**Table
            of Contents**





**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      DC 20549**





**FORM
      10-Q**





(Mark
      One)


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





For
      the
      quarterly period ended: September
      30, 2006




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, Quakertown, PA
            18951-9005(Address
                of Principal Executive Offices)
            (Zip
                Code)





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





Not
      Applicable


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





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





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


Large
      accelerated filer  ____  Accelerated
      filer   ü   Non-accelerated
      filer  ____





Indicate
      by check mark whether the Registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).


Yes ____ No   ü





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 November 6, 2006Common
                Stock, par value $.625
            
            3,126,985







**Table
        of Contents**




**QNB
      CORP. AND SUBSIDIARY**





**FORM
      10-Q**





**QUARTER
      ENDED SEPTEMBER 30, 2006**




**INDEX**





**PART
                I - FINANCIAL INFORMATION****ITEM
                1.**
            **CONSOLIDATED
                FINANCIAL STATEMENTS
                (Unaudited)**
            **PAGE**Consolidated
                Statements of Income for Three and Nine Months
                Ended September 30, 2006 and 2005
            1Consolidated
                Balance Sheets at September 30, 2006 and December
                31, 2005
            2Consolidated
                Statements of Cash Flows for Nine Months Ended
                September 30, 2006 and 2005
            3Notes
                to Consolidated Financial
                Statements
            4**ITEM
                2.**
            **MANAGEMENT'S
                DISCUSSION AND ANALYSIS OF RESULTS OF
                OPERATIONS AND FINANCIAL CONDITION**
            12**ITEM
                3.**
            **QUANTITATIVE
                AND QUALITATIVE DISCLOSURE ABOUT MARKET
                RISK**
            37**ITEM
                4.**
            **CONTROLS
                AND PROCEDURES**
            37**PART
                II - OTHER INFORMATION****ITEM
                1.**
            **LEGAL
                PROCEEDINGS**
            38**ITEM
                1A.**
            **RISK
                FACTORS**
            38**ITEM
                2.**
            **UNREGISTERED
                SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**
            38**ITEM
                3.**
            **DEFAULTS
                UPON SENIOR
                SECURITIES**
            38**ITEM
                4.**
            **SUBMISSIONS
                OF MATTERS TO A VOTE OF SECURITY
                HOLDERS**
            38**ITEM
                5.**
            **OTHER
                INFORMATION**
            38**ITEM
                6.**
            **EXHIBITS**
            38**SIGNATURES****CERTIFICATIONS**




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**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2006 AND 2005, AND DECEMBER 31, 2005**


**(Unaudited)**





1.
      REPORTING AND ACCOUNTING POLICIES





The
      accompanying unaudited consolidated financial statements include the accounts
      of
      QNB Corp. (QNB) and its wholly-owned subsidiary, The Quakertown National Bank
      (the Bank). 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 2005
      Annual Report incorporated in the Form 10-K. Operating results for the three-
      and nine-month periods ended September 30, 2006 are not necessarily indicative
      of the results that may be expected for the year ending December 31, 2006.





The
      unaudited consolidated financial statements reflect all adjustments, which
      in
      the opinion of management are necessary for a fair presentation of the results
      of the interim periods 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.





**STOCK-BASED
      COMPENSATION**





QNB
      sponsors stock-based compensation plans, administered by a committee, under
      which both qualified and non-qualified stock options may be granted periodically
      to certain employees. QNB accounted for all awards granted after January 1,
      2002
      under the “fair value” approach under Financial
      Accounting Standards Board (FASB) Statement No. 123, *Accounting
      for Stock-Based Compensation* .
      Effective January 1, 2006, QNB adopted FASB Statement No. 123 (revised 2004), *Share-Based
      Payment* (FASB
      No.
      123r), using the modified prospective application method. The modified
      prospective application method applies to new awards, to any outstanding
      liability awards, and to awards modified, repurchased, or cancelled after
      January 1, 2006. For all awards granted prior to January 1, 2006, unrecognized
      compensation cost, on the date of adoption, will be recognized as an expense
      in
      future periods. The results for prior periods have not been
      restated.





The
      adoption of FASB No. 123r reduced net income by approximately $27,000 and
      $86,000 for the three- and nine-months ended September 30, 2006, respectively. The
      following table illustrates the effect on net income and earnings per share
      if
      QNB had applied the fair value recognition provisions to stock-based employee
      compensation during the period presented. For purposes of this pro forma
      disclosure, the value of the options is estimated using the Black-Scholes
      option-pricing model and amortized to expense over the options’ vesting
      period.


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          of Contents**




**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2006 AND 2005, AND DECEMBER 31, 2005**


**(Unaudited)**





Three
                Months Ended
              September
                30, 2005
            
            Nine
                Months
              Ended
              September
                30, 2005Net
              income, as reported
            
            $
            1,431
            
            $
            3,833Deduct:
                Total stock-based employee compensationexpense
                determined under fair value basedmethod
                for all awards, net of related tax effects
            
            
            25
            
            
            76Pro
                forma net income
            
            $
            1,406
            
            $
            3,757Earnings
                per share
              Basic
                - as reported
            
            $
            .46
            
            $
            1.24Basic
                - pro forma
            
            $
            .45
            
            $
            1.21Diluted
                - as reported
            
            $
            .45
            
            $
            1.21Diluted
                - pro forma
            
            $
            .44
            
            $
            1.18





As
      of
      September 30, 2006, there was approximately $119,000 of unrecognized
      compensation cost related to unvested share-based compensation awards granted.
      That cost is expected to be recognized over the next two and a quarter
      years.





Options
      are granted to certain employees at prices equal to the market value of the
      stock on the date the options are granted. The 1998 Plan authorizes the issuance
      of 220,500 options. The time period during which any option is exercisable
      under
      the Plan is determined by the committee but shall not commence before the
      expiration of six months after the date of grant or continue beyond the
      expiration of ten years after the date the option is awarded. The granted
      options vest ratably over a three-year period. As of September 30, 2006, there
      were 180,458 options outstanding under this Plan. The 2005 Plan authorizes
      the
      issuance of 200,000 options. The terms of the 2005 Plan are identical to the
      1998 Plan, except options expire five years after the grant date. As of
      September 30, 2006, there were 8,900 options outstanding under this
      Plan.





The
      fair
      value of each option is amortized into compensation expense on a straight-line
      basis between the grant date for the option and each vesting date. QNB estimated
      the fair value of stock options on the date of the grant using the Black-Scholes
      option pricing model. The model requires the use of numerous assumptions, many
      of which are subjective in nature. The following assumptions were used in the
      option pricing model in determining the fair value of options granted during
      the
      three- and nine-months ended September 30:





Options
                granted
            
            2006
            
            2005
            
            2004Risk-free
                interest rate
            
            
            4.27
            %
            
            4.18
            %
            
            4.39
            %Dividend
                yield
            
            
            3.23
            
            
            2.40
            
            
            2.20Volatility
            
            
            13.28
            
            
            14.05
            
            
            13.61Expected
                life
            
            
            5
                yrs.
            
            
            10
                yrs.
            
            
            10
                yrs.





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


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**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2006 AND 2005, AND DECEMBER 31, 2005**


**(Unaudited)**





The
      fair
      market value of options granted in the first nine months of 2006 and 2005 was
      $3.13 and $6.46, respectively.





Stock
      option activity during the nine-months ended September 30, 2006 is as
      follows:




WeightedAverage
              
              AggregateWeighted
              
              Remaining
              
              IntrinsicNumber
                  of
              
              Average
              
              Contractual
              
              ValueOptions
              
              Exercise
                  Price
              
              Term
                  (in yrs.)
              
              (in
                  thousands)Outstanding
                  at January 1, 2006
              
              
              193,374
              
              $
              19.18
              
              
              5.93Exercised
              
              
              (21,416
              )
              
              16.27Granted
              
              
              17,400
              
              
              26.00Outstanding
                  at September 30, 2006
              
              
              189,358
              
              
              20.13
              
              
              5.17
              
              $
              1,177Exercisable
                  at September 30, 2006
              
              
              137,058
              
              
              16.16
              
              
              4.58
              
              $
              1,177




2.
      PER
      SHARE DATA





The
      following sets forth the computation of basic and diluted earnings per share
      (share and per share data are not in thousands):





For
                the Three Months
              Ended
                September 30,
            
            For
                the Nine Months
              Ended
                September 30,2006
            
            2005
            
            2006
            
            2005Numerator
                for basic and diluted earningsper
                share-net income
            
            $
            1,517
            
            $
            1,431
            
            $
            4,497
            
            $
            3,833Denominator
                for basic earnings per share-weighted
                average shares outstanding
            
            
            3,126,985
            
            
            3,102,628
            
            
            3,123,800
            
            
            3,101,300Effect
                of dilutive securities-employeestock
                options
            
            
            51,086
            
            
            71,420
            
            
            52,300
            
            
            74,898Denominator
                for diluted earnings pershare-
                adjusted weighted averageshares
                outstanding
            
            
            3,178,071
            
            
            3,174,048
            
            
            3,176,100
            
            
            3,176,198Earnings
                per share-basic
            
            $
            .48
            
            $
            .46
            
            $
            1.44
            
            $
            1.24Earnings
                per share-diluted
            
            $
            .48
            
            $
            .45
            
            $
            1.42
            
            $
            1.21




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**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2006 AND 2005, AND DECEMBER 31, 2005**


**(Unaudited)**





2.
      PER
      SHARE DATA (Continued):





There
      were 52,300 and 34,900 stock options that were anti-dilutive for the three-
      and
      nine-month periods ended September 30, 2006, respectively. There were 40,000
      stock options that were anti-dilutive for the three- and nine-month periods
      ended September 30, 2005. These stock options were not included in the above
      calculation.





3.
      COMPREHENSIVE INCOME





Comprehensive
      income is defined as the change in equity of a business entity during a period
      from transactions and other events and circumstances, excluding those resulting
      from investments by and distributions to owners. For QNB, the sole component
      of
      other comprehensive income is the unrealized holding gains and losses on
      available-for-sale investment securities.





The
      following table shows the components and activity of comprehensive income during
      the periods ended September 30, 2006 and 2005:





For
                the Three Months
              Ended
                September 30,
            
            For
                the Nine Months
              Ended
                September 30,2006
            
            2005
            
            2006
            
            2005Unrealized
                holding gains (losses) arising during the period on securities held
                (net
                of taxes of $(1,222), $718, $(215) and $1,052, respectively)
            
            $
            2,373
            
            $
            (1,283
            )
            $
            418
            
            $
            (1,811
            )Reclassification
                adjustment for (gains) losses included in net income (net of taxes
                of $67,
                $(1), $208 and $(7), respectively)
            
            
            (129
            )
            
            3
            
            
            (403
            )
            
            573Net
                change in unrealized gains (losses) during the period
            
            
            2,244
            
            
            (1,280
            )
            
            15
            
            
            (1,238
            )Unrealized
                holding (losses) gains, beginning of period
            
            
            (3,491
            )
            
            733
            
            
            (1,262
            )
            
            691Unrealized
                holding losses, end of period
            
            $
            (1,247
            )
            $
            (547
            )
            $
            (1,247
            )
            $
            (547
            )Net
                income
            
            $
            1,517
            
            $
            1,431
            
            $
            4,497
            
            $
            3,833Other
                comprehensive income, net of tax:
              Unrealized
                holding gains (losses) arising during the period (net of taxes of
                $(1,155), $717, $(7) and $1,045, respectively)
            
            
            2,244
            
            
            (1,280
            )
            
            15
            
            
            (1,238
            )Comprehensive
                income
            
            $
            3,761
            
            $
            151
            
            $
            4,512
            
            $
            2,595




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**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2006 AND 2005, AND DECEMBER 31, 2005**


**(Unaudited)**





4.
      LOANS





The
      following table presents loans by category as of September 30, 2006 and December
      31, 2005:





September
                30,
              2006
            
            December
                31,
              2005Commercial
                and industrial
            
            $
            64,477
            
            $
            64,812Construction
            
            
            11,084
            
            
            7,229Real
                estate-commercial
            
            
            114,386
            
            
            104,793Real
                estate-residential
            
            
            123,754
            
            
            112,920Consumer
            
            
            5,288
            
            
            5,080Indirect
                lease financing
            
            
            12,665
            
            
            6,451Total
                loans
            
            
            331,654
            
            
            301,285Unearned
                costs
            
            
            146
            
            
            64Total
                loans net of unearned costs
            
            $
            331,800
            
            $
            301,349





5.
      INTANGIBLE ASSETS





As
      a
      result of a purchase of deposits in 1997, QNB recorded a deposit premium of
      $511,000. This premium is being amortized, for book purposes, over ten years
      and
      is reviewed annually for impairment. The net deposit premium intangible was
      $56,000 and $94,000 at September 30, 2006 and December 31, 2005, respectively.
      Amortization expense for core deposit intangibles was $12,000 for both
      three-month periods ended September 30, 2006 and 2005 and $38,000 for both
      nine-month periods ended September 30, 2006 and 2005.





