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**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 June
      30,
      2006


OR


o
            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 ý No o


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 o Accelerated
      filer ý Non-accelerated
      filer o





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


Yes o No ý





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 August 4, 2006Common
                Stock, par value $.625
            
            3,126,985









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**QNB
      CORP. AND SUBSIDIARY**





**FORM
      10-Q**





**QUARTER
      ENDED JUNE 30, 2006**





**INDEX**





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




-i-
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*QNB
                    Corp. and Subsidiary*CONSOLIDATED
                    STATEMENTS OF INCOME
 (in
                  thousands, except share data)(unaudited)Three
                  Months
              
              Six
                  MonthsEnded
                  June 30,
              
              Ended
                  June 30,2006
              
              2005
              
              2006
              
              2005**Interest
                Income**Interest
                  and fees on loans
              
              $
              5,193
              
              $
              4,072
              
              $
              10,019
              
              $
              7,963Interest
                  and dividends on investment securities:Taxable
              
              
              2,067
              
              
              2,216
              
              
              4,075
              
              
              4,472Tax-exempt
              
              
              467
              
              
              567
              
              
              987
              
              
              1,131Interest
                  on Federal funds sold
              
              
              38
              
              
              68
              
              
              62
              
              
              86Interest
                  on interest-bearing balances and other interest income
              
              
              63
              
              
              33
              
              
              112
              
              
              63Total
                  interest income
              
              
              7,828
              
              
              6,956
              
              
              15,255
              
              
              13,715**Interest
                  Expense**Interest
                  on depositsInterest-bearing
                  demand
              
              
              531
              
              
              233
              
              
              970
              
              
              430Money
                  market
              
              
              386
              
              
              236
              
              
              643
              
              
              488Savings
              
              
              50
              
              
              55
              
              
              98
              
              
              109Time
              
              
              1,478
              
              
              1,205
              
              
              2,852
              
              
              2,327Time
                  over $100,000
              
              
              417
              
              
              316
              
              
              845
              
              
              596Interest
                  on short-term borrowings
              
              
              166
              
              
              57
              
              
              309
              
              
              99Interest
                  on Federal Home Loan Bank advances
              
              
              770
              
              
              743
              
              
              1,522
              
              
              1,470Total
                  interest expense
              
              
              3,798
              
              
              2,845
              
              
              7,239
              
              
              5,519Net
                  interest income
              
              
              4,030
              
              
              4,111
              
              
              8,016
              
              
              8,196Provision
                  for loan losses
              
              
              45
              
              
              —
              
              
              45
              
              
              —Net
                  interest income after provision for loan losses
              
              
              3,985
              
              
              4,111
              
              
              7,971
              
              
              8,196**Non-Interest
                  Income**Fees
                  for services to customers
              
              
              464
              
              
              452
              
              
              904
              
              
              891ATM
                  and debit card income
              
              
              195
              
              
              171
              
              
              379
              
              
              330Income
                  on bank-owned life insurance
              
              
              62
              
              
              64
              
              
              123
              
              
              127Mortgage
                  servicing fees
              
              
              25
              
              
              12
              
              
              48
              
              
              36Net
                  gain (loss) on investment securities available-for-sale
              
              
              60
              
              
              (1,189
              )
              
              415
              
              
              (576
              )Net
                  gain on sale of loans
              
              
              11
              
              
              60
              
              
              24
              
              
              95Other
                  income
              
              
              134
              
              
              258
              
              
              266
              
              
              594Total
                  non-interest income
              
              
              951
              
              
              (172
              )
              
              2,159
              
              
              1,497Non-Interest
                  ExpenseSalaries
                  and employee benefits
              
              
              1,814
              
              
              1,863
              
              
              3,619
              
              
              3,700Net
                  occupancy expense
              
              
              296
              
              
              272
              
              
              575
              
              
              553Furniture
                  and equipment expense
              
              
              255
              
              
              291
              
              
              486
              
              
              573Marketing
                  expense
              
              
              144
              
              
              156
              
              
              297
              
              
              306Third
                  party services
              
              
              196
              
              
              168
              
              
              365
              
              
              309Telephone,
                  postage and supplies expense
              
              
              136
              
              
              113
              
              
              276
              
              
              236State
                  taxes
              
              
              114
              
              
              114
              
              
              227
              
              
              217Other
                  expense
              
              
              327
              
              
              339
              
              
              673
              
              
              658Total
                  non-interest expense
              
              
              3,282
              
              
              3,316
              
              
              6,518
              
              
              6,552Income
                  before income taxes
              
              
              1,654
              
              
              623
              
              
              3,612
              
              
              3,141Provision
                  for income taxes
              
              
              352
              
              
              140
              
              
              632
              
              
              739Net
                  Income
              
              $
              1,302
              
              $
              483
              
              $
              2,980
              
              $
              2,402Earnings
                  Per Share - Basic
              
              $
              .42
              
              $
              .16
              
              $
              .95
              
              $
              .77Earnings
                  Per Share - Diluted
              
              $
              .41
              
              $
              .15
              
              $
              .94
              
              $
              .76Cash
                  Dividends Per Share
              
              $
              .21
              
              $
              .195
              
              $
              .42
              
              $
              .39
 *The
          accompanying notes are an integral part of the unaudited consolidated financial
          statements.*
 -1-
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          to Table of Contents**
  *QNB
                    Corp. and Subsidiary*CONSOLIDATED
                    BALANCE SHEETS
  (in
                    thousands)(unaudited)June
                    30,
                
                December
                    31,2006
                
                2005**Assets**Cash
                    and due from banks
                
                $
                19,629
                
                $
                20,807Federal
                    funds sold
                
                
                —
                
                
                —Total
                    cash and cash equivalents
                
                
                19,629
                
                
                20,807Investment
                    securitiesAvailable-for-sale
                    (cost $215,182 and $235,187)
                
                
                209,893
                
                
                233,275Held-to-maturity
                    (market value $6,005 and $6,082)
                
                
                5,894
                
                
                5,897Non-marketable
                    equity securities
                
                
                3,682
                
                
                3,684Loans
                    held-for-sale
                
                
                —
                
                
                134Total
                    loans, net of unearned income
                
                
                332,650
                
                
                301,349Allowance
                    for loan losses
                
                
                (2,549
                )
                
