QNB CORP. Results of Operations - Overview
QNB Corp. ("QNB" or the "Company") earns its net income primarily through its subsidiary,QNB Bank (the "Bank"). Net interest income, or the spread between the interest, dividends and fees earned on loans and investment securities and the expense incurred on deposits and other interest-bearing liabilities, is the primary source of operating income for QNB. QNB seeks to achieve sustainable and consistent earnings growth while maintaining adequate levels of capital and liquidity and limiting its exposure to credit and interest rate risk levels approved by the Board of Directors. Due to its limited geographic area, comprised principally of Bucks, Lehigh and Montgomery counties, growth is pursued through expansion of existing customer relationships and building new relationships by stressing a consistent high level of service at all points of contact.
Tabular information presented throughout management's discussion and analysis, other than share and per share data, is presented in thousands of dollars.
The following table displays five years of selected financial amounts and ratios for the QNB: Year ended December 31, 2022 2021 2020 2019 2018 Income and expense Net interest income$ 44,497 $ 42,127 $ 37,248 $ 36,294 $ 35,015 Provision for loan losses (850 ) 458 1,250 1,300 1,130 Non-interest income 5,731 9,781 7,602 8,317 4,892 Non-interest expense 31,492 30,997 28,955 28,104 25,885 Net income 15,921 16,492 12,083 12,357 11,335 Share and Per Share Data Net income - basic$ 4.47 $ 4.64 $ 3.42 $ 3.53 $ 3.27 Net income - diluted 4.47 4.64 3.42 3.53 3.25 Book value 19.78 38.41 37.80 34.30 29.95 Cash dividends 1.44 1.40 1.36 1.32 1.28 Average common shares outstanding - basic 3,564,481 3,553,949 3,537,323 3,498,326 3,463,450 Average common shares outstanding - diluted 3,564,481 3,554,138
3,537,360 3,504,150 3,482,509
Balance Sheet at Year-end Investment securities$ 558,581 $ 704,770 $ 448,495 $ 358,874 $ 353,642 Loans receivable 1,039,385 926,470 920,042 820,616 785,448 Allowance for loan losses (10,531 ) (11,184 ) (10,826 ) (9,887 ) (8,834 ) Other earning assets 1,242 4,196 25,909 5,210 570 Total assets 1,668,497 1,673,340 1,440,229 1,225,023 1,175,452 Deposits 1,418,369 1,449,745 1,228,067 1,037,860 1,015,598 Borrowed funds 171,327 78,476 68,838 55,931 50,872 Shareholders' equity 70,958 136,494 134,445 120,717 104,348 Selected Financial Ratios Net interest margin 2.71 % 2.79 % 2.92 % 3.16 % 3.13 % Net income as a percentage of: Average total assets 0.93 1.04 0.90 1.02 0.96 Average shareholders' equity 10.90 12.19 9.76 10.58 10.47 Average shareholders' equity to average total assets 8.54 8.53 9.21 9.63 9.20 Dividend payout ratio 32.24 30.15 39.82 37.39 39.12 Net income for the year endedDecember 31, 2022 was$15,921,000 , or$4.47 per share on a diluted basis. This compares to 2021 net income of$16,492,000 , or$4.64 per share on a diluted basis and 2020 net income of$12,083,000 , or$3.42 per share on a diluted basis. Two important measures of profitability in the banking industry are an institution's return on average assets and return on average shareholders' equity. Return on average assets was 0.93%, 1.04% and 0.90% in 2022, 2021, and 2020, respectively, and return on average shareholders' equity was 10.90%, 12.19% and 9.76%, respectively, during those same periods. - 18 - -------------------------------------------------------------------------------- The Bank contributed$16,445,000 to net income for the year endedDecember 31, 2022 compared to$14,607,000 for the same period in 2021; whereas the holding company reduced consolidated net income with a loss of$524,000 for the year endedDecember 31, 2022 compared to a contribution of$1,885,000 for the same period in 2021. The decrease at the holding company resulted primarily from a decrease in gains on sales of equity securities and a decrease in the fair value of the equity portfolio during 2022.
2022 versus 2021
The results for 2022 include the following significant components:
• Net interest income increased
• The net interest margin on a tax-equivalent basis decreased eight basis
points to 2.71% for 2022 from 2.79% for 2021.
• Provision for loan losses was a credit of
expense of $458,000 for 2021.
• Non-interest income for 2022 was
41.4%, compared with 2021.
• Non-interest expense for 2022 was
1.6%, compared with 2021.
• The fair value of the investment securities declined
21.1% from December 31, 2021 .
• Loans receivable grew $112,915,000 , or 12.2%, from December 31, 2021 .
• Deposits decreased $31,376,000 , or 2.2%, from December 31, 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
receivable at
2021. Net recoveries for 2022 were
loans, as compared with net charge-offs of
total loans for 2021.
2021 versus 2020
The results for 2021 include the following significant components:
• Net interest income increased
• The net interest margin on a tax-equivalent basis decreased 13 basis
points to 2.79% for 2021 from 2.92% for 2020.
• Provision for loan losses totaled
$1,250,000 for 2020.
• Non-interest income for 2021 was
28.7%, compared with 2020.
• Non-interest expense for 2021 was
or 7.1%, compared with 2020.
• Investment securities grew
• Loans receivable grew$6,428,000 , or 0.7%, fromDecember 31, 2020 . • Deposits increased$221,678,000 , or 18.1%, fromDecember 31, 2020 .
• 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
at
receivable at
2020. Net charge-offs for 2021 were $100,000 , or 0.01% of average total
loans, as compared with $311,000 , or 0.04% of average total loans for
2020.
These items, as well as others, will be explained more thoroughly in the next sections.
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Net Interest Income
The following table presents the adjustment to convert net interest income to
net interest income on a fully taxable equivalent basis for the years ended
Year ended December 31, 2022 2021 2020 Total interest income$ 52,421 $ 46,770 $ 43,693 Total interest expense 7,924 4,643 6,445 Net interest income 44,497 42,127 37,248 Tax-equivalent adjustment 713 706 691
Net interest income (tax-equivalent basis)
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 and interest-bearing balances at theFederal Reserve Bank (Fed). Sources used to fund these assets include deposits and borrowed funds. Net interest income is affected by changes in interest rates, the volume and mix of earning assets and interest-bearing liabilities, and the amount of earning assets funded by non-interest-bearing deposits. For purposes of this discussion, interest income and the average yield earned on loans and investment securities are adjusted to a tax-equivalent basis as detailed in the table that appears above. This adjustment to interest income is made for analysis purposes only. Interest income is increased by the amount of savings of Federal income taxes, which QNB realizes by investing in certain tax-exempt state and municipal securities and by making loans to certain tax-exempt organizations. In this way, the ultimate economic impact of earnings from various assets can be more easily compared. The net interest rate spread is the difference between average rates received on earning assets and average rates paid on interest-bearing liabilities, while the net interest margin, which includes interest-free sources of funds, is net interest income expressed as a percentage of average interest-earning assets.The Asset/Liability and Investment Management Committee works to manage and maximize the net interest margin for the Company.
2022 versus 2021
On a tax-equivalent basis, net interest income for 2022 increased$2,377,000 , or 5.5%, to$45,210,000 . The net interest margin, which decreased eight basis points to 2.71% was unfavorably impacted by increased rates on deposits and short-term borrowings. The average rate earned on earning assets increased nine basis points from 3.09% for 2021 to 3.18% for 2022 with the yield on investments increasing 14 basis points and the yield on loans increasing 11 basis points. The yield on investment securities was favorably impacted by increased yields on all categories except state and municipal securities, causing an increase in interest income of$1,296,000 ; additionally, the yield was favorably impacted by an increase in average volume of$130,234,000 contributing to a$1,758,000 increase in interest income. The yield on loans was favorably impacted by increased rates in all loan categories except tax-exempt loans, contributing to a net$1,410,000 increase in interest income. This was also favorably impacted by a$35,456,000 net increase in average volume, of which$80,201,000 was related to an increase in average commercial real estate loans, contributing$3,327,000 in interest income; partially offset by a decrease of$47,912,000 in commercial and industrial loans average balances, resulting in a decrease of$2,275,000 in interest income. The yield on total average interest-bearing liabilities increased 21 basis points from 0.39% for 2021 to 0.60% for 2022. The growth in loans and investment securities was funded by a$101,316,000 , or 7.5%, increase in average total deposits and by a$14,218,000 , or 19.8%, increase in short-term borrowings. The average rate paid on interest-bearing deposits increased from 0.38% to 0.57% for the same time periods, respectively, contributing to an increase in interest expense of$2,489,000 , and a$95,049,000 increase in average interest-bearing deposits resulting in additional interest expense of$189,000 . The average rate paid on short-term borrowings increased from 0.36% to 1.00% for the same time periods, respectively, contributing to an increase in interest expense of$552,000 . Loan and deposit growth was partially offset by the competitive local interest rate market for quality loans and deposits. Net interest spread decreased 12 basis points to 2.58% for 2022 compared to 2.70% for 2021.
2021 versus 2020
On a tax-equivalent basis, net interest income for 2021 increased$4,894,000 , or 12.9%, to$42,833,000 . The net interest margin, which decreased 13 basis points to 2.79% was unfavorably impacted by decreased rates on loans and investments. The average rate earned on earning assets decreased 33 basis points from 3.42% for 2020 to 3.09% for 2021 with the yield on investments decreasing 35 basis points and the yield on loans decreasing nine basis points. The yield on investment securities was unfavorably impacted by decreased yields on all categories except corporate debt securities, causing a reduction in interest income of$2,145,000 ; this was favorable offset by an increase in average volume of$175,018,000 contributing to a$3,528,000 increase in interest income. The yield on loans was unfavorably impacted by decreased rates in all loan categories except commercial and industrial loans, contributing to a$994,000 decline in interest income; this was favorably offset by a$59,997,000 net increase in average volume, of which$70,591,000 was related to an increase in average commercial real estate loans, contributing$2,727,000 in interest income. The yield on total average interest-bearing liabilities decreased 24 basis points from 0.63% for 2020 to 0.39% for 2021. The growth in loans and investment securities was funded by a$208,689,000 , or 18.1%, increase in average total deposits. The average rate paid on interest-bearing deposits decreased from 0.63% to 0.38% for the same time periods, respectively, contributing to a decrease in interest expense of$2,051,000 , partially offset by a$159,075,000 increase in average interest-bearing deposits resulting in additional interest expense of$215,000 . - 20 -
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Average Balances, Rates, and Interest Income and Expense Summary (Tax-Equivalent
Basis)
2022 2021 2020
Average Average Average Average Average Average
balance rate Interest balance rate Interest balance rate Interest
Assets
Investment securities (AFS
& Equities):
U.S. Treasury $ 524 1.18 % $ 6 $ - 0.00 % $ - $ - 0.00 % $ -
U.S. Government agencies 101,455 1.10 1,119 80,340 1.05 842 64,517 1.38 891
State and municipal 128,126 2.39 3,056 112,011 2.47 2,765 65,824 3.08 2,027
Mortgage-backed and CMOs 447,369 1.58 7,059 351,801 1.29 4,540 242,039 1.61 3,908
Corporate debt 6,673 4.37 291 7,291 4.01 292 7,450 3.69 275
Equities 12,011 3.32 399 14,481 3.02 437 11,076 3.54 392
Total investment securities
(AFS & Equities) 696,158 1.71 11,930 565,924 1.57 8,876 390,906 1.92 7,493
Loans:
Commercial real estate 637,023 4.20 26,759 556,822 4.15 23,098 486,231 4.46 21,662
Residential real estate 104,397 3.34 3,484 95,241 3.41 3,244 77,077 3.79 2,922
Home equity loans 56,155 4.38 2,459 57,311 3.29 1,886 61,493 3.79 2,328
Commercial and industrial 145,579 5.10 7,432 193,491 4.75 9,189 205,566 4.02 8,273
Consumer loans 4,512 5.63 254 5,097 4.98 254 5,959 5.28 314
Tax-exempt loans 19,778 3.42 676 24,026 3.47 835 35,665 3.57 1,274
Total loans, net of unearned
income* 967,444 4.24 41,064 931,988 4.13 38,506 871,991 4.22 36,773
Other earning assets 5,782 2.42 140 36,715 0.26 94 34,254 0.34 118
Total earning assets 1,669,384 3.18 53,134 1,534,627 3.09 47,476 1,297,151 3.42 44,384
Cash and due from banks 13,803 23,408 19,654
Allowance for loan losses (11,287 ) (11,157 ) (10,443 )
Other assets 38,549 38,749 37,622
Total assets $ 1,710,449 $ 1,585,627 $ 1,343,984
Liabilities and Shareholders' Equity
Interest-bearing deposits:
Interest-bearing demand $ 345,054 0.27 % $ 933 $ 307,258 0.20 % $ 624 $ 252,050 0.26 % $ 668
Municipals 122,824 1.43 1,758 127,828 0.32 411 119,673 0.57 679
Money market 137,830 0.45 617 122,361 0.31 381 90,989 0.45 405
Savings 443,104 0.49 2,175 386,630 0.30 1,178 288,285 0.40 1,155
Time less than $100 91,216 0.79 723 98,986 0.93 921 113,647 1.41 1,599
Time $100 through $250 52,314 0.93 489 52,693 0.86 454 65,840 1.54 1,012
Time greater than $250 25,296 0.83 209 26,833 0.96 257 33,030 1.65 544
Total interest-bearing deposits 1,217,638 0.57 6,904 1,122,589 0.38 4,226 963,514 0.63 6,062
Short-term borrowings 85,876 1.00 861 71,658 0.36 258 51,745 0.48 247
Long-term debt 10,000 1.57 159 10,000 1.57 159 8,566 1.57 136
Total interest-bearing liabilities 1,313,514 0.60 7,924 1,204,247 0.39 4,643 1,023,825 0.63 6,445
Non-interest-bearing deposits 242,778 236,511 186,897
Other liabilities 8,069 9,545 9,472
Shareholders' equity 146,088 135,324 123,790
Total liabilities and shareholders'
equity $ 1,710,449 $ 1,585,627 $ 1,343,984
Net interest rate spread 2.58 % 2.70 % 2.79 %
Margin/net interest income 2.71 % $ 45,210 2.79 % $ 42,833 2.92 % $ 37,939 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. Non-accrual loans and investment securities are included in earning assets.