The
      following table reflects the components of mortgage servicing rights as of
      the
      periods indicated:





September
                30,
            
            December
                31,2006
            
            2005Mortgage
                servicing rights beginning balance
            
            $
            528
            
            $
            552Mortgage
                servicing rights capitalized
            
            
            23
            
            
            80Mortgage
                servicing rights amortized
            
            
            (65
            )
            
            (109
            )Fair
                market value adjustments
            
            
            —
            
            
            5Mortgage
                servicing rights ending balance
            
            $
            486
            
            $
            528Mortgage
                loans serviced for others
            
            $
            76,369
            
            $
            77,196Amortization
                expense of intangibles
            
            
            103
            
            
            160




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**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2006 AND 2005, AND DECEMBER 31, 2005**


**(Unaudited)**





5.
      INTANGIBLE ASSETS (Continued):





The
      annual estimated amortization expense of intangible assets for each of the
      five
      succeeding fiscal years is as follows:





**Estimated
      Amortization Expense**





For
                the Year Ended 12/31/06
            
            $
            138For
                the Year Ended 12/31/07
            
            
            130For
                the Year Ended 12/31/08
            
            
            75For
                the Year Ended 12/31/09
            
            
            62For
                the Year Ended 12/31/10
            
            
            51





6.
      RELATED PARTY TRANSACTIONS





As
      of
      September 30, 2006, amounts due from directors, principal officers, and their
      related interests totaled $4,281,000. All of these transactions were made in
      the
      ordinary course of business on substantially the same terms, including interest
      rates and collateral, as those prevailing at the time for comparable
      transactions with other persons. The Bank believes that these loans did not
      involve a more than normal risk of collectibility or present any other
      unfavorable features.





On
      September 22, 2005, the Bank approved and entered into an agreement with Eugene
      T. Parzych, Inc. to act as the general contractor for the renovation of its
      property at 322 W. Broad Street, Quakertown, Pennsylvania to be used as
      additional office space. The bids for this project were submitted through a
      formal bidding process and reviewed by the Board of Directors. Mr. Gary S.
      Parzych is the president of Eugene T. Parzych, Inc. and is also a director
      of
      QNB Corp. Management and the Board of Directors of QNB Corp. and the Bank
      believe this is an arms-length transaction. The
      total
      paid to Eugene T. Parzych Inc. for this project was $1,243,000 with $1,029,000
      being paid during 2006.





7.
      RECENT
      ACCOUNTING PRONOUNCEMENTS





In
      February 2006, the FASB issued FASB No. 155, *Accounting
      for Certain Hybrid Instruments, as an amendment of FASB Statements No. 133
      and
      140* .
      FASB
      No. 155 allows financial instruments that have embedded derivatives to be
      accounted for as a whole (eliminating the need to bifurcate the derivative
      from
      its host) if the holder elects to account for the whole instrument on a fair
      value basis. This statement is effective for all financial instruments acquired
      or issued after the beginning of an entity’s first fiscal year that begins after
      September 15, 2006. The adoption of this standard is not expected to have a
      material effect on the QNB’s results of operations or financial
      position.





In
      March
      2006, the FASB issued FASB No. 156, *Accounting
      for Servicing of Financial Assets* .
      This
      Statement, which is an amendment to FASB No. 140, will simplify the accounting
      for servicing assets and liabilities, such as those common with mortgage
      securitization activities. Specifically, FASB No. 156 addresses the recognition
      and measurement of separately recognized servicing assets and liabilities and
      provides an approach to simplify efforts to obtain hedge-like (offset)
      accounting. FASB No. 156 also clarifies when an obligation to service financial
      assets should be separately recognized as a servicing asset or a servicing
      liability, requires that a separately recognized servicing asset or servicing
      liability be initially measured at fair value, if practicable, and permits
      an
      entity with a separately recognized


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          of Contents**




**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2006 AND 2005, AND DECEMBER 31, 2005**


**(Unaudited)**





servicing
      asset or servicing liability to choose either of the amortization or fair value
      methods for subsequent measurement. The provisions of FASB No. 156 are effective
      as of the beginning of the first fiscal year that begins after September 15,
      2006. The adoption of this standard is not expected to have a material effect
      on
      QNB’s results of operations or financial position.





In
      September 2006, the FASB issued FASB No. 157, *Fair
      Value Measurements* ,
      which
      provides enhanced guidance for using fair value to measure assets and
      liabilities. The standard applies whenever other standards require or permit
      assets or liabilities to be measured at fair value. The Standard does not expand
      the use of fair value in any new circumstances. FASB No. 157 is effective
      for financial statements issued for fiscal years beginning after
      November 15, 2007 and interim periods within those fiscal years. Early
      adoption is permitted. The adoption of this standard is not expected to have
      a
      material effect on QNB’s results of operations or financial position.





In
      June
      2006, the FASB issued FASB Interpretation No. 48 (FIN 48), *Accounting
      for Uncertainty in Income Taxes* .
      FIN 48
      is an interpretation of FASB No. 109, *Accounting
      for Income Taxes* ,
      and it
      seeks to reduce the diversity in practice associated with certain aspects of
      measurement and recognition in accounting for income taxes. In addition, FIN
      48
      requires expanded disclosure with respect to the uncertainty in income taxes
      and
      is effective for fiscal years beginning after December 15, 2006. The adoption
      of
      this standard is not expected to have a material effect on QNB’s results of
      operations





In
      September 2006, the SEC issued Staff Accounting Bulletin No. 108
      (SAB 108), *Considering
      the Effects of Prior Year Misstatements When Quantifying Misstatements in
      Current Year Financial Statements* ,
      providing guidance on quantifying financial statement misstatement and
      implementation when first applying this guidance. Under SAB 108, companies
      should evaluate a misstatement based on its impact on the current year income
      statement, as well as the cumulative effect of correcting such misstatements
      that existed in prior years existing in the current year's ending balance sheet.
      SAB 108 is effective for fiscal years ending after November 15, 2006. The
      adoption of this standard is not expected to have a material effect on QNB’s
      results of operations.





In
      September 2006, the FASB reached consensus on the guidance provided by Emerging
      Issues Task Force Issue 06-4 (EITF 06-4), *Accounting
      for Deferred Compensation and Postretirement Benefit Aspects of Endorsement
      Split-Dollar Life Insurance Arrangements* .
      The
      guidance is applicable to endorsement split-dollar life insurance arrangements,
      whereby the employer owns and controls the insurance policy, that are associated
      with a postretirement benefit. EITF 06-4 requires that for a split-dollar life
      insurance arrangement within the scope of the Issue, an employer should
      recognize a liability for future benefits in accordance with FAS No. 106 (if,
      in
      substance, a postretirement benefit plan exists) or Accounting Principles Board
      Opinion No. 12 (if the arrangement is, in substance, an individual deferred
      compensation contract) based on the substantive agreement with the employee.
      EITF 06-4 is effective for fiscal years beginning after December 15, 2007.
      QNB
      is currently evaluating the impact the adoption of the standard will have on
      its
      results of operations and financial position.





In
      September 2006, the FASB reached consensus on the guidance provided by Emerging
      Issues Task Force Issue 06-5 (EITF 06-5), *Accounting
      for Purchases of Life Insurance—Determining the Amount That Could Be Realized in
      Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases
      of
      Life Insurance* .
      EITF
      06-5 states that a policyholder should consider any additional amounts included
      in the contractual terms of the insurance policy other than the cash surrender
      value in determining the amount that could be realized under the insurance
      contract. EITF 06-5 also states that a


-10-
 **Table
          of Contents**




**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2006 AND 2005, AND DECEMBER 31, 2005**


**(Unaudited)**





policyholder
      should determine the amount that could be realized under the life insurance
      contract assuming the surrender of an individual-life by individual-life policy
      (or certificate by certificate in a group policy). EITF 06-5 is effective for
      fiscal years beginning after December 15, 2006. QNB is currently evaluating
      the
      impact the adoption of the standard will have on its results of operations
      and
      financial position.


-11-
 **Table
          of Contents**




**ITEM
      2.****MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
      CONDITION**





QNB
      Corp.
      (the Corporation) is a bank holding company headquartered in Quakertown,
      Pennsylvania. The Corporation, through its wholly-owned subsidiary, The
      Quakertown National Bank (the Bank), has been serving the residents and
      businesses of upper Bucks, northern Montgomery and southern Lehigh Counties
      in
      Pennsylvania since 1877. 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”.





**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
      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, could affect
      the future financial results of the Corporation 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:


·
            Operating,
                legal and regulatory risks


·
            Economic,
                political and competitive forces affecting the Corporation’s line of
                business


·
            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


·
            Volatility
                in interest rates and shape of the yield
                curve


·
            Increased
                credit risk





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 made, 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**





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 (GAAP). 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 disclosures of contingent assets and liabilities. QNB evaluates estimates on
      an
      on-going basis, including those


-12-
 **Table
            of Contents**




**QNB
      CORP. AND SUBSIDIARY**


**MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
        OPERATIONS AND FINANCIAL CONDITION**


**Critical
        Accounting Policies and Estimates (Continued):**


related
      to the allowance for loan losses, non-accrual loans, other real estate owned,
      other-than-temporary investment impairments, intangible assets, stock option
      plans 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.





QNB
      believes the following critical accounting policies affect its more significant
      judgments and estimates used in preparation of its consolidated financial
      statements: allowance for loan losses, income taxes and other-than-temporary
      investment security impairment. Each estimate is discussed below. The financial
      impact of each estimate is discussed in the applicable sections of Management’s
      Discussion and Analysis.





**Allowance
      for Loan Losses**





QNB
      considers that the determination of the allowance for loan losses involves
      a
      higher degree of judgment and complexity than its other significant accounting
      policies. The allowance for loan losses is calculated with the objective of
      maintaining a level believed by management to be sufficient to absorb probable
      known and inherent losses in the outstanding loan portfolio. The allowance
      is
      reduced by actual credit losses and is increased by the provision for loan
      losses and recoveries of previous losses. The provisions for loan losses are
      charged to earnings to bring the total allowance for loan losses to a level
      considered necessary by management.





The
      allowance for loan losses is based on management’s continuing review and
      evaluation of the loan portfolio. The level of the allowance is determined
      by
      assigning specific reserves to individually identified problem credits and
      general reserves to all other loans. The portion of the allowance that is
      allocated to internally criticized and non-accrual loans is determined by
      estimating the inherent loss on each credit after giving consideration to the
      value of underlying collateral. The general reserves are based on the
      composition and risk characteristics of the loan portfolio, including the nature
      of the loan portfolio, credit concentration trends, historic and anticipated
      delinquency and loss experience, as well as other qualitative factors such
      as
      current economic trends.





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





In
      addition, various regulatory agencies, as an integral part of their examination
      process, periodically review QNB’s allowance for loan losses. Such agencies may
      require QNB to recognize additions to the allowance based on their judgments
      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 GAAP. If circumstances differ
      substantially from the assumptions used in making determinations, future
      adjustments to the


-13-
 **Table
          of Contents**




**QNB
      CORP. AND SUBSIDIARY**


**MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
        OPERATIONS AND FINANCIAL CONDITION**
  **Critical
          Accounting Policies and Estimates (Continued):**


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.





**Income
      Taxes.**





QNB
      accounts for income taxes under the asset/liability method. 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.
      A valuation allowance of $46,000 existed as of September 30, 2006 to offset
      a
      portion of the tax benefits associated with certain impaired securities that
      management believes may not be realizable. Because the judgment about the level
      of future taxable income is dependent to a great extent on matters that may,
      at
      least in part, be beyond QNB’s control, it is at least reasonably possible that
      management’s judgment about the need for a valuation allowance for deferred
      taxes could change in the near term.





**Other-than-Temporary
      Impairment of Investment Securities**





Securities
      are evaluated periodically to determine whether a decline in their value is
      other-than-temporary. Management utilizes criteria such as the magnitude and
      duration of the decline, in addition to the reasons underlying the decline,
      to
      determine whether the loss in value is other-than-temporary. The term
“other-than-temporary” is not intended to indicate that the decline is
      permanent, but indicates that the prospects for a near-term recovery of value
      are not necessarily favorable, or that there is a lack of evidence to support
      realizable value equal to or greater than carrying value of the investment.
      Once
      a decline in value is determined to be other-than-temporary, the value of the
      security is reduced, and a corresponding charge to earnings is
      recognized.


-14-
 **Table
          of Contents**




**QNB
      CORP. AND SUBSIDIARY**


**MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
        OPERATIONS AND FINANCIAL CONDITION**




**RESULTS
      OF OPERATIONS - OVERVIEW**





QNB
      Corp.
      earns its net income primarily through its subsidiary, The Quakertown National
      Bank. Net interest income, or the spread between the interest, dividends and
      fees earned on loans and investment securities and the expense incurred on
      deposits and other interest-bearing liabilities, is the primary source of
      operating income for QNB. QNB seeks to achieve sustainable and consistent
      earnings growth while maintaining adequate levels of capital and liquidity
      and
      limiting its exposure to credit and interest rate risk to Board of Directors
      approved levels. Due to its limited geographic area, comprised principally
      of
      upper Bucks, southern Lehigh and northern Montgomery counties, growth is pursued
      through expansion of existing customer relationships and building new
      relationships by stressing a consistent ly
      high
      level of service at all points of contact.





QNB
      reported net income for the third quarter of 2006 of $1,517,000, or $.48 per
      common share on a diluted basis. The results for the 2006 period compare to
      net
      income of $1,431,000, or $.45 per share on a diluted basis, for the same period
      in 2005. Net income for the first nine months of 2006 was $4,497,000, or $1.42
      per diluted share, an increase from the $3,833,000, or $1.21 per diluted share,
      for the comparable period in 2005.





The
      results for the nine-month period ended September 30, 2005 were significantly
      impacted by a $1,253,000 unrealized loss as an other-than-temporary impairment
      related to certain Fannie Mae (FNMA) and Freddie Mac (FHLMC) preferred stock
      issues recorded in accordance with U.S. generally accepted accounting principles
      (GAAP). On an after-tax basis, the charge was approximately $1,017,000, or
      $.32
      per share diluted. QNB established a $190,000 valuation allowance to offset
      a
      portion of the tax benefits associated with the write-down of these securities
      because such tax benefits may not be realizable. During the first quarter of
      2006, QNB sold its preferred stock holdings and recorded a gain of $451,000
      on
      the carrying value of those issues that had previously been impaired and a
      $300,000 loss on one issue that was not impaired in 2005. In addition, during
      the first nine months of 2006, QNB realized capital gains which allowed a
      reversal of $164,000 of the tax valuation allowance provided in
      2005.





