QNB CORP. QNB Corp. is a bank holding company headquartered inQuakertown, Pennsylvania .QNB Corp. , through its wholly-owned subsidiary, the Bank, has been serving the residents and businesses of upperBucks , northernMontgomery and southernLehigh counties inPennsylvania since 1877. Due to its limited geographic area, growth is pursued through expansion of existing customer relationships and building new relationships by stressing a consistent high level of service at all points of contact. The Bank is a locally managed community bank that provides a full range of commercial and retail banking and retail brokerage services. The consolidated entity is referred to herein as "QNB" or the "Company".
Tabular information presented throughout management's discussion and analysis, other than share and per share data, is presented in thousands of dollars.
FORWARD-LOOKING STATEMENTS
In addition to historical information, this document contains forward-looking statements. Forward-looking statements are typically identified by words or phrases such as "believe," "expect," "anticipate," "intend," "estimate," "project" and variations of such words and similar expressions, or future or conditional verbs such as "will," "would," "should," "could," "may" or similar expressions. TheU.S. Private Securities Litigation Reform Act of 1995 provides a safe harbor in regard to the inclusion of forward-looking statements in this document and documents incorporated by reference. Shareholders should note that many factors, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference, including the risk factors identified in Item 1A of QNB's 2021 Form 10-K, could affect the future financial results of QNB and could cause those results to differ materially from those expressed in the forward-looking statements contained or incorporated by reference in this document. These factors include, but are not limited, to the following: • Volatility in interest rates and shape of the yield curve; • Credit risk; • Liquidity risk; • Operating, legal and regulatory risks;
• Economic, political and competitive forces affecting QNB's business,
including the effects of inflation;
• The effects of unforeseen external events, including acts of terrorism,
natural disasters, and pandemics, including the COVID-19 Pandemic; and
• The risk that the analysis of these risks and forces could be incorrect,
and/or that the strategies developed to address them could be
unsuccessful.
QNB cautions that these forward-looking statements are subject to numerous
assumptions, risks and uncertainties, all of which change over time, and QNB
assumes no duty to update forward-looking statements. Management cautions
readers not to place undue reliance on any forward-looking statements. These
statements speak only as of the date of this report on Form 10-Q, even if
subsequently made available by QNB on its website or otherwise, and they advise
readers that various factors, including those described above, could affect
QNB's financial performance and could cause actual results or circumstances for
future periods to differ materially from those anticipated or projected. Except
as required by law, QNB does not undertake, and specifically disclaims any
obligation, to publicly release any revisions to any forward-looking statements
to reflect the occurrence of anticipated or unanticipated events or
circumstances after the date of such statements.
36
--------------------------------------------------------------------------------QNB CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of the financial condition and results of operations are based on the consolidated financial statements of QNB, which are prepared in accordance withU.S. generally accepted accounting principles (U.S. GAAP) and predominant practices within the banking industry. The preparation of these consolidated financial statements requires QNB to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. QNB evaluates estimates on an on-going basis, including those related to the determination of the allowance for loan losses, the determination of the valuation of other real estate owned and foreclosed assets, other-than-temporary impairments on investment securities, the valuation of deferred tax assets, stock-based compensation and income taxes. QNB bases its estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Other-Than-Temporary Investment Security Impairment
Securities are evaluated periodically to determine whether a decline in their value is other-than-temporary. Management utilizes criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other-than-temporary. The term "other-than-temporary" is not intended to indicate that the decline is permanent, it indicates that the prospect for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. For equity securities that do not have readily-determinable fair values, once a decline in value is determined to be other-than-temporary, the value of the equity security is reduced and a corresponding charge to earnings is recognized. There were no other-than-temporary impairment charges recorded during the three or nine months endedSeptember 30, 2022 and 2021, respectively. The Company follows accounting guidance related to the recognition and presentation of other-than-temporary impairment that specifies (a) if a company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss. When an entity does not intend to sell the security, and it is more likely than not the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. There were no credit-related other-than-temporary impairment charges in the three or nine months endedSeptember 30, 2022 or 2021, respectively.
Allowance for Loan Losses
The determination of the allowance for loan losses involves a higher degree of
judgment and complexity than the Company's other significant accounting
policies. The allowance for loan losses is calculated with the objective of
maintaining a level believed by management to be sufficient to absorb probable
known and inherent losses in the outstanding loan portfolio. The allowance is
reduced by actual credit losses and is increased by the provision for loan
losses and recoveries of previous losses. The provisions for loan losses are
charged to earnings to bring the total allowance for loan losses to a level
considered necessary by management.
The allowance for loan losses is based on management's continual review and
evaluation of the loan portfolio. The level of the allowance is determined by
assigning specific reserves to individually identified problem credits and
general reserves to all other loans. The portion of the allowance that is
allocated to impaired loans is determined by estimating the inherent loss on
each credit after giving consideration to the value of underlying collateral or
present value of future estimated cash flows. The general reserves are based on
the composition and risk characteristics of the loan portfolio, including the
nature of the loan portfolio, credit concentration trends, delinquency and loss
experience, as well as other qualitative factors such as current economic
trends.
Management emphasizes loan quality and close monitoring of potential problem
credits. Credit risk identification and review processes are utilized to assess
and monitor the degree of risk in the loan portfolio. QNB's lending and credit
administration staff are charged with reviewing the loan portfolio and
identifying changes in the economy or in a borrower's circumstances which may
affect the ability to repay debt or the value of pledged collateral. A loan
classification and review system exists that identifies those loans with a
higher-than-normal risk of collection. Each commercial loan is assigned a grade
based upon an assessment of the borrower's financial capacity to service the
debt and the presence and value of collateral for the loan. An independent loan
review group tests risk assessments and evaluates the adequacy of the allowance
for loan losses. Management meets monthly to review the credit quality of the
loan portfolio and quarterly to review the allowance for loan losses.
37
--------------------------------------------------------------------------------QNB CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In addition, various regulatory agencies, as an integral part of their examination process, periodically review QNB's allowance for loan losses. Such agencies may require QNB to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. Management believes that it uses the best information available to make determinations about the adequacy of the allowance and that it has established its existing allowance for loan losses in accordance withU.S. GAAP. If circumstances differ substantially from the assumptions used in making determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be affected. Because future events affecting borrowers and collateral cannot be predicted with certainty, increases to the allowance may be necessary should the quality of any loans deteriorate as a result of the factors discussed above.
Foreclosed Assets
Assets acquired through, or in lieu of, loan foreclosure are held-for-sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses and changes in the valuation allowance are included in net expenses from foreclosed assets. Stock-Based Compensation QNB sponsors stock-based compensation plans, administered by a Board committee, under which both qualified and non-qualified stock options may be granted periodically to certain employees. QNB accounts for all awards granted under stock-based compensation plans in accordance with ASC 718, Compensation-Stock Compensation. Compensation cost has been measured using the fair value of an award on the grant date and is recognized over the service period, which is usually the vesting period. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the option and each vesting date. QNB estimates the fair value of stock options on the date of the grant using the Black-Scholes option pricing model. The model requires the use of numerous assumptions, many of which are highly subjective in nature. Income Taxes QNB accounts for income taxes under the asset/liability method in accordance with income tax accounting guidance, ASC 740, Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established against deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become available. Because the judgment about the level of future taxable income is dependent on matters that may, at least in part, be beyond QNB's control, it is at least reasonably possible that management's judgment about the need for a valuation allowance for deferred tax assets could change in the near term.