* Includes loans held-for-sale
- 21 ---------------------------------------------------------------------------------
Rate-Volume Analysis of Changes in Net Interest Income (1) (2) (3)
2022 vs. 2021 2021 vs. 2020
Due to change in: Total Due to change in: Total
Volume Rate Change Volume Rate Change
Interest income:
Investment securities (AFS &
Equities):
U.S. Treasury $ 6 $ - $ 6 $ - $ - $ -
U.S. Government agencies 221 56 277 219 (268 ) (49 )
State and municipal 397 (106 ) 291 1,423 (685 ) 738
Mortgage-backed and CMOs 1,233 1,286 2,519 1,772 (1,140 ) 632
Corporate debt (25 ) 24 (1 ) (6 ) 23 17
Equities (74 ) 36 (38 ) 120 (75 ) 45
Total investment securities (AFS
& Equities) 1,758 1,296 3,054 3,528 (2,145 ) 1,383
Loans:
Commercial real estate 3,327 334 3,661 3,145 (1,709 ) 1,436
Residential real estate 311 (71 ) 240 689 (367 ) 322
Home equity loans (38 ) 611 573 (159 ) (283 ) (442 )
Commercial and industrial (2,275 ) 518 (1,757 ) (487 ) 1,403 916
Consumer loans (29 ) 29 - (45 ) (15 ) (60 )
Tax-exempt loans (148 ) (11 ) (159 ) (416 ) (23 ) (439 )
Total loans 1,148 1,410 2,558 2,727 (994 ) 1,733
Other earning assets (79 ) 125 46 7 (31 ) (24 )
Total interest income 2,827 2,831 5,658 6,262 (3,170 ) 3,092
Interest expense:
Interest-bearing demand 77 232 309 146 (190 ) (44 )
Municipals (16 ) 1,363 1,347 46 (314 ) (268 )
Money market 47 189 236 140 (164 ) (24 )
Savings 172 825 997 394 (371 ) 23
Time less than $100 (73 ) (125 ) (198 ) (207 ) (471 ) (678 )
Time $100 through $250 (3 ) 38 35 (203 ) (355 ) (558 )
Time greater than $250 (15 ) (33 ) (48 ) (101 ) (186 ) (287 )
Total interest-bearing deposits 189 2,489 2,678 215 (2,051 ) (1,836 )
Short-term borrowings 51 552 603 95 (84 ) 11
Long-term debt - - - 23 - 23
Total interest expense 240 3,041 3,281 333 (2,135 ) (1,802 )
Net interest income $ 2,587 $ (210 ) $ 2,377 $ 5,929 $ (1,035 ) $ 4,894 (1) Loan fees have been included in the change in interest income totals
presented. Non-accrual loans and investment securities have been included in
average balances.
(2) Changes due to both volume and rates have been allocated in proportion to the
relationship of the dollar amount change in each.
(3) Interest income on loans and securities is presented on a tax-equivalent
basis.
The Rate-Volume Analysis 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
Investments 2022 versus 2021 Interest income on available-for-sale and equity investment securities increased$3,054,000 when comparing the two years. The increase in average balances contributed an additional$1,758,000 to interest income and the 14 basis-point increase in rate contributed$1,296,000 to interest income. The average yield on the available-for-sale and equity investment portfolio increased to 1.71% for 2022 compared to 1.57% for 2021. - 22 - -------------------------------------------------------------------------------- Income onU.S. Government agency securities increased$277,000 , due to a 5 basis-point increase in the yield from 1.05% for 2021 to 1.10% for 2022 and an increase in average balances totaling$21,115,000 . Most of the bonds in the agency portfolio have call features ranging from three months to three years, none of which were exercised during 2022. QNB invested excess funds toward the end of 2021 to earn a higher rate than current available on interest-earning deposits. Interest income on tax-exempt municipal securities increased$291,000 . Average balances, which increased$16,115,000 , contributed$397,000 to interest income. The decrease in yield of eight basis points from 2.47% in 2021 to 2.39% in 2022 partially offset the increase in interest income by$106,000 . Many of these bonds have either reached maturity or their call dates and are being replaced with municipal bonds with less favorable tax-equivalent yields. Typically, QNB purchased municipal bonds with 10- to 15-year maturities with call dates between 2 and 5 years. Future demand for tax-exempt municipal securities is uncertain, as the tax-equivalent yield could be less favorable compared to other securities with similar risk-based capital asset-weighting characteristics. All the mortgage-backed and collateralized mortgage obligations ("CMO") securities owned by QNB are issued byU.S. Government agencies and sponsored enterprises ("GSE") and carry the implicit backing of theU.S. Government , but they are not direct obligations of theU.S. Government . Interest income on mortgage-backed securities and CMOs increased$2,519,000 due to a$95,568,000 increase in average balances and a 29 basis-point increase in rate from 1.29% for 2021 to 1.58% for 2022. This portfolio generally provides higher yields relative to agency bonds and provides monthly cash flow which can be used for liquidity purposes or can be reinvested as interest rates increase. QNB invested excess funds toward the end of 2021 to earn a higher rate than current available on interest-earning deposits.
Income on corporate debt securities decreased
Excess cash at the holding company was invested in
Dividend income on equities decreased
2021 versus 2020 Interest income on available-for-sale and equity investment securities increased$1,383,000 when comparing the two years. The increase in average balances contributed an additional$3,528,000 to interest income but was partially offset by$2,145,000 due to a 35 basis-point decrease in rates. The average yield on the available-for-sale and equity investment portfolio decreased to 1.57% for 2021 compared to 1.92% for 2020. Income onU.S. Government agency securities decreased$49,000 , due to a 33 basis-point decrease in the yield from 1.38% for 2020 to 1.05% for 2021, partially offset by an increase in average balances totaling$15,823,000 . Most of the bonds in the agency portfolio have call features ranging from three months to three years, many of which were exercised during 2021 as a result of the declining rates during the year; these bonds were replaced by lower-yielding securities. Interest income on tax-exempt municipal securities increased$738,000 . Average balances, which increased$46,187,000 , contributed$1,423,000 to interest income. The decrease in yield of 61 basis points from 3.08% in 2020 to 2.47% in 2021 partially offset the increase in interest income by$685,000 .
Interest income on mortgage-backed securities and CMOs increased
Income on corporate debt securities increased
Dividend income on equities increased
Loans 2022 versus 2021 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, hotels, factories, warehouses, medical facilities and retail establishments, or residential real estate, usually the residence of the business owner or investment properties. The category also includes construction and land development loans. Income on commercial real estate loans increased$3,661,000 . The increase in average balances of$80,201,000 , or 14.4%, contributed an increase in interest income of$3,327,000 ; the five basis-point increase in yield, from 4.15% in 2021 to 4.20% in 2022 contributes$334,000 to the increase in interest income. - 23 - -------------------------------------------------------------------------------- Income on commercial and industrial loans, the second largest category, decreased$1,757,000 with average balances decreasing$47,912,000 resulting in a decrease to interest income of$2,275,000 , partially offset by the positive impact from an increase in average yield of 35 basis points to 5.10% in 2022 from 4.75% in 2021, contributing to a$518,000 increase 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 which contributed$41,515,000 of the net volume decrease. 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 basis points, resulting in a yield of approximately 11.07% for 2022 compared to 7.48% for 2021. Excluding the PPP loans, the yield on the commercial and industrial loans, the average yield increased 102 basis points to 4.62% in 2022 from 3.90% in 2021. Tax-exempt loan income decreased$159,000 to$676,000 in 2022. When comparing the same periods, average balances decreased$4,248,000 to$19,778,000 , which contributed a$148,000 decrease in interest income. The average yield on the tax-exempt loan portfolio decreased from 3.47% for 2021 to 3.42% for 2022, resulting in a decrease in interest income of$11,000 . QNB strives to be the "local consumer lender of choice." QNB continues to focus on its retail lending efforts by adding new product offerings and by marketing and promotion. Overall, retail lending balances increased$7,415,000 and interest income for retail lending increased$813,000 in 2022 compared with 2021, driven by a 33 basis-point decrease in yield. Given the low yields on alternative investment securities, QNB retained certain fixed rate and hybrid adjustable-rate mortgages to borrowers with high credit scores and low loan-to-value ratios. As a result, average residential mortgage loans secured by first lien 1-4 family residential mortgages increased by$9,156,000 , or 9.6%, to$104,397,000 for 2022. The average yield on the residential real estate portfolio decreased seven basis points to 3.34% for 2022 compared to 3.41% for 2021. Overall, interest income for this segment grew$240,000 in 2022. Income on home equity loans increased by$573,000 when comparing 2022 and 2021. During 2022 and 2021, QNB offered attractive rates on both variable rate and fixed rate home equity loans. Average balances in home equity loans decreased$1,156,000 , or 2.0%, to$56,155,000 when comparing 2022 and 2021. The yield on the home equity portfolio increased 109 basis points to 4.38% when comparing the two years. The home values have continued to grow; therefore, we expect that the demand for home equity loans will continue. Interest income on consumer loans remained flat. Consumer loans at QNB experienced a decline in average balances in 2022 of$585,000 , or 11.5%, led by a decline in installment loans and student loans. Installment loan average balances declined$357,000 and interest declined$14,000 . Student loan balances are no longer insured, and QNB ceased funding originations through its third-party provider during the second half of 2018; average balances decreased$283,000 and interest income increased$9,000 when comparing 2022 and 2021.
2021 versus 2020
Income on commercial real estate loans increased$1,436,000 . The increase in average balances of$70,591,000 , or 14.5%, contributed an increase in interest income of$3,145,000 ; this was partially offset by the 31-basis point decrease in yield from 4.46% in 2020 to 4.15% in 2021 which, which resulted in a decrease of interest income of$1,709,000 . Income on commercial and industrial loans increased$916,000 with a positive impact from an increase in yield of 73 basis points to 4.75% in 2021 from 4.02% in 2020, contributing to a$1,403,000 increase in interest income. This was partially offset by a decrease in average commercial and industrial loans of$12,075,000 , or 5.9%, to$193,491,000 for 2021, resulting in a$487,000 decrease in interest income. Included in this category are the PPP loans which contributed$7,422,000 of the net volume decrease. crease in average yield of 73 basis points to 4.75% in 2021 from 4.02% in 2020, contributing to a$1,403,000 increase in interest income. The PPP loans contributed 109 basis points to the increase in the average yield.
Tax-exempt loan income decreased
Retail lending balances increased$13,120,000 while interest income for retail lending decreased$180,000 in 2021 compared with 2020, driven by the 49-basis point decrease in yield. Average residential mortgage loans secured by first lien 1-4 family residential mortgages increased by$18,164,000 , or 23.6%, to$95,241,000 for 2021. The average yield on the residential real estate portfolio decreased 38 basis points to 3.41% for 2021 compared to 3.79% for 2020. Overall, interest income for this segment grew$322,000 in 2021. - 24 - -------------------------------------------------------------------------------- Average home equity loans balances decreased$4,182,000 , or 6.8%, to$57,311,000 when comparing 2021 and 2020. The yield on the home equity portfolio decreased 50 basis points to 3.29% when comparing the two years.