Two
      important measures of profitability in the banking industry are an institution's
      return on average assets and return on average shareholders' equity. Return
      on
      average assets was 1.00 percent and .97 percent, while the return on average
      equity was 11.99 percent and 12.19 percent, for the three-months ended September
      30, 2006 and 2005, respectively. For the nine-month periods ended September
      30,
      2006 and 2005, return on average assets was 1.02 percent and .88 percent, and
      the return on average equity was 12.18 percent and 11.07 percent, respectively.
      Excluding the impact of the impairment charge, the return on average assets
      for
      the nine-month period ended September 30, 2005 would have been 1.11 percent
      and
      the return on average equity would have been 14.00 percent.





QNB’s
      net
      interest income increased in the third quarter of 2006, to $4,040,000, as
      compared to $4,018,000 for the same quarter of 2005. Growth in average earning
      assets and the continued shift of the balance sheet from investment securities
      to loans helped offset the decline in the net interest margin. For the
      nine-month periods, net interest income declined by 1.3 percent, to $12,056,000,
      as the decrease in the net interest margin was only partially offset by growth
      in average earning assets and the change in the balance sheet composition.
      Like
      most financial institutions, QNB’s funding costs of deposits and borrowed money
      continued to increase at a faster pace than the rates earned on loans and
      investment securities. This trends is primarily the result of three factors:
      a
      highly competitive deposit and loan pricing environment, a sustained flat to
      inverted Treasury yield curve and the current structure of QNB’s balance sheet.
      The net interest margin declined 12 basis points, to 3.06 percent, from the
      third quarter of 2005 to the third quarter of 2006 and declined 9 basis points
      for the nine-month period, to 3.16 percent. Included in net interest income
      for
      the nine-month period of 2005 was $40,000 of interest income recovered on
      non-accrual and previously charged-off loans.


-15-
 **Table
          of Contents**




**QNB
      CORP. AND SUBSIDIARY**


**MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
        OPERATIONS AND FINANCIAL CONDITION**
  **RESULTS
          OF OPERATIONS - OVERVIEW (Continued)**


Total
      non-interest income was $1,147,000 for the third quarter of 2006, compared
      to
      $938,000 for the same period in 2005. Excluding gains and losses on securities
      and loans, non-interest income was $931,000 for the quarter-ended September
      30,
      2006 compared to $911,000 for the same period in 2005. An increase in ATM and
      debit card income accounted for the $20,000 difference in non-interest income.





For
      the
      nine-month period, total non-interest income increased $871,000, to $3,306,000.
      Excluding gains and losses on securities and loans, non-interest income for
      the
      nine-month period decreased $237,000. Included in


non-interest
      income, under the category other income, during 2005 were several non-operating
      items; life insurance proceeds of $61,000, a sales tax refund of $45,000 and
      a
      $209,000 gain on the liquidation of assets relinquished by a
      borrower.





QNB
      has
      been successful in operating efficiently and controlling the growth in
      non-interest expense. Total non-interest expense increased $114,000, or 3.6
      percent, for the three-month period with salary and benefit expense contributing
      $92,000 to the increase. Of the $92,000 increase in salaries and benefits
      expense, $27,000 related to the adoption of FASB No. 123r in 2006 and $40,000
      was a result of a reversal during the third quarter of 2005 of an accrual for
      incentive compensation that was recorded during the first quarter of 2005.





For
      the
      nine-month period, total non-interest expense increased $80,000, or .8 percent,
      to $9,772,000. Salary and benefit expense accounted for $11,000 of this increase
      when comparing the nine-month periods. Salary expense, excluding the impact
      of
      the stock option expense, actually decreased when comparing the nine-month
      periods, as the adoption of FASB No. 123r in 2006 had the impact of increasing
      salary expense $86,000 for the nine-month period. The remaining increase in
      non-interest expense was spread across various categories.





Loan
      growth, which has been extremely strong since the second quarter of 2005, slowed
      during the third quarter of 2006. Total loans decreased from $332,650,000 at
      June 30, 2006 to $331,800,000 at September 30, 2006. Some of this decline
      related to seasonal usage of commercial credit lines. However, when comparing
      total loans at September 30, 2005 and 2006, loans increased $44,312,000, or
      15.4
      percent. QNB’s successful loan growth is attributable to developing new
      relationships, as well as further developing existing relationships with small
      businesses in the communities served. Also contributing to loan growth was
      QNB’s
      entrance into indirect lease financing during the second quarter of 2005. This
      loan growth was achieved while maintaining excellent asset quality.
      Non-performing assets increased from .00 percent of total average assets at
      September 30, 2005 to .03 percent at September 30, 2006. While asset quality
      remained high, the strong growth in loans prompted the need for a provision
      for
      loan losses of $60,000 during the third quarter of 2006 and $105,000 for the
      first nine months of 2006. These provisions represented the first charges to
      loan loss expense since 1999. On the funding side of the balance sheet, total
      deposits increased $3,637,000, or .8 percent, from September 30, 2005 to
      September 30, 2006. The competition for deposits remains
      aggressive.





QNB
      operates in an attractive market for financial services, but also in a market
      with intense competition from other local community banks and regional and
      national financial institutions. QNB has been able to compete effectively with
      other financial institutions by emphasizing technology, including
      internet-banking and electronic bill pay, and customer service, including local
      decision-making on loans, an emphasis on long-term customer relationships and
      customer loyalty, and products and services designed to address the specific
      needs of our customers.





These
      items, as well as others, will be explained more thoroughly in the next
      sections.


-16-
 **Table
          of Contents**




**QNB
      CORP. AND SUBSIDIARY**


**MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
        OPERATIONS AND FINANCIAL CONDITION**
 **Average
          Balances, Rate, and Interest Income and Expense Summary (** ***Tax-Equivalent
          Basis*** **)**


**Three
                  Months Ended****September
                  30, 2006**
              
              **September
                  30, 2005****Average**
              
              **Average**
              
              
              
              **Average**
              
              **Average****Balance**
              
              **Rate**
              
              **Interest**
              
              **Balance**
              
              **Rate**
              
              **Interest****Assets**Federal
                  funds sold
              
              $
              10,570
              
              
              5.27
              %
              $
              140
              
              $
              6,779
              
              
              3.45
              %
              $
              59Investment
                  securities:U.S.
                  Treasury
              
              
              6,071
              
              
              4.35
              %
              
              67
              
              
              6,107
              
              
              2.22
              %
              
              34U.S.
                  Government agencies
              
              
              36,587
              
              
              5.03
              %
              
              460
              
              
              26,580
              
              
              3.98
              %
              
              265State
                  and municipal
              
              
              41,937
              
              
              6.62
              %
              
              694
              
              
              52,595
              
              
              6.50
              %
              
              855Mortgage-backed
                  and CMOs
              
              
              119,239
              
              
              4.30
              %
              
              1,282
              
              
              140,905
              
              
              4.17
              %
              
              1,468Other
              
              
              21,278
              
              
              6.54
              %
              
              348
              
              
              28,291
              
              
              5.87
              %
              
              415Total
                  investment securities
              
              
              225,112
              
              
              5.07
              %
              
              2,851
              
              
              254,478
              
              
              4.77
              %
              
              3,037Loans:Commercial
                  real estate
              
              
              148,679
              
              
              6.66
              %
              
              2,497
              
              
              125,132
              
              
              6.23
              %
              
              1,965Residential
                  real estate
              
              
              26,125
              
              
              5.92
              %
              
              387
              
              
              25,669
              
              
              5.85
              %
              
              375Home
                  equity loans
              
              
              68,377
              
              
              6.40
              %
              
              1,103
              
              
              61,055
              
              
              6.00
              %
              
              923Commercial
                  and industrial
              
              
              49,016
              
              
              7.26
              %
              
              897
              
              
              47,761
              
              
              6.33
              %
              
              763Indirect
                  lease financing
              
              
              10,642
              
              
              9.15
              %
              
              246
              
              
              3,674
              
              
              8.85
              %
              
              82Consumer
                  loans
              
              
              5,545
              
              
              9.31
              %
              
              130
              
              
              5,434
              
              
              8.68
              %
              
              119Tax-exempt
                  loans
              
              
              21,347
              
              
              5.95
              %
              
              320
              
              
              11,939
              
              
              5.21
              %
              
              157Total
                  loans, net of unearned*
              
              
              329,731
              
              
              6.71
              %
              
              5,580
              
              
              280,664
              
              
              6.20
              %
              
              4,384Other
                  earning assets
              
              
              4,706
              
              
              4.90
              %
              
              58
              
              
              4,716
              
              
              2.12
              %
              
              25Total
                  earning assets
              
              
              570,119
              
              
              6.00
              %
              $
              8,629
              
              
              546,637
              
              
              5.45
              %
              $
              7,505Cash
                  and due from banks
              
              
              14,087
              
              
              
              
              
              
              
              
              20,101Allowance
                  for loan losses
              
              
              (2,555
              )
              
              
              
              
              
              
              
              (2,582
              )Other
                  assets
              
              
              20,539
              
              
              
              
              
              
              
              
              19,112Total
                  assets
              
              $
              602,190
              
              
              
              
              
              
              
              $
              583,268**Liabilities
                  and Shareholders' Equity**Interest-bearing
                  deposits:Interest-bearing
                  demand
              
              $
              105,227
              
              
              2.62
              %
              $
              696
              
              $
              97,314
              
              
              1.43
              %
              $
              352Money
                  market
              
              
              54,154
              
              
              3.11
              %
              
              425
              
              
              45,183
              
              
              1.84
              %
              
              210Savings
              
              
              47,722
              
              
              0.39
              %
              
              47
              
              
              52,571
              
              
              0.39
              %
              
              52Time
              
              
              163,987
              
              
              3.90
              %
              
              1,612
              
              
              161,786
              
              
              3.11
              %
              
              1,270Time
                  over $100,000
              
              
              44,775
              
              
              4.16
              %
              
              469
              
              
              47,676
              
              
              3.21
              %
              
              386Total
                  interest-bearing deposits
              
              
              415,865
              
              
              3.10
              %
              
              3,249
              
              
              404,530
              
              
              2.23
              %
              
              2,270Short-term
                  borrowings
              
              
              23,337
              
              
              3.62
              %
              
              213
              
              
              17,693
              
              
              2.25
              %
              
              100Federal
                  Home Loan Bank advances
              
              
              55,000
              
              
              5.60
              %
              
              776
              
              
              55,000
              
              
              5.45
              %
              
              755Total
                  interest-bearing liabilities
              
              
              494,202
              
              
              3.40
              %
              
              4,238
              
              
              477,223
              
              
              2.60
              %
              
              3,125Non-interest-bearing
                  deposits
              
              
              54,383
              
              
              
              
              
              
              
              
              56,833Other
                  liabilities
              
              
              3,420
              
              
              
              
              
              
              
              
              2,643Shareholders'
                  equity
              
              
              50,185
              
              
              
              
              
              
              
              
              46,569Total
                  liabilities and shareholders' equity
              
              $
              602,190
              
              
              
              
              
              
              
              $
              583,268Net
                  interest rate spread
              
              
              
              
              
              2.60
              %
              
              
              
              
              
              
              
              2.85
              %Margin/net
                  interest income
              
              
              
              
              
              3.06
              %
              $
              4,391
              
              
              
              
              
              3.18
              %
              $
              4,380
  Tax-exempt
                  securities and loans were adjusted to a tax-equivalent basis and
                  are based
                  on the marginal Federal corporate tax rateof
                  34 percent.Non-accrual
                  loans are included in earning assets.*
                  Includes loans held-for-sale


-17-
 **Table
          of Contents**


**QNB
        CORP. AND SUBSIDIARY**
 
 **MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
        OPERATIONS AND FINANCIAL CONDITION**


**Average
        Balances, Rate, and Interest Income and Expense Summary (** ***Tax-Equivalent
        Basis*** **)**
 **Nine
                  Months Ended****September
                  30, 2006**
              
              **September
                  30, 2005****Average**
              
              **Average**
              
              
              
              **Average**
              
              **Average****Balance**
              
              **Rate**
              
              **Interest**
              
              **Balance**
              
              **Rate**
              
              **Interest****Assets**Federal
                  funds sold
              
              $
              5,309
              
              
              5.09
              %
              $
              202
              
              $
              6,312
              
              
              3.07
              %
              $
              145Investment
                  securities:U.S.
                  Treasury
              
