XOTC:QNBC Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

  

FORM 10-Q

 

(Mark One)

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

 

For the quarterly period ended                                         June 30, 2012                                              

OR

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

 

For the transition period from __________________________   to ___________________

 

Commission file number 0-17706

 

QNB Corp.

 

(Exact Name of Registrant as Specified in Its Charter)

 

Pennsylvania 23-2318082
(State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.)
   
15 North Third Street, P.O. Box 9005 Quakertown, PA 18951-9005
(Address of Principal Executive Offices) (Zip Code)

  

Registrant's Telephone Number, Including Area Code           (215) 538-5600                                

 

Not Applicable

 

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

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

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

 

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

 

Large accelerated filer  ¨ Accelerated filer ¨
Non-accelerated filer    ¨ Smaller Reporting Company x

 

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

 

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

 

Class Outstanding at August 6, 2012
Common Stock, par value $0.625 3,201,606

 

 
 

 

QNB CORP. AND SUBSIDIARY

FORM 10-Q

QUARTER ENDED JUNE 30, 2012

 

INDEX

PART I - FINANCIAL INFORMATION

 

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) PAGE
     
  Consolidated Balance Sheets at June 30, 2012  
  and December 31, 2011 3
     
  Consolidated Statements of Income for the Three and Six  
  Months Ended June 30, 2012 and 2011 4
     
  Consolidated Statements of Comprehensive Income for the Three and Six  
  Months Ended June 30, 2012 and 2011 5
     
  Consolidated Statement of Shareholders’ Equity for the Six  
  Months Ended June 30, 2012 6
     
  Consolidated Statements of Cash Flows for the Six  
  Months Ended June 30, 2012 and 2011 7
     
  Notes to Consolidated Financial Statements 8
     
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL  
  CONDITION AND RESULTS OF OPERATIONS 45
     
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT  
  MARKET RISK 74
     
ITEM 4. CONTROLS AND PROCEDURES 74
     
PART II - OTHER INFORMATION
     
ITEM 1. LEGAL PROCEEDINGS 75
     
ITEM 1A. RISK FACTORS 75
     
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND  
  USE OF PROCEEDS 75
     
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 75
     
ITEM 4. MINE SAFETY DISCLOSURES 75
     
ITEM 5. OTHER INFORMATION 75
     
ITEM 6. EXHIBITS 76
     
SIGNATURES   77
     
CERTIFICATIONS    

- 2 -
 

 

 

QNB Corp. and Subsidiary      
CONSOLIDATED BALANCE SHEETS      

 

   (in thousands, except share data) 
   (unaudited) 
   June 30,   December 31, 
   2012   2011 
Assets          
Cash and due from banks  $12,221   $9,736 
Interest-bearing deposits in banks   8,042    819 
Total cash and cash equivalents   20,263    10,555 
           
Investment securities          
Available-for-sale (amortized cost $351,762 and $341,023)   358,794    348,091 
Held-to-maturity (fair value $312 and $1,365)   287    1,327 
Restricted investment in bank stocks   1,636    1,775 
Loans held-for-sale   589    935 
Total loans, net of unearned fees and costs   491,263    489,936 
Allowance for loan losses   (9,467)   (9,241)
Net loans   481,796    480,695 
Bank-owned life insurance   9,887    9,728 
Premises and equipment, net   8,242    7,604 
Accrued interest receivable   3,007    2,990 
Other assets   5,635    5,104 
Total assets  $890,136   $868,804 
           
Liabilities          
Deposits          
Demand, non-interest bearing  $69,856   $66,850 
Interest-bearing demand   159,476    151,349 
Money market   71,222    79,856 
Savings   195,456    167,633 
Time   181,554    185,785 
Time of $100,000 or more   103,443    99,239 
Total deposits   781,007    750,712 
Short-term borrowings   26,570    24,021 
Long-term debt   5,293    20,299 
Accrued interest payable   509    789 
Other liabilities   2,078    2,142 
Total liabilities   815,457    797,963 
           
Shareholders' Equity          
Common stock, par value $0.625 per share;          
authorized 10,000,000 shares; 3,366,175 shares and 3,338,814          
shares issued; 3,201,606 and 3,174,245 shares outstanding   2,104    2,087 
Surplus   12,205    11,679 
Retained earnings   58,205    54,886 
Accumulated other comprehensive income, net of tax   4,641    4,665 
Treasury stock, at cost; 164,569 shares   (2,476)   (2,476)
Total shareholders' equity   74,679    70,841 
Total liabilities and shareholders' equity  $890,136   $868,804 

 

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

 

- 3 -
 

 

 

QNB Corp. and Subsidiary              
CONSOLIDATED STATEMENTS OF INCOME              

   (in thousands, except share data - unaudited) 
   Three Months   Six Months 
   Ended June 30,   Ended June 30, 
   2012   2011   2012   2011 
Interest Income                    
Interest and fees on loans  $6,163   $6,693   $12,441   $13,407 
Interest and dividends on investment securities:                    
Taxable   1,558    1,819    3,200    3,534 
Tax-exempt   693    666    1,397    1,325 
Interest on interest-bearing balances and other interest income   10    10    19    17 
Total interest income   8,424    9,188    17,057    18,283 
                     
Interest Expense                    
Interest on deposits                    
Interest-bearing demand   159    206    326    396 
Money market   66    84    137    178 
Savings   315    300    630    582 
Time   612    748    1,241    1,584 
Time of $100,000 or more   375    397    749    837 
Interest on short-term borrowings   26    58    53    113 
Interest on long-term debt   95    244    339    485 
Total interest expense   1,648    2,037    3,475    4,175 
Net interest income   6,776    7,151    13,582    14,108 
Provision for loan losses   -    450    300    1,100 
Net interest income after provision for loan losses   6,776    6,701    13,282    13,008 
                     
Non-Interest Income                    
Net gain on sale of investment securities   141    54    530    11 
Fees for services to customers   345    347    684    674 
ATM and debit card   367    366    731    694 
Bank-owned life insurance   78    80    156    190 
Merchant income   101    82    186    144 
Net gain on sale of loans   231    18    458    57 
Other   63    123    147    240 
Total non-interest income   1,326    1,070    2,892    2,010 
                     
Non-Interest Expense                    
Salaries and employee benefits   2,548    2,408    5,174    4,795 
Net occupancy   397    370    821    767 
Furniture and equipment   373    320    703    623 
Marketing   256    206    457    381 
Third party services   365    340    704    588 
Telephone, postage and supplies   156    158    306    306 
State taxes   167    150    327    300 
FDIC insurance premiums   162    276    342    538 
Other   404    356    845    706 
Total non-interest expense   4,828    4,584    9,679    9,004 
Income before income taxes   3,274    3,187    6,495    6,014 
Provision for income taxes   769    752    1,519    1,368 
Net Income  $2,505   $2,435   $4,976   $4,646 
Earnings Per Share - Basic  $0.79   $0.77   $1.56   $1.48 
Earnings Per Share - Diluted  $0.78   $0.77   $1.55   $1.47 
Cash Dividends Per Share  $0.26   $0.25   $0.52   $0.50 