                (2,526
                )Net
                    loans
                
                
                330,101
                
                
                298,823Bank-owned
                    life insurance
                
                
                8,231
                
                
                8,103Premises
                    and equipment, net
                
                
                6,458
                
                
                5,400Accrued
                    interest receivable
                
                
                2,724
                
                
                2,572Other
                    assets
                
                
                4,880
                
                
                3,510Total
                    assets
                
                $
                591,492
                
                $
                582,205**Liabilities**DepositsDemand,
                    non-interest bearing
                
                $
                57,831
                
                $
                56,461Interest-bearing
                    demand
                
                
                97,027
                
                
                101,614Money
                    market
                
                
                52,827
                
                
                39,170Savings
                
                
                49,618
                
                
                50,296Time
                
                
                161,536
                
                
                160,213Time
                    over $100,000
                
                
                43,749
                
                
                50,916Total
                    deposits
                
                
                462,588
                
                
                458,670Short-term
                    borrowings
                
                
                24,713
                
                
                19,596Federal
                    Home Loan Bank advances
                
                
                55,000
                
                
                55,000Accrued
                    interest payable
                
                
                1,806
                
                
                1,512Other
                    liabilities
                
                
                875
                
                
                863Total
                    liabilities
                
                
                544,982
                
                
                535,641Shareholders'
                    EquityCommon
                    stock, par value $.625 per share;authorized
                    10,000,000 shares; 3,233,671 and 3,210,762 shares issued;3,126,985
                    and 3,104,076 shares outstanding
                
                
                2,021
                
                
                2,007Surplus
                
                
                9,611
                
                
                9,117Retained
                    earnings
                
                
                39,863
                
                
                38,196Accumulated
                    other comprehensive (loss), net
                
                
                (3,491
                )
                
                (1,262
                )Treasury
                    stock, at cost; 106,686 shares
                
                
                (1,494
                )
                
                (1,494
                )Total
                    shareholders' equity
                
                
                46,510
                
                
                46,564Total
                    liabilities and shareholders' equity
                
                $
                591,492
                
                $
                582,205
 *The
          accompanying notes are an integral part of the unaudited consolidated financial
          statements.*
  -2-
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            to Table of Contents**
  *QNB
                  Corp. and Subsidiary*CONSOLIDATED
                    STATEMENTS OF CASH
                    FLOWS
  (in
                    thousands)(unaudited)Six
                    Months Ended June 30,
                
                2006
                
                2005**Operating
                    Activities**Net
                    income
                
                $
                2,980
                
                $
                2,402Adjustments
                    to reconcile net income to net cash provided by operating activitiesDepreciation
                    and amortization
                
                
                346
                
                
                437Provision
                    for loan losses
                
                
                45
                
                
                —Securities
                    gains
                
                
                (466
                )
                
                (677
                )Impairment
                    write-down of securities
                
                
                51
                
                
                1,253Net
                    gain on sale of repossessed assets
                
                
                —
                
                
                (209
                )Proceeds
                    from sale of repossessed assets
                
                
                9
                
                
                209Net
                    gain on sale of loans
                
                
                (24
                )
                
                (95
                )Loss
                    on disposal of premises and equipment
                
                
                1
                
                
                1Proceeds
                    from sales of residential mortgages
                
                
                2,140
                
                
                5,233Originations
                    of residential mortgages held-for-sale
                
                
                (2,007
                )
                
                (5,346
                )Income
                    on bank-owned life insurance
                
                
                (123
                )
                
                (127
                )Life
                    insurance proceeds/premiums, net
                
                
                (5
                )
                
                107Tax
                    benefit from exercise of stock options
                
                
                67
                
                
                —Stock-based
                    compensation expense
                
                
                58
                
                
                —Deferred
                    income tax (benefit)
                
                
                51
                
                
                (213
                )Net
                    increase (decrease) in income taxes payable
                
                
                67
                
                
                (308
                )Net
                    (increase) decrease in accrued interest receivable
                
                
                (152
                )
                
                22Net
                    amortization of premiums and discounts
                
                
                300
                
                
                477Net
                    increase in accrued interest payable
                
                
                294
                
                
                162Increase
                    in loan participation receivable
                
                
                —
                
                
                (1,100
                )Increase
                    in other assets
                
                
                (397
                )
                
                (512
                )Increase
                    (decrease) in other liabilities
                
                
                12
                
                
                (562
                )Net
                    cash provided by operating activities
                
                
                3,247
                
                
                1,154**Investing
                    Activities**Proceeds
                    from maturities and calls of investment securitiesavailable-for-sale
                
                
                11,727
                
                
                17,505held-to-maturity
                
                
                —
                
                
                300Proceeds
                    from sales of investment securitiesavailable-for-sale
                
                
                25,422
                
                
                36,793Purchase
                    of investment securitiesavailable-for-sale
                
                
                (16,953
                )
                
                (40,038
                )Proceeds
                    from sales of non-marketable equity securities
                
                
                1,242
                
                
                492Purchase
                    of non-marketable equity securities
                
                
                (1,240
                )
                
                —Net
                    increase in loans
                
                
                (31,323
                )
                
                (4,933
                )Net
                    purchases of premises and equipment
                
                
                (1,405
                )
                
                (169
                )Net
                    cash (used) provided by investing activities
                
                
                (12,530
                )
                
                9,950**Financing
                    Activities**Net
                    increase in non-interest bearing deposits
                
                
                1,370
                
                
                5,275Net
                    increase (decrease) in interest-bearing non-maturity deposits
                
                
                8,392
                
                
                (24,097
                )Net
                    (decrease) increase in time deposits
                
                
                (5,844
                )
                
                10,287Net
                    increase (decrease) in short-term borrowings
                
                
                5,117
                
                
                (1,061
                )Cash
                    dividends paid
                
                
                (1,313
                )
                
                (1,210
                )Proceeds
                    from issuance of common stock
                
                
                383
                
                
                76Net
                    cash provided (used) by financing activites
                
                
                8,105
                
                
                (10,730
                )(Decrease)
                    increase in cash and cash equivalents
                
                
                (1,178
                )
                
                374Cash
                    and cash equivalents at beginning of year
                
                
                20,807
                
                
                22,185Cash
                    and cash equivalents at end of period
                
                $
                19,629
                
                $
                22,559**Supplemental
                    Cash Flow Disclosures**Interest
                    paid
                
                $
                6,945
                
                $
                5,357Income
                    taxes paid
                
                
                431
                
                
                1,245Non-Cash
                    TransactionsChange
                    in net unrealized holding losses, net of taxes, on investment
                    securities
                    available-for-sale
                
                
                (2,229
                )
                
                42Transfer
                    of loans to repossessed assets
                
                
                9
                
                
                4
 *The
            accompanying notes are an integral part of the unaudited consolidated
            financial
            statements.*


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**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**JUNE
      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 six-month periods ended June 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 $31,000 and
      $58,000 for the three and six months ended June 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.