RESULTS OF OPERATIONS - OVERVIEW
QNB reported net income for the third quarter of 2022 of$3,415,000 , or$0.96 per share on a diluted basis, compared to net income of$3,424,000 , or$0.96 per share on a diluted basis, for the same period in 2021. For the nine-month period endedSeptember 30, 2022 , QNB reported net income of$10,474,000 , or$2.94 per share on a diluted basis, compared to net income of$12,343,000 , or$3.47 per share on a diluted basis, for the same period in 2021. The Bank contributed$12,037,000 to net income for the nine months endedSeptember 30, 2022 compared to$11,070,000 for the same period 2021; and the holding company contributed negative$1,563,000 to net income for the nine months endedSeptember 30, 2022 compared to income of$1,273,000 for the same period 2021. The results at the Bank were primarily due to increased net interest income. The results at the holding company are due primarily to the change in the fair value of the equity securities included in the investment portfolio. Net income expressed as an annualized rate of return on average assets and average shareholders' equity was 0.78% and 9.20%, respectively, for the quarter endedSeptember 30, 2022 compared with 0.84% and 9.92%, respectively, for the quarter endedSeptember 30, 2021 . For the nine months endedSeptember 30, 2022 , the annualized rate of return on average assets and average shareholders' equity was 0.82% and 9.68%, respectively, compared with 1.06% and 12.31%, for the same period in 2021. 38 --------------------------------------------------------------------------------
QNB CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Total assets as ofSeptember 30, 2022 were$1,645,068,000 , compared with$1,673,340,000 atDecember 31, 2021 . Loans receivable atSeptember 30, 2022 were$1,008,306,000 , a$81,836,000 increase over$926,470,000 atDecember 31, 2021 . QNB participated in theSmall Business Administration's ("SBA") Paycheck Protection Program ("PPP"). Excluding PPP loans net of deferred fees atSeptember 30, 2022 andDecember 31, 2021 , loans would have increased$93,364,000 since year-end 2021. Total deposits of$1,476,668,000 atSeptember 30, 2022 increased$26,923,000 compared with total deposits of$1,449,745,000 atDecember 31, 2021 .
Results for the three and nine months ended
• Net interest income increased
September 30, 2022 , respectively.
• Net interest margin on a tax-equivalent remained unchanged at 2.72% for the
quarter and decreased 11 basis points for nine months ended September 30,
2022 to 2.72% compared to 2.83 for the same period in 2021.
• QNB recorded no provision for loan losses for the quarter and for the nine
months ended
the same periods in 2021, respectively.
• Non-interest income decreased
and decreased
compared with the same periods in 2021. Excluding realized and unrealized
gains (losses) on equity securities, gains on sales of loans, and the life
insurance benefit of
income decreased $43,000 , or 2.5%, to $1,606,000 for the quarter and
increased $159,000 , or 3.4%, to $4,821,000 for the nine months ended
September 30, 2022 compared with the same periods in 2021.
• Non-interest expense increased $24000 to $7,814,000 for the quarter and
increased $511,000 to $23,373,000 for the nine months ended September 30,
2022 compared to the same periods in 2021.
• Total non-performing loans were
30, 2022 compared with
for the nine months ended
net charge-offs of
These items, as well as others, are explained more thoroughly in the next sections.
NET INTEREST INCOME
QNB earns its net income primarily through the Bank. Net interest income, or the spread between the interest, dividends and fees earned on loans and investment securities and the expense incurred on deposits and other interest-bearing liabilities, is the primary source of operating income for QNB. Management seeks to achieve sustainable and consistent earnings growth while maintaining adequate levels of capital and liquidity and limiting its exposure to credit and interest rate risk levels approved by the Board of Directors.
The following table presents the adjustment to convert net interest income to
net interest income on a fully taxable-equivalent basis for the three- and
nine-month periods ended
For the Three Months Ended September 30, For the Nine Months Ended
September 30,
2022 2021 2022 2021Total interest income$ 13,546 $ 11,721$ 37,682 $ 34,832 Total interest expense 2,167 1,137 4,464 3,513 Net interest income 11,379 10,584 33,218 31,319 Tax-equivalent adjustment 177 185 541 521 Net interest income (fully taxable-equivalent)$ 11,556 $ 10,769$ 33,759 $ 31,840 39
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QNB CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Net interest income is the primary source of operating income for QNB. Net interest income is interest income, dividends, and fees on earning assets, less interest expense incurred for funding sources. Earning assets primarily include loans, investment securities, interest bearing balances at theFederal Reserve Bank (Fed) and Federal funds sold. Sources used to fund these assets include deposits and borrowed funds. Net interest income is affected by changes in interest rates, the volume and mix of earning assets and interest-bearing liabilities, and the amount of earning assets funded by non-interest-bearing deposits. For purposes of this discussion, interest income and the average yield earned on loans and investment securities are adjusted to a tax-equivalent basis as detailed in the tables that appear above. This adjustment to interest income is made for analysis purposes only. Interest income is increased by the amount of savings of Federal income taxes, which QNB realizes by investing in certain tax-exempt state and municipal securities and by making loans to certain tax-exempt organizations. In this way, the ultimate economic impact of earnings from various assets can be more easily compared. The net interest rate spread is the difference between average rates received on earning assets and average rates paid on interest-bearing liabilities, while the net interest rate margin, which includes interest-free sources of funds, is net interest income expressed as a percentage of average interest-earning assets.The Asset/Liability and Investment Management Committee works to manage and maximize the net interest margin for the Company. 40 --------------------------------------------------------------------------------
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Average Balances, Rate, and Interest Income and Expense Summary (Tax-Equivalent
Basis)
For the Three Months Ended
September 30, 2022 September 30, 2021
Average Average Average Average
Balance Rate Interest Balance Rate Interest
Assets
Investment securities (AFS &
Equity):
U.S. Treasury securities $ 831 1.32 % $ 3 $ - 0.00 % $ -
U.S. Government agencies 101,938 1.11 283 82,645 1.07 221
State and municipal 127,929 2.38 761 118,245 2.43 719
Mortgage-backed and CMOs 441,952 1.61 1,783 376,278 1.28 1,203
Corporate debt securities 6,658 4.37 72 7,536 4.05 77
Equities 11,702 3.36 99 15,651 2.86 113
Total investment securities 691,010 1.74 3,001 600,355 1.55 2,333
Loans:
Commercial real estate 650,118 4.22 6,917 566,821 4.09 5,850
Residential real estate 105,723 3.33 880 97,346 3.33 811
Home equity loans 56,669 4.65 665 56,613 3.28 468
Commercial and industrial 148,545 5.25 1,965 176,226 4.82 2,139
Consumer loans 4,401 5.76 64 4,972 4.90 61
Tax-exempt loans 19,535 3.43 169 24,621 3.50 217
Total loans, net of unearned
income* 984,991 4.29 10,660 926,599 4.09 9,546
Other earning assets 8,038 3.02 62 42,420 0.25 27
Total earning assets 1,684,039 3.23 13,723 1,569,374 3.01 11,906
Cash and due from banks 15,544 26,472
Allowance for loan losses (11,323 ) (11,307 )
Other assets 38,872 39,165
Total assets $ 1,727,132 $ 1,623,704
Liabilities and Shareholders'
Equity
Interest-bearing deposits:
Interest-bearing demand $ 342,011 0.23 % 201 $ 313,011 0.22 % 154
Municipals 138,187 1.77 617 142,960 0.32 115
Money market 134,591 0.50 170 125,274 0.30 96
Savings 451,871 0.53 608 394,980 0.29 292
Time < $100 90,129 0.74 168 97,617 0.87 213
Time $100 through $250 54,168 0.87 118 51,635 0.79 102
Time >$250 25,616 0.86 56 26,030 0.86 56Total interest-bearing deposits 1,236,573 0.62 1,938
1,151,507 0.35 1,028
Short-term borrowings 85,943 0.87 189 78,680 0.34 68
Long-term debt 10,000 1.57 40 10,000 1.58 41
Total interest-bearing
liabilities 1,332,516 0.65 2,167 1,240,187 0.36 1,137
Non-interest-bearing deposits 239,095 237,642
Other liabilities 8,225 8,987
Shareholders' equity 147,296 136,888
Total liabilities and
shareholders' equity $ 1,727,132 $ 1,623,704
Net interest rate spread 2.58 % 2.65 %
Margin/net interest income 2.72 % $ 11,556 2.72 % $ 10,769
41
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QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Nine Months Ended
September 30, 2022 September 30, 2021
Average Average Average Average
Balance Rate Interest Balance Rate Interest
Assets
Investment securities (AFS &
Equity):
U.S. Treasury securities $ 600 1.12 % $ 5 $ - 0.00 % $ -
U.S. Government agencies 101,292 1.10 836 74,397 1.04 580
State and municipal 129,343 2.40 2,325 106,634 2.50 1,999
Mortgage-backed and CMOs 453,833 1.56 5,322 320,714 1.28 3,068
Corporate debt securities 6,682 4.36 218 7,486 3.91 220
Equities 12,172 3.26 297 14,613 2.98 326
Total investment securities 703,922 1.71 9,003 523,844 1.58 6,193
Loans:
Commercial real estate 623,193 4.11 19,181 547,264 4.18 17,110
Residential real estate 103,841 2.47 2,564 94,232 2.57 2,421
Home equity loans 55,244 3.93 1,624 57,674 3.30 1,424
Commercial and industrial 143,354 4.73 5,075 206,772 4.71 7,286
Consumer loans 4,585 5.31 182 5,173 4.94 191
Tax-exempt loans 19,482 3.41 497 24,678 3.53 652
Total loans, net of unearned
income* 949,699 4.10 29,123 935,793 4.16 29,084
Other earning assets 6,262 2.06 97 42,773 0.24 76
Total earning assets 1,659,883 3.08 38,223 1,502,410 3.15 35,353
Cash and due from banks 14,123 26,456
Allowance for loan losses (11,266 ) (11,136 )
Other assets 38,532 38,699
Total assets $ 1,701,272 $ 1,556,429
Liabilities and Shareholders'
Equity
Interest-bearing deposits:
Interest-bearing demand $ 342,955 0.20 % 521 $ 299,795 0.21 % 470
Municipals 121,332 0.91 825 123,599 0.32 298
Money market 139,700 0.38 401 116,986 0.31 271
Savings 446,196 0.39 1,312 377,727 0.31 869
Time < $100 91,223 0.76 522 100,397 0.96 723
Time $100 through $250 49,656 0.75 280 53,120 0.90 358
Time >$250 25,361 0.75 143 27,561 1.01 209Total interest-bearing deposits 1,216,423 0.44 4,004
1,099,185 0.39 3,198
Short-term borrowings 78,994 0.58 341 71,266 0.37 196
Long-term debt 10,000 1.57 119 10,000 1.57 119
Total interest-bearing
liabilities 1,305,417 0.46 4,464 1,180,451 0.40 3,513
Non-interest-bearing deposits 243,239 232,447
Other liabilities 7,940 9,523
Shareholders' equity 144,676 134,008
Total liabilities and
shareholders' equity $ 1,701,272 $ 1,556,429
Net interest rate spread 2.62 % 2.75 %
Margin/net interest income 2.72 % $ 33,759 2.83 % $ 31,840
Tax-exempt securities and loans were adjusted to a tax-equivalent basis and are
based on the marginal Federal corporate tax rate of 21 percent for three and
nine months ended September 30, 2022 and 2021.