 

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

- 4 -
 

 

 

 

QNB Corp. and Subsidiary                
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME                
   (in thousands, unaudited) 
   Three Months   Six Months 
   Ended June 30,   Ended June 30, 
   2012   2011   2012   2011 
Net income  $2,505   $2,435   $4,976   $4,646 
Other comprehensive income, net of tax:                    
Unrealized holding gains (losses) on securities:                    
Unrealized holding gains arising during the period   261    1,665    326    1,580 
Reclassification adjustment for gains included in net income   (93)   (36)   (350)   (7)
Other comprehensive income (loss), net of tax   168    1,629    (24)   1,573 
Comprehensive income  $2,673   $4,064   $4,952   $6,219 

 

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

 

- 5 -
 

 

 

 

QNB Corp. and Subsidiary
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
 

 

                   Accumulated         
   Number of               other         
(in thousands, except share data)  shares   Common       Retained   comprehensive   Treasury     
(unaudited)  outstanding   stock   Surplus   earnings   income   stock   Total 
Balance, December 31, 2011   3,174,245   $2,087   $11,679   $54,886   $4,665   $(2,476)  $70,841 
Net income        -    -    4,976    -    -    4,976 
Other comprehensive loss, net of tax        -    -    -    (24)   -    (24)
Cash dividends declared ($0.52 per share)        -    -    (1,657)   -    -    (1,657)
Stock issued in connection with dividend                                   
reinvestment and stock purchase plan   18,215    11    411    -    -    -    422 
Stock issued for employee stock purchase plan   2,186    2    41    -    -    -    43 
Stock issued for options exercised   6,960    4    28    -    -    -    32 
Tax benefit of stock options exercised        -    4    -    -    -    4 
Stock-based compensation expense        -    42    -    -    -    42 
Balance, June 30, 2012   3,201,606   $2,104   $12,205   $58,205   $4,641   $(2,476)  $74,679 

 

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

 

- 6 -
 

 

QNB Corp. and Subsidiary      
CONSOLIDATED STATEMENTS OF CASH FLOWS      

 

   (in thousands, unaudited) 
Six months ended June 30,  2012   2011 
Operating Activities          
Net income  $4,976   $4,646 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   472    398 
Provision for loan losses   300    1,100 
Net gains on investment securities available-for-sale   (530)   (11)
Net (gain) loss on sale or disposal of repossessed assets and premises and equipment   (5)   3 
Net gain on sale of loans   (458)   (57)
Proceeds from sales of residential mortgages held-for-sale   11,942    3,081 
Originated of residential mortgages held-for-sale   (11,138)   (3,639)
Income on bank-owned life insurance   (156)   (190)
Stock-based compensation expense   42    29 
Deferred income tax (benefit) expense   (47)   94 
Net increase (decrease) in income taxes payable   70    (91)
Net (increase) decrease in accrued interest receivable   (17)   121 
Amortization of mortgage servicing rights and change in valuation allowance   95    44 
Net amortization (accretion) of premiums and discounts on investment securities   958    623 
Net decrease in accrued interest payable   (280)   (302)
Increase in other assets   (316)   (1)
Decrease in other liabilities   (64)   (248)
Net cash provided by operating activities   5,844    5,600 
Investing Activities          
Proceeds from maturities and calls of investment securities          
available-for-sale   78,563    51,645 
held-to-maturity   1,040    825 
Proceeds from the sale of investment securities          
available-for-sale   15,798    23,434 
Purchases of investment securities          
available-for-sale   (105,528)   (108,838)
Proceeds from redemption of investment in restricted bank stock   139    211 
Net (increase) decrease in loans   (1,933)   5,237 
Redemption of Bank Owned Life Insurance   -    95 
Net purchases of premises and equipment   (1,112)   (378)
Proceeds from sales of repossessed assets   215    117 
Net cash used in investing activities   (12,818)   (27,652)
Financing Activities          
Net increase in non-interest bearing deposits   3,006    10,165 
Net increase in interest-bearing deposits   27,289    14,539 
Net increase in short-term borrowings   2,549    767 
Repayments of long-term debt   (15,006)   (5)
Tax benefit from exercise of stock options   4    23 
Cash dividends paid, net of reinvestment   (1,500)   (1,449)
Proceeds from issuance of common stock   340    282 
Net cash provided by financing activities   16,682    24,322 
Increase in cash and cash equivalents   9,708    2,270 
Cash and cash equivalents at beginning of year   10,555    14,912 
Cash and cash equivalents at end of period  $20,263   $17,182 
Supplemental Cash Flow Disclosures          
Interest paid  $3,755   $4,477 
Income taxes paid   1,490    1,340 
Non-cash transactions          
Transfer of loans to repossessed assets or other real estate owned   532    30 

 

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

 

- 7 -
 

  

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. BASIS OF PRESENTATION

 

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

 

These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in QNB's 2011 Annual Report incorporated in the Form 10-K. Operating results for the three and six month periods ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.

 

The unaudited consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the results of operations for the interim periods and are of a normal and recurring nature. Certain items in the 2011 consolidated financial statements have been reclassified to conform to the 2012 financial statement presentation format.

 

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

 

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

 

The Company has evaluated events and transactions occurring subsequent to the balance sheet date of June 30, 2012, for items that should potentially be recognized or disclosed in these financial statements.

 

 

2. RECENT ACCOUNTING PRONOUNCEMENTS

 

In April 2011, the FASB issued ASU No. 2011-03 Transfers and Servicing (Topic 860) — Reconsideration of Effective Control for Repurchase Agreements. Under the amended guidance, a transferor maintains effective control over transferred financial assets if there is an agreement that both entitles and obligates the transferor to repurchase the financial assets before maturity. In addition, the following requirements must be met: (a) the financial asset to be repurchased or redeemed is the same or substantially the same as those transferred, (b) the agreement is to repurchase or redeem the transferred financial asset before maturity at a fixed or determinable price, and (c) the agreement is entered into contemporaneously with, or in contemplation of the transfer. This guidance is effective prospectively for transactions, or modifications of existing transactions, that occur on or after the first interim or annual period beginning on or after December 15, 2011. The adoption of the guidance did not have a material impact on the Company’s consolidated financial statements.

 

In May 2011, the FASB issued ASU 2011-04 Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU amends FASB ASC Topic 820, Fair Value Measurements, to bring U.S. GAAP for fair value measurements in line with International Accounting Standards. The ASU clarifies existing guidance for items such as: the application of the highest and best use concept to non-financial assets and liabilities; the application of fair value measurement to financial instruments classified in a reporting entity’s stockholders’ equity; and disclosure requirements regarding quantitative information about unobservable inputs used in the fair value measurements of level 3 assets. The ASU also creates an exception to Topic 820 for entities which carry financial instruments within a portfolio or group, under which the entity is now permitted to base the price used for fair valuation upon a price that would be received to sell the net asset position or transfer a net liability position in an orderly transaction. The ASU also allows for the application of premiums and discounts in a fair value measurement if the financial instrument is categorized in level 2 or 3 of the fair value hierarchy. Lastly, the ASU contains new disclosure requirements regarding fair value amounts categorized as level 3 in the fair value hierarchy such as: disclosure of the valuation process used; effects of and relationships between unobservable inputs; usage of nonfinancial assets for purposes other than their highest and best use when that is the basis of the disclosed fair value; and categorization by level of items disclosed at fair value, but not measured at fair value for financial statement purposes. This ASU is effective for the Company for interim and annual periods beginning after December 15, 2011. The adoption of the guidance did not have a material impact on the Company’s consolidated financial statements. The additional disclosures are included in Note 9 of the unaudited financial statements.

