UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2023
OR
☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-17706
QNB Corp.
(Exact Name of Registrant as Specified in Its Charter)
Pennsylvania
23-2318082
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
15 North Third Street, P.O. Box 9005 Quakertown, PA
18951-9005
(Address of Principal Executive Offices)
(Zip Code)
(215) 538-5600
Registrant's Telephone Number, Including Area Code
Not Applicable
Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report
Securities registered pursuant to Section 12(b) of the Act: None.
Title of each class
Trading
Symbol(s)
Name of each exchange on which registered
Common Stock
QNBC
N/A
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☐
Accelerated filer
Non-accelerated filer
☒
Smaller Reporting Company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class
Outstanding at April 28, 2023
Common Stock, par value $0.625
3,597,345
QNB CORP. AND SUBSIDIARY
QUARTER ENDED March 31, 2023
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1.
CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
PAGE
Consolidated Balance Sheets at March 31, 2023 and December 31, 2022
2
Consolidated Statements of Income for the Three Months Ended March 31, 2023 and 2022
3
Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended March 31, 2023 and 2022
4
Consolidated Statement of Shareholders’ Equity for the Three Months Ended March 31, 2023 and 2022
5
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2023 and 2022
6
Notes to Consolidated Financial Statements
7
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
35
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
52
ITEM 4.
CONTROLS AND PROCEDURES
53
PART II - OTHER INFORMATION
LEGAL PROCEEDINGS
54
ITEM 1A.
RISK FACTORS
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
DEFAULTS UPON SENIOR SECURITIES
MINE SAFETY DISCLOSURES
ITEM 5.
OTHER INFORMATION
ITEM 6.
EXHIBITS
55
SIGNATURES
56
CERTIFICATIONS
1
QNB Corp. and Subsidiary
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(current period unaudited)
March 31, 2023
December 31, 2022
Assets
Cash and due from banks
$
11,452
14,657
Interest-bearing deposits in banks
2,749
1,242
Total cash and cash equivalents
14,201
15,899
Investments:
Available-for-sale (amortized cost $629,187 and $649,217)
537,904
546,525
Equity securities (cost of $11,885 and $12,091)
11,908
12,056
Restricted investment in stocks
2,098
5,193
Loans held-for-sale
388
—
Loans receivable
1,011,956
1,039,385
Allowance for credit losses on loans
(8,191
)
(10,531
Loans receivable, net
1,003,765
1,028,854
Bank-owned life insurance
11,712
11,625
Premises and equipment, net
15,557
15,463
Accrued interest receivable
3,425
5,038
Net deferred tax assets
20,169
23,077
Other assets
5,372
4,767
Total assets
1,626,499
1,668,497
Liabilities
Deposits
Demand, non-interest bearing
212,259
231,849
Interest-bearing demand
430,737
452,927
Money market
143,790
127,043
Savings
387,788
431,101
Time less than $100
104,460
91,329
Time $100 through $250
112,608
59,650
Time greater than $250
32,948
24,470
Total deposits
1,424,590
1,418,369
Short-term borrowings
110,192
161,327
Long-term debt
10,000
Accrued interest payable
923
467
Other liabilities
6,920
7,376
Total liabilities
1,542,625
1,597,539
Shareholders' Equity
Common stock, par value $0.625 per share;
authorized 10,000,000 shares; 3,806,031 shares and 3,796,948
shares issued; 3,597,345 and 3,588,262 shares outstanding
2,379
2,373
Surplus
25,048
24,798
Retained earnings
132,598
128,951
Accumulated other comprehensive loss, net of tax
(72,114
(81,127
Treasury stock, at cost; 208,686 and 208,686 shares
(4,037
Total shareholders' equity
83,874
70,958
Total liabilities and shareholders' equity
The accompanying notes are an integral part of the consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
For the Three Months Ended March 31,
(in thousands, except per share data - unaudited)
2023
2022
Interest income
Interest and fees on loans
12,714
9,003
Interest and dividends on available-for-sale & equity securities:
Taxable
2,279
2,274
Tax-exempt
374
517
Interest on interest-bearing balances and other interest income
96
15
Total interest income
11,809
Interest expense
Interest on deposits
1,377
237
342
106
1,077
321
382
184
Time of $100 through $250
727
85
123
42
Interest on short-term borrowings
995
59
Interest on long-term debt
23
39
Total interest expense
5,046
1,073
Net interest income
10,417
10,736
(Reversal) provision for credit losses
(1,805
Net interest income after provision for loan losses
12,222
Non-interest income
Net (loss) gain on sales and calls of available-for-sale and equity securities
(465
36
Unrealized gain (loss) on investment equity securities
57
(8
Fees for services to customers
402
384
ATM and debit card
659
641
Retail brokerage and advisory
234
205
86
81
Merchant
93
95
Net gain on sale of loans
Other
147
177
Total non-interest income
1,219
1,611
Non-interest expense
Salaries and employee benefits
4,563
4,266
Net occupancy
540
578
Furniture and equipment
837
687
Marketing
203
194
Third party services
609
667
Telephone, postage and supplies
167
State taxes
124
272
FDIC insurance premiums
175
217
982
738
Total non-interest expense
8,200
7,813
Income before income taxes
5,241
4,534
Provision for income taxes
1,123
824
Net income
4,118
3,710
Earnings per share - basic
1.15
1.04
Earnings per share - diluted
Cash dividends per share
0.37
0.36
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands - unaudited)
Before tax amount
Tax expense
Net of tax amount
Other comprehensive income (loss):
Net unrealized holding gains (losses) on available-for-sale securities:
Unrealized holding gains (losses) arising during the period
11,152
2,342
8,810
(46,331
(9,731
(36,600
Reclassification adjustment for losses (gains) included in net income
257
(1
11,409
2,396
9,013
(46,332
(36,601
Total comprehensive income (loss)
16,650
3,519
13,131
(41,798
(8,907
(32,891
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For the Three Months Ended March 31, 2023 and 2022
Accumulated
Number of
(unaudited)
Shares
Common
Retained
Comprehensive
Treasury
(in thousands, except share and per share data)
Outstanding
Stock
Earnings
Loss
Total
Balance, January 1, 2023
3,588,262
Cumulative change in accounting principle
857
Balance at Janaury 2, 2023 (as adjusted for change in acounting principle)
129,808
71,815
Other comprehensive income, net of tax
Cash dividends declared ($0.37 per share)
(1,328
Stock issued in connection with dividend reinvestment and stock purchase plan
9,083
230
236
Stock issued for employee stock purchase plan
Stock-based compensation expense
20
Balance, March 31, 2023
Balance, January 1, 2022
3,553,629
2,350
23,683
118,163
(3,740
(3,962
136,494
Other comprehensive loss, net of tax
Cash dividends declared ($0.36 per share)
(1,279
6,177
223
227
Stock issued for options exercised
22
Treasury stock purchase
(2,000
(75
Balance, March 31, 2022
3,557,806
2,354
23,928
120,594
(40,341
102,498
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
Operating Activities
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
412
419
Provision for credit losses
Net loss (gain) on calls and sales of debt and equity securities
465
(36
Net unrealized gain (loss) on equity securities
(57
8
(6
Proceeds from sales of residential mortgages held-for-sale
Origination of residential mortgages held-for-sale
(770
Increase in cash surrender value of bank-owned life insurance
(86
(81
Deferred income tax provision
284
131
Net decrease in income taxes payable
(284
(385
Net decrease in accrued interest receivable
1,613
323
Amortization of mortgage servicing rights and change in valuation allowance
11
Net amortization of premiums and discounts on investment securities
482
643
Net increase (decrease) in accrued interest payable
456
(34
Operating lease payments
(156
(154
Increase in other assets
(343
(759
Decrease in other liabilities
(663
(1,468
Net cash provided by operating activities
4,079
Investing Activities
Proceeds from payments, maturities and calls of investments available-for-sale
10,210
21,853
Proceeds from the sale of investments available-for-sale
9,081
Proceeds from the sale of equity securities
709
262
Purchases of investments available-for-sale
(33,312
Purchases of equity securities
(712
(477
Proceeds from redemption of investment in restricted stock
4,944
1,827
Purchases of restricted stock
(1,849
(1,835
Net decrease in loans
27,961
148
Net purchases of premises and equipment
(115
(93
Net cash provided by (used in) investing activities
50,229
(11,627
Financing Activities
Net decrease in non-interest bearing deposits
(19,590
(982
Net increase in interest-bearing deposits
25,811
2,990
Net (decrease) increase in short-term borrowings
(51,135
8,262
Repayment of long-term debt
(10,000
Cash dividends paid, net of reinvestment
(1,151
(1,131
Purchase of treasury shares
Proceeds from issuance of common stock
79
Net cash (used in) provided by financing activities
(56,006
9,143
Decrease in cash and cash equivalents
(1,698
(130
Cash and cash equivalents at beginning of year
13,390
Cash and cash equivalents at end of period
13,260
Supplemental Cash Flow Disclosures
Interest paid
4,590
1,106
Net income taxes paid
1,078
Non-cash transactions:
Cumulative change in accounting principal
Right-of-use assets obtained in exchange for new operating lease liabilities
369
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include the accounts of QNB Corp. and its wholly-owned subsidiary, QNB Bank (the “Bank”). The consolidated entity is referred to herein as “QNB” or the “Company”. All significant intercompany accounts and transactions are eliminated in the consolidated financial statements.
These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in QNB's 2022 Annual Report incorporated in the Form 10-K. Operating results for the three-month period ended March 31, 2023 are not necessarily indicative of the results that may be expected for the year ending December 31, 2023.
The unaudited consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the results of operations for the period and are of a normal and recurring nature.
Tabular information, other than share and per share data, is presented in thousands of dollars.
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from such estimates.
QNB has evaluated events and transactions occurring subsequent to the balance sheet date of March 31, 2023 for items that should potentially be recognized or disclosed in these consolidated financial statements.
2. RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2023, the Company adopted ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326), as amended ("ASU 326"), which replaces the incurred loss methodology with an expected credit losses (“CECL”) for financial instruments held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. The measurement under CECL is applicable to loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. Additionally, ASU 326 made changes to the accounting for available-for-sale debt securities, requiring credit losses to be presented as an allowance rather as a write-down on available-for-sale debt securities management does not intend to sell or believes it is more-likely-than-not they will be required to sell. The Company made an accounting policy election to exclude accrued interest receivable from the amortized cost basis of loans, available for sale securities, and held to maturity securities. Accrued interest receivable is reported as a component of accrued interest receivable on the Consolidated Statement of Financial Condition.
The Company adopted CECL using the modified retrospective method for all financial assets measured at amortized cost and off-balance-sheet credit exposures. Results for reporting periods beginning after December 31, 2022 are presented under ASU 326 while prior period amounts continue to be reported in accordance with previously applicable US GAAP. The Company recorded a net increase of $857,000 to retained earnings as of January 1, 2023 for the cumulative effect of adopting ASU 326.
The following table illustrates the impact of ASC 326:
January 1, 2023
As Reported under ASC 326
Pre-ASC 326 Adoption
Impact of ASC 326 Adoption
Assets:
Commercial loans:
Revolving real estate secured by 1-4 family properties
5,255
Retail loans:
1-4 family residential mortgages
105,524
105,654
Construction-individual
130
Revolving home equity secured by 1-4 family properties
36,732
41,987
(5,255
Allowance for credit losses on loans (ACL):
Commercial:
Commercial and industrial
(1,246
(1,316
70
Construction and land development
(745
(755
10
Real estate secured by multi-family properties
(1,679
(995
(684
Real estate secured by owner-occupied properties
(1,175
(1,549
Real estate secured by other commercial properties
(1,330
(2,458
1,128
Revolving real estate secured by 1-4 family properties-business
(32
(25
(7
Real estate secured by 1st lien on 1-4 family properties-business
(1,700
(1,210
(490
Real estate secured by junior lien on 1-4 family properties-business
(16
(30
14
State and political subdivisions
(74
(94
Retail:
(486
(682
196
Revolving home equity secured by 1-4 family properties-personal
(292
(299
Real estate secured by 1st lien on 1-4 family properties-personal
(72
(15
Real estate secured by junior lien on 1-4 family properties-personal
(84
(55
(29
Student loans
(466
(454
(12
Overdrafts
(11
(3
Other consumer
(33
(41
Unallocated
(502
502
Total ACL
(9,442
1,089
Deferred tax assets
4,540
(227
Liabilities:
Allowance for credit losses on unused commitments
122
117
Equity:
3. STOCK-BASED COMPENSATION AND SHAREHOLDERS’ EQUITY
QNB sponsors stock-based compensation plans, administered by a Board committee (the “Committee”), under which both qualified and non-qualified stock options may be granted periodically to certain employees. Compensation cost has been measured using the fair value of an award on the grant date and is recognized over the service period, which is usually the vesting period.
Stock-based compensation expense was $20,000 and $22,000 for the three months ended March 31, 2023 and 2022, respectively. At March 31, 2023, there was approximately $236,000 of unrecognized compensation cost related to unvested share-based compensation award grants that is expected to be recognized over the next 59 months.
