Item 2. Management’s Discussion and Analysis
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 2021 Form 10-K, could affect the future financial results of QNB Corp. and its subsidiary and could cause those results to differ materially from those expressed in the forward-looking statements contained or incorporated by reference in this document. These factors include, but are not limited, to the following:
•
Volatility in interest rates and shape of the yield curve;
•
Credit risk;
•
Liquidity risk;
•
Operating, legal and regulatory risks;
•
Economic, political and competitive forces affecting QNB’s business;
•
The effects of unforeseen external events, including acts of terrorism, natural disasters, and pandemics, including the COVID-19 Pandemic; and
•
The risk that the analysis of these risks and forces could be incorrect, and/or that the strategies developed to address them could be unsuccessful.
QNB cautions that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, all of which change over time, and QNB assumes no duty to update forward-looking statements. Management cautions readers not to place undue reliance on any forward-looking statements. These statements speak only as of the date of this report on Form 10-Q, even if subsequently made available by QNB on its website or otherwise, and they advise readers that various factors, including those described above, could affect QNB’s financial performance and could cause actual results or circumstances for future periods to differ materially from those anticipated or projected. Except as required by law, QNB does not undertake, and specifically disclaims any obligation, to publicly release any revisions to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
34
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of the financial condition and results of operations are based on the consolidated financial statements of QNB, which are prepared in accordance 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, 2022 and 2021, respectively.
The Company follows accounting guidance related to the recognition and presentation of other-than-temporary impairment that specifies (a) if a company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss. When an entity does not intend to sell the security, and it is more likely than not the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. There were no credit-related other-than-temporary impairment charges in the three months ended March 31, 2022 or 2021, respectively.
Allowance for Loan Losses
The determination of the allowance for loan losses involves a higher degree of judgment and complexity than the Company’s other significant accounting policies. The allowance for loan losses is calculated with the objective of maintaining a level believed by management to be sufficient to absorb probable known and inherent losses in the outstanding loan portfolio. The allowance is reduced by actual credit losses and is increased by the provision for loan losses and recoveries of previous losses. The provisions for loan losses are charged to earnings to bring the total allowance for loan losses to a level considered necessary by management.
The allowance for loan losses is based on management’s continual review and evaluation of the loan portfolio. The level of the allowance is determined by assigning specific reserves to individually identified problem credits and general reserves to all other loans. The portion of the allowance that is allocated to impaired loans is determined by estimating the inherent loss on each credit after giving consideration to the value of underlying collateral or present value of future estimated cash flows. The general reserves are based on the composition and risk characteristics of the loan portfolio, including the nature of the loan portfolio, credit concentration trends, delinquency and loss experience, as well as other qualitative factors such as current economic trends.
Management emphasizes loan quality and close monitoring of potential problem credits. Credit risk identification and review processes are utilized to assess and monitor the degree of risk in the loan portfolio. QNB’s lending and credit administration staff are charged with reviewing the loan portfolio and identifying changes in the economy or in a borrower’s circumstances which may affect the ability to repay debt or the value of pledged collateral. A loan classification and review system exists that identifies those loans with a higher than normal risk of collection. Each commercial loan is assigned a grade based upon an assessment of the borrower’s financial capacity to service the debt and the presence and value of collateral for the loan. An independent loan review group tests risk assessments and evaluates the adequacy of the allowance for loan losses. Management meets monthly to review the credit quality of the loan portfolio and quarterly to review the allowance for loan losses.
35
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
In addition, various regulatory agencies, as an integral part of their examination process, periodically review QNB’s allowance for loan losses. Such agencies may require QNB to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
Management believes that it uses the best information available to make determinations about the adequacy of the allowance and that it has established its existing allowance for loan losses in accordance 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 2022 of $3,710,000, or $1.04 per share on a diluted basis, compared to net income of $5,050,000, or $1.42 per share on a diluted basis, for the same period in 2021. The Bank contributed $3,708,000 to net income for the three months ended March 31, 2022 compared to $4,038,000 for the same period 2021; and the holding company contributed $2,000 to net income for the three months ended March 31, 2022 compared to $1,012,000 for the same period 2021. The results at the Bank were primarily due to a reduction in non-interest income as no mortgage loans were sold in 2022. The results at the holding company are due primarily to the change in the fair value of the equity portfolio.
Net income expressed as an annualized rate of return on average assets and average shareholders’ equity was 0.90% and 10.60%, respectively, for the quarter ended March 31, 2022 compared with 1.40% and 15.70%, respectively, for the quarter ended March 31, 2021.
Total assets at March 31, 2022 were $1,647,986,000, compared with $1,673,340,000 at December 31, 2021. Loans receivable at March 31, 2022 were $926,369,000, fairly level compared with $926,470,000 at December 31, 2021. QNB participated in the Small
36
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Business Administration’s (“SBA”) Paycheck Protection Program (“PPP ”) . Excluding PPP loans net of deferred fees at March 31, 2022 and December 31, 202 1 , loans would have in creased $ 7 , 900 , 000 since year-end 202 1 . Total deposits of $ 1 , 451 , 753 , 000 at March 31, 2022 increased $ 2 , 008 ,000 compared with total deposits of $1, 449 , 745 ,000 at December 31, 202 1 .
Results for the three months ended March 31, 2022 include the following significant components:
•
Net interest income increased $219,000, or 2.1%, to $10,736,000 for the three months ended March 31, 2022.
•
Net interest margin on a tax-equivalent basis decreased 36 basis points for the quarter to 2.71%.
•
QNB recorded no provision for loan losses for the first quarter of 2022 compared to a provision of $275,000 for the same period in 2021.
•
Non-interest income decreased $1,793,000, to $1,611,000, for the first quarter ended March 31, 2022 compared with the same period in 2021. Excluding realized and unrealized gains (losses) on equity securities and gains on sales of loans, and the life insurance benefit of $193,000 in 2021, non-interest income increased $160,000, or 11.2%, to $1,584,000 for the quarter ended March 31, 2022 compared with the same period in 2021.