 

 

- 8 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

2. RECENT ACCOUNTING PRONOUNCEMENTS (continued)

 

 

In June 2011, the FASB issued ASU 2011-05 Presentation of Comprehensive Income. The provisions of this ASU amend FASB ASC Topic 220, Comprehensive Income, to facilitate the continued alignment of U.S. GAAP with International Accounting Standards. The ASU prohibits the presentation of the components of comprehensive income in the statement of stockholders’ equity. Reporting entities are allowed to present either: a statement of comprehensive income, which reports both net income and other comprehensive income; or separate statements of net income and other comprehensive income. Under previous GAAP, all three presentations were acceptable. Regardless of the presentation selected, the reporting entity is required to present all reclassifications between other comprehensive and net income on the face of the new statement or statements. The provisions of this ASU are effective for the Company for fiscal years and interim periods beginning after December 31, 2011. QNB has included a separate statement of comprehensive income in these unaudited financial statements to address the new required presentation.

 

In December, 2011, the FASB issued ASU 2011-12, Deferral of the Effective Date to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update 2011-05. In response to stakeholder concerns regarding the operational ramifications of the presentation of these reclassifications for current and previous years, the FASB has deferred the implementation date of this provision to allow time for further consideration. The requirement in ASU 2011-05, Presentation of Comprehensive Income, for the presentation of a combined statement of comprehensive income or separate, but consecutive, statements of net income and other comprehensive income is still effective for fiscal years and interim periods beginning after December 15, 2011. The adoption of the guidance did not have a material impact on the Company’s consolidated financial statements.

 

3. STOCK-BASED COMPENSATION AND SHAREHOLDERS’ EQUITY

 

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

 

Stock-based compensation expense was approximately $26,000 and $17,000 for the three months ended June 30, 2012 and 2011, respectively, and $42,000 and $29,000 for the six months ended June 30, 2012 and 2011, respectively. As of June 30, 2012, there was approximately $110,000 of unrecognized compensation cost related to unvested share-based compensation award grants that is expected to be recognized over the next 31 months.

 

Options are granted to certain employees at prices equal to the market value of the stock on the date the options are granted. The 1998 Plan authorized the issuance of 220,500 shares. The time period during which any option is exercisable under the Plan is determined by the Committee but shall not commence before the expiration of six months after the date of grant or continue beyond the expiration of ten years after the date the option is awarded. The granted options vest ratably over a three-year period. As of June 30, 2012, there were 225,058 options granted, 28,444 options forfeited, 135,114 options exercised and 61,500 options outstanding under this Plan. The 1998 Plan expired on March 10, 2008, therefore no further options can be granted under this Plan.

 

The 2005 Plan authorizes the issuance of 200,000 shares. The terms of the 2005 Plan are identical to the 1998 Plan, except options expire five years after the grant date. As of June 30, 2012, there were 123,200 options granted, 41,175 options forfeited and 82,025 options outstanding under this Plan. The 2005 Plan expires March 15, 2015.

 

- 9 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

3. STOCK-BASED COMPENSATION AND SHAREHOLDERS’ EQUITY (continued)

 

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 six months ended June 30:

 

Options granted:  2012   2011 
Risk-free interest rate   0.39%   1.96%
Dividend yield   4.68    5.02 
Volatility   33.81    29.83 
Expected life (years)   5.00    5.00 

 

 

The risk-free interest rate was selected based upon yields of U.S. Treasury issues with a term approximating the expected life of the option being valued. Historical information was the primary basis for the selection of the expected dividend yield, expected volatility and expected lives of the options.

 

The fair market value of options granted in the first six months of 2012 and 2011 was $3.81 and $3.24, respectively.

 

Stock option activity during the six months ended June 30, 2012 is as follows:

 

   Number
of options
   Weighted
average
exercise price
   Weighted
average
remaining
contractual
term (in yrs.)
   Aggregate intrinsic value of in-the-money options 
Outstanding at January 1, 2012   156,275   $21.93           
Exercised   (20,700)   16.13           
Forfeited   (12,050)   25.15           
Granted   20,000    21.35           
Outstanding at June 30, 2012   143,525   $22.41    2.2   $637 
Exercisable at June 30, 2012   86,625   $24.09    1.3   $297 

 

4. SHARE REPURCHASE PLAN

 

The Board of Directors has authorized the repurchase of up to 100,000 shares of its common stock in open market or privately negotiated transactions. The repurchase authorization does not bear a termination date. There were no shares repurchased during the six months ended June 30, 2012. As of June 30, 2012, 57,883 shares were repurchased under this authorization at an average price of $16.97 and a total cost of $982,000.

 

- 10 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

5. EARNINGS PER SHARE

 

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

  

   For the Three Months   For the Six Months 
   Ended June 30,   Ended June 30, 
   2012   2011   2012   2011 
Numerator for basic and diluted earnings per share - net income  $2,505   $2,435   $4,976   $4,646 
Denominator for basic earnings per share - weighted average
   shares outstanding
   3,190,552    3,144,935    3,185,728    3,139,721 
Effect of dilutive securities - employee stock options   17,774    16,826    14,865    13,920 
Denominator for diluted earnings per share - adjusted
   weighted average shares outstanding
   3,208,326    3,161,761    3,200,593    3,153,641 
Earnings per share-basic  $0.79   $0.77   $1.56   $1.48 
Earnings per share-diluted  $0.78   $0.77   $1.55   $1.47 

 

There were 52,300 stock options that were anti-dilutive for both the three and six-month periods ended June 30, 2012. There were 41,850 and 58,850 stock options that were anti-dilutive for the three and six-month periods ended June 30 2011, respectively. These stock options were not included in the above calculation.

 

 

6. COMPREHENSIVE INCOME

 

For QNB, the sole component of other comprehensive income is the unrealized holding gains and losses on available-for-sale investment securities.