-4-
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**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


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


**(Unaudited)**




Three
                Months Ended
              June
                30, 2005
            
            Six
                Months Ended
              June
                30, 2005Net
                income, as reported
            
            $
            483
            
            $
            2,402Deduct:
                Total stock-based employee compensation expense determined under
                fair
                value based method for all awards, net of related tax
                effects
            
            
            25
            
            
            51Pro
                forma net income
            
            $
            458
            
            $
            2,351Earnings
                per share
              Basic
                - as reported
            
            $
            .16
            
            $
            .77Basic
                - pro forma
            
            $
            .15
            
            $
            .76Diluted
                - as reported
            
            $
            .15
            
            $
            .76Diluted
                - pro forma
            
            $
            .14
            
            $
            .74





As
      of
      June 30, 2006, there was approximately $146,000 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 half 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 shares. 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 June 30, 2006, there were
      180,458 options outstanding under this Plan. The 2005 Plan authorizes the
      issuance of 200,000 shares. The terms of the 2005 Plan are identical to the
      1998
      Plan, except options expire five years after the grant date. As of June 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 highly 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 six-months ended June 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.


-5-
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**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


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


**(Unaudited)**






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





Stock
      option activity during the six months ended June 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 June 30, 2006
            
            
            189,358
            
            
            20.13
            
            
            5.43
            
            $
            1,499Exercisable
                at June 30, 2006
            
            
            137,058
            
            
            16.16
            
            
            4.83
            
            $
            1,499




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
                June 30,
            
            For
                the Six Months
              Ended
                June 30,2006
            
            2005
            
            2006
            
            2005Numerator
                for basic and diluted earnings per share-net income
            
            $
            1,302
            
            $
            483
            
            $
            2,980
            
            $
            2,402Denominator
                for basic earnings per share-
              weighted
                average shares outstanding
            
            
            3,125,968
            
            
            3,101,194
            
            
            3,122,182
            
            
            3,100,624Effect
                of dilutive securities-employee stock options
            
            
            53,428
            
            
            75,836
            
            
            52,964
            
            
            76,571Denominator
                for diluted earnings per share- adjusted weighted average shares
                outstanding
            
            
            3,179,396
            
            
            3,177,030
            
            
            3,175,146
            
            
            3,177,195Earnings
                per share-basic
            
            $
            .42
            
            $
            .16
            
            $
            .95
            
            $
            .77Earnings
                per share-diluted
            
            $
            .41
            
            $
            .15
            
            $
            .94
            
            $
            .76




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      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


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


**(Unaudited)**






2.
            PER
                SHARE DATA (Continued):





There
      were 34,900 stock options that were anti-dilutive for the three and six-month
      periods ended June 30, 2006 and 40,000 stock options that were anti-dilutive
      for
      the three and six-month periods ended June 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 June 30, 2006 and 2005:





For
                the Three Months
              Ended
                June 30,
            
            For
                the Six Months
              Ended
                June 30,2006
            
            2005
            
            2006
            
            2005Unrealized
                holding (losses) gains arising during the period on securities held
                (net
                of taxes of $536, $(888), $1,007 and $334, respectively)
            
            $
            (1,039
            )
            $
            1,928
            
            $
            (1,955
            )
            $
            (528
            )Reclassification
                adjustment for (gains) losses included in net income (net of taxes
                of $20,
                $(214), $141 and $(6), respectively)
            
            
            (40
            )
            
            975
            
            
            (274
            )
            
            570Net
                change in unrealized (losses) gains during the period
            
            
            (1,079
            )
            
            2,903
            
            
            (2,229
            )
            
            42Unrealized
                holding (losses) gains, beginning of period
            
            
            (2,412
            )
            
            (2,170
            )
            
            (1,262
            )
            
            691Unrealized
                holding (losses) gains, end of period
            
            $
            (3,491
            )
            $
            733
            
            $
            (3,491
            )
            $
            733Net
                income
            
            $
            1,302
            
            $
            483
            
            $
            2,980
            
            $
            2,402Other
                comprehensive income, net of tax:
              Unrealized
                holding (losses) gains arising during the period (net of taxes of
                $556,
                $(1,102), $1,148 and $328, respectively)
            
            
            (1,079
            )
            
            2,903
            
            
            (2,229
            )
            
            42Comprehensive
                income
            
            $
            223
            
            $
            3,386
            
            $
            751
            
            $
            2,444




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      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


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


**(Unaudited)**






4.
            LOANS





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





June
                30,
              2006
            
            December
                31,
              2005Commercial
                and industrial
            
            $
            73,884
            
            $
            64,812Construction
            
            
            10,636
            
            
            7,229Real
                estate-commercial
            
            
            111,945
            
            
            104,793Real
                estate-residential
            
            
            121,527
            
            
            112,920Consumer
            
            
            5,280
            
            
            5,080Indirect
                lease financing
            
            
            9,244
            
            
            6,451Total
                loans
            
            
            332,516
            
            
            301,285Unearned
                costs
            
            
            134
            
            
            64Total
                loans net of unearned costs
            
            $
            332,650
            
            $
            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
      $68,000 and $94,000 at June 30, 2006 and December 31, 2005, respectively.
      Amortization expense for core deposit intangibles was $13,000 for both
      three-month periods ended June 30, 2006 and 2005 and $26,000 for both six-month
      periods ended June 30, 2006 and 2005.