Options are granted to certain employees at prices equal to the market value of the stock on the date the options are granted. The 2015 Plan authorized the issuance of 300,000 shares. The time period during which any option is exercisable under the 2015 Plan is determined by the Committee but shall not commence before the expiration of six months after the date of grant or continue beyond the expiration of five years after the date the option is awarded. The granted options vest after a three-year period. The 2015 Plan was amended, effective January 1 2023, to increase the maximum term of any options granted under the plan from five years to ten years, and to also require that awards granted under the Plan will vest 20% each consecutive year commencing on the first anniversary date of the award unless otherwise specified in an award agreement. As of March 31, 2023, there were 212,550 options granted, 120,875 options forfeited, 20,825 options exercised, and 121,550 options outstanding under this Plan. The 2015 Plan expires on February 24, 2025.
The following assumptions were used in the option pricing model in determining the fair value of options granted during the period:
Risk free interest rate
3.64
%
1.25
Dividend yield
4.80
Volatility
20.36
22.68
Expected life (years)
8.35
4.05
The risk-free interest rate was selected based upon yields of U.S. Treasury securities with a term approximating the expected life of the option being valued. Historical information was the basis for the selection of the expected dividend yield, expected volatility and expected lives of the options.
The fair market value of options granted in the three months ended March 31, 2023 and 2022 was $4.11 and $5.20, respectively.
Stock option activity during the three months ended March 31, 2023 and 2022 is as follows:
Number of options
Weighted averageexerciseprice
Weightedaverageremaining contractual term (in years)
Aggregate intrinsic value
Outstanding at December 31, 2022
109,150
37.65
Granted
35,000
29.51
Exercised
Forfeited
(22,600
43.15
Outstanding at March 31, 2023
121,550
34.29
4.59
Exercisable at March 31, 2023
41,375
37.37
1.35
Weightedaverageremaining contractual term(in years)
Outstanding at December 31, 2021
113,950
37.58
29,350
37.26
(21,250
37.69
Outstanding at March 31, 2022
122,050
37.49
3.01
Exercisable at March 31, 2022
44,500
40.86
1.39
9
4. EARNINGS PER SHARE & SHARE REPURCHASE PLAN
The following sets forth the computation of basic and diluted earnings per share:
Numerator for basic and diluted earnings per share - net income
Denominator for basic earnings per share - weighted average shares outstanding
3,588,363
3,552,854
Effect of dilutive securities - employee stock options
1,602
Denominator for diluted earnings per share - adjusted weighted average shares outstanding
3,554,456
There were 121,550 and 92,200 stock options that were anti-dilutive for the three-month periods ended March 31, 2023 and 2022, respectively. These stock options were not included in the above calculation.
QNB’s current stock repurchase plan was originally approved by the Board of Directors on January 21, 2008, increased in amount on February 9, 2009 to 100,000 shares, and subsequently increased on April 29, 2021 to up to 200,000 shares of common stock in the open market or privately negotiated transactions. The repurchase authorization has no termination date. There were 0 and 2,000 shares repurchased during the three months ended March 31, 2023 and 2022, respectively. As of March 31, 2023, 102,000 shares were repurchased under this authorization at an average price of $24.93 and a total cost of approximately $2,543,000.
5. COMPREHENSIVE INCOME (LOSS)
The following shows the components of accumulated other comprehensive income (loss) at March 31, 2023 and December 31, 2022:
March 31,
December 31,
Unrealized net holding losses on available-for-sale securities
(91,283
(102,692
Unrealized gains (losses) on available-for-sale securities for which a portion of an other-than-temporary impairment loss has been recognized in earnings
Accumulated other loss
Tax effect
19,169
21,565
The following table presents amounts reclassified out of accumulated other comprehensive income (loss) for the three months ended March 31, 2023 and 2022:
Amount reclassified fromaccumulated othercomprehensive income
Details about accumulated other comprehensive income
Affected line item in statement of income
Unrealized net holding (losses) gains on available-for-sale securities
(257
Net gain on sales of investments available-for-sale
Other-than-temporary impairment on investment securities
Net other-than-temporary impairment losses on investment securities
Total reclassification out of accumulated other comprehensive (loss) income, net of tax
(203
Net of tax
6. INVESTMENT SECURITIES
Available-For-Sale Securities
The amortized cost and estimated fair values of investment securities available-for-sale at March 31, 2023 and December 31, 2022 were as follows:
Gross
unrealized
Fair
holding
Amortized
value
gains
losses
cost
U.S. Treasury
U.S. Government agency
88,701
(13,243
101,944
State and municipal
89,917
(19,514
109,431
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed
252,984
(41,314
294,298
Collateralized mortgage obligations (CMOs)
100,083
(16,800
116,883
Corporate debt
6,219
(412
6,631
Total investment debt securities available-for-sale
629,187
U.S. Treasuries
301
299
86,709
(15,233
101,942
95,367
(23,494
118,861
256,161
(45,303
301,464
101,672
(18,338
120,010
6,315
(326
6,641
(102,694
649,217
The amortized cost and estimated fair value of securities available-for-sale by contractual maturity at March 31, 2023 are shown in the following table. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities are assigned to categories based on contractual maturity except for mortgage-backed securities and CMOs which are based on the estimated average life of these securities and municipal securities that have been pre-refunded.
Fair value
Amortized cost
Due in one year or less
329
338
Due after one year through five years
114,266
126,292
Due after five years through ten years
344,044
405,060
Due after ten years
79,265
97,497
Proceeds from sales of investment securities available-for-sale were approximately $9,081,000 and $0 for the three months ended March 31, 2023 and 2022, respectively.
At March 31, 2023 and December 31, 2022, investment securities available-for-sale totaling approximately $283,019,000 and $237,645,000, respectively, were pledged as collateral for repurchase agreements and deposits of public funds.
The following table presents information related to the Company’s gains and losses on the sales and calls of securities available-for-sale, and losses recognized for the other-than-temporary impairment (“OTTI”) of these investments. Gains and losses on
available-for-sale securities are computed on the specific identification method and included in non-interest income. Gross realized losses on debt securities are net of other-than-temporary impairment charges:
Gross realized gains
Gross realized losses
Other-than-temporary impairment
Total net gains (losses) on AFS securities
The tax applicable to the net realized gains for both of the three-month periods ended March 31, 2023 and 2022 was $54,000 and $0, respectively.
QNB recognizes OTTI for debt securities classified as available-for-sale in accordance with FASB ASC 320, Investments – Debt and Equity Securities, which requires an assessment of whether QNB intends to sell or it is more likely than not that QNB will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired and that QNB does not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, the amount of the impairment is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows discounted at the security’s effective yield. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and, therefore, is not required to be recognized as a loss in the statement of income but is recognized in other comprehensive income. QNB believes that it will fully collect the carrying value of securities on which it has recorded a non-credit related impairment in other comprehensive income. No credit impairments were recognized on debt securities during the three months ended March 31, 2023 and 2022, respectively.
The following table indicates the length of time individual debt securities have been in a continuous unrealized loss position as of March 31, 2023 and December 31, 2022:
Less than 12 months
12 months or longer
No. of
Unrealized
securities
46
192
4,746
(223
85,171
(19,291
191
4,584
(295
248,400
(41,019
128
8,213
(534
91,870
(16,266
2,909
(91
3,310
(321
561
20,452
(1,143
517,452
(90,140
3,647
(353
83,062
(14,880
216
50,156
(7,816
45,210
(15,678
95,366
197
58,811
(6,775
197,351
(38,528
256,162
129
35,797
(3,983
65,875
(14,355
6,262
(318
592
154,673
(19,245
391,551
(83,449
546,224
Management evaluates debt securities, which are comprised of U.S. Treasury, U.S. Government agencies, state and municipalities, mortgage-backed securities, CMOs and corporate debt securities, for other-than-temporary impairment and considers the current economic conditions, the length of time and the extent to which the fair value has been less than cost, interest rates and the bond rating
12
of each security. The unrealized losses at March 31, 2023 in U.S. Treasury, U.S. Government agency securities, state and municipal securities, mortgage-backed securities, and CMOs are primarily the result of interest rate fluctuations. If held to maturity, these bonds will mature at par, and QNB will not realize a loss. QNB has the intent to hold the securities and does not believe it will be required to sell the securities before recovery occurs.
QNB holds one pooled trust preferred security as of March 31, 2023. This security has a total amortized cost of approximately $61,000 and a fair value of $52,000. The pooled trust preferred security is available-for-sale and is carried at fair value.
Marketable Equity Securities
The Company’s investment in marketable equity securities primarily consists of investments with readily determinable fair values in large cap stock companies. Changes in fair value is recorded in unrealized gain/(losses) in non-interest income.
At March 31, 2023 and December 31, 2022, the Company had $11,908,000 and $12,056,000, respectively, in equity securities recorded at fair value. The following is a summary of unrealized and realized gains and losses recognized in net income on equity securities during the three months ended March 31, 2023 and 2022:
Net (loss) gains recognized during the period on equity securities
(151
27
Less: Net (losses) gains recognized during the period on equity securities sold during the period
(208
Net unrealized gains (losses) recognized during the reporting period on equity securities still held at the reporting date
Taxes applicable to the net losses recognized for the three months ended March 31, 2023 resulted in an expense of $44,000 compared to a net gain of $8,000 recognized for the three months ended March 31, 2022. Proceeds from sales of investment equity securities were $709,000 and $262,000 for the three months ended March 31, 2023 and 2022, respectively.
7. RESTRICTED INVESTMENT IN STOCKS
Restricted investment in stocks includes Federal Home Loan Bank of Pittsburgh (“FHLB”) with a carrying cost of $1,086,000, Atlantic Community Bankers Bank (“ACBB”) stock with a carrying cost of $12,000, VISA Class B stock with a carrying cost of $0 and Senior Housing Crime Prevention Investment Corporation ("SHCPFIC") preferred stock of $1,000,000 at March 31, 2023. FHLB and ACBB stock was issued to the Bank as a requirement to facilitate the Bank’s participation in borrowing and other banking services. The SHCPFIC stock was issued to the Bank to enable its participation in a Community Reinvestment Act qualified investment. The Bank’s investment in FHLB stock may fluctuate, as it is based on the member banks’ use of FHLB’s services.
The Bank owns 6,502 shares of Visa Class B stock, which was necessary to participate in Visa services in support of the Bank’s credit card, debit card, and related payment programs (permissible activities under banking regulations) as a member institution. Following the resolution of Visa’s covered litigation, shares of Visa’s Class B stock will be converted to Visa Class A shares using a conversion factor (1.5991 as of December 29, 2022), which is periodically adjusted to reflect VISA’s ongoing litigation costs. There is a very limited market for this stock, as only current owners of Class B shares are permitted to transact in Class B. Due to the lack of orderly trades and public information of such trades, Visa Class B stock does not have a readily determinable fair value.
The Bank owns 100 shares of preferred stock of SHCPFIC. These shares are not transferable without the consent of SHCPFIC and does not have a readily determinable fair value.
These restricted investments are carried at cost and evaluated for OTTI periodically. As of March 31, 2023, there was no OTTI associated with these shares.
8. LOANS & ALLOWANCE FOR LOAN LOSSES
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are stated at the principal amount outstanding, net of deferred loan fees and costs. Interest income is accrued on the principal amount outstanding. Loan origination and commitment fees and related direct costs are deferred and amortized to income over the term of the respective loan and loan commitment period as a yield adjustment.
13
Loans held-for-sale consists of residential mortgage loans that are carried at the lower of aggregate cost or fair value. Net unrealized losses, if any, are recognized through a valuation allowance charged to income. Gains and losses on residential mortgages held-for-sale are included in non-interest income.
The Company maintains an allowance for credit losses on loans, which is intended to absorb probable known and inherent losses in the outstanding loan portfolio. The allowance is reduced by actual credit losses and is increased or decreased by the provision (reversal) for loan losses and increased by recoveries of previous losses. The provisions or reversals for credit losses are charged to earnings to bring the total allowance for loan losses to a level considered necessary by management.
The allowance for credit losses is measured on a pool basis when similar risk characteristics exist; these pools are identified in the first table below. The Company establishes a general valuation allowance for performing loans, including non-accrual student loans. QNB calculates each segment's historical loss rate using a full economic cycle of loan balance and historical loss experienced. The level of the allowance is determined by assigning specific reserves to all non-accrual loans, except the homogeneous pool of student loans which are measured in the general reserve. An allowance on these non-accrual loans is established when the discounted cash flows (or collateral value) of the loan is lower than the carrying value of that loan. The portion of the allowance that is allocated to non-accrual loans is determined by estimating the inherent loss on each credit after giving consideration to the value of underlying collateral. The general component is adjusted for qualitative factors. These qualitative risk factors include:
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. The Company’s lending and credit administration staff are charged with reviewing the loan portfolio and identifying changes in the economy or in a borrower’s circumstances which may affect the ability to repay debt or the value of pledged collateral. A loan classification and review system exists that identifies those loans with a higher than normal risk of collectability. 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 firm reviews risk assessment 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 the Company's allowance for credit losses on loans. Such agencies may require the Company to recognize additions to the allowance based on their judgments using information available to them at the time of their examination.