 

The following shows the components and activity of comprehensive income during the three months ended June 30, 2012 and 2011:

 

Three months ended June 30, 2012  Pretax   Tax
effect
   After-tax 
Unrealized holding gains arising during the period  $396   $(135)  $261 
Reclassification adjustment for gains included in net income   (141)   48    (93)
Total other comprehensive income  $255   $(87)  $168

 

 

 

Three months ended June 30, 2011  Pretax   Tax
effect
   After-tax 
Unrealized holding gains arising during the period  $2,522   $(857)  $1,665 
Reclassification adjustment for gains included in net income   (54)   18    (36)
Total other comprehensive income  $2,468   $(839)  $1,629 

 

 

- 11 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

6. COMPREHENSIVE INCOME (continued)

 

The following shows the components and activity of comprehensive income during the six months ended June 30, 2012 and 2011:

 

 

Six months ended June 30, 2012  Pretax   Tax
effect
   After-tax 
Unrealized holding gains arising during the period  $494   $(168)  $326 
Reclassification adjustment for gains included in net income   (530)   180    (350)
Total other comprehensive loss  $(36)  $12   $(24)

 

 

 

Six months ended June 30, 2011  Pretax   Tax
effect
   After-tax 
Unrealized holding gains arising during the period  $2,394   $(814)  $1,580 
Reclassification adjustment for gains included in net income   (11)   4    (7)
Total other comprehensive income  $2,383   $(810)  $1,573 

   

7. INVESTMENT SECURITIES

 

The amortized cost and estimated fair values of investment securities available-for-sale at June 30, 2012 and December 31, 2011 were as follows:

 

Available-for-Sale                
June 30, 2012                
       Gross   Gross     
       unrealized   unrealized     
   Fair   holding   holding   Amortized 
   value   gains   losses   cost 
U.S. Government agency securities  $69,740   $643   $12   $69,109 
State and municipal securities   81,592    2,839    118    78,871 
U.S. Government agencies and sponsored enterprises (GSEs) - residential:                    
     Mortgage-backed securities   117,628    3,622    1    114,007 
     Collateralized mortgage obligations (CMOs)   81,368    1,445    60    79,983 
Pooled trust preferred securities   2,015    44    1,638    3,609 
Corporate debt securities   2,503    46    -    2,457 
Equity securities   3,948    402    180    3,726 
    Total investment securities available-for-sale  $358,794   $9,041   $2,009   $351,762 

 

- 12 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

7. INVESTMENT SECURITIES (continued)

 

December 31, 2011                
       Gross   Gross     
       unrealized   unrealized     
   Fair   holding   holding   Amortized 
   value   gains   losses   cost 
U.S. Government agency securities  $68,493   $635   $5   $67,863 
State and municipal securities   78,786    2,861    6    75,931 
U.S. Government agencies and sponsored enterprises (GSEs) - residential:                    
     Mortgage-backed securities   113,243    3,169    16    110,090 
     Collateralized mortgage obligations (CMOs)   79,345    1,577    27    77,795 
Pooled trust preferred securities   1,929    12    1,723    3,640 
Corporate debt securities   2,495    44    4    2,455 
Equity securities   3,800    610    59    3,249 
    Total investment securities available-for-sale  $348,091   $8,908   $1,840   $341,023 

 

The amortized cost and estimated fair value of securities available-for-sale by contractual maturity at June 30, 2012 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 
   Fair value   cost 
Due in one year or less  $15,197   $14,917 
Due after one year through five years   220,792    215,752 
Due after five years through ten years   68,270    66,925 
Due after ten years   50,587    50,442 
Equity securities   3,948    3,726 
Total investment securities available-for-sale  $358,794   $351,762 

 

 

Proceeds from sales of investment securities available-for-sale were $15,798,000 and $23,434,000 for the six months ended June 30, 2012 and 2011, respectively.

 

At June 30, 2012 and December 31, 2011, investment securities available-for-sale totaling $122,720,000 and $158,189,000, respectively, were pledged as collateral for repurchase agreements and deposits of public funds.

 

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

- 13 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

7. INVESTMENT SECURITIES (continued)

  

Six months ended June 30, 2012:                
           Other-than-     
   Gross   Gross   temporary     
   realized   realized   impairment     
   gains   losses   losses   Net gains 
Equity securities  $427    -   $-   $427 
Debt securities   107   $(4)   -    103 
Total  $534   $(4)  $-   $530 

  

Six months ended June 30, 2011:                
           Other-than-     
   Gross   Gross   temporary     
   realized   realized   impairment   Net gains 
   gains   losses   losses   (losses) 
Equity securities  $141    -   $-   $141 
Debt securities   248   $(378)   -    (130)
Total  $389   $(378)  $-   $11 

  

The tax expense applicable to the net realized gains for the six-month periods ended June 30, 2012 and 2011 amounted to $180,000 and $4,000, respectively.

 

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

 

The following table presents a 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, 2012. Credit-impaired debt securities must be presented in two components based upon whether the current period is the first time the debt security was credit-impaired (initial credit impairment) or is not the first time the debt security was credit-impaired (subsequent credit impairments). No credit impairments were recognized in 2012.

 

- 14 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

7. INVESTMENT SECURITIES (continued)

 

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:

 

 

   Three Months
Ended
June 30, 2012
   Six Months
Ended
June 30, 2012
 
Balance, beginning of period  $1,279   $1,279 
Additions:          
     Initial credit impairments   -    - 
     Subsequent credit impairments   -    - 
Balance, end of period  $1,279   $1,279 

 

 

The amortized cost and estimated fair values of investment securities held-to-maturity at June 30, 2012 and December 31, 2011 were as follows:

 

 

Held-To-Maturity                                
   June 30, 2012   December 31, 2011 
       Gross   Gross           Gross   Gross     
       unrealized   unrealized           unrealized   unrealized     
   Amortized   holding   holding   Fair   Amortized   holding   holding   Fair 
   cost   gains   losses   value   cost   gains   losses   value 
State and municipal securities  $287   $25    -   $312   $1,327   $38    -   $1,365 

 

 

The amortized cost and estimated fair value of securities held-to-maturity by contractual maturity at June 30, 2012 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.

  

       Amortized 
   Fair value   cost 
Due in one year or less  $145   $142 
Due after one year through five years   167    145 
Due after five years through ten years   -    - 
Due after ten years   -    - 
Total investment securities held-to-maturity  $312   $287 

 

There were no sales of investment securities classified as held-to-maturity during the six months ended June 30, 2012 or 2011.

 

- 15 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

7. INVESTMENT SECURITIES (continued)

 

The following table indicates the length of time individual securities have been in a continuous unrealized loss position at June 30, 2012 and December 31, 2011:

 

 

June 30, 2012                            
       Less than 12 months   12 months or longer   Total 
   No. of   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   securities   value   losses   value   losses   value   losses 
U.S. Government agency securities   12   $16,004   $12    -    -   $16,004   $12 
State and municipal securities   19    10,004    118    -    -    10,004    118 
Mortgage-backed securities   1    884    1    -    -    884    1 
Collateralized mortgage obligations (CMOs)   13    14,936    60    -    -    14,936    60 
Pooled trust preferred securities   5    -    -   $1,579   $1,638    1,579    1,638 
Equity securities   12    1,242    153    103    27    1,345    180 
Total   62   $43,070   $344   $1,682   $1,665   $44,752   $2,009 

  

December 31, 2011                            
       Less than 12 months   12 months or longer   Total 
   No. of   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   securities   value   losses   value   losses   value   losses 
U.S. Government agency securities   6   $6,995   $5    -    -   $6,995   $5 
State and municipal securities   5    1,772    5   $302   $1    2,074    6 
Mortgage-backed securities   4    7,531    16    -    -    7,531    16 
Collateralized mortgage obligations (CMOs)   6    7,270    27    -    -    7,270    27 
Pooled trust preferred securities   5    -    -    1,495    1,723    1,495    1,723 
Corporate debt securities   2    2,000    4    -    -    2,000    4 
Equity securities   8    490    44    324    15    814    59 
Total   36   $26,058   $101   $2,121   $1,739   $28,179   $1,840 

  

Management evaluates debt securities, which are comprised of U.S. Government agencies, state and municipalities, mortgage-backed securities, CMOs and other issuers, for other-than-temporary impairment and considers the current economic conditions, the length of time and the extent to which the fair value has been less than cost, interest rates and the bond rating of each security. The unrealized losses at June 30, 2012 in U.S. Government securities, state and municipal securities, mortgage-backed securities, and CMOs are primarily the result of interest rate fluctuations. If held to maturity, these bonds will mature at par, and QNB will not realize a loss. The Company has the intent to hold the securities and does not believe it will be required to sell the securities before recovery occurs.