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




June
                  30,
              
              December
                  31,2006
              
              2005Mortgage
                  servicing rights beginning balance
              
              $
              528
              
              $
              552Mortgage
                  servicing rights capitalized
              
              
              16
              
              
              80Mortgage
                  servicing rights amortized
              
              
              (47
              )
              
              (109
              )Fair
                  market value adjustments
              
              
              —
              
              
              5Mortgage
                  servicing rights ending balance
              
              $
              497
              
              $
              528


Mortgage
                loans serviced for others
            
            $
            73,491
            
            $
            77,196Amortization
                expense of intangibles
            
            
            73
            
            
            160




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      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**JUNE
      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
            
            $
            143For
                the Year Ended 12/31/07
            
            
            128For
                the Year Ended 12/31/08
            
            
            73For
                the Year Ended 12/31/09
            
            
            61For
                the Year Ended 12/31/10
            
            
            50





6.
            RELATED
                PARTY TRANSACTIONS





As
      of
      June 30, 2006, amounts due from directors, principal officers, and their related
      interests totaled $4,270,000. 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. Also, they 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. for the renovation of its property at 322 W. Broad Street,
      Quakertown, Pennsylvania to be used as additional office space. The cost of
      the
      renovations is expected to be approximately $1,250,000. 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 as of June 30, 2006 was $1,058,000.





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


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      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


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


**(Unaudited)**






7.
            RECENT
                ACCOUNTING PRONOUNCEMENTS
                (Continued):




initially
      measured at fair value, if practicable, and permits an entity with a separately
      recognized 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
      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. QNB is
      currently evaluating the impact the adoption of the standard will have on QNB’s
      results of operations.


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


**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


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      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


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      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 $124,000 existed as of June 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.


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      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 high level of service at all points
      of
      contact.





QNB
      reported net income for the second quarter of 2006 of $1,302,000, or $.41 per
      common share on a diluted basis. This compares to net income of $483,000, or
      $.15 per share on a diluted basis, for the same period in 2005. Net income
      for
      the first six months of 2006 was $2,980,000, or $.94 per share diluted, an
      increase from the $2,402,000, or $.76 per share diluted, for the comparable
      period in 2005.





The
      results for the 2005 quarter and six-month period 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 half of 2006, QNB realized capital gains which allowed a reversal
      of
      $86,000 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 .89 percent and .33 percent, while the return on average
      equity was 10.57 percent and 4.15 percent for the three months ended June 30,
      2006 and 2005, respectively. For the six-month periods ended June 30, 2006
      and
      2005, return on average assets was 1.03 percent and .83 percent, and the return
      on average equity was 12.29 percent and 10.49 percent, respectively. Excluding
      the impact of the impairment charge, the return on average assets for the three-
      and six-month periods ended June 30, 2005 was 1.03 percent and 1.18 percent,
      respectively, and the return on average equity was 12.89 percent and 14.93
      percent, respectively.





QNB’s
      net
      interest income declined in the second quarter of 2006, to $4,030,000, as
      compared to $4,111,000 for the same quarter of 2005. For the six-month periods
      net interest income declined by 2.2 percent to $8,016,000. The decline in net
      interest income was due to the continued pressure on the net interest margin.
      Funding costs of deposits and borrowed money continued to increase at a faster
      pace than the rate on earning assets. This difference was 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 10 basis points, to 3.18
      percent, from the second quarter of 2005 to the second quarter of 2006 and
      declined 7 basis points for the six-month period, to 3.22 percent. In addition,
      included in net interest income for the six-month period of 2005 was $40,000
      of
      interest income recovered on non-accrual and previously charged off
      loans.





Total
      non-interest income was $951,000 for the second quarter of 2006. This compares
      to a loss of $172,000 for the same period in 2005. Excluding the $1,253,000
      impairment charge included in net gains and losses on investment securities
      during the second quarter of 2005, total non-interest income was $1,081,000
      during that


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      CORP. AND SUBSIDIARY**


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


**RESULTS
      OF OPERATIONS - OVERVIEW (Continued)**





period.
      Included in non-interest income, under the category other income, during the
      second quarter of 2005 was two non-operating items; life insurance proceeds
      of
      $61,000 and a sales tax refund of $45,000. In addition, as a result of rising
      interest rates, mortgage activity has slowed and gains on the sale of
      residential mortgages declined by $49,000 when comparing the two
      quarters.





For
      the
      six-month period total non-interest income increased $662,000, to $2,159,000.
      Excluding gains and losses on securities and loans, non-interest income for
      the
      six-month period decreased $258,000. In addition to the two non-operating items
      mentioned previously, non-interest income during the first half of 2005 included
      a $209,000 gain on the liquidation of assets relinquished by a borrower. This
      item was also in the category of other income.





QNB
      has
      been very successful in operating efficiently and containing non-interest
      expense. Non-interest expense decreased $34,000, or 1.0 percent, for the
      three-month period and $34,000, or .5 percent, for the six-month period. Lower
      personnel expense, primarily as a result of a reduction in the number of full
      time equivalent employees, was the primary factor for the decline in
      non-interest expense. Salary and benefit expense declined $49,000 and $81,000,
      respectively, during these same periods. The adoption of FASB No. 123r had
      the
      impact of increasing salary expense by $31,000 for the quarter and $58,000
      for
      the six-month period. Salary expense for the six-month period in 2005 included
      a
      $40,000 accrual for incentive compensation.





The
      balance sheet continued to experienced strong growth in loans, with total loans
      increasing $59,648,000, or 21.8 percent, between June 30, 2005 and June 30,
      2006. QNB’s successful loan growth was attributable to developing new
      relationships, as well as further cultivating 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
      June
      30, 2005 to .02 percent at June 30, 2006. While asset quality remained high,
      the
      strong growth in loans prompted the need for a provision for loan losses of
      $45,000 during the second quarter of 2006. This represented the first provision
      for loan losses since 1999. On the funding side of the balance sheet, total
      deposits increased $4,635,000, or 1.0 percent, from June 30, 2005 to June 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, the establishment of 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.


