homeowners’ equity in their homes while others have taken advantage of the low interest rates on mortgages and refinanced their home equity loans into a new mortgage. Included in the home equity portfolio are floating rate home equity lines tied to the Prime lending rate. The average balance of these loans increased by $3,102,000, or 14.2%, to $24,992,000 for 2010. In contrast, average fixed-rate home equity loans declined by $7,828,000, or 18.1%, to $35,200,000. Customers who are opening home equity loans are choosing the floating rate option indexed to Prime even with a rate floor because the rate is currently significantly lower than a fixed rate home equity loan. In an attempt to boost demand, QNB has been offering an attractive fixed rate home equity loan promotion. This promotion which began during the second quarter of 2010 has had limited success, an indication of lack of demand by homeowners.
|
|
Income on other earning assets is comprised of interest on deposits in correspondent banks, primarily the Fed and dividends on restricted investments in bank stocks, primarily the Federal Home Loan Bank of Pittsburgh (FHLB). Income on other earning assets increased from $23,000 for 2009 to $40,000 for 2010. Beginning in December 2008, the Fed began paying 0.25% on balances in excess of required reserves. With this rate being above what could be earned on selling Federal funds or investing in AAA rated money market mutual funds excess liquidity was housed at the Fed. The average balance held at the Federal Reserve Bank was $14,671,000 for 2010 compared with $8,385,000 for 2009. In December 2008, the FHLB notified member banks that it was suspending dividend payments to preserve capital. There was no dividend income from the FHLB in either 2010 or 2009.
For the most part, earning assets are funded by deposits, which increased on average by $71,585,000, or 12.0%, to $665,913,000, when comparing 2010 and 2009. This follows an increase of $77,386,000, or 15.0% between 2008 and 2009. It appears that customers continue to be attracted to the safety of FDIC insured deposits and the stability of a strong local community bank as opposed to the volatility of the equity markets and the uncertainty of the larger regional and national banks. On October 3, 2008, in response to the ongoing economic crisis affecting the financial services industry, the Emergency Economic Stabilization Act of 2008 was enacted which temporarily raised the basic limit on FDIC coverage from $100,000 to $250,000 per depositor until December 31, 2009. However, legislation was passed during the second quarter of 2009 that extended the higher coverage through December 31, 2013. The recently enacted Dodd-Frank Act made the $250,000 coverage permanent. In addition, on October 13, 2008, the FDIC established a program under which the FDIC fully guaranteed all non-interest bearing transaction accounts until December 31, 2009 (the “Transaction Account Guarantee Program”). On August 26, 2009 the FDIC amended the program to extend the date six months until June 30, 2010 to those institutions that do not opt out of participating. On April 19, 2010 the program was extended again until December 31, 2010. QNB participated in the Transaction Account Guarantee Program. To participate in this program QNB paid a fee of 15 basis points in 2010. These programs likely contributed to the growth in deposits.
While total income on earning assets on a tax-equivalent basis increased $1,064,000 when comparing 2010 to 2009, total interest expense declined $3,397,000. Interest expense on total deposits decreased $2,961,000 while interest expense on borrowed funds decreased $436,000 when comparing the two years. The rate paid on interest-bearing liabilities decreased 73 basis points from 2.29% for 2009 to 1.56% for 2010. During this same period, the rate paid on interest-bearing deposits decreased 73 basis points from 2.20% to 1.47%.
All categories of average deposits, except for time deposits, increased when comparing 2010 to the same period in 2009. Unlike prior years the growth was not centered in time deposits but in accounts with greater liquidity, such as interest-bearing demand, interest-bearing municipal accounts, money market and savings deposits. Average interest-bearing demand accounts increased $13,148,000, or 18.7%, to $83,546,000 for 2010 compared to 2009. Interest expense on interest-bearing demand accounts increased from $403,000 for 2009 to $545,000 for 2010 while the average rate paid increased from 0.57% to 0.65%. The increase in the average rate paid reflects a change in the mix of accounts included in interest-bearing demand accounts. Included in this category is QNB Rewards checking, a high rate checking account. For most of 2009 the product paid a yield of 3.25% on balances up to $25,000. This yield was reduced on February 10, 2010 to 2.75% and again on August 18, 2010 to 2.05% as Treasury rates declined to historic lows. 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 per statement cycle. For 2010, the average balance in this product was $25,885,000 and the related interest expense was $512,000 for an average yield of 1.98%. This lower rate reflects the lower rate paid on accounts that do not meet the qualifications or on balances in excess of $25,000 which paid 1.01% until August 18, 2010 and 0.75% thereafter. In comparison the average balance for 2009 was $14,056,000 with a related interest expense of $373,000 and an average rate paid of 2.65%. 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 $56,342,000 for 2009 to $57,661,000 for 2010 while the average rate paid on these balances was 0.06% for both years.
24
Interest expense on municipal interest-bearing demand accounts increased from $357,000 for 2009 to $366,000 for 2010. The increase in interest expense was the result of an increase in average balances offsetting a slight decline in the rate paid. The average balance of municipal interest-bearing demand accounts increased $7,165,000, or 21.7%, while the average interest rate paid on these accounts decreased from 1.08% for 2009 to 0.91% for 2010. Most of these accounts are tied directly to the Federal funds rate with most having rate floors between 0.25% and 1.00%. The balances in many of these accounts are seasonal in nature and are dependent upon the timing of the receipt of taxes and the disbursement by the schools and municipalities.
Average money market accounts increased $14,593,000, or 24.1%, to $75,128,000 for 2010 compared with 2009. The growth in balances in money market accounts was centered primarily in business accounts. Despite the significant increase in balances, interest expense on money market accounts decreased $135,000 to $568,000 for 2010 compared to 2009. The average interest rate paid on money market accounts was 1.16% for 2009 and 0.76% for 2010, a decline of 40 basis points. Included in total money market balances is the Select money market account, a higher yielding money market product that pays a tiered rate based on account balances. With the sharp decline in short-term interest rates, the rates paid on the Select money market account have declined as well. The average rate paid on Select money market accounts in 2010 was 0.85% a decline of 48 basis points from the average rate of 1.33% paid in 2009.
During the second quarter of 2009, QNB introduced an online eSavings account to compete with other online savings accounts. This product was introduced at a yield of 1.85% and has been extremely successful having grown to balances of $67,435,000 at December 31, 2010. The eSavings yield was reduced to 1.60% on March 17, 2010 and to 1.30% on August 6, 2010. The average balance of this product was $42,582,000 for 2010 compared with $3,874,000 for 2009 and contributed to the $42,331,000, or 82.6%, increase in total average savings accounts when comparing the two years. Average statement savings accounts also increased $3,819,000, or 8.2%, when comparing the same periods. As a result of the eSavings product the average rate paid on savings accounts increased 42 basis points from 0.37% for 2009 to 0.79% for 2010 and interest expense increased $550,000 from $189,000 for 2009 to $739,000 for 2010. The growth in balances appears to reflect the desire for safety, liquidity and a better rate than short-term time deposits.
The repricing of time deposits at lower rates over the past couple of years has had the greatest impact on total interest expense when comparing the two years. Total interest expense on time deposits decreased $3,527,000, or 34.4%, to $6,726,000 for 2010. Average total time deposits decreased by $8,462,000, or 2.6%, to $317,349,000 for 2010. Similar to fixed-rate loans and investment securities, time deposits reprice over time and, therefore, have less of an immediate impact on costs in either a rising or falling rate environment. Unlike loans and investment securities, however, the maturity and repricing characteristics of time deposits tend to be shorter. Over the course of 2009 and 2010 a significant amount of time deposits have repriced lower as market rates have declined. The average rate paid on time deposits decreased from 3.15% to 2.12% when comparing 2009 to 2010.
Approximately $232,201,000, or 74.8%, of time deposits at December 31, 2010 will reprice or mature over the next 12 months. The average rate paid on these time deposits is approximately 1.76%. During the first quarter of 2011 approximately $104,417,000 of time deposits yielding 2.19% will reprice or mature. Given the short-term nature of QNB’s time deposit portfolio and the current rates being offered, it is likely that the average rate paid on time deposits should continue to decline during 2011 as higher costing time deposits are repriced lower. However, given the short-term nature of these deposits interest expense could increase if short-term time deposit rates were to increase suddenly. It is anticipated, given recent history, that some of these maturing time deposits will migrate to the online savings or money market accounts or be withdrawn.
Short-term borrowings are primarily comprised of sweep accounts structured as repurchase agreements with our commercial customers. Interest expense on short-term borrowings increased by $21,000 to $269,000 when comparing the two years. During this period average balances increased $5,841,000 to $27,658,000 while the average rate paid declined from 1.14% to 0.97%.
Contributing to the decrease in total interest expense was a reduction in interest expense on long-term debt of $457,000. In January 2010, $10,000,000 in FHLB advances at a rate of 2.97% matured and were repaid. In addition, in April 2010 another $5,000,000 of debt at a rate of 4.90% matured and was repaid resulting in the reduction in expense. The average balance of long-term debt for 2010 was $22,077,000 compared with $35,000,000 in 2009. Since the average rate paid on the debt that was repaid was lower than the remaining debt the average rate paid increased from 4.27% for 2009 to 4.72% for 2010.
25
Provision For Loan Losses
The provision for loan losses represents management’s determination of the amount necessary to be charged to operations to bring the allowance for loan losses to a level that represents management’s best estimate of the known and inherent losses in the existing loan portfolio. Actual loan losses, net of recoveries, serve to reduce the allowance. Recent economic conditions contributed to high rates of unemployment and a softening of the residential and commercial real estate markets. These factors have had a negative impact on both consumers and small businesses and have contributed to higher than historical levels of net charge-offs and non-performing, impaired and classified loans over the past two years. These results when combined with the inherent risk related to the significant growth in the loan portfolio, contributed to QNB recording provision for loan losses of $3,800,000 in 2010, a slight decrease from the $4,150,000 recorded in 2009. Further deterioration in credit quality could result in a continuation of an elevated provision for loan losses in 2011.
|
Non-Interest Income Comparison
|
||||||||||||||||
|
Change from Prior Year
|
||||||||||||||||
|
Year Ended December 31,
|
2010
|
2009
|
Amount
|
Percent
|
||||||||||||
|
Fees for services to customers
|
$ | 1,571 | $ | 1,743 | $ | (172 | ) | (9.9 | )% | |||||||
|
ATM and debit card
|
1,228 | 1,016 | 212 | 20.9 | ||||||||||||
|
Bank-owned life insurance
|
314 | 309 | 5 | 1.6 | ||||||||||||
|
Merchant income
|
278 | 243 | 35 | 14.4 | ||||||||||||
|
Net loss on investment securities
|
(1 | ) | (454 | ) | 453 | 99.8 | ||||||||||
|
Net gain on sale of loans
|
494 | 633 | (139 | ) | (22.0 | ) | ||||||||||
|
Other
|
455 | 395 | 60 | 15.2 | ||||||||||||
|
Total
|
$ | 4,339 | $ | 3,885 | $ | 454 | 11.7 | % | ||||||||
Non-Interest Income
QNB, through its core banking business, generates various fees and service charges. Total non-interest income is composed of service charges on deposit accounts, ATM and check card income, income on bank-owned life insurance, merchant income and gains and losses on investment securities and residential mortgage loans. Total non-interest income was $4,339,000 in 2010 compared with $3,885,000 in 2009, an increase of $454,000, or 11.7%.
Fees for services to customers, the largest component of non-interest income, are primarily comprised of service charges on deposit accounts. These fees were $1,571,000 for 2010, a $172,000, or 9.9%, decline from 2009. Overdraft income, which represents approximately 73% of total fees for services to customers in 2010, declined by $217,000, or 16.0%, when comparing 2010 to 2009. The decline in overdraft income is a result of the implementation of new rules under Regulation E and a reduction in the per item fee charged to customers. In March 2010, QNB reduced the per item charge for overdrafts by $2 to $35. Offsetting a portion of the decline in overdraft income was an increase in fees on business checking accounts of $35,000 when comparing 2010 to 2009. This increase reflects the impact of a lower earnings credit rate in 2010 compared to 2009, resulting from the decline in short-term interest rates. These earnings credits are applied against service charges to reduce the costs paid by the customer. Fees charged to commercial customers for the use of internet banking increased from $19,000 for 2009 to $32,000 in 2010 as more customers enrolled in the service.
ATM and debit card income is primarily comprised of transaction income on debit cards and ATM cards and ATM surcharge income for the use of QNB’s ATM machines by non-QNB customers. ATM and debit card income was $1,228,000 in 2010, an increase of $212,000, or 20.9%, from the amount recorded in 2009. Debit card income increased $130,000, or 18.0%, to $851,000 in 2010, while ATM interchange income increased $101,000, or 54.1%, to $290,000. The increase in debit and ATM card income was a result of the continuing increased reliance on the card as a means of paying for goods and services by both consumers and business cardholders. The higher rate of increase in ATM PIN-based transactions is a function of some merchants recommending lower costing PIN based transactions over higher costing signature debit transactions as well as an increase in the amount QNB receives per transaction. Helping to contribute to the growth in debit card transactions is the growth in the QNB Rewards checking product, a high-yield checking account which requires, among other terms, the posting of a minimum of twelve debit card purchase transactions per statement cycle to receive the high interest rate. The passage of the Dodd-Frank Act could have negative implications on the amount of interchange income earned by QNB in the future. The impact at this time is unknown. Partially offsetting these increases was a decline in ATM surcharge income of $15,000. Fewer non-customers are making cash withdrawals at QNB machines because they are finding machines without a surcharge, are getting cash back on PIN-based card transactions or are using less cash.
Income on bank-owned life insurance (BOLI) represents the earnings and death benefits on life insurance policies in which the Bank is the beneficiary. Income on these policies was $314,000 and $309,000 in 2010 and 2009, respectively. The insurance carriers reset the rates on these policies annually taking into consideration the interest rate environment as well as mortality costs. The existing policies have rate floors which minimize how low the earnings rate can go. Some of these policies are currently at their floor.
Merchant income represents fees charged to merchants for the bank’s handling of credit card or charge sales. Merchant income was $278,000 for 2010, an increase of $35,000, or 14.4%, from the amount reported in 2009. The increase in merchant income is primarily a result of an increase in the number of merchant’s QNB services.
26
The fixed-income securities portfolio represents a significant portion of QNB’s earning assets and is also a primary tool in liquidity and asset/liability management. QNB actively manages its fixed-income portfolio in an effort to take advantage of changes in the shape of the yield curve, changes in spread relationships in different sectors, and for liquidity purposes. 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 recorded net losses on investment securities of $1,000 in 2010 compared with net losses of $454,000 in 2009. Net securities losses of $1,000 for 2010 include credit related OTTI charges of $277,000 on three pooled trust preferred securities and OTTI charges of $33,000 on an equity security. These OTTI charges were almost entirely offset by net gains on the sales of securities, primarily equity securities of $309,000. The net loss for 2009 included credit related OTTI charges on pooled trust preferred securities of $1,002,000. The impairment charges on the pooled trust preferred securities for the past two years resulted from a valuation performed by an independent third party that included a review of all eight pooled trust preferred securities owned by the Bank. A description of the valuation methodology used can be found in Footnotes 4 and 17. The net loss for 2009 also included OTTI charges on equity securities of $521,000, net gains on the sale of debt securities of $660,000 and net gains on the sale of equity securities of $409,000. During 2009, in an effort to reduce credit risk QNB sold $6,000,000 in corporate bonds issued by financial institutions and $3,347,000 of non-agency issued collateralized mortgage backed securities. In addition, $14,345,000 of higher coupon faster paying mortgage-backed securities were sold in the fourth quarter of 2009 to reposition the cash-flow of the portfolio.
When QNB sells its residential mortgages in the secondary market, it retains servicing rights. A normal servicing fee is retained on all mortgage loans sold and serviced. QNB recognizes its obligation to service financial assets that are retained in a transfer of assets in the form of a servicing asset. The servicing asset is amortized in proportion to, and over, the period of net servicing income or loss. On a quarterly basis, servicing assets are assessed for impairment based on their fair value. The timing of mortgage payments and delinquencies also impacts the amount of servicing fees recorded.
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. The net gain on the sale of residential mortgage loans was $494,000 and $633,000 for 2010 and 2009, respectively. This $139,000 decrease in the net gain on sale of loans was primarily a result of decreased refinancing activity. Many customers who were able to refinance have already done so due to the low interest rate environment that has existed for the past two years. Included in the gains on the sale of residential mortgages in 2010 and 2009 are $89,000 and $189,000, respectively, related to the recognition of mortgage servicing assets. Proceeds from the sale of residential mortgages were $12,124,000 and $25,400,000 for 2010 and 2009, respectively. While the total gains on the sale of mortgages has declined as a result of reduced volume, the amount of gain recognized on each sale has increased because of the historically low level of mortgage rates.
Other income increased by $60,000 when comparing the $455,000 recorded in 2010 to the $395,000 recorded in 2009. The majority of the difference was a result of the following:
|
•
|
Losses on the sale of other real estate owned and repossessed assets were $2,000 in 2010 compared with losses of $134,000 in 2009. Approximately half the loss in 2009 relate to the sale of two foreclosed residential properties while the other half relates to the sale of repossessed vehicles and equipment from the indirect lease portfolio.
|
|
•
|
Income from an investment in a title insurance company decreased by $30,000 as a result of a decline in mortgage activity compared to the prior year.
|
|
•
|
Other income in 2009 included the recognition of income related to the reversal of a $44,000 accrual recorded in prior years as a result of a decision to amend the terms of a group term life plan.
|
|
•
|
Other income in 2010 includes a sales and use tax refund of $22,000.
|
|
Non-Interest Expense Comparison
|
||||||||||||||||
|
Change from Prior Year
|
||||||||||||||||
|
Year Ended December 31,
|
2010
|
2009
|
Amount
|
Percent
|
||||||||||||
|
Salaries and employee benefits
|
$ | 8,999 | $ | 8,525 | $ | 474 | 5.6 | % | ||||||||
|
Net occupancy
|
1,535 | 1,343 | 192 | 14.3 | ||||||||||||
|
Furniture and equipment
|
1,202 | 1,220 | (18 | ) | (1.5 | ) | ||||||||||
|
Marketing
|
737 | 647 | 90 | 13.9 | ||||||||||||
|
Third party services
|
1,116 | 1,075 | 41 | 3.8 | ||||||||||||
|
Telephone, postage and supplies
|
612 | 609 | 3 | 0.5 | ||||||||||||
|
State taxes
|
561 | 539 | 22 | 4.1 | ||||||||||||
|
FDIC insurance premiums
|
1,041 | 1,211 | (170 | ) | (14.0 | ) | ||||||||||
|
Other
|
1,598 | 1,417 | 181 | 12.8 | ||||||||||||
|
Total
|
$ | 17,401 | $ | 16,586 | $ | 815 | 4.9 | % | ||||||||
27
Non-Interest Expense
Non-interest expense is comprised of costs related to salaries and employee benefits, net occupancy, furniture and equipment, marketing, third party services, FDIC insurance premiums, regulatory assessments and taxes and various other operating expenses. Total non-interest expense was $17,401,000 in 2010, an increase of $815,000, or 4.9%, from the $16,586,000 recorded in 2009. QNB’s overhead efficiency ratio, which represents the percentage of each dollar of revenue that is used for non-interest expense, is calculated by taking non-interest expense divided by net operating revenue on a tax-equivalent basis. QNB’s efficiency ratios for 2010 and 2009 were 54.1% and 60.9%, respectively.
Salaries and benefits expense is 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 where appropriate. Salaries and benefits expense for 2010 was $8,999,000, an increase of $474,000, or 5.6%, over the $8,525,000 reported in 2009. Salary expense for 2010 was $7,208,000, an increase of $365,000, or 5.3%, over the $6,843,000 reported in 2009. Included in salary expense in 2010 was an accrual for incentive compensation of $211,000. There was no incentive compensation expense in 2009. Also included in salary expense for 2010 and 2009 was $130,000 and $109,000, respectively, in severance expense for former executives of the Company. Excluding the cost of incentive compensation and severance pay, salary expense increased $133,000, or 2.0%, when comparing 2010 to 2009. Merit increases, as well as an increase in the average number of full-time equivalent employees by three contributed to the higher salary expense. Included in salary expense for most of 2009 were costs associated with the Chief Operating Officer position. This position was vacant for the first eight months of 2010.
Benefit expense for 2010 was $1,791,000, an increase of $109,000, or 6.5%, from the amount recorded in 2009. Payroll tax and retirement plan expense increased $42,000 and $14,000, respectively, principally a function of higher salary expense, while medical and dental premiums increased $44,000 compared to 2009, an 8.9% increase.
Net occupancy expense for 2010 was $1,535,000, an increase of $192,000, or 14.3%, from the amount reported in 2009. Branch rent expense accounted for $101,000 of the increase with the lease on the permanent Wescosville branch being the most significant contributor to this increase. Also contributing to the higher net occupancy cost in 2010 were increases in utilities expense of $31,000, building repairs and maintenance expense of $32,000 and building security expense of $20,000. Some of these increases also relate to the new branch. Rate increases by the utility companies as well as an increase in usage also contributed to the increase in utilities expense. The increase in security expense also relates to the ongoing expense of tracking devices in the branches added over the past two years.
Furniture and equipment expense decreased $18,000, or 1.5%, to $1,202,000, when comparing 2010 to 2009. Depreciation expense declined by $40,000 while equipment maintenance costs increased by $25,000 when comparing the two years.
Marketing expense was $737,000 for 2010, an increase of $90,000, or 13.9%, from the $647,000 recorded in 2009. The majority of the increase relates to a $56,000 increase in donations and a $15,000 increase in public relations expense. QNB contributes to many not-for-profit organizations and clubs and sponsors many local events in the Bank’s communities it serves. Marketing costs also increased in 2010 as a result of the opening of the permanent Wescosville branch and the launching of the new marketing campaign, “Always You, Always QNB. Yesterday, Today, Tomorrow.”
Third-party services are comprised of professional services including legal, accounting and auditing, and consulting services, as well as fees paid to outside vendors for services in support of day-to-day operations. These support services include correspondent banking services, statement printing and mailing, investment security safekeeping and supply management services. Third-party services expense was $1,116,000 in 2010, compared to $1,075,000 in 2009, an increase of $41,000, or 3.8%. The largest portion of the increase relate to the following third party services:
|
•
|
Audit and accounting cost increased $50,000 compared to the prior year. The main contributors are costs associated with complying with the upcoming XBRL requirements as well as additional services related to Sarbanes-Oxley documentation and testing contracted with the Company’s outsourced internal audit firm.
|
|
•
|
Consultant expense decreased by $42,000 to $91,000 in 2010. Included in 2009 were expenses associated with an executive search consultant used to fill the open Chief Operating Officer position.
|
|
•
|
Costs associated with the registration, printing and mailing and ongoing expenses of the Dividend Reinvestment and Stock Purchase Plan contributed approximately $17,000 to the increase in 2010.
|
State tax expense represents the payment of the Pennsylvania Shares Tax, which is based primarily on the equity of the Bank, Pennsylvania sales and use tax and the Pennsylvania capital stock tax. State tax expense was $561,000 and $539,000 for the years 2010 and 2009, respectively. The Pennsylvania Shares Tax was $557,000 in 2010, an increase of $26,000 reflecting higher equity levels.
28
FDIC insurance premiums decreased $170,000, or 14.0%, to $1,041,000 for 2010. The lower expense is a result of a special assessment levied on all insured institutions by the FDIC during the second quarter of 2009. These actions were taken by the FDIC in order to replenish the Deposit Insurance Fund which was reduced as a result of bank failures. The special assessment contributed $332,000 to the total FDIC costs in 2009. There was no similar special assessment in 2010. Partially offsetting this reduction in 2010 was the impact on FDIC premiums resulting from the significant growth in deposits combined with a slightly higher assessment rate in 2010 compared with 2009.