 

QNB holds eight pooled trust preferred securities as of June 30, 2012. These securities have a total amortized cost of $3,609,000 and a fair value of $2,015,000. Five of the eight securities have been in an unrealized loss position for more than twelve months. All of the pooled trust preferred securities are available-for-sale securities and are carried at fair value.

 

- 16 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

7. INVESTMENT SECURITIES (continued)

 

The following table provides additional information related to pooled trust preferred securities (PreTSLs) as of June 30, 2012:

 

 

Deal  Class  Book
value
   Fair
value
   Unreal-
ized gains (losses)
   Realized
OTTI
credit
loss
(YTD 2012)
   Total
Recognized
OTTI
Credit
Loss
   Moody's
/Fitch
ratings
  Current
number of
performing
banks
   Current
number of
performing
insurance
companies
   Actual deferrals and defaults as a % of total collateral   Total performing collateral as a % of outstanding bonds 
PreTSL IV  Mezzanine*  $242   $198   $(44)  $-   $(1)  Caa2/CCC   4    -    27.1%   124.6%
PreTSL V  Mezzanine*   -    -    -    -    (118)  C/D   -    -    100.0    12.1 
PreTSL VI  Mezzanine*   91    104    13    -    (8)  Ca/D   3    -    73.6    51.7 
PreTSL XVII  Mezzanine   752    367    (385)   -    (222)  C/C   29    4    41.8    70.6 
PreTSL XIX  Mezzanine   988    422    (566)   -    -   C/C   35    12    27.6    76.4 
PreTSL XXV  Mezzanine   766    350    (416)   -    (222)  C/C   42    6    34.2    76.9 
PreTSL XXVI  Mezzanine   469    242    (227)   -    (270)  C/C   40    8    29.4    82.4 
PreTSL XXVI  Mezzanine   301    332    31    -    (438)  C/C   40    8    29.4    82.4 
      $3,609   $2,015   $(1,594)  $-   $(1,279)                       

 

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

 

The market for these securities at June 30, 2012 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. 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, the Company has the intent to hold the securities and does not believe it will be required to sell the securities before recovery occurs. As illustrated in the table above, 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 book value and the fair value of the security less any current quarter credit related impairment. For the six months ended June 30, 2012, no other-than-temporary impairment charges representing credit impairment were recognized on our pooled trust preferred collateralized debt obligations. A discounted cash flow analysis provides the best estimate of credit related OTTI for these securities. Additional information related to this analysis follows:

 

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

 

- 17 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

7. INVESTMENT SECURITIES (continued)

 

 

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 0-1%). In addition to the base prepayment assumption, due to the recent enactment of the Dodd-Frank financial legislation additional prepayment analysis was performed. First, trust preferred securities issued by banks with more than $15 billion in total assets at December 31, 2009 were identified. The current credit rating of these institutions was reviewed and it was assumed that any issuer with an investment grade credit rating would prepay their issuance 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. For those institutions rated below investment grade the holding companies’ approximate cost of long-term funding given their rating and marketplace interest rate was estimated. The following assumption was made; any holding company that could refinance for a cost savings of more than 2% will refinance and will do so on January 1, 2013, or July 1, 2015. Finally, for issuers not impacted by the Tier 1 regulatory capital legislation enacted by the Dodd-Frank act, we identified the issuers that have shown a recent history of prepayment of both floating rate and fixed rate issues and assumed these issuers will prepay as soon as possible.

 

·Credit Analysis – A quarterly credit evaluation is performed for the companies comprising the collateral across the various pooled trust preferred securities. This credit evaluation considers 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 for 2013 and beyond the rate used is calculated based on using the above mentioned thirty-six basis points and factoring that number based on a comparison of key financial ratios of active individual issuers without a short-term probability of default compared to all FDIC insured banks.

 

·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 2013 and thereafter.

 

In addition to the above factors, the evaluation of impairment also includes a stress test analysis which provides an estimate of future risk 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 the asset quality in those pools can be monitored more closely for potential deterioration of credit quality.

 

- 18 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

7. INVESTMENT SECURITIES (continued)

 

Based upon the analysis performed by management as of June 30, 2012, it is probable that we will collect all contractual principal and interest payments on two of our eight pooled trust preferred securities, PreTSL XIX and PreTSL VI (which was paid off entirely in July 2012). The expected principal shortfall on the remaining pooled trust preferred securities has resulted in credit related other-than-temporary impairment charges in previous years. All of these pooled trust preferred securities held by QNB could be subject to additional writedowns in the future if additional deferrals and defaults occur.

  

8. LOANS & ALLOWANCE FOR LOAN LOSSES

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are stated at the principal amount outstanding, net of deferred loan fees and costs. Interest income is accrued on the principal amount outstanding. Loan origination and commitment fees and related direct costs are deferred and amortized to income over the term of the respective loan and loan commitment period as a yield adjustment.

 

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

 

QNB maintains an allowance for loan losses, which is intended to absorb probable known and inherent losses in the outstanding loan portfolio. The allowance is reduced by actual credit losses and is increased by the provision for loan losses and recoveries of previous losses. The provisions for loan losses are charged to earnings to bring the total allowance for loan losses to a level considered necessary by management.

 

The allowance for loan losses is based on management’s continuing review and evaluation of the loan portfolio. The level of the allowance is determined by assigning specific reserves to individually identified problem credits and general reserves to all other loans. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value) of the impaired loan is lower than the carrying value of that loan. The portion of the allowance that is allocated to internally criticized and non-accrual loans is determined by estimating the inherent loss on each credit after giving consideration to the value of underlying collateral. The general component covers pools of loans by loan class including commercial loans not considered impaired, as well as smaller balance homogeneous loans, such as residential real estate, home equity and other consumer loans. These pools of loans are evaluated for loss exposure based upon historical loss rates. These loss rates are based on a three year history of charge-offs and are more heavily weighted for recent experience for each of these categories of loans, adjusted for qualitative factors. These qualitative risk factors include:

 

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

 

- 19 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)

 

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

 

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

 

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

 

Management believes that it uses the best information available to make determinations about the adequacy of the allowance and that it has established its existing allowance for loan losses in accordance with GAAP. If circumstances differ substantially from the assumptions used in making determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be affected. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that increases to the allowance will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above.