Management believes that it uses the best information available to make determinations about the adequacy of the allowance and that it has established its existing allowance for credit losses on loans in accordance with U.S. GAAP. If circumstances differ substantially from the current calculation, future adjustments to the allowance for credit losses on loans may be necessary and results of operations could be affected. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that increases to the allowance will not be necessary should the quality of any loans deteriorate.
Major classes of loans are as follows:
144,909
59,639
98,886
156,812
257,944
6,552
96,703
3,457
20,078
106,758
152
34,454
10,697
11,355
1,917
103
1,736
Total loans
1,012,152
Net unearned (fees) costs
(196
160,875
Construction
62,955
Secured by commercial real estate
518,070
Secured by residential real estate
103,419
20,971
Home equity loans and lines
63,580
Consumer
4,113
1,039,637
(252
Allowance for loan losses
Overdrafts are reclassified as loans and at December 31, 2022 are included in consumer loans above and total loans receivable on the Consolidated Balance Sheets. At December 31, 2022, overdrafts were approximately $132,000. Loans secured by commercial real estate include all loans collateralized at least in part by commercial real estate. These loans may not be for the express purpose of conducting commercial real estate transactions.
QNB generally lends in Bucks, Lehigh, and Montgomery counties in southeastern Pennsylvania. To a large extent, QNB makes loans collateralized at least in part by real estate. Its lending activities could be affected by changes in the general economy, the regional economy, or real estate values.
The Company engages in a variety of lending activities, including commercial, residential real estate and consumer transactions. The Company focuses its lending activities on individuals, professionals and small to medium sized businesses. Risks associated with lending activities include economic conditions and changes in interest rates, which can adversely impact both the ability of borrowers to repay their loans and the value of the associated collateral.
Commercial and industrial loans, commercial real estate loans, construction loans and residential real estate loans with a business purpose are generally perceived as having more risk of default than residential real estate loans with a personal purpose and consumer loans. These types of loans involve larger loan balances to a single borrower or groups of related borrowers and are more susceptible to a risk of loss during a downturn in the business cycle. These loans may involve greater risk because the availability of funds to repay these loans depends on the successful operation of the borrower’s business. The assets financed are used within the business for its ongoing operation. Repayment of these kinds of loans generally comes from the cash flow of the business or the ongoing conversions of assets, such as accounts receivable and inventory, to cash. Typical collateral for commercial and industrial loans includes the borrower’s accounts receivable, inventory and machinery and equipment. Commercial real estate and residential real estate loans secured for a business purpose are originated primarily within the eastern Pennsylvania market area at conservative loan-to-value ratios and often backed by the individual guarantees of the borrowers or owners. Repayment of this kind of loan is dependent upon either the ongoing cash flow of the borrowing entity or the resale or lease of the subject property. Commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers’ ability to repay their loans depends on successful development of their properties, as well as the factors affecting residential real estate borrowers.
Loans to state and political subdivisions are tax-exempt or taxable loans to municipalities, school districts and housing and industrial development authorities. These loans can be general obligations of the municipality or school district repaid through their taxing authority, revenue obligations repaid through the income generated by the operations of the authority, such as a water or sewer authority, or loans issued to a housing and industrial development agency, for which a private corporation is responsible for payments on the loans.
The Company originates fixed-rate and adjustable-rate real estate-residential mortgage loans for personal purposes that are secured by first liens on the underlying 1-4 family residential properties. Credit risk exposure in this area of lending is minimized by the evaluation of the credit worthiness of the borrower, including debt-to-income ratios, credit scores and adherence to underwriting policies that emphasize conservative loan-to-value ratios of generally no more than 80%. Residential mortgage loans granted in excess of the 80% loan-to-value ratio criterion are generally insured by private mortgage insurance.
The real estate-home equity portfolio consists of fixed-rate home equity loans and variable-rate home equity lines of credit. Risks associated with loans secured by residential properties are generally lower than commercial loans and include general economic risks, such as the strength of the job market, employment stability and the strength of the housing market. Since most loans are secured by a primary or secondary residence, the borrower’s continued employment is the greatest risk to repayment.
The Company offers a variety of loans to individuals for personal and household purposes. Consumer loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or, if they are secured, the value of the collateral may be difficult to assess and is more likely to decrease in value than real estate. Credit risk in this portfolio is controlled by conservative underwriting standards that consider debt-to-income levels and the creditworthiness of the borrower and, if secured, collateral values.
The Company employs a ten-grade risk rating system related to the credit quality of commercial loans and loans to state and political subdivisions of which the first six categories are pass categories (credits not adversely rated). The following is a description of the internal risk ratings and the likelihood of loss related to each risk rating.
The Company maintains a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential problem loans. Each loan officer assigns a rating to all loans in the portfolio at the time the loan is originated. Loans with risk
16
ratings of one through five are reviewed annually based on the borrower’s fiscal year. Loans with risk ratings of six are reviewed every six to twelve months based on the dollar amount of the relationship with the borrower. Loans with risk ratings of seven through ten are reviewed at least quarterly, and as often as monthly, at management’s discretion. The Company also utilizes an outside loan review firm to review the portfolio on a semi-annual basis to provide the Board of Directors and senior management an independent review of the Company’s loan portfolio on an ongoing basis. These reviews are designed to recognize deteriorating credits in their earliest stages in an effort to reduce and control risk in the lending function as well as identifying potential shifts in the quality of the loan portfolio. The examinations by the outside loan review firm include the review of lending activities with respect to underwriting and processing new loans, monitoring the risk of existing loans and to provide timely follow-up and corrective action for loans showing signs of deterioration in quality. In addition, the outside firm reviews the methodology for the allowance for loan losses to determine compliance to policy and regulatory guidance.
The following tables present the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company’s internal risk rating system as of March 31, 2023 and December 31, 2022:
Term Loans by Origination Year
2021
2020
2019
Prior
Revolving
Commercial Loans
Commercial and industrial:
Risk rating
Pass
3,608
16,665
10,412
8,233
7,095
8,984
87,955
142,952
Special mention
28
Substandard
179
24
242
1,480
1,929
Doubtful
Total commercial and industrial
16,844
8,237
7,119
9,226
89,463
Construction and land development:
6,821
27,572
13,172
3,441
4,160
4,424
59,590
49
Total construction and land development
4,473
Real estate secured by multi-family properties:
100
27,489
23,048
10,258
6,005
29,533
96,433
718
1,735
2,453
Total real estate secured by multi-family properties
6,723
31,268
Real estate secured by owner-occupied properties:
1,338
27,684
29,038
19,841
12,403
59,744
150,048
127
6,637
Total real estate secured by owner-occupied properties
29,171
66,375
Real estate secured by other commercial properties:
7,015
45,257
46,480
20,637
32,055
102,370
253,814
4,130
Total real estate secured by other commercial properties
106,500
17
Revolving real estate secured by 1-4 family properties-business:
Total revolving real estate secured by 1-4 family properties-business
Real estate secured by 1st lien on 1-4 family properties-business:
2,170
28,943
21,342
11,431
9,148
22,722
95,756
193
139
332
455
160
615
Total real estate secured by 1st lien on 1-4 family properties-business
29,136
21,481
9,603
22,882
Real estate secured by junior lien on 1-4 family properties-business:
306
632
567
633
45
1,006
3,189
268
Total real estate secured by junior lien on 1-4 family properties-business
1,274
State and political subdivisions:
40
5,017
25
5,931
9,065
Total Commercial Loans:
21,358
174,282
149,076
74,499
76,842
237,848
94,507
828,412
266
1,784
2,989
479
13,579
Total Commercial loans
174,654
149,348
74,503
78,039
251,063
96,015
844,980
Specialmention
157,914
2,938
505,657
2,597
9,816
102,295
930
849,792
2,814
13,684
866,290
18
For retail loans, the Company evaluates credit quality based on the performance of the individual credits. The following tables present the recorded investment in the retail classes of the loan portfolio based on payment activity as of March 31, 2023 and December 2022:
Retail Loans
1-4 family residential mortgages:
Payment performance
Performing
3,029
15,329
33,433
21,625
4,797
28,097
106,310
Nonperforming
448
Total 1-4 family residential mortgages
28,545
Construction-individual:
Total construction-individual
Revolving home equity secured by 1-4 family properties-personal:
34,271
183
Total revolving home equity secured by 1-4 family properties-personal
Real estate secured by 1st lien on 1-4 family properties-personal:
639
1,771
3,486
1,117
1,109
2,438
10,560
137
Total real estate secured by 1st lien Real estate secured by 1st lien on 1-4 family properties-personal
2,575
Real estate secured by junior lien on 1-4 family properties-personal:
946
1,887
2,613
1,510
766
3,633
Total real estate secured by junior lien on 1-4 family properties-personal
Student loans:
1,900
Total student loans
Overdrafts:
Total overdrafts
Other consumer:
163
474
446
155
78
202
1,693
Total other consumer
121
Total Retail Loans:
4,777
19,461
40,130
24,427
6,827
36,146
34,576
166,344
645
828
Total Retail Loans
36,791
34,759
167,172
19
Non-performing
104,933
721
62,900
680
4,023
90
171,856
1,491
173,347
The performance and credit quality of the loan portfolio is also monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the past due status as of March 31, 2023 and December 31, 2022:
30-59 dayspast due
60-89 dayspast due
90 days ormore pastdue
Total pastdue loans
Current
Total loansreceivable
144,869
2,978
153,834
1,588
256,356
96,694
1,130
116
1,246
105,512
34,401
101
10,596
11,336
1,727
5,780
226
6,065
1,006,087
2,288
596
2,885
157,990
30
103,389
1,139
1,266
104,388
21
31
63,549
4,082
3,468
763
4,243
1,035,394
As previously discussed, the Company maintains a loan review system, which includes a continuous review of the loan portfolio by internal and external parties to aid in the early identification of potential impaired loans. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. When placing a loan on non-accrual status, management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. All non-accrual loans, except student loans, are individually evaluated for an ACL. This ACL is measured using either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.
An allowance for credit loss is established for a non-accrual loan if its carrying value exceeds its estimated fair value. The estimated fair values of the majority of the Company’s non-accrual loans are measured based on the estimated fair value of the loan’s collateral.
For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.
For commercial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable agings or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.The following table disclose the recorded investment in loans receivable that are either on non-accrual status or past due 90 days or more and still accruing interest as of March 31, 2023:
90 Days or More Past Due-Still Accruing
Nonaccrual With No Specifically-Related ACL
Nonaccrual With Related ACL
Total Nonaccrual Loans
391
825
2,263
245
158
3,767
794
4,561
QNB recognized interest income of $14,000 on non-accrual loans during the three months ended March 31, 2023.
The following table presents the collateral-dependent loans by loan category at March 31, 2023:
Real Estate Secured
Other (1)
Deficiency in Collateral
Total Collateral Dependent Nonaccrual Loans
294
97
68
115
3,750
337
457
4,544
(1) Secured by business assets, personal property and equipment or guarantees
The following tables disclose the recorded investment in loans receivable that are either on non-accrual status or past due 90 days or more and still accruing interest as of December 31, 2022:
90 days ormore past due(still accruing)
Non-accrual
3,369
7,530
The following table present the balance in the allowance for loan losses at December 31, 2022 disaggregated on the basis of the Company’s impairment method by class of loans receivable along with the balance of loans receivable by class, excluding unearned fees and costs, disaggregated on the basis of the Company’s impairment methodology:
Allowance for Loan Losses
Loans Receivable
Balance
Balancerelatedto loansindividuallyevaluated forimpairment
Balancerelatedto loanscollectivelyevaluated forimpairment
Balance individuallyevaluated forimpairment
Balancecollectivelyevaluated forimpairment
1,316
125
1,191
1,821
159,054
755
5,002
4,871
5,309
512,761
1,240
919
1,362
102,057
94
683
628
105,026
437
119
318
63,178
4,068
10,531
696
9,333
9,567
1,030,070
The following table summarizes additional information, in regards to impaired loans by loan portfolio class, as of December 31, 2022:
Recordedinvestment(aftercharge-offs)
Unpaidprincipalbalance
Relatedallowance
With no specific allowance recorded:
1,402
1,694
2,198
2,608
430
678
240
296
62
4,943
5,820
With an allowance recorded:
601
3,111
3,312
932
1,065
162
4,624
5,169
Total:
2,295
5,920
1,547
487
10,989
Activity in the allowance for credit losses on loans for the three months ended March 31, 2023 and 2022 are as follows:
For the Three Months Ended March 31, 2023
Beginning balance prior to adoption of ASC 326
Impact of adopting ASC 326
Credit loss expense (reversal)
Charge-offs
Recoveries
Balance, endof period
(70
(940
593
899
(10
749
684
(102
1,577
1,549
(374
972
2,458
(1,128
(239
1,091
34
1,210
490
(430
1,273
(14
258
(20
(19
682
405
-
(43
249
64
29
(9
77
454
(17
41
(1,089
(1,783
(78
610
8,191
For the Three Months Ended March 31, 2022
Balance,beginning ofperiod
Provision for(credit to)loan losses
4,050
(658
32
3,424
346
389
3,736
417
4,153
871
270
(38
1,122
89
88
533
565
386
(22
358
265
356
(111
544
550
571
10,826
458
(161
91
11,214
The Company had extended, restructured, or otherwise modified the terms of loans, on a case-by-case basis, to remain competitive and retain certain customers, as well as assist other customers that had been experiencing financial difficulties. A loan is considered to be a troubled debt restructuring (“TDR”) loan when the Company granted a concession to the borrower because of the borrower’s financial condition that it would not have otherwise considered. Such concessions include the reduction of interest rates, forgiveness of principal or interest, or other modifications of interest rates to less than the current market rate for new obligations with similar risk. Loans classified as TDRs are considered non-performing.