•
Non-interest expense increased $490,000, or 6.7%, to $7,813,000 for the quarter ended March 31, 2022 compared to the same period in 2021.
•
Total non-performing loans were $11,647,000, or 1.26% of loans receivable at March 31, 2022, compared to $11,672,000, or 1.26% of loans receivable at December 31, 2021. Loans on non-accrual status were $7,272,000 at March 31, 2022 compared with $7,530,000 at December 31, 2021. Net loan recoveries for the three months ended March 31, 2022 were $47,000, compared with $14,000 for the same period in 2021.
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, 2022 and 2021.
For the Three Months Ended March 31,
2022
2021
Total interest income
$
11,809
$
11,731
Total interest expense
1,073
1,214
Net interest income
10,736
10,517
Tax-equivalent adjustment
184
162
Net interest income (fully taxable-equivalent)
$
10,920
$
10,679
Net interest income is the primary source of operating income for QNB. Net interest income is interest income, dividends, and fees on earning assets, less interest expense incurred for funding sources. Earning assets primarily include loans, investment securities, interest bearing balances at the Federal Reserve Bank (Fed) and Federal funds sold. Sources used to fund these assets include deposits and borrowed funds. Net interest income is affected by changes in interest rates, the volume and mix of earning assets and interest-bearing liabilities, and the amount of earning assets funded by non-interest-bearing deposits.
For purposes of this discussion, interest income and the average yield earned on loans and investment securities are adjusted to a tax-equivalent basis as detailed in the 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
37
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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
March 31, 2021
Average
Average
Average
Average
Balance
Rate
Interest
Balance
Rate
Interest
Assets
Investment securities (AFS & Equity):
U.S. Treasury securities
$
89
0.74
%
$
—
$
—
0.00
%
$
—
U.S. Government agencies
99,979
1.08
270
70,229
1.02
178
State and municipal
129,790
2.41
781
93,723
2.59
608
Mortgage-backed and CMOs
461,137
1.49
1,718
262,937
1.30
856
Corporate debt securities
6,700
4.34
73
7,242
3.70
68
Equities
12,414
3.20
98
13,159
3.26
106
Total investment securities
710,109
1.66
2,940
447,290
1.62
1,816
Loans:
Commercial real estate
597,661
4.04
5,957
530,672
4.34
5,680
Residential real estate
101,431
3.23
818
88,506
3.50
775
Home equity loans
54,618
3.36
453
58,738
3.47
502
Commercial and industrial
140,588
4.57
1,585
228,337
5.00
2,814
Consumer loans
4,735
5.05
59
5,333
4.91
65
Tax-exempt loans
19,569
3.41
165
25,075
3.57
221
Total loans, net of unearned income*
918,602
3.99
9,037
936,661
4.35
10,057
Other earning assets
6,689
0.97
16
28,562
0.29
20
Total earning assets
1,635,400
2.97
11,993
1,412,513
3.41
11,893
Cash and due from banks
13,082
26,844
Allowance for loan losses
(11,204
)
(10,935
)
Other assets
38,107
38,098
Total assets
$
1,675,385
$
1,466,520
Liabilities and Shareholders' Equity
Interest-bearing deposits:
Interest-bearing demand
$
338,296
0.18
%
146
$
281,728
0.21
%
148
Municipals
116,516
0.32
91
112,550
0.32
90
Money market
141,296
0.30
106
105,556
0.31
82
Savings
437,645
0.30
321
354,018
0.33
290
Time < $100
92,692
0.80
184
103,783
1.09
279
Time $100 through $250
48,537
0.71
85
55,491
1.03
145
Time > $250
24,970
0.69
42
29,396
1.19
86
Total interest-bearing deposits
1,199,952
0.33
975
1,042,522
0.44
1,120
Short-term borrowings
71,480
0.33
59
58,086
0.39
55
Long-term debt
10,000
1.57
39
10,000
1.57
39
Total interest-bearing liabilities
1,281,432
0.34
1,073
1,110,608
0.44
1,214
Non-interest-bearing deposits
244,097
216,293
Other liabilities
7,870
9,146
Shareholders' equity
141,986
130,473
Total liabilities and shareholders' equity
$
1,675,385
$
1,466,520
Net interest rate spread
2.63
%
2.97
%
Margin/net interest income
2.71
%
$
10,920
3.07
%
$
10,679
38
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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, 2022 and 2021.
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.
For the Three Months Ended
March 31, 2022 compared
to March 31, 2021
Total
Due to change in:
Change
Volume
Rate
Interest income:
Investment securities (AFS & Equity):
U.S. Treasury securities
$
—
$
—
$
—
U.S. Government agencies
92
76
16
State and municipal
173
234
(61
)
Mortgage-backed and CMOs
862
645
217
Corporate debt securities
5
(6
)
11
Equities
(8
)
(6
)
(2
)
Total Investment securities (AFS & Equity)
1,124
943
181
Loans:
Commercial real estate
277
717
(440
)
Residential real estate
43
113
(70
)
Home equity loans
(49
)
(35
)
(14
)
Commercial and industrial
(1,229
)
(1,081
)
(148
)
Consumer loans
(6
)
(8
)
2
Tax-exempt loans
(56
)
(48
)
(8
)
Total Loans
(1,020
)
(342
)
(678
)
Other earning assets
(4
)
(15
)
11
Total interest income
100
586
(486
)
Interest expense:
Interest-bearing deposits:
Interest-bearing demand
(2
)
30
(32
)
Municipals
1
3
(2
)
Money market
24
27
(3
)
Savings
31
69
(38
)
Time < $100
(95
)
(30
)
(65
)
Time $100 through $250
(60
)
(18
)
(42
)
Time > $250
(44
)
(13
)
(31
)
Total interest-bearing deposits
(145
)
68
(213
)
Short-term borrowings
4
13
(9
)
Long-term debt
—
—
—
Total interest expense
(141
)
81
(222
)
Net interest income
$
241
$
505
$
(264
)
39
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Net Interest Income and Net Interest Margin – Quarterly Comparison
Average earning assets for the first quarter of 2022 were $1,675,385,000, an increase of $208,865,000, or 14.2%, from the first quarter of 2021, with average loans decreasing $18,059,000, or 1.9%, and average investment securities increasing $262,819,000, or 58.8%, over the same period in 2021. Excess cash from deposit growth was deployed to the securities portfolio, which earns a better yield than Fed Funds or deposits at the Federal Reserve Bank. Average loans as a percent of average earning assets was 56.2% for the first quarter of 2022, compared with 66.3% for the first quarter of 2021. On the funding side, average deposits increased $185,234,000, or 14.7%, to $1,444,049,000 for the first quarter of 2022 primarily due to growth in non-interest-bearing and interest-bearing demand, money market and savings deposits. Customers continue to reinvest funds into more liquid accounts. Average short-term borrowed funds, which consisted primarily of average commercial repurchase agreements, increased $13,394,000 to $71,480,000 during the first quarter of 2022 compared to $58,086,000 for the same period in 2021.