Interest income on consumer loans decreased
Deposits and Borrowings
2022 versus 2021
Earning assets are funded primarily by deposits, which increased on average by$101,316,000 , or 7.5%, to$1,460,416,000 , when comparing 2022 and 2021. Total interest expense for 2022 was$7,924,000 compared with$4,643,000 for 2021, an increase of$3,281,000 . Interest expense on total deposits increased$2,678,000 and interest expense on borrowed funds increased$603,000 when comparing the two years. The rate paid on interest-bearing deposits increased 19 basis points; the rate paid on borrowings increased 64 basis points, when comparing the two periods. Deposit and borrowing costs are expected to increase as the competition for deposits increases when rates rise. Consistent with the past several years, the growth in deposits during 2022 was centered in accounts with greater liquidity. Average non-interest-bearing demand accounts increased$6,267,000 , or 2.6%, to$242,778,000 for 2022; QNB has been successful in increasing business checking accounts. Average interest-bearing demand accounts increased$37,796,000 , or 12.3%, to$345,054,000 for 2022 compared with 2021, with interest expense on interest-bearing demand accounts increasing$309,000 to$933,000 for 2022. The average rate paid increased seven basis points to 0.27% for 2022 compared to 0.20% for 2021. Interest-bearing business checking account average balances increased by$7,918,000 , or 12.8%, and related interest expense increased$141,000 , or 17 basis points in yield, when comparing the two years. Also included in this category is QNB-Rewards checking, a tiered-rate checking account product. 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 debit card purchase transactions post and clear per statement cycle. If these qualifications are not met, the rate paid is 0.10%. For 2022, the average balance in this product was$104,122,000 and the related interest expense was$366,000 for an average cost of funds of 0.35%. In comparison, the average balance in this product for 2021 was$96,522,000 and the related interest expense was$350,000 for an average cost of funds of 0.36%. The rates paid on the QNB-Rewards product, assuming qualifications are met, is attractive relative to competitors' offerings as well as other QNB products. This product also generates fee income through the use of the debit card. The average balance of other interest-bearing demand accounts included in this category increased from$148,969,000 for 2021 to$171,247,000 for 2022. The average rate paid on these balances was 0.05% in 2021 and 0.13% in 2022. Average money market accounts increased$15,469,000 , or 12.6%, to$137,830,000 for 2022 compared with 2021. Interest expense on money market accounts increased$236,000 to$617,000 for 2022 compared with 2021. The average interest rate paid on money market accounts was 0.45% for 2022, an increase of 14 basis points compared with 2021. The balances in this category primarily comprise Select money market accounts, a product that pays a tiered rate based on account balances. The balances remaining in these accounts for 2022 were primarily at higher-yielding tiers. Interest expense on municipal interest-bearing demand accounts increased$1,347,000 to$1,758,000 for 2022. The average balance of municipal interest-bearing demand accounts decreased$5,004,000 , or 3.9%, to$122,824,000 and the average interest rate paid on these accounts increased 111 basis points to 1.43% for 2022 from 0.32% for 2021. Most of these accounts are indexed to the Federal funds rate with negotiated rate floors between 0.15% and 0.35%. Many of these deposits are seasonal in nature and are received during the third quarter as tax receipts are collected and are withdrawn over the course of the next year. QNB's online e-Savings product is the largest category of savings deposits and was created to compete with other online savings accounts. Average e-Savings balances increased$45,577,000 , or 15.7%, to$335,490,000 in 2022 compared with$289,913,000 in 2021. The average cost of funds on these accounts was 0.59% for 2022 and 0.36% for 2021. The yield on this account may rise along with market rates and as competition for savings balances increases. Traditional statement savings accounts and club accounts are also included in the savings category and increased on average by$10,897,000 , or 11.3%, to$107,614,000 . The average rate paid on total savings accounts was 0.49% for 2022, a 19 basis-point increase from 0.30% for 2021 and interest expense increased$997,000 , to$2,175,000 from$1,178,000 over the same period. Interest expense on time deposits decreased$211,000 , to$1,421,000 in 2022, due to a decrease in average balances of$9,686,000 in 2022, to$168,826,000 and a seven basis-point decrease in yield, from 0.91% in 2021 to 0.84% in 2022. Similar to fixed-rate loans and investment securities, time deposits reprice over time and, therefore, have less of an immediate impact on costs in either a rising or falling rate environment. However, the maturity and repricing characteristics of time deposits tend to be shorter. - 25 - -------------------------------------------------------------------------------- Approximately$85,267,000 , or 48.6%, in time deposits will reprice or mature over the next 12 months compared with 56.8% of the portfolio atDecember 31, 2021 . The average rate paid on these time deposits is approximately 0.81%. Short-term borrowings are comprised of sweep accounts structured as repurchase agreements with our commercial customers and overnight borrowings from correspondent banks with average balances in 2022 of$68,650,000 and$17,226,000 , respectively. Interest expense on short-term borrowings increased by$603,000 to$861,000 when comparing the two years. During this period average balances of repurchase agreements decreased$2,817,000 with a 14 basis-point increase in average rate paid, resulting in an increase of cost of funds of$85,000 . The average balances of borrowings from correspondent banks increased$17,035,000 and the average rate paid increased 249 basis points, resulting in an increase in cost of funds of$518,000 .
Average long-term debt was
2021 versus 2020
Total interest expense for 2021 was$4,643,000 compared with$6,445,000 for 2020, a decrease of$1,802,000 . Interest expense on total deposits decreased$1,836,000 and interest expense on borrowed funds increased$34,000 when comparing the two years. The rate paid on interest-bearing deposits decreased 25 basis points; the rate paid on borrowings decreased 13 basis points, when comparing the two periods. Average non-interest-bearing demand accounts increased$49,614,000 , or 26.5%, to$236,511,000 for 2021; QNB has been successful in increasing both personal and business checking accounts. Average interest-bearing demand accounts increased$55,208,000 , or 21.9%, to$307,258,000 for 2021 compared with 2020, with interest expense on interest-bearing demand accounts decreasing$44,000 to$624,000 for 2021. The average rate paid decreased six basis points to 0.20% for 2021 compared to 0.26% for 2020. Interest-bearing business checking account average balances increased by$7,025,000 , or 12.8%, and related interest expense decreased$79,000 , or 19 basis points in yield, when comparing the two years. For 2021, the average balance QNB-Rewards checking was$96,522,000 and the related interest expense was$350,000 for an average cost of funds of 0.36%. In comparison, the average balance in this product for 2020 was$74,447,000 and the related interest expense was$325,000 for an average cost of funds of 0.44%. The average balance of other interest-bearing demand accounts included in this category increased from$122,861,000 for 2020 to$148,969,000 for 2021. The average rate paid on these balances was 0.05% for both years. Average money market accounts increased$31,372,000 , or 34.5%, to$122,361,000 for 2021 compared with 2020. Interest expense on money market accounts decreased$24,000 to$381,000 for 2021 compared with 2020. The average interest rate paid on money market accounts was 0.31% for 2021, a decrease of 14 basis points compared with 2020. Online eSavings average balances increased$82,736,000 , or 39.9%, to$289,913,000 in 2021 compared with$207,177,000 in 2020. The average cost of funds on these accounts was 0.36% for 2021 and 0.50% for 2020. Traditional statement savings accounts and club accounts are also included in the savings category and increased on average by$15,609,000 , or 19.2%, to$96,717,000 . The average rate paid on total savings accounts was 0.30% for 2021, a ten-basis point decrease from 0.40% for 2020 and interest expense increased$23,000 , to$1,178,000 from$1,155,000 over the same period.
Interest expense on time deposits decreased
Short-term borrowing average balances in 2021 comprised of sweep accounts structured as repurchase agreements with our commercial customers and overnight borrowings from correspondent banks of$71,467,000 and$191,000 , respectively. Interest expense on short-term borrowings increased by$11,000 to$258,000 when comparing the two years. During this period average balances of repurchase agreements increased$21,460,000 with a seven-basis point decrease in average rate paid, resulting in an increase of cost of funds of$43,000 . The average balances of borrowings from correspondent banks declined$1,547,000 and the average rate paid decreased 138 basis points, resulting in a decrease in cost of funds of$32,000 .
Average long-term debt was
- 26 ---------------------------------------------------------------------------------
Provision for Loan Losses
The provision for loan losses represents management's determination of the amount necessary to be charged to operations to bring the allowance for loan losses to a level that represents management's best estimate of the known and inherent losses in the existing loan portfolio. QNB recorded a reversal of the provision for loan losses of$850,000 for the twelve months endedDecember 31, 2022 compared to a provision for loan losses of$458,000 and$1,250,000 for the twelve-month periods endedDecember 31, 2021 and 2020, respectively. Net loan recoveries were$197,000 , or 0.02% of total average loans for 2022 compared with net charge-offs of$100,000 , or 0.01% of total average loans for 2021 and$311,000 , or 0.04% of total average loans in 2020. The majority of the commercial loans charged off during 2021 and 2020 had specific reserves established during the allowance for loan loss calculation process prior to the decision to charge-off the loans. The majority of the recoveries during 2022, were on these previously charged off commercial loans. Deterioration in credit quality or significant growth in the loan portfolio may result in a higher provision for loan losses in 2023.
Non-Interest Income
Non-interest income comparison
Change from prior year
$ Change % Change
Year ended December 31, 2022 2021 2020
2022 to 2021 2021 to 2020 2022 to 2021 2021 to 2020
Fees for services to customers
288 $ 11 21.7 % 0.8 %
ATM and debit card 2,719 2,682 2,195 37 487 1.4 22.2
Retail brokerage and advisory 788 786 581 2 205 0.3 35.3
Bank-owned life insurance 361 497 294 (136 ) 203 -27.4 69.0
Merchant 394 451 417 (57 ) 34 -12.6 8.2
Net gain (loss) on sale of
investment
securities 266 1,806 609 (1,540 ) 1,197 -85.3 196.6
Unrealized gain (loss) on
investment equity
securities (1,026 ) 926 (47 ) (1,952 ) 973 -210.8 N/M
Net gain on sale of loans 6 595 1,724
(589 ) (1,129 ) -99.0 -65.5
Other 609 712 514 (103 ) 198 -14.5 38.5
Total $ 5,731 $ 9,781 $ 7,602 $ (4,050 ) $ 2,179 -41.4 % 28.7 %
N/M - Not Meaningful
2022 versus 2021
QNB, through its core banking business, generates various fees and service
charges. Total non-interest income includes service charges on deposit accounts,
ATM and debit card income, retail brokerage and advisory income, income on
bank-owned life insurance, merchant income and gains and losses on investment
securities and residential mortgage loans. Total non-interest income was
$5,731,000 in 2022 compared with $9,781,000 in 2021, a decrease of $4,050,000 .
Excluding the unrealized (losses)gains on equity securities, gains(losses) on
sales of investment securities and gains on sales of loans, noninterest income
was $6,485,000 in 2022 compared to $6,454,000 in 2021, an increase of $31,000 .
Fees for services to customers are primarily comprised of service charges on
deposit accounts. These fees were $1,614,000 for 2022, an increase of $288,000
from 2021. Overdraft income, which represented approximately 78% and 72% of
total fees for services to customers in 2022 and 2021, respectively, increased
by $312,000 , or 32.8%, when comparing 2022 to 2021. The increase in overdraft
income primarily reflects an increase in the number of overdraft occurrences.
ATM and debit card income is primarily comprised of transaction income on debit
cards and ATM cards and ATM surcharge income for the use of QNB's ATM machines
by non-QNB customers. ATM and debit card income was $2,719,000 in 2022, an
increase of $37,000 , or 1.4%, from the amount recorded in 2021. Debit card
interchange income increased $44,000 , or 1.7%, to $2,664,000 in 2022, while ATM
surcharge income and monthly card fees income decreased $7,000 to $55,000 . The
growth in checking accounts and card usage contributed to the increase in debit
card income, including the QNB Rewards checking product, a tiered-rate checking
account which requires, among other terms, the posting of a minimum of twelve
debit card purchase transactions per statement cycle to receive the high
interest rate.
QNB provides securities and advisory services under the name QNB Financial
Services through an independent third-party registered Broker/Dealer and
Registered Investment Advisor. QNB terminated its contract with its third-party
broker-dealer effective August 1, 2018 and entered into a similar arrangement
with another third-party provider. QNB Financial Services finalized the
transferring of accounts to the new provider's platform during 2019. QNB
receives a percentage of the revenue generated but is responsible for salaries
and expenses of advisors who are QNB employees. Retail brokerage and advisory
revenue was $788,000 for 2022 compared with $786,000 for 2021, an increase of
$2,000 , or 0.3%. Advisory fees increased $31,000 comparing 2022 to 2021. Sales
in front-loaded products, such as annuities and alternative investments (which
include private equity, hedge funds, managed futures, real estate
- 27 -
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"REITs", commodities and derivatives contracts) and trailing income related to
these decreased $29,000 in 2022 over 2021. In 2022, the net income provided by
QNB Financial Services was $210,000 , compared with $206,000 in net income for
2021.
Income on bank-owned life insurance ("BOLI") represents the earnings and death
benefits on life insurance policies in which the Bank is the beneficiary. The
insurance carriers reset the rates on these policies annually taking into
consideration the interest rate environment as well as mortality costs. The
existing policies have rate floors which limit how low the earnings rate can go.
Some of these policies are currently at their floor. Income on these policies
during 2022 was $361,000 compared to $497,000 for 2021; included in these
numbers was a life insurance benefit of $46,000 realized during 2022 and a
benefit of $193,000 realized during 2021.
Merchant income represents fees charged to merchants for the Bank's handling of
credit card or charge sales. Merchant income was $394,000 for 2022, a decrease
of $57,000 , or 12.6%, from the amount reported in 2021. The decrease in merchant
income is primarily a result of decreased usage.
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, 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. In addition, the Corporation owns a small
portfolio of equity securities for the purpose of generating both dividend
income and capital appreciation.
Net gains on sales of investment securities decreased $1,540,000 to a net gain
of $266,000 for the year ended December 31, 2022 , compared with a net gain of
$1,806,000 for the year ended December 31, 2021 , primarily due to market
conditions which resulted in greater opportunities for profitable sales in 2021
compared with 2022. Gains from equity securities were $405,000 in 2022 compared
to gains of $1,788,000 in 2021. Net losses/gains on the sale of fixed income
securities were a net loss of $139,000 for 2022 compared to a net gain of
$18,000 for 2021. Unrealized losses/gains on equity securities were unrealized
losses of $1,026,000 recorded during 2022 compared to unrealized gains of
$926,000 during 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. The net gain on the sale of residential mortgage loans was $6,000
and $595,000 for 2022 and 2021, respectively. Mortgage financing activity was
greater in 2021, as an improvement in rates prompted borrowers to purchase.
Proceeds from the sale of residential mortgages were $304,000 and $16,773,000
for the years ended December 31, 2022 and 2021, respectively. Included in the
gains on the sale of residential mortgages in 2022 and 2021 are $2,000 and
$122,000 , respectively, related to the recognition of mortgage servicing
assets.