The concessions made for the TDRs reported in the following disclosures involve lowering the monthly payments on loans through periods of interest only payments, a reduction in interest rate below a market rate or an extension of the term of the loan without a corresponding adjustment to the risk premium reflected in the interest rate, or a combination of these three methods. The restructurings rarely result in the forgiveness of principal or accrued interest. If the borrower has demonstrated performance under the previous terms and our underwriting process shows the borrower has the capacity to continue to perform under the restructured terms, the loan will continue to accrue interest. Non-accruing restructured loans may be returned to accrual status when there has been a sustained period of repayment performance (generally six consecutive months of payments) and both principal and interest are deemed collectible. TDR loans that are in compliance with their modified terms and that yield a market rate may be removed from the TDR status after a period of performance.
Since the implementation of ASU 326 on January 1, 2023, the Company measures loan modifications to borrowers in financial distress as either a TDR or a troubled debt modification ("TDM"). If the modification is not considered a TDR it is further analyzed for consideration as a TDM. A TDM could involve principal forgiveness, term extension, an other-than-insignificant payment delay, interest rate reduction or exchanging or paying off existing debt for new debt with the Company. Any amount forgiven would be charged to the allowance for credit losses.
There were no loans modified as TDRs or TDMs in 2023. The Company closely monitors the performance of loans that are modified to understand the effectiveness of its modification efforts. There were no payment default (60 days or more past due) during the three months ended March 31, 2023 and 2022, respectively, on loans modified within 12 months prior to March 31, 2023 and 2022, respectively.
Performing TDRs (not reported as non-accrual or past due 90 days or more and still accruing) totaled $4,224,000 and $4,301,000 as of March 31, 2023 and December 31, 2022, respectively. Non-performing TDRs totaled $333,000 and $371,000 as of March 31, 2023 and December 31, 2022, respectively. Non-accrual TDRs are included in the specific reserve calculation in 2023. All TDRs were included in the specific reserve calculation for 2022.
The following table illustrates the specific reserve for loan losses allocated to loans modified as TDRs. These specific reserves are included in the allowance for loan losses for loans individually evaluated. There were no loans modified as TDMs during the period.
TDRs with no specific allowance recorded
4,312
1,272
TDRs with an allowance recorded
3,400
392
4,557
4,672
As of March 31, 2023 and December 31, 2022, QNB had $7,000 and $5,000, respectively, in commitments to lend additional funds to customers with loans whose terms have been modified as TDRs. There were no charge-offs during the three months ended March 31, 2023 and 2022, resulting from loans previously modified as TDRs.
The Company has one loan secured by residential real estate for which foreclosure proceedings are in process at March 31, 2023 with a total recorded investment of $116,000.
9. FAIR VALUE MEASUREMENTS AND DISCLOSURES
FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (fair values are not adjusted for transaction costs). ASC 820 also establishes a framework (fair value hierarchy) for measuring fair value under U.S. GAAP and expands disclosures about fair value measurements.
26
ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:
Level 1:Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2:Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.
Level 3:Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).
An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The measurement of fair value should be consistent with one of the following valuation techniques: market approach, income approach, and/or cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). For example, valuation techniques consistent with the market approach often use market multiples derived from a set of comparables. Multiples might lie in ranges with a different multiple for each comparable. The selection of where within the range the appropriate multiple falls requires judgment, considering factors specific to the measurement (qualitative and quantitative). Valuation techniques consistent with the market approach include matrix pricing. Matrix pricing is a mathematical technique used principally to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the security’s relationship to other benchmark quoted securities.
The following table sets forth QNB’s financial assets measured at fair value on a recurring and nonrecurring basis and the fair value measurements by level within the fair value hierarchy as of March 31, 2023:
Quoted pricesin activemarketsfor identicalassets(Level 1)
Significantotherobservableinputs(Level 2)
Significantunobservableinputs(Level 3)
Balance at endof period
Recurring fair value measurements
Available-for-sale securities:
U.S. Treasury securities
U.S. Government agency securities
State and municipal securities
Mortgage-backed securities
Corporate debt securities
6,167
Total debt securities available-for-sale
537,852
Equity securities
Total recurring fair value measurements
549,812
Nonrecurring fair value measurements*
Impaired loans
Mortgage servicing rights
Total nonrecurring fair value measurements
*Impairment
Debt securities available-for-sale
546,472
558,581
3,928
3,929
There were no transfers in and out of Level 1, Level 2, or Level 3 fair value measurements during the three months ended March 31, 2023. There were no losses included in earnings attributable to the change in unrealized gains or losses relating to the available-for-sale securities above with fair value measurements utilizing significant unobservable inputs for the three-month period ended March 31, 2023.
The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which QNB has utilized Level 3 inputs to determine fair value:
Quantitative information about Level 3 fair value measurements
Valuationtechniques
Unobservableinputs
Value or rangeof values
Appraisal of collateral
(1)
Appraisal adjustments
(2)
-20% to -100%
Liquidation expenses
(3)
-10
Financial statement values for UCC collateral
Financial statement value discounts
(4)
-30% to -100%
Discounted cash flow
Remaining term
2 to 28 years
Prepayment speeds
118% to 254%
Discount rate
12.0% to 12.5%
3,634
-15% to -100%
113% to 235%
The following table presents additional information about the available-for-sale securities measured at fair value on a recurring basis and for which QNB utilized significant unobservable inputs (Level 3 inputs) to determine fair value for the three months ended March 31, 2023 and 2022:
Fair value measurementsusing significantunobservable inputs(Level 3)
Balance, January 1,
75
Payments received
Total gains or losses (realized/unrealized)
Included in earnings
Included in other comprehensive (loss) income
Transfers in and/or out of Level 3
Balance, March 31,
The Level 3 securities consist of one collateralized debt obligation security, the PreTSL security, which is backed by trust preferred securities issued by banks. The market for this security at March 31, 2023 was not active and markets for similar securities also are not active. The new issue market is also inactive and there are currently very few market participants who are willing and or able to transact for these securities.
Given conditions in the debt markets today and the absence of observable transactions in the secondary and new issue markets, we determined:
QNB used an independent third party to value this security using a discounted cash flow analysis. Based on management’s review of the bond’s three underlying issuers, there are no expected credit losses or prepayments; cashflows used were contractual based on the Bloomberg YA screen. The assumed cashflows have been discounted using an estimated market discount rate based on the 30-year swap rate. The 30-year is used as the reference rate since it is indicative of market expectation for short-term rates in the future. This is consistent with the 30-year nature of the PreTSL security, which is priced using the 3-month LIBOR as a reference rate. The discount rate of 7.67% includes the risk-free rate, a credit component and a spread for illiquidity.
The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of QNB’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between QNB’s disclosures and those of other companies may not be meaningful.
The following methods and assumptions were used to estimate the fair values of each major classification of financial instrument and non-financial asset at March 31, 2023 and December 31, 2022:
Cash and cash equivalents, accrued interest receivable and accrued interest payable (carried at cost): The carrying amounts reported in the balance sheet approximate those assets’ fair value.
Investment securities (carried at fair value): The fair value of securities is primarily determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. Level 2 debt securities are valued by a third-party pricing service commonly used in the banking industry. Level 2 fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution date, market consensus prepayment speeds, credit information and the security’s terms and conditions, among other things. For certain securities which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3). In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) were used to support fair values of certain Level 3 investments.
Restricted investment in stocks (carried at cost): The fair value of stock in Atlantic Community Bankers Bank, the Federal Home Loan Bank, VISA Class B and SHCPFIC is the carrying amount, based on redemption provisions, and considers the limited marketability of and restrictions on such securities.
Loans Held for Sale (carried at lower of cost or fair value): The fair value of loans held for sale is determined, when possible, using quoted secondary market prices. If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan.
Loans Receivable (carried at cost): The fair values of loans are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the liquidity, credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.
Impaired Loans (generally carried at fair value): Impaired loans are loans for which the Company has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.
Mortgage Servicing Rights (carried at lower of cost or fair value): The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The mortgage servicing rights are stratified into tranches based on predominant characteristics, such as interest rate, loan type and investor type. The valuation incorporates assumptions that market participants would use in estimating future net servicing income.
Deposit liabilities (carried at cost): The fair value of deposits with no stated maturity (e.g. demand deposits, interest-bearing demand accounts, money market accounts and savings accounts) are by definition, equal to the amount payable on demand at the reporting date (i.e. their carrying amounts). This approach to estimating fair value excludes the significant benefit that results from the low-cost funding provided by such deposit liabilities, as compared to alternative sources of funding. Deposits with a stated maturity (time deposits) have been valued using the present value of cash flows discounted at rates approximating the current market for similar deposits.
Short-term borrowings (carried at cost): The carrying amount of short-term borrowings approximates their fair values.
Long-term debt (carried at cost): Long-term debt has stated maturities and have been valued using the present value of cash flows discounted at rates approximating the current market for similar debt instruments.
Off-balance-sheet instruments (disclosed at cost): The fair values for QNB’s off-balance sheet instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.
Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in sales transaction on the dates indicated. The estimated fair value amounts have been measured as of the respective period ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period end.
The estimated fair values and carrying amounts of the Company’s financial and off-balance sheet instruments are summarized as follows:
Fair value measurements
Carryingamount
Quotedprices inactivemarkets foridenticalassets(Level 1)
Significantotherobservableinputs (Level 2)
Significantunobservableinputs (Level 3)
Financial assets
Cash and cash equivalents
Investment securities:
Available-for-sale
Equities
Loans held for sale
Net loans
980,285
460
621
Financial liabilities
Deposits with no stated maturities
1,174,574
Deposits with stated maturities
250,016
244,751
Off-balance sheet instruments
Commitments to extend credit
Standby letters of credit
83
Carrying amount
1,001,103
469
638
1,242,920
175,449
168,554
69
10. COMMITMENTS AND CONTINGENCIES
Financial Instruments with off-balance sheet risk:
In the normal course of business there are various legal proceedings, commitments, and contingent liabilities which are not reflected in the consolidated financial statements. Management does not anticipate any material losses as a result of these transactions and activities. They include, among other things, commitments to extend credit and standby letters of credit. The maximum exposure to credit loss, which represents the possibility of sustaining a loss due to the failure of the other parties to a financial instrument to perform according to the terms of the contract, is represented by the contractual amount of these instruments. QNB uses the same lending standards and policies in making credit commitments as it does for on-balance sheet instruments. The activity is controlled through credit approvals, control limits, and monitoring procedures.
A summary of the Company's financial instrument commitments is as follows:
Commitments to extend credit and unused lines of credit
389,336
339,312
20,359
19,512
Total financial instrument commitments
409,695
358,824
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. QNB evaluates each customer’s creditworthiness on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Company to guarantee the financial or performance obligation of a customer to a third party. QNB’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making conditional obligations as it does for on-balance sheet instruments. Standby letters of credit of $17,633,000 will expire within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending other loan commitments. The Company requires collateral and personal guarantees supporting these letters of credit as deemed necessary. Management believes that the proceeds obtained through a liquidation of such collateral and the enforcement of personal guarantees would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees. The amount of the liability as of March 31, 2023 and December 31, 2022 for guarantees under standby letters of credit issued is not material.
The amount of collateral obtained for letters of credit and commitments to extend credit is based on management’s credit evaluation of the customer. Collateral varies, but may include real estate, accounts receivable, marketable securities, pledged deposits, inventory or equipment.
Other commitments:
QNB has committed to various operating leases for several of their branch and office facilities. Some of these leases include specific provisions relating to rent increases. Some of the leases contain renewal options to extend the initial terms of the lease for periods ranging from five to ten years and certain leases allow for multiple extensions. During the three months ended March 31, 2023, QNB renewed one lease and recorded an additional right-of-use asset in exchange for an operating lease liability of $369,000.
11. REGULATORY RESTRICTIONS
Dividends payable by QNB and the Bank are subject to various limitations imposed by statutes, regulations and policies adopted by bank regulatory agencies. Under Federal and Pennsylvania banking law, the Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. Under Federal Reserve regulations, the Bank is limited as to the amount it may lend affiliates, including QNB, unless such loans are collateralized by specific obligations.
Both the QNB and the Bank are subject to regulatory capital requirements administered by Federal banking agencies. Failure to meet minimum capital requirements can initiate actions by regulators that could have an effect on the financial statements. Under the framework for prompt corrective action, the Bank must meet capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items. The capital amounts and classification are also subject to qualitative judgments by the regulators. Management believes, as of March 31, 2023, that QNB and the Bank met capital adequacy requirements to which they were subject.
As of the most recent notification, the primary regulator of the Bank considered it to be “well capitalized” under the regulatory framework. There are no conditions or events since that notification that management believes have changed the classification. To be categorized as well capitalized, bank holding companies and insured depository institutions must maintain minimum ratios as set forth in the following table below.