The net interest margin for the first quarter of 2022 decreased 36 points to 2.71% from 3.07% for the same period in 2021. Competition for quality loans in our local market continues to exert pressure on the net interest margin. The increase in interest rates starting in March 2022 is expected to compress the net interest margin initially as QNB is liability sensitive; but is expected to improve as loans and securities reprice.
The Rate-Volume Analysis tables, as presented on a tax-equivalent basis, highlight the impact of changing rates and volumes on interest income and interest expense. Total interest income on a tax-equivalent basis increased $100,000, or 0.8%, to $11,993,000 for the first quarter of 2022; total interest expense decreased $141,000, or 11.6%, to $1,073,000. All categories of interest-bearing deposits, except municipal deposits, experienced lower rates in the first quarter of 2022 compared to the first quarter of 2021.
The yield on earning assets on a tax-equivalent basis decreased 44 basis points from 3.41% for the first quarter of 2021, to 2.97% for the first quarter of 2022. The cost of interest-bearing liabilities was 0.34% for the first quarter of 2022, compared with 0.44% for the same period in 2021.
Interest income on investment securities (available-for-sale and equity) increased $1,124,000 when comparing the quarters ended March 31, 2022 and 2021. The average yield on the investment portfolio was 1.66% for the first quarter of 2022 compared with 1.62% for the first quarter of 2021.
QNB invested in U.S. Treasury securities during the first quarter of 2022 which yielded 0.74%. Income on U.S. Government agency securities increased $92,000 as the average balances increased $29,750,000 and the rate increased six basis points.
Interest income on municipal securities, which are primarily tax-exempt, increased due to a $36,067,000 increase in average balances, partially offset by an 18 basis-point decline in rates. Proceeds from matured, called securities and proceeds from deposits were invested back into the U.S. Government agency, municipal and mortgage-backed securities portfolios. Typically, QNB purchases municipal bonds with 10-20-year maturities and may have call dates between 2-10 years.
Interest income on mortgage-backed securities and CMOs increased $862,000 while average balances increased $198,200,000 and yield increased 19 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 decreased $1,020,000 to $9,037,000 when comparing the first quarters of 2022 and 2021, with a 1.9% decline in average balances contributing a decrease in interest income of $342,000 and a 36-basis point decline in yield contributing to a $678,000 decrease in interest income. Low interest rates during the repricing period of the loans as well as competitive pressures compressed the yields on new loans being originated.
The largest category of the loan portfolio is commercial real estate loans. This category of loans includes commercial purpose loans secured by either commercial properties such as office buildings, factories, warehouses, hotels and restaurants, medical facilities and retail establishments, or residential real estate, usually the residence of the business owner. The category also includes construction and land development loans. Income on commercial real estate loans increased $277,000 when comparing the first quarters of 2022 and 2021, primarily due to increased average balances of $66,989,000, or 12.6%, offset in part by a 30-basis point decrease in rate from 4.34% in 2021 to 4.04% in 2022.
40
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Income on commercial and industrial loans de creased $ 1,229 ,000 when comparing the first quarter s of 202 2 and 202 1 . The average yield on these loans de creased 43 basis points to 4.57 % resulting in a de crease in income of $ 148 ,0 00; a verage balances de creased $ 87 , 749 ,00 0, to $ 140 , 588 , 000 for the first quarter of 2 02 2 resulting in a $ 1,081 ,000 dec rease in interest income. Many of the loans in this category are indexed to the prime interest rate. Included in this category are the PPP loans ; forgiveness of the PPP loans contributed approximately $ 62 , 433 ,000 of the net volume de crease and $807,000 of the decrease in interest . The PPP loans yield one percent to the customer : however , QNB received origination fees from the SBA ranging from a flat fee of $2,500 to one to five hundred basis points . The accretion of SBA origination fees is accelerated upon forgiveness of the loan. Income on PPP loan forgiveness was $298,000 for the first quarter of 2022 compared to $744,000 for the same period in 2021 . Excluding the PPP loans, the average balance of commercial and industrial loan portfolio decreased $25,316,000 and the yield declined 47 basis points, comparing the first quarter of 2022 to 2021 .
Tax-exempt loan income was $165,000 for the first quarter of 2022, a decrease of $56,000, or 25.3%, from the same period in 2021. Average balances decreased $5,506,000, or 22.0%, to $19,569,000 for the first quarter of 2022, resulting in a decrease of $48,000 in income. The yield on municipal loans decreased 16 basis points, to 3.41% for the first quarter of 2022, compared with the same period in 2021, resulting in a decrease of $8,000 in interest income. The decrease in volume during 2022 was a result of municipal loans being refinanced as bonds.