 

Major classes of loans are as follows: 

   June 30,   December 31, 
   2012   2011 
Commercial:          
Commercial and industrial  $106,539   $96,163 
Construction   15,687    15,959 
Secured by commercial real estate   195,857    195,813 
Secured by residential real estate   43,564    45,070 
State and political subdivisions   30,872    35,127 
Loans to depository institutions   4,500    4,515 
Indirect lease financing   10,990    11,928 
Retail:          
1-4 family residential mortgages   26,847    25,518 
Home equity loans and lines   54,280    57,579 
Consumer   2,164    2,308 
Total loans   491,300    489,980 
Net unearned (fees) costs   (37)   (44)
Loans receivable  $491,263   $489,936 

 

 

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.

 

 

- 20 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)

 

Overdrafts are reclassified as loans and are included in consumer loans above and total loans on the balance sheet. At June 30, 2012 and December 31, 2011, overdrafts were $102,000 and $91,000, respectively.

 

QNB generally lends in its trade area which is comprised of Quakertown and the surrounding communities. To a large extent, QNB makes loans collateralized at least in part by real estate. Its lending activities could be affected by changes in the general economy, the regional economy, or real estate values. Other than disclosed in the table above, at June 30, 2012, there were no concentrations of loans exceeding 10% of total loans.

 

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

 

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

 

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

 

Loans to depository institutions consist of a loan to a commercial bank in Lehigh County, Pennsylvania. This loan is secured by shares of common stock of the borrowing institution.

 

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.

 

- 21 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)

 

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

 

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

 

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

1 - Excellent - no apparent risk

2 - Good - minimal risk

3 - Acceptable - average risk

4 - Watch List - greater than average risk

5 - Special Mention - potential weaknesses

6 - Substandard - well defined weaknesses

7 - Doubtful - full collection unlikely

8 - Loss - considered uncollectible

 

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

 

- 22 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)

 

The following tables present the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company’s internal risk rating system as of June 30, 2012 and December 31, 2011:

 

 

June 30, 2012  Pass   Special mention   Substandard   Doubtful   Total 
Commercial:                         
Commercial and industrial  $93,088   $4,701   $8,713   $37   $106,539 
Construction   8,544    1,568    5,575    -    15,687 
Secured by commercial real estate   156,750    8,734    30,373    -    195,857 
Secured by residential real estate   37,604    2,343    3,617    -    43,564 
State and political subdivisions   28,837    -    2,035    -    30,872 
Loans to depository institutions   4,500    -    -    -    4,500 
Indirect lease financing   10,464    -    526    -    10,990 
   $339,787   $17,346   $50,839   $37   $408,009 

 

December 31, 2011  Pass   Special mention   Substandard   Doubtful   Total 
Commercial:                         
Commercial and industrial  $83,477   $2,313   $10,332   $41   $96,163 
Construction   6,608    3,067    6,284    -    15,959 
Secured by commercial real estate   152,637    9,323    33,402    451    195,813 
Secured by residential real estate   39,657    1,220    4,193    -    45,070 
State and political subdivisions   32,928    2,013    186    -    35,127 
Loans to depository institutions   4,515    -    -    -    4,515 
Indirect lease financing   11,548    -    380    -    11,928 
   $331,370   $17,936   $54,777   $492   $404,575 

  

For retail loans, the Company evaluates credit quality based on the performance of the individual credits. The following tables present the recorded investment in the retail classes of the loan portfolio based on payment activity as of June 30, 2012 and December 31, 2011:

 

June 30, 2012  Performing   Non-performing   Total 
Retail:               
1-4 family residential mortgages  $26,495   $352   $26,847 
Home equity loans and lines   54,115    165    54,280 
Consumer   2,127    37    2,164 
   $82,737   $554   $83,291 

 

- 23 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)

  

December 31, 2011  Performing   Non-performing   Total 
Retail:               
1-4 family residential mortgages  $25,003   $515   $25,518 
Home equity loans and lines   57,211    368    57,579 
Consumer   2,308    -    2,308 
   $84,522   $883   $85,405 

 

The performance and credit quality of the loan portfolio is also monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the past due status as of June 30, 2012 and December 31, 2011:

 

June 30, 2012  30-59 days past due   60-89 days past due   90 days or more past due   Total past due loans   Current   Total loans receivable 
Commercial:                              
Commercial and industrial  $62   $52    -   $114   $106,425   $106,539 
Construction   -    -   $408    408    15,279    15,687 
Secured by commercial real estate   1,253    16    2,190    3,459    192,398    195,857 
Secured by residential real estate   727    -    143    870    42,694    43,564 
State and political subdivisions   44    -    -    44    30,828    30,872 
Loans to depository institutions   -    -    -    -    4,500    4,500 
Indirect lease financing   190    78    58    326    10,664    10,990 
Retail:                              
1-4 family residential mortgages   -    198    52    250    26,597    26,847 
Home equity loans and lines   194    155    -    349    53,931    54,280 
Consumer   22    -    37    59    2,105    2,164 
   $2,492   $499   $2,888   $5,879   $485,421   $491,300 

 

- 24 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)

  

December 31, 2011  30-59 days past due   60-89 days past due   90 days or more past due   Total past due loans   Current   Total loans receivable 
Commercial:                              
Commercial and industrial  $113    -    -   $113   $96,050   $96,163 
Construction   1,436    -    -    1,436    14,523    15,959 
Secured by commercial real estate   1,857   $1,699   $1,017    4,573    191,240    195,813 
Secured by residential real estate   778    70    395    1,243    43,827    45,070 
State and political subdivisions   50    -    44    94    35,033    35,127 
Loans to depository institutions   -    -    -    -    4,515    4,515 
Indirect lease financing   353    146    123    622    11,306    11,928 
Retail:                              
1-4 family residential mortgages   200    166    -    366    25,152    25,518 
Home equity loans and lines   158    66    190    414    57,165    57,579 
Consumer   14    -    -    14    2,294    2,308 
   $4,959   $2,147   $1,769   $8,875   $481,105   $489,980 

 

 

The following tables disclose the recorded investment in loans receivable that are either on non-accrual status or past due 90 days or more and still accruing interest as of June 30, 2012 and December 31, 2011:

  

June 30, 2012  90 days or more past due (still accruing)   Non-accrual 
Commercial:          
Commercial and industrial   -   $5,809 
Construction  $408    2,794 
Secured by commercial real estate   -    5,841 
Secured by residential real estate   -    1,226 
State and political subdivisions   -    10 
Loans to depository institutions   -    - 
Indirect lease financing   30    67 
Retail:          
1-4 family residential mortgages   -    352 
Home equity loans and lines   -    165 
Consumer   37    - 
   $475   $16,264 

 

 

- 25 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)

 

 