QNB retains servicing rights for residential mortgages sold in the secondary
market. A servicing fee is retained on all mortgage loans sold and serviced. QNB
recognizes its obligation to service financial assets that are retained in a
transfer of assets in the form of a servicing asset. The servicing asset is
amortized in proportion to, and over, the period of net servicing income or
loss. On a quarterly basis, servicing assets are assessed for impairment based
on their fair value. Mortgage servicing income of $143,000 for 2022 and $102,000
for 2021 is included in other non-interest income.
Other non-interest income, excluding mortgage servicing income, was $466,000 for
2022, a decrease of $144,000 from the amount recorded in 2021. Other
non-interest income included broker-dealer conversion costs reimbursements of
$39,000 and $55,000 for 2022 and 2021, respectively. Other non-interest income
included $37,000 in an anti-trust settlement in 2021. Title company income
decreased $83,000 and letter of credit fees decreased $30,000 when comparing
2022 to 2021.
2021 versus 2020
Total non-interest income was
Fees for services to customers are primarily comprised of service charges on deposit accounts. These fees were$1,326,000 for 2021, an increase of$11,000 from 2020. Overdraft income, which represented approximately 72% and 71% of total fees for services to customers in 2021 and 2020, respectively, increased by$20,000 , or 2.2%, when comparing 2021 to 2020. Advisory fees increased$175,000 comparing 2021 to 2020. Sales in front-loaded products, such as annuities and alternative investments (which include private equity, hedge funds, managed futures, real estate "REITs", commodities and derivatives contracts) and trailing income related to these increased$30,000 in 2021 over 2020. In 2021, the net income provided byQNB Financial Services was$206,000 , compared with$197,000 in net income for 2020. - 28 -
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BOLI income during 2021 was
Merchant income was
Net gains on sales of investment securities increased$1,197,000 to a net gain of$1,806,000 for the year endedDecember 31, 2021 , compared with a net gain of$609,000 for the year endedDecember 31, 2020 , primarily due to market conditions which resulted in greater opportunities for profitable sales in 2021 compared with 2020. Gains from equity securities were$1,788,000 in 2021 compared to gains of$585,000 in 2020. Net gains on the sale of fixed income securities were$18,000 for 2021 compared to$24,000 for 2020. Unrealized losses on equity securities of$47,000 were recorded during 2020 compared to unrealized gains$926,000 during 2021. The net gain on the sale of residential mortgage loans was$595,000 and$1,724,000 for 2021 and 2020, respectively. Mortgage financing activity increased in 2020, as an improvement in rates prompted borrowers to purchase and continued to represent opportunities in 2021. Proceeds from the sale of residential mortgages were$16,773,000 and$35,605,000 for the years endedDecember 31, 2021 and 2020, respectively. Included in the gains on the sale of residential mortgages in 2021 and 2020 are$122,000 and$249,000 , respectively, related to the recognition of mortgage servicing assets. Other non-interest income, excluding mortgage servicing income, was$610,000 for 2021, an increase of$137,000 from the amount recorded in 2020. Other non-interest income included broker-dealer conversion costs reimbursements of$55,000 and$66,000 for 2021 and 2020, respectively. Other non-interest income included$37,000 in an anti-trust settlement. Title company income increased$79,000 and letter of credit fees increased$45,000 when comparing 2021 to 2020.
Non-Interest Expense
Non-interest expense comparison
Change from prior year
$ Change % Change
Year ended December 31, 2022 2021 2020
2022 to 2021 2021 to 2020 2022 to 2021 2021 to 2020
Salaries and employee benefits
(147 ) $ 912 -0.8 % 5.5 %
Net occupancy 2,195 2,228 2,164 (33 ) 64 -1.5 3.0
Furniture and equipment 2,917 2,787 2,750 130 37 4.7 1.3
Marketing 870 922 876 (52 ) 46 -5.6 5.3
Third party services 2,474 2,160 1,923 314 237 14.5 12.3Telephone, postage and supplies 748 715 736
33 (21 ) 4.6 -2.9
State taxes 1,004 1,013 887 (9 ) 126 -0.9 14.2
FDIC insurance premiums 768 793 569 (25 ) 224 -3.2 39.4
Other 3,210 2,926 2,509 284 417 9.7 16.6
Total $ 31,492 $ 30,997 $ 28,955 $
495 $ 2,042 1.6 % 7.1 %
2022 versus 2021
Non-interest expense is comprised of costs related to salaries and employee
benefits, net occupancy, furniture and equipment, marketing, third party
services, FDIC insurance premiums, regulatory assessments and taxes and various
other operating expenses. Total non-interest expense was $31,492,000 in 2022, an
increase of $495,000 , or 1.6%, from the $30,997,000 in 2021. QNB's overhead
efficiency ratio, which represents the percentage of each dollar of revenue that
is used for non-interest expense, is calculated by taking non-interest expense
divided by net operating revenue (tax-equivalent net interest income plus
non-interest income). QNB's efficiency ratios for 2022, 2021 and 2020 were
61.8%, 58.9%, and 63.6%, respectively. The unfavorable increase in the 2022
efficiency ratio is primarily due to a reduction in tax-equivalent non-interest
income of $4,050,000 in 2022 over 2021, partially offset by an increase in
tax-equivalent interest income of $2,377,000 over the same period.
Salaries and benefits expense is the largest component of non-interest expense.
QNB monitors, using various surveys, the competitive salary and benefit
information in its markets and makes adjustments when appropriate. Salaries and
benefits expense for 2022 was $17,306,000 , a decrease of $147,000 compared with
$17,453,000 reported in 2021. Salary expense and related payroll taxes for 2022
was $14,739,000 , an increase of $35,000 compared with $14,704,000 reported in
2021. Included in salary expense in 2022 was incentive compensation plus related
payroll taxes of $607,000 , a $575,000 decrease over incentive compensation in
2021. Benefit expense for 2022 was $2,567,000 , a decline of $182,000 , or 6.6%,
from the amount recorded in 2021. Medical premiums decreased
- 29 -
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$235,000 primarily due to a reduction in claims. Retirement plan matching and
safe harbor increased $15,000 compared to 2021. QNB utilized unvested forfeited
401(k) contributions to offset retirement plan matching in 2022 and 2021.
Net occupancy and furniture and equipment expense increased
Marketing expense was$870,000 for 2022, a$52,000 decrease from the expense recorded in 2021. Advertising and sales promotions costs decreased$40,000 . QNB's contributions and sponsorships for not-for-profit organizations, events and clubs in the communities it serves are included in public relations expense which decreased$9,000 in 2022. 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, statement printing and mailing, investment security safekeeping and supply management services. Third party services increased$314,000 ; QNB incurred additional legal, consulting and other third-party services to implement core-processing software. Telephone, postage and supplies expense increased$33,000 to$748,000 in 2022 compared with 2021, primarily due to higher transportation costs for supplies and mail delivery services. The premium assessment formula for small institutions is based on asset growth and related risk assumptions determined by theFDIC as well as capital. Small institutions, forFDIC premium assessments purposes, are defined as those with total consolidated assets less than$10 billion .FDIC insurance premium expense decreased$25,000 in 2022. State tax expense represents the payment of the Pennsylvania Shares Tax andPennsylvania sales and use tax. State tax expense was$1,004,000 and$1,013,000 for the years 2022 and 2021, respectively. The Pennsylvania Shares Tax is based primarily on the equity of the Bank. The decrease in Pennsylvania Shares Tax is a result of a lower apportionment factor inPennsylvania . Other operating expenses for the twelve months endedDecember 31, 2022 increased$284,000 , or 9.7%. Checkcard expense increased$114,000 and employee travel, training, entertainment and membership fees collectively increased$100,000 as in-person events opened after the Covid-19 pandemic.
2021 versus 2020
Total non-interest expense was$30,997,000 in 2021, an increase of$2,042,000 , or 7.1%, from the$28,955,000 in 2020. Salaries and benefits expense for 2021 was$17,453,000 , an increase of$912,000 compared with$16,541,000 reported in 2020. Salary expense and related payroll taxes for 2021 was$14,704,000 , an increase of$942,000 compared with$13,762,000 reported in 2020. Included in salary expense in 2021 was incentive compensation plus related payroll taxes of$1,182,000 , a$451,000 increase over incentive compensation in 2020. Benefit expense for 2021 was$1,544,000 , a decline of$94,000 , or 5.7%, from the amount recorded in 2020. Medical premiums decreased$151,000 primarily due to stop-loss adjustments. Retirement plan matching and safe harbor declined$18,000 compared to 2020. QNB utilized unvested forfeited 401(k) contributions to offset retirement plan matching in 2021 and 2020.
Net occupancy and furniture and equipment expense increased
Marketing expense was$922,000 for 2021, a$46,000 increase from the expense recorded in 2020. QNB's contributions and sponsorships for not-for-profit organizations, events and clubs in the communities it serves are included in public relations expense which increased$45,000 in 2021; many of these events were cancelled or postponed in 2020 due to the COVID-19 Pandemic..
Third party services increased
Telephone, postage and supplies expense decreased$21,000 to$715,000 in 2021 compared with 2020, primarily due to an increase in supplies during 2020 related to the COVID-19 Pandemic. - 30 -
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State tax expense was$1,013,000 and$887,000 for the years 2021 and 2020, respectively. The Pennsylvania Shares Tax is based primarily on the equity of the Bank. The increase in Pennsylvania Shares Tax is a result of growth of the Bank's capital. Other operating expenses for the twelve months endedDecember 31, 2021 increased$417,000 , or 16.6%. During 2020 there was reduced business development, travel, seminar and meeting expenses related to cancellations of events due to the COVID-19 Pandemic; many of these activities returned in 2021.
Income Taxes
Applicable income tax expense and effective tax rates were$3,665,000 , or 18.7% for 2022,$3,961,000 , or 19.4% for 2021 and$2,562,000 , or 17.5% for 2020. The primary reason for the decreased effective tax rate for 2022 over 2021 was due to the state taxes on the realized gains on equity sales securities in 2021. The primary reason for the increased effective tax rate for 2021 over 2020 2020 was due to the state taxes on the realized gains on equity sales securities in 2021. QNB expects the effective tax rate in 2023 to be less than the 21% corporate rate, due to its holdings of tax-free assets, including municipal bonds, municipal loans, and life insurance contracts. For a more comprehensive analysis of income tax expense and deferred taxes, refer to Note 11 in the Notes to Consolidated Financial Statements.
Financial Condition
ASSETS
The following table presents total assets at the dates indicated:
Change from prior year
Year ended December 31, 2022 2021 Amount Percent
Cash and cash equivalents $ 15,899 $ 13,390 $ 2,509 18.7 %
Investment securities AFS 546,525 692,360 (145,835 ) -21.1
Investment equity securities 12,056 12,410 (354 ) -2.9
Restricted investment in bank stocks 5,193 1,329 3,864 290.7
Loans receivable 1,039,385 926,470 112,915 12.2
Allowance for loan losses (10,531 ) (11,184 ) 653 5.8
Premises and equipment, net 15,463 16,540 (1,077 ) -6.5
Bank-owned life insurance 11,625 11,497 128 1.1
Accrued interest receivable 5,038 4,104 934 22.8
Other assets 27,844 6,424 21,420 333.4
Total assets $ 1,668,497 $ 1,673,340 $ (4,843 ) -0.3 %
Cash and interest-earning deposits
Total cash and cash equivalents increased$2,509,000 to$15,899,000 atDecember 31, 2022 from$13,390,000 atDecember 31, 2021 . QNB had interest-bearing balances at theFederal Reserve Bank of$880,000 compared with$2,931,000 and interest-bearing balances in a brokerage account of$353,000 compared with$1,234,000 atDecember 31, 2022 andDecember 31, 2021 , respectively. Net cash was provided by both operating and financing activities. The maturity, prepayment and sales of investment securities, proceeds received from deposit growth and proceeds from short-term borrowings more than offset loan growth and the purchases of investment securities.
At
QNB accounts for its investments by classifying securities into four categories.
Debt securities that are bought and held principally for the purpose of selling
them in the near term are classified as trading securities and reported at fair
value, with unrealized gains and losses included in earnings. Debt securities
that QNB has the positive intent and ability to hold to maturity are classified
as held-to-maturity securities and reported at amortized cost. Debt securities
not classified as either held-to-maturity securities or trading securities are
classified as available-for-sale securities and reported at fair value, with
unrealized gains and losses, net of tax, excluded
- 31 -
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from earnings and reported as a separate component of shareholders' equity.
Equity investments with readily determinable fair values are measured at fair
value with changes in fair value recognized in net income. Management determines
the appropriate classification of securities at the time of purchase.