Other expense increased $181,000, or 12.8%, to $1,598,000 for the year ended December 31, 2010. The majority of the difference was a result of the following:
|
•
|
Costs related to appraisals and title searches on loans, particularly classified loans, increased $60,000 when comparing 2010 to 2009. These expenses are a result of the Company’s ongoing efforts to obtain the most recent and relevant information to analyze classified loans in connection with the calculation of the allowance for loan losses.
|
|
•
|
Directors’ fees increased $31,000 for 2010 when compared to 2009. This was partly attributable to an increase in the number of meetings held and a portion of the increase is a result of deferred loan fees decreasing by $18,000. These fees have the impact of offsetting a portion of the directors’ fees related to meetings for loans that require director approval. These fees were lower than the prior year due to a reduction in the number of loans requiring director approval in 2010 as commercial loan demand softened due to the economy.
|
|
•
|
Expenses in connection with foreclosed real estate and repossessed assets increased $89,000, with the majority of the increase related to costs associated with maintaining a property the Bank owns that is classified as OREO. Also contributing to the increase in foreclosed real estate expense is the payment of past due real estate taxes in order to preserve the Bank’s lien position on several mortgages.
|
|
•
|
Refund of ATM fees related to the QNB Rewards product increased $20,000.
|
|
•
|
Charge-offs related to fraudulent ATM and checkcard transactions increased $15,000.
|
|
•
|
Employee training expenses decreased $16,000. Prior year included higher costs for service and sales training for branch and call center personnel.
|
Income Taxes
Applicable income taxes and effective tax rates were $1,834,000, or 20.3%, for 2010 compared to $623,000, or 12.8%, for 2009. The higher effective tax rate for 2010 is predominately a result of tax-exempt income from loans and securities comprising a lower proportion of pre-tax income. For a more comprehensive analysis of income tax expense and deferred taxes, refer to Note 11 in the Notes to Consolidated Financial Statements.
Financial Condition
Financial service organizations are challenged to demonstrate they can generate sustainable and consistent earnings growth in a dynamic operating environment. This challenge was evident in 2010 and 2009 as financial institutions, including QNB, had to operate in an unprecedented economic environment which included a global recession, the freeze up in credit markets, the bursting of the housing bubble, significant volatility in the equity markets and historically low interest rates. While the economy is showing signs of improvement, a challenging economic environment is anticipated to continue in 2011.
QNB operates in an attractive but highly competitive market for financial services. Competition comes in many forms including other local community banks, regional banks, national financial institutions and credit unions, all with a physical presence in the markets we serve. In addition, other strong forms of competition have emerged, such as internet banks. The internet has enabled customers to “rate shop” financial institutions throughout the nation, both for deposits and retail loans. QNB has been able to compete effectively by emphasizing a consistently high level of customer service, including local decision-making on loans and by providing a broad range of high quality financial products designed to address the specific needs of our customers. The establishment of long-term customer relationships and customer loyalty remain our primary focus.
Total assets at December 31, 2010 were $809,260,000, an increase of $46,834,000, or 6.1%, when compared with total assets of $762,426,000 at December 31, 2009. The growth in total assets since December 31, 2009 was centered in loans receivable and investment securities which increased $32,761,000 and $33,022,000, respectively. Partially offsetting these increases was a $15,744,000 decrease in interest-bearing deposits in banks, primarily deposits at the Fed. Higher balances were maintained at the Fed at December 31, 2009 compared to December 31, 2010 in anticipation of paying down FHLB advances in January 2010 and for the payment of $4,998,000 of unsettled investment trades. The category of other assets decreased $477,000 from December 31, 2009 to December 31, 2010. Contributing to the decrease in other assets was a reduction in the prepaid FDIC assessment account of $973,000 to $2,236,000 at December 31, 2010 compared to $3,209,000 at December 31, 2009. On September 29, 2009, the FDIC adopted an Amended Restoration Plan. Pursuant to this Plan, the FDIC amended its assessment regulations to require all institutions to prepay, on December 30, 2009, their estimated risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012, as estimated by the FDIC. The assessment paid by the Bank was $3,407,000 and the amount related to 2010 through 2012 was recorded in a prepaid asset account. The remaining prepaid asset will be expensed monthly during the years 2011 and 2012 based on actual FDIC assessment rate calculations. Also included in other assets is a net deferred tax asset of $2,572,000 at December 31, 2010 compared to $1,610,000 at December 31, 2009. The detail of the net deferred tax asset can be found in Footnote 11 in the Notes to the Consolidated Financial Statements.
Funding the growth in assets was an increase in total deposits of $60,874,000, or 9.6%, to $694,977,000 at December 31, 2010. The growth in total deposits reflects increases in core deposits, including interest-bearing demand, money market and savings accounts. Offsetting some of the growth in funding sources from deposits was a reduction in long-term debt of $14,692,000. As noted above $10,000,000 in FHLB borrowings matured and were repaid in January 2010 and in April 2010, $5,000,000 of repurchase agreements matured and were repaid. The category of other liabilities decreased $4,889,000 from December 31, 2009 to December 31, 2010. Included in the December 31, 2009 balance of other liabilities were $4,998,000 of unsettled trades of investment securities. These trades settled in January 2010.
29
The following discussion will further detail QNB’s financial condition during 2010 and 2009.
|
Investment Portfolio History
|
||||||||||||
|
December 31,
|
2010
|
2009
|
2008
|
|||||||||
|
Investment Securities Available-for-Sale
|
||||||||||||
|
U.S. Treasuries
|
– | $ | 5,013 | $ | 5,124 | |||||||
|
U.S. Government agencies
|
$ | 66,448 | 69,731 | 44,194 | ||||||||
|
State and municipal securities
|
63,588 | 54,160 | 42,300 | |||||||||
|
U.S. Government agencies and sponsored enterprises (GSEs) - residential:
|
||||||||||||
|
Mortgage-backed securities
|
78,801 | 61,649 | 67,347 | |||||||||
|
Collateralized mortgage obligations (CMOs)
|
75,573 | 61,317 | 49,067 | |||||||||
|
Other debt securities
|
2,384 | 1,533 | 8,476 | |||||||||
|
Equity securities
|
3,770 | 3,459 | 3,089 | |||||||||
|
Total investment securities available-for-sale
|
$ | 290,564 | $ | 256,862 | $ | 219,597 | ||||||
|
Investment Securities Held-to-Maturity
|
||||||||||||
|
State and municipal securities
|
$ | 2,667 | $ | 3,347 | $ | 3,598 | ||||||
|
Total investment securities held-to-maturity
|
$ | 2,667 | $ | 3,347 | $ | 3,598 | ||||||
|
Total investment securities
|
$ | 293,231 | $ | 260,209 | $ | 223,195 | ||||||
Investment Securities and Other Short-Term Investments
QNB had interest bearing balances at the Federal Reserve Bank of $6,405,000 at December 31, 2010 compared with $22,125,000 at December 31, 2009. These balances are included in the category of interest bearing deposits in banks. At December 31, 2010 and 2009 QNB had no Federal funds sold. With the decline in the Federal funds rate to between 0.0% and 0.25% the decision was made to maintain excess funds for liquidity purposes at the Fed which was paying 0.25% and carries a 0% risk weighting for risk-based capital calculation purposes. Higher balances were maintained at the Fed at December 31, 2009 compared to December 31, 2010 in anticipation of paying down $10,000,000 in FHLB advances in January 2010 and for the payment of the unsettled investment trades, noted previously.
The total carrying amount of investment securities at December 31, 2010 and 2009 were $293,231,000 and $260,209,000, respectively. For the same periods, approximately 75.3% and 76.0%, respectively, of QNB’s investment securities were either U.S. Government, U.S. Government agency debt securities, U.S. Government agency issued mortgage-backed securities or collateralized mortgage obligation securities (CMOs). As of December 31, 2010, QNB held no securities of any one issue or any one issuer (excluding the U.S. Government and its agencies) that were in excess of 10% of shareholders’ equity.
In light of the fact that QNB’s investment portfolio represents a significant portion of earning assets and interest income, QNB actively manages the portfolio in an attempt to maximize earnings, while considering liquidity needs, interest rate risk and credit risk. Proceeds from the sale of investments were $7,490,000 in 2010 compared to $26,006,000 during 2009. To reduce credit risk in the portfolio QNB has proactively sold over the past two years corporate bonds issued by financial institutions, nonagency issued CMOs and noninvestment grade and nonrated state and municipal bonds. These sales generally resulted in the recording of gains but usually also resulted in the selling of some higher yielding bonds. In addition to the proceeds from the sale of investment securities, proceeds from maturities, calls and prepayments of securities were $131,527,000 in 2010, compared with $88,575,000 in 2009. The significant amount of proceeds in both years reflects the low interest rate environment that has existed for the past two years which resulted in an increase in the amount of bonds called as well as the amount of prepayments on mortgage-backed securities and CMOs. The 2010 and 2009 proceeds along with the increase in deposits were used primarily to fund loan growth and purchase replacement securities. During 2010, $178,411,000 of investment securities were purchased compared with $144,365,000 during 2009.
As a result of this activity and the effort to manage cash flow in the low interest rate environment, the composition of the portfolio changed over the past year. While the portfolio is fairly even split between the four main sectors at December 31, 2010, an effort was made to increase the amount of amortizing securities in anticipation of rising rates. To accomplish this goal the percentage of mortgage-backed securities and CMO’s was increased. The balance of mortgage-backed securities increased by $17,152,000 to $78,801,000 at December 31, 2010 and represent 26.9% of the portfolio at December 31, 2010 compared with 23.7% of balances at the end of 2009. The balance of CMOs increased by $14,256,000 to $75,573,000 at December 31, 2010 and represent 25.8% of the portfolio at December 31, 2010, compared with 23.6% at December 31, 2009. QNB continues to purchase Government National Mortgage Association (GNMA) CMOs as these securities qualify for 0% risk-weighting for capital purposes. Municipal bond yields did not decline to the same degree as yields on other types of securities. To take advantage of these higher yields QNB expanded its purchase of tax-exempt state and municipal securities, increasing its holdings by $8,748,000 to represent 22.6% of the portfolio at December 31, 2010, compared with 22.1% at December 31, 2009. When QNB purchases a municipal security it focuses on the credit rating of the underlying issuer not the rating of bond insurer, if present. In contrast to the other three sectors, the balance of U.S. Government agency securities, primarily callable agency bonds decreased from $69,731,000, or 26.8% of the portfolio at the end of 2009, to $66,448,000, or 22.7% of the portfolio at December 31, 2010. With the significant decline in Treasury rates during 2010 and the tightening of spreads, on agency, mortgage and municipal securities, yields on investment securities were anemic during most of 2010. The weighted average yield on the portfolio declined from 4.43% as of December 31, 2009 to 3.79% at December 31, 2010. The decline in yield is the result of an increase in liquidity resulting from deposit growth and a significant increase in cash flow from the investment portfolio as prepayment speeds on mortgage-backed securities and CMOs ramped-up as did the amount of calls of agency and municipal securities. The reinvestment of these funds was generally in securities that had lower yields than what they replaced. It is anticipated that the yield will continue to decline in 2011 as the proceeds from the call and maturity of investment securities continues to be reinvested at lower rates.
30
Collateralized debt obligations (CDO) are securities derived from the packaging of various assets with many backed by subprime mortgages. These instruments are complex and difficult to value. QNB did a review of its mortgage related securities and concluded that it has minimal exposure to subprime mortgages within its U.S. government sponsored agency (GNMA, FHLMC and FNMA) mortgage-backed and CMO investment portfolio. QNB does not own any non-agency mortgage security or CDO backed by subprime mortgages.
QNB does own CDOs in the form of pooled trust preferred securities. These securities are comprised mainly of securities issued by financial institutions, and to a lesser degree, insurance companies. QNB owns the mezzanine tranches of these securities. These securities are structured so that the senior and mezzanine tranches are protected from defaults by over-collateralization and cash flow default protection provided by subordinated tranches. QNB holds eight of these securities with an amortized cost of $3,640,000 and a fair value of $1,866,000. All of the trust preferred securities are available-for-sale securities and are carried at fair value. During 2010 and 2009, QNB took credit related OTTI charges through the income statement of $277,000 and $1,002,000, respectively. For additional detail on these securities see Note 4 Investment Securities and Note 17 Fair Value Measurements and Fair Values of Financial Instruments.
QNB accounts for its investments by classifying its securities into three categories. Securities that QNB has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses, net of tax, excluded from earnings and reported as a separate component of shareholders’ equity. Management determines the appropriate classification of securities at the time of purchase. QNB held no trading securities at December 31, 2010 or 2009.
At December 31, 2010 and 2009, investment securities totaling $133,446,000 and $133,136,000, respectively, were pledged as collateral for repurchase agreements and public deposits.
31
|
Investment Portfolio Maturities and Weighted Average Yields
|
||||||||||||||||||||
|
Under
|
1-5 | 5-10 |
Over 10
|
|||||||||||||||||
|
December 31, 2010
|
1 Year
|
Years
|
Years
|
Years
|
Total
|
|||||||||||||||
|
Investment Securities Available-for-Sale
|
||||||||||||||||||||
|
U.S. Government agencies:
|
||||||||||||||||||||
|
Fair value
|
– | $ | 38,847 | $ | 27,601 | – | $ | 66,448 | ||||||||||||
|
Weighted average yield
|
– | 1.95 | % | 2.24 | % | – | 2.07 | % | ||||||||||||
|
State and municipal securities:
|
||||||||||||||||||||
|
Fair value
|
$ | 2,937 | $ | 3,792 | $ | 14,897 | $ | 41,962 | $ | 63,588 | ||||||||||
|
Weighted average yield
|
8.05 | % | 6.53 | % | 5.95 | % | 5.51 | % | 5.79 | % | ||||||||||
|
Mortgage-backed securities:
|
||||||||||||||||||||
|
Fair value
|
– | $ | 75,664 | $ | 3,137 | – | $ | 78,801 | ||||||||||||
|
Weighted average yield
|
– | 3.80 | % | 2.93 | % | – | 3.77 | % | ||||||||||||
|
Collateralized mortgage obligations (CMOs):
|
||||||||||||||||||||
|
Fair value
|
$ | 1,960 | $ | 67,304 | $ | 6,309 | – | $ | 75,573 | |||||||||||
|
Weighted average yield
|
5.10 | % | 3.69 | % | 3.40 | % | – | 3.70 | % | |||||||||||
|
Other debt securities:
(1)
|
||||||||||||||||||||
|
Fair value
|
– | $ | 518 | – | $ | 1,866 | $ | 2,384 | ||||||||||||
|
Weighted average yield
|
– | 9.04 | % | – | 0.17 | % | 1.14 | % | ||||||||||||
|
Equity securities:
|
||||||||||||||||||||
|
Fair value
|
– | – | – | $ | 3,770 | $ | 3,770 | |||||||||||||
|
Weighted average yield
|
– | – | – | 3.61 | % | 3.61 | % | |||||||||||||
|
Total fair value
|
$ | 4,897 | $ | 186,125 | $ | 51,944 | $ | 47,598 | $ | 290,564 | ||||||||||
|
Weighted average yield
|
6.87 | % | 3.43 | % | 3.46 | % | 4.99 | % | 3.76 | % | ||||||||||
|
Investment Securities Held-to-Maturity
|
||||||||||||||||||||
|
State and municipal securities:
|
||||||||||||||||||||
|
Amortized cost
|
$ | 825 | – | $ | 1,842 | – | $ | 2,667 | ||||||||||||
|
Weighted average yield
|
7.43 | % | – | 6.94 | % | – | 7.09 | % | ||||||||||||
Securities are assigned to categories based on stated contractual maturity except for mortgage-backed securities and CMOs which are based on anticipated payment periods. Tax-exempt securities were adjusted to a tax-equivalent basis and are based on the marginal Federal corporate tax rate of 34 percent and a Tax Equity and Financial Responsibility Act (TEFRA) adjustment of 13 basis points. Weighted average yields on investment securities available-for-sale are based on amortized cost.
(1)
Category includes $1,672,000 of pooled trust preferred securities that are on non-accrual status.
Investments Available-For-Sale
Available-for-sale investment securities include securities that management intends to use as part of its liquidity and asset/liability management strategy. These securities may be sold in response to changes in market interest rates, changes in the securities prepayment or credit risk or in response to the need for liquidity. At December 31, 2010, the fair value of investment securities available-for-sale was $290,564,000, or $2,332,000 above the amortized cost of $288,232,000. This compared to a fair value of $256,862,000, or $2,611,000 above the amortized cost of $254,251,000, at December 31, 2009. Unrealized holding gains, net of tax, of $1,539,000 and $1,723,000 were recorded as an increase to shareholders’ equity as of December 31, 2010 and 2009, respectively. The available-for-sale portfolio, excluding equity securities, had a weighted average maturity of approximately 4 years at December 31, 2010, and 3 years at December 31, 2009. The weighted average tax-equivalent yield was 3.76% and 4.39% at December 31, 2010 and 2009, respectively.
The weighted average maturity is based on the stated contractual maturity or likely call date of all securities except for mortgage-backed securities and CMOs, which are based on estimated average life. The maturity of the portfolio could be shorter if interest rates would decline and prepayments on mortgage-backed securities and CMOs increase or if more securities are called. However, the estimated average life could be longer if rates were to increase and principal payments on mortgage-backed securities and CMOs would slow or bonds anticipated to be called are not called.
Investments Held-To-Maturity
Investment securities held-to-maturity are recorded at amortized cost. Included in this portfolio are state and municipal securities. At December 31, 2010 and 2009, the amortized cost of investment securities held-to-maturity was $2,667,000 and $3,347,000, respectively, and the fair value was $2,729,000 and $3,471,000, respectively. The held-to-maturity portfolio had a weighted average maturity of approximately 11 months at December 31, 2010, and 1 year 7 months at December 31, 2009. The weighted average tax-equivalent yield was 7.09% and 7.12% at December 31, 2010 and 2009, respectively.
32
Loans
QNB’s primary business is to accept deposits and to make loans to meet the credit needs of the communities it serves. Loans are the most significant component of earning assets and growth in loans to small businesses and residents of these communities has been a primary focus of QNB. QNB has been successful in achieving loan growth even during this difficult economic period. 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 has comprehensive policies and procedures that define and govern commercial loan, retail loan and indirect lease financing originations and the management of risk. All loans are underwritten in a manner that emphasizes the borrowers’ capacity to pay. The measurement of capacity to pay delineates the potential risk of non-payment or default. The higher potential for default determines the need for and amount of collateral required. QNB makes unsecured commercial loans when the capacity to pay is considered substantial. As capacity lessens, collateral is required to provide a secondary source of repayment and to mitigate the risk of loss. Various policies and procedures provide guidance to the lenders on such factors as amount, terms, price, maturity and appropriate collateral levels. Each risk factor is considered critical to ensuring that QNB receives an adequate return for the risk undertaken, and that the risk of loss is minimized.
QNB manages the risk associated with commercial loans by having lenders work in tandem with credit analysts while maintaining independence between personnel. In addition, a Bank loan committee and a committee of the Board of Directors review and approve certain loan requests on a weekly basis. At December 31, 2010, there were no concentrations of loans exceeding 10% of total loans other than disclosed in the Loan Portfolio table.
QNB’s commercial lending activity is focused on small businesses within the local community. Commercial purpose loans 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 group 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 come from the cash flow of the business or the ongoing conversions of assets, such as accounts receivable and inventory, to cash. Commercial and industrial loans represent commercial purpose loans that are either secured by collateral other than real estate or unsecured.
|
Commercial loans secured by commercial real estate include commercial purpose loans collateralized at least in part by commercial real estate. Some of these loans may not be for the express purpose of conducting commercial real estate transactions. Commercial loans secured by residential real estate are commercial purpose loans generally secured by the business owner’s residence. Commercial loans secured by either commercial real estate or residential real estate are originated primarily within the Eastern Pennsylvania market area at conservative loan-to-value ratios and also usually include the guarantee of the borrowers. 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 and commercial construction 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.
|
|
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.
Indirect lease financing receivables represent loans to small businesses that are collateralized by equipment. These loans tend to have higher risk characteristics but generally provide higher rates of return. These loans are originated by a third party and purchased by QNB based on criteria specified by QNB. The criteria include minimum credit scores of the borrower, term of the lease, type and age of equipment financed and geographic area. The geographic area primarily represents states contiguous to Pennsylvania. QNB is not the lessor and does not service these loans.
The Company originates fixed rate and adjustable-rate residential real estate loans that are secured by the underlying 1-to-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, credits scores and adherence to underwriting policies that emphasize conservative loan-to-value ratios of generally no more than 80%. To reduce interest rate risk, substantially all originations of fixed-rate loans to individuals for 1-4 family residential mortgages with maturities of 15 years or greater are sold in the secondary market. At December 31, 2010 and 2009, real estate residential loans held-for-sale were $228,000 and $534,000, respectively. These loans are carried at the lower of aggregate cost or market.
33
The home equity portfolio consists of fixed-rate home equity loans and variable rate home equity lines of credit. These loans are often in a junior lien position and therefore carry a higher risk than first lien 1-4 family residential loans. Risks associated with loans secured by residential properties, either first lien residential mortgages or home equity loans and lines, 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 loans secured by residential real estate because they may be unsecured, or, if they are secured, the value of the collateral may be difficult to assess or 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, the value of the collateral.
Total loans, excluding loans held-for-sale, at December 31, 2010 were $482,182,000, an increase of $32,761,000, or 7.3%, from December 31, 2009. A key financial ratio is the loan to deposit ratio which was 69.4% at December 31, 2010, compared with 71.0%, at December 31, 2009. The slight decline in the loan to deposit ratio is both a function of the significant increase in deposits as well as a slowdown in loan demand, both a result of economic conditions. Despite the difficult economic environment, the Bank continues to make loans available to credit worthy residents and businesses. The hiring of additional experienced commercial loan officers and additional credit administration staff in each of the past three years provides support to our continued goal of increasing loans outstanding and building customer relationships.
The Allowance for Loan Losses Allocation table shows the percentage composition of the loan portfolio over the past five years. Between 2009 and 2010 the makeup of the portfolio changed slightly with loans secured by commercial real estate, the largest sector of the portfolio, increasing from 37.0% of the portfolio at December 31, 2009 to 41.4% of the portfolio at December 31, 2010. Loans secured by commercial real estate increased by $33,777,000, or 20.3%, to $199,874,000 at December 31, 2010, following a 20.1% increase between December 31, 2008 and 2009. While loans secured by commercial real estate represent a significant portion of the total portfolio, the collateral is diversified including investment properties, manufacturing facilities, office buildings, hospitals, retirement and nursing home facilities, warehouses and owner-occupied facilities. Commercial real estate loans have drawn the attention of the regulators in recent years as a potential source of risk. As a result, QNB has increased its monitoring of these types of loans including obtaining updated appraisals on loans classified substandard or worse. As detailed in the Allowance for Loan Losses table, QNB had $278,000 in charge-offs in this category in 2010, but no charge-offs of commercial real estate loans for the period 2006 through 2009.
Commercial and industrial loans, the second largest sector of the portfolio, increased $4,116,000, or 5.0%, to $86,628,000 at December 31, 2010 and represented 18.0% of the portfolio at year-end compared with 18.4% at December 31, 2009. As noted earlier this category of loans presents a greater risk than loans secured by real estate since these loans are either secured by accounts receivable, inventory or equipment, or unsecured. Losses in commercial and industrial loans have been significant during the past two years with charge-offs of $568,000 and $682,000 for 2010 and 2009, respectively.
Construction loans decreased from $27,483,000, or 6.1% of the portfolio at December 31, 2009 to $18,611,000, or 3.9%, of the portfolio as of December 31, 2010. These loans are primarily to developers and builders for the construction of residential units or commercial buildings or to businesses for the construction of owner-occupied facilities. This portfolio is diversified among different types of collateral including: 1-4 family residential construction, medical facilities, factories, office buildings, funeral homes and land for development loans. Construction loans are generally made only on projects that have municipal approval. These loans are usually originated to include a short construction period followed by permanent financing provided through a commercial mortgage after construction is complete. Once construction is complete the balance is moved to the secured by commercial real estate category if the permanent financing is provided by the Bank. Most of the decline in balances relates to this type of transfer.