December 31, 2011  90 days or more past due (still accruing)   Non-accrual 
Commercial:          
Commercial and industrial   -   $5,410 
Construction   -    3,474 
Secured by commercial real estate  $286    7,547 
Secured by residential real estate   -    1,158 
State and political subdivisions   40    4 
Loans to depository institutions   -    - 
Indirect lease financing   54    121 
Retail:          
1-4 family residential mortgages   -    515 
Home equity loans and lines   -    368 
Consumer   -    - 
   $380   $18,597 

 

 

Activity in the allowance for loan losses for the three months ended June 30, 2012 and 2011 are as follows:

 

 

Three months ended June 30, 2012  Balance, beginning of period   Provision for (credit to) loan losses   Charge-offs   Recoveries   Balance, end of period 
Commercial:                         
Commercial and industrial  $3,317   $164   $(74)  $60   $3,467 
Construction   333    20    -    -    353 
Secured by commercial real estate   3,126    2    -    62    3,190 
Secured by residential real estate   773    88    (50)   -    811 
State and political subdivisions   301    (79)   -    -    222 
Loans to depository institutions   20    -    -    -    20 
Indirect lease financing   238    21    (13)   22    268 
Retail:                         
1-4 family residential mortgages   303    (5)   -    2    300 
Home equity loans and lines   547    37    (1)   12    595 
Consumer   17    10    (11)   2    18 
Unallocated   481    (258)    N/A     N/A    223 
   $9,456   $-   $(149)  $160   $9,467 

 

- 26 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)

  

Three months ended June 30, 2011  Balance, beginning of period   Provision for (credit to) loan losses   Charge-offs   Recoveries   Balance, end of period 
Commercial:                         
Commercial and industrial  $3,119   $(276)  $(24)  $7   $2,826 
Construction   660    345    (397)   -    608 
Secured by commercial real estate   3,180    284    (349)   4    3,119 
Secured by residential real estate   625    62    -    -    687 
State and political subdivisions   107    44    -    -    151 
Indirect lease financing   470    (99)   -    5    376 
Retail:                         
1-4 family residential mortgages   205    29    -    -    234 
Home equity loans and lines   605    52    (43)   2    616 
Consumer   27    (11)   (2)   5    19 
Unallocated   194    20     N/A     N/A    214 
   $9,192   $450   $(815)  $23   $8,850 

 

 

Activity in the allowance for loan losses for the six months ended June 30, 2012 and 2011 are as follows:

 

 

Six months ended June 30, 2012  Balance, beginning of year   Provision for (credit to) loan losses   Charge-offs   Recoveries   Balance, end of period 
Commercial:                         
Commercial and industrial  $2,959   $520   $(74)  $62   $3,467 
Construction   556    (203)   -    -    353 
Secured by commercial real estate   3,124    4    -    62    3,190 
Secured by residential real estate   746    151    (86)   -    811 
State and political subdivisions   195    27    -    -    222 
Loans to depository institutions   20    -    -    -    20 
Indirect lease financing   312    (47)   (23)   26    268 
Retail:                         
1-4 family residential mortgages   249    70    (21)   2    300 
Home equity loans and lines   625    (23)   (19)   12    595 
Consumer   20    13    (20)   5    18 
Unallocated   435    (212)    N/A     N/A    223 
   $9,241   $300   $(243)  $169   $9,467 

 

 

- 27 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

  

8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)

 

 

Six months ended June 30, 2011  Balance, beginning of period   Provision for (credit to) loan losses   Charge-offs   Recoveries   Balance, end of period 
Commercial:                         
Commercial and industrial  $2,136   $769   $(89)  $10   $2,826 
Construction   633    372    (397)   -    608 
Secured by commercial real estate   3,875    (119)   (641)   4    3,119 
Secured by residential real estate   676    65    (54)   -    687 
State and political subdivisions   108    43    -    -    151 
Indirect lease financing   496    (129)   -    9    376 
Retail:                  -      
1-4 family residential mortgages   212    22    -    -    234 
Home equity loans and lines   646    20    (53)   3    616 
Consumer   32    (16)   (6)   9    19 
Unallocated   141    73     N/A     N/A    214 
   $8,955   $1,100   $(1,240)  $35   $8,850 

  

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.

 

- 28 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)

 

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

 

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

 

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

 

QNB assesses all loan restructurings under the guidance of ASU 2011-02. Performing TDRs (not reported as non-accrual or past due 90 days or more and still accruing) totaled $4,085,000 and $2,413,000 as of June 30, 2012 and December 31, 2011, respectively. Non-performing TDRs totaled $2,628,000 and $2,437,000 as of June 30, 2012 and December 31, 2011, respectively. All TDRs are included in impaired loans presented in the section above.

 

The following tables present loans by loan class modified as TDRs during the three and six months ended June 30, 2012. The pre-modification and post-modification outstanding recorded investments disclosed in the tables below, represent carrying amounts immediately prior to the modification and at June 30, 2012, respectively.

 

 

Three months ended June 30, 2012  Number of contracts   Pre-modification outstanding recorded
investment
   Post-modification outstanding recorded
investment
 
Commercial:               
Commercial and industrial   2   $482   $476 
Secured by commercial real estate   1    2,380    2,380 
Retail:               
1-4 family residential mortgages   1    145    141 
    4   $3,007   $2,997 

 

 

- 29 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)

 

 

Six months ended June 30, 2012  Number of contracts   Pre-modification outstanding recorded
investment
   Post-modification outstanding recorded
investment
 
Commercial:               
Commercial and industrial   2   $482   $476 
Secured by commercial real estate   1    2,380    2,380 
Retail:               
1-4 family residential mortgages   1    145    141 
Home equity loans and lines   1    38    38 
    5   $3,045   $3,035 

 

 

The TDR concessions made during the six months ended June 30, 2012 primarily involved the reduction of interest rates and/or interest only repayment periods on the loans. There were specific reserve for loan losses allocated to the loans modified as TDRs during the three and six months ended June 30, 2012 of $365,000 and $373,000, respectively. Any required specific reserves are included in the allowance for loan losses for loans individually evaluated for impairment. There were no charge-offs resulting from loans modified as TDRs during the six months ended June 30, 2012.