QNB desires to be the “local consumer lender of choice”, focusing its retail lending efforts on product offerings and marketing and promotion. Interest income on residential mortgage loans secured by first lien 1-4 family increased $43,000 when comparing the first quarter of 2022 to the same period in 2021. Average residential mortgage loan balances increased by $12,925,000, or 14.6%, to $101,431,000 for the first quarter of 2022 compared to the same period in 2021, which contributed a $113,000 increase in interest income. However, the average yield on the portfolio decreased 27 basis points to 3.23% for the first quarter of 2022, which resulted in a $70,000 decrease in 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 decreased by $4,120,000, or 7.0%, to $54,618,000 and the average yield decreased 11 basis points to 3.36% resulting in a combined decrease in interest income of $49,000. The yield on the consumer portfolio increased 14 basis points to 5.05% for the first quarter of 2022 and there was a $598,000 decrease in average balances resulting in a combined $6,000 decrease in interest income.
Earning assets are funded by deposits and borrowed funds. Interest expense decreased $141,000, when comparing the first quarter of 2022 to the same period in 2021. The growth in average deposits continues to be centered in accounts with greater liquidity. Average non-interest-bearing demand accounts increased $27,804,000, or 12.9%, to $244,097,000 for the first quarter of 2022. Average interest-bearing demand accounts increased $56,568,000, or 20.1%, to $338,296,000 for the first quarter of 2022. Interest expense on interest-bearing demand accounts decreased $2,000 to $146,000 for the same period, as the average rate paid decreased three basis points to 0.18% for the first quarter 2022. Included in this category is QNB-Rewards checking, a higher-rate checking account product that pays 1.00% on balances up to $25,000 and 0.15% for balances over $25,000. In order to receive the high rate a customer must receive an electronic statement, have one direct deposit or other ACH transaction and have at least 12 check card purchase transactions post and clear per statement cycle. For the first quarter of 2022, the average balance in this product was $96,522,000 and the related interest expense was $80,000 for an average yield of 0.34%. In comparison, the average balance of the QNB-Rewards accounts for the first quarter of 2021 was $89,966,000 and the related interest expense was $79,000 for an average yield of 0.36%. This product also generates fee income through the use of the check card.
Interest expense on municipal interest-bearing demand accounts increased $1,000 to $91,000 for the first quarter of 2022. The average interest rate paid on municipal interest-bearing demand accounts remained the same at 0.32% for the first quarter of 2022 and 2021, and average balances increased $3,966,000, or 3.5%, to $116,516,000. 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 first and second quarters as tax receipts are collected and are withdrawn over the course of the year.
Average money market accounts increased $35,740,000, or 33.9%, to $141,296,000 for the first quarter of 2022 compared with the same period in 2021. Interest expense on money market accounts increased $24,000 to $106,000, and the average interest rate paid on money market accounts decreased one basis point to 0.30% for the first quarter of 2022. Most of the balances in this category are in a product that pays a tiered rate based on account balances.
Interest expense on savings accounts increased $31,000 when comparing the first quarter of 2022 to the first quarter of 2021. The average interest rate paid on savings accounts decreased three basis points to 0.30% for the first quarter of 2022. When comparing these same periods, average savings accounts increased $83,627,000, or 23.6%, to $437,645,000 for the first quarter of 2022 primarily
41
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
due to in creases 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 202 2 of $ 334 , 096 ,000 compared to $ 263 , 038 , 000 in the same period of 202 1 . The average yield paid on these accounts was 0 . 35 % for the first quarter of 202 2 and 0. 4 0 % for the same period in 202 1 . 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 in creased $ 12 , 569 ,000 when comparing the first quarter of 202 2 average to the same period in 2021 . Many of the Bank’s maturing time deposits throughout 202 1 and into 202 2 were deposited to these liquid interest-bearing accounts.
Interest expense on time deposits totaled $311,000 for the first quarter of 2022 compared to $510,000 in 2021. Average total time deposits decreased $22,471,000 to $166,199,000 for the first quarter of 2022. As with fixed-rate loans and investment securities, these deposits reprice over time and, therefore, have less of an immediate impact on costs in either a rising or falling rate environment; however, the maturity and repricing characteristics of time deposits tend to be shorter. The average rate paid on total time deposits decreased 34 basis points from 1.10% to 0.76% when comparing the first quarter of 2021 to the same period in 2022.
Approximately $88,395,000, or 55%, of time deposits at March 31, 2022 will mature over the next 12 months. The average rate paid on these time deposits is approximately 0.54%. The yield on the time deposit portfolio may change slightly 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, 2022 and March 31, 2021. Interest expense on short-term borrowings increased $4,000 for the first quarter of 2022 to $59,000 when compared to the same period in 2021. When comparing these same periods, average balances increased $13,394,000 to $71,480,000. 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.
PROVISION FOR LOAN LOSSES AND ALLOWANCE FOR LOAN LOSSES
The provision for loan losses represents management's determination of the amount necessary to be charged to operations to bring the allowance for loan losses to a level that represents management’s best estimate of the known and inherent losses in the existing loan portfolio. Management believes that it uses the best information available to make determinations about the adequacy of the allowance and that it has established its existing allowance for loan losses in accordance with U.S. GAAP. The determination of an appropriate level for the allowance for loan losses is based upon an analysis of the risks inherent in QNB’s loan portfolio. Management, in determining the allowance for loan losses, makes significant estimates and assumptions.
Since the allowance for loan losses is dependent, to a great extent, on conditions that may be beyond QNB’s control, it is at least reasonably possible that management’s estimates of the allowance for loan losses and actual results could differ. In addition, various regulatory agencies, as an integral part of their examination process, periodically review QNB’s allowance for losses on loans. Such agencies may require QNB to recognize changes to the allowance based on their judgments about information available to them at the time of their examination. Actual loan losses, net of recoveries, serve to reduce the allowance.
Management closely monitors the quality of its loan portfolio and performs a quarterly analysis of the appropriateness of the allowance for loan losses. This analysis considers several relevant factors including specific impairment reserves, historical loan loss experience, general economic conditions, levels of and trends in delinquent and non-performing loans, levels of classified loans, trends in the growth rate of loans and concentrations of credit.