Investment Portfolio History
December 31, 2022 2021 2020
Investment Securities Available-for-Sale U.S. Treasuries$ 301 $ - $ - U.S. Government agency 86,709 97,499 69,776 State and municipal 95,367 131,035 87,812U.S. Government agencies and sponsored enterprises (GSEs): Mortgage-backed 256,161 329,938
175,847
Collateralized mortgage obligations (CMOs) 101,672 127,012
94,948
Corporate debt 6,315 6,876
7,263
Total investment securities available-for-sale
$ 435,646 Equity Investments Equity$ 12,056 $ 12,410 $ 12,849 Total equity investments$ 12,056 $ 12,410 $ 12,849 Total investment securities$ 558,581 $ 704,770 $ 448,495
Available-for-sale investment securities include securities that management intends to use as part of its liquidity and asset/liability management strategy. These securities may be sold in response to changes in market interest rates, changes in the securities prepayment or credit risk, the need for liquidity, or growth in loan demand. AtDecember 31, 2022 , the fair value of investment debt securities available-for-sale was$546,525,000 , or$102,692,000 less the amortized cost of$649,217,000 . This compares to a fair value of$692,360,000 , or$4,734,000 less the amortized cost of$697,094,000 , atDecember 31, 2021 . The available-for-sale portfolio had a weighted average maturity of approximately 7.2 years atDecember 31, 2022 and 5.7 years atDecember 31, 2021 . The weighted average tax-equivalent yield was 1.68% and 1.56% atDecember 31, 2022 and 2021, respectively. AtDecember 31, 2022 , approximately 81% of QNB's investment securities available-for-sale were eitherU.S. Government agency debt securities,U.S. Government agency issued mortgage-backed securities or CMOs. As ofDecember 31, 2022 , QNB held no securities of any one issue or any one issuer (excluding theU.S. Government and its agencies) that were in excess of 10% of shareholders' equity. The QNB investment portfolio represents a significant portion of earning assets and interest income. QNB actively manages the investment portfolio in an attempt to maximize earnings, while considering liquidity needs, interest rate risk and credit risk. The decrease of the investment portfolio as a percent of total assets in 2022 is due to a decrease in the fair value and loan growth. During 2022,$35,001,000 of investment securities available-for-sale were purchased compared with$385,926,000 during 2021. Proceeds from the sale of investment securities available-for-sale were$7,551,000 during 2022 compared with$282,000 during 2021. In addition to the proceeds from the sale of investment securities available-for-sale, proceeds from maturities, calls and prepayments were$72,965,000 in 2022 compared with$113,911,000 in 2021.
The balance ofU.S. Government agency securities decreased$10,790,000 to$86,709,000 atDecember 31, 2022 and represents 15.9% of the available-for-sale investment portfolio, compared with 14.1% atDecember 31, 2021 .U.S. Government agency issued CMO and MBS balances decreased$99,117,000 to$357,833,000 and represents 65.5% of the available-for-sale portfolio compared with 66.0% atDecember 31, 2021 . These bonds provide monthly cash flow to be reinvested in either loans or other securities, potentially at higher yields as rates increase. - 32 - -------------------------------------------------------------------------------- The balance of municipal securities decreased$35,668,000 to$95,367,000 atDecember 31, 2022 , representing 17.4% of the available-for-sale portfolio compared with 18.9% atDecember 31, 2021 . QNB focuses on the financial performance of the underlying issuer for municipal bond purchases in addition to the bond rating of the issuer or the rating of bond insurer, if present. Eight bonds were purchased with a book value of$4,627,000 ; 20 bonds with a book value of$7,865,000 were called or matured in 2022; and 20 bonds with a book value of$7,387,0000 were sold in 2022. QNB owns one collateralized debt obligations ("CDO") in the form of a pooled trust preferred security and is included in the Corporate debt category. The security is comprised of securities issued by banks or bank holding companies. QNB owns the mezzanine tranche of this security. The security is structured so that the senior and mezzanine tranches are protected from defaults by over-collateralization and cash flow default protection provided by subordinated tranches. The trust preferred security the Bank continues to hold has a carrying balance of$53,000 atDecember 31, 2022 and represents the senior-most obligation of the trust. There was no credit-related other-than-temporary impairment charge during 2022, 2021 or 2020. Future estimates of fair value of the remaining security could require recording additional OTTI charges through earnings. For additional detail on these securities see Note 17 of the Notes to Consolidated Financial Statements. The weighted average maturity is based on the stated contractual maturity or likely call date of all securities except for MBS and CMOs, which are based on estimated average life. The maturity of the portfolio could become shorter if interest rates decline and prepayments on MBS and CMOs increase or securities are called. However, the estimated average life could lengthen if interest rates were to increase and principal payments on MBS and CMOs slowed or securities anticipated to be called extend past their call date.
Investment Portfolio Maturities and Weighted Average Yields
After one After five
year years
One year through through After ten
December 31, 2022 or less five years ten years years Total
Investment Securities
Available-for-Sale
U.S. Treasuries
Fair value $ 301 $ - $ - $ - $ 301
Weighted average yield 1.34 % - - - 1.34 %
U.S. Government agency:
Fair value - $ 23,420 $ 63,289 - $ 86,709
Weighted average yield - 0.76 % 1.23 % - 1.10 %
State and municipal:
Fair value - 1,464 15,535 78,368 95,367
Weighted average yield - 3.45 % 2.76 % 2.11 % 2.24 %
Mortgage-backed:
Fair value 1 48,304 207,856 - 256,161
Weighted average yield 2.79 % 1.68 % 1.59 % - 1.61 %
Collateralized mortgage
obligations (CMOs):
Fair value 187 19,804 81,681 - 101,672
Weighted average yield 2.23 % 1.87 % 1.60 % - 1.65 %
Corporate debt:
Fair value - 1,957 4,358 - 6,315
Weighted average yield - 2.30 % 5.36 % - 4.41 %
Total fair value $ 489 $ 94,949 $ 372,719 $ 78,368 $ 546,525
Weighted average yield 1.68 % 1.53 % 1.62 % 2.11 % 1.68 %
Securities are assigned to categories based on stated contractual maturity
except for mortgage-backed securities and CMOs which are based on anticipated
payment periods and state and municipal securities which are based on
pre-refunded date, if applicable. Tax-exempt securities were adjusted to a
tax-equivalent basis and are based on the marginal Federal corporate tax rate of
21% and a Tax Equity and Financial Responsibility Act ("TEFRA") adjustment for
the cost of funds. Weighted average yields on investment securities
available-for-sale are based on amortized cost.
Investments in
Equity securities decreased$354,000 to$12,056,000 atDecember 31, 2022 from$12,410,000 atDecember 31, 2021 . QNB sold$1,594,000 in equity securities for a net gain of$405,000 and purchased$1,860,000 in equities during 2022. - 33 - -------------------------------------------------------------------------------- Increases and decreases in the fair value of equity securities were recognized in net income, AtDecember 31, 2022 , the fair value of the equity securities was$12,056,000 , or$35,000 below the cost of$12,091,000 compared to$12,410,000 , or$991,000 above the cost of$11,419,000 atDecember 31, 2021 . The equities portfolio comprises blue-chip large-capitalized stocks, providing a taxable equivalent dividend yield of 3.32%. The estimated cumulative contribution (realized and unrealized net gains (losses), plus dividends) of the equity portfolio to earnings per share fromJanuary 1, 2012 throughDecember 31, 2022 is$2.39 per diluted share. Details of the equity portfolio's contribution to net income is detailed in the following table. Net Income (Expense) on Equity Securities For the Year Ended December 31, 2015 2016 2017
2018 2019 2020 2021 2022
691 758 1,557 (79 ) 1,781 585 1,788 405
OTTI (55 ) (192 ) (80 ) N/A N/A N/A N/A N/A
Unrealized (loss) gain N/A N/A N/A (336 ) 770 (47 ) 926 (1,026 )
Tax-equivalent income before
tax 880 799 1,726 (115 ) 2,825 930 3,151 (222 )
Tax expense (benefit)* 357 324 701 (33 ) 816 269 910 (64 )
Net income $ 523 $ 475 $ 1,025 $ (82 ) $ 2,009 $ 661 $ 2,241 $ (158 ) Earnings per share - basic
0.14 0.30 (0.02 ) 0.57 0.19 0.63 (0.04 ) Tax-equivalent yield
3.35 % 3.13 % 3.49 % 3.08 % 3.31 % 3.54 % 3.02 % 3.32 %
*Based on Federal tax rates of 34% for the 2015 and 2016 periods and 21% for the 2017, 2018, 2019, 2020, 2021 and 2022 periods.
Loans
QNB's primary business is to accept deposits and to make loans to meet the credit needs of the communities it serves. Loans are the most significant component of earning assets, and growth in loans to small businesses and residents of these communities has been a primary focus of QNB. Inherent within the lending function is the evaluation and acceptance of credit risk and interest rate risk. QNB manages credit risk associated with its lending activities through portfolio diversification, underwriting policies and procedures and loan monitoring practices.
QNB has comprehensive policies and procedures that define and govern commercial and retail loan originations and the management of risk. All loans are underwritten in a manner that emphasizes the borrowers' capacity to pay. The measurement of capacity to pay delineates the potential risk of non-payment or default. The higher potential for default determines the need for and amount of collateral required. QNB makes unsecured commercial loans when the capacity to pay is considered substantial. As capacity lessens, collateral is required to provide a secondary source of repayment and to mitigate the risk of loss. Various policies and procedures provide guidance to the lenders on such factors as amount, terms, price, maturity and appropriate collateral levels. Each risk factor is considered critical to ensuring that QNB receives an adequate return for the risk undertaken, and that the risk of loss is minimized. QNB manages the risk associated with commercial loans by having lenders work in tandem with credit analysts while maintaining independence between personnel. In addition, a Bank loan committee and a committee of the Board of Directors review and approve certain loan requests on a weekly basis. Other than disclosed in the forthcoming Loan Portfolio Table, atDecember 31, 2022 , there was a concentration of loans to lessors of residential buildings and dwellings of 20.0% of total loans and to lessors of nonresidential buildings of 22.5% of total loans, compared with 18.0% and 24.2% of total loans, respectively, atDecember 31, 2021 . These concentrations were primarily within the commercial real estate categories. - 34 - -------------------------------------------------------------------------------- QNB's commercial lending activity is focused on small businesses within the local community. Commercial purpose loans are generally perceived as having more risk of default than residential real estate loans with a personal purpose and consumer loans. These types of loans involve larger loan balances to a single borrower or group of related borrowers and are more susceptible to a risk of loss during a downturn in the business cycle. These loans may involve greater risk because the availability of funds to repay these loans depends on the successful operation of the borrower's business. The assets financed are used within the business for its ongoing operation. Repayment of these types 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. Commercial and industrial loans represent commercial purpose loans that are either secured by collateral other than real estate or unsecured. Commercial loans secured by commercial real estate include commercial purpose loans collateralized at least in part by commercial real estate. Some of these loans may not be for the express purpose of conducting commercial real estate transactions. Commercial loans secured by residential real estate are commercial purpose loans generally secured by the business owner's residence or residential investment properties owned by the borrower and rented to tenants. Commercial loans secured by either commercial real estate or residential real estate are originated primarily within theEastern Pennsylvania market area, are within the Bank's underwriting criteria, and generally include the guarantee of the borrowers. Repayment of this kind of loan is dependent upon either the ongoing cash flow of the borrowing entity or the resale of or lease of the subject property. Commercial real estate and commercial construction loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers' ability to repay their loans depends on successful development of their properties. Loans to state and political subdivisions are tax-exempt or taxable loans to municipalities, school districts and housing and industrial development authorities. These loans can be general obligations of the municipality or school district repaid through their taxing authority, revenue obligations repaid through the income generated by the operations of the authority, such as a water or sewer authority, or loans issued to a housing and industrial development agency, for which a private corporation is responsible for payments on the loans. The Company originates fixed rate and adjustable-rate residential real estate loans that are secured by 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%. To reduce interest rate risk, qualifying originations of fixed-rate loans to individuals for 1-4 family residential mortgages with maturities of 15 years or greater are generally sold in the secondary market. Mortgage loan origination activity decreased in 2022 with$298,000 in residential mortgages originated for sale during 2022, compared with$4,892,000 for 2021. There were no in residential mortgage loans held-for-sale atDecember 31, 2022 or atDecember 31, 2021 . Loan held for sale are carried at the lower of aggregate cost or market. The home equity portfolio consists of fixed-rate home equity loans and variable rate home equity lines of credit. These loans are often in a junior lien position and therefore carry a higher risk than first lien 1-4 family residential loans. Risks associated with loans secured by residential properties, either first lien residential mortgages or home equity loans and lines, are generally lower than commercial loans and include general economic risks, such as the strength of the job market, employment stability and the strength of the housing market. Since most loans are secured by a primary or secondary residence, the borrower's continued employment is the greatest risk to repayment. The Company offers a variety of loans to individuals for personal and household purposes. Consumer loans are generally considered to have greater risk than loans secured by residential real estate because they may be unsecured, or, if they are secured, the value of the collateral may be difficult to assess or more likely to decrease in value than real estate. Credit risk in this portfolio is controlled by conservative underwriting standards that consider debt-to-income levels and the creditworthiness of the borrower, and, if secured, the value of the collateral. Under the CARES Act, enacted onMarch 27, 2020 , QNB continues to provide customers experiencing financial hardship caused by the COVID-19 Pandemic, solutions to help them through this difficult period. QNB had modified a total 305 commercial loans or$160,676,000 and 61 retail loans or$8,808,000 during 2020 due to COVID-19. As ofDecember 31, 2022 , QNB had no modifications related to the COVID-19 Pandemic. QNB will continue to work with our borrowers during this difficult time. During 2020, the Bank originated$82,475,000 in PPP loans, enabling 660 businesses to maintain their payrolls and stay in operation. AtDecember 31, 2020 , QNB had 556 PPP loans totaling$72,821,000 reported in commercial and industrial loans. AtDecember 31, 2021 there were 16 loans remaining outstanding under the 2020 originated PPP loans totaling$806,000 and related net originations fees were$11,000 which are recognized in interest income as a yield adjustment over the term of the loans. AtDecember 31, 2022 there were three loans remaining outstanding under the 2020 originated PPP loans totaling$329,000 and related net originations fees were$1,000 . Under the Economic Aid Act, enacted onDecember 27, 2020 , QNB originated additional first draw PPP loans and second draw PPP loans during 2021. QNB closed 315 loans totaling$35,021,000 , including first draw loans of$2,781,000 and second draw loans of$32.241.000 . There were 82 loans totaling$13,521,000 outstanding atDecember 31, 2021 and one loan totaling$2,000,000 at - 35 - --------------------------------------------------------------------------------December 31, 2022 . QNB received origination fees from the SBA ranging from a flat fee of$2,500 to five basis points which are recognized in interest income as a yield adjustment over the term of the loan. Net unearned fees and costs on these PPP loans was$471,000 atDecember 31, 2021 and$38,000 atDecember 31, 2022 . The PPP loans are 100% guaranteed by the SBA.