The Company and the Bank’s actual capital amounts and ratios are presented as follows:
Capital levels
Actual
Adequately capitalized
Well capitalized
Amount
Ratio
Total risk-based capital (to risk-weighted assets):
The Company
164,271
13.53
97,099
8.00
121,374
10.00
Bank
151,466
12.86
94,219
117,774
Tier 1 capital (to risk-weighted assets):
155,980
12.85
72,825
6.00
143,175
12.16
70,664
Common equity tier 1 capital (to risk-weighted assets):
54,618
4.50
52,998
76,553
6.50
Tier 1 capital (to average assets):
9.07
68,766
4.00
8.39
68,249
85,311
5.00
As of December 31, 2022
162,725
13.19
98,701
123,376
149,908
12.52
95,796
119,746
152,077
12.33
74,025
139,260
11.63
71,847
95,896
55,519
53,886
77,835
8.75
69,507
8.07
69,009
86,261
33
12. REVENUE RECOGNITION FROM CONTRACTS WITH CUSTOMERS
The Company generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers. The main types of revenue contracts included in non-interest income within the consolidated statements of operations are as follows:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
QNB Corp. is a bank holding company headquartered in Quakertown, Pennsylvania. QNB Corp., through its wholly-owned subsidiary, the Bank, has been serving the residents and businesses of upper Bucks, northern Montgomery and southern Lehigh counties in Pennsylvania since 1877. Due to its limited geographic area, growth is pursued through expansion of existing customer relationships and building new relationships by stressing a consistent high level of service at all points of contact. The Bank is a locally managed community bank that provides a full range of commercial and retail banking and retail brokerage services. The consolidated entity is referred to herein as “QNB” or the “Company”.
Tabular information presented throughout management’s discussion and analysis, other than share and per share data, is presented in thousands of dollars.
FORWARD-LOOKING STATEMENTS
In addition to historical information, this document contains forward-looking statements. Forward-looking statements are typically identified by words or phrases such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “project” and variations of such words and similar expressions, or future or conditional verbs such as “will,” “would,” “should,” “could,” “may” or similar expressions. The U.S. Private Securities Litigation Reform Act of 1995 provides a safe harbor in regard to the inclusion of forward-looking statements in this document and documents incorporated by reference.
Shareholders should note that many factors, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference, including the risk factors identified in Item 1A of QNB’s 2022 Form 10-K, could affect the future financial results of QNB and could cause those results to differ materially from those expressed in the forward-looking statements contained or incorporated by reference in this document. These factors include, but are not limited, to the following:
QNB cautions that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, all of which change over time, and QNB assumes no duty to update forward-looking statements. Management cautions readers not to place undue reliance on any forward-looking statements. These statements speak only as of the date of this report on Form 10-Q, even if subsequently made available by QNB on its website or otherwise, and they advise readers that various factors, including those described above, could affect QNB’s financial performance and could cause actual results or circumstances for future periods to differ materially from those anticipated or projected. Except as required by law, QNB does not undertake, and specifically disclaims any obligation, to publicly release any revisions to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of the financial condition and results of operations are based on the consolidated financial statements of QNB, which are prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) and predominant practices within the banking industry. The preparation of these consolidated financial statements requires QNB to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. QNB evaluates estimates on an on-going basis, including those related to the determination of the allowance for loan losses, the determination of the valuation of other real estate owned and foreclosed assets, other-than-temporary impairments on investment securities, the valuation of deferred tax assets, stock-based compensation and income taxes. QNB bases its estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Other-Than-Temporary Investment Security Impairment
Securities are evaluated periodically to determine whether a decline in their value is other-than-temporary. Management utilizes criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other-than-temporary. The term “other-than-temporary” is not intended to indicate that the decline is permanent, it indicates that the prospect for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. For equity securities that do not have readily-determinable fair values, once a decline in value is determined to be other-than-temporary, the value of the equity security is reduced and a corresponding charge to earnings is recognized. There were no other-than-temporary impairment charges recorded during the three months ended March 31, 2023 and 2022, respectively.
The Company follows accounting guidance related to the recognition and presentation of other-than-temporary impairment that specifies (a) if a company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss. When an entity does not intend to sell the security, and it is more likely than not the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. There were no credit-related other-than-temporary impairment charges in the three months ended March 31, 2023 or 2022, respectively.
The Company maintains an allowance for credit losses on loans, which is intended to absorb probable known and inherent losses in the outstanding loan portfolio. The allowance is reduced by actual credit losses and is increased or decreased by the provision (reversal) for loan losses and increased by recoveries of previous losses. 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 provisions or reversals for credit losses are charged to earnings.
Management emphasizes loan quality and close monitoring of potential problem credits. Credit risk identification and review processes are utilized to assess and monitor the degree of risk in the loan portfolio. QNB’s lending and credit administration staff are charged with reviewing the loan portfolio and identifying changes in the economy or in a borrower’s circumstances which may affect the ability to repay debt or the value of pledged collateral. A loan classification and review system exists that identifies those loans with a higher-than-normal risk of collection. Each commercial loan is assigned a grade based upon an assessment of the borrower’s financial capacity to service the debt and the presence and value of collateral for the loan. An independent loan review group tests risk assessments and evaluates the adequacy of the allowance for loan losses. Management meets monthly to review the credit quality of the loan portfolio and quarterly to review the allowance for loan losses.
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 U.S. GAAP. If circumstances differ substantially from the assumptions used in making determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be affected. Because future events affecting borrowers and collateral cannot be predicted with certainty, increases to the allowance may be necessary should the quality of any loans deteriorate as a result of the factors discussed above.
Foreclosed Assets
Assets acquired through, or in lieu of, loan foreclosure are held-for-sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses and changes in the valuation allowance are included in net expenses from foreclosed assets.
Stock-Based Compensation
QNB sponsors stock-based compensation plans, administered by a Board committee, under which both qualified and non-qualified stock options may be granted periodically to certain employees. QNB accounts for all awards granted under stock-based compensation plans in accordance with ASC 718, Compensation-Stock Compensation. Compensation cost has been measured using the fair value of an award on the grant date and is recognized over the service period, which is usually the vesting period. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the option and each vesting date. QNB estimates the fair value of stock options on the date of the grant using the Black-Scholes option pricing model. The model requires the use of numerous assumptions, many of which are highly subjective in nature.
Income Taxes
QNB accounts for income taxes under the asset/liability method in accordance with income tax accounting guidance, ASC 740, Income Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established against deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become available. Because the judgment about the level of future taxable income is dependent on matters that may, at least in part, be beyond QNB’s control, it is at least reasonably possible that management’s judgment about the need for a valuation allowance for deferred tax assets could change in the near term.
RESULTS OF OPERATIONS - OVERVIEW
QNB reported net income for the first quarter of 2023 of $4,118,000, or $1.15 per share on a diluted basis, compared to net income of $3,710,000, or $1.04 per share on a diluted basis, for the same period in 2022. The Bank contributed $4,287,000 to net income for the three months ended March 31, 2023 compared to $3,708,000 for the same period 2022; and the holding company contributed negative $169,000 to net income for the three months ended March 31, 2023 compared to income of $2,000 for the same period 2022. The results
37
at the Bank were primarily due to the reversal for credit losses in loans of $1,783,000. The results at the holding company are due primarily to the change in the fair value of the equity securities included in the investment portfolio.
Net income expressed as an annualized rate of return on average assets and average shareholders’ equity was 0.97% and 10.81%, respectively, for the quarter ended Mach 31, 2023 compared with 0.90% and 10.60%, respectively, for the quarter ended March 31, 2022.
Total assets as of March 31, 2023 were $1,626,499,000, compared with $1,668,497,000 at December 31, 2022. Loans receivable at March 31, 2023 were $1,011,956,000, a $27,429,000 decrease from $1,039,385,000 at December 31, 2022. Total deposits of $1,424,590,000 at March 31, 2023 increased $6,221,000 compared with total deposits of $1,418,369,000 at December 31, 2022.
Results for the three months ended March 31, 2023 include the following significant components:
These items, as well as others, are explained more thoroughly in the next sections.
NET INTEREST INCOME
QNB earns its net income primarily through the Bank. Net interest income, or the spread between the interest, dividends and fees earned on loans and investment securities and the expense incurred on deposits and other interest-bearing liabilities, is the primary source of operating income for QNB. Management seeks to achieve sustainable and consistent earnings growth while maintaining adequate levels of capital and liquidity and limiting its exposure to credit and interest rate risk levels approved by the Board of Directors.
The following table presents the adjustment to convert net interest income to net interest income on a fully taxable-equivalent basis for the three-month periods ended March 31, 2023 and 2022.
Tax-equivalent adjustment
150
Net interest income (fully taxable-equivalent)
10,567
10,920
38
Net interest income is the primary source of operating income for QNB. Net interest income is interest income, dividends, and fees on earning assets, less interest expense incurred for funding sources. Earning assets primarily include loans, investment securities, interest bearing balances at the Federal Reserve Bank and Federal funds sold. Sources used to fund these assets include deposits and borrowed funds. Net interest income is affected by changes in interest rates, the volume and mix of earning assets and interest-bearing liabilities, and the amount of earning assets funded by non-interest-bearing deposits.
For purposes of this discussion, interest income and the average yield earned on loans and investment securities are adjusted to a tax-equivalent basis as detailed in the tables that appear above. This adjustment to interest income is made for analysis purposes only. Interest income is increased by the amount of savings of Federal income taxes, which QNB realizes by investing in certain tax-exempt state and municipal securities and by making loans to certain tax-exempt organizations. In this way, the ultimate economic impact of earnings from various assets can be more easily compared.
The net interest rate spread is the difference between average rates received on earning assets and average rates paid on interest-bearing liabilities, while the net interest rate margin, which includes interest-free sources of funds, is net interest income expressed as a percentage of average interest-earning assets. The Asset/Liability and Investment Management Committee works to manage and maximize the net interest margin for the Company.
Average Balances, Rate, and Interest Income and Expense Summary (Tax-Equivalent Basis)
For the Three Months Ended
March 31, 2022
Average
Rate
Interest
Investment securities (AFS & Equity):
269
1.49
0.74
U.S. Government agencies
101,943
1.11
283
99,979
1.08
111,150
2.23
129,790
2.41
781
Mortgage-backed and CMOs
417,137
1.62
1,685
461,137
1,718
6,636
4.40
73
6,700
4.34
12,096
3.39
12,414
3.20
98
Total investment securities
649,231
1.70
2,764
710,109
1.66
2,940
Loans:
Commercial real estate
681,615
4.52
7,602
597,661
4.04
5,957
Residential real estate
105,698
3.55
937
101,431
3.23
818
Home equity loans
56,645
6.23
870
3.36
453
152,756
8.22
3,096
140,588
4.57
1,585
Consumer loans
4,089
6.73
4,735
5.05
Tax-exempt loans
20,591
3.49
19,569
3.41
165
Total loans, net of unearned income*
1,021,394
5.06
12,750
918,602
3.99
9,037
Other earning assets
7,001
5.71
99
6,689
0.97
Total earning assets
1,677,626
3.77
15,613
1,635,400
2.97
11,993
12,881
13,082
(9,937
(11,204
38,597
38,107
1,719,167
1,675,385
Liabilities and Shareholders' Equity
Interest-bearing deposits:
317,615
0.39
302
338,296
0.18
146
Municipals
111,954
3.89
1,075
116,516
0.32
130,627
1.06
141,296
0.30
406,072
437,645
Time < $100
101,208
1.53
92,692
0.80
97,617
3.02
48,537
0.71
Time > $250
27,723
1.80
24,970
0.69
Total interest-bearing deposits
1,192,816
1.37
4,028
1,199,952
0.33
975
134,918
2.99
71,480
5,833
1.57
Total interest-bearing liabilities
1,333,567
1,281,432
0.34
Non-interest-bearing deposits
221,948
244,097
9,149
7,870
Shareholders' equity
154,503
141,986
Net interest rate spread
2.24
2.63
Margin/net interest income
2.55
2.71
Tax-exempt securities and loans were adjusted to a tax-equivalent basis and are based on the marginal Federal corporate tax rate of 21 percent for three months ended March 31, 2023 and 2022.
Non-accrual loans are included in earning assets.
* Includes loans held-for-sale
Rate/Volume Analysis. The following table shows the fully taxable equivalent effect of changes in volumes and rates on interest income and interest expense. Changes in net interest income that could not be specifically identified as either a rate or volume change were allocated to changes in volume.