-15-
 **Back
          to 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****June
                  30, 2006**
              
              **June
                  30, 2005****Average**
              
              **Average**
              
              
              
              **Average**
              
              **Average****Balance**
              
              **Rate**
              
              **Interest**
              
              **Balance**
              
              **Rate**
              
              **Interest****Assets**Federal
                  funds sold
              
              $
              3,136
              
              
              4.81
              %
              $
              38
              
              $
              9,213
              
              
              2.98
              %
              $
              68Investment
                  securities:U.S.
                  Treasury
              
              
              6,120
              
              
              3.73
              %
              
              57
              
              
              6,114
              
              
              2.04
              %
              
              31U.S.
                  Government agencies
              
              
              29,887
              
              
              4.76
              %
              
              355
              
              
              38,273
              
              
              3.77
              %
              
              361State
                  and municipal
              
              
              42,336
              
              
              6.69
              %
              
              708
              
              
              52,851
              
              
              6.50
              %
              
              859Mortgage-backed
                  and CMOs
              
              
              122,811
              
              
              4.29
              %
              
              1,317
              
              
              134,782
              
              
              4.19
              %
              
              1,413Other
              
              
              21,461
              
              
              6.41
              %
              
              344
              
              
              30,146
              
              
              5.79
              %
              
              436Total
                  investment securities
              
              
              222,615
              
              
              5.00
              %
              
              2,781
              
              
              262,166
              
              
              4.73
              %
              
              3,100Loans:Commercial
                  real estate
              
              
              142,524
              
              
              6.54
              %
              
              2,322
              
              
              122,520
              
              
              6.19
              %
              
              1,892Residential
                  real estate
              
              
              25,980
              
              
              5.88
              %
              
              382
              
              
              25,534
              
              
              5.85
              %
              
              373Home
                  equity loans
              
              
              66,696
              
              
              6.31
              %
              
              1,050
              
              
              59,938
              
              
              5.87
              %
              
              878Commercial
                  and industrial
              
              
              50,831
              
              
              7.17
              %
              
              908
              
              
              45,474
              
              
              6.02
              %
              
              683Indirect
                  lease financing
              
              
              8,704
              
              
              9.31
              %
              
              202
              
              
              749
              
              
              10.39
              %
              
              19Consumer
                  loans
              
              
              5,130
              
              
              9.23
              %
              
              118
              
              
              5,293
              
              
              8.74
              %
              
              115Tax-exempt
                  loans
              
              
              22,130
              
              
              5.78
              %
              
              319
              
              
              12,846
              
              
              5.28
              %
              
              169Total
                  loans, net of unearned*
              
              
              321,995
              
              
              6.60
              %
              
              5,301
              
              
              272,354
              
              
              6.08
              %
              
              4,129Other
                  earning assets
              
              
              4,548
              
              
              5.54
              %
              
              63
              
              
              4,514
              
              
              2.91
              %
              
              33Total
                  earning assets
              
              
              552,294
              
              
              5.94
              %
              
              8,183
              
              
              548,247
              
              
              5.36
              %
              
              7,330Cash
                  and due from banks
              
              
              19,243
              
              
              
              
              
              
              
              
              19,388Allowance
                  for loan losses
              
              
              (2,524
              )
              
              
              
              
              
              
              
              (2,597
              )Other
                  assets
              
              
              20,155
              
              
              
              
              
              
              
              
              19,000Total
                  assets
              
              $
              589,168
              
              
              
              
              
              
              
              $
              584,038**Liabilities
                  and Shareholders' Equity**Interest-bearing
                  deposits:Interest-bearing
                  demand
              
              $
              99,056
              
              
              2.15
              %
              $
              531
              
              $
              91,585
              
              
              1.02
              %
              $
              233Money
                  market
              
              
              52,655
              
              
              2.94
              %
              
              386
              
              
              56,839
              
              
              1.67
              %
              
              236Savings
              
              
              50,476
              
              
              0.39
              %
              
              50
              
              
              55,475
              
              
              0.39
              %
              
              55Time
              
              
              161,804
              
              
              3.66
              %
              
              1,478
              
              
              164,801
              
              
              2.93
              %
              
              1,205Time
                  over $100,000
              
              
              43,901
              
              
              3.81
              %
              
              417
              
              
              43,332
              
              
              2.93
              %
              
              316Total
                  interest-bearing deposits
              
              
              407,892
              
              
              2.81
              %
              
              2,862
              
              
              412,032
              
              
              1.99
              %
              
              2,045Short-term
                  borrowings
              
              
              18,914
              
              
              3.51
              %
              
              166
              
              
              11,580
              
              
              1.96
              %
              
              57Federal
                  Home Loan Bank advances
              
              
              55,000
              
              
              5.62
              %
              
              770
              
              
              55,000
              
              
              5.42
              %
              
              743Total
                  interest-bearing liabilities
              
              
              481,806
              
              
              3.16
              %
              
              3,798
              
              
              478,612
              
              
              2.38
              %
              
              2,845Non-interest-bearing
                  deposits
              
              
              54,790
              
              
              
              
              
              
              
              
              56,118Other
                  liabilities
              
              
              3,143
              
              
              
              
              
              
              
              
              2,647Shareholders'
                  equity
              
              
              49,429
              
              
              
              
              
              
              
              
              46,661Total
                  liabilities andshareholders'
                  equity
              
              $
              589,168
              
              
              
              
              
              
              
              $
              584,038Net
                  interest rate spread
              
              
              
              
              
              2.78
              %
              
              
              
              
              
              
              
              2.98
              %Margin/net
                  interest income
              
              
              
              
              
              3.18
              %
              
              4,385
              
              
              
              
              
              3.28
              %
              
              4,485Tax-exempt
                  securities and loans were adjusted to a tax-equivalent basis and
                  are based
                  on the marginal Federal corporate tax raterate
                  of 34 percent.Non-accrual
                  loans are included in earning assets.*
                  Includes loans held-for-sale




-16-
 **Back
          to 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*****)****Six
                  Months Ended****June
                  30, 2006**
              
              **June
                  30, 2005****Average**
              
              **Average**
              
              
              