Commercial loans secured by residential real estate increased by $6,665,000, or 17.6%, to $44,444,000 at December 31, 2010 and represent 9.2% of the portfolio at that date. This represents a slight increase from the 8.4% that these loans represented at December 31, 2009. The asset quality of this portfolio remains strong with only $97,000 at December 31, 2010 classified as nonaccrual or past due 90 days or more and accruing. This compares to $375,000 at December 31, 2009. Loan charge-offs in this portfolio were $113,000 for 2010, representing the only charge-offs in this category during the past five years.
Loans to state and political subdivisions increased from $26,698,000 at December 31, 2009 to $31,053,000 at December 31, 2010, an increase of $4,355,000, or 16.3%. As a result of concerns about the municipal bond market and the monoline insurers of municipal bonds many municipalities and schools opted not to issue bonds but to bid their loans out to financial institutions. During 2010, QNB was successful in winning some of those bids resulting in an increase in balances.
34
At December 31, 2010, indirect lease financing receivables represent approximately 2.7% of the portfolio compared to 3.1% of the portfolio at December 31, 2009. Total balances at December 31, 2010 and 2009 were $12,995,000 and $14,061,000, respectively. This portfolio contains loans to businesses in the trucking and construction industries which have been hit hard by high fuel costs and the slowdown in the economy. As a result of a high level of charge-offs and delinquency in this portfolio in 2008 and 2009, QNB strengthened its underwriting standards with regard to this portfolio. This has resulted in a reduction in net charge-offs and the balance of non-performing leases. QNB experienced net charge-offs in this portfolio of $36,000 and $549,000 in 2010 and 2009, respectively and non-performing assets, including repossessed equipment, were $270,000 and $418,000 as of December 31, 2010 and 2009, respectively.
Retail loans which include first lien 1-4 family residential mortgages, home equity loans and lines and consumer loans declined over the past several years as consumers were concerned about the state of the economy including declining home values and their employment status. Residential mortgage loans secured by first lien 1-4 family residential mortgages decreased by $812,000 from $23,929,000 at December 31, 2009 to $23,127,000 at December 31, 2010 and home equity loans and lines declined by $4,475,000, or 6.7%, to $62,726,000 at December 31, 2010. With the historically low level of interest rates, mortgage activity, especially refinancing activity, was high, particularly in 2009. However, because the interest rates on these loans were low, QNB decided to sell most of the fixed-rate loans originated to the secondary market in order to reduce interest rate risk in the future.
The demand for home equity loans has declined as home values have fallen eliminating some homeowners’ equity in their homes while others have taken advantage of the low interest rates on mortgages and refinanced their home equity loans into a new mortgage. Included in the home equity portfolio are floating rate home equity lines tied to the Prime lending rate. The balance of these loans increased by $1,738,000, or 6.1%, to $30,399,000 at year-end 2010. In contrast, fixed-rate home equity loans declined by $6,213,000, or 16.1%, to $32,327,000. Customers who are opening home equity loans are choosing the floating rate option indexed to Prime even with a rate floor because the rate is currently lower than a fixed-rate home equity loan. In an attempt to boost demand, QNB has been offering an attractive fixed-rate home equity loan promotion. This promotion which began during the second quarter of 2010 has had limited success, an indication of lack of demand by consumers. QNB’s line of credit product, Equity Choice, offers a variable-rate line of credit indexed to the prime rate that allows the borrower to carve out portions of the variable-rate balance and to fix the rate on that portion based on the term and rate at that time. As the fixed-rate portion is paid down, the available amount under the line increases.
|
Loan Portfolio
|
||||||||||||||||||||
|
December 31,
|
2010
|
2009
|
2008
|
2007
|
2006
|
|||||||||||||||
|
Commercial:
|
||||||||||||||||||||
|
Commercial and industrial
|
$ | 86,628 | $ | 82,512 | $ | 72,924 | $ | 70,044 | $ | 55,125 | ||||||||||
|
Construction
|
18,611 | 27,483 | 21,894 | 23,958 | 10,242 | |||||||||||||||
|
Secured by commercial real estate
|
199,874 | 166,097 | 138,246 | 126,621 | 114,760 | |||||||||||||||
|
Secured by residential real estate
|
44,444 | 37,779 | 31,027 | 24,656 | 25,404 | |||||||||||||||
|
State and political subdivisions
|
31,053 | 26,698 | 25,613 | 23,171 | 20,959 | |||||||||||||||
|
Indirect lease financing
|
12,995 | 14,061 | 15,716 | 13,431 | 13,405 | |||||||||||||||
|
Retail:
|
||||||||||||||||||||
|
1-4 family residential mortgages
|
23,127 | 23,929 | 22,091 | 21,997 | 26,866 | |||||||||||||||
|
Home equity loans and lines
|
62,726 | 67,201 | 71,420 | 72,546 | 71,562 | |||||||||||||||
|
Consumer
|
2,751 | 3,702 | 4,483 | 4,442 | 5,044 | |||||||||||||||
|
Total loans
|
482,209 | 449,462 | 403,414 | 380,866 | 343,367 | |||||||||||||||
|
Net unearned (fees) costs
|
(27 | ) | (41 | ) | 165 | 150 | 129 | |||||||||||||
|
Loans receivable
|
$ | 482,182 | $ | 449,421 | $ | 403,579 | $ | 381,016 | $ | 343,496 | ||||||||||
35
| Loan Maturities and Interest Rate Sensitivity | ||||||||||||||||
|
Under
|
1-5 |
Over
|
||||||||||||||
|
December 31, 2010
|
1 Year
|
Years
|
5 Years
|
Total
|
||||||||||||
|
Commercial:
|
||||||||||||||||
|
Commercial and industrial
|
$ | 13,142 | $ | 55,820 | $ | 17,666 | $ | 86,628 | ||||||||
|
Construction
|
8,994 | 2,990 | 6,627 | 18,611 | ||||||||||||
|
Secured by commercial real estate
|
11,614 | 11,761 | 176,499 | 199,874 | ||||||||||||
|
Secured by residential real estate
|
3,493 | 4,477 | 36,474 | 44,444 | ||||||||||||
|
State and political subdivisions
|
20 | 6,560 | 24,473 | 31,053 | ||||||||||||
|
Indirect lease financing
|
889 | 12,106 | – | 12,995 | ||||||||||||
|
Retail:
|
||||||||||||||||
|
1-4 family residential mortgages
|
71 | 245 | 22,811 | 23,127 | ||||||||||||
|
Home equity loans and lines
|
3,663 | 8,065 | 50,998 | 62,726 | ||||||||||||
|
Consumer
|
613 | 1,510 | 628 | 2,751 | ||||||||||||
|
Total
|
$ | 42,499 | $ | 103,534 | $ | 336,176 | $ | 482,209 | ||||||||
Demand loans, loans having no stated schedule of repayment and no stated maturity, are included in under one year.
The following shows the amount of loans due after one year that have fixed, variable or adjustable interest rates at December 31, 2010:
|
Loans with fixed predetermined interest rates:
|
$ | 96,120 | ||
|
Loans with variable or adjustable interest rates:
|
$ | 343,590 |
Non-Performing Assets
Non-performing assets include accruing loans past due 90 days or more, non-accruing loans, restructured loans, other real estate owned, other repossessed assets and non-accruing pooled trust preferred securities. The chart that follows shows the history of non-performing assets over the past five years. Total non-performing assets were $11,634,000 at December 31, 2010, or 1.44%, of total assets. This represents an increase from the December 31, 2009 balance of $7,032,000, or 0.92% of total assets. Included in non-performing assets in 2010 and 2009 is $1,672,000 and $863,000 of pooled trust preferred securities, discussed in the section titled “Investment Securities and Other Short-Term Investments”. The increase in the amount of non-performing pooled trust preferred securities is a result of the increase in the fair value of these securities, not as a result of the classification of additional securities.
QNB’s non-performing loans (loans past due 90 days or more and accruing, non-accrual loans, and restructured loans) were $9,872,000, or 2.05% of total loans, at December 31, 2010, compared to $6,102,000, or 1.36% of total loans at December 31, 2009. The increase in non-performing loans since December 31, 2009 reflects the impact of the recession and issues in the commercial and residential real estate markets on customers, especially commercial borrowers. Despite the increase, QNB’s percentages continue to compare favorably with the average of 3.14% of total loans for Pennsylvania commercial banks with assets between $500 million and $1 billion as reported by the FDIC using December 31, 2010 data.
Loans past due 90 days or more and still accruing totaled $268,000 at December 31, 2010, a decrease from the $759,000 reported as of December 31, 2009. Non-accrual loans are those on which the accrual of interest has ceased. Loans and indirect financing leases are placed on non-accrual status immediately if, in the opinion of management, collection is doubtful, or when principal or interest is past due 90 days or more and collateral is insufficient to protect principal and interest. Included in the loan portfolio are loans on non-accrual status of $7,183,000 at December 31, 2010 compared with $3,086,000 at December 31, 2009. Most of the increase in non-accrual loans was in the category of loans secured by commercial real estate which increased from $354,000 at December 31, 2009 to $3,837,000 at December 31, 2010. Non-accrual commercial and industrial loans also increased from $486,000 to $1,082,000 over this same period.
Restructured loans, as defined in accounting guidance for troubled debt restructuring in ASC 310-40, that have not already been included in loans past due 90 days or more or in non-accrual loans totaled $2,421,000 and $2,257,000 at December 31, 2010 and 2009, respectively. Included in restructured loans at December 31, 2010 are seven loans with the largest loan of $1,192,000 related to a construction loan that has been placed on interest only.
Other real estate owned of $75,000 at December 31, 2010 represents one commercial property that was sold in February 2011. QNB did not have any other real estate owned as of December 31, 2009. Repossessed assets, which primarily includes commercial trucks and equipment from the indirect leasing portfolio, was $15,000 and $67,000 at December 31, 2010 and 2009, respectively.
Loans not included in past due, non-accrual or restructured categories, but where known information about possible credit problems causes management to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms, totaled $50,049,000 and $31,145,000 at December 31, 2010 and 2009, respectively. The increase from 2010 levels reflects the economic environment of the past several years particularly with regard to customers impacted by the downturn in the real estate market, either commercial or residential. These customers include owners of investment properties who have seen vacancy rates increase and rental rates decline as well as businesses who are suppliers of products for new construction or home remodeling. Additional loan quality information can be found in Note 5 of the Notes to the Consolidated Financial Statements.
36
Allowance For Loan Losses
The allowance for loan losses represents management’s best estimate of the known and inherent losses in the existing loan portfolio. Management believes that it uses the best information available to make determinations about the adequacy of the allowance and that it has established its existing allowance for loan losses in accordance with U.S. generally accepted accounting principles (GAAP). The determination of an appropriate level of the allowance for loan losses is based upon an analysis of the risks inherent in QNB’s loan portfolio. Management, 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.
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 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. As a result of an increase in specific reserves for impaired loans, loan growth, increases in non-performing, delinquent and classified loans and continued concerns related to current economic conditions, QNB has increased the allowance for loan losses to reflect these conditions. The allowance for loan losses was $8,955,000 at December 31, 2010 and represents 1.86% of total loans, compared with $6,217,000, or 1.38% of total loans, at December 31, 2009. QNB’s management determined a $3,800,000 provision for loan losses was appropriate in 2010 compared to a provision of $4,150,000 in 2009.
37
|
Allowance for Loan Losses Allocation
|
||||||||||||||||||||||||||||||||||||||||
|
December 31,
|
2010
|
2009
|
2008
|
2007
|
2006
|
|||||||||||||||||||||||||||||||||||
|
Percent
|
Percent
|
Percent
|
Percent
|
Percent
|
||||||||||||||||||||||||||||||||||||
|
Gross
|
Gross |
Gross
|
Gross
|
Gross
|
||||||||||||||||||||||||||||||||||||
|
|
Amount
|
Loans
|
Amount
|
Loans
|
Amount
|
Loans
|
Amount
|
Loans
|
Amount
|
Loans
|
||||||||||||||||||||||||||||||
|
Balance at end of period applicable to:
|
||||||||||||||||||||||||||||||||||||||||
|
Commercial:
|
||||||||||||||||||||||||||||||||||||||||
|
Commercial and industrial
|
$ | 2,136 | 18.0 | % | $ | 1,601 | 18.4 | % | $ | 783 | 18.1 | % | $ | 752 | 18.4 | % | $ | 503 | 16.1 | % | ||||||||||||||||||||
|
Construction
|
633 | 3.9 | 382 | 6.1 | 219 | 5.4 | 249 | 6.3 | 138 | 3.0 | ||||||||||||||||||||||||||||||
|
Secured by commercial real estate
|
3,875 | 41.4 | 2,038 | 37.0 | 1,382 | 34.3 | 1,401 | 33.2 | 1,187 | 33.4 | ||||||||||||||||||||||||||||||
|
Secured by residential real estate
|
676 | 9.2 | 549 | 8.4 | 264 | 7.7 | 140 | 6.5 | 194 | 7.4 | ||||||||||||||||||||||||||||||
|
State and political subdivisions
|
108 | 6.4 | 125 | 5.9 | 90 | 6.3 | 132 | 6.1 | 147 | 6.1 | ||||||||||||||||||||||||||||||
|
Indirect lease financing
|
496 | 2.7 | 673 | 3.1 | 438 | 3.9 | 259 | 3.5 | 214 | 3.9 | ||||||||||||||||||||||||||||||
|
1-4 family residential mortgages
|
212 | 4.8 | 153 | 5.3 | 88 | 5.5 | 66 | 5.8 | 41 | 7.8 | ||||||||||||||||||||||||||||||
|
Home equity loans and lines
|
646 | 13.0 | 420 | 15.0 | 375 | 17.7 | 221 | 19.0 | 143 | 20.8 | ||||||||||||||||||||||||||||||
|
Consumer
|
32 | 0.6 | 61 | 0.8 | 69 | 1.1 | 56 | 1.2 | 61 | 1.5 | ||||||||||||||||||||||||||||||
|
Unallocated
|
141 | 215 | 128 | 3 | 101 | |||||||||||||||||||||||||||||||||||
|
Total
|
$ | 8,955 | 100.0 | % | $ | 6,217 | 100.0 | % | $ | 3,836 | 100.0 | % | $ | 3,279 | 100.0 | % | $ | 2,729 | 100.0 | % | ||||||||||||||||||||
Gross loans represent loans before unamortized net loan fees and costs. Percent gross loans lists the percentage of each loan type to total loans.
A loan is considered impaired, based on current information and events, if it is probable that QNB will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and shortfalls on a case-by-case basis, taking into consideration all the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial loans and indirect lease financing 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. At December 31, 2010 and 2009, the recorded investment in loans for which impairment has been identified totaled $20,863,000 and $5,699,000 of which $12,568,000 and $4,622,000, respectively, required no specific allowance for loan loss. The recorded investment in impaired loans requiring an allowance for loan losses was $8,295,000 and $1,077,000 at December 31, 2010 and 2009, respectively. At December 31, 2010 and 2009 the related allowance for loan losses associated with these loans was $2,281,000 and $528,000, respectively. Most of the loans that have been identified as impaired are collateral-dependent. See Note 5 to the Notes to Consolidated Financial Statements for additional detail of impaired loans.
QNB had net loan charge-offs of $1,062,000, or 0.23% of average total loans for 2010 compared to $1,769,000, or 0.41% of average total loans for 2009. The majority of charge-offs during 2010 were in the commercial loan portfolio and represented $959,000 of the $1,327,000 total charge-offs for 2010. Commercial and industrial loan charge-offs totaled $568,000 in 2010, a $350,000 charge-off related to a customer in the construction industry being the largest. Charge-offs for commercial loans secured by commercial real estate and residential real estate totaled $278,000 and $113,000, respectively, during 2010. Approximately $209,000 of the $278,000 in charge-offs on loans secured by commercial real estate relates to a non-owner occupied commercial property that is being carried at $75,000 in other real estate owned at December 31, 2010.
Charge-offs in the retail portfolio during 2010 were comprised of $60,000 related to home equity lines and loans and $54,000 to consumer loans. Indirect lease financing net charge-offs were $36,000 and $549,000 for 2010 and 2009, respectively. This portfolio contains loans to businesses in the trucking and construction industries which were hit hard by the significant increase in fuel costs during 2007 and most of 2008 followed by the overall slowdown in the economy during 2008 and 2009. The lower amount of net charge-offs in the lease portfolio in 2010 reflects a strengthening of the underwriting standards in this portfolio. In addition, recoveries of previously charged-off indirect lease financing receivables were $218,000 in 2010 compared with $96,000 in 2009.
Management believes the allowance for loan losses of $8,955,000 is adequate as of December 31, 2010 in relation to the estimate of known and inherent losses in the portfolio.
38
Deposits
QNB primarily attracts deposits from within its market area by offering various deposit products. These deposits are in the form of time deposits which include certificates of deposit and individual retirement accounts (IRA’s) which have a stated maturity and non-maturity deposit accounts which include: non-interest bearing demand accounts, interest-bearing demand accounts, money market accounts and savings accounts.
Total deposits increased $60,874,000, or 9.6%, to $694,977,000 at December 31, 2010. This follows an increase of 15.3% between 2008 and 2009. Average deposits increased $71,585,000, or 12.0%, during 2010 compared with $77,386,000, or 15.0%, in 2009.
39
| The growth in deposits as well as the mix of deposits continues to be impacted by customers’ reactions to the industry, regulations and the interest rate environment. Most customers continue to look for the highest rate for the shortest term if looking for a time deposit or rate and liquidity in choosing a transaction account. In addition, with concerns over the safety of their deposits and the strength of their financial institutions, customers appear to be looking for the safety of FDIC insured deposits and the stability of a strong local community bank. On October 3, 2008, in response to the ongoing economic crisis affecting the financial services industry, the Emergency Economic Stabilization Act of 2008 was enacted which temporarily raised the basic limit on FDIC coverage from $100,000 to $250,000 per depositor. In addition, on October 13, 2008, the FDIC established a Temporary Liquidity Guarantee Program under which the FDIC fully guaranteed all non-interest-bearing transaction accounts through December 31, 2010 (the “Transaction Account Guarantee Program”). QNB elected to participate in the Transaction Account Guarantee Program and was assessed an additional ten basis points for FDIC insurance for transaction account balances in excess of $250,000 during 2009 and fifteen basis points during 2010. On July 21, 2010, the Dodd-Frank Act was enacted which permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2013. |
|
All categories of deposits, except for time deposits, increased when comparing balances at December 31, 2010 to December 31, 2009. Unlike prior years the growth was not centered in time deposits but in lower-cost core deposits including interest-bearing demand, money market and savings deposits, accounts with greater liquidity. This growth is consistent with customers looking for the highest rate for the shortest term. The Bank currently offers several attractive non-maturity interest-bearing account options that pay very competitive rates and allow the flexibility to add and withdraw funds without penalty. In anticipation of rates increasing at some point in the future, customers have been migrating to these types of accounts rather than committing to a specific rate and term for a time deposit account.
Of the $60,874,000 increase in deposits between 2009 and 2010, savings accounts accounted for $49,708,000 of the increase. During the second quarter of 2009, QNB introduced an online eSavings account to compete with competitors online savings products. The eSavings account was introduced at a yield of 1.85% and despite reducing the yield to 1.30% during 2010, the account continues to be extremely successful with balances increasing $47,491,000 between December 31, 2009 and December 31, 2010 to $67,435,000.
Interest-bearing demand accounts, which include municipal accounts, increased $11,946,000, or 9.9%, to $132,500,000 at December 31, 2010. Municipal accounts which include school district and township deposits increased $7,642,000, or 20.8% to $44,350,000 at December 31, 2010. The balances in these accounts are seasonal in nature and can be volatile on a daily basis. QNB is a depository for many school districts in the area. Most of the school district taxes are collected during the third quarter of the year and are disbursed over a nine month period. Also contributing to the increase in interest-bearing demand account balances was the QNB Rewards checking product, a high-rate checking account. For most of 2009 the product paid a yield of 3.25% on balances up to $25,000. This yield was reduced on February 10, 2010 to 2.75% and again on August 18, 2010 to 2.05% as Treasury rates declined to historic lows. In order to receive the high interest 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 per statement cycle. If these criteria are not met the customer receives a rate of 0.15%. At December 31, 2010, QNB Rewards checking accounts had a balance of $29,487,000 compared to a balance of $22,210,000 at year end 2009.
Money market accounts increased $8,637,000, or 12.3%, to $78,802,000 at December 31, 2010. Business and municipal money market accounts increased by $9,704,000 while personal money market accounts decreased by $1,067,000. Average money market balances increased 24.1% in 2010 compared to an increase in average balances of 26.0% in 2009. QNB offers a Select Money Market product that has a tiered structure paying higher interest rates on higher balances. With the rates paid on some of the money market account balance tiers exceeding the rates on short-term time deposits, some customers have opted to move balances to money market accounts.
At year-end 2010, non-interest bearing demand accounts increased 2.7% to $55,377,000. This compares to an increase of 1.2% at year-end 2009 compared with year-end 2008. Average non-interest bearing demand accounts increased $2,810,000, or 5.3%, to $56,072,000 when comparing 2010 to 2009. This compares to an increase of 4.1% in average balances when comparing 2009 to 2008. These deposits are primarily comprised of business checking accounts and are volatile depending on the timing of deposits and withdrawals. Balances in non-interest bearing demand accounts could change significantly as a result of the the Dodd-Frank Act. Effective July 21, 2011, a provision of the Dodd-Frank Act eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse impact on the Company’s interest expense.
40
Total time deposit account balances were $310,232,000 at December 31, 2010, a decline of $10,864,000, or 3.4%, from the amount reported at December 31, 2009. Significant growth in time deposits occurred during 2008 as rates on time deposits did not initially decline at the speed or to the magnitude of rates on non-maturity deposits. As the decline in time deposit rates took hold during the second half of 2009 and all of 2010 customers began looking to other interest-bearing deposit accounts that provided a fair return and liquidity. Much of the growth in time deposits during 2008 occurred in maturity ranges of twelve to twenty-four months as a result of several specials, which QNB promoted in response to customers’ preferences and competitors’ offerings. As these time deposits matured during 2009 and 2010 some were reinvested in time deposits with shorter maturities while some migrated to the high yielding and liquid eSavings account. During the first quarter of 2011 approximately $104,417,000 of time deposits yielding 2.19% will reprice or mature while during all of 2011 approximately $232,201,000, or 74.8%, of time deposits at December 31, 2010 will reprice or mature. The average rate paid on these time deposits is approximately 1.76%. Given the current rates being offered on time deposits and the anticipation of rising rates in 2012 it is anticipated, given recent history, that some of these maturing time deposits will migrate to the online savings or money market accounts or be withdrawn.
To continue to attract and retain deposits, QNB plans to be competitive with respect to rates and to continue to deliver products with terms and features that appeal to customers. The QNB Rewards checking and online eSavings accounts are examples of such products.
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Maturity of Time Deposits of $100,000 or More
|
||||||||||||
|
Year Ended December 31,
|
2010
|
2009
|
2008
|
|||||||||
|
Three months or less
|
$ | 37,945 | $ | 20,316 | $ | 24,026 | ||||||
|
Over three months through six months
|
16,861 | 17,409 | 11,357 | |||||||||
|
Over six months through twelve months
|
22,797 | 22,576 | 43,552 | |||||||||
|
Over twelve months
|
26,000 | 45,640 | 26,031 | |||||||||
|
Total
|
$ | 103,603 | $ | 105,941 | $ | 104,966 | ||||||
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 in an attempt to match the volatility, seasonality, interest rate 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 maturities and repayments 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 December 31, 2010, the Bank had a maximum borrowing capacity with the FHLB of approximately $165,352,000. The maximum borrowing capacity changes as a function of qualifying collateral assets. At December 31, 2009, the Bank had $10,000,000 in outstanding advances from the FHLB at a rate of 2.97%. These borrowings matured in January 2010 and were repaid. In addition, the Bank maintains two unsecured Federal funds lines with two correspondent banks totaling $18,000,000. At December 31, 2010 and 2009 there were no outstanding borrowings under these lines. Future availability under these lines is subject to the policies of the granting banks and may be withdrawn.