March 31, 2023 compared
to March 31, 2022
Due to change in:
Change
Volume
Interest income:
(160
(112
(48
(164
Total Investment securities (AFS & Equity)
(176
(274
1,645
808
400
1,511
1,374
Total Loans
3,713
1,025
2,688
82
3,620
752
2,868
Interest expense:
156
984
(4
988
756
(23
779
198
181
642
557
76
3,053
2,991
936
884
3,973
3,875
654
(1,007
Net Interest Income and Net Interest Margin – Quarterly Comparison
Average earning assets for the first quarter of 2023 were $1,677,626,000, an increase of $42,226,000, or 2.6%, from the first quarter of 2022, with average loans increasing $102,792,0000, or 11.2%, and average investment securities decreasing $60,878,000, or 8.6%, over the same period in 2022. Cash generated from maturities and sales in the investment portfolio and an increase in borrowed funds of $52,135,000 supported loan growth. Average loans as a percent of average earning assets was 60.9% for the first quarter of 2023, compared with 56.2% for the first quarter of 2022. On the funding side, average deposits decreased $29,285,000, or 2.0%, to $1,414,049,000 for the first quarter of 2023 primarily due to a decrease in non-interest bearing demand products. Average short-term borrowed funds, which consisted primarily of average commercial repurchase agreements and over-night FHLB borrowings, increased $63,438,000 to $134,918,000 during the first quarter of 2023 compared to $71,480,000 for the same period in 2022.
The net interest margin for the first quarter of 2023 decreased 16 basis points to 2.55% from 2.71% or the same period in 2022. Competition for quality loans and deposits in our local market continues to exert pressure on the net interest margin. The increases in
interest rates starting in March 2022 has compressed the net interest margin as QNB is liability sensitive; but is expected to improve as loans and securities reprice.
The Rate-Volume Analysis tables, as presented on a tax-equivalent basis, highlight the impact of changing rates and volumes on interest income and interest expense. Total interest income on a tax-equivalent basis increased $3,620,000, or 30.2%, to $15,613,000 for the first quarter of 2023; total interest expense increased $3,973,000 to $5,046,000. The rate on Municipal deposits increased 357 basis points in the first quarter of 2023 compared to the same period in 2022.
The yield on earning assets on a tax-equivalent basis increased 80 basis points to 3.77% for the first quarter of 2023, from 2.97% for the first quarter of 2022. The cost of interest-bearing liabilities was 1.53% for the first quarter of 2023, compared with 0.34% for the same period in 2022.
Interest income on investment securities (available-for-sale and equity) decreased $176,000 when comparing the quarters ended March 31, 2023 and 2022. The average yield on the investment portfolio was 1.70% for the first quarter of 2023 compared with 1.66% for the same period in 2022.
QNB invested in U.S. Treasury securities during 2022 which yielded 1.49%; the securities matured in the first quarter of 2023. Income on U.S. Government agency securities increased $13,000 as the average balances increased $1,964,000 and the rate increased three basis points.
Interest income on municipal securities, which are primarily tax-exempt, decreased $160,000 due to a $18,6404,000 decrease in average balances and an 18 basis-point decrease in rate. Typically, QNB purchases municipal bonds with 10- to 20-year maturities and may have call dates between 2-10 years.
Interest income on mortgage-backed securities and CMOs decreased $33,000 while average balances decreased $44,000,000 and yield increased 13 basis points. This portfolio generally provides higher yields relative to agency bonds and also provides monthly cash flow which can be used for liquidity purposes or can be reinvested as interest rates increase. Since most of these securities were purchased at a premium, any prepayments result in a shorter amortization period of this premium and therefore a reduction in income.
Income on loans increased $3,713,000 to $12,750,000 when comparing the first quarters of 2023 and 2022, with a $102,792,000 increase in average balances contributing to an increase in interest income of $1,025,000 and a 107-basis point increase in yield contributing to a $2,688,000 increase in interest income. Higher interest rates during the repricing period were partially offset by competitive pressures that compressed the yields on new loans.
The largest category of the loan portfolio is commercial real estate loans. This category of loans includes commercial purpose loans secured by either commercial properties such as office buildings, factories, warehouses, hotels and restaurants, medical facilities and retail establishments, or residential real estate, usually the residence of the business owner. The category also includes construction and land development loans. Income on commercial real estate loans increased $1,645,000 when comparing the first quarters of 2023 and 2022, primarily due to increased average balances of $83,954,000, or 14.0%, and a 48-basis point increase in rate from 4.04% in 2022 to 4.52% in 2023.
Income on commercial and industrial loans increased $1,511,000 when comparing the first quarters of 2023 and 2022. The average yield on these loans increased 365 basis points to 8.22% resulting in an increase in income of $1,374,000; average balances increased $12,168,000, to $152,756,000 for the first quarter of 2023 resulting in a $137,000 increase in interest income. Many of the loans in this category are indexed to the prime interest rate.
Tax-exempt loan income was $177,000 for the first quarter of 2023, an increase of $12,000 from the same period in 2022. Average balances increased $1,022,000, or 11.2%, to $20,591,000 for the first quarter of 2023, resulting in an increase of $8,000 in income. The yield on municipal loans increased eight basis points, to 3.49% for the first quarter of 2023, compared with the same period in 2022, resulting in an increase of $4,000 in interest income.
QNB desires to be the “local consumer lender of choice”, focusing its retail lending efforts on product offerings and marketing and promotion. Interest income on residential mortgage loans secured by first lien 1-4 family increased $119,000 when comparing the first quarter of 2023 to the same period in 2022. Average residential mortgage loan balances increased by $4,267,000, or 4.2%, to $105,698,000 for the first quarter of 2023 compared to the same period in 2022, which contributed a $34,000 increase in interest income. The average yield on the portfolio increased 32 basis points and contributed an increase of $85,000 to interest income. QNB chose to
retain certain mortgage loans instead of selling them in the secondary market, as the yield on our originated mortgages was higher than comparable mortgage-backed securities. Average home equity loans increased during the 2023 period by $2,027,000 to $56,645,000; interest income increased $417,000 as the average yield increased 287 basis points to 6.23%. The yield on the consumer portfolio increased 168 basis points to 6.73% for the first quarter of 2023 and there was a $646,000 decrease in average balances resulting in a net $8,000 decrease in interest income.
Earning assets are funded by deposits and borrowed funds. Interest expense increased $3,973,000, when comparing the first quarter of 2023 to the same period in 2022. QNB experienced a decrease in accounts with greater liquidity and an increase in time deposits. Average non-interest-bearing demand accounts decreased $22,149,000 to $221,948,000 for the first quarter of 2023. Average interest-bearing demand accounts decreased $20,681,000, or 6.1%, to $317,615,000 for the first quarter of 2023. Interest expense on interest-bearing demand accounts increased $156,000 to $302,000 for the same period, as the average rate paid increased 21 basis points to 0.39% for the first quarter of 2023. Included in this category is QNB-Rewards checking, a higher-rate checking account product that pays 1.25% on balances up to $25,000 and 0.35% for balances over $25,000. In order to receive the higher rate, a customer must receive an electronic statement, have one direct deposit or other ACH transaction and have at least 12 check card purchase transactions post and clear per statement cycle. For the first quarter of 2023, the average balance in this product was $98,186,000 and the related interest expense was $97,000 for an average yield of 0.40%. In comparison, the average balance of the QNB-Rewards accounts for the first quarter of 2022 was $103,020,000 and the related interest expense was $80,000 for an average yield of 0.31%. This product also generates fee income through the use of the check card. Also included in this category are business interest-checking accounts which include several large-deposit customers for which competitive pricing is used to maintain these deposits and reduce the reliance on higher-cost short-term borrowings. Business interest-checking balances decreased $6,223,000 comparing first quarter of 2023 to 2022; however, interest expense increased $138,000 primarily related to an increase in rate of 95 basis points.
Interest expense on municipal interest-bearing demand accounts increased $984,000 to $1,075,000 for the first quarter of 2023. The average interest rate paid on municipal interest-bearing demand accounts increased 357 basis points to 3.89% for the first quarter of 2023 over the same quarter of 2022, and average balances decreased $4,562,000, or 3.9%, to $111,954,000. Many of these accounts are indexed to the Federal funds rate with rate floors. Municipal deposits are seasonal in nature and are received during the second and third quarters as tax receipts are collected and are withdrawn over the course of the year.
Average money market accounts decreased $10,669,000, or 7.6%, to $130,627,000 for the first quarter of 2023 compared with the same period in 2022. Interest expense on money market accounts increased $236,000 to $342,000, and the average interest rate paid on money market accounts increased 76 basis point to 1.06% for the first quarter of 2023. Most of the balances in this category are in a product that pays a tiered rate based on account balances.
Interest expense on savings accounts increased $756,000 when comparing the first quarter of 2023 to the same quarter of 2022. The average interest rate paid on savings accounts increased 78 basis points to 1.08% for the first quarter of 2023. When comparing these same periods, average savings accounts decreased $31,573,000, or 7.2%, to $406,072,000 for the first quarter of 2023 primarily due to decreases in the e-Savings product. QNB’s online e-Savings product is the largest category of savings deposits, with average balances for the first quarter of 2023 of $304,409,000 compared to $334,096,000 in the same period of 2022. The average yield paid on these accounts was 1.36% for the first quarter of 2023 and 0.35% for the same period in 2022. Traditional statement savings accounts, passbook savings and club accounts are also included in the savings category and average balances in these types of savings accounts decreased $1,886,000 when comparing the first quarter of 2023 to the same period in 2022.
Interest expense on time deposits totaled $1,232,000 for the first quarter of 2023 compared to $311,000 in 2022. Average total time deposits increased $60,349,000 to $226,548,000 for the first quarter of 2023. As with fixed-rate loans and investment securities, these deposits reprice over time and, therefore, have less of an immediate impact on costs in either a rising or falling rate environment; however, the maturity and repricing characteristics of time deposits tend to be shorter. The average rate paid on total time deposits increased 145 basis points from 0.76% to 2.21% when comparing the first quarter of 2023 to the same period in 2022.
Approximately $143,200,000, or 57%, of time deposits at March 31, 2023 will mature over the next 12 months. The average rate paid on these time deposits is approximately 2.60%. The yield on the time deposit portfolio may change in the next quarter as short-term time deposits reprice; however, given the short-term nature of these deposits, interest expense may increase if short-term time deposit rates were to increase suddenly or if customers select higher paying time deposits.
Short-term borrowings were comprised primarily of sweep accounts structured as repurchase agreements with our commercial customers at March 31, 2023 and March 31, 2022. At March 31, 2023 short-term borrowing also included overnight FHLB borrowing and
short-term Federal Reserve Bank ("FRB") borrowing. Interest expense on short-term borrowings increased $936,000 for the first quarter of 2023 to $995,000 when compared to the same period in 2022. When comparing these same periods, average balances increased $63,438,000 to $134,918,000. The yield on customer repos increased 73 basis points for the first quarter of 2023 to 1.06%. The yield on the short-term FHLB borrowing was 4.88% for the first quarter of 2023. During the first quarter of 2023, QNB borrowed $50,000,000 from the FRB under its Bank Term Funding Program and locked in a rate of 4.39%; there are no pre-payment penalties. Average balances of the FRB borrowing were $8,889,000 in short-term borrowings. During 2020, QNB borrowed long-term debt of $10,000,000 to lock in borrowing at a lower yield than short-term borrowings at that time; this borrowing matured during the first quarter of 2023.
PROVISION FOR CREDIT LOSSES, ALLOWANCE FOR CREDIT LOSSES ON LOANS AND ALLOWANCE FOR CREDIT LOSSES ON UNUSED COMMITMENTS
On January 1, 2023, the Company adopted ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326), as amended ("ASU 326"), which replaces the incurred loss methodology with an expected credit losses (“CECL”) for financial instruments held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. On January 1, 2023 QNB recorded a decrease to its allowance for credit losses on loans of $989,000 and an increase to its allowance for credit losses on unused commitments of $5,000.
The provision for credit losses represents management's determination of the amount necessary to be charged to operations to bring the allowance for credit losses on loans and the allowance for credit losses on unused commitments to amounts that are intended to absorb historical loss experience, current conditions and reasonable and supportable forecasts, in the outstanding loan portfolio and the unused commitments. Management believes that it uses the best information available to make determinations about the adequacy of these allowances and that it has established its existing allowances for credit losses on loan and on unused commitments in accordance with U.S. GAAP. The determination of an appropriate level for the allowance for credit losses on loans and the allowance for credit losses on unused commitments are based upon an analysis of the risks inherent in QNB’s loan portfolio.
Since the allowance for credit losses on loans and the reserve on unused commitments is dependent, to a great extent, on conditions that may be beyond QNB’s control, it is at least reasonably possible that management’s calculations and actual results could differ. In addition, various regulatory agencies, as an integral part of their examination process, periodically review QNB’s allowance for credit 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.
Based on this analysis, QNB recorded a reversal through the provision for credit losses for the three months ended March 31, 2023 of $1,783,000 for the allowance for credit losses on loans and $22,000 for the allowance for credit losses for unused commitments compared to no adjustment to the allowance for loan losses and an additional $7,000 through non-interest expense for the reserve on unused commitments for the same period in 2022.
QNB's allowance for credit losses on loans of $8,191,000 represents 0.81% of loans receivable at March 31, 2023 compared with an allowance for loan losses of $10,531,000, or 1.01% of loans receivable, at December 31, 2022, and $11,231,000, or 1.21%, at March 31, 2022. Management believes the allowance for credit losses on loans at March 31, 2023 is adequate as of that date based on its analysis of historical loss experience, current conditions and reasonable and supportable forecasts in the portfolio.