              **Average**
              
              **Average****Balance**
              
              **Rate**
              
              **Interest**
              
              **Balance**
              
              **Rate**
              
              **Interest****Assets**Federal
                  funds sold
              
              $
              2,635
              
              
              4.72
              %
              $
              62
              
              $
              6,075
              
              
              2.85
              %
              $
              86Investment
                  securities:U.S.
                  Treasury
              
              
              6,076
              
              
              3.48
              %
              
              105
              
              
              6,132
              
              
              2.05
              %
              
              62U.S.
                  Government agencies
              
              
              25,339
              
              
              4.51
              %
              
              572
              
              
              43,048
              
              
              3.66
              %
              
              788State
                  and municipal
              
              
              45,297
              
              
              6.61
              %
              
              1,497
              
              
              52,692
              
              
              6.50
              %
              
              1,714Mortgage-backed
                  and CMOs
              
              
              125,851
              
              
              4.28
              %
              
              2,692
              
              
              134,989
              
              
              4.19
              %
              
              2,830Other
              
              
              23,618
              
              
              6.19
              %
              
              731
              
              
              30,011
              
              
              5.55
              %
              
              833Total
                  investment securities
              
              
              226,181
              
              
              4.95
              %
              
              5,597
              
              
              266,872
              
              
              4.67
              %
              
              6,227Loans:Commercial
                  real estate
              
              
              138,874
              
              
              6.50
              %
              
              4,474
              
              
              122,501
              
              
              6.10
              %
              
              3,708Residential
                  real estate
              
              
              25,963
              
              
              5.85
              %
              
              759
              
              
              24,595
              
              
              5.88
              %
              
              723Home
                  equity loans
              
              
              65,236
              
              
              6.27
              %
              
              2,027
              
              
              59,614
              
              
              5.81
              %
              
              1,719Commercial
                  and industrial
              
              
              51,016
              
              
              7.02
              %
              
              1,775
              
              
              44,545
              
              
              6.05
              %
              
              1,337Indirect
                  lease financing
              
              
              7,975
              
              
              9.32
              %
              
              368
              
              
              376
              
              
              10.40
              %
              
              19Consumer
                  loans
              
              
              5,020
              
              
              9.12
              %
              
              227
              
              
              5,229
              
              
              8.91
              %
              
              231Tax-exempt
                  loans
              
              
              20,635
              
              
              5.76
              %
              
              589
              
              
              13,062
              
              
              5.27
              %
              
              342Total
                  loans, net of unearned*
              
              
              314,719
              
              
              6.55
              %
              
              10,219
              
              
              269,922
              
              
              6.04
              %
              
              8,079Other
                  earning assets
              
              
              4,567
              
              
              4.94
              %
              
              112
              
              
              4,675
              
              
              2.70
              %
              
              63Total
                  earning assets
              
              
              548,102
              
              
              5.88
              %
              
              15,990
              
              
              547,544
              
              
              5.32
              %
              
              14,455Cash
                  and due from banks
              
              
              18,821
              
              
              
              
              
              
              
              
              18,821Allowance
                  for loan losses
              
              
              (2,519
              )
              
              
              
              
              
              
              
              (2,602
              )Other
                  assets
              
              
              19,694
              
              
              
              
              
              
              
              
              19,007Total
                  assets
              
              $
              584,098
              
              
              
              
              
              
              
              $
              582,770**Liabilities
                  and Shareholders' Equity**Interest-bearing
                  deposits:Interest-bearing
                  demand
              
              $
              97,650
              
              
              2.00
              %
              $
              970
              
              $
              91,471
              
              
              0.95
              %
              $
              430Money
                  market
              
              
              47,964
              
              
              2.71
              %
              
              643
              
              
              60,100
              
              
              1.64
              %
              
              488Savings
              
              
              50,371
              
              
              0.39
              %
              
              98
              
              
              55,491
              
              
              0.39
              %
              
              109Time
              
              
              161,599
              
              
              3.56
              %
              
              2,852
              
              
              163,596
              
              
              2.87
              %
              
              2,327Time
                  over $100,000
              
              
              46,255
              
              
              3.68
              %
              
              845
              
              
              42,595
              
              
              2.82
              %
              
              596Total
                  interest-bearing deposits
              
              
              403,839
              
              
              2.70
              %
              
              5,408
              
              
              413,253
              
              
              1.93
              %
              
              3,950Short-term
                  borrowings
              
              
              19,106
              
              
              3.26
              %
              
              309
              
              
              11,112
              
              
              1.79
              %
              
              99Federal
                  Home Loan Bank advances
              
              
              55,000
              
              
              5.58
              %
              
              1,522
              
              
              55,000
              
              
              5.39
              %
              
              1,470Total
                  interest-bearing liabilities
              
              
              477,945
              
              
              3.05
              %
              
              7,239
              
              
              479,365
              
              
              2.32
              %
              
              5,519Non-interest-bearing
                  deposits
              
              
              54,227
              
              
              
              
              
              
              
              
              54,358Other
                  liabilities
              
              
              3,004
              
              
              
              
              
              
              
              
              2,882Shareholders'
                  equity
              
              
              48,922
              
              
              
              
              
              
              
              
              46,165Total
                  liabilities andshareholders'
                  equity
              
              $
              584,098
              
              
              
              
              
              
              
              $
              582,770Net
                  interest rate spread
              
              
              
              
              
              2.83
              %
              
              
              
              
              
              
              
              3.00
              %Margin/net
                  interest income
              
              
              
              
              
              3.22
              %
              
              8,751
              
              
              
              
              
              3.29
              %
              
              8,936Tax-exempt
                  securities and loans were adjusted to a tax-equivalent basis and
                  are based
                  on the marginal Federal corporate tax raterate
                  of 34 percent.Non-accrual
                  loans are included in earning assets.*
                  Includes loans held-for-sale




-17-
 **Back
          to Table of Contents**




**QNB
      CORP. AND SUBSIDIARY**


**MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
        OPERATIONS AND FINANCIAL CONDITION**
  **Three
                    Months Ended**
                
                **Six
                    Months Ended****June
                    30, 2006 compared to**
                
                **June
                    30, 2006 compared to****June
                    30, 2005**
                
                **June
                    30, 2005**Total
                
                Due
                    to change in:
                