Excluding PPP loans net of deferred fees at
Total loan receivables atDecember 31, 2022 were$1,039,385,000 , an increase of$112,915,000 , or 12.2%, fromDecember 31, 2021 . A key financial ratio, loans to deposits was 73.3% atDecember 31, 2022 , compared with 63.9% atDecember 31, 2021 . QNB continues to be committed to make loans available to credit worthy consumers and businesses. Loan Portfolio December 31, 2022 2021 2020 2019 2018 Commercial: Commercial and industrial$ 160,875 $ 148,610 $ 227,431 $ 168,031 $ 162,452 Construction 62,955 55,855 57,594 56,209 50,135 Secured by commercial real estate 518,070 451,404 377,586 336,050 308,590 Secured by residential real estate 103,419 84,741 81,897 72,443 68,581 State and political subdivisions 20,971 19,775 25,302 38,376 43,737 Retail: 1-4 family residential mortgages 105,654 100,281 82,739 69,469 67,453 Home equity loans and lines 63,580 61,782 63,943 73,311 77,475 Consumer 4,113 4,699 5,364 6,530 6,785 Total loans 1,039,637 927,147 921,856 820,419 785,208 Net unearned costs (fees) (252 ) (677 ) (1,814 ) 197 240 Loans receivable$ 1,039,385 $ 926,470 $ 920,042 $ 820,616 $ 785,448
Loan Maturities and Interest Sensitivity
Loans due after one year
After one After With fixed With variable or
One year year through five through After predetermined adjustable
December 31, 2022 or less five years 15 years 15 years Total interest rate interest rates
Commercial:
Commercial and
industrial $ 102,133 $ 40,841 $ 17,133 $ 768 $ 160,875 $ 35,301 $ 23,441
Construction 17,267 12,998 4,114 28,576 62,955 1,571 44,117
Secured by
commercial real
estate 12,626 27,096 166,917 311,431 518,070 41,674 463,770
Secured by
residential real
estate 1,411 3,145 29,868 68,995 103,419 2,821 99,187
State and political
subdivisions - 1,145 15,199 4,627 20,971 1,306 19,665
Retail:
1-4 family
residential
mortgages 130 701 14,091 90,732 105,654 43,701 61,823
Home equity loansand lines 5,240 2,743 17,041 38,556 63,580 21,337 37,003 Consumer 396 1,450 653 1,614 4,113 1,767 1,950 Total$ 139,203 $ 90,119 $ 265,016 $ 545,299 $ 1,039,637 $ 149,478$ 750,956
Demand loans and loans with no stated maturity are included in one year or less. Table details final maturity.
The Allowance for Loan Losses Allocation table on Page 39 shows the percentage composition of the loan portfolio over the past five years. There was little change in the composition of the portfolio between the periods endedDecember 31, 2022 and 2021. Loans secured by commercial real estate remained the largest sector of the portfolio amounting to 49.8% and 48.7% of the portfolio atDecember 31, 2022 andDecember 31, 2021 , respectively, as the balances in this sector grew by$66,666,000 , or 14.8%, from$431,404,000 atDecember 31, 2021 to$518,070,000 atDecember 31, 2022 . While loans secured by commercial real estate represent a significant portion of the total portfolio, the collateral is diversified, including investment properties, manufacturing facilities, office - 36 - -------------------------------------------------------------------------------- buildings, hospitality properties, hospitals, retirement and nursing home facilities, warehouses and owner-occupied facilities. Commercial real estate loans have drawn the attention of the regulators in recent years as a potential source of risk. QNB monitors these types of loans closely, obtaining updated appraisals on loans classified substandard or worse. As detailed in the Allowance for Loan Losses table, QNB had no charge-offs in this category in 2022, 2021 or 2020. Commercial loans secured by residential real estate increased by$18,678,000 , or 22.0%, to$103,419,000 atDecember 31, 2022 and at 9.9% represent a slightly higher share of the overall portfolio than the 9.2% atDecember 31, 2021 . Some of the properties that serve as collateral for these loans are located outside the Bank's market area and have experienced vacancies and significant declines in market value in prior years. Non-accrual commercial loans secured by residential real estate were$285,000 ,$391,000 , and$875,000 atDecember 31, 2022 , 2021, and 2020, respectively. Charge-offs in this category have significantly decreased over the past three years. Net recoveries of$45,000 in 2022, compared to net charge-off of$17,000 in 2021 and net recoveries of$68,000 in 2020. In 2022,$41,000 in net recoveries were on out-of-market properties compared with$23,000 of the net charge-offs in 2021 and$64,000 of the net recoveries in 2020. Commercial and industrial loans, the second largest sector of the portfolio, experienced an increase in balances of$12,265,000 , or 8.3%, to$160,875,000 atDecember 31, 2022 . This followed a decline in this category of$78,821,000 , or 34.7%, in 2021. Excluding PPP loans, commercial and industrial loans increased$24,263,000 , or 18.1%, in 2022 and increased$49,069,000 , or 7.0%, in 2021. Commercial and industrial loans represented 15.5% of the portfolio at year-end 2022 compared with 16.0% atDecember 31, 2021 . Excluding PPP loans, commercial and industrial loans represented 15.3% of the portfolio at year-end 2022 compared to 14.7% of the portfolio at year-end 2021. This category of loans generally presents a greater risk than loans secured by real estate since these loans are either secured by accounts receivable, inventory or equipment, or are unsecured. During 2022, nonaccrual commercial and industrial loan balances decreased$1,794,000 to$1,575,000 , the majority of which is due to paydowns of$1,811,000 . During 2021, nonaccrual commercial and industrial loan balances decreased$998,000 to$3,369,000 , the majority of which is due to paydowns of$998,000 . During 2020, nonaccrual commercial and industrial loan balances decreased$1,534,000 to$4,367,000 , the majority of which is due to paydowns of$1,270,000 and the partial charge-off of three credits totaling of$263,000 . In 2021, 2020 and 2019, there were charge-off of$0 ,$268,000 and$207,000 , respectively. Construction loans increased 12.7% to$62,955,000 , or 6.1% of the portfolio atDecember 31, 2022 , from$55,855,000 , or 6.0% of the portfolio atDecember 31, 2021 . These loans are primarily to developers and builders for the construction of residential units or commercial buildings or to businesses for the construction of owner-occupied facilities. This portfolio is diversified among different types of collateral including: 1-4 family residential construction, medical and retirement home facilities, office buildings, hotels and land for development loans. Construction loans are generally made only on projects that have municipal approval. These loans are usually originated to include a short construction period followed by permanent financing provided through a commercial mortgage after construction is complete. Once construction is complete, the balance is moved to the secured by commercial real estate category if the permanent financing is provided by the Bank. There were no charge-offs in the construction loan portfolio since 2011, and no construction loans on non-accrual since 2014. Loans to state and political subdivisions increased$1,196,000 , or 2.9%, to$20,971,000 atDecember 31, 2022 from$19,775,000 atDecember 31, 2021 . This sector decreased to 2.0% of the total loan portfolio atDecember 31, 2022 from 2.1% atDecember 31, 2021 . Many municipalities, counties and school districts refinanced their existing bonds or bank debt due to rate. The decrease in 2021 in the above table was primarily due to one relationship lost during the end of 2021. Residential mortgage loans secured by first lien balances increased by$5,373,000 , or 5.4%, to$105,654,000 atDecember 31, 2022 . This followed an increase of$17,542,000 , or 21.2%, to$100,281,000 , betweenDecember 31, 2020 andDecember 31, 2021 . In 2022 and 2021, QNB retained some adjustable and fixed rate mortgages to borrowers with high credit scores and low loan-to-value ratios. Balances in home equity loans and lines increased$1,798,000 , or 2.9%, to$63,580,000 atDecember 31, 2022 . During 2022, QNB continued to offer very attractive rates on both variable and fixed rate home equity loans and lines. These attractive rates, along with excellent customer service, including quick turnaround time, resulted in new originations in home equity loans, however, paydowns and refinancing into mortgage loans contributed to the decline. QNB expects demand for home equity loans will increase as rates normalize and debt consolidation into mortgage loans decline. Consumer loan balances decreased$586,000 to$4,113,000 atDecember 31, 2022 . In 2013, QNB reentered the private student loan market through a relationship with a third party. These student loans are either fixed or variable rate with the rate dependent on the credit scores of the student and/or the cosigner. As ofDecember 31, 2022 the balance of student loans was$2,180,000 , a decrease of$256,000 compared withDecember 31, 2021 . Student loan balances will decline, as their balances are no longer insured, and QNB ceased funding originations through the third party during 2019 and forward.
Non-Performing Assets
Non-performing assets include non-performing loans, OREO and repossessed assets. Non-performing assets totaled$9,121,000 , or 0.55% of total assets atDecember 31, 2022 , a$2,551,000 decrease over the$11,672,000 , or 0.70% of total assets atDecember 31, 2021 .
Total non-performing loans, which represent loans on non-accrual status, loans
past due 90 days or more and still accruing interest and troubled debt
restructured loans were
- 37 -
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$11,672,000 , or 1.26% of total loans receivable at December 31, 2021 . Loans on
non-accrual status were $4,820,000 at December 31, 2022 compared $7,530,000 at
December 31, 2021 . The decrease was primarily due to paydowns of $2,288,000 , net
charge-offs of $66,000 and loans returned to accruing of $519,000 ; partially
offset by $163,000 being placed on nonaccrual of which $138,000 were due to
retail relationships. Specific impairment reserves have been established based
on updated collateral values even if the borrower continues to pay in accordance
with the terms of the agreement. Of the total amount of non-accrual loans at
December 31, 2022 , $3,345,000 , or approximately 71% of the loans classified as
non-accrual, are current or past due less than 30 days.
QNB had no loans 90 days or more past due and still accruing at December 31,
2022 or at December 31, 2021 . Total loans that are 30 days or more past due
decreased $1,804,000 to $2,439,000 , representing 0.23% of total loans at
December 31, 2022 compared with $4,243,000 and 0.46% of total loans at December
31, 2021 . Restructured loans, as defined in accounting guidance for troubled
debt restructuring in ASC 310-40, that have not already been included in loans
past due 90 days or more and still accruing or in non-accrual loans, totaled
$4,301,000 and $4,142,000 at December 31, 2022 and 2021, respectively.