Non-accrual loans are included in earning assets.
* Includes loans held-for-sale
42
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QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Rate/Volume Analysis. The following table shows the fully taxable equivalent
effect of changes in volumes and rates on interest income and interest expense.
Changes in net interest income that could not be specifically identified as
either a rate or volume change were allocated to changes in volume.
For the Three Months Ended For the Nine Months Ended
September 30, 2022 compared September 30, 2022 compared
to September 30, 2021 to September 30, 2021
Total Due to change in: Total Due to change in:
Change Volume Rate Change Volume Rate
Interest income:
Investment securities
(AFS & Equity):
U.S. Treasury
securities $ 3 $ - $ 3 $ 5 $ - $ 5
U.S. Government
agencies 62 52 10 256 194 62
State and municipal 42 58 (16 ) 326 458 (132 )
Mortgage-backed and
CMOs 580 211 369 2,254 947 1,307
Corporate debt
securities (5 ) (10 ) 5 (2 ) (32 ) 30
Equities (14 ) (29 ) 15 (29 ) (54 ) 25
Total Investment
securities (AFS &
Equity) 668 282 386 2,810 1,513 1,297
Loans:
Commercial real
estate 1,067 860 207 2,071 2,375 (304 )
Residential real
estate 69 69 - 143 247 (104 )
Home equity loans 197 - 197 200 (60 ) 260
Commercial and
industrial (174 ) (336 ) 162 (2,211 ) (2,235 ) 24
Consumer loans 3 (7 ) 10 (9 ) (22 ) 13
Tax-exempt loans (48 ) (44 ) (4 ) (155 ) (137 ) (18 )
Total Loans 1,114 542 572 39 168 (129 )
Other earning assets 35 (21 ) 56 21 (65 ) 86
Total interest income 1,817 803 1,014 2,870 1,616 1,254
Interest expense:
Interest-bearing
deposits:
Interest-bearing
demand 47 14 33 51 67 (16 )
Municipals 502 (4 ) 506 527 (5 ) 532
Money market 74 6 68 130 52 78
Savings 316 43 273 443 157 286
Time < $100 (45 ) (16 ) (29 ) (201 ) (66 ) (135 )
Time $100 through
$250 16 5 11 (78 ) (23 ) (55 )
Time >$250 - - - (66 ) (16 ) (50 )
Total
interest-bearing
deposits 910 48 862 806 166 640
Short-term borrowings 121 6 115 145 21 124
Long-term debt (1 ) - (1 ) - - -
Total interest
expense 1,030 54 976 951 187 764
Net interest income $ 787 $ 749 $ 38 $ 1,919 $ 1,429 $ 490
43--------------------------------------------------------------------------------
QNB CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net Interest Income and Net Interest Margin - Quarterly Comparison
Average earning assets for the third quarter of 2022 were$1,684,039,000 , an increase of$114,665,000 , or 7.3%, from the third quarter of 2021, with average loans increasing$58,392,0000 , and average investment securities increasing$90,655,000 , or 15.1%, over the same period in 2021. Excess cash from deposit growth was deployed to the investment portfolio during the fourth quarter of 2021, which earned a better yield than Fed Funds or deposits at theFederal Reserve Bank . Average loans as a percent of average earning assets was 58.5% for the third quarter of 2022, compared with 59.0% for the third quarter of 2021. On the funding side, average deposits increased$86,519,000 , or 6.2%, to$1,475,668,000 for the third quarter of 2022 primarily due to growth in interest-bearing demand, money market and savings deposits. Customers continue to reinvest funds into more liquid accounts. Average short-term borrowed funds, which consisted primarily of average commercial repurchase agreements and over-night FHLB borrowings, increased$7,263,000 to$85,943,000 during the third quarter of 2022 compared to$78,680,000 for the same period in 2021. The net interest margin for the third quarter of 2022 remained flat at 2.72% compared to the same period in 2021. Competition for quality loans in our local market continues to exert pressure on the net interest margin. The increases in interest rates starting inMarch 2022 is expected to compress the net interest margin initially as QNB is liability sensitive; but is expected to improve as loans and securities reprice. The Rate-Volume Analysis tables, as presented on a tax-equivalent basis, highlight the impact of changing rates and volumes on interest income and interest expense. Total interest income on a tax-equivalent basis increased$1,817,000 , or 15.3%, to$13,723,000 for the third quarter of 2022; total interest expense increased$1,030,000 , or 90.6%, to$2,167,000 . The Municipal, Money Market and savings account experienced higher rates in the third quarter of 2022 compared to the third quarter of 2021. The yield on earning assets on a tax-equivalent basis increased 22 basis points from 3.01% for the third quarter of 2021, to 3.23% for the third quarter of 2022. The cost of interest-bearing liabilities was 0.65% for the third quarter of 2022, compared with 0.36% for the same period in 2021.