Based on this analysis, QNB recorded no provision for the three months ended March 31, 2022 and recorded $275,000 in provision for loan losses for the same period in 2021. QNB's allowance for loan losses of $11,231,000 represents 1.21% of loans receivable at March 31, 2022 compared with an allowance for loan losses of $11,184,000, or 1.21% of loans receivable, at December 31, 2021, and $11,115,000, or 1.18% of loans receivable, at March 31, 2021. Management believes the allowance for loan losses at March 31, 2022 is adequate as of that date based on its analysis of known and inherent losses in the portfolio. Excluding PPP loans, the allowance level stated as a percent of loans receivable was 1.22% at March 31, 2022, 1.23% at December 31, 2021, and 1.27% at March 31, 2021.
Net recoveries were $47,000 for the three months ended March 31, 2022 compared to net recoveries of $14,000 for the three months ended March 31, 2021. Charge-offs of approximately $31,000 during the three months ended March 31, 2022 consisted primarily of consumer loans of $13,000 and overdrafts of $18,000. These were offset by $78,000 in recoveries comprising $72,000 in repayments
42
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
from borrowers of previously charged-off credits, and $ 6 ,000 related to overdraft recoveries. Annualized net recoveries as a percentage of average loans receivable were 0 . 02 % fo r th e three months ended March 31, 2022, compared to annualized net recoveries of 0.01% for the three months ended March 31, 2021 .
Non-performing assets were $11,647,000 at March 31, 2022 compared to $11,672,000 as of December 31, 2021 and $13,266,000 at March 31, 2021. Total non-performing loans, which represent loans on non-accrual status, loans past due 90 days or more and still accruing interest and restructured loans, were 1.26% of loans receivable at March 31, 2022 and December 31, 2021, and 1.40% of loans receivable at March 31, 2021. In cases where there is a collateral shortfall on non-accrual loans, specific impairment reserves have been established based on updated collateral values even if the borrower continues to pay in accordance with the terms of the agreement. At March 31, 2022, $4,144,000, or approximately 57% of the loans classified as non-accrual, are current or past due less than 30 days. Commercial loans classified as substandard or doubtful totaled $19,072,000, an increase of $541,000, or 2.9%, from the $18,531,000 reported at December 31, 2021 and a decrease of $2,863,000, or 13.1%, from the $21,935,000 reported at March 31, 2021. The increase in classified loans since December 31, 2021 is due to the classification of one large credit, partially offset by repayments on existing substandard loans. The decrease since March 31, 2021 is primarily repayments on existing substandard loans.
QNB had no loans past due 90 days or more and still accruing interest at March 31, 2022, December 31, 2021, or March 31, 2021. Total loans 30 days or more past due, which includes non-accrual loans by actual number of days delinquent, represented 0.39% of loans receivable at March 31, 2022 compared with 0.46% at December 31, 2021, and 0.60% at March 31, 2021.
Troubled debt restructured loans, not classified as non-accrual loans or loans past due 90 days or more and accruing, were $4,375,000 at March 31, 2022, compared with $4,142,000 at December 31, 2021, and $4,379,000 at March 31, 2021. There was one new troubled debt restructuring identified during the three months ended March 31, 2022, as QNB extended credit to an existing TDR customer. QNB had no other real estate owned or repossessed assets at March 31, 2022, December 31, 2021, or March 31, 2021.
A loan is considered impaired, based on current information and events, if it is probable that QNB will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and shortfalls on a case-by-case basis, taking into consideration all the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.
43
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following table shows detailed information and ratios pertaining to the Company’s loan and asset quality:
March 31,
December 31,
March 31,
2022
2021
2021
Non-accrual loans
$
7,272
$
7,530
$
8,887
Loans past due 90 days or more and still accruing interest
—
—
—
Troubled debt restructured loans (not already included above)
4,375
4,142
4,379
Total non-performing loans
11,647
11,672
13,266
Total non-performing assets
$
11,647
$
11,672
$
13,266
Total loans (excluding loans held-for-sale):
Average total loans (YTD)
$
918,602
$
928,017
$
932,617
Total loans
926,369
926,470
945,645
Allowance for loan losses
11,231
11,184
11,115
Allowance for loan losses to:
Non-performing loans
96.43
%
95.82
%
83.79
%
Total loans (excluding held-for-sale)
1.21
%
1.21
%
1.18
%
Average total loans (excluding held-for-sale)
1.22
%
1.21
%
1.19
%
Non-performing loans / total loans (excluding held-for-sale)
1.26
%
1.26
%
1.40
%
Non-performing assets / total assets
0.71
%
0.70
%
0.84
%
An analysis of net loan charge-offs (recoveries) for the three months ended March 31, 2022 compared to 2021 is as follows:
For the Three Months Ended March 31,
2022
2021
Net charge-offs
$
(47
)
$
(14
)
Net annualized charge-offs to:
Total loans
(0.02
%)
(0.01
%)
Average total loans excluding held-for-sale
(0.02
%)
(0.01
%)
Allowance for loan losses
(1.70
%)
(0.51
%)
At March 31, 2022 and December 31, 2021, the recorded investment in loans for which impairment has been identified totaled $12,066,000 and $12,192,000 of which $7,046,000 and $4,633,000, respectively, required no specific allowance for loan loss. The recorded investment in impaired loans requiring an allowance for loan losses was $5,020,000 and $7,559,000 at March 31, 2022 and December 31, 2021, respectively, and the related allowance for loan losses associated with these loans was $2,634,000 and $2,873,000, respectively. Most of the loans that have been identified as impaired are collateral-dependent. See Note 8 to the Notes to Consolidated Financial Statements for additional detail of impaired loans.