              
              6,075
              
              
              3.77
              %
              
              171
              
              
              6,124
              
              
              2.10
              %
              
              96U.S.
                  Government agencies
              
              
              29,129
              
              
              4.72
              %
              
              1,032
              
              
              37,498
              
              
              3.74
              %
              
              1,052State
                  and municipal
              
              
              44,165
              
              
              6.61
              %
              
              2,190
              
              
              52,660
              
              
              6.50
              %
              
              2,569Mortgage-backed
                  and CMOs
              
              
              123,623
              
              
              4.29
              %
              
              3,975
              
              
              136,983
              
              
              4.18
              %
              
              4,299Other
              
              
              22,829
              
              
              6.30
              %
              
              1,080
              
              
              29,431
              
              
              5.66
              %
              
              1,249Total
                  investment securities
              
              
              225,821
              
              
              4.99
              %
              
              8,448
              
              
              262,696
              
              
              4.70
              %
              
              9,265Loans:Commercial
                  real estate
              
              
              142,179
              
              
              6.56
              %
              
              6,971
              
              
              123,388
              
              
              6.15
              %
              
              5,674Residential
                  real estate
              
              
              26,017
              
              
              5.87
              %
              
              1,146
              
              
              24,957
              
              
              5.87
              %
              
              1,098Home
                  equity loans
              
              
              66,294
              
              
              6.31
              %
              
              3,131
              
              
              60,100
              
              
              5.88
              %
              
              2,642Commercial
                  and industrial
              
              
              50,342
              
              
              7.09
              %
              
              2,671
              
              
              45,628
              
              
              6.15
              %
              
              2,099Indirect
                  lease financing
              
              
              8,874
              
              
              9.25
              %
              
              614
              
              
              1,488
              
              
              9.11
              %
              
              101Consumer
                  loans
              
              
              5,197
              
              
              9.19
              %
              
              357
              
              
              5,298
              
              
              8.83
              %
              
              350Tax-exempt
                  loans
              
              
              20,875
              
              
              5.82
              %
              
              909
              
              
              12,683
              
              
              5.25
              %
              
              499Total
                  loans, net of unearned*
              
              
              319,778
              
              
              6.61
              %
              
              15,799
              
              
              273,542
              
              
              6.09
              %
              
              12,463Other
                  earning assets
              
              
              4,614
              
              
              4.92
              %
              
              170
              
              
              4,689
              
              
              2.50
              %
              
              88Total
                  earning assets
              
              
              555,522
              
              
              5.93
              %
              $
              24,619
              
              
              547,239
              
              
              5.37
              %
              $
              21,961Cash
                  and due from banks
              
              
              17,225
              
              
              
              
              
              
              
              
              19,252Allowance
                  for loan losses
              
              
              (2,531
              )
              
              
              
              
              
              
              
              (2,595
              )Other
                  assets
              
              
              19,979
              
              
              
              
              
              
              
              
              19,006Total
                  assets
              
              $
              590,195
              
              
              5.58
              %
              
              
              
              $
              582,902
              
              
              5.04
              %**Liabilities
                  and Shareholders' Equity**Interest-bearing
                  deposits:Interest-bearing
                  demand
              
              $
              100,204
              
              
              2.22
              %
              $
              1,666
              
              $
              93,440
              
              
              1.12
              %
              $
              782Money
                  market
              
              
              50,050
              
              
              2.85
              %
              
              1,068
              
              
              55,073
              
              
              1.69
              %
              
              698Savings
              
              
              49,478
              
              
              0.39
              %
              
              145
              
              
              54,507
              
              
              0.39
              %
              
              160Time
              
              
              162,404
              
              
              3.68
              %
              
              4,464
              
              
              162,986
              
              
              2.95
              %
              
              3,597Time
                  over $100,000
              
              
              45,756
              
              
              3.84
              %
              
              1,314
              
              
              44,307
              
              
              2.96
              %
              
              983Total
                  interest-bearing deposits
              
              
              407,892
              
              
              2.84
              %
              
              8,657
              
              
              410,313
              
              
              2.03
              %
              
              6,220Short-term
                  borrowings
              
              
              20,532
              
              
              3.40
              %
              
              522
              
              
              13,330
              
              
              2.00
              %
              
              199Federal
                  Home Loan Bank advances
              
              
              55,000
              
              
              5.59
              %
              
              2,298
              
              
              55,000
              
              
              5.41
              %
              
              2,225Total
                  interest-bearing liabilities
              
              
              483,424
              
              
              3.17
              %
              
              11,477
              
              
              478,643
              
              
              2.41
              %
              
              8,644Non-interest-bearing
                  deposits
              
              
              54,279
              
              
              
              
              
              
              
              
              55,192Other
                  liabilities
              
              
              3,144
              
              
              
              
              
              
              
              
              2,766Shareholders'
                  equity
              
              
              49,348
              
              
              
              
              
              
              
              
              46,301Total
                  liabilities and shareholders' equity
              
              $
              590,195
              
              
              2.60
              %
              
              
              
              $
              582,902
              
              
              1.98
              %Net
                  interest rate spread
              
              
              
              
              
              2.76
              %
              
              
              
              
              
              
              
              2.96
              %Margin/net
                  interest income
              
              
              
              
              
              3.16
              %
              $
              13,142
              
              
              
              
              
              3.25
              %
              $
              13,317
  Tax-exempt
                  securities and loans were adjusted to a tax-equivalent basis and
                  are based
                  on the marginal Federal corporate tax rateof
                  34 percent.Non-accrual
                  loans are included in earning assets.*
                  Includes loans held-for-sale


-18-
 **Table
          of Contents**


**QNB
        CORP. AND SUBSIDIARY**
 
 **MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
        OPERATIONS AND FINANCIAL CONDITION**


**Three
                    Months Ended**
                
                **Nine
                    Months Ended****September
                    30, 2006 compared**
                
                **September
                    30, 2006 compared****to
                    September 30, 2005**
                
                **to
                    September 30, 2005**Total
                
                Due
                    to change in:
                
                Total
                
                Due
                    to change in:Change
                
                Volume
                
                Rate
                
                Change
                
                Volume
                
                Rate**Interest
                    income:**Federal
                    funds sold
                
                $
                81
                
                $
                33
                
                $
                48
                
                $
                57
                
                $
                (23
                )
                $
                80Investment
                    securities:U.S.
                    Treasury
                
                
                33
                
                
                (0
                )
                
                33
                
                
                75
                
                
                (1
                )
                
                76U.S.
                    Government agencies
                
                
                195
                
                
                99
                
                
                96
                
                
                (20
                )
                
                (235
                )
                
                215State
                    and municipal
                
                
                (161
                )
                
                (173
                )
                
                12
                
                
                (379
                )
                
                (415
                )
                
                36Mortgage-backed
                    and CMOs
                
                
                (186
                )
                
                (226
                )
                
                40
                
                
                (324
                )
                
                (419
                )
                
                95Other
                
                
                (67
                )
                
                (103
                )
                
                36
                
                
                (169
                )
                
                (280
                )
                
                111Loans:Commercial
                    real estate
                
                
                532
                
                
                370
                
                
                162
                
                
                1,297
                
                
                864
                
                
                433Residential
                    real estate
                
                
                12
                
                
                7
                
                
                5
                
                
                48
                
                
                47
                
                
                1Home
                    equity loans
                
                
                180
                
                
                111
                
                
                69
                
                
                489
                
                
                272
                
                
                217Commercial
                    and industrial
                
                
                134
                
                
                20
                
                
                114
                
                
                572
                
                
                217
                
                
                355Indirect
                    lease financing
                
                
                164
                
                
                156
                
                
                8
                
                
                513
                
                
                503
                
                
                10Consumer
                    loans
                
                
                11
                
                
                2
                
                
                9
                
                
                7
                
                
                (7
                )
                
                14Tax-exempt
                    loans
                
                
                163
                
                
                124
                
                
                39
                
                
                410
                
                
                322
                
                
                88Other
                    earning assets
                
                
                33
                
                
                (0
                )
                
                33
                
                
                82
                
                
                (2
                )
                
                84Total
                    interest income
                
                $
                1,124
                
                $
                420
                
                $
                704
                
                $
                2,658
                
                $
                843
                
                $
                1,815**Interest
                    expense:**Interest-bearing
                    demand
                
                $
                344
                
                $
                28
                
                $
                316
                
                $
                884
                
                $
                56
                
                $
                828Money
                    market
                
                
                215
                
                
                42
                
                
                173
                
                
                370
                
                
                (63
                )
                
                433Savings
                
                
                (5
                )
                
                (5
                )
                
                0
                
                
                (15
                )
                
                (15
                )
                
                (0
                )Time
                
                
                342
                
                
                17
                
                
                325
                
                
                867
                
                
                (13
                )
                
                880Time
                    over $100,000
                
                
                83
                
                
                (23
                )
                
                106
                
                
                331
                
                
                32
                
                
                299Short-term
                    borrowings
                
                
                113
                
                
                32
                
                
                81
                
                
                323
                
                
                108
                
                
                215Federal
                    Home Loan Bank advances
                
                
                21
                
                
                —
                
                
                21
                
                
                73
                
                
                —
                
                
                73Total
                    interest expense
                
                
                1,113
                
                
                91
                
                
                1,022
                
                
                2,833
                
                
                105
                
                
                2,728**Net
                    interest income**
                
                $
                11
                
                $
                329
                
                $
                (318
                )
                $
                (175
                )
                $
                738
                
                $
                (913
                )
 
 -19-
 **Table
          of Contents**




**QNB
      CORP. AND SUBSIDIARY**


**MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
        OPERATIONS AND FINANCIAL CONDITION**






**NET
      INTEREST INCOME**





The
      following table presents the adjustment to convert net interest income to net
      interest income on a fully taxable equivalent basis for the three- and
      nine-month periods ended September 30, 2006 and 2005.




For
                  the Three Months
              
              For
                  the Nine MonthsEnded
                  September 30,
              
              Ended
                  September 30,2006
              
              2005
              
              2006
              
              2005Total
                  interest income
              
              $
              8,278
              
              $
              7,143
              
              $
              23,533
              
              $
              20,858Total
                  interest expense
              
              
              4,238
              
              
              3,125
              
              
              11,477
              
              
              8,644Net
                  interest income
              
              
              4,040
              
              
              4,018
              
              
              12,056
              
              
              12,214Tax
                  equivalent adjustment
              
              
              351
              
              
              362
              
              
              1,086
              
              
              1,103Net
                  interest income (fully taxable equivalent)
              
              $
              4,391
              
              $
              4,380
              
              $
              13,142
              
              $
              13,317





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 on funding sources. Earning assets primarily include loans,
      investment securities and Federal funds sold. Sources used to fund these assets
      include deposits, borrowed funds and shareholders’ equity. 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 on pages 17 and 18. 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 includes interest-free sources of funds.





Net
      interest income increased .5 percent, to $4,040,000, for the quarter ended
      September 30, 2006, as compared to $4,018,000 for the quarter ended September
      30, 2005. On a tax-equivalent basis, net interest income increased by .3
      percent, from $4,380,000, for the three-months ended September 30, 2005 to
      $4,391,000 for the same period ended September 30, 2006. As mentioned
      previously, t he
      growth
      in average earning assets and the continued shift of the balance sheet from
      investment securities to loans helped offset the continued decline in the net
      interest margin. When
      comparing the third quarters of 2006 and 2005, the net interest margin declined
      by 12 basis points. The net interest margin decreased to 3.06 percent for the
      third quarter of 2006 from 3.18 percent for the third quarter of 2005. The
      third
      quarter net interest margin also represents a 12 basis point decline from the
      3.18 percent recorded in the second quarter of 2006. Funding costs for deposits
      and borrowed money continue to increase at a faster pace than the rate on
      earning assets. Contributing to this difference was the interest rate
      environment over the past year as short-term interest rates


-20-
 **Table
          of Contents**




**QNB
      CORP. AND SUBSIDIARY**


**MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**NET
      INTEREST INCOME (Continued)**




have
      increased at a much faster pace than mid- and long-term interest rates,
      resulting in a flat to inverted yield curve. Th e
      structure of QNB’s balance sheet, which is comprised primarily of fixed-rate
      investments and loans and funding sources with relatively short-term repricing
      characteristics, as well as the strong competition for loans and deposits,
      has
      also contributed to the decline in the net interest margin.





Also
      contributing to the decline in the net interest margin, when comparing both
      the
      decline from the third quarter of 2005 and the second quarter of 2006, were
      the
      seasonal tax deposits of municipalities and school districts with whom QNB
      has
      built strong relationships. These deposits tend to be short-term and are priced
      at thin margins. The average balance of municipal interest-bearing accounts
      was
      $51,827,000 for the third quarter of 2006, compared to $40,079,000 for the
      third
      quarter of 2005 and $43,426,000 for the second quarter of 2006.





While average
      earning assets increased 4.3 percent, from $546,637,000 for the third quarter
      of
      2005 to $570,119,000 for the third quarter of 2006, total interest income
      increased $1,124,000, or 15.0 percent, during the same period. The increase
      in
      interest income was a result of the increase in market interest rates and
      particularly the prime lending rate, in conjunction with the shift in the
      composition of the assets from investment securities to loans, as loans, in
      general, earn more than investment securities. When comparing the two quarters,
      average loans increased $49,067,000, or 17.5 percent, while average investment
      securities decreased $29,366,000, or 11.5 percent. Contributing to the increase
      in average earning assets and interest income was QNB’s ability, at the end of
      the second quarter of 2006, to reclassify some of its deposits for reserve
      calculation purposes. This reclassification enabled QNB to reduce its reserve
      requirements at the Federal Reserve Bank by approximately $8,500,000. These
      funds went from a non-earning asset into Federal funds sold and investment
      securities, thereby increasing interest income.





The
      Federal Reserve Board ended its increase of short-term interest rates during
      the
      third quarter by leaving the Federal funds rate unchanged at 5.25 percent.
      While
      short-term interest rates have increased significantly since June 2004, when
      the
      Federal funds rate was 1.00 percent to its current rate of 5.25 percent, the
      yield on earning assets on a tax-equivalent basis has only increased from 5.45
      percent for the third quarter of 2005 to 6.00 percent for the third quarter
      of
      2006. This differential was due to a number of factors including the long period
      of historically low interest rates since 2001 which enabled borrowers to lock
      into low-rate longer-term fixed-rate loans, the flat to inverted shape of the
      yield curve since the Federal Reserve began raising interest rates, the
      fixed-rate nature of the investment and loan portfolio and the price competition
      for loans.