                Total
                
                Due
                    to change in:Change
                
                Volume
                
                Rate
                
                Change
                
                Volume
                
                Rate**Interest
                    income:**Federal
                    funds sold
                
                $
                (30
                )
                $
                (45
                )
                $
                15
                
                $
                (24
                )
                $
                (49
                )
                $
                25Investment
                    securities:U.S.
                    Treasury
                
                
                26
                
                
                0
                
                
                26
                
                
                43
                
                
                (1
                )
                
                44U.S.
                    Government agencies
                
                
                (6
                )
                
                (79
                )
                
                73
                
                
                (216
                )
                
                (324
                )
                
                108State
                    and municipal
                
                
                (151
                )
                
                (171
                )
                
                20
                
                
                (217
                )
                
                (241
                )
                
                24Mortgage-backed
                    and CMOs
                
                
                (96
                )
                
                (125
                )
                
                29
                
                
                (138
                )
                
                (191
                )
                
                53Other
                
                
                (92
                )
                
                (126
                )
                
                34
                
                
                (102
                )
                
                (178
                )
                
                76Loans:Commercial
                    real estate
                
                
                430
                
                
                309
                
                
                121
                
                
                766
                
                
                496
                
                
                270Residential
                    real estate
                
                
                9
                
                
                7
                
                
                2
                
                
                36
                
                
                40
                
                
                (4
                )Home
                    equity loans
                
                
                172
                
                
                99
                
                
                73
                
                
                308
                
                
                162
                
                
                146Commercial
                    and industrial
                
                
                225
                
                
                80
                
                
                145
                
                
                438
                
                
                194
                
                
                244Indirect
                    lease financing
                
                
                183
                
                
                206
                
                
                (23
                )
                
                349
                
                
                392
                
                
                (43
                )Consumer
                    loans
                
                
                3
                
                
                (3
                )
                
                6
                
                
                (4
                )
                
                (9
                )
                
                5Tax-exempt
                    loans
                
                
                150
                
                
                122
                
                
                28
                
                
                247
                
                
                198
                
                
                49Other
                    earning assets
                
                
                30
                
                
                0
                
                
                30
                
                
                49
                
                
                (2
                )
                
                51Total
                    interest income
                
                
                853
                
                
                274
                
                
                579
                
                
                1,535
                
                
                487
                
                
                1,048**Interest
                    expense:**Interest-bearing
                    demand
                
                
                298
                
                
                19
                
                
                279
                
                
                540
                
                
                29
                
                
                511Money
                    market
                
                
                150
                
                
                (17
                )
                
                167
                
                
                155
                
                
                (99
                )
                
                254Savings
                
                
                (5
                )
                
                (5
                )
                
                (0
                )
                
                (11
                )
                
                (10
                )
                
                (1
                )Time
                
                
                273
                
                
                (22
                )
                
                295
                
                
                525
                
                
                (28
                )
                
                553Time
                    over $100,000
                
                
                101
                
                
                4
                
                
                97
                
                
                249
                
                
                51
                
                
                198Short-term
                    borrowings
                
                
                109
                
                
                36
                
                
                73
                
                
                210
                
                
                71
                
                
                139Federal
                    Home Loan Bank advances
                
                
                27
                
                
                —
                
                
                27
                
                
                52
                
                
                —
                
                
                52Total
                    interest expense
                
                
                953
                
                
                15
                
                
                938
                
                
                1,720
                
                
                14
                
                
                1,706**Net
                    interest income**
                
                $
                (100
                )
                $
                259
                
                $
                (359
                )
                $
                (185
                )
                $
                473
                
                $
                (658
                )




-18-
 **Back
          to 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 six-month
      periods ended June 30, 2006 and 2005.




For
                  the Three Months
              
              For
                  the Six MonthsEnded
                  June 30,
              
              Ended
                  June 30,2006
              
              2005
              
              2006
              
              2005Total
                  interest income
              
              $
              7,828
              
              $
              6,956
              
              $
              15,255
              
              $
              13,715Total
                  interest expense
              
              
              3,798
              
              
              2,845
              
              
              7,239
              
              
              5,519Net
                  interest income
              
              
              4,030
              
              
              4,111
              
              
              8,016
              
              
              8,196Tax
                  equivalent adjustment
              
              
              355
              
              
              374
              
              
              735
              
              
              740Net
                  interest income (fully taxable equivalent)
              
              $
              4,385
              
              $
              4,485
              
              $
              8,751
              
              $
              8,936


Net
      interest income is the primary source of operating income for QNB. Net interest
      income is interest income, dividends, and fees on earning assets, less interest
      expense incurred for funding sources. Earning assets primarily include loans,
      investment securities and 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 page 16 and 17. 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 decreased 2.0 percent, to $4,030,000, for the quarter ended
      June
      30, 2006 as compared to $4,111,000 for the quarter ended June 30, 2006. On
      a
      tax-equivalent basis, net interest income decreased by 2.2 percent, from
      $4,485,000 for the three months ended June 30, 2005 to $4,385,000 for the same
      period ended June 30, 2006. The decline in net interest income was the result
      of
      a lower net interest margin. When comparing the second quarters of 2006 and
      2005, the net interest margin declined by 10 basis points. The net interest
      margin decreased to 3.18 percent for the second quarter of 2006 from 3.28
      percent for the second quarter of 2005. The second quarter net interest margin
      also represents an 8 basis point decline from the 3.26 percent recorded in
      the
      first 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 is the interest rate environment over the past year as short-term
      interest rates have increased at a much faster pace than mid- and long-term
      interest rates resulting in a flat to inverted yield curve. The
      structure of QNB’s balance sheet, which


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


**NET
      INTEREST INCOME (Continued)**





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. The
      strong growth in loans has helped partially offset the impact of the higher
      funding costs.





While
      average earning assets increased slightly from $548,247,000 for the second
      quarter of 2005 to $552,294,000 for the second quarter of 2006, total interest
      income increased $853,000, or 11.6 percent, during the same period. The increase
      in interest income is 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 $49,641,000, or 18.2 percent, while average investment
      securities decreased $39,551,000, or 15.1 percent.