Net recoveries were $532,000 for the three months ended March 31, 2023 compared to net recoveries of $47,000 for the three months ended March 31, 2022. Recoveries of approximately $610,000 during the three months ended March 31, 2023 consisted of one commercial real estate loan of $582,000, $18,000 in repayments from borrowers of previously charged-off credits and overdrafts recoveries of $10,000. These were offset by $78,000 in charge-offs comprising a $43,000 student loan, a $3,000 home-equity loan and overdrafts of $32,000. Annualized net recoveries as a percentage of average loans receivable were 0.21% for the three months ended March 31, 2023, compared to annualized net recoveries of 0.02% for the three months ended March 31, 2022.
44
Non-performing assets were $8,785,000 at March 31, 2023 compared to $9,121,000 as of December 31, 2022 and $11,647,000 at March 31, 2022. 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 0.87% of loans receivable at March 31, 2023, 0.88% at December 31, 2022, and 1.26% of loans receivable at March 31, 2022. In cases where there is a collateral shortfall on non-accrual loans, specific impairment reserves have been established based on updated collateral values even if the borrower continues to pay in accordance with the terms of the agreement. At March 31, 2023, $4,335,000, or approximately 95%, of the loans classified as non-accrual are current or past due less than 30 days. Commercial loans classified as substandard or doubtful totaled $13,579,000, a decrease of $105,000 from the $13,684,000 reported at December 31, 2022 and a decrease of $5,493,000, or 28.8%, from the $19,072,000 reported at March 31, 2022. The decrease in classified loans since December 31, 2022 and since March 31, 2022 is primarily due to repayments and pay-offs on existing substandard loans.
QNB had no loans past due 90 days or more and still accruing interest at March 31, 2023, December 31, 2022, or March 31, 2022. Total loans 30 days or more past due, which includes non-accrual loans by actual number of days delinquent, represented 0.60% of loans receivable at March 31, 2023 compared with 0.23% at December 31, 2022, and 0.39% at March 31, 2022.
Troubled debt restructured loans, not classified as non-accrual loans or loans past due 90 days or more and accruing, were $4,224,000 at March 31, 2022, compared with $4,301,000 at December 31, 2022, and $4,375,000 at March 31, 2022. There were no new troubled debt restructuring or modifications identified during the three months ended March 31, 2023. QNB had no other real estate owned or repossessed assets at March 31, 2023, December 31, 2022 or March 31, 2022
A loan is considered impaired, based on current information and events, if it is probable that QNB will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and shortfalls on a case-by-case basis, taking into consideration all the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for all non-accrual loans, except student loans, by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.
The following table shows detailed information and ratios pertaining to the Company’s loan and asset quality:
Non-accrual loans
4,820
7,272
Loans past due 90 days or more and still accruing interest
Troubled debt restructured loans (not already included above)
4,224
4,301
4,375
Total non-performing loans
8,785
9,121
11,647
Total non-performing assets
Total loans (excluding loans held-for-sale):
Average total loans (YTD)
1,021,265
967,438
926,369
11,231
Allowance for loan losses to:
Non-performing loans
93.24
115.46
96.43
Total loans (excluding held-for-sale)
0.81
1.01
1.21
Average total loans (excluding held-for-sale)
1.09
1.22
Non-performing loans / total loans (excluding held-for-sale)
0.87
0.88
1.26
Non-performing assets / total assets
0.54
0.55
An analysis of net loan charge-offs (recoveries) for the three months ended March 31, 2023 compared to 2022 is as follows:
Net (recoveries) charge-offs
(532
(47
Net annualized (recoveries) charge-offs to:
(0.21
%)
(0.02
Average total loans excluding held-for-sale
(26.34
(1.70
At March 31 2023 and December 31, 2022, the recorded investment in loans for which impairment has been identified totaled $4,561,000 and $9,567,000 of which $3,767,000 and $4,943,000, respectively, required no specific allowance for loan loss. The recorded investment in impaired loans requiring an allowance for loan losses was $794,000 and $4,624,000 at March 31, 2023 and December 31, 2022, respectively, and the related allowance for loan losses associated with these loans was $457,000 and $696,000, respectively. Most of the loans that have been identified as impaired are collateral-dependent. See Note 8 to the Notes to Consolidated Financial Statements for additional detail of impaired loans.
NON-INTEREST INCOME
Non-Interest Income Comparison
Change from prior year
Percent
Net gain on sales of investment securities
(501
-1391.7
65
(812.5
4.7
2.8
14.1
6.2
(2
(2.1
N/M
(16.9
(392
-24.3
Quarter to Quarter Comparison
Total non-interest income for the first quarter of 2023 was $1,219,000, a decrease of $392,000, compared to $1,611,000 for the first quarter of 2022. Excluding realized and unrealized gains (losses) on securities and gains on sales of loans, non-interest income increased $38,000, or 2.4%, to $1,621,000 for the quarter ended March 31, 2023 compared with the same period in 2022
During the first quarter of 2023, unrealized gains on investment equity securities of $57,000 were recorded compared to losses of $8,000 in the same period of 2022. The unrealized losses and gains for the three months ended March 31, 2023 and 2022 resulted from the change in the fair value of the equities included in the investment portfolio. The equities portfolio comprises blue-chip large-capitalized stocks, providing a year-to-date taxable equivalent dividend yield of 3.39%. The estimated cumulative contribution (realized and unrealized net gains (losses), plus dividends) of the equity portfolio to earnings per share from January 1, 2011 through March 31, 2023 is $2.37 per diluted share. Details of the equity portfolio’s contribution to net income since January 1, 2016 is detailed in the following table.
Net Income (Expense) on Equity Securities
For the Year Ended December 31,
2016
2017
2018
Equity Securities:
Tax-equivalent dividends*
233
300
274
399
Net gain (loss) on sales
758
1,557
(79
1,781
585
1,788
OTTI
(192
(80
Unrealized (loss) gain
(336
770
926
(1,026
Tax-equivalent income before tax
799
1,726
2,825
3,151
(222
(50
2,967
Tax expense (benefit)*
324
700
816
910
(64
475
1,026
(82
2,009
661
2,241
(158
2,110
0.14
0.57
0.19
0.63
(0.04
(0.01
0.59
Tax-equivalent yield*
3.13
3.08
3.31
3.54
3.32
*Based on Federal tax rates of 34% for the 2016 period and 21% for all 2017, 2018, 2019, 2020, 2021, 2022 and 2023 periods.
QNB originates residential mortgage loans for sale in the secondary market. Net gain on sale of loans was $6,000 for first quarter of 2023; there were no sales in the first quarter of 2022. The net gain on residential mortgage sales is directly related to the volume of mortgages sold and the timing of the sales relative to the interest rate environment. Residential mortgage loans to be sold are identified at origination. Proceeds from the sale of residential mortgages were $388,000 for the first quarter of 2023.
Fees for services to customers increased $18,000 to $402,000 for the first quarter of 2023, due primarily to an increase in net overdraft income. ATM and debit card income decreased $18,000 to $659,000 for the first quarter of 2023, compared to the same period in 2022, due primarily to debit card interchange fee income.
QNB provides securities and advisory services under the name QNB Financial Services. Retail brokerage and advisory fees increased for the first quarter of 2023 compared to the same period in 2022. Advisory fees decreased $12,000 for the first quarter of 2023 compared with the same period in 2022 due to a decrease in the value of assets under management, while transactional fees increased $41,000 when comparing the first quarters of 2023 and 2022 due to sales of annuity products.
Other non-interest income decreased $30,000. There was a decrease in title company income of $19,000 due to the decreased volume of mortgage originations and a decrease of $11,000 in mortgages servicing fees.
47
NON-INTEREST EXPENSE
Non-Interest Expense Comparison
297
7.0
(6.6
21.8
4.6
Third-party services
(58
(8.7
(27
(13.9
(148
(54.4
(42
(19.4
244
33.1
387
5.0
Total non-interest expense was $8,200,000 for the first quarter of 2023, an increase of $387,000 compared to the first quarter of 2022.
Salaries and benefits comprise the largest component of non-interest expense. QNB monitors, through the use of various surveys, the competitive salary and benefit information in its markets and makes adjustments when appropriate. Salaries and benefits expense increased $297,000, or 7.0%, to $4,563,000 when comparing the two quarters. Salary expense and related payroll taxes increased $361,000 to $3,967,000 during the first quarter of 2023 compared to the same period in 2022 due to pay increases and filling open positions. Medical and dental premiums, net of employee contributions, decreased $61,000 when comparing the two quarters due to a decrease in medical claims.
Net occupancy and furniture and equipment expenses combined increased $112,000, or 8.9%, when comparing the first quarters of 2023 and 2022. This is due primarily to increased software maintenance expense. Marketing expense increased $9,000, or 4.6%, to $203,000 for the quarter ended March 31, 2023, due to timing of promotions and community support donations.
Third-party services are comprised of professional services, including legal, accounting, auditing and consulting services, as well as fees paid to outside vendors for support services of day-to-day operations. These support services include correspondent banking services, IT services, statement printing and mailing, investment security safekeeping and supply management services. Third party services expense decreased $58,000 primarily due to lower legal costs. State taxes decreased $148,000, or 54.4%, due to lower banks shares tax as there was a decline in capital from year-end 2021 to year-end 2022. FDIC insurance premiums decreased $42,000 due to a reduction in the assessment rate.
Other non-interest expense increased $224,000, or 33.1%, due to a $144,000 increase in deposit-related charge-offs related to fraud, an increase in check-card expense of $51,000, and an increase in director fees of $28,000.
INCOME TAXES
QNB utilizes an asset and liability approach for financial accounting and reporting of income taxes. As of March 31, 2023, QNB’s net deferred tax asset was $20,169,000. The primary components of deferred taxes are deferred tax assets of which $19,169,000 relates to investment securities fair value adjustments and $1,720,000 relates to the allowance for credit losses on loans. As of December 31, 2022, QNB’s net deferred tax asset was $23,077,000 of which $21,565,000 related to investment securities fair value adjustments and $2,212,000 was related to the allowance for loan losses. The decrease in the balance of net deferred tax assets when comparing March 31, 2023 to December 31, 2022 is due to the improvement in unrealized losses on available for sale securities at March 31, 2023 compared to December 31, 2022, contributing $2,396,000 of the increase.
The realizability of deferred tax assets is dependent upon a variety of factors, including the generation of future taxable income, the existence of taxes paid and recoverable, the reversal of deferred tax liabilities and tax planning strategies. Based upon these and other factors, management believes it is more likely than not that QNB will realize the benefits of these remaining deferred tax assets.
48
Applicable income tax expense was $1,123,000 for the quarter ended March 31, 2023, compared to $824,000 for the quarter ended March 31, 2022. The effective tax rate for the first quarter ended March 31, 2023 was 21.4% compared with 18.2% for the same period in 2022. The increase in the effective tax rate for the three months ended March 31, 2023 as pre-tax income was higher in 2023 compared to 2022 and there was a lower proportion of tax-exempt net interest income to income before taxes for 2023 over 2022.
FINANCIAL CONDITION ANALYSIS
Financial service organizations are challenged to demonstrate they can generate sustainable and consistent earnings growth in a dynamic operating environment. Rate competition for quality loans is anticipated to continue through 2023. It is also anticipated that the rate competition for attracting and retaining deposits may increase in 2023, which could result in a lower net interest margin and a decline in net interest income.
QNB’s primary business is accepting deposits and making loans to meet the credit needs of the communities it serves. Loans are the most significant component of earning assets and growth in loans to small businesses and residents of these communities has been a primary focus of QNB. Inherent within the lending function is the evaluation and acceptance of credit risk and interest rate risk. QNB manages credit risk associated with its lending activities through portfolio diversification, underwriting policies and procedures and loan monitoring practices. QNB is committed to make credit available to its customers.
Total assets at March 31, 2023 were $1,626,499,000 compared with $1,668,497,000 at December 31, 2022. Cash and cash equivalents decreased $1,698,000 from $15,899,000 at December 31, 2022 to $14,201,000 at March 31, 2023.
The fixed-income securities portfolio represents a significant portion of QNB’s earning assets and is also a primary tool in liquidity and asset/liability management. QNB actively manages its fixed income portfolio to take advantage of changes in the shape of the yield curve and changes in spread relationships in different sectors and for liquidity purposes. Management continually reviews strategies that will result in an increase in the yield or improvement in the structure of the investment portfolio, including monitoring credit and concentration risk in the portfolio. The available-for-sale securities portfolio decreased $8,621,000, due to maturities and prepayments of $10,210,000 and sales of $9,081,000; partly offset by improvement in the fair value mark of $11,409,000.
Loans receivable decreased $27,429,000 with commercial loans decreasing $26,565,000 to $844,980,000 at March 31, 2023, compared with $871,545,000 at year-end 2022.