Interest
      income on investment securities decreased $186,000 when comparing the two
      quarters, as the decline in balances offset the increase in the yield on the
      portfolio. The average yield increased from 4.77 percent for the third quarter
      of 2005 to 5.07 percent for the third quarter of 2006. Most of the increase
      in
      the yield was a result of the sale, maturity or payments of lower yielding
      securities. QNB has purchased very few securities over the past year, a period
      of increased interest rates, because of the growth in loans. Management has
      performed purchase and sale transactions in an attempt to increase the yield
      on
      the portfolio and to reposition the cash flow from the portfolio. Management
      will continue to look at trades that will enhance the structure and yield of
      the
      investment portfolio.





The
      yield
      on loans increased 51 basis points, to 6.71 percent, when comparing the third
      quarter of 2006 to the third quarter of 2005. The average prime rate when
      comparing these same periods increased 183 basis points, from 6.42 percent
      to
      8.25 percent. While QNB was positively impacted by the increases in the prime
      rate, the overall yield on the loan portfolio did not increase proportionately,
      since only a small portion of the loan portfolio reprices immediately with
      changes in the prime rate. As short-term interest rates were increasing, mid-
      and longer-term interest rates were increasing but at a slower rate, creating
      a
      yield curve that is flat and


-21-
 **Table
          of Contents**




**QNB
      CORP. AND SUBSIDIARY**


**MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**NET
      INTEREST INCOME (Continued)**




even
      inverted at points. This rate phenomenon, along with the competition for loans,
      has created an environment where borrowers are refinancing variable-rate and
      adjustable-rate loans tied to prime into lower fixed-rate borrowings, and new
      originations, while at higher rates than two years ago, are still at relatively
      low rates.





While
      total interest income on a tax-equivalent basis increased $1,124,000 ,
      or 15.0
      percent, when comparing the third quarter of 2006 to the third quarter of 2005,
      total interest expense increased $1,113,000, or 35.6 percent. Average deposits
      increased $8,885,000, or 1.9 percent, when comparing the third quarters of
      2006
      and 2005. The increase in interest expense was a result of the increase in
      interest rates paid on both deposits and short-term borrowings. The rate paid
      on
      interest-bearing liabilities increased from 2.60 percent for the third quarter
      of 2005 to 3.40 percent for the third quarter of 2006, while the rate paid
      on
      interest-bearing deposits increased from 2.23 percent to 3.10 percent during
      this same period. Interest expense on interest-bearing demand accounts increased
      $344,000, and the rate paid increased from 1.43 percent to 2.62 percent when
      comparing the two quarters. Approximately 49.3 percent of the average balances
      of interest-bearing demand accounts for the third quarter of 2006 are the
      municipal deposits discussed previously. This compares to 41.2 percent of the
      average balance for the third quarter of 2005. The rates on these accounts
      are
      generally indexed to the Federal funds rate so the rate paid on these accounts
      has increased as the Federal funds rate has increased over the past two years.
      Interest expense on money market accounts increased by $215,000, and the rate
      paid increased from 1.84 percent to 3.11 percent when comparing the two
      quarters. The increase in the rate paid was primarily the result of the majority
      of the balances being in the Treasury Select product which is indexed to a
      percentage of the 91-day Treasury bill rate. This rate has also increased as
      short-term interest rates have increased. The average balance of money market
      accounts increased $8,971,000, or 19.9 percent, when comparing the two quarters
      with balances of the Treasury Select product increasing $16,171,000, or 64.2
      percent.





Interest
      expense on time deposits increased $425,000, while the average rate paid on
      time
      deposits increased from 3.14 percent to 3.96 percent when comparing the two
      periods. Like fixed-rate loans and investment securities, time deposits reprice
      over time and, therefore, have less of an immediate impact on costs in either
      a
      rising or falling rate environment. Unlike loans and investment securities,
      the
      maturity and repricing characteristics tend to be shorter. With interest rates
      increasing over the past two years, customers have opted for shorter maturity
      time deposits. This result, combined with the strong rate competition for these
      deposits, has led to the increase in the yield on time deposits in 2006. Average
      time deposits decreased $700,000, or .3 percent, when comparing the third
      quarter of 2006 to the third quarter of 2005.





Interest
      expense on short-term borrowings increased $113,000, both as a result of an
      increase in balances and rates. The average rate paid increased from 2.25
      percent for the third quarter of 2005 to 3.62 percent for the third quarter
      of
      2006, while average balances increased $5,644,000, to $23,337,000. Most of
      this
      increase was centered in repurchase agreements, a sweep product for commercial
      customers.





For
      the
      nine-month period ended September 30, 2006, net interest income decreased
      $158,000, or 1.3 percent, to $12,056,000. On a tax-equivalent basis, net
      interest income decreased $175,000, or 1.3 percent. Included in net interest
      income for the first nine months of 2005 was $40,000 in interest recognized
      on
      the pay-off of loans that had not been accruing interest or had previously
      been
      charged off. Average earning assets increased $8,283,000, or 1.5 percent, while
      the net interest margin declined 9 basis points. The net interest margin on
      a
      tax-equivalent basis was 3.16 percent for the nine-month period ended September
      30, 2006 compared with 3.25 percent for the same period in 2005.


-22-
 **Table
          of Contents**
  **QNB
        CORP. AND SUBSIDIARY**


**MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**NET
      INTEREST INCOME (Continued)**





Total
      interest income on a tax-equivalent basis increased $2,658,000, from $21,961,000
      to $24,619,000, when comparing the nine-month periods ended September 30, 2005
      to September 30, 2006. With the small growth in earning assets, the increase
      in
      interest income was mostly a result of rate increases and the movement of
      balances from investment securities to loans. Approximately $843,000 of the
      increase in interest income was related to volume, while $1,815,000 was due
      to
      higher interest rates. The higher volume of loans resulted in an additional
      $2,218,000 in interest income, with growth in commercial loans including
      tax-exempt loans contributing $1,403,000. Growth in the indirect leasing
      portfolio contributed $503,000 while growth in home equity loans contributed
      $272,000. The impact on interest income from the growth in loans was partially
      offset by a reduction in interest income of $1,350,000 resulting from a lower
      volume of investment securities. The yield on earning assets increased from
      5.37
      percent to 5.93 percent for the nine-month periods. The yield on loans increased
      from 6.09 percent to 6.61 percent during this time, while the yield on
      investments increased from 4.70 percent to 4.99 percent when comparing the
      nine-month periods. The yield on commercial and industrial loans benefited
      the
      most from the increase in interest rates as most of these loans are indexed
      to
      the prime lending rate.





Total
      interest expense increased $2,833,000, from $8,644,000 to $11,477,000, for
      the
      nine-month periods with interest on demand accounts, money market accounts,
      and
      time deposits accounting for $884,000, $370,000 and $1,198,000, respectively,
      of
      the increase. Approximately $2,728,000 of the increase in interest expense
      was a
      result of higher interest rates. The yield on interest-bearing demand accounts,
      money market accounts and time deposits increased 110 basis points, 116 basis
      points and 76 basis points, respectively, when comparing the average rate paid
      for the nine-month periods ended September 30, 2006 and 2005. As was the case
      for the quarter, the municipal deposits had the largest impact on interest
      expense on interest-bearing demand accounts and the Treasury Select money market
      account had the greatest impact on money market expense. The average balance
      of
      municipal interest bearing demand accounts increased $10,571,000, or 30.7
      percent, when comparing the nine-month periods and the average balance in the
      Treasury Select product increased $11,858,000, or 49.0 percent, during the
      same
      time period. Interest expense on short-term borrowings increased by $323,000
      as
      the average rate paid on these accounts increased from 2.00 percent to 3.40
      percent. The average balance of short-term borrowings, mostly commercial sweep
      accounts, increased $7,202,000, or 54.0 percent, to $20,532,000 for the
      nine-months ended September 30, 2006.





Management
      expects the remainder of 2006 and most of 2007 to be challenging with respect
      to
      net interest income and the net interest margin. The extremely competitive
      environment for loans and deposits, as well as the flat yield curve, is expected
      to continue. These factors combined with QNB’s current interest rate sensitivity
      position, which has funding sources repricing sooner than earning assets, will
      likely put more pressure on the net interest margin. However, the ability to
      continue to successfully increase loan balances should have a positive impact
      on
      the net interest margin and interest income, as loans tend to earn a higher
      yield than investment securities. Mixed signals resulting from recent data
      on
      the United States economy make it uncertain whether the Federal
      Reserve ’s
      next
      move will be to lower or raise short-term interest rates.


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 **Table
          of Contents**
  **QNB
        CORP. AND SUBSIDIARY**


**MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**PROVISION
      FOR LOAN LOSSES**





The
      provision for loan losses represents management's determination of the amount
      necessary to be charged to operations to bring the allowance for loan losses
      to
      a level that represents management’s best estimate of the known and inherent
      losses in the existing loan portfolio. Actual loan losses, net of recoveries,
      serve to reduce the allowance.





The
      determination of an appropriate level of the allowance for loan losses is based
      upon an analysis of the risk inherent in QNB's loan portfolio. Management uses
      various tools to assess the adequacy of the allowance for loan losses. One
      tool
      is a model recommended by the Office of the Comptroller of the Currency. This
      model considers a number of relevant factors including: historical loan loss
      experience, the assigned risk rating of the credit, current and projected credit
      worthiness of the borrower, current value of the underlying collateral, levels
      of and trends in delinquencies and non-accrual loans, trends in volume and
      terms
      of loans, concentrations of credit, and national and local economic trends
      and
      conditions. This model is supplemented with another analysis that also
      incorporates QNB’s portfolio exposure to borrowers with large dollar
      concentration. Other tools include ratio analysis and peer group
      analysis.





QNB’s
      management determined that $60,000 and $105,000 provisions for loan losses
      were
      necessary for the three- and nine-month periods ended September 30, 2006. There
      was no provision for loan losses necessary for the same periods in 2005. The
      need for a provision was determined by the analysis described above and resulted
      in an allowance for loan losses that management believes is adequate in relation
      to the estimate of known and inherent losses in the portfolio.





Loan
      charge-offs and non-performing assets remain at low levels. QNB had net
      charge-offs of $36,000 and $17,000 during the third quarters of 2006 and 2005,
      respectively. For the nine-month periods ended September 30, 2006 and 2005,
      QNB
      had net charge-offs of $58,000 and $44,000, respectively. The net charge-offs
      during both periods related primarily to loans in the consumer loan portfolio.
      The asset quality of the commercial portfolio remains excellent.




Non-performing
      assets (non-accruing loans, loans past due 90 days or more, other real estate
      owned and other repossessed assets) amounted to .03 percent and .00 percent
      of
      total assets, respectively, at September 30, 2006 and 2005. These levels compare
      to .002 percent at December 31, 2005. Non-accrual loans were $117,000 at
      September 30, 2006. There were no non-accrual loans at December 31, 2005 or
      September 30, 2005. QNB did not have any other real estate owned as of September
      30, 2006, December 31, 2005 or September 30, 2005. There were no repossessed
      assets at September 30, 2006, December 31, 2005 or September 30,
      2005.





There
      were no restructured loans as of September 30, 2006, December 31, 2005 or
      September 30, 2005 as defined in FASB Statement No. 15, *Accounting
      by Debtors and Creditors for Troubled Debt Restructurings* ,
      that
      have not already been included in loans past due 90 days or more or non-accrual
      loans.





The
      allowance for loan losses was $2,573,000 and $2,526,000 at September 30, 2006
      and December 31, 2005, respectively. The ratio of the allowance to total loans
      was .78 percent and .84 percent at the respective period end dates. The decrease
      in the ratio is a result of the strong growth in the loan portfolio. While
      QNB
      believes that its allowance is adequate to cover losses in the loan portfolio,
      there remain inherent uncertainties regarding future economic events and their
      potential impact on asset quality.


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 **Table
          of Contents**
  **QNB
        CORP. AND SUBSIDIARY**


**MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**PROVISION
      FOR LOAN LOSSES (Continued)**





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.
      The
      measurement of impaired loans is generally based on the present value of
      expected future cash flows discounted at the historical effective interest
      rate,
      except that all collateral-dependent loans are measured for impairment based
      on
      the fair value of the collateral. At
      September 30, 2006, the recorded investment in loans for which impairment had
      been recognized in accordance with FASB Statement No. 114, *Accounting
      by Creditors for Impairment of a Loan—an amendment of FASB Statements No. 5 and
      15* , totaled
      $117,000. The loans identified as impaired were collateral-dependent, with
      no
      valuation allowance necessary. There were no loans considered impaired at
      September 30, 2005.





Management
      in determining the allowance for loan losses makes significant estimates and
      assumptions. Consideration is given to a variety of factors in establishing
      these estimates including current economic conditions, diversification of the
      loan portfolio, delinquency statistics, results of loan reviews, borrowers’
perceived financial and managerial strengths, the adequacy of underlying
      collateral if collateral dependent, or the present value of future cash flows.





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 the near term. 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 additions to
      the
      allowance based on their judgments about information available to them at the
      time of their examination.





**NON-INTEREST
      INCOME**





QNB,
      through its core banking business, generates various fees and service charges.
      Total non-interest income is composed of service charges on deposit accounts,
      ATM and debit card income, income on bank-owned life insurance, mortgage
      servicing fees, gains or losses on the sale of investment securities, gains
      on
      the sale of residential mortgage loans, and other miscellaneous fee income.





Total
      non-interest income increased $209,000, to $1,147,000, for the quarter ended
      September 30, 2006, when compared to September 30, 2005. For the nine-month
      period, total non-interest income increased $871,000, to $3,306,000. Excluding
      gains and losses on the sale of securities and loans, non-interest income for
      the three-month period increased $20,000, or 2.2 percent, and for the nine-month
      period decreased $237,000, or 8.2 percent. The first nine months of 2005 had
      several non-operating items: gain on the liquidation of assets relinquished
      by a
      borrower of $209,000, life insurance proceeds of $61,000 and a sales tax refund
      of $45,000. These items were included in the category other income.