Total cash and cash equivalents, available-for-sale securities and loans held-for-sale totaled $305,704,000 at December 31, 2010 and $288,395,000 at December 31, 2009. The increase in liquid sources is primarily the result of an increase in the available-for-sale securities portfolio partially offset by a decline in interest-bearing deposits held at the Federal Reserve Bank. These sources should be adequate to meet normal fluctuations in loan demand or deposit withdrawals. With the current low interest rate environment, it is anticipated that the investment portfolio will continue to provide significant liquidity as agency and municipal bonds are called and as cash flow on mortgage-backed and CMO securities continues to be steady. In the event that interest rates would increase the cash flow available from the investment portfolio could decrease.
Approximately $133,446,000 and $133,136,000 of available-for-sale securities at December 31, 2010 and 2009, respectively, were pledged as collateral for repurchase agreements and deposits of public funds.
As an additional source of liquidity, 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. In 2011, QNB plans to offer Insured Cash Sweep (ICS), a product similar to CDARS, but one that provides liquidity like a money market or savings account.
41
Capital Adequacy
A strong capital position is fundamental to support continued growth and profitability and to serve the needs of depositors. QNB’s shareholders’ equity at December 31, 2010 was $61,090,000, or 7.55% of total assets, compared to shareholders’ equity of $56,426,000, or 7.40% of total assets, at December 31, 2009. Shareholders’ equity at December 31, 2010 and 2009 included a positive adjustment of $1,539,000 and $1,723,000, respectively, related to unrealized holding gains, net of taxes, on investment securities available-for-sale. Without these adjustments, shareholders’ equity to total assets would have been 7.36% and 7.17% at December 31, 2010 and 2009, respectively.
Average shareholders’ equity and average total assets were $57,589,000 and $776,599,000 for 2010, an increase of 5.3% and 9.3%, respectively, from 2009 average equity and average total assets of $54,710,000 and $710,580,000, respectively. The ratio of average total equity to average total assets was 7.42% for 2010, compared to 7.70% for 2009.
QNB is subject to restrictions on the payment of dividends to its shareholders pursuant to the Pennsylvania Business Corporation Law as amended (the BCL). The BCL operates generally to preclude dividend payments, if the effect thereof would render QNB insolvent, as defined. As a practical matter, QNB’s payment of dividends is contingent upon its ability to obtain funding in the form of dividends from the Bank. Under Pennsylvania banking law, the Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. At December 31, 2010, $53,247,000 of retained earnings was available for dividends without prior regulatory approval, subject to the regulatory capital requirements discussed below. QNB paid dividends to its shareholders of $0.96 per share in 2010 and 2009.
QNB is subject to various regulatory capital requirements as issued by Federal regulatory authorities. Regulatory capital is defined in terms of Tier I capital (shareholders’ equity excluding unrealized gains or losses on available-for-sale securities and disallowed intangible assets), Tier II capital which includes the allowable portion of the allowance for loan losses which is limited to 1.25% of risk-weighted assets and a portion of the unrealized gains on equity securities, and total capital (Tier I plus Tier II). Risk-based capital ratios are expressed as a percentage of risk-weighted assets. Risk-weighted assets are determined by assigning various weights to all assets and off-balance sheet arrangements, such as letters of credit and loan commitments, based on associated risk. Regulators have also adopted minimum Tier I leverage ratio standards, which measure the ratio of Tier I capital to total quarterly average assets.
The minimum regulatory capital ratios are 4.00% for Tier I, 8.00% for total risk-based and 4.00% for leverage. Under the requirements, at December 31, 2010 and 2009, QNB has a Tier I capital ratio of 10.52% and 10.30%, a total risk-based ratio of 11.82% and 11.51%, and a leverage ratio of 7.42% and 7.34%, respectively.
All regulatory capital ratios have improved slightly from December 31, 2009 as the growth rate of Tier I and total risk based capital has exceeded the growth rate of risk-weighted and quarterly average assets. During the first quarter of 2010, QNB began offering 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 $473,000 to capital during 2010.
On January 24, 2008, QNB announced that the Board of Directors authorized the repurchase of up to 50,000 shares of its common stock in open market or privately negotiated transactions. The repurchase authorization does not bear a termination date. On February 9, 2009, the Board of Directors approved increasing the authorization to 100,000 shares. As of December 31, 2010 and 2009, 57,883 shares were repurchased under this authorization at an average price of $16.97 and a total cost of $982,000. There were no shares repurchased under the plan since the first quarter of 2009.
Also impacting the regulatory capital ratios was an increase in risk-weighted assets during 2010. Loan growth, primarily centered in commercial loans which generally carry a 100% risk-weighting, accounted for virtually all of the $34,814,000 growth in risk-weighted assets. Continuing to impact risk-weighted assets is the $27,483,000 of risk-weighted assets due to mezzanine tranches of pooled trust preferred securities that were downgraded below investment grade during the first quarter of 2009. Although the amortized cost of these securities was only $3,640,000 at December 31, 2010, regulatory guidance required an additional $27,483,000 to be included in risk-weighted assets. The Bank utilized the method as outlined in the Call Report Instructions for an available-for-sale bond that has not triggered the Low Level Exposure (LLE) rule. The mezzanine tranches of CDOs that utilized this method of risk-weighting are 5 out of 8 pooled trust preferred securities (PreTSLs) held by the Bank as of December 31, 2010. The other three pooled trust preferred securities have only one tranche remaining so the treatment noted above does not apply.
The Federal Deposit Insurance Corporation Improvement Act of 1991 established five capital level designations ranging from “well capitalized” to “critically undercapitalized.” At December 31, 2010 and December 31, 2009, management believes that the Company and the Bank met all capital adequacy requirements to which they are subject and have met the “well capitalized” criteria which requires minimum Tier I and total risk-based capital ratios of 6.00% and 10.00%, respectively, and a leverage ratio of 5.00%.
42
|
Capital Ratios
|
||||||||
|
December 31,
|
2010
|
2009
|
||||||
|
Tier I capital/risk-weighted assets
|
10.52 | % | 10.30 | % | ||||
|
Total risk-based capital/risk-weighted assets
|
11.82 | 11.51 | ||||||
|
Tier I capital/average assets (leverage ratio)
|
7.42 | 7.34 | ||||||
Recently Issued Accounting Standards
Refer to Note 1 of the Notes to Consolidated Financial Statements for discussion of recently issued accounting standards.
Critical Accounting Policies and Estimates
Disclosure of the Company’s significant accounting policies is included in Note 1 to the consolidated financial statements. Additional information is contained in Management’s Discussion and Analysis and the Notes to the Consolidated Financial Statements for the most sensitive of these issues. 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, 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.
Effective April 1, 2009, the Company adopted new accounting guidance related to recognition and presentation of other-than-temporary impairment. This accounting guidance amends the recognition guidance for other-than-temporary impairments of debt securities and expands the financial statement disclosures for other-than-temporary impairment losses on debt securities. The guidance replaced the “intent and ability” indication in previous guidance by specifying that (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 should be amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.
43
Impairment of Restricted Investment in Bank Stock
Restricted bank stock is comprised of restricted stock of the Federal Home Loan Bank of Pittsburgh (FHLB) and the Atlantic Central Bankers Bank at December 31, 2010. Federal law requires a member institution of the FHLB to hold stock of its district bank according to a predetermined formula.
In December 2008, the FHLB notified member banks that it was suspending dividend payments and the repurchase of capital stock to preserve capital. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB. Management believes no impairment charge is necessary related to the restricted stock as of December 31, 2010.
On October 28, 2010 the FHLB announced their decision to have a limited excess capital stock repurchase. QNB received $115,000 on October 29, 2010. Further repurchases will be evaluated quarterly by the FHLB.
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.
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
At December 31, 2010, QNB sponsored 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.
44
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 taxes could change in the near term.
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ITEM 7A.
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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|
As a smaller reporting company (as defined) we are not required to provide this information.
|
ITEM 8.
|
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|
The following audited financial statements are set forth in this Annual Report of Form 10-K on the following pages:
|
Report of Independent Registered Public Accounting Firm
|
Page 46
|
|
Consolidated Balance Sheets
|
Page 47
|
|
Consolidated Statements of Income
|
Page 48
|
|
Consolidated Statements of Shareholders’ Equity
|
Page 49
|
|
Consolidated Statements of Cash Flows
|
Page 50
|
|
Notes to Consolidated Financial Statements
|
Page 51
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45
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
QNB Corp.
We have audited the accompanying consolidated balance sheets of QNB Corp. and subsidiary (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of income, shareholders’ equity, and cash flows for the years then ended. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of QNB Corp. and subsidiary as of December 31, 2010 and 2009, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
|
Allentown, Pennsylvania
March 30, 2011
46
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of the consolidated financial statements.
47
CONSOLIDATED STATEMENTS OF INCOME
The accompanying notes are an integral part of the consolidated financial statements.
48
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
|
Accumulated
|
||||||||||||||||||||||||||||
|
|
Other
|
|||||||||||||||||||||||||||
|
Number
|
|
Comprehensive
|
||||||||||||||||||||||||||
|
of Shares
|
Common
|
|
Retained
|
Income
|
Treasury
|
|||||||||||||||||||||||
|
(in thousands, except share data)
|
Outstanding
|
Stock
|
Surplus
|
Earnings
|
(Loss)
|
Stock
|
Total
|
|||||||||||||||||||||
|
Balance, December 31, 2008
|
3,131,815 | $ | 2,028 | $ | 10,057 | $ | 43,667 | $ | (233 | ) | $ | (1,610 | ) | $ | 53,909 | |||||||||||||
|
Comprehensive income:
|
||||||||||||||||||||||||||||
|
Net income
|
– | – | – | 4,227 | – | – | 4,227 | |||||||||||||||||||||
|
Other comprehensive income
|
– | – | – | – | 1,956 | – | 1,956 | |||||||||||||||||||||
|
Total comprehensive income
|
6,183 | |||||||||||||||||||||||||||
|
Cash dividends declared ($.96 per share)
|
– | – | – | (2,972 | ) | – | – | (2,972 | ) | |||||||||||||||||||
|
Stock issued for employee stock purchase plan
|
4,849 | 3 | 68 | – | – | – | 71 | |||||||||||||||||||||
|
Stock issued for options exercised
|
7,786 | 5 | 28 | – | – | – | 33 | |||||||||||||||||||||
|
Tax benefit stock options exercised
|
– | – | 10 | – | – | – | 10 | |||||||||||||||||||||
|
Purchase of treasury stock
|
(51,225 | ) | – | – | – | – | (866 | ) | (866 | ) | ||||||||||||||||||
|
Stock-based compensation expense
|
– | – | 58 | – | – | – | 58 | |||||||||||||||||||||
|
Balance, December 31, 2009
|
3,093,225 | 2,036 | 10,221 | 44,922 | 1,723 | (2,476 | ) | 56,426 | ||||||||||||||||||||
|
Comprehensive income:
|
||||||||||||||||||||||||||||
|
Net income
|
– | – | – | 7,217 | – | – | 7,217 | |||||||||||||||||||||
|
Other comprehensive loss
|
– | – | – | – | (184 | ) | – | (184 | ) | |||||||||||||||||||
|
Total comprehensive income
|
7,033 | |||||||||||||||||||||||||||
|
Cash dividends declared ($.96 per share)
|
– | – | – | (2,982 | ) | – | – | (2,982 | ) | |||||||||||||||||||
|
Stock issued in connection with dividend reinvestment and stock purchase plan
|
25,317 | 16 | 457 | – | – | – | 473 | |||||||||||||||||||||
|
Stock issued for employee stock purchase plan
|
4,118 | 3 | 65 | – | – | – | 68 | |||||||||||||||||||||
|
Stock issued for options exercised
|
6,458 | 4 | 14 | – | – | – | 18 | |||||||||||||||||||||
|
Tax benefit stock options exercised
|
– | – | 3 | – | – | – | 3 | |||||||||||||||||||||
|
Stock-based compensation expense
|
– | – | 51 | – | – | – | 51 | |||||||||||||||||||||
|
Balance, December 31, 2010
|
3,129,118 | $ | 2,059 | $ | 10,811 | $ | 49,157 | $ | 1,539 | $ | (2,476 | ) | $ | 61,090 | ||||||||||||||
The accompanying notes are an integral part of the consolidated financial statements.
49
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of the consolidated financial statements.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Business
QNB Corp. (the Company), through its wholly-owned subsidiary, QNB Bank (the Bank), has been serving the residents and businesses of upper Bucks, southern Lehigh, and northern Montgomery counties in Pennsylvania since 1877. The Bank is a locally managed community bank that provides a full range of commercial, retail banking and retail brokerage services. The Bank encounters vigorous competition for market share in the communities it serves from bank holding companies, other community banks, thrift institutions, credit unions and other non-bank financial organizations such as mutual fund companies, insurance companies and brokerage companies. The Company manages its business as a single operating segment.
The Bank is a Pennsylvania chartered commercial bank. The Company and the Bank are subject to regulations of certain state and Federal agencies. These regulatory agencies periodically examine the Company and the Bank for adherence to laws and regulations.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. The consolidated entity is referred to herein as “QNB”. All significant inter-company accounts and transactions have been eliminated in the consolidated financial statements.
For comparative purposes, prior year’s consolidated financial statements have been reclassified to conform with report classifications of the current year. The reclassifications had no effect on net income.
Tabular information, other than share and per share data, is presented in thousands of dollars.
Use of Estimates
These statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP) and predominant practices within the banking industry. The preparation of these consolidated financial statements requires QNB to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. QNB evaluates estimates on an on-going basis. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the determination of the valuation of other real estate owned, other-than-temporary impairment of investment securities, the determination of impairment of restricted bank stock and the valuation of deferred tax assets 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.
Significant Group Concentrations of Credit Risk
Most of the Company’s activities are with customers located within Bucks, Montgomery and Lehigh Counties in southeastern Pennsylvania. Note 4 discusses the types of investment securities in which the Company invests. Note 5 discusses the types of lending in which the Company engages. The Company does not have any significant concentrations to any one industry or customer. Although the Company has a diversified loan portfolio, its debtors’ ability to honor their contracts is influenced by the region’s economy.
Cash and Cash Equivalents
For purposes of the statement of cash flows, cash and cash equivalents consist of cash on hand, cash items in process of collection, amounts due from banks, interest-bearing deposits in the Federal Reserve Bank and other banks and Federal funds sold. QNB maintains a portion of its interest-bearing deposits in other banks at various commercial financial institutions. At times, the balances exceed the FDIC insured limits.
Investment securities that QNB has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses, net of tax, excluded from earnings and reported in other comprehensive income or loss, a separate component of shareholders’ equity. Management determines the appropriate classification of securities at the time of purchase. QNB had no trading securities at December 31, 2010 and 2009.
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Available-for-sale securities include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in credit ratings, changes in market interest rates and related changes in the securities’ prepayment risk or to meet liquidity needs.
Premiums and discounts on debt securities are recognized in interest income using a constant yield method. Gains and losses on sales of available-for-sale securities are computed on the specific identification method and included in non-interest income.
Other-than-Temporary Impairment of Investment Securities
Securities are evaluated periodically to determine whether a decline in their value is other-than-temporary. Management utilizes criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other-than-temporary. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support realizable value equal to or greater than carrying value of the investment. 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.
Effective April 1, 2009, the Company adopted new accounting guidance related to recognition and presentation of other-than-temporary impairment. This recent accounting guidance amends the recognition guidance for other-than-temporary impairments of debt securities and expands the financial statement disclosures for other-than-temporary impairment (OTTI) losses on debt securities. The recent guidance replaced the “intent and ability” indication in previous guidance by specifying that (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 should be amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.
Restricted Investment in Bank Stock
Restricted bank stock is comprised of restricted stock of the Federal Home Loan Bank of Pittsburgh (FHLB) in the amount of $2,164,000 and the Atlantic Central Bankers Bank in the amount of $12,000 at December 31, 2010. Federal law requires a member institution of the FHLB to hold stock of its district bank according to a predetermined formula. These restricted securities are carried at cost.
In December 2008, the FHLB of Pittsburgh notified member banks that it was suspending dividend payments and the repurchase of capital stock to preserve capital. Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the FHLB. Management believes no impairment charge is necessary related to the restricted stock as of December 31, 2010.
On October 28, 2010, the FHLB announced their decision to have a limited excess capital stock repurchase. QNB received $115,000 on October 29, 2010. Further repurchases will be evaluated quarterly by the FHLB.
Loans
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 consist of residential mortgage loans and 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.
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Non-Performing Assets
Non-performing assets are comprised of accruing loans past due 90 days or more, non-accrual loans and investment securities, restructured loans, other real estate owned and repossessed assets. Non-accrual loans and investment securities are those on which the accrual of interest has ceased. Loans and indirect lease financing loans are placed on non-accrual status immediately if, in the opinion of management, collection is doubtful, or when principal or interest is past due 90 days or more and collateral is insufficient to cover principal and interest. Interest accrued, but not collected at the date a loan is placed on non-accrual status, is reversed and charged against interest income. Subsequent cash receipts are applied either to the outstanding principal or recorded as interest income, depending on management’s assessment of the ultimate collectibility of principal and interest. Loans are returned to an accrual status when the borrower’s ability to make periodic principal and interest payments has returned to normal (i.e. brought current with respect to principal or interest or restructured) and the paying capacity of the borrower and/or the underlying collateral is deemed sufficient to cover principal and interest.
Accounting for impairment in the performance of a loan is required when it is probable that all amounts, including both principal and interest, will not be collected in accordance with the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, at the loan’s observable market price or the fair value of the collateral if the loans are collateral dependent. Impairment criteria are applied to the loan portfolio exclusive of smaller homogeneous loans such as residential mortgage and consumer loans which are evaluated collectively for impairment.
Loans are fully charged-off or charged down to net realizable value (fair value of collateral less estimated costs to sell) when deemed uncollectible due to bankruptcy or other factors, or when they reach a defined number of days past due based on loan product, industry practice, terms and other factors.
Loans are considered past due when contractually required principal or interest payments have not been made on the due dates.
Allowance for Loan Losses
QNB maintains an allowance for loan losses, which is intended to absorb probable known and inherent losses in the outstanding loan portfolio. The allowance is reduced by actual credit losses and is increased by the provision for loan losses and recoveries of previous losses. The provisions for loan losses are charged to earnings to bring the total allowance for loan losses to a level considered necessary by management.
The allowance for loan losses is based on management’s continuing review and evaluation of the loan portfolio. The level of the allowance is determined by assigning specific reserves to individually identified problem credits and general reserves to all other loans. 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. Effect of external factors, such as legal and regulatory requirements.
|
|
2.
|
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.
|
|
3.
|
Nature and volume of the portfolio including growth.
|
|
4.
|
Experience, ability, and depth of lending management and staff.
|
|
5.
|
Volume and severity of past due, classified and nonaccrual loans.
|
|
6.
|
Quality of the Company’s loan review system, and the degree of oversight by the Company’s Board of Directors.
|
|
7.
|
Existence and effect of any concentrations of credit and changes in the level of such concentrations.
|
Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation.
An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses and is limited by policy to +/- 3% of the calculated amount. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
Management emphasizes loan quality and close monitoring of potential problem credits. Credit risk identification and review processes are utilized in order to assess and monitor the degree of risk in the loan portfolio. QNB’s lending and credit administration staff are charged with reviewing the loan portfolio and identifying changes in the economy or in a borrower’s circumstances which may affect the ability to repay debt or the value of pledged collateral. A loan classification and review system exists that identifies those loans with a higher than normal risk of uncollectibility. Each commercial loan is assigned a grade based upon an assessment of the borrower’s financial capacity to service the debt and the presence and value of collateral for the loan. An independent loan review group tests risk assessments and evaluates the adequacy of the allowance for loan losses. Management meets monthly to review the credit quality of the loan portfolio and quarterly to review the allowance for loan losses.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In addition, various regulatory agencies, as an integral part of their examination process, periodically review QNB’s allowance for loan losses. Such agencies may require QNB to recognize additions to the allowance based on their judgments using information available to them at the time of their examination.
Management believes that it uses the best information available to make determinations about the adequacy of the allowance and that it has established its existing allowance for loan losses in accordance with GAAP. If circumstances differ substantially from the assumptions used in making determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be affected. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that increases to the allowance will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Servicing Assets
Servicing assets are recognized as separate assets when rights are acquired through the sale of financial assets. When mortgage loans are sold, a portion of the cost of originating the loan is allocated to the servicing rights based on relative fair value. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The Company subsequently measures servicing rights using the amortization method where servicing rights are amortized in proportion to and over the period of estimated net servicing income. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the capitalized amount for the tranches. If the Company later determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the allowance may be recorded as an increase to income. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.
Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal, or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income.
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 from operations and changes in the valuation allowance are included in net expenses from foreclosed assets. At December 31, 2010 and 2009 the Company had foreclosed assets of $90,000 and $67,000, respectively. These amounts are included in other assets on the balance sheet.
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are calculated principally on an accelerated or straight-line basis over the estimated useful lives of the assets, or the shorter of the estimated useful life or lease term for leasehold improvements, as follows: buildings—10 to 40 years, and equipment—3 to 10 years. Expenditures for maintenance and repairs are charged to operations as incurred. Gains or losses upon disposition are reflected in earnings as realized.
Bank-Owned Life Insurance
The Bank invests in bank-owned life insurance (BOLI) as a source of funding for employee benefit expenses. BOLI involves the purchasing of life insurance by the Bank on a select group of employees. The Bank is the owner and beneficiary of the policies. Income from the increase in cash surrender value of the policies as well as the receipt of death benefits is included in non-interest income on the income statement.
Effective January 1, 2008, the Company adopted new accounting guidance for postretirement benefit aspects of endorsement split-dollar life insurance arrangements. This guidance applies to life insurance arrangements that provide an employee with a specified benefit that is not limited to the employee’s active service period, including certain bank-owned life insurance policies and requires an employer to recognize a liability and related compensation costs for future benefits that extend to postretirement periods. The expense recorded during 2010 and 2009 was approximately $53,000 and $64,000, respectively, and is included in non-interest expense under salaries and benefits expense.
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock-Based Compensation
At December 31, 2010, QNB sponsored 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 The FASB Accounting Standards Codification (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.
Stock-based compensation expense was approximately $51,000 and $58,000 for the years ended December 31, 2010 and 2009, respectively. There was no tax benefit recognized related to this compensation for the years ended December 31, 2010 and 2009.
The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the option and each vesting date. QNB estimated the fair value of stock options on the date of the grant using the Black-Scholes option pricing model. The model requires the use of numerous assumptions, many of which are highly subjective in nature. The following assumptions were used in the option pricing model in determining the fair value of options granted during the periods presented.
|
2010
|
2009
|
|||||||
|
Risk free interest rate
|
2.19 | % | 1.48 | % | ||||
|
Dividend yield
|
5.26 | 4.80 | ||||||
|
Volatility
|
27.77 | 25.04 | ||||||
|
Expected life
|
5 yrs.
|
5 yrs.
|
||||||
The risk-free interest rate was selected based upon yields of U.S. Treasury issues with a term equal to the expected life of the option being valued. Historical information was the primary basis for the selection of the expected dividend yield, expected volatility and expected lives of the options.
The weighted average fair value per share of options granted during 2010 and 2009 was $2.55 and $2.17, respectively.
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 taxes could change in the near term.
In connection with the accounting guidance related to accounting for uncertainty in income taxes, which sets out a consistent framework to determine the appropriate level of tax reserves to maintain for uncertain tax positions, QNB has evaluated its tax positions as of December 31, 2010. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that has more than a 50 percent likelihood of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. Under the “more-likely-than-not” threshold guidelines, QNB believes no significant uncertain tax positions exist, either individually or in the aggregate, that would give rise to the non-recognition of an existing tax benefit. As of December 31, 2010, QNB had no material unrecognized tax benefits or accrued interest and penalties. QNB’s policy is to account for interest as a component of interest expense and penalties as a component of other expense. The Company and its subsidiary are subject to U.S. Federal income tax as well as income tax of the Commonwealth of Pennsylvania. QNB is no longer subject to examination by U.S. Federal or State taxing authorities for years before 2007.