QNB held no OREO at
Non-Performing Assets December 31, 2022 2021 2020 2019 2018 Loans past due 90 days or more and accruing Commercial: Commercial and industrial $ - $ - $ - $ - $ - Construction - - - - - Secured by commercial real estate - - - - - Secured by residential real estate - - - - - State and political subdivisions - - - - - Indirect lease financing - - - - - Retail: - - - - - 1-4 family residential mortgages - - - - - Home equity loans and lines - - - - - Consumer - - - - - Total loans past due 90 days or more and accruing - - - - - Non-accrual loans Commercial: Commercial and industrial 1,575 3,369 4,367 5,901 3,179 Construction - - - - - Secured by commercial real estate 2,031 2,279 2,905 3,640 1,965 Secured by residential real estate 289 391 875 851 1,102 State and political subdivisions - - - - - Retail: 1-4 family residential mortgages 461 721 636 636 940 Home equity loans and lines 402 680 752 537 166 Consumer 62 90 105 139 126 Total non-accrual loans 4,820 7,530 9,640 11,704 7,478 Troubled debt restructured loans, not included above 4,301 4,142 4,469 4,760 2,160 Total non-performing assets$ 9,121 $ 11,672 $ 14,109 $ 16,464 $ 9,638 Total non-performing assets as a percent of total assets 0.55 % 0.70 % 0.98 % 1.34 % 0.82 % Nonaccrual loans to total loans 0.88 1.26 1.53 2.01 1.23 Additional loan quality information can be found in Note 5 of the Notes to the Consolidated Financial Statements included in Item 8 of this Form 10-K. Management's view is that loans classified as substandard or doubtful that are not included in the past due, non-accrual or restructured categories are potential problem loans. For some of these loans, management may have knowledge of possible credit problems that will cause management to question the ability of the borrowers to comply with the present loan repayment terms. Commercial loans classified as substandard or doubtful, which includes non-performing loans, continue to show improvement. AtDecember 31, 2022 , substandard or doubtful loans totaled$13,684,000 , a decrease of$4,847,000 , or 26.6%, from the$18,531,000 , reported as ofDecember 31, 2021 . - 38 -
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Allowance for Loan Losses
The allowance for loan losses represents management's best estimate of the known and inherent losses in the existing loan portfolio. Management believes that it uses the best information available to make determinations about the adequacy of the allowance and that it has established its existing allowance for loan losses in accordance withU.S. generally accepted accounting principles ("US GAAP"). The determination of an appropriate level of the allowance for loan losses is based upon an analysis of the risks inherent in QNB's loan portfolio. Management, in determining the allowance for loan losses, makes significant estimates and assumptions. Since the allowance for loan losses is dependent 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 and the level of unallocated reserves. This analysis considers a number of relevant factors including: specific impairment reserves, historical loan loss experience, general economic conditions, levels of and trends in delinquent and non-performing loans, levels of classified loans, trends in the growth rate of loans, and concentrations of credit. Economic conditions, nationally and in QNB's market, improved in 2022 and asset quality remained strong. The allowance level stated as a percent of loans receivable decreased from 1.21% atDecember 31, 2021 to 1.01% atDecember 31, 2022 . Excluding PPP loans, the allowance level stated as a percent of loans receivable was 1.23% atDecember 31, 2021 and 1.02% atDecember 31, 2022 . PPP loans are 100% guaranteed by the SBA. The allowance for loan losses decreased to$10,531,000 at year-end 2022 from$11,184,000 at year-end 2021, due to the decrease in non-performing assets loans and improvements in credit quality. Allowance for Loan Losses Allocation December 31, 2022 2021 2020 2019 2018 Percent Percent Percent Percent Percent gross gross gross gross gross Amount loans Amount loans Amount loans Amount loans Amount loans Balance at end of period applicable to: Commercial: Commercial and industrial$ 1,316 15.5 % $
3,368 16.0 %
755 6.1 363 6.0 346 6.2 590 6.8 551 6.4 Secured by commercial real estate
5,002 49.8 4,280 48.7 3,736 41.0 2,519 41.0 2,824 39.3 Secured by residential real estate
1,240 9.9 1,035 9.2 871 8.9 629 8.8 754 8.7
State and political subdivisions 94 2.0 69 2.1 89 2.7 115 4.7 153 5.6
Retail:
1-4 family residential mortgages 683 10.2 646 10.8 533 9.0 549 8.5 497 8.6
Home equity loans and lines 437 6.1 376 6.7 386 6.9 310 8.9 338 9.9
Consumer 502 0.4 542 0.5 265 0.6 230 0.8 164 0.8
Unallocated 502 505 550 256 461
Total $ 10,531 100.0 % $ 11,184 100.0 % $ 10,826 100.0 % $ 9,887 100.0 % $ 8,834 100.0 %
Gross loans represent loans before unamortized net loan fees and costs. Percent gross loans lists the percentage of each loan type to total loans.
A loan is considered impaired, based on current information and events, if it is probable that QNB will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls may not be 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. AtDecember 31, 2022 and 2021, the recorded investment in loans for which impairment has been identified totaled$9,567,000 and$12,192,000 , respectively, of which$4,943,000 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$4,624,000 and$7,559,000 atDecember 31, 2022 and 2021, respectively. AtDecember 31, 2022 and - 39 - -------------------------------------------------------------------------------- 2021, the related allowance for loan losses associated with these loans was$696,000 and$2,873,000 , respectively. See Note 5 to the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K for additional detail of impaired loans.
Allowance for Loan Losses
2022 2021 2020 2019 2018
Allowance for loan losses:
Balance, January 1 $ 11,184 $ 10,826 $ 9,887 Charge-offs
Commercial:
Commercial and industrial 38 - 268 207 - Construction - - - - - Secured by commercial real estate - - - - - Secured by residential real estate - 38 - 51 77 State and political subdivisions - - - - - Retail: 1-4 family residential mortgages - - - - 1 Home equity loans and lines - 49 - 17 84 Consumer 158 176 282 197 112 Total charge-offs 196 263 550 472 274 Recoveries Commercial: Commercial and industrial 306 92 40 33 40 Construction - - - - - Secured by commercial real estate - - 12 10 23 Secured by residential real estate 45 21 68 123 27 State and political subdivisions - - - - - Retail: 1-4 family residential mortgages - - - - - Home equity loans and lines 6 7 41 15 13 Consumer 36 43 78 44 34 Total recoveries 393 163 239 225 137 Net charge-offs 197 (100 ) (311 ) (247 ) (137 ) Provision for loan losses (850 ) 458 1,250 1,300 1,130 Balance, December 31$ 10,531 $ 11,184 $ 10,826
Total loans (excluding loans held-for-sale) Average$ 967,438 $ 928,017 $ 868,461 $ 811,413 $ 766,692 Year-end 1,039,385 926,470 920,042 820,616 785,448 Ratios: Net charge-offs to: Average loans -0.02 % 0.01 % 0.04 % 0.03 % 0.02 % Loans at year-end -0.02 0.01 0.03 0.03 0.02 Allowance for loan losses -1.87 0.89 2.87 2.50 1.55 Provision for loan losses 23.18 21.83 24.88
19.00 12.12
Allowance for loan losses to: Average loans 1.09 % 1.35 % 1.25 % 1.22 % 1.22 % Loans at year-end 1.01 1.21 1.18 1.20 1.12 Nonaccrual loans 218.49 148.53 112.30
84.48 118.13
QNB had net loan recoveries of $197,000 , or 0.02% of average loans for 2022
compared to net charge-off of $100,000 , or 0.01% of average loans for 2021 and
$311,000 , or 0.04% of average loans for 2020. The majority of charge-offs
recorded during these periods had specific reserves established during the
allowance for loan loss calculation process prior to the decision to charge-off
the loan. The increase in commercial and industrial charge-offs in 2020 and 2019
was primarily related to a single relationship.
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Management believes the allowance for loan losses of $10,531,000 is adequate as
of December 31, 2022 , in relation to the estimate of known and inherent losses
in the portfolio.
Premises and equipment
Premises and equipment includes a right-of-use asset of $2,909,000 and
$3,423,000 at December 31, 2022 and December 31, 2022 respectively. The discount
rates used in determining the initial value of the right of use assets are based
on the FHLB Amortizing Fixed Loan Rate for the term of each lease. QNB typically
enters into lease agreements with an initial term of 5 to 10 years and
subsequent additional optional terms in increments of 5 years. The lease
agreements also contain termination options. None of the leases contain purchase
options and none transfer the ownership of the leased asset. QNB has renewed one
operating lease during 2022. QNB renewed one operating lease during 2021 and
acquired the underlying assets of one of its leased properties. Operating lease
liabilities are included with "Other liabilities" on the Consolidated Balance
Sheets. All operating lease costs are included in non-interest expense within
"Net occupancy" on the Consolidated Statements of Income. Other premises and
equipment, net of depreciation decreased $563,000 to $12,554,000 at December 31,
2022 ; this was primarily due to depreciation.
Other assets
Other assets increased$21,420,000 from$6,424,000 atDecember 31, 2021 to$27,844,000 atDecember 31, 2022 . Most of the increase in other assets relates to a$20,628,000 increase to the deferred tax asset resulting from the fair value adjustment on investment securities available-for-sale of$20,571,000 . The detail of the net deferred tax asset can be found in Note 11 in the Notes to Consolidated Financial Statements.
LIABILITIES
The following table presents total liabilities at the dates indicated:
Change from prior year
Year ended December 31, 2022 2021 Amount Percent
Deposits $ 1,418,369 $ 1,449,745 $ (31,376 ) -2.2 %
Short-term borrowings 161,327 68,476 92,851 135.6
Long-term debt 10,000 10,000 - N/M
Accrued interest payable 467 211 256 121.3
Other liabilities 7,376 8,414 (1,038 ) -12.3
Total liabilities $ 1,597,539 $ 1,536,846 $ 60,693 3.9 %
Deposits
QNB primarily attracts deposits from within its market area by offering various
deposit products. These deposits are in the form of time deposits, which include
certificates of deposit and individual retirement accounts ("IRAs") which have a
stated maturity, and non-maturity deposit accounts, which include:
non-interest-bearing demand accounts, interest-bearing demand accounts, money
market accounts and savings accounts.
Total deposits decreased $31,376,000 , or 2.2%, to $1,418,369,000 at December 31,
2022 , due to the competitive local interest rate market for deposits. The mix of
deposits continues to be impacted by customers' reactions to the competition,
regulations and the interest rate environment. Many customers are looking for
transaction accounts that provide liquidity and pay a reasonable amount of
interest, while others look for high rate. Time deposit balances increased
$7,076,000 , or 4.2% between 2021 and 2022, as customers took advantage of a
higher rate environment. Customers appear to be looking for the safety of FDIC
insured deposits and the stability of a strong local community bank.
Non-interest-bearing demand accounts decreased $11,157,000 to $231,849,000 at
December 31, 2022 . These deposits are both retail and commercial checking
accounts and are volatile depending on the timing of deposits and withdrawals.
QNB has been successful in attracting new customers and expanding relationships
with existing customers, which provides an opportunity for fee income.
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Interest-bearing demand accounts, retail and business interest-checking and
municipal accounts, decreased $15,272,000 , or 3.3%, to $452,927,000 at December
31, 2022 . All three segments experienced a decline in 2022. QNB has been
successful in developing relationships with several school districts and
municipalities as well as expanding existing relationships, the balances in
these accounts are seasonal in nature and can be volatile on a daily basis. Most
of the school district taxes are collected during the third quarter of the year
and are disbursed over a nine-month period. Business checking decreased from
$67,069,000 at December 31, 2021 to $66,606,000 at December 31, 2022 . Retail
checking accounts decreased $4,358,000 , or 1.6%, to $267,980,000 at December 31,
2022 . QNB continues to open a significant number of new checking accounts;
additionally, customers may choose to switch products. Rewards checking balances
decreased $2,437,000 from $107,470,000 at December 31, 2021 to $105,033,000 at
December 31, 2022 , and personal interest-bearing balances increased $1,147,000 .
The balances in the Select 50 product decreased $3,186,000 from $134,915,000 at
December 31, 2021 to $131,729,000 at December 31, 2022 .
Money Market accounts decreased from 143,942,000 at
Total savings account balances increased$4,876,000 , or 1.1%, to$431,101,000 atDecember 31, 2022 . This increase is due primarily to an increase in Statement Savings of$3,604,000 , or 3.5%, and an increase of$1,285,000 , or 0.4%, in the online eSavings accounts overDecember 31, 2021 . The rate on eSavings accounts was changed from 0.35% at the end of 2021 to 1.25% in 2022. Total time deposit account balances were$175,449,000 atDecember 31, 2022 , an increase of$7,076,000 , or 4.2%, from the amount reported atDecember 31, 2021 . QNB was able to retain many maturing deposits during 2022 by offering competitive rates and many current customers move balances from more liquid accounts to take advantage of these rates. Maturity of Time Deposits of$250,000 or More Year ended December 31, 2022 2021
2020
Three months or less$ 3,287 $ 4,749 $
9,150
Over three months through six months 3,579 4,224
4,318
Over six months through twelve months 7,645 7,395 7,284 Over twelve months 9,959 8,619 8,767 Total$ 24,470 $ 24,987 $ 29,519 To continue to attract and retain deposits, QNB plans to remain competitive with respect to rates and to continue to deliver products with terms and features that appeal to customers. The QNB Rewards checking accounts and time deposits are examples of such products. The following table presents trends in balances and yield on the major deposit groups. Average Deposits by Major Classification 2022 2021 2020 Balance Rate Balance Rate Balance Rate Demand, non-interest bearing$ 242,778 $ 236,511 $ 186,897 Interest-bearing demand 345,054 0.27 % 307,258 0.20 % 252,050 0.26 % Municipals interest-bearing demand 122,824 1.43 127,828 0.32 119,673 0.57 Money market 137,830 0.45 122,361 0.31 90,989 0.45 Savings 443,104 0.49 386,630 0.30 288,285 0.40 Time less than$100 91,216 0.79 98,986 0.93 113,647 1.41 Time$100 through$250 52,314 0.93 52,693 0.86 65,840 1.54 Time greater than$250 25,296 0.83 26,833 0.96 33,030 1.65 Total$ 1,460,416 0.47 %$ 1,359,100 0.31 %$ 1,150,411 0.53 % Short-term borrowings Short-term borrowings comprising commercial sweep accounts and overnight FHLB borrowings increased$92,851,000 , or 135.6%, to$161,327,000 atDecember 31, 2022 . There were no overnight FHLB borrowings outstanding atDecember 31, 2021 and$92,018,000 atDecember 31, 2022 . The FHLB borrowings were used to support loan growth. Long-term debt
Long-term debt comprises of
- 42 ---------------------------------------------------------------------------------
Other liabilities
Other liabilities comprise accrued expenses including salaries, post-retirement life insurance benefits and income taxes, operating lease liability, deferred revenue, and ATM/debit card processing clearing. These balances decreased$1,038,000 , to$7,376,000 atDecember 31, 2022 .
SHAREHOLDERS' EQUITY
The following table presents total shareholders' equity at the dates indicated:
Change from prior year
Year ended December 31, 2022 2021 Amount Percent
Common stock $ 2,373 $ 2,350 $ 23 1.0 %
Surplus 24,798 23,683 1,115 4.7
Retained earnings 128,951 118,163 10,788 9.1
Accumulated other comprehensive
loss, net of tax (81,127 ) (3,740 ) (77,387 ) N/M
Treasury stock (4,037 ) (3,962 ) (75 ) 1.9
Total shareholders' equity $ 70,958 $ 136,494 $ (65,536 ) -48.0 %
Total shareholders' equity decreased $65,536,000 , or 48.0%, to $70,958,000 at
December 31, 2022 with the negative impact of the market value of
available-for-sale securities, net of tax, adjustment contributing
$77,387,000 . This was partially offset with retained earnings (net income less
dividends paid) contributing $10,788,000 and the dividend reinvestment and stock
purchase plan, employee stock purchase plan and stock option plan contributing
$1,138,000 . During 2022, QNB purchased $75,000 in treasury stock.