Fees
      for
      services to customers are primarily comprised of service charges on deposit
      accounts. These fees remained flat at $488,000 when comparing the two quarters
      and increased $13,000, or .9 percent, to $1,392,000 when comparing the
      nine-month periods. Overdraft income increased $18,000 for the three-month
      period and $51,000 for the nine-month period as a result of an increase in
      the
      volume of overdrafts. This additional income helped offset a decline in fee
      income on business checking accounts and internet bill pay. Fees on business
      checking accounts declined $10,000 and $26,000 for the three- and nine-month
      periods, respectively. This decline reflects the impact of a higher earnings
      credit rate, resulting from the increases in short-term interest rates, applied
      against balances to offset service charges incurred. QNB eliminated the fee
      it
      charged retail customers for the use of internet bill pay during the fourth
      quarter of 2005, resulting in a


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 **Table
          of Contents**




**QNB
      CORP. AND SUBSIDIARY**


**MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**NON-INTEREST
      INCOME (Continued)**





reduction
      in fee income of $7,000 and $19,000, respectively, when comparing the three-
      and
      nine-month periods.





ATM
      and
      debit card income is primarily comprised of income on debit cards and ATM
      surcharge income for the use of QNB ATM machines by non-QNB customers. ATM
      and
      debit card income was $196,000 for the third quarter of 2006, an increase of
      $20,000, or 11.4 percent, from the amount recorded during the third quarter
      of
      2005. Income from ATM and debit cards was $575,000 and $506,000 for the
      nine-months ended September 30, 2006 and 2005, respectively. This represents
      an
      increase of 13.6 percent. Debit card income increased $17,000, or 13.7 percent,
      and $58,000, or 16.4 percent, for the three- and nine-month periods,
      respectively. The increase in debit card income was a result of the increased
      reliance on the card as a means of paying for goods and services by both
      consumers and business cardholders. QNB has been successfully promoting the
      use
      of the card by its business customers. In addition, an increase in pin-based
      transactions, as well as the fee received from VISA, resulted in additional
      interchange income of $6,000 and $19,000, respectively, when comparing the
      respective three- and nine-month periods. Partially offsetting these positive
      variances was a reduction in ATM surcharge income of $2,000 and $6,000,
      respectively, for the three- and nine-month periods. This decrease was a result
      of fewer transactions by non-QNB customers at QNB’s ATM machines.





Income
      on
      bank-owned life insurance represents the earnings on life insurance policies
      in
      which the Bank is the beneficiary. The earnings on these policies were $63,000
      and $61,000 for the three-months ended September 30, 2006 and 2005,
      respectively. For the nine-month period, earnings on these policies were
      $186,000 and $187,000, respectively. The insurance carriers reset the rates
      on
      these policies annually.





When
      QNB
      sells its residential mortgages in the secondary market, it retains servicing
      rights. A normal servicing fee is retained on all mortgage loans sold and
      serviced. QNB
      recognizes its obligation to service financial assets that are retained in
      a
      transfer of assets in the form of a servicing asset. The servicing asset is
      amortized in proportion to and over the period of net servicing income or loss.
      Servicing assets are assessed for impairment based on their fair value. Mortgage
      servicing fees for the three- and nine-month periods ended September 30, 2006
      were $26,000 and $74,000, respectively. For the three- and nine-month periods
      ended September 30, 2005, mortgage servicing income was $27,000 and $63,000,
      respectively. Included in the 2005 results is a $6,000 and $5,000 positive
      adjustment to the valuation allowance for impairment resulting from the increase
      in interest rates during the third quarter of 2005. Excluding the valuation
      allowance adjustments in 2005, mortgage servicing income would have been $21,000
      and $58,000 for the respective three- and nine-month periods. Mortgage servicing
      income for both the three- and nine-month periods of 2006 was positively
      impacted by the reduction in amortization expense. Amortization expense for
      the
      three-month periods ended September 30, 2006 and 2005 was $18,000 and $27,000,
      respectively. For the respective nine-month periods, amortization expense was
      $65,000 and $86,000, respectively. The higher amortization expense in 2005
      was a
      result of early payoffs of mortgage loans through refinancing. As mortgage
      interest rates have increased, refinancing activity has slowed dramatically.
      The
      slowdown in mortgage activity has also had a negative impact on the average
      balance of mortgages sold and serviced as well as the fee income generated
      from
      these loans. The average balance of mortgages serviced for others was
      $72,662,000 for the third quarter of 2006 compared to $77,066,000 for the third
      quarter of 2005, a decrease of 5.7 percent. The average balance of mortgages
      serviced was approximately $74,294,000 for the nine-month period ended September
      30, 2006, compared to $77,630,000 for the first nine months of 2005, a decrease
      of 4.3 percent. The timing of mortgage payments and delinquencies also impacts
      the amount of servicing fees recorded.





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 in an


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 **Table
          of Contents**
  **QNB
        CORP. AND SUBSIDIARY**


**MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**NON-INTEREST
      INCOME (Continued)**





effort
      to
      take advantage of changes in the shape of the yield curve, changes in spread
      relationships in different sectors and for liquidity purposes, as needed. Management
      continually reviews strategies that will result in an increase in the yield
      or
      improvement in the structure of the investment portfolio.





QNB
      recorded a net gain/(loss) on investment securities of $196,000 and $(4,000)
      for
      the three-month periods ended September 30, 2006 and 2005, respectively. For
      the
      third quarter of 2006, gains on the sale of equity securities contributed
      $207,000, while the sale of fixed-income securities resulted in a loss of
      $11,000.





Net
      security gains/(losses) were $611,000 and ($580,000) for the nine-month periods
      ended September 30, 2006 and 2005, respectively. Of the gains recorded in 2006,
      $465,000 was from the marketable equity securities portfolio at the Corporation
      and $146,000 were from the sale of debt and equity securities at the Bank.
      During the first quarter of 2006, QNB entered into several liquidity
      transactions through the sale of investment securities to fund strong growth
      in
      loans. In addition, QNB sold its
      preferred stock holdings and recorded a gain of $451,000 on the carrying value
      of those issues that had previously been impaired and a $300,000 loss on one
      issue that was not impaired in 2005. Excluding
      the impairment charge of
      $1,253,000 in the second quarter of 2005 related to perpetual preferred stock
      of
      FNMA and FHLMC, QNB
      recorded net securities gains of $673,000 during the first nine months of 2005,
      $240,000 from the sale of debt securities and $433,000 from the sale of equity
      securities.





The
      net
      gain on the sale of residential mortgage loans was $20,000 and $31,000 for
      the
      quarters ended September 30, 2006 and 2005, respectively. For the nine-month
      periods ended September 30, 2006 and 2005, net gains on the sale of loans were
      $44,000 and $127,000, respectively. Residential mortgage loans to be sold are
      identified at origination. 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. The net gain on the sale of residential mortgage loans has declined
      as a result of the increase in interest rates over the past year. The increase
      in interest rates has reduced both the volume of origination and sales activity
      and the amount of gains recorded at the time of sale. Included in the gains
      on
      the sale of residential mortgages in the three-month periods ended September
      30,
      2006 and 2005 were $7,000 and $17,000 related to the recognition of mortgage
      servicing assets. Included
      in the gains on the sale of residential mortgages in the nine-month periods
      ended September 30, 2006 and 2005 were $23,000 and $56,000, respectively,
      related to the recognition of mortgage servicing assets. Proceeds from the
      sale
      of mortgages were $908,000 and $2,277,000 for the third quarter of 2006 and
      2005, respectively. For the nine-month periods, proceeds from the sale of
      residential mortgage loans amounted to $3,048,000 and $7,510,000, respectively.





Other
      income remained flat when comparing the third quarters of 2006 and 2005. For
      the
      nine-month period, other operating income decreased $329,000, or 43.7 percent,
      to $424,000. The
      non-operating items mentioned earlier accounted for most of
      the
      decrease.





**NON-INTEREST
      EXPENSE**





Non-interest
      expense is comprised of costs related to salaries and employee benefits, net
      occupancy, furniture and equipment, marketing, third party services and various
      other operating expenses. Total non-interest expense of $3,254,000 for the
      quarter ended September 30, 2006 represents an increase of $114,000, or 3.6
      percent, from levels reported in the third quarter of 2005. Total non-interest
      expense for the nine-months ended September 30, 2006 was $9,772,000, an increase
      of $80,000, or .8 percent, over 2005 levels.


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 **Table
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**QNB
        CORP. AND SUBSIDIARY**
 **MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**NON-INTEREST
      EXPENSE (Continued)**





Salaries
      and benefits is the largest component of non-interest expense. Salary and
      benefit expense increased $92,000, or 5.3 percent, to $1,820,000 for the quarter
      ended September 30, 2006 compared to the same quarter in 2005. Salary expense
      increased $84,000, or 6.0 percent, during the period to $1,487,000, while
      benefits expense increased $8,000, or 2.5 percent, to $333,000. Included in
      salary expense for the third quarter of 2006 was $27,000 of stock option expense
      associated with the adoption of FASB No. 123r.





Included
      as a reduction to salary expense for the three-months ended September 30, 2005
      was a reversal of $40,000 of anticipated incentive compensation accrued during
      the first quarter of 2005. Excluding the impact of the stock option expense
      in
      the third quarter of 2006 and the reversal of the incentive compensation accrual
      in the third quarter of 2005, salary expense increased 1.2 percent for the
      three-month period. The number of full time-equivalent employees decreased
      by
      one when comparing the third quarters of 2006 and 2005. The increase in benefits
      expense was primarily in payroll tax expense and retirement plan
      expense.





For
      the
      nine-month period ended September 30, 2006, salary and benefit expense increased
      $11,000, to $5,439,000, compared to the same period in 2005. Salary expense
      increased by $12,000, or .3 percent, to $4,368,000, while benefits expense
      decreased by $1,000, or .1 percent, to $1,071,000, when comparing the two
      periods. Included in salary expense for the nine-month period of 2006 was
      $86,000 in stock option expense associated with the adoption of FASB No. 123r.
      Excluding the impact of the stock option expense, salary expense decreased
      1.7
      percent for the nine-month period. The number of full time-equivalent employees
      decreased by five when comparing the nine-month periods.





Net
      occupancy expense increased $19,000, to $287,000, when comparing the third
      quarter of 2006 to the third quarter of 2005. For the nine-month period, net
      occupancy expense increased $41,000, to $862,000. Contributing to the increase
      in both the three- and nine-month periods was higher costs related to
      depreciation, building maintenance, utilities and real estate taxes. A portion
      of these increases were
      a
      result of the opening of a loan center in June 2006.





Furniture
      and equipment expense decreased $13,000, or 4.6 percent, to $269,000, when
      comparing the three-month periods ended September 30, 2006 and 2005 and
      decreased $100,000, or 11.7 percent, to $755,000, when comparing the nine-month
      periods. Depreciation on furniture and equipment and amortization of software
      costs declined by $28,000 for the three-month period and $119,000 for the
      nine-month period. Hardware and software associated with the Bank’s core
      computer system acquired in 2000 became fully depreciated in 2005. The rate
      of
      decline in depreciation and amortization expense has slowed throughout 2006
      as
      some hardware associated with the computer system was replaced during the second
      quarter of 2006 and due to the acquisition of assets associated with the loan
      center. Partially offsetting these savings were higher costs associated with
      equipment maintenance, both repairs and maintenance contracts.





Third
      party services are comprised of professional services including legal,
      accounting and auditing and consulting services, as well as fees paid to outside
      vendors for support services of day-to-day operations. These support services
      include correspondent banking services, statement printing and mailing,
      investment security safekeeping and supply management services. Third party
      services expense was $164,000 in the third quarter of 2006, compared to $171,000
      for the third quarter of 2005. During the third quarter of 2005, QNB used
      consultants to assist its entrance into the indirect leasing business and for
      the development of its strategic plan, resulting in a higher expense in the
      third quarter of 2005 than the same period in 2006. Partially offsetting these
      savings was an increase in outsourced internal audit and external auditing
      fees
      and legal expense. For the nine-month period, third party services increased
      $49,000, to $529,000. Legal expense increased $33,000 when comparing the
      nine-month periods due to special project work. Outsourced internal


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 **Table
          of Contents**




**QNB
        CORP. AND SUBSIDIARY**
 **MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**NON-INTEREST
      EXPENSE (Continued)**





audit,
      external audit and accounting fees increased $26,000 due to a general increase
      in fees and special project work. In addition, with the elimination of the
      fee
      charged to consumers for the use of internet bill pay services, QNB has
      experienced rapid growth in this service. As a result, the fees paid to the
      vendor who processes these payments have increased by $24,000 for the nine-month
      period. QNB stopped offering trust services in 2006 resulting in a savings
      of
      $14,000 previously paid to a third party vendor.





Telephone,
      postage and supplies expense decreased $5,000, to $120,000, when comparing
      the
      three-month periods, but increased $35,000, to $396,000, when comparing the
      nine-month periods. Postage expense increased $14,000 when comparing the
      nine-month periods, as a result of an increase in both the volume of mailings
      as
      well as the cost per mailing as the U.S. Postal service raised rates effective
      January 2006. Supplies expense increased $18,000 when comparing the nine-month
      periods. Contributing to this increase were costs for ATM cards and costs
      related to supplies for the new loan center.