Interest income on investment securities (available-for-sale and equity)
increased
QNB invested inU.S. Treasury securities during 2022 which yielded 1.32%. Income onU.S. Government agency securities increased$62,000 as the average balances increased$19,293,000 and the rate increased four basis points. Interest income on municipal securities, which are primarily tax-exempt, increased due to a$9,684,000 increase in average balances, partially offset by a five basis-point decline in rates. Proceeds from matured, called securities and proceeds from deposits were invested back into theU.S. Government agency, municipal and mortgage-backed securities portfolios. Typically, QNB purchases municipal bonds with 10-20-year maturities and may have call dates between 2-10 years. Interest income on mortgage-backed securities and CMOs increased$580,000 while average balances increased$65,674,000 and yield increased 33 basis points. This portfolio generally provides higher yields relative to agency bonds and also provides monthly cash flow which can be used for liquidity purposes or can be reinvested as interest rates increase. Since most of these securities were purchased at a premium, any prepayments result in a shorter amortization period of this premium and therefore a reduction in income. Income on loans increased$1,114,000 to$10,660,000 when comparing the third quarters of 2022 and 2021, with a$58,392,000 increase in average balances contributing to an increase in interest income of$542,000 and a 20-basis point increase in yield contributing to a$572,000 increase in interest income. Higher interest rates during the repricing period were partially offset by competitive pressures compressed the yields on new loans being originated. The largest category of the loan portfolio is commercial real estate loans. This category of loans includes commercial purpose loans secured by either commercial properties such as office buildings, factories, warehouses, hotels and restaurants, medical facilities and retail establishments, or residential real estate, usually the residence of the business owner. The category also includes construction and land development loans. Income on commercial real estate loans increased$1,067,000 when comparing the third quarters of 2022 and 2021, primarily due to increased average balances of$83,297,000 , or 14.7%, and a 13-basis point increase in rate from 4.09% in 2021 to 4.22% in 2022. 44 --------------------------------------------------------------------------------
QNB CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Income on commercial and industrial loans decreased$174,000 when comparing the third quarters of 2022 and 2021. The average yield on these loans increased 43 basis points to 5.25% resulting in an increase in income of$162,000 ; average balances decreased$27,681,000 , to$148,545,000 for the third quarter of 2022 resulting in a$336,000 decrease in interest income. Many of the loans in this category are indexed to the prime interest rate. Included in this category are the PPP loans; forgiveness of the PPP loans contributed approximately$32,756,000 of the net volume decrease and$761,000 of the decrease in interest. The PPP loans yield one percent to the customer; however, QNB received origination fees from the SBA ranging from a flat fee of$2,500 to one to five hundred basis points. The accretion of SBA origination fees is accelerated upon forgiveness of the loan. Income on PPP loan forgiveness was$44,000 for the third quarter of 2022 compared to$642,000 for the same period in 2021. Excluding the PPP loans, the average balance of commercial and industrial loan portfolio increased$5,075,000 and the yield increased 146 basis points, comparing the third quarter of 2022 to 2021. Tax-exempt loan income was$169,000 for the third quarter of 2022, a decrease of$48,000 , or 22.1%, from the same period in 2021. Average balances decreased$5,086,000 , or 20.7%, to$19,535,000 for the third quarter of 2022, resulting in a decrease of$44,000 in income. The yield on municipal loans decreased seven basis points, to 3.43% for the third quarter of 2022, compared with the same period in 2021, resulting in a decrease of$4,000 in interest income. The decrease in volume during 2022 was a result of municipal loans being refinanced as bonds. QNB desires to be the "local consumer lender of choice", focusing its retail lending efforts on product offerings and marketing and promotion. Interest income on residential mortgage loans secured by first lien 1-4 family increased$69,000 when comparing the third quarter of 2022 to the same period in 2021. Average residential mortgage loan balances increased by$8,377,000 , or 8.6%, to$105,723,000 for the third quarter of 2022 compared to the same period in 2021, which contributed a$69,000 increase in interest income. The average yield on the portfolio remained the same at 3.33% for the third quarters of 2022 and 2021. QNB chose to retain certain mortgage loans instead of selling them in the secondary market, as the yield on our originated mortgages was higher than comparable mortgage-backed securities. Average home equity loans increased by$56,000 to$56,669,000 ; interest income increased$197,000 as the average yield increased 137 basis points to 4.65%. The yield on the consumer portfolio increased 86 basis points to 5.76% for the third quarter of 2022 and there was a$571,000 decrease in average balances resulting in a net$3,000 increase in interest income. Earning assets are funded by deposits and borrowed funds. Interest expense increased$1,030,000 , when comparing the third quarter of 2022 to the same period in 2021. The growth in average deposits continues to be centered in accounts with greater liquidity. Average non-interest-bearing demand accounts increased$1,453,000 to$239,095,000 for the third quarter of 2022. Average interest-bearing demand accounts increased$29,000,000 , or 9.3%, to$342,011,000 for the third quarter of 2022. Interest expense on interest-bearing demand accounts increased$47,000 to$201,000 for the same period, as the average rate paid increased three basis points to 0.23% for the third quarter 2022. Included in this category is QNB-Rewards checking, a higher-rate checking account product that pays 1.10% on balances up to$25,000 and 0.15% for balances over$25,000 . In order to receive the high rate a customer must receive an electronic statement, have one direct deposit or other ACH transaction and have at least 12 check card purchase transactions post and clear per statement cycle. For the third quarter of 2022, the average balance in this product was$105,117,000 and the related interest expense was$93,000 for an average yield of 0.35%. In comparison, the average balance of the QNB-Rewards accounts for the third quarter of 2021 was$97,356,000 and the related interest expense was$87,000 for an average yield of 0.35%. This product also generates fee income through the use of the check card. Interest expense on municipal interest-bearing demand accounts increased$502,000 to$617,000 for the third quarter of 2022. The average interest rate paid on municipal interest-bearing demand accounts increased 145 basis points to 1.77% for the third quarter of 2022 over the third quarter of 2021, and average balances decreased$4,773,000 , or 3.3%, to$138,187,000 . Many of these accounts are indexed to the Federal funds rate with rate floors. Municipal deposits are seasonal in nature and are received during the second and third quarters as tax receipts are collected and are withdrawn over the course of the year. Average money market accounts increased$9,317,000 , or 7.4%, to$134,591,000 for the third quarter of 2022 compared with the same period in 2021. Interest expense on money market accounts increased$74,000 to$170,000 , and the average interest rate paid on money market accounts increased 20 basis point to 0.50% for the third quarter of 2022. Most of the balances in this category are in a product that pays a tiered rate based on account balances. Interest expense on savings accounts increased$316,000 when comparing the third quarter of 2022 to the third quarter of 2021. The average interest rate paid on savings accounts increased 24 basis points to 0.53% for the third quarter of 2022. When comparing these same periods, average savings accounts increased$56,891,000 , or 14.4%, to$451,871,000 for the third quarter of 2022 primarily due 45 --------------------------------------------------------------------------------
QNB CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS to increases in the e-Savings product. QNB's online e-Savings product is the largest category of savings deposits, with average balances for the third quarter of 2022 of$342,334,000 compared to$296,579,000 in the same period of 2021. The average yield paid on these accounts was 0.65% for the third quarter of 2022 and 0.35% for the same period in 2021. Traditional statement savings accounts, passbook savings and club accounts are also included in the savings category and average balances in these types of savings accounts increased$11,136,000 when comparing the third quarter of 2022 to the same period in 2021. Many of the Bank's maturing time deposits throughout 2021 and into 2022 were deposited to these liquid interest-bearing accounts. Interest expense on time deposits totaled$342,000 for the third quarter of 2022 compared to$371,000 in 2021. Average total time deposits decreased$5,369,000 to$169,913,000 for the third quarter of 2022. As with fixed-rate loans and investment securities, these deposits reprice over time and, therefore, have less of an immediate impact on costs in either a rising or falling rate environment; however, the maturity and repricing characteristics of time deposits tend to be shorter. The average rate paid on total time deposits decreased four basis points from 0.84% to 0.80% when comparing the third quarter of 2021 to the same period in 2022. Approximately$96,140,000 , or 55%, of time deposits atSeptember 30, 2022 will mature over the next 12 months. The average rate paid on these time deposits is approximately 0.70%. The yield on the time deposit portfolio may change in the next quarter as short-term time deposits reprice; however, given the short-term nature of these deposits, interest expense may increase if short-term time deposit rates were to increase suddenly or if customers select higher paying time deposits. Short-term borrowings were comprised primarily of sweep accounts structured as repurchase agreements with our commercial customers atSeptember 30, 2022 andSeptember 30, 2021 . AtSeptember 30, 2022 short-term borrowing also included overnight FHLB borrowing. Interest expense on short-term borrowings increased$121,000 for the third quarter of 2022 to$189,000 when compared to the same period in 2021. When comparing these same periods, average balances increased$7,263,000 to$85,943,000 . The yield on customer repos increased 15 basis points for the third quarter of 2022 to 0.49%. The yield on the short-term FHLB borrowing was 2.48% for the third quarter of 2022. During 2020, QNB borrowed long-term debt of$10,000,000 to lock in borrowing at a lower yield than short-term borrowings at that time.