Accumulated other comprehensive loss decreased from a loss of $3,740,000 to a
loss of $81,127,000 , resulting from the decrease in fair value of the
available-for-sale investment portfolio primarily due to a decline in market
values.
QNB offers a Dividend Reinvestment and Stock Purchase Plan (the "Plan") to
provide participants a convenient and economical method for investing cash
dividends paid on the Company's common stock in additional shares. The Plan also
allows participants to make additional cash purchases of stock. Stock purchases
under the Plan contributed $917,000 and $841,000 to capital during 2022 and
2021, respectively.
The Board of Directors has authorized the repurchase of up to 200,000 shares of
QNB's common stock in open market or privately
negotiated transactions. The repurchase authorization does not bear a
termination date. During 2022, 2,000 shares were repurchased at an average price
of $37.07 . As of December 31, 2022 , a total of 102,000 shares were repurchased
under this authorization at an average price of $24.93 and a total cost of
$2,543,000 .
Liquidity and Capital Resources
Liquidity Management
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.
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An additional source of liquidity is provided by the Bank's membership in the
FHLB. At December 31, 2022 , the Bank's total maximum borrowing capacity at the
FHLB was $396,973,000 of which $294,496,000 remained available. The Bank had
$10,000,000 in long-term debt over-night funds of $92,018,000 outstanding at
year-end 2022, related interest payable of $92,000 , and $350,000 in FHLB-issued
letters of credit. The maximum borrowing capacity changes depending upon the
Bank's level of qualifying collateral assets. In addition, the Bank maintains
five unsecured Federal funds lines with five correspondent banks totaling
$101,000,000 . At December 31, 2022 and 2021, 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. As part of its
contingency funding plan, QNB successfully tested its ability to borrow from
these sources during 2022.
Total cash and cash equivalents, equity and available-for-sale securities and
loans held-for-sale totaled $574,480,000 at December 31, 2022 and $718,160,000
at December 31, 2021 , of which $237,645,000 and $264,154,000 , respectively, were
pledged as collateral for repurchase agreements and public deposits. This
decrease in liquid sources is primarily the result of the market value decline
in available-for-sale securities. Management anticipates that these liquid
sources are adequate to meet normal fluctuations in loan demand or deposit
withdrawals. It is anticipated that the investment portfolio will continue to
provide sufficient liquidity as municipal bonds are called and as principal and
interest payments on mortgage-backed and CMO securities provide steady cash
flow. Increases in interest rates, however, result in decreased cash flow
available from the investment portfolio.
QNB is a member of the Certificate of Deposit Account Registry Services
("CDARS") program offered by the Promontory Interfinancial Network, LLC . CDARS
is a funding and liquidity management tool used by banks to access funds and
manage their balance sheet. It enables financial institutions to provide
customers with full FDIC insurance on time deposits over $250,000 that are
placed in the program. QNB also has available Insured Cash Sweep ("ICS"),
another program through Promontory Interfinancial Network, LLC , which is a
product similar to CDARS, but one that provides liquidity like a money market or
savings account. QNB had $11,284,000 in CDARS time deposits at December 31,
2022 .
Capital Resources
A strong capital position is fundamental to support continued growth and profitability and to serve the needs of depositors. QNB's shareholders' equity atDecember 31, 2022 was$70,958,000 , or 4.25% of total assets, compared with shareholders' equity of$136,494,000 , or 8.16% of total assets, atDecember 31, 2021 . Shareholders' equity atDecember 31, 2022 included a negative$81,127,000 related to unrealized holding losses, net of taxes, on investment securities available for sale, compared to a negative$3,740,000 related to unrealized holding losses, net of taxes, on investment securities available for sale atDecember 31, 2021 . Excluding these adjustments, shareholders' equity to total assets would have been 8.69% and 8.36% atDecember 31, 2022 and 2021, respectively.
Average shareholders' equity and average total assets were
QNB is subject to restrictions on the payment of dividends to its shareholders pursuant to the Pennsylvania Business Corporation Law of 1988 as amended (the BCL). The BCL operates generally to preclude dividend payments, if the effect thereof would render QNB insolvent, as defined. As a practical matter, QNB's payment of dividends is contingent upon its ability to obtain funding in the form of dividends from the Bank. UnderPennsylvania banking law, the Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. AtDecember 31, 2022 , the retained earnings of the Bank totaling$122,052,000 was available for dividends without priorPennsylvania Department of Banking approval, subject to the regulatory capital requirements discussed below. Under the Federal Deposit Insurance Act, an insured depository institution may not pay a dividend if, after the payment of the dividend, the institution would be undercapitalized under theFDIC's prompt corrective action rules. In addition, federal banking agencies have the authority to restrict dividend payments under certain circumstances if such payments are not consistent with the capital needs and financial condition of the institution. It is the policy of theFederal Reserve that a bank holding company generally should not maintain its existing rate of cash dividends on common stock unless the net income available to common shareholders over the prior four quarters, net of dividends previously paid during that period, has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with the company's capital needs, asset quality, and overall financial condition. QNB paid dividends to its shareholders of$1.44 per share,$1.40 per share, and$1.36 per share, in 2022, 2021, and 2020, respectively. QNB is subject to various regulatory capital requirements as issued by Federal regulatory authorities. Regulatory capital is defined in terms of Tier 1 capital and Tier 2. Risk-based capital ratios are expressed as a percentage of risk-weighted assets. Risk-weighted assets are determined by assigning various weights to all assets and off-balance sheet arrangements, such as letters of credit and loan commitments, based on associated risk. QNB is subject to various regulatory capital requirements as issued by Federal regulatory authorities. - 44 - -------------------------------------------------------------------------------- Minimum requirements for both the quantity and quality of capital held by banks are as follows: Common equity Tier 1 capital to risk-weighted assets of 4.5%; Tier 1 capital to risk-weighted assets of 6.0%; Total Capital to risk-weighted assets of 8.0%; and Tier 1 leverage ratio of 4.0%. The capital conservation buffer, comprised of common equity Tier 1 capital, was established above the regulatory minimum capital requirements at 2.5%. The Federal Deposit Insurance Corporation Improvement Act of 1991 established five capital level designations for insured institutions ranging from "well capitalized" to "critically undercapitalized." AtDecember 31, 2022 and 2021, management believes that the Company and the Bank met all capital adequacy requirements to which they are subject and have met the "well capitalized" criteria. Capital Analysis December 31, 2022 2021 Regulatory Capital Shareholders' equity$ 70,958 $ 136,494 Net unrealized securities losses, net of tax 81,127
3,740
Deferred tax assets on net operating loss - - Disallowed goodwill and other disallowed intangible assets (8 ) (8 ) Common equity tier I capital 152,077
140,226
Tier 1 capital 152,077
140,226
Allowable portion: Allowance for loan losses and reserve for
unfunded commitments 10,648 11,275 Total regulatory capital$ 162,725 $ 151,501 Risk-weighted assets$ 1,233,758 $ 1,113,887 Quarterly average assets for leverage capital purposes$ 1,737,671 $ 1,672,259 Capital Ratios December 31, 2022 2021
Common equity tier I capital / risk-weighted assets 12.33 % 12.59 % Tier 1 capital / risk-weighted assets
12.33 % 12.59 %
Total regulatory capital / risk-weighted assets 13.19 % 13.60 % Tier 1 capital / average assets (leverage ratio) 8.75 % 8.39 %
Material Cash Requirements from Known Contractual and Other Obligations
QNB has various financial obligations, including contractual obligations and commitments, which may require future cash payments.
The following table presents, as ofDecember 31, 2022 , significant contractual obligations to third parties by payment date and the amounts and expected maturities of significant commitments. Further discussion of the nature of each obligation can be found in the Notes to Consolidated Financial Statements. The Company's reserve for unfunded commitments totaled$117,000 atDecember 31, 2022 compared to$91,000 atDecember 31, 2021 . After one After three year years One year through through After December 31, 2022 or less three years five years five years Total Time deposits$ 85,267 $ 61,954 $ 28,228 $ -$ 175,449 Short-term borrowings 161,327 - - - 161,327 Long-term debt 10 - - - 10 Operating leases 569 931 555 2,433 4,488 Commitments to extend credit (a) 189,275 77,669 13,107 59,261 339,312 Standby letters of credit 17,800 1,712 - - 19,512 Total$ 454,248 $ 142,266 $ 41,890 $ 61,694 $ 700,098
(a) Includes available amounts for overdraft protection program in one year or
less
- 45 --------------------------------------------------------------------------------- Commitments to extend credit, including loan commitments, standby letters of credit, and commercial letters of credit do not necessarily represent future cash requirements, as these commitments often expire without being drawn upon. The Company does not currently have any commitments for significant capital expenditures or other purchase obligations.
RECENTLY ISSUED ACCOUNTING STANDARDS
Refer to Note 1 of the Notes to Consolidated Financial Statements for discussion of recently issued accounting standards.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Disclosure of the Company's significant accounting policies is included in Note 1 to Consolidated Financial Statements. Additional information is contained in Management's Discussion and Analysis and the Notes to Consolidated Financial Statements for the most sensitive of these issues. The discussion and analysis of the financial condition and results of operations are based on the Consolidated Financial Statements of QNB, which are prepared in accordance with US GAAP and predominant practices within the banking industry. The preparation of these Consolidated Financial Statements requires QNB to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. QNB evaluates estimates on an on-going basis, including those related to the determination of the allowance for loan losses, the determination of the valuation of other real estate owned, other-than-temporary impairments on investment securities, the determination of impairment of restricted bank stock, the valuation of deferred tax assets, stock-based compensation and income taxes. QNB bases its estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Other-than-Temporary Investment Security Impairment
Securities are evaluated periodically to determine whether a decline in their value is other-than-temporary. Management utilizes criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other-than-temporary. The term "other-than-temporary" is not intended to indicate that the decline is permanent but indicates that the prospect for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. The Company follows the accounting guidance inFinancial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 320-10 as it relates to the recognition and presentation of other-than-temporary impairment ("OTTI"). This accounting guidance specifies that (a) if a company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss. When an entity does not intend to sell the security, and it is more likely than not, the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held to maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the non-credit portion of a previous other-than-temporary impairment should be amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security. For equity securities without a readily determinable market value, 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.
Allowance for Loan Losses
QNB considers that the determination of the allowance for loan losses involves a
higher degree of judgment and complexity than its other significant accounting
policies. The allowance for loan losses is calculated with the objective of
maintaining a level believed by management to be sufficient to absorb probable
known and inherent losses in the outstanding loan portfolio. The allowance is
reduced by actual credit losses and is increased by the provision for loan
losses and recoveries of previous losses. The provisions for loan losses are
charged to earnings to bring the total allowance for loan losses to a level
considered necessary by management.
The allowance for loan losses is based on management's continual review and
evaluation of the loan portfolio. The level of the allowance is determined by
assigning specific reserves to individually identified problem credits and
general reserves to all other loans. The portion of the allowance that is
allocated to impaired loans is determined by estimating the inherent loss on
each credit after giving consideration to the value of underlying collateral.
The general reserves are based on the composition and risk characteristics of
the loan portfolio, including the nature of the loan portfolio, credit
concentration trends, delinquency and loss experience, as well as other
qualitative factors such as current economic trends.
Management emphasizes loan quality and close monitoring of potential problem
credits. Credit risk identification and review processes are utilized in order
to assess and monitor the degree of risk in the loan portfolio. QNB's lending
and credit administration staff are charged with reviewing the loan portfolio
and identifying changes in the economy or in a borrower's circumstances which
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may affect the ability to repay debt or the value of pledged collateral. A loan
classification and review system exists that identifies those loans with a
higher-than-normal risk of collection. Each commercial loan is assigned a grade
based upon an assessment of the borrower's financial capacity to service the
debt and the presence and value of collateral for the loan. An independent loan
review group tests risk assessments and evaluates the adequacy of the allowance
for loan losses. Management meets monthly to review the credit quality of the
loan portfolio and quarterly to review the allowance for loan losses.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review QNB's allowance for loan losses. Such
agencies may require QNB to recognize additions to the allowance based on their
judgments about information available to them at the time of their examination.
Management believes that it uses the best information available to make
determinations about the adequacy of the allowance and that it has established
its existing allowance for loan losses in accordance with US 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 sponsored stock-based compensation plans, administered by a Board committee, under which both qualified and nonqualified stock options may be granted periodically to certain employees. QNB accounts for all awards granted under stock-based compensation plans in accordance with ASC 718, Compensation - Stock Compensation. Compensation cost has been measured using the fair value of an award on the grant date and is recognized over the service period, which is usually the vesting period. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the option and each vesting date. QNB estimates the fair value of stock options on the date of the grant using the Black-Scholes option pricing model. The model requires the use of numerous assumptions, many of which are highly subjective in nature. Income Taxes QNB accounts for income taxes under the asset/liability method in accordance with income tax accounting guidance, ASC 740 - Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established against deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become available. Because the judgment about the level of future taxable income is dependent to a great extent on matters that may, at least in part, be beyond QNB's control, it is at least reasonably possible that management's judgment about the need for a valuation allowance for deferred taxes could change in the near term.
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