State
      tax
      expense represents the payment of the Pennsylvania shares tax, which is based
      on
      the equity of the Bank, Pennsylvania sales and use tax and the Pennsylvania
      capital stock tax. For the three-month period ended September 30, 2006, state
      tax expense increased $9,000, to $112,000, while for the nine-month period
      state
      taxes increased $19,000, to $339,000. The shares tax increased $9,000 for the
      quarter and $27,000 for the nine-month period, a result of the increase in
      the
      Bank’s equity. This increase for the nine-month period was offset by a decrease
      in the capital stock tax paid by the Corporation of $8,000 for the nine-month
      period.





**INCOME
      TAXES**





QNB
      utilizes an asset and liability approach for financial accounting and reporting
      of income taxes. As of September 30, 2006, QNB's net deferred tax asset was
      $1,346,000. The primary components of deferred taxes are a deferred tax asset
      of
      $847,000 relating to the allowance for loan losses and a deferred tax asset
      of
      $642,000 resulting from the FASB No. 115
      adjustment for available-for-sale investment securities. As of September 30,
      2005, QNB's net deferred tax asset was $959,000. The primary components of
      deferred taxes was a deferred tax asset of $743,000 relating to the allowance
      for loan losses, $390,000 related to impaired equity securities and $175,000
      resulting from the FASB No. 115 adjustment for available-for-sale investment
      securities.





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. A valuation allowance of $190,000 was established as of June 30,
      2005 to offset a portion of the tax benefits associated with certain impaired
      securities that management believed may not be realizable. This valuation
      allowance was increased to $209,000 at December 31, 2005. Approximately $163,000
      of this valuation allowance was reversed during the first nine months of 2006
      as
      a result of the ability to realize tax benefits associated with certain impaired
      securities. Management believes it is more likely than not that QNB will realize
      the benefits of these remaining deferred tax assets. The net deferred tax asset
      is included in other assets on the consolidated balance sheet.





Applicable
      income taxes and effective tax rates were $356,000, or 19.0 percent, for the
      three-month period ended September 30, 2006, and $385,000, or 21.2 percent,
      for
      the same period in 2005. For the nine-month periods, applicable income taxes
      and
      effective tax rates were $988,000, or 18.0 percent, in 2006 and $1,124,000,
      or
      22.7 percent, in 2005. The establishment of the valuation allowance in 2005
      and
      the partial reversal in 2006 contributed to the differences in the effective
      tax
      rates when comparing the periods.


-29-
 **Table
          of Contents**
  **QNB
        CORP. AND SUBSIDIARY**


**MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**FINANCIAL
      CONDITION ANALYSIS**





The
      following balance sheet analysis compares average balance sheet data for the
      nine-months ended September 30, 2006 and 2005, as well as the period end
      balances as of September 30, 2006 and December 31, 2005.





QNB’s
      primary functions and responsibilities are to accept deposits and to make loans
      to meet the credit needs of the communities it serves. Loans are the most
      significant component of earning assets and growth in loans to small businesses
      and residents of these communities has been a primary focus of QNB. Once again,
      QNB has been successful in achieving strong growth in total loans, while at
      the
      same time maintaining excellent asset quality.





Average
      earning assets for the nine-month period ended September 30, 2006 increased
      $8,283,000, or 1.5 percent, to $555,522,000, from $547,239,000 for the
      nine-months ended September 30, 2005. Average loans increased $46,236,000,
      or
      16.9 percent, while average investments decreased $36,875,000, or 14.0 percent.
      Average Federal funds sold decreased $1,003,000 when comparing these same
      periods. The growth in average loans during the past year was funded primarily
      through the reduction of the investment portfolio and an increase in commercial
      sweep balances classified as short-term borrowings.





Total
      loans increased 15.4 percent between September 30, 2006 and September 30, 2005
      and 10.1 percent since December 31, 2005. This loan growth was achieved despite
      the extremely competitive environment for both commercial and consumer loans.
      Continued loan growth remains one of the primary goals of QNB.





Average
      total commercial loans increased $31,697,000 when comparing the first nine
      months of 2006 to the first nine months of 2005. Most of the 17.4 percent growth
      in average commercial loans is in loans secured by real estate, either
      commercial or residential properties, which increased $18,791,000. Of this
      increase $15,476,000, or 82.4 percent, are adjustable-rate loans. While
      adjustable, most of these loans have a fixed rate for a period of time, from
      one
      year to ten years, before the rate adjusts. The growth in the commercial and
      industrial category represents loans with fixed interest rates. Given the
      significant increase in the prime rate over the past two years and the flat
      shape of the yield curve, customers are requesting to lock in a fixed-rate
      versus a rate floating with prime. Also contributing to the growth in total
      commercial loans was an increase in tax-exempt loans. QNB continues to be
      successful in competing for loans to schools and municipalities. Average
      tax-exempt loans increased $8,192,000, or 64.6 percent, when comparing the
      nine-month periods.





Indirect
      lease financing receivables represent loans to small businesses that are
      collateralized by equipment. These loans are originated by a third party and
      purchased by QNB based on criteria specified by QNB. The criteria include
      minimum credit scores of the borrower, term of the lease, type and age of
      equipment financed and geographic area. The geographic area primarily represents
      states contiguous to Pennsylvania. QNB is not the lessor and does not service
      these loans. Average indirect lease financing loans increased $7,386,000 when
      comparing the nine-month periods. QNB began purchasing these loans in the second
      quarter of 2005.





Average
      home equity loans and residential mortgage loans increased $6,194,000 and
      $1,060,000, respectively, when comparing the first nine months of 2006 to the
      first nine months of 2005. The 10.3 percent increase in average home equity
      loans reflects their continued popularity with consumers, especially those
      refinancing existing residential mortgage loans, because they have lower
      origination costs than residential mortgage loans. When comparing average
      balances, all of the growth in home equity loans in the past year has been
      in
      fixed-rate home equity term loans. This product became more attractive to
      consumers as the prime rate rose during 2005 and 2006, which resulted in many
      borrowers refinancing their floating-rate lines into fixed-rate home equity
      loans. QNB has been aggressive in pricing its fixed-rate home equity loans
      relative to the market.


-30-
 **Table
          of Contents**




**QNB
        CORP. AND SUBSIDIARY**
 **MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**FINANCIAL
      CONDITION ANALYSIS (Continued)**





Total
      average deposits decreased $3,334,000, or .7 percent, to $462,171,000 for the
      nine months of 2006 compared to the first nine months of 2005. Money market
      account balances decreased $5,023,000 on average. The decrease in money market
      balances reflects the decision made during the third quarter of 2005 not to
      aggressively seek to retain the short-term deposits of a school district by
      paying high short-term rates. With the flat yield curve, these funds would
      not
      have added significant incremental net interest income and would have further
      eroded the net interest margin. The impact of the loss of these balances was
      partially offset by growth in the Treasury Select money market product. Average
      balances of these accounts increased $11,858,000, or 49.0 percent, to
      $36,049,000. This product is a variable-rate account, indexed to a percentage
      of
      the monthly average of the 91-day Treasury bill rate based on balances in the
      account. This product has become a popular alternative to time deposits and
      saving accounts because of its competitive rate and the ability to make deposits
      and withdrawals. Average savings accounts declined $5,029,000, or 9.2 percent,
      when comparing the nine-month periods as some customers sought out higher
      yielding money market accounts and short-term time deposits.





The
      decline in money market and savings accounts was partially offset by growth
      in
      average interest-bearing demand deposits, which increased $6,764,000 when
      comparing the two periods. The growth in interest-bearing demand deposits is
      centered in the deposits of local municipalities and school districts.





Increasing
      time deposit balances continues to be a challenge because of the rate
      competition for such deposits, particularly with maturities between six months
      through two years. Matching or beating competitors’ rates could have a negative
      impact on the net interest margin. Average time deposits increased $867,000,
      or
      .4 percent, to $208,160,000 for the nine months of 2006.





QNB
      used
      short-term borrowings, including overnight borrowings and repurchase agreements,
      to help fund the loan growth and decline in deposits. Total average short-term
      borrowings increased $7,202,000 when comparing the two periods with repurchase
      agreements, a sweep product for commercial customers, increasing
      $5,627,000.





Total
      assets at September 30, 2006 were $592,874,000, compared with $582,205,000
      at
      December 31, 2005, an increase of 1.8 percent. The composition of the asset
      side
      of the balance sheet shifted from year-end with total loans increasing
      $30,451,000 between December 31, 2005 and September 30, 2006. In contrast,
      total
      investment securities declined by $19,895,000 between these dates. Cash and
      due
      from banks decreased by $9,660,000, primarily as a result of deposit
      reclassification which enabled QNB to reduce its required balances at the
      Federal Reserve Bank. Premises and equipment increased $1,119,000 primarily
      as a
      result of the cost of renovations and furniture for the new loan
      center.





On
      the
      liability side, total deposits increased by $4,831,000, or 1.1 percent, since
      year-end. The composition of the deposits changed slightly as declines in
      non-interest bearing demand accounts of $4,807,000 and savings accounts of
      $4,471,000 was offset by growth of $12,930,000 in money market accounts.
      Treasury Select money market balances increased $15,241,000 between December
      31,
      2005 and September 30, 2006. Time deposits increased only $169,000 between
      December 31, 2005 and September 30, 2006.





Short-term
      borrowings increased $2,132,000 between December 31, 2005 and September 30,
      2006, as repurchase agreement balances increased $3,622,000 and Federal funds
      purchased decreased $1,490,000.


-31-
 **Table
          of Contents**




**QNB
      CORP. AND SUBSIDIARY**


**MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**FINANCIAL
      CONDITION ANALYSIS (Continued)**





At
      September 30, 2006, the fair value of investment securities available-for-sale
      was $213,384,000, or $1,890,000 below the amortized cost of $215,274,000. This
      compares to a fair value of $233,275,000, or $1,912,000 below the amortized
      cost
      of $235,187,000, at December 31, 2005. An unrealized holding loss, net of taxes,
      of $1,247,000 was recorded as a decrease to shareholders’ equity at September
      30, 2006, while an unrealized holding loss of $1,262,000 was recorded as a
      decrease to shareholders' equity at December 31, 2005.





The
      available-for-sale portfolio had a weighted average maturity of approximately
      3
      years, 11 months at September 30, 2006 and 4 years, 5 months at December 31,
      2005. The weighted average tax-equivalent yield was 5.05 percent and 4.87
      percent at September 30, 2006 and December 31, 2005. The weighted average
      maturity is based on the stated contractual maturity or likely call date of
      all
      securities except for mortgage-backed securities and collateralized mortgage
      obligations (CMOs), which are based on estimated average life. The maturity
      of
      the portfolio could be shorter if interest rates would decline and prepayments
      on mortgage-backed securities and CMOs increased or if more securities are
      called. However, the estimated average life could be longer if rates were to
      increase and principal payments on mortgage-backed securities and CMOs would
      slow or bonds anticipated to be called are not called. The interest rate
      sensitivity analysis reflects the repricing term of the securities portfolio
      based upon estimated call dates and anticipated cash flows assuming an unchanged
      as well as a shocked interest rate environment.





Investment
      securities held-to-maturity are reported at amortized cost. The held-to-maturity
      portfolio is comprised solely of tax-exempt municipal securities. As of
      September 30, 2006 and December 31, 2005, QNB had securities classified as
      held-to-maturity with an amortized cost of $5,893,000 and $5,897,000 and a
      market value of $6,047,000 and $6,082,000, respectively. The held-to-maturity
      portfolio had a weighted average maturity of approximately 3 years, 1 month
      at
      September 30, 2006 and 3 years, 10 months at December 31, 2005. The weighted
      average tax-equivalent yield was 6.75 percent at September 30, 2006 and 6.78
      percent at December 31, 2005.





**LIQUIDITY**





Liquidity
      represents an institution’s ability to generate cash or otherwise obtain funds
      at reasonable rates to satisfy commitments to borrowers and demands of
      depositors. QNB manages its mix of cash, Federal funds sold and investment
      securities in order to match the volatility, seasonality, interest sensitivity
      and growth trends of its deposit funds. Liquidity is provided from asset sources
      through maturities and repayments of loans and investment securities. The
      portfolio of investment securities available-for-sale and QNB's policy of
      selling certain residential mortgage originations in the secondary market also
      provide sources of liquidity. Additional sources of liquidity are provided
      by
      the Bank’s membership in the Federal Home Loan Bank of Pittsburgh (FHLB) and two
      $10,000,000 unsecured Federal funds line granted by correspondent banks. In
      addition, the Bank has a maximum borrowing capacity with the FHLB of
      approximately $246,381,000. At September 30, 2006, QNB’s outstanding borrowings
      under the FHLB credit facilities totaled $55,000,000.





Cash
      and
      due from banks, Federal funds sold, available-for-sale securities and loans
      held-for-sale totaled $232,577,000 and $254,216,000 at September 30, 2006 and
      December 31, 2005, respectively. These sources should be adequate to meet normal
      fluctuations in loan demand and deposit withdrawals. During the first nine
      months of 2006, QNB used both its Federal funds line and overnight borrowings
      with the FHLB to help temporarily fund deposit withdrawals and loan growth.
      In
      addition, QNB entered into several investment sales transactions during the
      first quarter of 2006 for the purpose of providing liquidity. Average Federal
      funds


-32-
 **Table
          of Contents**




**QNB
      CORP. AND SUBSIDIARY**


**MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**LIQUIDITY
      (Continued)**





purchased
      and overnight borrowings were $776,000 during the third quarter of 2006 compared
      to $56,000 for the same period in 2005. At September 30, 2006, QNB had no
      Federal funds purchased.