Net Interest Income and Net Interest Margin - Nine-Month Comparison
For the nine-month period endingSeptember 30, 2022 , average earning assets increased$157,473,000 , or 10.5%, to$1,659,883,000 , with average investment securities increasing$180,078,000 and average loans increasing$13,906,000 , partially offset by a decrease in other earning assets of$36,511,000 . The increase in average loans excluding PPP loans, was$64,263,000 , an increase of 7.3%. Average total deposits increased$128,030,000 , or 9.6% to$1,459,662,000 for the nine-month period endedSeptember 30, 2022 compared to the same period in 2021. The net interest margin on a tax-equivalent basis was 2.72% for the nine-month period endedSeptember 30, 2022 , an 11-basis point decrease from the same period in 2021. Total interest income on a tax-equivalent basis increased$2,870,000 , or 8.1%, to$38,223,000 from$35,353,000 , when comparing the nine-month periods endedSeptember 30, 2022 andSeptember 30, 2021 primarily due to an increase in volume and rate on investment securities. Interest income increased$1,513,000 as a result of volume and increased$1,297,000 as a result of yields. The analysis of the nine-month comparison periods is similar to what was described in the quarterly analysis. The yield on earning assets decreased from 3.15% to 3.08% for the nine-month periods with the yield on loans down six basis points to 4.10%. QNB continues to experience pressure on yields due to competitive pressures on loan pricing. The yield on investments increased 13 basis points from 1.58% to 1.71% when comparing the nine-month periods. Total interest expense increased$951,000 for the nine-month period endedSeptember 30, 2022 compared with the same period in 2021, attributable to an increase in rates. The average rate paid on interest bearing deposits increased five basis points to 0.44% for the nine-month period endedSeptember 30, 2022 versus the same period in 2021. QNB invested proceeds from growth in deposits and non-interest-earning and interest-earning bank deposits, into investment securities. Proceeds from the payoff of PPP loans were utilized to fund loan growth. The average balance of total short-term borrowings increased$7,728,000 primarily due to overnight FHLB borrowing. The yield on interest-bearing liabilities increased six basis points to 0.46% for the nine months endedSeptember 30, 2022 . 46
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QNB CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
PROVISION FOR LOAN LOSSES AND ALLOWANCE FOR LOAN LOSSES
The provision for loan losses represents management's determination of the amount necessary to be charged to operations to bring the allowance for loan losses to a level that represents management's best estimate of the known and inherent losses in the existing loan portfolio. Management believes that it uses the best information available to make determinations about the adequacy of the allowance and that it has established its existing allowance for loan losses in accordance withU.S. GAAP. The determination of an appropriate level for the allowance for loan losses is based upon an analysis of the risks inherent in QNB's loan portfolio. Management, in determining the allowance for loan losses, makes significant estimates and assumptions. Since the allowance for loan losses is dependent, to a great extent, on conditions that may be beyond QNB's control, it is at least reasonably possible that management's estimates of the allowance for loan losses and actual results could differ. In addition, various regulatory agencies, as an integral part of their examination process, periodically review QNB's allowance for losses on loans. Such agencies may require QNB to recognize changes to the allowance based on their judgments about information available to them at the time of their examination. Actual loan losses, net of recoveries, serve to reduce the allowance. Management closely monitors the quality of its loan portfolio and performs a quarterly analysis of the appropriateness of the allowance for loan losses. This analysis considers several relevant factors including specific impairment reserves, historical loan loss experience, general economic conditions, levels of and trends in delinquent and non-performing loans, levels of classified loans, trends in the growth rate of loans and concentrations of credit. Based on this analysis, QNB recorded no provision for the three months endedSeptember 30, 2022 and for the same period in 2021. QNB's allowance for loan losses of$11,338,000 represents 1.12% of loans receivable atSeptember 30, 2022 compared with an allowance for loan losses of$11,184,000 , or 1.21% of loans receivable, atDecember 31, 2021 , and$11,214,000 , or 1.21% of loans receivable, atSeptember 30, 2021 . Management believes the allowance for loan losses atSeptember 30, 2022 is adequate as of that date based on its analysis of known and inherent losses in the portfolio. Excluding PPP loans, the allowance level stated as a percent of loans receivable was 1.13% atSeptember 30, 2022 , 1.23% atDecember 31, 2021 , and 1.25% atSeptember 30, 2021 . Net recoveries were$41,000 for the three months endedSeptember 30, 2022 compared to net recoveries of$12,000 for the three months endedSeptember 30, 2021 . Charge-offs of approximately$92,000 during the three months endedSeptember 30, 2022 consisted of one commercial loan of$30,000 , one student loan of$37,000 and overdrafts of$25,000 . These were offset by$133,000 in recoveries comprising$123,000 in repayments from borrowers of previously charged-off credits, and$10,000 related to overdraft recoveries. Annualized net recoveries as a percentage of average loans receivable were 0.02% for the three months endedSeptember 30, 2022 , compared to annualized net recoveries of 0.01% for the three months endedSeptember 30, 2021 . Net recoveries were$154,000 for the nine months endedSeptember 30, 2022 compared to net charge-offs of$70,000 for the nine months endedSeptember 30, 2021 . Charge-offs of approximately$147,000 during the nine months endedSeptember 30, 2022 consisted primarily of commercial loans of$38,000 , consumer loans of$54,000 and overdrafts of$55,000 . These were offset by$301,000 in recoveries comprising$280,000 in repayments from borrowers of previously charged-off credits, and$21,000 related to overdraft recoveries. Annualized net recoveries as a percentage of average loans receivable were 0.02% for the nine months endedSeptember 30, 2022 , compared to annualized net charge-offs of 0.01% for the nine months endedSeptember 30, 2021 . Non-performing assets were$10,694,000 atSeptember 30, 2022 compared to$11,672,000 as ofDecember 31, 2021 and$12,144,000 atSeptember 30, 2021 . Total non-performing loans, which represent loans on non-accrual status, loans past due 90 days or more and still accruing interest and restructured loans, were 1.06% of loans receivable atSeptember 30, 2022 , 1.26% atDecember 31, 2021 , and 1.31% of loans receivable atSeptember 30, 2021 . In cases where there is a collateral shortfall on non-accrual loans, specific impairment reserves have been established based on updated collateral values even if the borrower continues to pay in accordance with the terms of the agreement. AtSeptember 30, 2022 ,$3,889,000 , or approximately 61% of the loans classified as non-accrual, are current or past due less than 30 days. Commercial loans classified as substandard or doubtful totaled$17,554,000 , a decrease of$977,000 , or 5.3%, from the$18,531,000 reported atDecember 31, 2021 and a decrease of$1,976,000 , or 7.3%, from the$18,946,000 reported atSeptember 30, 2021 . The decrease in classified loans sinceDecember 31, 2021 and sinceSeptember 30, 2021 is primarily due to repayments and pay-offs on existing substandard loans. QNB had no loans past due 90 days or more and still accruing interest atSeptember 30, 2022 ,December 31, 2021 , orSeptember 30, 2021 . Total loans 30 days or more past due, which includes non-accrual loans by actual number of days delinquent, represented 0.30% of loans receivable atSeptember 30, 2022 compared with 0.46% atDecember 31, 2021 , and 0.55% atSeptember 30, 2021 . 47 --------------------------------------------------------------------------------
QNB CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Troubled debt restructured loans, not classified as non-accrual loans or loans past due 90 days or more and accruing, were$4,357,000 atSeptember 30, 2022 , compared with$4,142,000 atDecember 31, 2021 , and$4,317,000 atSeptember 30, 2021 . There were two new troubled debt restructuring identified during the nine months endedSeptember 30, 2022 , as QNB extended credit to an existing TDR customer and the other was having temporary cash-flow issues. QNB had no other real estate owned or repossessed assets atSeptember 30, 2022 ,December 31, 2021 , orSeptember 30, 2021 . A loan is considered impaired, based on current information and events, if it is probable that QNB will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and shortfalls on a case-by-case basis, taking into consideration all the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower's prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent.
The following table shows detailed information and ratios pertaining to the Company's loan and asset quality:
September 30 ,
2022 2021 2021
Non-accrual loans $ 6,337 $ 7,530 $ 7,827
Loans past due 90 days or more and still
accruing interest - - -
Troubled debt restructured loans (not
already included above) 4,357 4,142 4,317
Total non-performing loans 10,694 11,672 12,144
Total non-performing assets $ 10,694 $ 11,672 $ 12,144
Total loans (excluding loans held-for-sale):
Average total loans (YTD) $ 949,691 $ 928,017 $ 931,080
Total loans 1,008,306 926,470 923,778
Allowance for loan losses 11,338 11,184 11,214
Allowance for loan losses to:
Non-performing loans 106.02 % 95.82 % 92.34 %
Total loans (excluding held-for-sale) 1.12 % 1.21 % 1.21 %
Average total loans (excluding
held-for-sale) 1.19 % 1.21 % 1.20 %
Non-performing loans / total loans
(excluding held-for-sale) 1.06 % 1.26 % 1.31 %
Non-performing assets / total assets 0.65 % 0.70 % 0.73 %
An analysis of net loan charge-offs (recoveries) for the three and nine months
ended
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
Net (recoveries) charge-offs $ (41 ) $ (12 ) $ (154 ) $ 70
Net annualized (recoveries) charge-offs to:
Total loans (0.02 %) (0.01 %) -0.02 % 0.01 %
Average total loans excluding held-for-sale (0.02 %) (0.01 %) -0.02 % 0.01 %
Allowance for loan losses (1.43 %) (0.42 %) -1.82 % 0.84 %
48--------------------------------------------------------------------------------
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
At September 30, 2022 and December 31, 2021 , the recorded investment in loans
for which impairment has been identified totaled $11,126,000 and $12,192,000 of
which $6,915,000 and $4,633,000 , respectively, required no specific allowance
for loan loss. The recorded investment in impaired loans requiring an allowance
for loan losses was $4,211,000 and $7,559,000 at September 30, 2022 and December
31, 2021 , respectively, and the related allowance for loan losses associated
with these loans was $1,486,000 and $2,873,000 , respectively. Most of the loans
that have been identified as impaired are collateral-dependent. See Note 8 to
the Notes to Consolidated Financial Statements for additional detail of impaired
loans.