Treasury Stock
Common stock shares repurchased are recorded as treasury stock at cost.
Earnings Per Share
Basic earnings per share excludes any dilutive effects of options and is computed by dividing net income by the weighted average number of shares outstanding during the period. Diluted earnings per share gives effect to all dilutive potential common shares that were outstanding during the period. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method.
Treasury shares are not deemed outstanding for earnings per share calculations.
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Comprehensive Income
Comprehensive income is defined as the change in equity of a business entity during a period due to transactions and other events and circumstances, excluding those resulting from investments by and distributions to owners. Comprehensive income consists of net income and other comprehensive income. For QNB, the primary component of other comprehensive income is the unrealized holding gains or losses on available-for-sale investment securities and unrealized losses on available-for-sale investment securities related to factors other than credit on debt securities.
Subsequent Events
QNB has evaluated events and transactions occurring subsequent to the balance sheet date of December 31, 2010 for items that should potentially be recognized or disclosed in these financial statements.
Recent Accounting Pronouncements
In October 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2009-16,
Transfers and Servicing (Topic 860) – Accounting for Transfers of Financial Assets
. The amendments in this update improve financial reporting by eliminating the exceptions for qualifying special-purpose entities from the consolidation guidance and the exception that permitted sale accounting for certain mortgage securitizations when a transferor has not surrendered control over the transferred financial assets. In addition, the amendments require enhanced disclosures about the risks that a transferor continues to be exposed to because of its continuing involvement in transferred financial assets. Comparability and consistency in accounting for transferred financial assets will also be improved through clarifications of the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. This guidance became effective for the Company on January 1, 2010 and did not have a material impact on our financial position or results of operations.
In January 2010, the FASB issued ASU 2010-06,
Fair Value Measurements and Disclosures (Topic 820): Improving Disclosure about Fair Value Measurements
. This ASU requires some additional disclosures and clarifies some existing disclosure requirements about fair value measurements as set forth in Codification Subtopic 820-10. The FASB‘s objective is to improve these disclosures and, thus, increase transparency in financial reporting. Specifically, ASU 2010-06 amends Codification Subtopic 820-10 to now require:
|
•
|
A reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and
|
|
•
|
In the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements.
|
In addition, ASU 2010-06 clarifies the requirements of the following existing disclosures:
|
•
|
For purposes of reporting fair value measurements for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and
|
|
•
|
A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements.
|
ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuance, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years after December 15, 2010 and for interim periods within those fiscal years. The adoption of this update did not materially impact the Company’s currrent fair value measurment disclosures.
In July 2010, FASB issued ASU 2010-20,
Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses,
which is intended to help investors assess the credit risk of a company’s receivables portfolio and the adequacy of its allowance for credit losses held against the portfolios by expanding credit risk disclosures. This ASU requires more information about the credit quality of financing receivables in the disclosures to financial statements, such as aging information and credit quality indicators. Both new and existing disclosures must be disaggregated by portfolio segment or class. The disaggregation of information will be based on how a company develops its allowance for credit losses and how it manages its credit exposure. The amendments in this update apply to all entities with financing receivables. Financing receivables include loans and trade accounts receivable. However, short-term trade accounts receivable, receivables measured at fair value or lower of cost or fair value, and debt securities are exempt from these disclosure amendments. The effective date of ASU 2010-20 differs for public and nonpublic companies. For the Company, the amendments that require disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010 and are included in Note 5. The amendments that require disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010.
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In January 2011, FASB issued ASU 2011-01,
Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20.
The amendments in this Update temporarily delay the effective date of the disclosures about troubled debt restructurings in Update 2010-20 for public entities. Under the existing effective date in Update 2010-20, public-entity creditors would have provided disclosures about troubled debt restructurings for periods beginning on or after December 15, 2010. The delay is intended to allow FASB time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. The deferral in this amendment was effective upon issuance.
The following table sets forth the computation of basic and diluted earnings per share:
|
2010
|
2009
|
|||||||
|
Numerator for basic and diluted earnings per share - net income
|
$ | 7,217 | $ | 4,227 | ||||
|
Denominator for basic earnings per share - weighted average shares outstanding
|
3,105,565 | 3,094,624 | ||||||
|
Effect of dilutive securities - employee stock options
|
9,157 | 8,809 | ||||||
|
Denominator for diluted earnings per share - adjusted weighted average shares outstanding
|
3,114,722 | 3,103,433 | ||||||
|
Earnings per share - basic
|
$ | 2.32 | $ | 1.37 | ||||
|
Earnings per share - diluted
|
2.32 | 1.36 | ||||||
There were 117,225 and 130,300 stock options that were anti-dilutive as of December 31, 2010 and 2009, respectively. These stock options were not included in the above calculation.
On January 24, 2008, QNB announced that the Board of Directors authorized the repurchase of up to 50,000 shares of its common stock in open market or privately negotiated transactions. On February 9, 2009, the Board of Directors approved increasing the authorization to 100,000 shares. The repurchase authorization does not bear a termination date. As of December 31, 2010 and December 31, 2009, 57,883 shares were repurchased under this authorization at an average price of $16.97 and a total cost of $982,000. There were no shares repurchased during 2010.
Included in cash and cash equivalents are reserves in the form of deposits with the Federal Reserve Bank of $225,000 as of December 31, 2010 and 2009.
The amortized cost and fair values of investment securities available-for-sale at December 31, 2010 and 2009 were as follows:
|
December 31, 2010
|
||||||||||||||||||||
|
Gross
|
Gross
|
|||||||||||||||||||
|
unrealized
|
unrealized holding losses
|
|||||||||||||||||||
|
Fair
|
holding
|
Non-credit
|
Amortized
|
|||||||||||||||||
|
value
|
gains
|
OTTI
|
Other
|
cost
|
||||||||||||||||
|
U.S. Government agency securities
|
$ | 66,448 | $ | 241 | – | $ | 869 | $ | 67,076 | |||||||||||
|
State and municipal securities
|
63,588 | 675 | – | 514 | 63,427 | |||||||||||||||
|
U.S. Government agencies and sponsored enterprises (GSEs) - residential:
|
||||||||||||||||||||
|
Mortgage-backed securities
|
78,801 | 2,438 | – | 311 | 76,674 | |||||||||||||||
|
Collateralized mortgage obligations (CMOs)
|
75,573 | 1,890 | – | 137 | 73,820 | |||||||||||||||
|
Other debt securities
|
2,384 | 69 | $ | 1,224 | 550 | 4,089 | ||||||||||||||
|
Equity securities
|
3,770 | 667 | – | 43 | 3,146 | |||||||||||||||
|
Total investment securities available-for-sale
|
$ | 290,564 | $ | 5,980 | $ | 1,224 | $ | 2,424 | $ | 288,232 | ||||||||||
|
December 31, 2009
|
||||||||||||||||||||
|
|
Gross
|
Gross
|
||||||||||||||||||
|
unrealized
|
unrealized holding losses
|
|||||||||||||||||||
|
Fair
|
holding
|
Non-credit
|
Amortized
|
|||||||||||||||||
|
value
|
gains
|
OTTI
|
Other
|
cost
|
||||||||||||||||
|
U.S. Treasury
|
$ | 5,013 | $ | 2 | – | $ | 1 | $ | 5,012 | |||||||||||
|
U.S. Government agency securities
|
69,731 | 261 | – | 316 | 69,786 | |||||||||||||||
|
State and municipal securities
|
54,160 | 1,287 | – | 59 | 52,932 | |||||||||||||||
|
U.S. Government agencies and sponsored enterprises (GSEs) - residential:
|
||||||||||||||||||||
|
Mortgage-backed securities
|
61,649 | 2,215 | – | 69 | 59,503 | |||||||||||||||
|
Collateralized mortgage obligations (CMOs)
|
61,317 | 1,787 | – | 60 | 59,590 | |||||||||||||||
|
Other debt securities
|
1,533 | 78 | $ | 2,410 | 655 | 4,520 | ||||||||||||||
|
Equity securities
|
3,459 | 565 | – | 14 | 2,908 | |||||||||||||||
|
Total investment securities available-for-sale
|
$ | 256,862 | $ | 6,195 | $ | 2,410 | $ | 1,174 | $ | 254,251 | ||||||||||
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The amortized cost and fair value of securities available-for-sale by contractual maturity at December 31, 2010 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.
|
Amortized
|
||||||||
|
December 31, 2010
|
Fair value
|
cost
|
||||||
|
Due in one year or less
|
$ | 4,897 | $ | 4,804 | ||||
|
Due after one year through five years
|
186,125 | 182,293 | ||||||
|
Due after five years through ten years
|
51,944 | 52,159 | ||||||
|
Due after ten years
|
43,828 | 45,830 | ||||||
|
Equity securities
|
3,770 | 3,146 | ||||||
|
Total securities available-for-sale
|
$ | 290,564 | $ | 288,232 | ||||
Proceeds from sales of investment securities available-for-sale were $7,490,000 and $26,006,000 for the years ended December 31, 2010 and 2009, respectively.
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 of these investments. Gains and losses on available-for-sale securities are computed on the specific identification method and included in non-interest income.
|
December 31,
|
2010
|
2009
|
||||||||||||||||||||||||||||||
|
Other-than-
|
Other-than- | |||||||||||||||||||||||||||||||
|
Gross
|
Gross
|
temporary
|
Gross
|
Gross
|
temporary
|
|||||||||||||||||||||||||||
|
realized
|
realized
|
impairment
|
Net gains
|
realized
|
realized
|
impairment
|
Net
|
|||||||||||||||||||||||||
|
gains
|
losses
|
losses
|
(losses)
|
gains
|
losses
|
losses
|
losses
|
|||||||||||||||||||||||||
|
Equity securities
|
$ | 287 | – | $ | (33 | ) | $ | 254 | $ | 410 | $ | (1 | ) | $ | (521 | ) | $ | (112 | ) | |||||||||||||
|
Debt securities
|
24 | $ | (2 | ) | (277 | ) | (255 | ) | 729 | (69 | ) | (1,002 | ) | (342 | ) | |||||||||||||||||
|
Total
|
$ | 311 | $ | (2 | ) | $ | (310 | ) | $ | (1 | ) | $ | 1,139 | $ | (70 | ) | $ | (1,523 | ) | $ | (454 | ) | ||||||||||
All OTTI writedowns on equity securities were on marketable equity securities held at the Corp. All OTTI writedowns on debt securities were on pooled trust preferred securities, which are included in the other debt securities category, held at the Bank.
The tax benefit applicable to the net realized losses for the years ended December 31, 2010 and 2009 amounted to $0 and $154,000, respectively.
The following table presents a summary of the other-than-temporary impairment charges recognized for debt securities still held by QNB:
|
December 31,
|
2010
|
2009
|
||||||
|
OTTI on debt securities:
|
||||||||
|
Recorded as part of gross realized losses (credit-related)
|
$ | 277 | $ | 1,002 | ||||
|
Recorded directly to other comprehensive income for non-credit related impairment
|
27 | 2,031 | ||||||
|
Total OTTI on debt securities
|
$ | 304 | $ | 3,033 | ||||
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. 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.
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents a rollforward of the credit loss component recognized in earnings. The credit loss component of the amortized cost represents the difference between the present value of expected future cash flows and the amortized cost basis of the security prior to considering credit losses. The beginning balance represents the credit loss component for debt securities for which OTTI occurred prior to January 1, 2010. OTTI recognized in earnings in 2010 for credit-impaired debt securities is presented as additions 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). If we sell, intend to sell or believe we will be required to sell previously credit-impaired debt securities, an OTTI write-down is recognized in earnings equal to the difference between the security’s amortized cost basis and its fair value. The following 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:
|
Year Ended December 31,
|
2010
|
2009
|
||||||
|
Balance, beginning of year
|
$ | 1,002 | – | |||||
|
Additions:
|
||||||||
|
Initial credit impairments
|
– | $ | 1,002 | |||||
|
Subsequent credit impairments
|
277 | – | ||||||
|
Balance, end of year
|
$ | 1,279 | $ | 1,002 | ||||
Held-To-Maturity
The amortized cost and fair values of investment securities held-to-maturity at December 31, 2010 and 2009 were as follows:
|
December 31,
|
2010
|
2009
|
||||||||||||||||||||||||||||||
|
Gross
|
Gross
|
Gross
|
Gross
|
|||||||||||||||||||||||||||||
|
unrealized
|
unrealized
|
unrealized
|
unrealized
|
|||||||||||||||||||||||||||||
|
Amortized
|
holding
|
holding
|
Fair
|
Amortized
|
holding
|
holding
|
Fair
|
|||||||||||||||||||||||||
|
cost
|
gains
|
losses
|
value
|
cost
|
gains
|
losses
|
value
|
|||||||||||||||||||||||||
| $ | 2,667 | $ | 62 | – | $ | 2,729 | $ | 3,347 | $ | 124 | – | $ | 3,471 | |||||||||||||||||||
The amortized cost and estimated fair values of securities held-to-maturity by contractual maturity at December 31, 2010, are shown in the following table. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
|
Amortized
|
||||||||
|
December 31, 2010
|
Fair value
|
cost
|
||||||
|
Due in one year or less
|
$ | 830 | $ | 825 | ||||
|
Due after one year through five years
|
– | – | ||||||
|
Due after five years through ten years
|
1,899 | 1,842 | ||||||
|
Due after ten years
|
– | – | ||||||
|
Total securities held-to-maturity
|
$ | 2,729 | $ | 2,667 | ||||
There were no sales of investment securities classified as held-to-maturity during 2010 or 2009.
At December 31, 2010 and 2009, investment securities available-for-sale totaling $133,446,000 and $133,136,000, respectively, were pledged as collateral for repurchase agreements and deposits of public funds.
Securities that have been in a continuous unrealized loss position are as follows:
|
Less than 12 months
|
12 months or longer
|
Total
|
Total
|
|||||||||||||||||||||||||
|
Number of
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
||||||||||||||||||||||
|
As of December 31, 2010
|
securities
|
value
|
losses
|
value
|
losses
|
value
|
losses
|
|||||||||||||||||||||
|
U.S. Government agency securities
|
30 | $ | 40,179 | $ | 869 | – | – | $ | 40,179 | $ | 869 | |||||||||||||||||
|
State and municipal securities
|
40 | 19,207 | 482 | $ | 468 | $ | 32 | 19,675 | 514 | |||||||||||||||||||
|
Mortgage-backed securities
|
19 | 21,999 | 311 | – | – | 21,999 | 311 | |||||||||||||||||||||
|
Collateralized mortgage obligations (CMOs)
|
7 | 6,918 | 137 | – | – | 6,918 | 137 | |||||||||||||||||||||
|
Other debt securities
|
7 | – | – | 1,866 | 1,774 | 1,866 | 1,774 | |||||||||||||||||||||
|
Equity securities
|
5 | 740 | 43 | – | – | 740 | 43 | |||||||||||||||||||||
|
Total
|
108 | $ | 89,043 | $ | 1,842 | $ | 2,334 | $ | 1,806 | $ | 91,377 | $ | 3,648 | |||||||||||||||
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|
Less than 12 months
|
12 months or longer
|
Total
|
Total
|
|||||||||||||||||||||||||
|
Number of
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
Fair
|
Unrealized
|
||||||||||||||||||||||
|
As of December 31, 2009
|
securities
|
value
|
losses
|
value
|
losses
|
value
|
losses
|
|||||||||||||||||||||
|
U.S. Treasuries
|
3 | $ | 2,509 | $ | 1 | – | – | $ | 2,509 | $ | 1 | |||||||||||||||||
|
U.S. Government agency securities
|
24 | 28,675 | 316 | – | – | 28,675 | 316 | |||||||||||||||||||||
|
State and municipal securities
|
17 | 6,309 | 45 | $ | 659 | $ | 14 | 6,968 | 59 | |||||||||||||||||||
|
Mortgage-backed securities
|
5 | 6,934 | 69 | – | – | 6,934 | 69 | |||||||||||||||||||||
|
Collateralized mortgage obligations (CMOs)
|
6 | 6,929 | 60 | – | – | 6,929 | 60 | |||||||||||||||||||||
|
Other debt securities
|
8 | – | – | 1,008 | 3,065 | 1,008 | 3,065 | |||||||||||||||||||||
|
Equity securities
|
4 | 392 | 4 | 137 | 10 | 529 | 14 | |||||||||||||||||||||
|
Total
|
67 | $ | 51,748 | $ | 495 | $ | 1,804 | $ | 3,089 | $ | 53,552 | $ | 3,584 | |||||||||||||||
At December 31, 2010 the unrealized losses in QNB’s debt securities holdings are primarily related to the dynamic nature of interest rates as well as the impact of current market conditions. One of QNB’s prime objectives with the investment portfolio is to invest excess liquidity that is not needed to fund loans. As a result, QNB adds new investments throughout the year as they become available through deposit inflows or roll-off from loans and securities. The unrealized losses in U.S. Government agency securities, state and municipal securities, mortgage-backed securities and CMOs are primarily the result of purchases made when market interest rates were lower than at year end. As interest rates increase, fixed-rate securities generally fall in market price to reflect the higher market yield. If held to maturity, all of the bonds will mature at par, and QNB will not realize a loss. QNB has the intent to hold these 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. As a result of declines in equity values during 2009, $521,000 of other-than-temporary impairment charges were taken in 2009. During 2010, $33,000 of OTTI charges were taken on equity securities. QNB had 5 equity securities with unrealized losses of $43,000 in this position for a time period less than twelve months and no equity securities with unrealized losses for more than twelve months. 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.
All of the securities in the other debt securities category with unrealized losses greater than twelve months as of December 31, 2010 are pooled trust preferred security issues. QNB holds eight of these securities with an amortized cost of $3,640,000 and a fair value of $1,866,000. All of the trust preferred securities are available-for-sale securities and are carried at fair value.
The following table provides additional information related to pooled trust preferred securities as of December 31, 2010:
|
Total
|
||||||||||||||||||||||||||||||||||||||||||
|
2010
|
Total
|
Actual
|
performing
|
|||||||||||||||||||||||||||||||||||||||
|
Realized
|
Realized
|
Current
|
deferrals and
|
collateral as a
|
||||||||||||||||||||||||||||||||||||||
|
OTTI
|
OTTI
|
Moody’s/
|
Current
|
number of
|
defaults as a %
|
% of
|
||||||||||||||||||||||||||||||||||||
|
|
Book
|
Fair
|
Unrealized
|
Credit
|
Credit
|
Fitch
|
number
|
insurance
|
of total
|
outstanding
|
||||||||||||||||||||||||||||||||
|
Deal
|
Class
|
Value
|
Value
|
loss
|
Loss
|
Loss
|
ratings
|
of banks
|
companies
|
collateral
|
bonds
|
|||||||||||||||||||||||||||||||
|
PreTSL IV
|
Mezzanine*
|
$ | 243 | $ | 194 | $ | (49 | ) | – | $ | (1 | ) |
Ca/CCC
|
5 | – | 27.1 | % | 123.9 | % | |||||||||||||||||||||||
|
PreTSL V
|
Mezzanine*
|
– | – | – | $ | (71 | ) | (118 | ) |
Ba3/D
|
1 | – | 100.0 | 11.5 | ||||||||||||||||||||||||||||
|
PreTSL VI
|
Mezzanine*
|
121 | 120 | (1 | ) | – | (8 | ) |
Ca/D
|
5 | – | 81.0 | 50.3 | |||||||||||||||||||||||||||||
|
PreTSL XVII
|
Mezzanine
|
752 | 274 | (478 | ) | (197 | ) | (222 | ) |
Ca/C
|
47 | 6 | 35.3 | 76.9 | ||||||||||||||||||||||||||||
|
PreTSL XIX
|
Mezzanine
|
988 | 438 | (550 | ) | – | – | C/C | 51 | 14 | 24.6 | 84.0 | ||||||||||||||||||||||||||||||
|
PreTSL XXV
|
Mezzanine
|
766 | 327 | (439 | ) | (9 | ) | (222 | ) | C/C | 60 | 9 | 35.9 | 72.9 | ||||||||||||||||||||||||||||
|
PreTSL XXVI
|
Mezzanine
|
469 | 227 | (242 | ) | – | (270 | ) | C/C | 52 | 10 | 30.2 | 79.6 | |||||||||||||||||||||||||||||
|
Pre TSL XXVI
|
Mezzanine
|
301 | 286 | (15 | ) | – | (438 | ) | C/C | 52 | 10 | 30.2 | 79.6 | |||||||||||||||||||||||||||||
|
Total
|
$ | 3,640 | $ | 1,866 | $ | (1,774 | ) | $ | (277 | ) | $ | (1,279 | ) | |||||||||||||||||||||||||||||
* - only class of bonds still outstanding (represents the senior-most obligation of the trust)
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The market for these securities at December 31, 2010 is not active and markets for similar securities are also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which pooled trust preferred securities trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive and the market values for these securities (and any securities other than those issued or guaranteed by U.S. Government agencies) are depressed relative to historical levels. In today’s market, a low market price for a particular bond may only provide evidence of a recent widening of corporate spreads in general versus being an indicator of credit problems with a particular issuer. Lack of liquidity in the market for trust preferred collateralized debt obligations, credit rating downgrades and market uncertainties related to the financial industry are all factors contributing to the temporary impairment of these securities. Although these securities are classified as available-for-sale, QNB has the intent to hold the securities and does not believe it will be required to sell the securities before recovery occurs. As illustrated in the previous table, these securities are comprised mainly of securities issued by banks, and to a lesser degree, insurance companies. QNB owns the mezzanine tranches of these securities.
On a quarterly basis we evaluate our debt securities for other-than-temporary impairment (OTTI), which involves the use of a third-party valuation firm to assist management with the valuation. When evaluating these investments a credit related portion and a non-credit related portion of OTTI 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 fair value of the security and the amount of credit related impairment. During 2010, $277,000 in OTTI charges representing credit impairment were recognized on our pooled trust preferred collateralized debt obligations. A discounted cash flow analysis provides the best estimate of credit related OTTI for these securities. Additional information related to this analysis follows:
All of the pooled trust preferred collateralized debt obligations held by QNB are rated lower than AA and are measured for OTTI within the scope of ASC 325 (formerly known as EITF 99-20),
Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to be Held by a Transferor in Securitized Financial Assets, and Amendments to the Impairment Guidance of EITF Issue No. 99-20
(formerly known as EITF 99-20-1). QNB performs a discounted cash flow analysis on all of its impaired debt securities to determine if the amortized cost basis of an impaired security will be recovered. In determining whether a credit loss exists, QNB uses its best estimate of the present value of cash flows expected to be collected from the debt security and discounts them at the effective yield implicit in the security at the date of acquisition or the prospective yield for those securities with prior OTTI charges. The discounted cash flow analysis is considered to be the primary evidence when determining whether credit related other-than-temporary impairment exists.