Approximately
      $87,707,000 and $68,917,000 of available-for-sale securities at September 30,
      2006 and December 31, 2005, respectively, were pledged as collateral for
      repurchase agreements and deposits of public funds. The increase in the pledged
      balances at September 30, 2006 reflects the increase in the seasonal deposits
      of
      public funds as well as the increase in repurchase agreements since December
      31,
      2005. In addition, under the terms of its agreement with the FHLB, QNB maintains
      otherwise unencumbered qualifying assets (principally 1-4 family residential
      mortgage loans and U.S. Government and agency notes, bonds, and mortgage-backed
      securities) in the amount of at least as much as its advances from the FHLB.





QNB
      anticipates the rate of loan growth, which slowed during the third quarter
      of
      2006, to remain slow during the next couple of quarters as the economy cools.
      In
      addition, the deposit balances held by school districts should decrease during
      the next few quarters as the taxes collected are used to fund
      operations.





**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 September
      30, 2006 was $49,641,000, or 8.37 percent of total assets. This level
      compares to shareholders' equity of $46,564,000, or 8.00 percent of total
      assets, at December 31, 2005. Shareholders’ equity at September 30, 2006
      includes a negative adjustment of $1,247,000 related to unrealized holding
      losses, net of taxes, on investment securities available-for-sale, while
      shareholders' equity at December 31, 2005 includes a negative adjustment of
      $1,262,000. Without these adjustments shareholders' equity to total assets
      would
      have been 8.58 percent and 8.21 percent at September 30, 2006 and December
      31,
      2005, respectively. The increase in the ratio was a result of the rate of
      capital retention exceeding the rate of asset growth. Total assets increased
      1.8
      percent between December 31, 2005 and September 30, 2006, while shareholders’
equity, excluding the net unrealized holding losses, increased 6.4
      percent.





Shareholders'
      equity averaged $49,348,000 for the first nine months of 2006 and $46,580,000
      during all of 2005, an increase of 5.9 percent. The ratio of average total
      equity to average total assets increased to 8.36 percent for the first nine
      months of 2006, compared to 7.98 percent for all of 2005.





QNB
      is
      subject to various regulatory capital requirements as issued by Federal
      regulatory authorities. Regulatory capital is defined in terms of Tier I capital
      (shareholders’ equity excluding unrealized gains or losses on available-for-sale
      securities and disallowed intangible assets), Tier II capital, which includes
      the allowance for loan losses and a portion of the unrealized gains on equity
      securities, and total capital (Tier I plus Tier II). 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. Regulators have also adopted minimum Tier I leverage ratio
      standards, which measure the ratio of Tier I capital to total quarterly average
      assets.





The
      minimum regulatory capital ratios are 4.00 percent for Tier I, 8.00 percent
      for
      the total risk-based and 4.00 percent for leverage. Under the requirements,
      QNB
      had a Tier I capital ratio of 13.21 percent and 13.04 percent, a total
      risk-based ratio of 13.89 percent and 13.77 percent and a leverage ratio of
      8.44
      percent and 8.15 percent at September 30, 2006 and December 31, 2005,
      respectively.


-33-
 **Table
          of Contents**
  **QNB
        CORP. AND SUBSIDIARY**


**MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**CAPITAL
      ADEQUACY (Continued)**





The
      Federal Deposit Insurance Corporation Improvement Act of 1991 established five
      capital level designations ranging from "well capitalized" to "critically
      undercapitalized." At September 30, 2006 and December 31, 2005, QNB met the
      "well capitalized" criteria, which requires minimum Tier I and total risk-based
      capital ratios of 6.00 percent and 10.00 percent, respectively, and a Tier
      I
      leverage ratio of 5.00 percent.





**INTEREST
      RATE SENSITIVITY**





Since
      the
      assets and liabilities of QNB have diverse repricing characteristics that
      influence net interest income, management analyzes interest sensitivity through
      the use of gap analysis and simulation models. Interest rate sensitivity
      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. The Asset/Liability Management
      Committee (ALCO) is responsible for managing interest rate risk and for
      evaluating the impact of changing interest rate conditions on net interest
      income.





Gap
      analysis measures the difference between volumes of rate-sensitive assets and
      liabilities and quantifies these repricing differences for various time
      intervals. Static gap analysis describes interest rate sensitivity at a point
      in
      time. However, it alone does not accurately measure the magnitude of changes
      in
      net interest income because changes in interest rates do not impact all
      categories of assets and liabilities equally or simultaneously. Interest rate
      sensitivity analysis also involves assumptions on certain categories of assets
      and deposits. For purposes of interest rate sensitivity analysis, assets and
      liabilities are stated at their contractual maturity, estimated likely call
      date, or earliest repricing opportunity. Mortgage-backed securities, CMOs and
      amortizing loans are scheduled based on their anticipated cash flow. Savings
      accounts, including passbook, statement savings, money market, and
      interest-bearing demand accounts, do not have a stated maturity or repricing
      terms and can be withdrawn or repriced at any time. This may impact QNB’s margin
      if more expensive alternative sources of deposits are required to fund loans
      or
      deposit runoff. Management projects the repricing characteristics of these
      accounts based on historical performance and assumptions that it believes
      reflect their rate sensitivity. The Treasury Select Indexed Money Market account
      reprices monthly, based on a percentage of the average of the 91-day Treasury
      bill rate.





A
      positive gap results when the amount of interest rate sensitive assets exceeds
      interest rate sensitive liabilities. A negative gap results when the amount
      of
      interest rate sensitive liabilities exceeds interest rate sensitive assets.





QNB
      primarily focuses on the management of the one-year interest rate sensitivity
      gap. At September 30, 2006, interest-earning assets scheduled to mature or
      likely to be called, repriced or repaid in one year were $188,792,000.
      Interest-sensitive liabilities scheduled to mature or reprice within one year
      were $288,022,000. The one-year cumulative gap, which reflects QNB’s interest
      sensitivity over a period of time, was a negative $99,230,000 at September
      30,
      2006. The cumulative one-year gap equals -17.27 percent of total rate sensitive
      assets. This compares to a negative gap position of $39,123,000, or -7.04
      percent, of total rate sensitive assets, at December 31, 2005. The increase
      in
      the negative gap position in the one-year time frame was primarily the result
      of
      changes in the repricing and maturity structure of the Bank’s interest sensitive
      liabilities. The amount of time deposits maturing or repricing in less than
      one
      year increased significantly. At September 30, 2006, $142,923,000, or 67.6
      percent, of total time deposits were scheduled to reprice or mature in the
      next
      twelve months. This level compares to $95,840,000, or 45.4 percent, of total
      time deposits at December 31, 2005. In addition, balances in the Treasury Select
      Money Market account increased by $15,241,000 between December 31, 2005 and
      September 30, 2006. Both of these events reflect consumers desire to invest
      in
      shorter term investments whose rates have increased significantly and which
      could increase further if market rates


-34-
 **Table
          of Contents**




**QNB
      CORP. AND SUBSIDIARY**


**MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**INTEREST
      RATE SENSITIVITY** **(Continued)**





continue
      to increase. Also contributing to the increase in interest sensitive liabilities
      was the interest bearing municipal deposit accounts which increased by
      $9,045,000 between December 31, 2005 and September 30, 2006 due to the seasonal
      tax deposits of the municipalities and school districts. On the asset side,
      the
      amount of assets maturing or repricing increased by $9,460,000 from December
      31,
      2005 to September 30, 2006. This increase was primarily caused by the shorter
      average life of the investment portfolio and a $7,976,000 increase in Federal
      funds from December. This was offset by a decline of $6,333,000 in loans
      maturing or repricing in the one-year time frame. This decline was partially
      a
      result of customers negotiating existing variable-rate loans to longer-term
      fixed rate loans. This negative gap position has contributed to the decline
      in
      the net interest margin as interest rates have increased on a greater amount
      of
      liabilities than earning assets.





QNB
      also
      uses a simulation model to assess the impact of changes in interest rates on
      net
      interest income. The model reflects management’s assumptions related to asset
      yields and rates paid on liabilities, deposit sensitivity, and the size,
      composition and maturity or repricing characteristics of the balance sheet.
      The
      assumptions are based on what management believes at that time to be the most
      likely interest rate environment. Management also evaluates the impact of higher
      and lower interest rates by simulating the impact on net interest income of
      changing rates. While management performs rate shocks of 100, 200 and 300 basis
      points, it believes, that given the level of interest rates at September 30,
      2006, that it is unlikely that interest rates would decline by 300 basis points.
      The simulation results can be found in the chart on page 36.





The
      decline in net interest income in a rising rate environment is consistent with
      the gap analysis and reflects the fixed-rate nature of the investment and loan
      portfolio and the increased expense associated with higher costing deposits
      and
      short-term borrowings. Also, impacting net interest income in a rising rate
      environment would be the conversion of some of the borrowings from the FHLB
      from
      fixed rate to variable rate tied to LIBOR. If converted, QNB has the option
      to
      return the borrowings to the FHLB without penalty. Net interest income increases
      slightly if rates would to decline by 100 basis points. However, in the 200
      basis point down scenario, net interest income remains relatively flat which
      indicates the current interest pricing on interest-bearing transaction accounts,
      regular money market accounts and savings accounts are at their hypothetical
      floors. Interest rates on these products do not have the ability to decline
      to
      the degree that rates on earning assets can. These results are inconsistent
      with
      the gap analysis and identify some of the weaknesses of gap analysis which
      does
      not take into consideration the magnitude of the rate change on different
      instruments or the timing of the rate change.





Actual
      results may differ from simulated results due to various factors including
      time,
      magnitude and frequency of interest rate changes, the relationship or spread
      between various rates, loan pricing and deposit sensitivity, and asset/liability
      strategies.





Management
      believes that the assumptions utilized in evaluating the vulnerability of QNB’s
      net interest income to changes in interest rates approximate actual experience.
      However, the interest rate sensitivity of QNB’s assets and liabilities, as well
      as the estimated effect of changes in interest rates on net interest income,
      could vary substantially if different assumptions are used or actual experience
      differs from the experience on which the assumptions were based.





The
      nature of QNB’s current operation is such that it is not subject to foreign
      currency exchange or commodity price risk. Additionally, neither the Corporation
      nor the Bank owns trading assets. At September 30, 2006, QNB did not have any
      hedging transactions in place such as interest rate swaps, caps or
      floors.


-35-
 **Table
          of Contents**




**QNB
      CORP. AND SUBSIDIARY**


**MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**INTEREST
      RATE SENSITIVITY** **(Continued)**





The
      table
      below summarizes estimated changes in net interest income over a twelve-month
      period, under alternative interest rate scenarios.





Change
                in Interest Rates
            
            Net
                Interest Income
            
            Dollar
                Change
            
            %
                Change+300
                Basis Points
            
            $
            13,010
            
            $
            (2,815
            )
            
            (17.79
            )%+200
                Basis Points
            
            
            14,020
            
            
            (1,805
            )
            
            (11.41
            )+100
                Basis Points
            
            
            15,101
            
            
            (724
            )
            
            (4.57
            )FLAT
                RATE
            
            
            15,825
            
            
            —
            
            
            —-100
                Basis Points
            
            
            16,084
            
            
            259
            
            
            1.64-200
                Basis Points
            
            
            15,822
            
            
            (3
            )
            
            (0.02
            )




-36-
 **Table
          of Contents**
  **QNB
        CORP. AND SUBSIDIARY**


**MANAGEMENT'S
            DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
            OPERATIONS AND FINANCIAL CONDITION**


**ITEM
      3.****QUANTITATIVE
      AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.**





The
      information required herein is set forth in Item 2, above.





**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 controls over financial reporting or other
      factors that have materially affected, or are reasonably likely to materially
      affect, these controls during the prior fiscal quarter covered by this
      report.


-37-
 **Table
          of Contents**




**QNB
      CORP. AND SUBSIDIARY**




**PART
      II. OTHER INFORMATION**


**SEPTEMBER
      30, 2006**





Item
              1.
            Legal
                Proceedings




None.




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, 2005.




Item
              2.
            Unregistered
                Sales of Equity Securities and Use of
                Proceeds




None.




Item
              3.
            Default
                Upon Senior Securities




None.




Item
              4.
            Submission
                of Matters to Vote of Security
                Holders




None.




Item
              5.
            Other
                Information




None.




Item
              6.
            Exhibits




Exhibit
              3(i)
            Articles
                of Incorporation of Registrant, as amended. (Incorporated by reference
                to
                Exhibit 3(i) of Registrants Form DEF 14-A filed with the Commission
                on
                April 15, 2005).





Exhibit
              3(ii)
            Bylaws
                of Registrant, as amended. (Incorporated by reference to Exhibit
                3(ii) of
                Registrants Form 8-K filed with the Commission on January 23,
                2006).





Exhibit
              10.9
            QNB
                Corp. 2006 Employee Stock Purchase Plan. (Incorporated by reference
                to
                Exhibit 99.1 to Registration Statement No. 333-135408 on Form S-8,
                filed
                with the Commission on June 28,
                2006.)





Exhibit
              11
            Statement
                Re: Computation of Earnings Per Share. (Included in Part I, Item
                I,
                hereof.)





Exhibit
              31.1
            Section
                302 Certification of President and
                CEO





Exhibit
              31.2
            Section
                302 Certification of Chief Financial
                Officer





Exhibit
              32.1
            Section
                906 Certification of President and
                CEO





Exhibit
              32.2
            Section
                906 Certification of Chief Financial
                Officer




-38-
 **Table
          of Contents**




**SIGNATURES**






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.






QNB
      Corp.







Date: November
      8, 2006


By: /s/
      Thomas J. Bisko


Thomas
      J.
      Bisko


President/CEO








Date: November
      8, 2006


By: /s/
      Bret
      H. Krevolin


Bret
      H.
      Krevolin


Chief
      Financial Officer


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