Deposits grew $6,221,000 from December 31, 2022 to March 31, 2023. Non-interest-bearing demand deposits decreased $19,590,000, with balances of $212,259,000 at March 31, 2023 compared with $213,849,000 at year-end 2022. Interest-bearing demand balances, excluding municipal deposits, decreased $12,325,000, or 3.7%, to $322,261,000, with decreases in personal interest-bearing checking and the business checking product as customer used funds to paydown higher-yielding loans or moving funds to high-yielding products. The $16,747,000 increase in money market accounts was primarily to a new premium money market product offered to both personal and business customers. The $43,313,000 decrease in savings was primarily due to declines in the E-Savings on-line product as some of these funds moved to higher-yield certificates of deposit or the new premium money market accounts. Total time deposits increased $74,567,000 from December 31, 2022 to March 31, 2023 as customers took advantage of higher-yields time deposits, moving from lower-yielding products. Municipal deposit balances decreased $9,865,000, to $108,476,000, during the first three months of 2023. Municipal deposits can be volatile depending on the timing of deposits and withdrawals, and the cash flow needs of the school districts or municipalities. Municipal deposits increase as tax money is received from the local school districts during second and third quarters and it is anticipated that these funds will flow out for the subsequent twelve months as the schools use the funds for operations. These deposits provide an incremental funding source as they are used to fund loans as opposed to borrowing at a higher rate; this improves the net interest margin as it increases the spread related to the net interest margin.
Short-term borrowings decreased 31.7%, from $161,327,000 at December 31, 2022 to $110,192,000 at March 31, 2023. Commercial sweep accounts comprised most of balance of the short-term borrowing in both periods and decreased $9,117,000; these funds may be volatile based on businesses’ receipt and disbursement of funds and is offset by business non-interest-bearing demand accounts. There were $92,018,000 in overnight borrowings from FHLB at December 31, 2022, and none at March 31, 2023; however, during the first quarter of 2023, QNB borrowed $50,000,000 from the FRB under its Bank Term Funding Program and locked in a rate of 4.39%; there are pre-payment penalties. In 2020, QNB borrowed long-term debt from the FHLB of $10,000,000 to lock in a rate at a low yield; this debt matured during the first three months of 2023.
LIQUIDITY
Liquidity represents an institution’s ability to generate cash or otherwise obtain funds at reasonable rates to satisfy demand for loans and deposit withdrawals. QNB attempts to manage its mix of cash and interest-bearing balances, Federal funds sold and investment securities to match the volatility, seasonality, interest sensitivity and growth trends of its loans and deposits. The Company manages its liquidity risk by measuring and monitoring its liquidity sources and estimated funding needs. Liquidity is provided from asset sources through repayments and maturities of loans and investment securities. The portfolio of investment securities classified as available for sale and QNB's policy of selling certain residential mortgage originations in the secondary market also provide sources of liquidity. Core deposits and cash management repurchase agreements have historically been the most significant funding source for QNB. These deposits and repurchase agreements are generated from a base of consumers, businesses and public funds primarily located in the Company’s market area.
Additional sources of liquidity are provided by the Bank’s membership in the FHLB. At March 31, 2023 the Bank had a maximum borrowing availability with the FHLB of approximately $392,410,000, which is net of a $350,000 letter of credit and accrued interest payable. The maximum borrowing depends upon qualifying collateral assets and the Bank’s asset quality and capital adequacy. In addition, the Bank maintains unsecured Federal funds lines with five correspondent banks totaling $91,000,000. At March 31, 2023 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. Additional funding is available at the FRB Discount Window under its Bank Term Funding Program; QNB had $50,000,000 in outstandings at March 31, 2023.
Liquid sources of funds, including cash, available-for-sale and equity investment securities, and loans held-for-sale have decreased $10,079,000 since December 31, 2022, totaling $564,401,000 at March 31, 2023. The reduction in the liquid sources of funds is primarily due to maturities and sales of available-for-sale securities. Growth in deposits provided cash flows of $6,221,000, net proceeds from available-for-sale investment activities provided $19,291,000, and net payments on loans provided $27,961,000 in net proceeds; combined the proceeds enabled the net paydown on short-term borrowings and long-term debt of $61,135,000. Management expects these liquid sources will be adequate to meet normal fluctuations in loan demand or deposit withdrawals. The investment portfolio is expected to continue to provide sufficient liquidity, as municipal bonds are called or mature and cash flow on mortgage-backed and CMO securities continues to be steady.
Approximately $283,019,000 and $237,645,000 of available-for-sale debt securities at March 31, 2023 and December 31, 2022, respectively, were pledged as collateral for repurchase agreements and deposits of public funds and the FRB short-term borrowing. The level of pledged securities corresponds with the municipal deposit and repurchase agreement balances.
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.
CAPITAL ADEQUACY
A strong capital position is fundamental to support continued growth and profitability and to serve the needs of depositors. QNB's shareholders' equity at March 31, 2023 was $83,874,000, or 5.16% of total assets, compared with shareholders' equity of $70,958,000, or 4.25% of total assets, at December 31, 2022. Shareholders’ equity at March 31, 2023 included a negative adjustment of $71,114,000 compared to a negative adjustment of $81,127,000 at December 31, 2022, related to unrealized holding losses, net of taxes, on investment securities available-for-sale. Without these adjustments, shareholders' equity to total assets would have been 9.18% and 8.68% at March 31, 2023 and December 31, 2022, respectively.
Average shareholders' equity and average total assets were $154,503,000 and $1,719,167,000 for the three months ended March 31, 2023, an increase of 8.8% and 2.6%, respectively, from the averages for the three months ended March 31, 2022. The ratio of average total equity to average total assets was 10.81% for the three months ended March 31, 2023 compared to 8.47% for the same period in 2022.
Retained earnings at March 31, 2023 were impacted by three months of net income totaling $4,118,000 and the cumulative effect of a change in accounting policy of $857,0000, offset by dividends declared and paid of $1,328,000 for the three-month period. QNB offers a Dividend Reinvestment and Stock Purchase Plan (the “Plan”) to provide participants a convenient and economical method for investing
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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 $236,000 to capital during the three months ended March 31, 2023.
The Board of Directors has authorized the repurchase of up to 200,000 shares of QNB common stock in open market or privately negotiated transactions. The repurchase authorization does not bear a termination date. As of March 31, 2023, 102,000 shares have been repurchased since the initial authorization at an average price of $24.93 and a total cost of $2,543,000.
QNB is subject to various regulatory capital requirements as issued by Federal regulatory authorities. Regulatory capital is defined in terms of Tier 1 capital and Tier 2 capital. Risk-based capital ratios are expressed as a percentage of risk-weighted assets. Risk-weighted assets are determined by assigning various weights to all assets and off-balance sheet arrangements, such as letters of credit and loan commitments, based on associated risk.
The required minimum Common equity Tier 1 capital to risk-weighted assets ratio is 4.5%, the required minimum ratio of Tier 1 capital to risk-weighted assets is 6.0%, the required minimum ratio of Total Capital to risk-weighted assets is 8.0%, and the required minimum Tier 1 leverage ratio is 4.0%. A capital conservation buffer of 2.5% of risk-weighted assets also applies to avoid limitations on certain capital distributions.
The following table sets forth consolidated information for QNB:
Capital Analysis
Regulatory Capital
Net unrealized securities losses, net of tax
72,114
81,127
Deferred tax assets on net operating loss
Disallowed intangible assets
Common equity tier I capital
Tier 1 capital
Allowable portion: Allowance for loan losses and reserve for unfunded commitments
8,291
10,648
Total regulatory capital
Risk-weighted assets
1,213,742
1,233,758
Quarterly average assets for leverage capital purposes
1,719,159
1,737,671
Capital Ratios
Common equity tier I capital / risk-weighted assets
Tier 1 capital / risk-weighted assets
Total regulatory capital / risk-weighted assets
Tier 1 capital / average assets (leverage ratio)
At March 31, 2023, common equity Tier 1, Tier 1 capital, and total regulatory capital ratios improved since December 31, 2022. The Company remains well-capitalized by all applicable regulatory requirements as of March 31, 2023.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
MARKET RISK MANAGEMENT
Market risk reflects the risk of economic loss resulting from changes in interest rates and market prices. QNB’s primary market risk exposure is interest rate risk and liquidity risk. QNB’s liquidity position was discussed in a prior section.
QNB’s largest source of revenue is net interest income, which is subject to changes in market interest rates. Interest rate risk management seeks to minimize the effect of interest rate changes on net interest margins and interest rate spreads and to provide growth in net interest income through periods of changing interest rates. QNB’s Asset/Liability and Investment Management Committee (ALCO) is responsible for managing interest rate risk and for evaluating the impact of changing interest rate conditions on net interest income.
QNB uses computer simulation analysis to measure the sensitivity of projected earnings to changes in interest rates. Simulation considers current balance sheet volumes and the scheduled repricing dates, instrument level optionality, and maturities of assets and liabilities. It incorporates assumptions for growth, changes in the mix of assets and liabilities, prepayments, and average rates earned and paid. Based on this information, management uses the model to project net interest income under multiple interest rate scenarios.
A balance sheet is considered liability sensitive when its liabilities (deposits and borrowings) reprice faster than its earning assets (loans and securities). A liability sensitive balance sheet will produce relatively less net interest income when interest rates rise and more net interest income when they decline. Based on our simulation analysis, management believes QNB’s interest sensitivity position at March 31, 2023 is liability sensitive. Management expects that market interest rates may increase over the next 12 months, based on the economic environment and policy of the Board of Governors of the Federal Reserve System.
The following table shows the estimated impact of changes in interest rates on net interest income as of March 31, 2023 and 2022 assuming instantaneous rate shocks, and consistent levels of assets and liabilities. Net interest income for the subsequent twelve months is projected to decrease when interest rates are higher than current rates.
Estimated Change in Net Interest Income
Changes in Interest rates
(in basis points)
+300
-8.93
-16.85
+200
-5.88
-10.53
+100
-2.91
-4.57
-100
2.37
-1.49
-200
2.62
-5.71
-300
1.40
-11.64
Computations of future effects of hypothetical interest rate changes are based on numerous assumptions and should not be relied upon as indicative of actual results. Assets and liabilities may react differently than projected to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while rates on other types of assets and liabilities may lag changes in market interest rates. Interest rate shifts may not be parallel.
Changes in interest rates can cause substantial changes in the amount of prepayments of loans and mortgage-backed securities, which may in turn affect QNB’s interest rate sensitivity position. Additionally, credit risk may rise if an interest rate increase adversely affects the ability of borrowers to service their debt.
QNB is not subject to foreign currency exchange or commodity price risk. At March 31, 2023, QNB did not have any hedging transactions in place such as interest rate swaps, caps, or floors.
ITEM 4. CONTROLS AND PROCEDURES
We maintain a system of controls and procedures designed to provide reasonable assurance as to the reliability of the consolidated financial statements and other disclosures included in this report, as well as to safeguard assets from unauthorized use or disposition. We evaluated the effectiveness of the design and operation of our disclosure controls and procedures under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of the end of the period covered by this report. No changes were made to our internal control over financial reporting during the fiscal quarter covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
September 30, 2022
Item 1. Legal Proceedings
No material proceedings.
Item 1A. Risk Factors
There were no material changes to the Risk Factors described in Item 1A in QNB’s Annual Report on Form 10-K for the period ended December 31, 2023.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
QNB did not repurchase shares of its common stock during the quarter ended March 31, 2023. The following provides certain information relating to QNB's stock repurchase plan.
Period
Total Number ofShares Purchased
Average PricePaid per Share
Total Number ofSharesPurchased asPart of PubliclyAnnouncedPlan
MaximumNumber ofShares thatmay yet bePurchasedUnder the Plan
January 1, 2023 through January 31, 2023
98,000
February 1, 2023 through February 28, 2023
March 1, 2023 through March 31, 2023
Item 3. Default Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
Exhibit 3.1
Articles of Incorporation of Registrant, as amended. (Incorporated by reference to Exhibit 3(i) of Registrant’s Annual Report on Form 10-K, SEC File No. 0-17706, filed with the Commission on September 13, 2015.)
Exhibit 3.2
By-laws of Registrant, as amended January 26, 2021. (Incorporated by reference to Exhibit 3.1 of the Registrant's Report on Form 8-K, SEC File No. 0-17706, filed with the Commission on January 27, 2021.)
Exhibit 31.1
Section 302 Certification of Chief Executive Officer
Exhibit 31.2
Section 302 Certification of Chief Financial Officer
Exhibit 32.1
Section 1350 Certification of Chief Executive Officer
Exhibit 32.2
Section 1350 Certification of Chief Financial Officer
The following Exhibits are being furnished* as part of this report:
No.
Description
101.SCH
iXBRL Taxonomy Extension Schema Document.*
101.CAL
iXBRL Taxonomy Extension Calculation Linkbase Document.*
101.LAB
iXBRL Taxonomy Extension Label Linkbase Document.*
101.PRE
iXBRL Taxonomy Extension Presentation Linkbase Document.*
101.DEF
iXBRL Taxonomy Extension Definitions Linkbase Document.*
104
Cover Page Interactive Data File (formatted as inline iXBRL and contained in Exhibit 101)
* These interactive data files are being furnished as part of this Quarterly Report, and, in accordance with Rule 402 of Regulation S-T, shall not be deemed filed for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability under those sections.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: May 10, 2023
By:
/s/ David W. Freeman
David W. Freeman
Chief Executive Officer
/s/ Jeffrey Lehocky
Jeffrey Lehocky
Chief Financial Officer
/s/ Mary E. Liddle
Mary E. Liddle
Chief Accounting Officer, QNB Bank