Results of a discounted cash flow test are significantly affected by other variables such as the estimate of future cash flows (including prepayments), credit worthiness of the underlying banks and insurance companies and determination of probability and severity of default of the underlying collateral. The following provides additional information for each of these variables:
|
•
|
Estimate of Future Cash Flows – Cash flows are constructed in an INTEX desktop valuation model. INTEX is a proprietary cash flow model recognized as the industry standard for analyzing all types of structured debt products. It includes each deal’s structural features updated with trustee information, including asset-by-asset detail, as it becomes available. The modeled cash flows are then used to determine if all the scheduled principal and interest payments of the investments will be returned. For purposes of the cash flow analysis, relatively modest rates of prepayment were forecasted (ranging from 0-2%). In addition to the base prepayment assumption, due to the recent enactment of the Dodd-Frank financial legislation additional prepayment analysis was performed. First, all fixed-rate trust preferred securities issued by banks with more than $15 billion in total assets at December 31, 2009 were identified. Next the holding companies’ approximate cost of long-term funding given their rating and marketplace interest rates were estimated. The following assumption was made; any holding company that could refinance for a cost savings of more than 2% will refinance and will do so on January 1, 2013, or July 1, 2015 for bank holding company subsidiaries of foreign banking organizations that have relied on Supervision and Regulation Letter SR-01-1.
|
|
•
|
Credit Analysis – A quarterly credit evaluation is performed for the companies comprising the collateral across the various pooled trust preferred securities. This credit evaluation considers all available evidence and focuses on capitalization, asset quality, profitability, liquidity, stock price performance, whether the institution has received TARP funding and whether the institution has shown the ability to raise capital.
|
|
•
|
Probability of Default – A near-term probability of default is determined for each issuer based on its financial condition and is used to calculate the expected impact of future deferrals and defaults on the expected cash flows. Each issuer in the collateral pool is assigned a near-term probability of default based on individual performance and financial characteristics. Various studies suggest that the rate of bank failures between 1934 and 2008 were approximately 0.36%. Thus, in addition to the specific bank default assumptions used for the near term, future defaults on the individual banks in the analysis are assumed at 0.75% for 2012 (two times historical levels) and for 2013 and beyond the rate used is calculated based upon individual issuers estimated CAMEL rating as projected by VERIBANC®. Banks in the pool are assigned a probability of default based on their unique credit characteristics and market indicators.
|
|
•
|
Severity of Loss – In addition to the probability of default discussed above, a severity of loss (projected recovery) is determined in all cases. In the current analysis, the severity of loss ranges from 0% to 100% depending on the estimated credit worthiness of the individual issuer, with a 95% severity of loss utilized for defaults projected in 2011 and thereafter.
|
In addition to the above factors, the evaluation of impairment also includes a stress test analysis which provides an estimate of excess subordination for each tranche. This stressed breakpoint is then compared to the level of assets with credit concerns in each tranche. This comparison allows management to identify those pools that are at a greater risk for a future adverse change in cash flows so that we can monitor the asset quality in those pools more closely for potential deterioration of credit quality.
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Based upon the analysis performed by management as of December 31, 2010, it is probable that we will collect all contractual principal and interest payments on one of our eight pooled trust preferred securities, PreTSL XIX. The expected principal shortfall on the remaining pooled trust preferred securities have resulted in credit related other-than-temporary impairment charges either during 2010 or in previous years, and these securities could be subject to additional writedowns in the future if additional deferrals and defaults occur.
Major classes of loans are as follows:
|
|
||||||||
|
December 31,
|
2010
|
2009
|
||||||
|
Commercial
|
||||||||
|
Commercial and industrial
|
$ | 86,628 | $ | 82,512 | ||||
|
Construction
|
18,611 | 27,483 | ||||||
|
Secured by commercial real estate
|
199,874 | 166,097 | ||||||
|
Secured by residential real estate
|
44,444 | 37,779 | ||||||
|
State and political subdivisions
|
31,053 | 26,698 | ||||||
|
Indirect lease financing
|
12,995 | 14,061 | ||||||
|
Retail
|
||||||||
|
1-4 family residential mortgages
|
23,127 | 23,929 | ||||||
|
Home equity loans and lines
|
62,726 | 67,201 | ||||||
|
Consumer
|
2,751 | 3,702 | ||||||
|
Total loans
|
482,209 | 449,462 | ||||||
|
Net unearned (fees) costs
|
(27 | ) | (41 | ) | ||||
|
Loans receivable
|
$ | 482,182 | $ | 449,421 | ||||
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.
Overdraft deposits are reclassified as loans and are included in consumer loans above and total loans on the balance sheet. For the years ended December 31, 2010 and 2009, overdrafts were $93,000 and $98,000, 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. At December 31, 2010, there were no concentrations of loans exceeding 10 percent of total loans other than disclosed in the table above.
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 come 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 include 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 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 authori¬ties. 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.
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Indirect lease financing receivables represent loans to small businesses that are collateralized by equipment. These loans tend to have higher risk characteristics but generally provide higher rates of return. These loans are originated by a third party and purchased by QNB based on criteria specified by QNB. The criteria include minimum credit scores of the borrower, term of the lease, type and age of equipment financed and geographic area. The geographic area primarily represents states contiguous to Pennsylvania. QNB is not the lessor and does not service these loans.
The Company originates fixed-rate and adjustable-rate real estate-residential mortgage loans for personal purposes that are secured by first liens on the underlying 1-4 family residential properties. Credit risk exposure in this area of lending is minimized by the evaluation of the credit worthiness of the borrower, including debt-to-income ratios, credit scores and adherence to underwriting policies that emphasize conservative loan-to-value ratios of generally no more than 80%. Residential mortgage loans granted in excess of the 80% loan-to-value ratio criterion are generally insured by private mortgage insurance.
The real estate-home equity portfolio consists of fixed-rate home equity loans and variable-rate home equity lines of credit. Risks associated with loans secured by residential properties are generally lower than commercial loans and include general economic risks, such as the strength of the job market, employment stability and the strength of the housing market. Since most loans are secured by a primary or secondary residence, the borrower’s continued employment is the greatest risk to repayment.
The Company offers a variety of loans to individuals for personal and household purposes. Consumer loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or, if they are secured, the value of the collateral may be difficult to assess and is more likely to decrease in value than real estate. Credit risk in this portfolio is controlled by conservative underwriting standards that consider debt-to-income levels and the creditworthiness of the borrower and, if secured, collateral values.
The Company employs an eight (8) grade risk rating system related to the credit quality of commercial loans, loans to state and political subdivisions and indirect lease financing of which the first four categories are pass categories (credits not adversely rated). The following is a description of the internal risk ratings and the likelihood of loss related to each risk rating.
1 - Excellent - no apparent risk
2 - Good - minimal risk
3 - Acceptable - average risk
4 - Watch List - greater than average risk
5 - Special Mention - potential weaknesses
6 - Substandard - well defined weaknesses
7 - Doubtful - full collection unlikely
8 - Loss - considered uncollectible
The Company maintains a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential problem loans. Each loan officer assigns a rating to all loans in the portfolio at the time the loan is originated. Loans with risk ratings of one through three are reviewed annually based on the borrower’s fiscal year. Loans with risk ratings of four are reviewed every six to twelve months based on the dollar amount of the relationship with the borrower. Loans with risk ratings of five through eight are reviewed at least quarterly, and as often as monthly, at management’s discretion. The Company also utilizes an outside loan review firm to review the portfolio on a semi-annual basis to provide the Board of Directors and senior management an independent review of the Bank’s loan portfolio on an ongoing basis. These reviews are designed to recognize deteriorating credits in their earliest stages in an effort to reduce and control risk in the lending function as well as identifying potential shifts in the quality of the loan portfolio. The examinations by the outside loan review firm includes 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.
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents 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 December 31, 2010:
|
Special
|
||||||||||||||||||||
|
Pass
|
Mention
|
Substandard
|
Doubtful
|
Total
|
||||||||||||||||
|
Commercial
|
||||||||||||||||||||
|
Commercial and industrial
|
$ | 74,315 | $ | 1,378 | $ | 10,878 | $ | 57 | $ | 86,628 | ||||||||||
|
Construction
|
9,888 | 5,993 | 2,730 | – | 18,611 | |||||||||||||||
|
Secured by commercial real estate
|
154,697 | 6,537 | 37,942 | 698 | 199,874 | |||||||||||||||
|
Secured by residential real estate
|
39,823 | 1,038 | 3,583 | – | 44,444 | |||||||||||||||
|
State and political subdivisions
|
28,649 | 2,338 | 66 | – | 31,053 | |||||||||||||||
|
Indirect lease financing
|
12,460 | – | 535 | – | 12,995 | |||||||||||||||
| $ | 319,832 | $ | 17,284 | $ | 55,374 | $ | 755 | $ | 393,605 | |||||||||||
For retail loans, the Company evaluates credit quality based on the performance of the individual credits. The following table presents the recorded investment in the retail classes of the loan portfolio based on payment activity as of December 31, 2010:
|
Non-
|
||||||||||||
|
Performing
|
Performing
|
Total
|
||||||||||
|
Retail
|
||||||||||||
|
1-4 family residential mortgages
|
$ | 22,694 | $ | 433 | $ | 23,127 | ||||||
|
Home equity loans and lines
|
62,581 | 145 | 62,726 | |||||||||
|
Consumer
|
2,751 | – | 2,751 | |||||||||
| $ | 88,026 | $ | 578 | $ | 88,604 | |||||||
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 December 31, 2010:
|
30-59 Days
|
60-89 Days
|
>90 Days
|
Total Past
|
Total Loans
|
||||||||||||||||||||
|
Past Due
|
Past Due
|
Past Due
|
Due Loans
|
Current
|
Receivable
|
|||||||||||||||||||
|
Commercial
|
||||||||||||||||||||||||
|
Commercial and industrial
|
$ | 228 | $ | 66 | $ | 197 | $ | 491 | $ | 86,137 | $ | 86,628 | ||||||||||||
|
Construction
|
39 | – | 1,334 | 1,373 | 17,238 | 18,611 | ||||||||||||||||||
|
Secured by commercial real estate
|
527 | 4,517 | 3,257 | 8,301 | 191,573 | 199,874 | ||||||||||||||||||
|
Secured by residential real estate
|
857 | 125 | 54 | 1,036 | 43,408 | 44,444 | ||||||||||||||||||
|
State and political subdivisions
|
– | 8 | 9 | 17 | 31,036 | 31,053 | ||||||||||||||||||
|
Indirect lease financing
|
495 | 244 | 72 | 811 | 12,184 | 12,995 | ||||||||||||||||||
|
Retail
|
||||||||||||||||||||||||
|
1-4 family residential mortgages
|
668 | – | 433 | 1,101 | 22,026 | 23,127 | ||||||||||||||||||
|
Home equity loans and lines
|
220 | 203 | 29 | 452 | 62,274 | 62,726 | ||||||||||||||||||
|
Consumer
|
32 | – | – | 32 | 2,719 | 2,751 | ||||||||||||||||||
| $ | 3,066 | $ | 5,163 | $ | 5,385 | $ | 13,614 | $ | 468,595 | $ | 482,209 | |||||||||||||
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table discloses the recorded investment in loans receivable that are either on non-accrual status or past due more than 90 days and still accruing interest as of December 31, 2010:
Activity in the allowance for loan losses is shown below:
|
December 31,
|
2010
|
2009
|
||||||
|
Balance at beginning of year
|
$ | 6,217 | $ | 3,836 | ||||
|
Charge-offs
|
(1,327 | ) | (1,934 | ) | ||||
|
Recoveries
|
265 | 165 | ||||||
|
Net charge-offs
|
(1,062 | ) | (1,769 | ) | ||||
|
Provision for loan losses
|
3,800 | 4,150 | ||||||
|
Balance at end of year
|
$ | 8,955 | $ | 6,217 | ||||
Additional details for changes in the allowance for loan losses for the year ended December 31, 2010 are as follows:
|
Balance
|
Provision
|
|
||||||||||||||||||
|
beginning
of
period
|
(credit) for
loan losses
|
Charge-offs
|
Recoveries
|
Balance, end
of period
|
|
|||||||||||||||
|
Commercial
|
||||||||||||||||||||
|
Commercial and industrial
|
$ | 1,601 | $ | 1,090 | $ | (568 | ) | $ | 13 | $ | 2,136 | |||||||||
|
Construction
|
382 | 251 | – | – | 633 | |||||||||||||||
|
Secured by commercial real estate
|
2,038 | 2,115 | (278 | ) | – | 3,875 | ||||||||||||||
|
Secured by residential real estate
|
549 | 240 | (113 | ) | – | 676 | ||||||||||||||
|
State and political subdivisions
|
125 | (17 | ) | – | – | 108 | ||||||||||||||
|
Indirect lease financing
|
673 | (141 | ) | (254 | ) | 218 | 496 | |||||||||||||
|
Retail
|
||||||||||||||||||||
|
1-4 family residential mortgages
|
153 | 59 | – | – | 212 | |||||||||||||||
|
Home equity loans and lines
|
420 | 286 | (60 | ) | – | 646 | ||||||||||||||
|
Consumer
|
61 | (9 | ) | (54 | ) | 34 | 32 | |||||||||||||
|
Unallocated
|
215 | (74 | ) | N/A | N/A | 141 | ||||||||||||||
| $ | 6,217 | $ | 3,800 | $ | (1,327 | ) | $ | 265 | $ | 8,955 | ||||||||||
Information with respect to loans that are considered to be impaired in accordance with the impairment accounting guidance as follows:
|
December 31,
|
2010
|
2009
|
||||||||||||||
|
Loan Balance
|
Specific Allowance
|
Loan Balance
|
Specific Allowance
|
|||||||||||||
|
Recorded investment in impaired loans at year-end subject to a
specific allowance for loan losses and corresponding specific allowance
|
$ | 8,295 | $ | 2,281 | $ | 1,077 | $ | 528 | ||||||||
| 12,568 | – | 4,622 | – | |||||||||||||
|
Recorded investment in impaired loans at year-end
|
$ | 20,863 | $ | 5,699 | ||||||||||||
|
Average recorded investment in impaired loans
|
$ | 8,738 | $ | 1,898 | ||||||||||||
QNB recognized $27,000 and $48,000 of interest income on impaired loans in 2010 and 2009, respectively.
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information regarding non-performing loans greater than 90 days past due is as follows:
|
December 31,
|
2010
|
2009
|
||||||
|
Recorded investment in non-accrual loans
|
$ | 7,183 | $ | 3,086 | ||||
|
Recorded investment in loans greater than 90 days past due and still accruing interest
|
268 | 759 | ||||||
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 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.
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 designated as impaired. 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.
66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the balance in the allowance of loan losses at December 31, 2010 disaggregated on the basis of the Company’s impairment method by class of loans receivable along with the balance of loans receivable by class disaggregated on the basis of the Company’s impairment methodology:
|
Allowance for Loan Losses
|
Loans Receivable
|
|||||||||||||||||||||||
|
Balance
|
Balance
|
|||||||||||||||||||||||
|
Related to
|
Related to
|
|||||||||||||||||||||||
|
Loans
|
Loans
|
Balance
|
Balance
|
|||||||||||||||||||||
|
Individually
|
Collectively
|
Individually
|
Collectively
|
|||||||||||||||||||||
|
Evaluated for
|
Evaluated for
|
Evaluated for
|
Evaluated for
|
|||||||||||||||||||||
|
Balance
|
Impairment
|
Impairment
|
Balance
|
Impairment
|
Impairment
|
|||||||||||||||||||
|
Commercial
|
||||||||||||||||||||||||
|
Commercial and industrial
|
$ | 2,136 | $ | 878 | $ | 1,258 | $ | 86,628 | $ | 4,710 | $ | 81,918 | ||||||||||||
|
Construction
|
633 | 370 | 263 | 18,611 | 2,650 | 15,961 | ||||||||||||||||||
|
Secured by commercial real estate
|
3,875 | 687 | 3,188 | 199,874 | 9,213 | 190,661 | ||||||||||||||||||
|
Secured by residential real estate
|
676 | 179 | 497 | 44,444 | 2,624 | 41,820 | ||||||||||||||||||
|
State and political subdivisions
|
108 | – | 108 | 31,053 | – | 31,053 | ||||||||||||||||||
|
Indirect lease financing
|
496 | 64 | 432 | 12,995 | 275 | 12,720 | ||||||||||||||||||
|
Retail
|
||||||||||||||||||||||||
|
1-4 family residential mortgages
|
212 | 41 | 171 | 23,127 | 606 | 22,521 | ||||||||||||||||||
|
Home equity loans and lines
|
646 | 62 | 584 | 62,726 | 785 | 61,941 | ||||||||||||||||||
|
Consumer
|
32 | – | 32 | 2,751 | – | 2,751 | ||||||||||||||||||
|
Unallocated
|
141 | N/A | N/A | N/A | N/A | N/A | ||||||||||||||||||
| $ | 8,955 | $ | 2,281 | $ | 6,533 | $ | 482,209 | $ | 20,863 | $ | 461,346 | |||||||||||||
The following table summarizes additional information in regards to impaired loans by loan portfolio class as of December 31, 2010:
|
Recorded
|
Unpaid
|
Average
|
Interest
|
|||||||||||||||||
|
Investment
|
Principal
|
Related
|
Recorded
|
Income
|
||||||||||||||||
|
(After Charge-offs)
|
Balance
|
Allowance
|
Investment
|
Recognized
|
||||||||||||||||
|
With no specific allowance recorded:
|
||||||||||||||||||||
|
Commercial
|
||||||||||||||||||||
|
Commercial and industrial
|
$ | 3,218 | $ | 3,225 | – | |||||||||||||||
|
Construction
|
1,316 | 1,316 | – | |||||||||||||||||
|
Secured by commercial real estate
|
5,495 | 5,497 | – | |||||||||||||||||
|
Secured by residential real estate
|
1,558 | 1,558 | – | |||||||||||||||||
|
State and political subdivisions
|
– | – | – | |||||||||||||||||
|
Indirect lease financing
|
55 | 60 | – | |||||||||||||||||
|
Retail
|
||||||||||||||||||||
|
1-4 family residential mortgages
|
434 | 436 | – | |||||||||||||||||
|
Home equity loans and lines
|
492 | 492 | – | |||||||||||||||||
|
Consumer
|
– | – | – | |||||||||||||||||
| $ | 12,568 | $ | 12,584 | – | ||||||||||||||||
|
With an allowance recorded:
|
||||||||||||||||||||
|
Commercial
|
||||||||||||||||||||
|
Commercial and industrial
|
$ | 1,492 | $ | 1,492 | $ | 878 | ||||||||||||||
|
Construction
|
1,334 | 1,340 | 370 | |||||||||||||||||
|
Secured by commercial real estate
|
3,718 | 3,821 | 687 | |||||||||||||||||
|
Secured by residential real estate
|
1,066 | 1,066 | 179 | |||||||||||||||||
|
State and political subdivisions
|
– | – | – | |||||||||||||||||
|
Indirect lease financing
|
220 | 239 | 64 | |||||||||||||||||
|
Retail
|
||||||||||||||||||||
|
1-4 family residential mortgages
|
172 | 172 | 41 | |||||||||||||||||
|
Home equity loans and lines
|
293 | 293 | 62 | |||||||||||||||||
|
Consumer
|
– | – | – | |||||||||||||||||
| $ | 8,295 | $ | 8,423 | $ | 2,281 | |||||||||||||||
67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|
Recorded
|
Unpaid
|
Average
|
Interest | |||||||||||||||||
|
Investment
|
Principal
|
Related
|
Recorded
|
Income
|
||||||||||||||||
|
(After Charge-offs)
|
Balance
|
Allowance
|
Investment
|
Recognized
|
||||||||||||||||
|
Total:
|
||||||||||||||||||||
|
Commercial
|
||||||||||||||||||||
|
Commercial and industrial
|
$ | 4,710 | $ | 4,717 | $ | 878 | $ | 1,306 | $ | 12 | ||||||||||
|
Construction
|
2,650 | 2,656 | 370 | 1,817 | 1 | |||||||||||||||
|
Secured by commercial real estate
|
9,213 | 9,318 | 687 | 4,582 | 11 | |||||||||||||||
|
Secured by residential real estate
|
2,624 | 2,624 | 179 | 495 | 1 | |||||||||||||||
|
State and political subdivisions
|
– | – | – | – | – | |||||||||||||||
|
Indirect lease financing
|
275 | 299 | 64 | 260 | 2 | |||||||||||||||
|
Retail
|
||||||||||||||||||||
|
1-4 family residential mortgages
|
606 | 608 | 41 | 126 | – | |||||||||||||||
|
Home equity loans and lines
|
785 | 785 | 62 | 152 | – | |||||||||||||||
|
Consumer
|
– | – | – | – | – | |||||||||||||||
| $ | 20,863 | $ | 21,007 | $ | 2,281 | $ | 8,738 | $ | 27 | |||||||||||
Premises and equipment, stated at cost less accumulated depreciation and amortization, are summarized below:
|
December 31,
|
2010
|
2009
|
||||||
|
Land and buildings
|
$ | 7,200 | $ | 7,184 | ||||
|
Furniture and equipment
|
10,556 | 10,055 | ||||||
|
Leasehold improvements
|
2,229 | 1,668 | ||||||
|
Book value
|
19,985 | 18,907 | ||||||
|
Accumulated depreciation and amortization
|
(13,433 | ) | (12,659 | ) | ||||
|
Net book value
|
$ | 6,552 | $ | 6,248 | ||||
Depreciation and amortization expense on premises and equipment amounted to $853,000 and $894,000 for the years ended December 31, 2010 and 2009, respectively.
Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage loans serviced for others were $79,334,000 and $79,952,000 at December 31, 2010 and 2009, respectively.
The following table reflects the activity of mortgage servicing rights for the periods indicated:
|
Years Ended December 31,
|
2010
|
2009
|
||||||
|
Balance at beginning of year
|
$ | 519 | $ | 402 | ||||
|
Mortgage servicing rights capitalized
|
89 | 189 | ||||||
|
Mortgage servicing rights amortized
|
(98 | ) | (100 | ) | ||||
|
Fair market value adjustments
|
(6 | ) | 28 | |||||
|
Balance at end of year
|
$ | 504 | $ | 519 | ||||
The balance of these mortgage servicing rights are included in other assets at December 31, 2010 and 2009. The fair value of these rights was $620,000 and $637,000, respectively. The fair value of servicing rights was determined using a 9.0% discount rate for both 2010 and 2009.
The annual estimated amortization expense of intangible assets for each of the five succeeding fiscal years is as follows:
|
2011
|
$ | 124 | ||
|
2012
|
98 | |||
|
2013
|
74 | |||
|
2014
|
54 | |||
|
2015
|
39 |
68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The aggregate amount of time deposits, including deposits in denominations of $100,000 or more, was $310,232,000 and $321,096,000 at December 31, 2010 and 2009, respectively.
At December 31, 2010, the scheduled maturities of time deposits were as follows:
|
2011
|
$ | 231,692 | ||
|
2012
|
34,882 | |||
|
2013
|
13,055 | |||
|
2014
|
12,776 | |||
|
2015
|
17,827 | |||
|
Thereafter
|
– | |||
|
Total time deposits
|
$ | 310,232 |
|
Securities Sold under
|
Other
|
|||||||
|
December 31,
|
Agreements to Repurchase
|
(a) |
Short-term Borrowings
|
(b) | ||||
|
2010
|
||||||||
|
Balance
|
$ | 29,186 | $ | 600 | ||||
|
Maximum indebtedness at any month end
|
34,784 | 853 | ||||||
|
Daily average indebtedness outstanding
|
27,156 | 502 | ||||||
|
Average rate paid for the year
|
0.99 | % | 0.05 | % | ||||
|
Average rate on period-end borrowings
|
0.89 | – | ||||||
|
2009
|
||||||||
|
Balance
|
$ | 28,055 | $ | 378 | ||||
|
Maximum indebtedness at any month end
|
30,938 | 3,657 | ||||||
|
Daily average indebtedness outstanding
|
20,707 | 1,110 | ||||||
|
Average rate paid for the year
|
1.18 | % | 0.39 | % | ||||
|
Average rate on period-end borrowings
|
1.00 | – | ||||||
(a)
Securities sold under agreements to repurchase mature overnight. The repurchase agreements were collateralized by U.S. Government mortgage-backed securities and CMOs with an amortized cost of $36,149,000 and $38,040,000 and a fair value of $37,627,000 and $39,444,000 at December 31, 2010 and 2009, respectively. These securities are held in safekeeping at the Federal Reserve Bank.
(b)
Other short-term borrowings include Federal funds purchased, overnight borrowings from the FHLB and Treasury tax and loan notes.
The Bank has two unsecured Federal funds lines granted by correspondent banks totaling $18,000,000. Federal funds purchased under these lines were $0 at both December 31, 2010 and 2009.
Under terms of its agreement with the FHLB, QNB maintains otherwise unencumbered qualifying assets (principally 1-4 family residential mortgage loans and U.S. Government and agency notes, bonds, and mortgage-backed securities) in the amount of at least as much as its advances from the FHLB. QNB’s FHLB stock of $2,164,000 and $2,279,000 at December 31, 2010 and 2009, respectively, is also pledged to secure these advances.