 

The following table presents loans modified as TDRs within 12 months prior to June 30, 2012, and for which there was a payment default (90 days or more past due or on non-accrual) during the three and six months ended June 30, 2012:

 

   Three Months Ended
June 30, 2012
   Six Months Ended
June 30, 2012
 
TDRs subsequently defaulted  Number of contracts   Recorded investment   Number of Contracts   Recorded Investment 
Commercial:                    
Commercial and industrial   1   $419    1   $419 
Retail:                    
1-4 family residential mortgages   1    141    1    141 
    2   $560    2   $560 

  

The following tables present the balance in the allowance for loan losses at June 30, 2012 and December 31, 2011 disaggregated on the basis of the Company’s impairment method by class of loans receivable along with the balance of loans receivable by class, excluding unearned fees and costs, disaggregated on the basis of the Company’s impairment methodology:

 

 

- 30 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)

  

   Allowance for Loan Losses   Loans Receivable 
June 30, 2012  Balance   Balance related to loans individually evaluated for impairment   Balance related to loans collectively evaluated for impairment   Balance   Balance  individually evaluated for impairment   Balance collectively evaluated for impairment 
Commercial:                              
Commercial and industrial  $3,467   $1,935   $1,532   $106,539   $7,608   $98,931 
Construction   353    -    353    15,687    5,575    10,112 
Secured by commercial real estate   3,190    181    3,009    195,857    15,816    180,041 
Secured by residential real estate   811    273    538    43,564    2,274    41,290 
State and political subdivisions   222    5    217    30,872    1,915    28,957 
Loans to depository institutions   20    -    20    4,500    -    4,500 
Indirect lease financing   268    9    259    10,990    67    10,923 
Retail:                              
1-4 family residential mortgages   300    88    212    26,847    475    26,372 
Home equity loans and lines   595    49    546    54,280    202    54,078 
Consumer   18    -    18    2,164    -    2,164 
Unallocated   223     N/A     N/A     N/A     N/A     N/A 
   $9,467   $2,540   $6,704   $491,300   $33,932   $457,368 

  

   Allowance for Loan Losses   Loans Receivable 
December 31, 2011  Balance   Balance related to loans individually evaluated for impairment   Balance related to loans collectively evaluated for impairment   Balance   Balance  individually evaluated for impairment   Balance collectively evaluated for impairment 
Commercial:                              
Commercial and industrial  $2,959   $1,444   $1,515   $96,163   $8,088   $88,075 
Construction   556    65    491    15,959    4,663    11,296 
Secured by commercial real estate   3,124    181    2,943    195,813    13,579    182,234 
Secured by residential real estate   746    211    535    45,070    2,567    42,503 
State and political subdivisions   195    2    193    35,127    4    35,123 
Loans to depository institutions   20    -    20    4,515    -    4,515 
Indirect lease financing   312    18    294    11,928    121    11,807 
Retail:                              
1-4 family residential mortgages   249    81    168    25,518    640    24,878 
Home equity loans and lines   625    63    562    57,579    706    56,873 
Consumer   20    -    20    2,308    -    2,308 
Unallocated   435     N/A      N/A      N/A      N/A      N/A  
   $9,241   $2,065   $6,741   $489,980   $30,368   $459,612 

 

- 31 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)

 

The following tables summarize additional information in regards to impaired loans by loan portfolio class as of June 30, 2012 and December 31, 2011:

 

 

June 30, 2012  Recorded investment (after charge-offs)   Unpaid principal balance   Related
allowance
   Average recorded investment   Interest income recognized 
With no specific allowance recorded:                         
Commercial:                         
Commercial and industrial  $5,179   $5,339   $-           
Construction   5,575    5,689    -           
Secured by commercial real estate   15,180    16,197    -           
Secured by residential real estate   800    810    -           
State and political subdivisions   1,905    1,905    -           
Loans to depository institutions   -    -    -           
Indirect lease financing   36    65    -           
Retail:                         
1-4 family residential mortgages   193    205    -           
Home equity loans and lines   46    54    -           
Consumer   -    -    -           
   $28,914   $30,264   $-           
                          
With an allowance recorded:                         
Commercial:                         
Commercial and industrial  $2,429   $2,496   $1,935           
Construction   -    -    -           
Secured by commercial real estate   636    647    181           
Secured by residential real estate   1,474    1,510    273           
State and political subdivisions   10    13    5           
Loans to depository institutions   -    -    -           
Indirect lease financing   31    37    9           
Retail:                         
1-4 family residential mortgages   282    290    88           
Home equity loans and lines   156    165    49           
Consumer   -    -    -           
   $5,018   $5,158   $2,540           
                          
Total:                         
Commercial:                         
Commercial and industrial  $7,608   $7,835   $1,935   $7,426   $43 
Construction   5,575    5,689    -    5,432    73 
Secured by commercial real estate   15,816    16,844    181    13,848    219 
Secured by residential real estate   2,274    2,320    273    2,250    31 
State and political subdivisions   1,915    1,918    5    1,137    22 
Loans to depository institutions   -    -    -    -    - 
Indirect lease financing   67    102    9    88    - 
Retail:   -    -    -           
1-4 family residential mortgages   475    495    88    566    3 
Home equity loans and lines   202    219    49    534    4 
Consumer   -    -    -    -    - 
   $33,932   $35,422   $2,540   $31,281   $395 

 

- 32 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)

 

December 31, 2011  Recorded investment (after charge-offs)   Unpaid
principal
balance
   Related
allowance
 
With no specific allowance recorded:          
Commercial:               
Commercial and industrial  $4,923   $5,580   $- 
Construction   4,016    4,047    - 
Secured by commercial real estate   10,400    10,841    - 
Secured by residential real estate   1,598    1,603    - 
State and political subdivisions   -    -    - 
Loans to depository institutions   -    -    - 
Indirect lease financing   47    71    - 
Retail:               
1-4 family residential mortgages   352    384    - 
Home equity loans and lines   486    492    - 
Consumer   -    -    - 
   $21,822   $23,018   $- 
                
With an allowance recorded:               
Commercial:               
Commercial and industrial  $3,165   $3,231   $1,444 
Construction   647    654    65 
Secured by commercial real estate   3,179    3,779    181 
Secured by residential real estate   969    985    211 
State and political subdivisions   4    5    2 
Loans to depository institutions   -    -    - 
Indirect lease financing   74    84    18 
Retail:               
1-4 family residential mortgages   288    293    81 
Home equity loans and lines   220    224    63 
Consumer   -    -    - 
   $8,546   $9,255   $2,065 
                
Total:               
Commercial:               
Commercial and industrial  $8,088   $8,811   $1,444 
Construction   4,663    4,701    65 
Secured by commercial real estate   13,579    14,620    181 
Secured by residential real estate   2,567    2,588    211 
State and political subdivisions   4    5    2 
Loans to depository institutions   -    -    - 
Indirect lease financing   121    155    18 
Retail:               
1-4 family residential mortgages   640    677    81 
Home equity loans and lines   706    716    63 
Consumer   -    -    - 
   $30,368   $32,273   $2,065 

 

- 33 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

9. FAIR VALUE MEASUREMENTS AND DISCLOSURES

 

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

 

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

 

Level 1:Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2:Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.
Level 3:Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).

 

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

 

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

 

- 34 -

QNB CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

9. FAIR VALUE MEASUREMENTS AND DISCLOSURES (continued)

 

The following table sets forth QNB’s financial assets measured at fair value on a recurring and nonrecurring basis and the fair value measurements by level within the fair value hierarchy as of June 30, 2012:

 

 

June 30, 2012  Quoted prices in active markets for identical assets (Level 1)   Significant other observable input (Level 2)   Significant unobservable inputs (Level 3)   Balance at end of period 
Recurring fair value measurements                    
Securities available-for-sale                    
U.S. Government agency securities   -   $69,740    -   $69,740 
State and municipal securities   -    81,592    -    81,592 
U.S. Government agencies and sponsored enterprises (GSEs) - residential        - 
Mortgage-backed securities   -    117,628    -    117,628 
Collateralized mortgage
obligations (CMOs)
&nbs