44
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
NON-INTEREST INCOME
Non-Interest Income Comparison
For the Three Months Ended March 31,
Change from prior year
2021
2021
Amount
Percent
Net gain on sales of investment securities
$
36
$
342
$
(306
)
-89.5
%
Unrealized gain (loss) on investment equity securities
(8
)
1,096
(1,104
)
(100.7
)
Fees for services to customers
384
299
85
28.4
ATM and debit card
641
593
48
8.1
Retail brokerage and advisory
205
167
38
22.8
Bank-owned life insurance
81
263
(182
)
(69.2
)
Merchant
95
104
(9
)
(8.7
)
Net gain on sale of loans
—
352
(352
)
(100.0
)
Other
177
188
(11
)
(5.9
)
Total
$
1,611
$
3,404
$
(1,793
)
-52.7
%
Quarter to Quarter Comparison
Total non-interest income for the first quarter of 2022 was $1,611,000, a decrease of $1,793,000, compared to $3,404,000 for the first quarter of 2021. Excluding realized and unrealized gains (losses) on equity securities, gains on sales of loans, and the life insurance benefit claim of $193,000 in 2021, non-interest income decreased $160,000, or 11.2%, to $1,584,000 for the quarter ended March 31, 2022 compared with the same period in 2021
During the first quarter of 2022, unrealized losses on investment equity securities of $8,000 were recorded compared to gains of $1,096,000 in the same period of 2021. The unrealized losses and gains for the three months ended March 31, 2022 and 2021 resulted from the change in the fair value of the equities portfolio. The equities portfolio comprises blue-chip large-capitalized stocks, providing a year-to-date taxable equivalent dividend yield of 3.20%. 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, 2022 is $2.46 per diluted share. Details of the equity portfolio’s contribution to net income is detailed in the following table.
45
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Net Income (Expense) on Equity Securities
For the Year Ended December 31,
For the Three Months Ended March 31,
2015
2016
2017
2018
2019
2020
2021
2022
2021
Equity Securities:
Tax-equivalent dividends*
$
244
$
233
$
249
$
300
$
274
$
392
$
437
$
98
$
106
Net gain (loss) on sales
691
758
1,557
(79
)
1,781
585
1,788
35
339
OTTI
(55
)
(192
)
(80
)
N/A
N/A
N/A
N/A
N/A
N/A
Unrealized (loss) gain
N/A
N/A
N/A
(336
)
770
(47
)
926
(8
)
1,096
Tax-equivalent income before tax
880
799
1,726
(115
)
2,825
930
3,151
125
1,541
Tax expense (benefit)*
357
324
700
(33
)
816
269
910
36
445
Net income
$
523
$
475
$
1,026
$
(82
)
$
2,009
$
661
$
2,241
$
89
$
1,096
Earnings per share - basic
$
0.16
$
0.14
$
0.30
$
(0.02
)
$
0.57
$
0.19
$
0.63
$
0.03
$
0.31
Earnings per share - diluted
$
0.16
$
0.14
$
0.30
$
(0.02
)
$
0.57
$
0.19
$
0.63
$
0.03
$
0.31
Tax-equivalent yield*
3.35
%
3.13
%
3.49
%
3.08
%
3.31
%
3.54
%
3.02
%
3.20
%
3.26
%
*Based on Federal tax rates of 34% for the 2015 and 2016 periods and 21% for all 2017, 2018, 2019, 2020, 2021 and 2022 periods.
QNB originates residential mortgage loans for sale in the secondary market. There were no gains on sale of loans during the first quarter of 2022 compared with $352,000 in the first quarter of 2021. The net gain on residential mortgage sales is directly related to the volume of mortgages sold and the timing of the sales relative to the interest rate environment. Residential mortgage loans to be sold are identified at origination. There were no sales of residential mortgages in the first quarter of 2022 compared to proceeds from the sale of residential mortgages of $9,105,000 for the first quarter 2021.
Fees for services to customers increased $85,000 to $384,000 for the first quarter of 2022, due primarily to an increase in net overdraft income. ATM and debit card income increased $48,000 to $641,000 for the first quarter of 2022, compared to the same period in 2021, due primarily to debit card interchange fee income.
QNB provides securities and advisory services under the name QNB Financial Services. Retail brokerage and advisory fees increased for the first quarter of 2022 compared to the same period in 2021. Advisory fees increased $39,000 for the first quarter of 2022 compared with the same period in 2021 due to increased assets under management, while transactional fees decreased $1,000 when comparing the first quarters of 2022 and 2021 due to the sale of annuity products.
Bank-owned life insurance income includes a life insurance benefit claim of $193,000 in the first quarter of 2021. Merchant income decreased by $9,000 to $95,000 for the first quarter of 2022, compared to the same period in 2021. Other non-interest income decreased $11,000. There was a decrease in title company income of $23,000 due to the decreased volume of mortgage originations. There was an increase of $20,000 in mortgages servicing fees due to a change in the fair value of previously impaired pools of mortgages.
46
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
NON-INTEREST EXPENSE
Non-Interest Expense Comparison
For the Three Months Ended March 31,
Change from prior year
2022
2021
Amount
Percent
Salaries and employee benefits
$
4,266
$
4,017
$
249
6.2
%
Net occupancy
578
618
(40
)
(6.5
)
Furniture and equipment
687
670
17
2.5
Marketing
194
214
(20
)
(9.3
)
Third-party services
667
488
179
36.7
Telephone, postage and supplies
194
198
(4
)
(2.0
)
State taxes
272
273
(1
)
(0.4
)
FDIC insurance premiums
217
171
46
26.9
Other
738
674
64
9.5
Total
$
7,813
$
7,323
$
490
6.7
%
Quarter to Quarter Comparison
Total non-interest expense was $7,813,000 for the first quarter of 2022, an increase of $490,000, or 6.7%, compared to the first quarter of 2021.
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 $249,000, or 6.2%, to $4,266,000 when comparing the two quarters. Salary expense and related payroll taxes increased $178,000 to $3,606,000 during the first quarter of 2022 compared to the same period in 2021 due to increased compensation and related taxes of $71,000, bonus accruals of $11,000 and lower contra loan origination deferred costs of $97,000. Medical and dental premiums, net of employee contributions, decreased $71,000 to $660,000 when comparing the two quarters due to a decrease in medical claims.
Net occupancy and furniture and equipment expenses combined decreased $23,000, or 1.8%, when comparing the first quarters of 2022 and 2021. This is due primarily to decreased building repair expense and decreased leasehold and furniture depreciation and computer software amortization expense, offset in part by increased software maintenance expense. Marketing expense decreased $20,000, or 9.3%, to $194,000 for the quarter ended March 31, 2022, due to timing of promotions and community support donations.