QNB has a maximum borrowing capacity with the FHLB of approximately $165,352,000. At December 31, 2010, QNB had no borrowings outstanding with the FHLB. At December 31, 2009, there were $10,000,000 in outstanding advances with a fixed interest rate of 2.97%, which matured in January 2010.
Repurchase agreements are treated as financings with the obligations to repurchase securities sold reflected as a liability in the balance sheet. The dollar amount of securities underlying the agreements remains recorded as an asset, although the securities underlying the agreements are delivered to the broker who arranged the transactions. The broker/dealer who participated with the Company in these agreements is PNC Bank. Securities underlying sales of securities under repurchase agreements consisted of municipal securities that had an amortized cost of $22,769,000 and a fair value of $23,140,000 at December 31, 2010.
69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fixed-rate securities sold under agreements to repurchase as of December 31, 2010 and 2009 mature as follows:
|
2010
|
2009
|
|||||||||||||||
|
Weighted
|
Weighted
|
|||||||||||||||
|
Average
|
Average
|
|||||||||||||||
|
Balance
|
Rate
|
Balance
|
Rate
|
|||||||||||||
|
2010
|
– | – | $ | 5,000 | 4.90 | % | ||||||||||
|
2012
|
$ | 15,000 | 1 | 4.75 | % | 15,000 | 4.75 | |||||||||
|
2014
|
5,000 | 2 | 4.77 | 5,000 | 4.77 | |||||||||||
|
Total
|
$ | 20,000 | 4.76 | % | $ | 25,000 | 4.78 | % | ||||||||
1
$5,000,000 callable beginning 4/17/09, $10,000,000 callable beginning 4/17/10
2
$2,500,000 callable beginning 4/17/10, $2,500,000 callable beginning 4/17/12
Long term debt at December 31, 2010 also includes secured borrowings of $308,000.
The components of the provision for income taxes are as follows:
|
Year Ended December 31,
|
2010
|
2009
|
||||||
|
Current Federal income taxes
|
$ | 2,701 | $ | 1,681 | ||||
|
Deferred Federal income taxes
|
(867 | ) | (1,058 | ) | ||||
|
Net provision
|
$ | 1,834 | $ | 623 | ||||
At December 31, 2010 and 2009, the tax effects of temporary differences that represent the significant portion of deferred tax assets and liabilities are as follows:
|
December 31,
|
2010
|
2009
|
||||||
|
Deferred tax assets
|
||||||||
|
Allowance for loan losses
|
$ | 3,045 | $ | 2,114 | ||||
|
Impaired securities
|
623 | 645 | ||||||
|
Capital loss carryover
|
93 | 63 | ||||||
|
Non-credit OTTI on investment securities available-for-sale
|
416 | 819 | ||||||
|
Deferred compensation
|
17 | 29 | ||||||
|
Deposit premium
|
21 | 33 | ||||||
|
Non-accrual interest income
|
19 | – | ||||||
|
Other
|
9 | 15 | ||||||
| 4,243 | 3,718 | |||||||
|
Deferred tax liabilities
|
||||||||
|
Depreciation
|
137 | 83 | ||||||
|
Mortgage servicing rights
|
171 | 176 | ||||||
|
Net unrealized holding gains on investment securities available-for-sale
|
1,209 | 1,707 | ||||||
|
Prepaid expenses
|
152 | 140 | ||||||
|
Other
|
2 | 2 | ||||||
|
Total deferred tax liabilities
|
1,671 | 2,108 | ||||||
|
Net deferred tax asset
|
$ | 2,572 | $ | 1,610 | ||||
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 the above deferred tax assets. The net deferred tax asset is included in other assets on the consolidated balance sheet. As of December 31, 2010, QNB has a capital loss carryover of $184,000 that will expire on December 31, 2014, if not utilized.
A reconciliation of the tax provision on income before taxes computed at the statutory rate of 34% and the actual tax provision was as follows:
|
Year Ended December 31,
|
2010
|
2009
|
||||||
|
Provision at statutory rate
|
$ | 3,077 | $ | 1,649 | ||||
|
Tax-exempt interest and dividend income
|
(1,178 | ) | (994 | ) | ||||
|
Bank-owned life insurance
|
(107 | ) | (105 | ) | ||||
|
Stock-based compensation expense
|
17 | 20 | ||||||
|
Other
|
25 | 53 | ||||||
|
Total provision
|
$ | 1,834 | $ | 623 | ||||
70
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The QNB Bank Retirement Savings Plan provides for elective employee contributions up to the maximum allowed by the IRS and a matching company contribution limited to 3 percent. In addition, the plan provides for safe harbor nonelective contributions of 5 percent of total compensation by QNB. QNB contributed a matching contribution of approximately $164,000 and $161,000 for the years ended December 31, 2010 and 2009, respectively, and a safe harbor contribution of approximately $327,000 for 2010 and $316,000 for 2009.
QNB’s Employee Stock Purchase Plan (the Plan) offers eligible employees an opportunity to purchase shares of QNB Corp. Common Stock at a 10 percent discount from the lesser of fair market value on the first or last day of each offering period (as defined by the plan). The 2006 Plan authorizes the issuance of 20,000 shares. As of December 31, 2010, 17,620 shares were issued under the 2006 Plan. The 2006 Plan expires May 31, 2011.
Shares issued pursuant to the Plan were as follows:
|
Year Ended December 31,
|
Shares
|
Price per Share
|
|||||||||||
|
2010
|
4,118 | $ | 15.30 |
and
|
$ | 17.96 | |||||||
|
2009
|
4,849 | 14.04 |
and
|
15.30 | |||||||||
QNB has stock option plans (the Plans) administered by a committee which consists of three or more members of QNB’s Board of Directors. The Plans provide for the granting of either (i) Non-Qualified Stock Options (NQSOs) or (ii) Incentive Stock Options (ISOs). The exercise price of an option, as defined by the Plans, is the fair market value of QNB’s common stock at the date of grant. The Plans provide for the exercise either in cash or in securities of the Company or in any combination thereof.
The 1998 Plan authorizes the issuance of 220,500 shares. The time period by which any option is exercisable under the Plan is determined by the Committee but shall not commence before the expiration of six months after the date of grant or continue beyond the expiration of ten years after the date the option is awarded. The granted options vest after a three-year period. As of December 31, 2010, there were 225,058 options granted, 19,944 options forfeited, 95,474 options exercised and 109,640 options outstanding under this Plan. The 1998 Plan expired March 10, 2008.
The 2005 Plan authorizes the issuance of 200,000 shares. The terms of the 2005 Plan are identical to the 1998 Plan except the options expire five years after the grant date. As of December 31, 2010, there were 83,700 options granted, 22,825 options forfeited and 60,875 options outstanding under this Plan. The 2005 Plan expires March 15, 2015.
As of December 31, 2010, there was approximately $52,000 of unrecognized compensation cost related to unvested stock option awards granted. That cost is expected to be recognized over the next three years.
Stock option activity during 2010 and 2009, was as follows:
|
Weighted Average
|
||||||||||||||||
|
Weighted
|
Remaining
|
Aggregate Intrinsic | ||||||||||||||
|
Number of Options
|
Average Exercise Price
|
Contractual Term (in yrs)
|
Value
|
|||||||||||||
|
Outstanding December 31, 2008
|
221,323 | $ | 20.60 | |||||||||||||
|
Exercised
|
(38,317 | ) | 15.02 | |||||||||||||
|
Forfeited
|
(2,204 | ) | 16.70 | |||||||||||||
|
Granted
|
20,000 | 17.15 | ||||||||||||||
|
Outstanding December 31, 2009
|
200,802 | 21.36 | ||||||||||||||
|
Exercised
|
(19,716 | ) | 14.03 | |||||||||||||
|
Forfeited
|
(30,571 | ) | 22.32 | |||||||||||||
|
Granted
|
20,000 | 17.63 | ||||||||||||||
|
Outstanding at December 31, 2010
|
170,515 | $ | 21.60 | 2.08 | $ | 243 | ||||||||||
|
Exercisable at December 31, 2010
|
127,990 | $ | 22.66 | 1.69 | $ | 176 | ||||||||||
71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2010, outstanding stock options consist of the following:
|
Remaining
|
||||||||||||||||||||
|
Options
|
Exercise
|
Life
|
Options
|
Exercise
|
||||||||||||||||
|
Outstanding
|
Price
|
(in years)
|
Exercisable
|
Price
|
||||||||||||||||
| 13,440 | $ | 13.30 | 0.04 | 13,440 | $ | 13.30 | ||||||||||||||
| 26,200 | 16.13 | 1.04 | 26,200 | 16.13 | ||||||||||||||||
| 13,650 | 17.15 | 3.06 | – | – | ||||||||||||||||
| 14,400 | 17.25 | 4.13 | – | – | ||||||||||||||||
| 3,000 | 19.76 | 4.69 | – | – | ||||||||||||||||
| 31,700 | 20.00 | 2.06 | 31,700 | 20.00 | ||||||||||||||||
| 11,475 | 21.00 | 2.04 | – | – | ||||||||||||||||
| 12,050 | 25.15 | 1.04 | 12,050 | 25.15 | ||||||||||||||||
| 14,800 | 26.00 | 0.05 | 14,800 | 26.00 | ||||||||||||||||
| 14,800 | 32.35 | 4.05 | 14,800 | 32.35 | ||||||||||||||||
| 15,000 | 33.25 | 3.32 | 15,000 | 33.25 | ||||||||||||||||
|
Outstanding as of December 31, 2010
|
170,515 | $ | 21.60 | 2.08 | 127,990 | $ | 22.66 | |||||||||||||
The cash proceeds, tax benefits and intrinsic value related to total stock options exercised during 2010 and 2009 are as follows:
|
2010
|
2009
|
|||||||
|
Tax benefits related to stock options exercised
|
$ | 3 | $ | 10 | ||||
|
Intrinsic value of stock options exercised
|
110 | 105 | ||||||
The following table presents activity in the amounts due from directors, principal officers, and their related interests. All of these transactions were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. Also, they did not involve a more than normal risk of collectibility or present any other unfavorable features.
|
Balance, December 31, 2009
|
$ | 5,276 | ||
|
New loans
|
4,800 | |||
|
Repayments
|
(4,447 | ) | ||
|
Balance, December 31, 2010
|
$ | 5,629 |
In previous years, QNB allowed its directors to defer a portion of their compensation. The amount of deferred compensation accrued as of December 31, 2010 and 2009, was $51,000 and $85,000, respectively.
Financial instruments with off-balance-sheet risk:
In the normal course of business there are various legal proceedings, commitments, and contingent liabilities which are not reflected in the financial statements. Management does not anticipate any material losses as a result of these transactions and activities. They include, among other things, commitments to extend credit and standby letters of credit. Outstanding standby letters of credit amounted to $13,519,000 and $14,071,000, and commitments to extend credit and unused lines of credit totaled $103,012,000 and $99,119,000 at December 31, 2010 and 2009, respectively. The maximum exposure to credit loss, which represents the possibility of sustaining a loss due to the failure of the other parties to a financial instrument to perform according to the terms of the contract, is represented by the contractual amount of these instruments. QNB uses the same lending standards and policies in making credit commitments as it does for on-balance sheet instruments. The activity is controlled through credit approvals, control limits, and monitoring procedures.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. QNB evaluates each customer’s creditworthiness on a case-by-case basis.
72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. These standby letters of credit expire within three years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending other loan commitments. The Bank requires collateral and personal guarantees supporting these letters of credit as deemed necessary. Management believes that the proceeds obtained through a liquidation of such collateral and the enforcement of personal guarantees would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees. The amount of the liability as of December 31, 2010 and 2009 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.
QNB has committed to various operating leases for several of their branch and office facilities. Some of these leases include renewal options as well as specific provisions relating to rent increases. The minimum annual rental commitments under these leases outstanding at December 31, 2010 are as follows:
|
Minimum Lease Payments
|
||||
|
2011
|
$ | 417 | ||
|
2012
|
408 | |||
|
2013
|
368 | |||
|
2014
|
346 | |||
|
2015
|
343 | |||
|
Thereafter
|
4,557 | |||
The leases contain renewal options to extend the initial terms of the lease from one to ten years. With the exception of the renewals for a land lease related to a permanent branch site, the commitment for such renewals is not included above. Rent expense under leases for the years ended December 31, 2010 and 2009, was $525,000 and $426,000, respectively.
The components of comprehensive income are as follows:
|
Year Ended December 31,
|
2010
|
2009
|
||||||
|
Unrealized holding (losses) gains arising during the period on available-for-sale securities
|
$ | (280 | ) | $ | 2,510 | |||
|
Reclassification adjustment for gains included in net income
|
(309 | ) | (1,069 | ) | ||||
|
Reclassification adjustment for OTTI losses included in net income
|
310 | 1,523 | ||||||
|
Net unrealized (losses) gains on available-for-sale securities
|
(279 | ) | 2,964 | |||||
|
Tax effect
|
95 | (1,008 | ) | |||||
|
Other comprehensive (loss) income, net of tax
|
(184 | ) | 1,956 | |||||
|
Net income
|
7,217 | 4,227 | ||||||
|
Total comprehensive income
|
$ | 7,033 | $ | 6,183 | ||||
The components of accumulated other comprehensive income are as follows:
|
December 31,
|
2010
|
2009
|
||||||
|
Unrealized net holding gains on available-for-sale securities
|
$ | 3,556 | $ | 5,021 | ||||
|
Unrealized losses on available-for-sale securities for which a portion of an other-than-temporary impairment has been recognized in earnings
|
(1,224 | ) | (2,410 | ) | ||||
|
Accumulated other comprehensive income
|
2,332 | 2,611 | ||||||
|
Tax Effect
|
(793 | ) | (888 | ) | ||||
|
Accumulated other comprehensive income, net of tax
|
$ | 1,539 | $ | 1,723 | ||||
Financial Accounting Standards Board (FASB) ASC 820,
Fair Value Measurements and Disclosures
, defines fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (fair values are not adjusted for transaction costs). ASC 820 also establishes a framework (fair value hierarchy) for measuring fair value under GAAP, and expands disclosures about fair value measurements.
ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under this guidance are as follows:
73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|
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.
For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used were as follows:
|
Quoted Prices
|
Significant Other
|
Significant
|
||||||||||||||
|
in Active Markets
|
Observable
|
Unobservable
|
Balance at end
|
|||||||||||||
|
December 31, 2010
|
for Identical Assets (Level 1)
|
Inputs (Level 2)
|
Inputs (Level 3)
|
of Period
|
||||||||||||
|
Securities available-for-sale
|
||||||||||||||||
|
U.S. Government
agencies
|
– | $ | 66,448 | – | $ | 66,448 | ||||||||||
|
State and municipal securities
|
– | 63,588 | – | 63,588 | ||||||||||||
|
U.S. Government agencies and sponsored enterprises (GSEs) - residential
|
||||||||||||||||
|
Mortgage-backed securities
|
– | 78,801 | – | 78,801 | ||||||||||||
|
Collateralized mortgage obligations (CMOs)
|
– | 75,573 | – | 75,573 | ||||||||||||
|
Other debt securities
|
– | 518 | $ | 1,866 | 2,384 | |||||||||||
|
Equity securities
|
$ | 3,770 | – | – | 3,770 | |||||||||||
|
Total
|
$ | 3,770 | $ | 284,928 | $ | 1,866 | $ | 290,564 | ||||||||
74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents a reconciliation of the securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31:
|
Fair Value Measurements Using
|
||||||||
|
Significant Unobservable Inputs
|
||||||||
|
(Level 3)
|
||||||||
|
Securities available-for-sale
|
2010
|
2009
|
||||||
|
Balance, beginning of year
|
$ | 1,008 | 1,963 | |||||
|
Settlements
|
(156 | ) | $ | (19 | ) | |||
|
Total gains or losses (realized/unrealized)
|
||||||||
|
Included in earnings
|
(277 | ) | (1,002 | ) | ||||
|
Included in other comprehensive income
|
1,291 | 66 | ||||||
|
Transfers in and/or out of Level 3
|
– | – | ||||||
|
Balance, end of year
|
$ | 1,866 | $ | 1,008 | ||||
There were no transfers in and out of Level 1 and Level 2 fair value measurements during the year ended December 31, 2010. There were also no transfers in or out of level 3 for the same period. There were $277,000 and $1,002,000 of 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 years ended December 31, 2010 and 2009, respectively.
The Level 3 securities consist of eight collateralized debt obligation securities that are backed by trust preferred securities issued by banks, thrifts, and insurance companies (PreTSLs). The market for these securities at December 31, 2010 is not active and markets for similar securities are also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which PreTSLs trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive as there are 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 December 31, 2010;
|
|
•
|
An income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than the market approach valuation technique used at prior measurement dates; and
|
|
•
|
PreTSLs will be classified within Level 3 of the fair value hierarchy because significant adjustments are required to determine fair value at the measurement date.
|
The Bank is aware of several factors indicating that recent transactions of PreTSL securities are not orderly including an increased spread between bid/ask prices, lower sales transaction volumes for these types of securities, and a lack of new issuances. As a result, the Bank engaged an independent third party to value the securities using a discounted cash flow analysis. The estimated cash flows are based on specific assumptions about defaults, deferrals and prepayments of the trust preferred securities underlying each PreTSL. The resulting collateral cash flows are allocated to the bond waterfall using the INTEX desktop valuation model.
The estimates for the conditional default rates (CDR) are based on the payment characteristics of the trust preferred securities themselves (e.g. current, deferred, or defaulted) as well as the financial condition of the trust preferred issuers in the pool. A near-term CDR for each issuer in the pool is estimated based on their financial condition using key financial ratios relating to the financial institution’s capitalization, asset quality, profitability and liquidity. In addition to the specific bank default assumptions, default rates are modeled to two times historic levels throughout 2012. In 2013 and beyond the CDR rate is calculated based upon individual issuers’ estimated CAMEL rating as projected by VERIBANC®.
The base loss severity assumption is 95%. The severity factor for near-term CDRs is vectored to reflect the relative expected performance of the institutions modeled to default, with lower forecasted severities used for the higher quality institutions. The long-term loss severity is modeled at 95%.
Prepayments are modeled to take into account the disruption in the asset-backed securities marketplace and the lack of new trust preferred issuances. For purposes of the cash flow analysis, relatively modest rates of prepayment were forecasted (ranging from 0-2%). In addition to the base prepayment assumption, due to the recent enactment of the Dodd-Frank financial legislation additional prepayment analysis was performed. First, all fixed rate trust preferred securities issued by banks with more than $15 billion in total assets at December 31, 2009 were identified. Next the holding companies’ approximate cost of long-term funding given their rating and marketplace interest rates were estimated. The following assumption was made; any holding company that could refinance for a cost savings of more than 2% will refinance and will do so on January 1, 2013, or July 1, 2015 for bank holding company subsidiaries of foreign banking organizations that have relied on Supervision and Regulation Letter SR-01-1.
75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The internal rate of return is the pre-tax yield used to discount the best estimate of future cash flows after credit losses. The cash flows have been discounted using estimated market discount rates of 3 month LIBOR plus spreads ranging from 5.10% to 10.10%. The determination of appropriate market discount rates involved the consideration of the following:
|
•
|
the time value of money
|
|
•
|
the price for bearing uncertainty in cash flows
|
|
•
|
other factors that would be considered by market participants
|
The analysis of discount rates involved the review of corporate bond spreads for banks, U.S. Treasury yields, credit default swap rates for financial companies (utilized as a proxy for credit), the swap/LIBOR yield curve and the characteristics of the individual securities being valued.
For assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used are as follows:
|
Quoted Prices
|
Significant Other
|
Significant
|
||||||||||||||
|
in Active Markets
|
Observable
|
Unobservable
|
Balance
|
|||||||||||||
|
for Identical Assets (Level 1)
|
Inputs (Level 2)
|
Inputs (Level 3)
|
End of Year
|
|||||||||||||
|
December 31, 2010
|
||||||||||||||||
|
Mortgage Servicing Rights
|
– | – | $ | 504 | $ | 504 | ||||||||||
|
Impaired Loans
|
– | – | 6,014 | 6,014 | ||||||||||||
|
December 31, 2009
|
||||||||||||||||
|
Mortgage Servicing Rights
|
– | – | 519 | 519 | ||||||||||||
|
Impaired Loans
|
– | – | 549 | 549 | ||||||||||||
|
Foreclosed Assets
|
– | – | 67 | 67 | ||||||||||||
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 instruments at December 31, 2010 and 2009:
Cash and due from banks, Federal funds sold, 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:
The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) 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. 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. Internal cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) were used to support fair values of certain Level 3 investments.
Restricted investment in bank stocks (Carried at Cost):
The fair value of stock in Atlantic Central Bankers Bank and the Federal Home Loan Bank is the carrying amount, based on redemption provisions, and considers the limited marketability of such securities.
Loans Held for Sale (Carried at Lower of Cost or Fair Value):
The fair value of loans held for sale is determined, when possible, using quoted secondary-market prices. If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan.
Loans Receivable (Carried at Cost):
The fair values of loans are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.
Impaired Loans (Generally Carried at Fair Value):
Impaired loans are those that are accounted for under the accounting guidance of ASC 310-10-35-16, in which the Bank 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. At December 31, 2010 the fair value consists of the loan balances of $8,295,000, net of a valuation allowance of $2,281,000. At December 31, 2009 the fair value consists of loan balances of $1,077,000, net of a valuation allowance of $528,000.
76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. After stratifying the rights 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. QNB is able to compare the valuation model inputs and results to widely available published industry data for reasonableness.
During 2010, mortgage servicing rights, which are carried at lower of cost or fair value, were written down to fair value resulting in a charge to earnings to record a valuation allowance of $6,000. During 2009, as a result of a recovery in the fair value of mortgage servicing rights, $28,000 of the valuation allowance was reversed and recognized in earnings during the period.
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.
Long-term debt (Carried at Cost):
The fair values of FHLB advances and securities sold under agreements to repurchase are estimated using discounted cash flow analysis, based on quoted prices for new long-term debt with similar credit risk characteristics, terms and remaining time to maturity. These prices obtained from this active market represent a fair value that is deemed to represent the transfer price if the liability were assumed by a third party.
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.