NON-INTEREST INCOME
Non-Interest Income
Comparison
For the Three Months Ended For the Nine Months Ended
September 30, Change from prior year September 30, Change from prior year
2022 2021 Amount Percent 2022 2021 Amount Percent
Net gain on sales of
investment securities $ - $ 404 $ (404 ) -100.0 % $ 493 $ 1,040 $ (547 ) -52.6 %
Unrealized gain (loss)
on investment equity
securities (1,174 ) (836 ) (338 ) 40.4 (2,628 ) 839 (3,467 ) (413.2 )
Fees for services to
customers 423 363 60 16.5 1,210 958 252 26.3
ATM and debit card 669 687 (18 ) (2.6 ) 2,015 1,989 26 1.3
Retail brokerage and
advisory 194 218 (24 ) (11.0 ) 604 578 26 4.5
Bank-owned life
insurance 121 87 34 39.1 277 423 (146 ) (34.5 )
Merchant 98 122 (24 ) (19.7 ) 302 345 (43 ) (12.5 )
Net gain on sale of
loans 6 65 (59 ) (90.8 ) 6 537 (531 ) (98.9 )
Other 147 205 (58 ) (28.3 ) 455 544 (89 ) (16.4 )
Total $ 484 $ 1,315 $ (831 ) -63.2 % $ 2,734 $ 7,253 $ (4,519 ) -62.3 %
Quarter to Quarter Comparison
Total non-interest income for the third quarter of 2022 was$484,000 , a decrease of$831,000 , compared to$1,315,000 for the third quarter of 2021. Excluding realized and unrealized gains (losses) on equity securities, gains on sales of loans, anti-trust settlement of$37,000 in 2021 and claims on bank-owned life insurance of$46,000 in 2022, non-interest income decreased$43,000 , or 2.6%, to$1,606,000 for the quarter endedSeptember 30, 2022 compared with the same period in 2021 During the third quarter of 2022, unrealized losses on investment equity securities of$1,174,000 were recorded compared to losses of$836,000 in the same period of 2021. The unrealized losses and gains for the three months endedSeptember 30, 2022 and 2021 resulted from the change in the fair value of the equities included in the investment portfolio. The equities portfolio comprises blue-chip large-capitalized stocks, providing a year-to-date taxable equivalent dividend yield of 3.26%. The estimated cumulative contribution (realized and unrealized net gains (losses), plus dividends) of the equity portfolio to earnings per share fromJanuary 1, 2011 throughSeptember 30, 2022 is$2.07 per diluted share. Details of the equity portfolio's contribution to net income sinceJanuary 1, 2015 is detailed in the following table. 49 -------------------------------------------------------------------------------- QNB CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Net Income (Expense) on Equity Securities For the Year Ended December 31, For the Nine Months Ended September 30, 2015 2016 2017 2018 2019 2020 2021 2022 2021 Equity Securities: Tax-equivalent dividends*$ 244 $ 233 $ 249 $ 300 $
274
489 1,022
OTTI (55 ) (192 ) (80 ) N/A N/A N/A N/A N/A N/A
Unrealized (loss) gain N/A N/A N/A (336 )
770 (47 ) 926 (2,628 ) 839 Tax-equivalent income before tax 880 799 1,726 (115 ) 2,825 930 3,151 (1,842 ) 2,187
Tax expense (benefit)* 357 324 700 (33 )
816 269 910 (532 ) 631 Net income$ 523 $ 475 $ 1,026 $ (82 ) $
2,009
Earnings per share - basic$ 0.16 $ 0.14 $ 0.30 $ (0.02 ) $
0.57
$ 0.16 $ 0.14 $ 0.30 $ (0.02 ) $
0.57
2.98 %
*Based on Federal tax rates of 34% for the 2015 and 2016 periods and 21% for all 2017, 2018, 2019, 2020, 2021 and 2022 periods.
QNB originates residential mortgage loans for sale in the secondary market. Net gain on sale of loans decreased$59,000 when comparing the third quarter of 2022 to the third quarter of 2021. The net gain on residential mortgage sales is directly related to the volume of mortgages sold and the timing of the sales relative to the interest rate environment. Residential mortgage loans to be sold are identified at origination. Proceeds from the sale of residential mortgages were$304,000 and$1,899,000 for the third quarters of 2022 and 2021, respectively. Fees for services to customers increased$60,000 to$423,000 for the third quarter of 2022, due primarily to an increase in net overdraft income. ATM and debit card income decreased$18,000 to$669,000 for the third quarter of 2022, compared to the same period in 2021, due primarily to debit card interchange fee income. QNB provides securities and advisory services under the nameQNB Financial Services . Retail brokerage and advisory fees decreased for the third quarter of 2022 compared to the same period in 2021. Advisory fees decreased$9,000 for the third quarter of 2022 compared with the same period in 2021 due to a decrease in the value of assets under management, while transactional fees decreased$15,000 when comparing the third quarters of 2022 and 2021 due to less sales of annuity products. Bank-owned life insurance income includes a life insurance benefit claim of$46,000 in 2022. Merchant income decreased by$24,000 to$98,000 for the third quarter of 2022, compared to the same period in 2021. Other non-interest income decreased$58,000 . QNB recorded$37,000 in other income due to an anti-trust class action settlement related to the purchase and sale of US government agency securities over several years. There was a decrease in title company income of$14,000 due to the decreased volume of mortgage originations and a decrease of$10,000 in mortgages servicing fees. Nine-Month Comparison 50
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QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Total non-interest income for the nine-month periods ended September 30, 2022
and 2021 was $2,734,000 and $7,253,000 , respectively, a decrease of
$4,519,000 . Excluding realized and unrealized gain and losses on equity
securities, gains on sales of loans, anti-trust settlement of $37,000 in 2021
and claims on bank-owned life insurance of $46,000 in 2022 and $193,000 in 2021,
total non-interest income was $4,821,000 and $4,625,000 , respectively, an
increase of $196,000 , or 4.2%.
Net investment securities gains decreased $547,000 to $493,000 for the nine
months ended September 30, 2022 compared to $1,040,000 for the comparable nine
months in 2021. Market conditions in the equities market for the nine months
ended September 30, 2021 versus the same period in 2022 resulted in greater
opportunities for profitable sales in 2021. QNB recorded unrealized losses of
$2,628,000 compared to gains of $839,000 on equity securities for the nine
months ended September 30, 2022 and 2021, respectively.
Net gains on sales of loans decreased to $6,000 from $537,000 , when comparing
the nine months ended September 30, 2022 to the same period in 2021. Proceeds
from the sale of residential mortgages were $304,000 and $15,023,000 for the
nine-month periods ended September 30, 2022 and 2021, respectively.
Fees for services to customers increased $252,000 to $1,210,000 for the third
quarter of 2022, due primarily to an increase in net overdraft income. ATM and
debit card increased $26,000 for the nine months of 2022 compared to 2021, due
to increased interchange income.
Retail brokerage and advisory fees increased $26,000 , or 4.5%, to $604,000 for
the nine months ended September 30, 2022 compared to the same period in 2021;
advisory fees increased $50,000 and transaction-based fees decreased $24,000 .
Bank-owned life insurance income includes a life insurance benefit claim of
$46,000 in 2022 and $193,000 in 2021. Merchant income decreased $43,000 . Other
non-interest income decreased $89,000 . QNB recorded $37,000 in other income due
to an anti-trust class action settlement related to the purchase and sale of US
government agency securities over several years. Mortgage servicing income
increased $26,000 when comparing the two periods primarily due to an increase in
the fair value of servicing rights. There was a decrease in title company income
of $61,000 and letter of credit fees of $19,000 ; partly offset by a $19,000
increase in credit card income for the nine months of 2022 compared to 2021.