Third-party services are comprised of professional services, including legal, accounting, auditing and consulting services, as well as fees paid to outside vendors for support services of day-to-day operations. These support services include correspondent banking services, IT services, statement printing and mailing, investment security safekeeping and supply management services. Third party services expense increased $179,000 when comparing the two periods, due primarily to increases in fees paid to outside vendors for support services. FDIC insurance premiums increased $46,000 due to asset growth.
Other non-interest expense increased $64,000, or 9.5%, primarily due to increased travel and entertainment expense and check fraud cost.
INCOME TAXES
QNB utilizes an asset and liability approach for financial accounting and reporting of income taxes. As of March 31, 2022, QNB’s net deferred tax asset was $12,046,000. The primary components of deferred taxes are deferred tax assets of which $10,724,000 relates to investment securities fair value adjustments and $2,358,000 relates to the allowance for loan losses. As of December 31, 2021, QNB’s net deferred tax asset was $2,449,000 of which $994,000 related to investment securities fair value adjustments and $2,349,000 was related to the allowance for loan losses. The increase in the balance of net deferred tax assets when comparing March 31, 2022 to December 31, 2021 is due to the increase in unrealized losses on available for sale securities at March 31, 2022 compared to December 31, 2021, contributing to $9,730,000 of the increase.
47
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The realizability of deferred tax assets is dependent upon a variety of factors, including the generation of future taxable income, the existence of taxes paid and recoverable, the reversal of deferred tax liabilities and tax planning strategies. Based upon these and other factors, management believes it is more likely than not that QNB will realize the benefits of these remaining deferred tax assets.
Applicable income tax expense was $824,000 for the first quarter of 2022, compared to $1,273,000 for the first quarter of 2021. The effective tax rate for first quarter of 2022 was 18.2% compared with 20.1% for the same period in 2021. The decrease in the effective tax rate for the three months ended March 31, 2022 is due to the state income tax at the parent company related to higher gains in 2021 compared to 2022 on the equities portfolio; and as pre-tax income was lower in 2022 compared to 2021, there was a higher proportion of tax-exempt net interest income to income before taxes for 2022 over 2021.
FINANCIAL CONDITION ANALYSIS
Financial service organizations are challenged to demonstrate they can generate sustainable and consistent earnings growth in a dynamic operating environment. Rate competition for quality loans is anticipated to continue through 2022. It is also anticipated that the rate competition for attracting and retaining deposits may increase in 2022, which could result in a lower net interest margin and a decline in net interest income.
QNB’s primary business is accepting deposits and making loans to meet the credit needs of the communities it serves. Loans are the most significant component of earning assets and growth in loans to small businesses and residents of these communities has been a primary focus of QNB. Inherent within the lending function is the evaluation and acceptance of credit risk and interest rate risk. QNB manages credit risk associated with its lending activities through portfolio diversification, underwriting policies and procedures and loan monitoring practices. QNB is committed to make credit available to its customers.
Total assets at March 31, 2022 were $1,647,986,000 compared with $1,673,340,000 at December 31, 2021. Cash and cash equivalents decreased $130,000 from $13,390,000 at December 31, 2021 to $13,260,000 at March 31, 2022, due primarily to increases in investment securities during the three months ended March 31, 2022.
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.
Loans receivable decreased $101,000 with commercial loans decreasing $2,579,000 to $757,806,000 at March 31, 2022, compared with $760,385,000 at year-end 2021. Excluding PPP loans, commercial loans increased $5,735,000. Retail loan balances increased $2,192,000 comparing March 31, 2022 to December 31, 2021. QNB continues to provide solutions to customers experiencing financial hardship caused by the COVID-19 Pandemic. As of March 31, 2022 QNB had modifications to two loans in the commercial portfolio, with balances totaling $321,000, and had no modifications to the retail loan portfolio, related to the COVID-19 Pandemic. At March 31, 2022, QNB had 32 PPP loans totaling $6,013,000 reported in commercial and industrial loans. In 2020, the Bank originated $82,475,000 in PPP loans, enabling 660 businesses to maintain their payrolls and stay in operation. Of this first round of funding, 653 loans have been forgiven in full and $80,497,000 in balances have been forgiven. The Bank originated 315 PPP loans, or $35,021,000, during the second round of funding which started in January 2021. Second-draw customers made up 244 of these loans, or $32,240,000, and one-draw customers made of the remaining 71 loans, or $2,781,000. Of this second round of funding, 290 loans have been forgiven in full and $29,449,000 in balances have been forgiven. Excluding PPP loans net of deferred fees at March 31, 2022 and at December 31, 2021, loans receivable would have increased $7,900,000, or 0.9%, since year-end 2021.
Deposits grew $2,008,000 from December 31, 2021 to March 31, 2022. Non-interest-bearing demand deposits decreased $982,000, with balances of $242,024,000 at March 31, 2022 compared with $243,006,000 at year-end 2021. Interest-bearing demand balances, excluding municipal deposits, increased $8,248,000, or 2.4%, to $347,655,000, with increases in all personal checking products and in the business checking product. The $218,000 decrease in money market accounts was limited primarily to business products. The $21,531,000 increase in savings was partially offset by the decline in time deposits as balances were moved to more liquid accounts. Total time deposits declined $4,718,000 from December 31, 2021 to March 31, 2022. Municipal deposit balances decreased $21,853,000, to $106,939,000, during the first quarter of 2022. Municipal deposits can be volatile depending on the timing of deposits and withdrawals, and the cash flow needs of the school districts or municipalities. Municipal deposits increase as tax money is received from the local school districts during first and second quarters and it is anticipated that these funds will flow out for the
48
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
subsequent twelve months as the schools use the funds for operations. These deposits provide incremental income as they are invested in short-term investment securities but will further reduce the net interest margin as the spread earned is significantly less than the current net interest margin.