The estimated fair values and carrying amounts are summarized as follows:
|
December 31,
|
2010
|
2009
|
||||||||||||||
|
Carrying Amount
|
Estimated Fair Value
|
Carrying Amount
|
Estimated Fair Value
|
|||||||||||||
|
Financial Assets
|
||||||||||||||||
|
Cash and due from banks
|
$ | 14,912 | $ | 14,912 | $ | 30,999 | $ | 30,999 | ||||||||
|
Investment securities available-for-sale
|
290,564 | 290,564 | 256,862 | 256,862 | ||||||||||||
|
Investment securities held-to-maturity
|
2,667 | 2,729 | 3,347 | 3,471 | ||||||||||||
|
Restricted investment in bank stocks
|
2,176 | 2,176 | 2,291 | 2,291 | ||||||||||||
|
Loans held-for-sale
|
228 | 228 | 534 | 537 | ||||||||||||
|
Net loans
|
473,227 | 458,040 | 443,204 | 423,036 | ||||||||||||
|
Mortgage servicing rights
|
504 | 620 | 519 | 637 | ||||||||||||
|
Accrued interest receivable
|
2,988 | 2,988 | 2,848 | 2,848 | ||||||||||||
|
Financial Liabilities
|
||||||||||||||||
|
Deposits with no stated maturities
|
$ | 384,745 | $ | 384,745 | $ | 313,007 | $ | 313,007 | ||||||||
|
Deposits with stated maturities
|
310,232 | 312,016 | 321,096 | 323,437 | ||||||||||||
|
Short-term borrowings
|
29,786 | 29,786 | 28,433 | 28,433 | ||||||||||||
|
Long-term debt
|
20,308 | 21,666 | 35,000 | 36,559 | ||||||||||||
|
Accrued interest payable
|
1,089 | 1,089 | 1,565 | 1,565 | ||||||||||||
The estimated fair value of QNB’s off-balance sheet financial instruments is as follows:
|
December 31,
|
2010
|
2009
|
||||||||||||||
|
Notional Amount
|
Fair Value
|
Notional Amount
|
Fair Value
|
|||||||||||||
|
Commitments to extend credit
|
$ | 103,012 | – | $ | 99,119 | – | ||||||||||
|
Standby letters of credit
|
13,519 | – | 14,071 | – | ||||||||||||
77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Condensed financial statements of QNB Corp. only:
Balance Sheets
78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Statements of Cash Flows
|
Year Ended December 31,
|
2010
|
2009
|
||||||
|
Operating Activities
|
||||||||
|
Net income
|
$ | 7,217 | $ | 4,227 | ||||
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
||||||||
|
Equity in undistributed income from subsidiary
|
(4,627 | ) | (1,033 | ) | ||||
|
Net securities (gains)/losses
|
(254 | ) | 112 | |||||
|
Stock-based compensation expense
|
51 | 58 | ||||||
|
Decrease (increase) in other assets
|
554 | (752 | ) | |||||
|
(Decrease) increase in other liabilities
|
(246 | ) | 646 | |||||
|
Deferred income tax provision
|
86 | 13 | ||||||
|
Net cash provided by operating activities
|
2,781 | 3,271 | ||||||
|
Investing Activities
|
||||||||
|
Purchase of investment securities
|
(1,067 | ) | (1,183 | ) | ||||
|
Proceeds from sale of investment securities
|
1,083 | 1,625 | ||||||
|
Net cash provided by investing activities
|
16 | 442 | ||||||
|
Financing Activities
|
||||||||
|
Repayment of advances from subsidiaries
|
(400 | ) | – | |||||
|
Cash dividends paid
|
(2,821 | ) | (2,972 | ) | ||||
|
Purchase of treasury stock
|
– | (866 | ) | |||||
|
Proceeds from issuance of common stock
|
398 | 104 | ||||||
|
Tax benefit from exercise of stock options
|
3 | 10 | ||||||
|
Net cash used by financing activities
|
(2,820 | ) | (3,724 | ) | ||||
|
Decrease in cash and cash equivalents
|
(23 | ) | (11 | ) | ||||
|
Cash and cash equivalents at beginning of year
|
27 | 38 | ||||||
|
Cash and cash equivalents at end of year
|
$ | 4 | $ | 27 | ||||
Dividends payable by the Company and the Bank are subject to various limitations imposed by statutes, regulations and policies adopted by bank regulatory agencies. Under Pennsylvania banking law, the Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. Under Federal Reserve regulations, the Bank is limited as to the amount it may lend affiliates, including the Company, unless such loans are collateralized by specific obligations.
Both the Company and the Bank are subject to regulatory capital requirements administered by Federal banking agencies. Failure to meet minimum capital requirements can initiate actions by regulators that could have an effect on the financial statements. Under the framework for prompt corrective action, both the Company and the Bank must meet capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items. The capital amounts and classification are also subject to qualitative judgments by the regulators. Management believes, as of December 31, 2010, 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 set forth in the 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 December 31, 2010
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||||||||||
|
Total risk-based capital (to risk weighted assets):
1
|
||||||||||||||||||||||||
|
Consolidated
|
$ | 66,932 | 11.82 | % | $ | 45,289 | 8.00 | % | N/A | N/A | ||||||||||||||
|
Bank
|
62,901 | 11.18 | 44,995 | 8.00 | $ | 56,243 | 10.00 | % | ||||||||||||||||
|
Tier I capital (to risk weighted assets):
1
|
||||||||||||||||||||||||
|
Consolidated
|
59,551 | 10.52 | 22,644 | 4.00 | N/A | N/A | ||||||||||||||||||
|
Bank
|
55,847 | 9.93 | 22,497 | 4.00 | 33,746 | 6.00 | ||||||||||||||||||
|
Tier I capital (to average assets):
|
||||||||||||||||||||||||
|
Consolidated
|
59,551 | 7.42 | 32,086 | 4.00 | N/A | N/A | ||||||||||||||||||
|
Bank
|
55,847 | 6.99 | 31,947 | 4.00 | 39,934 | 5.00 | ||||||||||||||||||
79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|
Capital Levels
|
||||||||||||||||||||||||
|
Actual
|
Adequately Capitalized
|
Well Capitalized
|
||||||||||||||||||||||
|
As of December 31, 2009
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||||||||||
|
Total risk-based capital (to risk weighted assets):
1
|
||||||||||||||||||||||||
|
Consolidated
|
$ | 61,168 | 11.51 | % | $ | 42,504 | 8.00 | % | N/A | N/A | ||||||||||||||
|
Bank
|
57,436 | 10.89 | 42,212 | 8.00 | $ | 52,765 | 10.00 | % | ||||||||||||||||
|
Tier I capital (to risk weighted assets):
1
|
||||||||||||||||||||||||
|
Consolidated
|
54,703 | 10.30 | 21,252 | 4.00 | N/A | N/A | ||||||||||||||||||
|
Bank
|
51,219 | 9.71 | 21,106 | 4.00 | 31,659 | 6.00 | % | |||||||||||||||||
|
Tier I capital (to average assets):
1
|
||||||||||||||||||||||||
|
Consolidated
|
54,703 | 7.34 | 29,822 | 4.00 | N/A | N/A | ||||||||||||||||||
|
Bank
|
51,219 | 6.90 | 29,679 | 4.00 | 37,099 | 5.00 | % | |||||||||||||||||
1
As defined by the regulators
The unaudited quarterly results of operations for the years ended 2010 and 2009 are in the following table:
|
Quarters Ended 2010
|
Quarters Ended 2009
|
|||||||||||||||||||||||||||||||
|
March 31
|
June 30
|
Sept. 30
|
Dec. 31
|
March 31
|
June 30
|
Sept. 30
|
Dec. 31
|
|||||||||||||||||||||||||
|
Interest income
|
$ | 8,828 | $ | 9,049 | $ | 9,117 | $ | 9,189 | $ | 8,626 | $ | 8,859 | $ | 8,946 | $ | 8,937 | ||||||||||||||||
|
Interest expense
|
2,804 | 2,614 | 2,476 | 2,376 | 3,545 | 3,539 | 3,419 | 3,164 | ||||||||||||||||||||||||
|
Net interest income
|
6,024 | 6,435 | 6,641 | 6,813 | 5,081 | 5,320 | 5,527 | 5,773 | ||||||||||||||||||||||||
|
Provision for loan losses
|
700 | 700 | 1,200 | 1,200 | 600 | 500 | 1,500 | 1,550 | ||||||||||||||||||||||||
|
Non-interest income
|
1,132 | 1,027 | 1,004 | 1,176 | 733 | 1,067 | 514 | 1,571 | ||||||||||||||||||||||||
|
Non-interest expense
|
4,118 | 4,241 | 4,478 | 4,564 | 3,929 | 4,384 | 3,926 | 4,347 | ||||||||||||||||||||||||
|
Income before income taxes
|
2,338 | 2,521 | 1,967 | 2,225 | 1,285 | 1,503 | 615 | 1,447 | ||||||||||||||||||||||||
|
Provision (benefit) for income taxes
|
512 | 558 | 349 | 415 | 191 | 276 | (56 | ) | 212 | |||||||||||||||||||||||
|
Net Income
|
$ | 1,826 | $ | 1,963 | $ | 1,618 | $ | 1,810 | $ | 1,094 | $ | 1,227 | $ | 671 | $ | 1,235 | ||||||||||||||||
|
Earnings Per Share - basic
|
$ | 0.59 | $ | 0.63 | $ | 0.52 | $ | 0.58 | $ | 0.35 | $ | 0.40 | $ | 0.22 | $ | 0.40 | ||||||||||||||||
|
Earnings Per Share - diluted
|
$ | 0.59 | $ | 0.63 | $ | 0.52 | $ | 0.58 | $ | 0.35 | $ | 0.40 | $ | 0.22 | $ | 0.40 | ||||||||||||||||
80
|
ITEM 9.
|
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|
(a) None.
(b) None.
|
ITEM 9A.
|
CONTROLS AND PROCEDURES
|
The Company’s management, with the participation of the Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of December 31, 2010. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer conclude that the Company’s disclosure controls and procedures are effective as of such date.
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) promulgated under the Exchange Act. The Company’s management, with the participation of the Company’s principal executive officer and principal financial officer, has evaluated the effectiveness of our internal control over financial reporting based on the framework in
Internal Control—Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in
Internal Control—Integrated Framework
, the Company’s management concluded that our internal control over financial reporting was effective as of December 31, 2010.
There have been no changes in the Company’s internal control over financial reporting during the fourth quarter of 2010 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
(a) Management’s Report on Internal Control Over Financial Reporting
Management is responsible for the preparation, integrity, and fair presentation of the consolidated financial statements included in this annual report. The consolidated financial statements and notes included in this annual report have been prepared in conformity with U.S. generally accepted accounting principles, and as such, include some amounts that are based on management’s best estimates and judgments.
The Company’s management is responsible for establishing and maintaining effective internal control over financial reporting. The system of internal control over financial reporting, as it relates to the financial statements, is evaluated for effectiveness by management and tested for reliability through a program of internal audits and management testing and review. Actions are taken to correct potential deficiencies as they are identified. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only a reasonable assurance with respect to financial statement preparation.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in
Internal Control — Integrated Framework.
Based on our assessment, management concluded that, as of December 31, 2010, the Company’s internal control over financial reporting is effective and meets the criteria of the
Internal Control — Integrated Framework.
This annual report does not include an attestation report of the Company’s registered independent public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered independent public accounting firm pursuant to the provisions of the Dodd-Frank Act that permits the Company, as a smaller reporting company, to provide only management’s report in this annual report.
|
/s/ Thomas J. Bisko
|
/s/ Bret H. Krevolin
|
|
|
Thomas J. Bisko
|
Bret H. Krevolin
|
|
|
Chief Executive Officer
|
|
Chief Financial Officer
|
March 30, 2011
None.
81
|
ITEM 10.
|
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
|
The information required by Item 10 is incorporated by reference to information appearing in QNB Corp.’s definitive proxy statement to be used in connection with the 2011 Annual Meeting of Shareholders under the captions
• “Election of Directors”
• “Governance of the Company - Code of Ethics”
• “Section 16(a) Beneficial Ownership Compliance”
• “Meetings and Committees of the Board of Directors of QNB and the Bank”
• “Executive Officers of QNB and/or the Bank”
The Company has adopted a Code of Business Conduct and Ethics applicable to its CEO, CFO and Controller as well as its long-standing Code of Ethics which applies to all directors and employees. The codes are available on the Company’s website at www.qnb.com.
|
ITEM 11.
|
E
XECUTIVE COMPENSATION
|
The information required by Item 11 is incorporated by reference to the information appearing in QNB Corp.’s definitive proxy statement to be used in connection with the 2011 Annual Meeting of Shareholders under the captions
• “Compensation Committee Report”
• “Executive Compensation”
• “Director Compensation”
• “Compensation Tables”
|
ITEM 12.
|
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
|
Equity Compensation Plan Information
The following table summarizes QNB’s equity compensation plan information as of December 31, 2010. Information is included for both equity compensation plans approved by QNB shareholders and equity compensation plans not approved by QNB shareholders.
| Number of shares | ||||||||||||
|
Number of shares
|
Weighted-average
|
available for future
|
||||||||||
|
to be issued upon
|
exercise price of
|
issuance under equity
|
||||||||||
|
exercise of
|
outstanding
|
compensation plans
|
||||||||||
|
outstanding options,
|
options, warrants
|
[excluding securities
|
||||||||||
|
Plan Category
|
warrants and rights
|
and rights
|
||||||||||
|
(a)
|
(b)
|
(c)
|
||||||||||
|
Equity compensation plans approved by QNB shareholders
|
||||||||||||
|
1998 Stock Option Plan
|
109,640 | $ | 22.20 | – | ||||||||
|
2005 Stock Option Plan
|
60,875 | 20.53 | 116,300 | |||||||||
|
2006 Employee Stock Purchase Plan
|
– | – | 2,380 | |||||||||
|
Equity compensation plans not approved by QNB shareholders
|
||||||||||||
|
None
|
– | – | – | |||||||||
|
Totals
|
170,515 | $ | 21.60 | 118,680 | ||||||||
Additional information required by Item 12 is incorporated by reference to the information appearing in QNB Corp.’s definitive proxy statement to be used in connection with the 2011 Annual Meeting of Shareholders under the captions
• “Security Ownership of Certain Beneficial Owners and Management”
82
|
ITEM 13.
|
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS, AND DIRECTOR INDEPENDENCE
|
The information required by Item 13 is incorporated by reference to the information appearing in QNB Corp.’s definitive proxy statement to be used in connection with the 2011 Annual Meeting of Shareholders under the captions
• “Certain Relationships and Related Party Transactions”
• “Governance of the Company - Director Independence”
|
ITEM 14.
|
PRINCIPAL ACCOUNTANT FEES AND SERVICES
|
The information required by Item 14 is incorporated by reference to the information appearing in QNB Corp.’s definitive proxy statement to be used in connection with the 2011 Annual Meeting of Shareholders under the captions
• “Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditors”
• “Audit Fees, Audit Related Fees, Tax Fees, and All Other Fees”
|
ITEM 15.
|
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
|
|
(a)
|
1. Financial Statements
|
|
|
The following financial statements are included by reference in Part II, Item 8 hereof.
|
||
|
Report of Independent Registered Public Accounting Firm
|
||
|
Consolidated Balance Sheets
|
||
|
Consolidated Statements of Income
|
||
|
Consolidated Statements of Shareholders’ Equity
|
||
|
Consolidated Statements of Cash Flows
|
||
|
Notes to Consolidated Financial Statements
|
||
|
2. Financial Statement Schedules
|
||
|
The financial statement schedules required by this Item are omitted because the information is either inapplicable, not required or is in the consolidated financial statements as a part of this Report.
|
||
|
3. The following exhibits are incorporated by reference herein or annexed to this Form 10-K:
|
||
|
3(i)-
|
||
|
3(ii)-
|
By-laws of Registrant, as amended. (Incorporated by reference to Exhibit 3(ii) of Registrant’s Current Report on Form 8-K, SEC File No. 0-17706, filed with the Commission on January 23, 2006.)
|
|
|
10.1-
|
Employment Agreement between the Registrant and Thomas J. Bisko. (Incorporated by reference to Exhibit 10.1 of Registrant’s Quarterly report on Form 10-Q, SEC File No. 0-17706, filed with the Commission on November 15, 2004.)
|
|
|
10.2-
|
Salary Continuation Agreement between the Registrant and Thomas J. Bisko. (Incorporated by reference to Exhibit 10.2 of Registrant’s Quarterly report on Form 10-Q, SEC File No. 0-17706, filed with the Commission on November 15, 2004.)
|
|
|
10.3-
|
QNB Corp. 1998 Stock Incentive Plan. (Incorporated by reference to Exhibit 4.3 to Registration Statement No. 333-91201 on Form S-8, filed with the Commission on November 18, 1999.)
|
|
|
10.4-
|
The Quakertown National Bank Retirement Savings Plan. (Incorporated by reference to Exhibit 10.4 of Registrant’s Quarterly report on Form 10-Q, SEC File No. 0-17706, filed with the Commission on August 14, 2003.)
|
|
|
10.5-
|
Change of Control Agreement between Registrant and Bret H. Krevolin. (Incorporated by reference to Exhibit 10.6 of Registrant’s Quarterly
report on Form 10-Q, SEC File No. 0-17706, filed with the Commission on November 8, 2005.)
|
|
83
|
10.6-
|
Employment Agreement between Registrant and David W. Freeman. (Incorporated by reference to Exhibit 10.1 of Registrant’s Current Report on Form 8-K, SEC File No. 0-17706, filed with the Commission on September 13, 2010.)
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10.7-
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QNB Corp. 2005 Stock Incentive Plan (Incorporated by reference to Exhibit 99.1 to Registration Statement No. 333-125998 on Form S-8, filed with the Commission on June 21, 2005).
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10.8-
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QNB Corp. 2006 Employee Stock Purchase Plan (Incorporated by reference to Exhibit 99.1 to Registration Statement No. 333-135408 on Form S-8, filed with the Commission on June 28, 2006).
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10.9-
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Separation Agreement between Registrant and Robert C. Werner (Incorporated by reference to Exhibit 10.1 of Registrant’s Current Report on Form 8-K, SEC File No. 0-17706, filed with the Commission on December 23, 2009.)
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10.10-
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Separation Agreement between Registrant and Mary Ann Smith (Incorporated by reference to Exhibit 10.1 of Registrant’s Current Report on Form 8-K, SEC File No. 0-17706, filed with the Commission on August 26, 2010.)
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21-
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Subsidiaries of the Registrant.
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23.1-
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Consent of Independent Registered Public Accounting Firm
|
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31.1-
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Section 302 Certification of the Chief Executive Officer.
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31.2-
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Section 302 Certification of the Chief Financial Officer.
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32.1-
|
Section 906 Certification of the Chief Executive Officer.
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32.2-
|
Section 906 Certification of the Chief Financial Officer.
|
84
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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QNB Corp.
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||
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March 30, 2011
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||
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BY:
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/s/ Thomas J. Bisko
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Thomas J. Bisko
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||
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Chief Executive Officer
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||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report is signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
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/s/ Thomas J. Bisko
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Chief Executive Officer,
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March 30, 2011
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||
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Thomas J. Bisko
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Principal Executive
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|||
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Officer and Director
|
||||
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/s/ Bret H. Krevolin
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Chief Financial Officer
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March 30, 2011
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||
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Bret H. Krevolin
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and Principal Financial and
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Accounting Officer
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||||
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/s/ Kenneth F. Brown, Jr.
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Director
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March 30, 2011
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||
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Kenneth F. Brown, Jr.
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||||
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/s/ Dennis Helf
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Director, Chairman
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March 30, 2011
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||
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Dennis Helf
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||||
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/s/ G. Arden Link
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Director
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March 30, 2011
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||
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G. Arden Link
|
||||
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/s/ Charles M. Meredith, III
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Director
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March 30, 2011
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||
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Charles M. Meredith, III
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||||
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/s/ Anna Mae Papso
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Director
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March 30, 2011
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||
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Anna Mae Papso
|
||||
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/s/ Gary S. Parzych
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Director
|
March 30, 2011
|
||
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Gary S. Parzych
|
||||
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/s/ Bonnie L. Rankin
|
Director
|
March 30, 2011
|
||
|
Bonnie L. Rankin
|
||||
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/s/ Henry L. Rosenberger
|
Director
|
March 30, 2011
|
||
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Henry L. Rosenberger
|
||||
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/s/ Edgar L. Stauffer
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Director
|
March 30, 2011
|
||
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Edgar L. Stauffer
|
|
|
85
QNB CORP.
FORM 10-K
FOR YEAR ENDED DECEMBER 31, 2010
EXHIBIT INDEX
|
Exhibit
|
||
|
3(i)-
|
Articles of Incorporation of Registrant, as amended. (Incorporated by reference to Exhibit 3(i) of Registrant’s proxy statement on Schedule
14-A, SEC File No. 0-17706, filed with the Commission on April 15, 2005.)
|
|
|
3(ii)-
|
By-laws of Registrant, as amended. (Incorporated by reference to Exhibit 3(ii) of Registrant’s Current Report on Form 8-K, SEC File No. 0-17706, filed with the Commission on January 23, 2006.)
|
|
|
10.1-
|
Employment Agreement between the Registrant and Thomas J. Bisko. (Incorporated by reference to Exhibit 10.1 of Registrant’s Quarterly
Report on Form 10-Q, SEC File No. 0-17706, filed with the Commission on November 15, 2004.)
|
|
|
10.2-
|
Salary Continuation Agreement between the Registrant and Thomas J. Bisko. (Incorporated by reference to Exhibit 10.2 of Registrant’s Quarterly Report on Form 10-Q, SEC File No. 0-17706, filed with the Commission on November 15, 2004.)
|
|
|
10.3-
|
QNB Corp. 1998 Stock Incentive Plan. (Incorporated by reference to Exhibit 4.3 to Registration Statement No. 333-91201 on Form S-8, filed with the Commission on November 18, 1999.)
|
|
|
10.4-
|
The Quakertown National Bank Retirement Savings Plan. (Incorporated by reference to Exhibit 10.4 of Registrants Quarterly Report on Form 10-Q, SEC File No. 0-17706, filed with the Commission on August 14, 2003)
|
|
|
10.5-
|
Change of Control Agreement between Registrant and Bret H. Krevolin. (Incorporated by reference to Exhibit 10.6 of Registrant’s Quarterly Report on Form 10-Q, SEC File No. 0-17706, filed with the Commission on November 8, 2005.)
|
|
|
10.6-
|
Employment Agreement between Registrant and David W. Freeman. (Incorporated by reference to Exhibit 10.1 of Registrant’s Current Report on Form 8-K, SEC File No. 0-17706, filed with the Commission on September 13, 2010.)
|
|
|
10.7-
|
QNB Corp. 2005 Stock Incentive Plan (Incorporated by reference to Exhibit 99.1 to Registration Statement No. 333-125998 on Form S-8, filed with the Commission on June 21, 2005).
|
|
|
10.8-
|
QNB Corp. 2006 Employee Stock Purchase Plan (Incorporated by reference to Exhibit 99.1 to Registration Statement No. 333-135408 on Form S-8, filed with the Commission on June 28, 2006).
|
|
|
10.9-
|
Separation Agreement between Registrant and Robert C. Werner (Incorporated by reference to Exhibit 10.1 of Registrant’s Current Report on Form 8-K, SEC File No. 0-17706, filed with the Commission on December 23, 2009.)
|
|
|
10.10 -
|
Separation Agreement between Registrant and Mary Ann Smith (Incorporated by reference to Exhibit 10.1 of Registrant’s Current Report on Form 8-K, SEC File No. 0-17706, filed with the Commission on August 26, 2010.)
|
|
|
21-
|
Subsidiaries of the Registrant.
|
|
|
23.1-
|
Consent of Independent Registered Public Accounting Firm
|
|
|
31.1-
|
Section 302 Certification of the Chief Executive Officer.
|
|
|
31.2-
|
Section 302 Certification of the Chief Financial Officer.
|
|
|
32.1-
|
Section 906 Certification of the Chief Executive Officer.
|
|
|
32.2-
|
86
TABLE OF CONTENTS
Part IItem 1. BusinessItem 1A. Risk FactorsItem 1B. Unresolved Staff CommentsItem 2. PropertiesItem 3. Legal ProceedingsItem 4. [removed and Reserved]Part IIItem 5. Market For The Registrant S Common Equity, Related Stockholder Matters and Issuer Purchases Of Equity SecuritiesItem 6. Selected Financial Data (in Thousands, Except Share and Per Share Data)Item 7. Management S Discussion and Analysis Of Financial Condition and Results Of OperationsItem 7A. Quantitative and Qualitative Disclosures About Market RiskItem 8. Financial Statements and Supplementary DataNote 1 - Summary Of Significant Accounting PoliciesNote 2 - Earnings Per Share and Share Repurchase PlanNote 3 - Cash and Cash EquivalentsNote 4 - Investment Securities Available-for-saleNote 5 - Loans Receivable and The Allowance For Loan LossesNote 6 - Premises and EquipmentNote 7 - Intangible Assets and ServicingNote 8 - Time DepositsNote 9 - Short-term BorrowingsNote 10 - Long-term DebtNote 11 - Income TaxesNote 12 - Employee Benefit PlansNote 13 - Stock Option PlanNote 14 - Related Party TransactionsNote 15 - Commitments and ContingenciesNote 16 - Comprehensive IncomeNote 17 - Fair Value Measurements and Fair Values Of Financial InstrumentsNote 18 - Parent Company Financial InformationNote 19 - Regulatory RestrictionsNote 20 - Consolidated Quarterly Financial Data (unaudited)Item 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureItem 9A. Controls and ProceduresItem 9B. Other InformationPart IIIItem 10. Directors, Executive Officers and Corporate GovernanceItem 11. Executive CompensationItem 12. Security Ownership Of Certain Beneficial Owners and Management and Related Stockholder MattersItem 13. Certain Relationships and Related Party Transactions, and Director IndependenceItem 14. Principal Accountant Fees and ServicesPart IVItem 15. Exhibits, Financial Statement Schedules