NON-INTEREST EXPENSE
Non-Interest
Expense
Comparison
For the Three Months Ended For the Nine Months Ended
September 30, Change from prior year September 30, Change from prior year
2022 2021 Amount Percent 2022 2021 Amount Percent
Salaries and
employee
benefits $ 4,371 $ 4,554 $ (183 ) -4.0 % $ 12,842 $ 12,913 $ (71 ) -0.5 %
Net occupancy 535 535 - - 1,663 1,688 (25 ) (1.5 )
Furniture and
equipment 779 714 65 9.1 2,190 2,054 136 6.6
Marketing 141 180 (39 ) (21.7 ) 632 655 (23 ) (3.5 )
Third-party
services 582 470 112 23.8 1,839 1,552 287 18.5
Telephone,
postage and
supplies 187 158 29 18.4 555 532 23 4.3
State taxes 272 238 34 14.3 732 738 (6 ) (0.8 )
FDIC insurance
premiums 177 195 (18 ) (9.2 ) 574 577 (3 ) (0.5 )
Other 770 746 24 3.2 2,346 2,153 193 9.0
Total $ 7,814 $ 7,790 $ 24 0.3 % $ 23,373 $ 22,862 $ 511 2.2 %
Quarter to Quarter Comparison
Total non-interest expense was
51
--------------------------------------------------------------------------------QNB CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Salaries and benefits comprise the largest component of non-interest expense. QNB monitors, through the use of various surveys, the competitive salary and benefit information in its markets and makes adjustments when appropriate. Salaries and benefits expense decreased$183,000 , or 4.0%, to$4,371,000 when comparing the two quarters. Salary expense and related payroll taxes decreased$172,000 to$3,727,000 during the third quarter of 2022 compared to the same period in 2021 due to a reduction in the bonus and related tax accruals of$263,000 ; partly offset by an increase in salary and related taxes of$82,000 . Medical and dental premiums, net of employee contributions, decreased$31,000 when comparing the two quarters due to a decrease in medical claims. Net occupancy and furniture and equipment expenses combined increased$65,000 , or 5.2%, when comparing the third quarters of 2022 and 2021. This is due primarily to increased software maintenance expense. Marketing expense decreased$39,000 , or 21.7%, to$141,000 for the quarter endedSeptember 30, 2022 , due to timing of promotions and community support donations. Third-party services are comprised of professional services, including legal, accounting, auditing and consulting services, as well as fees paid to outside vendors for support services of day-to-day operations. These support services include correspondent banking services, IT services, statement printing and mailing, investment security safekeeping and supply management services. Third party services expense increased$112,000 primarily due to costs association with the Bank's core system conversion. State taxes increased$34,000 , or 14.3%, due to the timing of$36,000 in tax credits received in the second quarter of 2022 versus the third quarter of 2021.FDIC insurance premiums decreased$18,000 due to a reduction in the assessment rate. Other non-interest expense increased$24,000 , or 3.2%, due to additional loss reserves on unused commitments of$14,000 , travel, entertainment, training, membership and licensing costs of$22,000 , appraisal costs of$15,000 , bond insurance of$11,000 , and check-card expense of$9,000 ; partially offset by a$45,000 reimbursement from a customer for insurance costs paid by the Bank.
Nine-Month Comparison
Total non-interest expense was
Salaries and benefits expense decreased$71,000 to$12,842,000 for the nine months endedSeptember 30, 2022 compared to the same period in 2021. Salary and related payroll tax expense decreased$112,000 during the period, to$10,869,000 while medical and dental premiums, net of employee contributions, increased$25,000 , to$1,031,000 . Net occupancy and furniture and equipment expense increased$111,000 , or 3.0%, to$3,853,000 , due to the reasons described in the quarter comparison. Third-party services increased$287,000 , or 18.5%, to$1,839,000 for the nine months endedSeptember 30, 2022 due to the reasons described in the quarter comparison.FDIC insurance premiums decreased$3,000 and state taxes decreased$6,000 . Other non-interest expense increased due to the reasons described above in the quarter comparison. INCOME TAXES QNB utilizes an asset and liability approach for financial accounting and reporting of income taxes. As ofSeptember 30, 2022 , QNB's net deferred tax asset was$25,884,000 . The primary components of deferred taxes are deferred tax assets of which$23,784,000 relates to investment securities fair value adjustments and$2,381,000 relates to the allowance for loan losses. As ofDecember 31, 2021 , QNB's net deferred tax asset was$2,449,000 of which$994,000 related to investment securities fair value adjustments and$2,349,000 was related to the allowance for loan losses. The increase in the balance of net deferred tax assets when comparingSeptember 30, 2022 toDecember 31, 2021 is due to the increase in unrealized losses on available for sale securities atSeptember 30, 2022 compared toDecember 31, 2021 , contributing$22,790,000 of the increase. The realizability of deferred tax assets is dependent upon a variety of factors, including the generation of future taxable income, the existence of taxes paid and recoverable, the reversal of deferred tax liabilities and tax planning strategies. Based upon these and other factors, management believes it is more likely than not that QNB will realize the benefits of these remaining deferred tax assets. Applicable income tax expense was$634,000 for the quarter, and$2,105,000 for the nine months endedSeptember 30, 2022 , compared to$685,000 for the quarter and$2,909,000 for the nine months endedSeptember 30, 2021 . The effective tax rate for the third quarter and nine-month period endedSeptember 30, 2022 was 15.7% and 16.7%, respectively, compared with 16.7% and 19.1%, 52 --------------------------------------------------------------------------------
QNB CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS respectively, for the same period in 2021. The decrease in the effective tax rate for the nine months endedSeptember 30, 2022 is due to the state income tax at the parent company related to higher gains in 2021 compared to 2022 on the equities portfolio; and as pre-tax income was lower in 2022 compared to 2021, there was a higher proportion of tax-exempt net interest income to income before taxes for 2022 over 2021.
FINANCIAL CONDITION ANALYSIS
Financial service organizations are challenged to demonstrate they can generate sustainable and consistent earnings growth in a dynamic operating environment. Rate competition for quality loans is anticipated to continue through 2022. It is also anticipated that the rate competition for attracting and retaining deposits may increase in 2022, which could result in a lower net interest margin and a decline in net interest income. QNB's primary business is accepting deposits and making loans to meet the credit needs of the communities it serves. Loans are the most significant component of earning assets and growth in loans to small businesses and residents of these communities has been a primary focus of QNB. Inherent within the lending function is the evaluation and acceptance of credit risk and interest rate risk. QNB manages credit risk associated with its lending activities through portfolio diversification, underwriting policies and procedures and loan monitoring practices. QNB is committed to make credit available to its customers.