Short-term borrowings increased 12.1%, from $68,476,000 at December 31, 2021 to $76,738,000 at March 31, 2022. Commercial sweep accounts comprised most of balance of the short-term borrowing in both periods and increased $3,371,000; 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 $4,891,000 in overnight borrowings from FHLB at March 31, 2022 and none at December 31, 2021. In 2020, QNB borrowed long-term debt from the FHLB of $10,000,000 to lock in a rate at a low yield.
LIQUIDITY
Liquidity represents an institution’s ability to generate cash or otherwise obtain funds at reasonable rates to satisfy demand for loans and deposit withdrawals. QNB attempts to manage its mix of cash and interest-bearing balances, Federal funds sold and investment securities to match the volatility, seasonality, interest sensitivity and growth trends of its loans and deposits. The Company manages its liquidity risk by measuring and monitoring its liquidity sources and estimated funding needs. Liquidity is provided from asset sources through repayments and maturities of loans and investment securities. The portfolio of investment securities classified as available for sale and QNB's policy of selling certain residential mortgage originations in the secondary market also provide sources of liquidity. Core deposits and cash management repurchase agreements have historically been the most significant funding source for QNB. These deposits and repurchase agreements are generated from a base of consumers, businesses and public funds primarily located in the Company’s market area.
Additional sources of liquidity are provided by the Bank’s membership in the FHLB. At March 31, 2022 the Bank had a maximum borrowing availability with the FHLB of approximately $343,789,000, which is net of the $10,000,000 in long-term borrowings, short-term borrowings of $4,891,000, a $350,000 letter of credit and accrued interest payable and credit enhancements. The maximum borrowing depends upon qualifying collateral assets and the Bank’s asset quality and capital adequacy. In addition, the Bank maintains unsecured Federal funds lines with five correspondent banks totaling $101,000,000. At March 31, 2022 there were no outstanding borrowings under these lines. Future availability under these lines is subject to the policies of the granting banks and may be withdrawn.
Liquid sources of funds, including cash, available-for-sale and equity investment securities, and loans held-for-sale have decreased $34,402,000 since December 31, 2021, totaling $682,758,000 at March 31, 2022. Growth in deposits since year-end 2021 has been used to fund loans. Excess cash was invested in debt securities, primarily amortizing securities, and to cover operating expenses. 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 $243,162,000 and $264,154,000 of available-for-sale debt securities at March 31, 2022 and December 31, 2021, respectively, were pledged as collateral for repurchase agreements and deposits of public funds. 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, 2022 was $102,498,000, or 6.22% of total assets, compared with shareholders' equity of $136,494,000, or 8.16% of total assets, at December 31, 2021. Shareholders’ equity at March 31, 2022 included a negative adjustment of $40,341,000 compared to a negative adjustment of $3,740,000 at December 31, 2021, related to unrealized holding losses, net of taxes, on investment securities available-for-sale. Without these adjustments, shareholders' equity to total assets would have been 8.46% and 8.36% at March 31, 2022 and December 31, 2021, respectively.
49
QNB CORP. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Average shareholders' equity and average total assets were $ 141 , 986 ,000 and $ 1 , 675 , 385 ,000 for the three months e nded March 31, 2022 , an increase of 8.8 % and 14.2 %, respectively, from the averages for the three months ende d March 31 , 20 2 1 . The ratio of average total equity to average total assets was 8.47 % for the three months ended March 31 , 202 2 compared to 8.90 % for the same period in 20 2 1 .
Retained earnings at March 31, 2022 were impacted by three months of net income totaling $3,710,000 offset by dividends declared and paid of $1,279,000 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 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 $227,000 to capital during the three months ended March 31, 2022.
The Board of Directors has authorized the repurchase of up to 200,000 shares of QNB common stock in open market or privately negotiated transactions. The repurchase authorization does not bear a termination date. As of March 31, 2022, 102,000 shares have been repurchased since the initial authorization at an average price of $24.93 and a total cost of $2,543,000.
QNB is subject to various regulatory capital requirements as issued by Federal regulatory authorities. Regulatory capital is defined in terms of Tier 1 capital and Tier 2 capital. Risk-based capital ratios are expressed as a percentage of risk-weighted assets. Risk-weighted assets are determined by assigning various weights to all assets and off-balance sheet arrangements, such as letters of credit and loan commitments, based on associated risk.
The required minimum Common equity Tier 1 capital to risk-weighted assets ratio is 4.5%, the required minimum ratio of Tier 1 capital to risk-weighted assets is 6.0%, the required minimum ratio of Total Capital to risk-weighted assets is 8.0%, and the required minimum Tier 1 leverage ratio is 4.0%. A capital conservation buffer of 2.5% of risk-weighted assets also applies to avoid limitations on certain capital distributions.
The following table sets forth consolidated information for QNB:
March 31,
December 31,
Capital Analysis
2022
2021
Regulatory Capital
Shareholders' equity
$
102,498
$
136,494
Net unrealized securities losses, net of tax
40,341
3,740
Deferred tax assets on net operating loss
—
—
Disallowed intangible assets
(8
)
(8
)
Common equity tier 1 capital
142,831
140,226
Tier 1 capital
142,831
140,226
Allowable portion: Allowance for loan losses and reserve
for unfunded commitments
11,329
11,275
Total regulatory capital
$
154,160
$
151,501
Risk-weighted assets
$
1,146,662
$
1,113,887
Quarterly average assets for leverage capital purposes
$
1,675,385
$
1,672,259
March 31,
December 31,
Capital Ratios
2022
2021
Common equity tier 1 capital / risk-weighted assets
12.46
%
12.59
%
Tier 1 capital / risk-weighted assets
12.46
12.59
Total regulatory capital / risk-weighted assets
13.44
13.60
Tier 1 capital / average assets (leverage ratio)
8.52
8.39
At March 31, 2022, common equity Tier 1, Tier 1 capital, and total regulatory capital ratios were fairly level with December 31, 2021. The Company remains well-capitalized by all applicable regulatory requirements as of March 31, 2022.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.