Total assets at
The fixed-income securities portfolio represents a significant portion of QNB's earning assets and is also a primary tool in liquidity and asset/liability management. QNB actively manages its fixed income portfolio to take advantage of changes in the shape of the yield curve and changes in spread relationships in different sectors and for liquidity purposes. Management continually reviews strategies that will result in an increase in the yield or improvement in the structure of the investment portfolio, including monitoring credit and concentration risk in the portfolio. The available-for-sale securities portfolio decreased$136,650,000 , due to a reduction of the fair value mark of$108,522,000 and maturities and prepayments of$61,413,000 ; partly offset by purchases of$35,001,000 . Loans receivable increased$81,836,000 with commercial loans increasing$71,755,000 to$832,140,000 atSeptember 30, 2022 , compared with$760,385,000 at year-end 2021. Excluding PPP loans, commercial loans increased$83,723,000 . Retail loan balances increased$9,659,000 comparingSeptember 30, 2022 toDecember 31, 2021 . AtSeptember 30, 2022 , QNB had 4 PPP loans totaling$2,359,000 reported in commercial and industrial loans. In 2020, the Bank originated$82,475,000 in PPP loans, enabling 660 businesses to maintain their payrolls and stay in operation. Of this first round of funding, 657 loans have been forgiven in full and$80,544,000 in balances have been forgiven. The Bank originated 315 PPP loans, or$35,021,000 , during the second round of funding which started inJanuary 2021 . Second-draw customers made up 244 of these loans, or$32,240,000 , and one-draw customers made of the remaining 71 loans, or$2,781,000 . Of this second round of funding, 314 loans have been forgiven in full and$33,021,000 in balances have been forgiven. Excluding PPP loans net of deferred fees atSeptember 30, 2022 and atDecember 31, 2021 , loans receivable would have increased$93,364,000 , or 10.2%, since year-end 2021. Deposits grew$26,923,000 fromDecember 31, 2021 toSeptember 30, 2022 . Non-interest-bearing demand deposits decreased$6,839,000 , with balances of$236,167,000 atSeptember 30, 2022 compared with$243,006,000 at year-end 2021. Interest-bearing demand balances, excluding municipal deposits, increased$8,112,000 , or 12.4%, to$347,519,000 , with increases in personal interest-bearing checking and the business checking product. The$9,424,000 decrease in money market accounts was limited primarily to business products. The$15,598,000 increase in savings was primarily due to growth in the E-Savings on-line product. Total time deposits increased$6,656,000 fromDecember 31, 2021 toSeptember 30, 2022 . Municipal deposit balances increased$12,820,000 , to$141,612,000 , during the first nine months of 2022. Municipal deposits can be volatile depending on the timing of deposits and withdrawals, and the cash flow needs of the school districts or municipalities. Municipal deposits increase as tax money is received from the local school districts during first and second quarters and it is anticipated that these funds will flow out for the subsequent twelve months as the schools use the funds for operations. These deposits provide an incremental funding source as they are used to fund loans as opposed to borrowing at a higher rate; this improves the net interest margin as it increases the spread related to the net interest margin. Short-term borrowings increased 35.7%, from$68,476,000 atDecember 31, 2021 to$92,896,000 atSeptember 30, 2022 . Commercial sweep accounts comprised most of balance of the short-term borrowing in both periods and increased$2,448,000 ; these funds may be volatile based on businesses' receipt and disbursement of funds and is offset by business non-interest-bearing demand accounts. There 53 --------------------------------------------------------------------------------
QNB CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS were$21,972,000 in overnight borrowings from FHLB atSeptember 30, 2022 , and none atDecember 31, 2021 . In 2020, QNB borrowed long-term debt from the FHLB of$10,000,000 to lock in a rate at a low yield.
LIQUIDITY
Liquidity represents an institution's ability to generate cash or otherwise obtain funds at reasonable rates to satisfy demand for loans and deposit withdrawals. QNB attempts to manage its mix of cash and interest-bearing balances, Federal funds sold and investment securities to match the volatility, seasonality, interest sensitivity and growth trends of its loans and deposits. The Company manages its liquidity risk by measuring and monitoring its liquidity sources and estimated funding needs. Liquidity is provided from asset sources through repayments and maturities of loans and investment securities. The portfolio of investment securities classified as available for sale and QNB's policy of selling certain residential mortgage originations in the secondary market also provide sources of liquidity. Core deposits and cash management repurchase agreements have historically been the most significant funding source for QNB. These deposits and repurchase agreements are generated from a base of consumers, businesses and public funds primarily located in the Company's market area. Additional sources of liquidity are provided by the Bank's membership in the FHLB. AtSeptember 30, 2022 the Bank had a maximum borrowing availability with the FHLB of approximately$342,627,000 , which is net of the$10,000,000 in long-term borrowings, short-term borrowings of$21,971,000 , a$350,000 letter of credit and accrued interest payable. The maximum borrowing depends upon qualifying collateral assets and the Bank's asset quality and capital adequacy. In addition, the Bank maintains unsecured Federal funds lines with five correspondent banks totaling$101,000,000 . AtSeptember 30, 2022 there were no outstanding borrowings under these lines. Future availability under these lines is subject to the policies of the granting banks and may be withdrawn. Liquid sources of funds, including cash, available-for-sale and equity investment securities, and loans held-for-sale have decreased$134,788,000 sinceDecember 31, 2021 , totaling$583,372,000 atSeptember 30, 2022 . The reduction in the liquid sources of funds is primarily due to a reduction of the fair value mark on the available-for-sale securities of$108,522,000 . Growth in deposits provided cash flows$26,923,000 , net proceeds from available-for-sale investment activities provided$26,412,000 , and net short-term borrowings provided$24,420,000 ; these were used to fund loans. Management expects these liquid sources will be adequate to meet normal fluctuations in loan demand or deposit withdrawals. The investment portfolio is expected to continue to provide sufficient liquidity, as municipal bonds are called or mature and cash flow on mortgage-backed and CMO securities continues to be steady.
Approximately
QNB is a member of the Certificate of Deposit Account Registry Services (CDARS) program offered by thePromontory Interfinancial Network, LLC . CDARS is a funding and liquidity management tool used by banks to access funds and manage their balance sheet. It enables financial institutions to provide customers with fullFDIC insurance on time deposits over$250,000 that are placed in the program. QNB also has available Insured Cash Sweep (ICS), another program throughPromontory Interfinancial Network, LLC , which is a product similar to CDARS, but one that provides liquidity like a money market or savings account.
CAPITAL ADEQUACY
A strong capital position is fundamental to support continued growth and profitability and to serve the needs of depositors. QNB's shareholders' equity atSeptember 30, 2022 was$58,124,000 , or 3.53% of total assets, compared with shareholders' equity of$136,494,000 , or 8.16% of total assets, atDecember 31, 2021 . Shareholders' equity atSeptember 30, 2022 included a negative adjustment of$89,472,000 compared to a negative adjustment of$3,740,000 atDecember 31, 2021 , related to unrealized holding losses, net of taxes, on investment securities available-for-sale. Without these adjustments, shareholders' equity to total assets would have been 8.51% and 8.36% atSeptember 30, 2022 andDecember 31, 2021 , respectively. Average shareholders' equity and average total assets were$144,676,000 and$1,701,272,000 for the nine months endedSeptember 30, 2022 , an increase of 8.0% and 9.3%, respectively, from the averages for the nine months endedSeptember 30, 2021 . The ratio of average total equity to average total assets was 8.50% for the nine months endedSeptember 30, 2022 compared to 8.61% for the same period in 2021. Retained earnings atSeptember 30, 2022 were impacted by nine months of net income totaling$10,474,000 offset by dividends declared and paid of$3,845,000 for the nine-month period. QNB offers a Dividend Reinvestment and Stock Purchase Plan (the 54 --------------------------------------------------------------------------------
QNB CORP. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS "Plan") to provide participants a convenient and economical method for investing cash dividends paid on the Company's common stock in additional shares. The Plan also allows participants to make additional cash purchases of stock. Stock purchases under the Plan contributed$683,000 to capital during the nine months endedSeptember 30, 2022 . The Board of Directors has authorized the repurchase of up to 200,000 shares of QNB common stock in open market or privately negotiated transactions. The repurchase authorization does not bear a termination date. As ofSeptember 30, 2022 , 102,000 shares have been repurchased since the initial authorization at an average price of$24.93 and a total cost of$2,543,000 . QNB is subject to various regulatory capital requirements as issued by Federal regulatory authorities. Regulatory capital is defined in terms of Tier 1 capital and Tier 2 capital. Risk-based capital ratios are expressed as a percentage of risk-weighted assets. Risk-weighted assets are determined by assigning various weights to all assets and off-balance sheet arrangements, such as letters of credit and loan commitments, based on associated risk. The required minimum Common equity Tier 1 capital to risk-weighted assets ratio is 4.5%, the required minimum ratio of Tier 1 capital to risk-weighted assets is 6.0%, the required minimum ratio of Total Capital to risk-weighted assets is 8.0%, and the required minimum Tier 1 leverage ratio is 4.0%. A capital conservation buffer of 2.5% of risk-weighted assets also applies to avoid limitations on certain capital distributions.
The following table sets forth consolidated information for QNB:
September 30, December 31,
Capital Analysis 2022 2021
Regulatory Capital
Shareholders' equity $ 58,124 $ 136,494
Net unrealized securities losses, net of tax 89,472 3,740
Deferred tax assets on net operating loss - -
Disallowed intangible assets (8 ) (8 )
Common equity tier I capital 147,588 140,226
Tier 1 capital 147,588 140,226Allowable portion: Allowance for loan losses and reserve
for unfunded commitments 11,450 11,275 Total regulatory capital$ 159,038 $ 151,501 Risk-weighted assets$ 1,220,589 $ 1,113,887 Quarterly average assets for leverage capital purposes$ 1,727,124 $ 1,672,259 September 30, December 31, Capital Ratios 2022 2021 Common equity tier I capital / risk-weighted assets 12.09 % 12.59 % Tier 1 capital / risk-weighted assets 12.09
12.59
Total regulatory capital / risk-weighted assets 13.03
13.60
Tier 1 capital / average assets (leverage ratio) 8.55
8.39
At
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