The
      Federal Reserve Board continued to increase short-term interest rates by
      increasing the Federal funds rate twice by 25 basis points each time during
      the
      second quarter of 2006. While short-term interest rates have increased
      significantly since June of 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 5.36 percent for the second quarter
      of 2005 to 5.94 percent for the second quarter of 2006. This differential is
      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 $319,000 when comparing the two
      quarters, as the decline in balances offset the increase in the yield on the
      portfolio. The average yield increased from 4.73 percent for the second quarter
      of 2005 to 5.00 percent for the second quarter of 2006. Most of the increase
      in
      the yield was a result of the sale, maturity or payments of lower yielding
      securities since QNB has purchased very few securities over the past year
      because of the growth in loans.





The
      yield
      on loans increased 52 basis points, to 6.60 percent, when comparing the second
      quarter of 2006 to the second quarter of 2005. The average prime rate when
      comparing these same periods increased 199 basis points, from 5.91 percent
      to
      7.90 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 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 even inverted at points. This rate phenomenon,
      along with the extreme competition for loans, has created an environment where
      borrowers are refinancing variable-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.





For
      the
      most part, earning assets are funded by deposits, which declined when comparing
      the two quarters. Average
      deposits decreased $4,140,000, or 1.0 percent, when comparing the second
      quarters of 2006 and 2005. Total interest expense increased by $953,000, or
      33.5
      percent, when comparing the second quarter of 2006 to the second quarter of
      2005. The increase in interest expense was a result of an increase in interest
      rates paid on both deposits and short-term borrowings. The rate paid on
      interest-bearing liabilities increased from 2.38 percent for the second quarter
      of 2005 to 3.16 percent for the second quarter of 2006, with the rate paid
      on
      interest-bearing deposits increasing from 1.99 percent to 2.81 percent during
      this same period. Interest expense on interest-bearing demand accounts increased
      $298,000, and the rate paid increased from 1.02 percent to 2.15 percent when


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**QNB
        CORP. AND SUBSIDIARY**
 
 **MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF RESULTS**
 **OF
        OPERATIONS AND FINANCIAL CONDITION**
   **NET
        INTEREST INCOME (Continued)**





comparing
      the two quarters. Approximately 43.8 percent of these balances are municipal
      deposits that adjust with Federal funds, accounting for the increase in the
      rate
      paid on interest-bearing demand accounts. The average balance of interest
      bearing demand accounts increased $7,471,000, or 8.2 percent, when comparing
      the
      two quarters. Interest expense on money market accounts increased by $150,000
      as
      the $4,184,000 decline in average balances was offset by a 127 basis point
      increase in the average rate paid. 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. The increase
      in
      the average rate on money market accounts 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 increased as
      short-term interest rates have increased over the past year.





Interest
      expense on time deposits increased $374,000, while the average rate paid on
      time
      deposits increased from 2.93 percent to 3.70 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 $2,428,000, or 1.2 percent, when comparing the second
      quarter of 2006 to the second quarter of 2005.





Interest
      expense on short-term borrowings increased $109,000, both as a result of an
      increase in balances and rates. The average rate paid increased from 1.96
      percent for the second quarter of 2005 to 3.51 percent for the second quarter
      of
      2006, while average balances increased $7,334,000, to $18,914,000. Most of
      this
      increase was centered in repurchase agreements, a sweep product for commercial
      customers.





For
      the
      six-month period ended June 30, 2006, net interest income decreased $180,000,
      or
      2.2 percent, to $8,016,000. On a tax-equivalent basis net interest income
      decreased $185,000, or 2.1 percent. Included in net interest income for the
      first six 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 $558,000, or .1 percent, while the net interest
      margin declined 7 basis points. The net interest margin on a tax-equivalent
      basis was 3.22 percent for the six-month period ended June 30, 2006 compared
      with 3.29 percent for the same period in 2006.





Total
      interest income on a tax-equivalent basis increased $1,535,000, from $14,455,000
      to $15,990,000, when comparing the six-month periods ended June 30, 2005 to
      June
      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 $487,000 of the increase in
      interest income was related to volume, while $1,048,000 was due to higher rates.
      Average loans increased 16.6 percent to $314,719,000, while average investment
      securities decreased 15.3 percent to $226,181,000. The yield on earning assets
      increased from 5.32 percent to 5.88 percent for the six-month periods. The
      yield
      on loans increased from 6.04 percent to 6.55 percent during this time, while
      the
      yield on investments increased from 4.67 percent to 4.95 percent when comparing
      the six-month periods. The yield on commercial real estate loans and commercial
      and industrial loans benefited the most from the increase in interest
      rates.


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


**NET
      INTEREST INCOME (Continued)**





Total
      interest expense increased $1,720,000, from $5,519,000 to $7,239,000, for the
      six-month periods with interest on demand accounts, money market accounts,
      and
      time deposits accounting for $540,000, $155,000 and $774,000, respectively,
      of
      the increase. Approximately $1,706,000 of the increase in interest expense
      is a
      result of higher interest rates. The yield on interest-bearing demand accounts,
      money market accounts and time deposits increased 105 basis points, 107 basis
      points and 73 basis points, respectively, when comparing the average rate paid
      for the six-month periods ended June 30, 2006 and 2005. Interest expense on
      short-term borrowings increased by $210,000 as the average rate paid on these
      accounts increased from 1.79 percent to 3.26 percent.





Management
      expects the remainder of 2006 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. In addition, at the end of the second quarter, QNB was
      able to reclassify some of its deposits for reserve calculation purposes. This
      reclassification will enable QNB to reduce its reserve requirements at the
      Federal Reserve Bank by approximately $8,500,000. These funds will go from
      a
      non-earning asset into either Federal funds sold or investment securities,
      thereby increasing net interest income.





**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 a $45,000 provision for loan losses was necessary for
      the
      three- and six-month periods ended June 30, 2006. There was no provision for
      loan losses necessary for the same periods in 2005. The need for a provision
      during the second quarter of 2006 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 $2,000 and $21,000 during the second quarter of 2006 and 2005,
      respectively. For the six-month periods ended June 30, 2006 and 2005 QNB had
      net
      charge-offs of $22,000 and $27,000, respectively.


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


**PROVISION
      FOR LOAN LOSSES (Continued)**





Non-performing
      assets (non-accruing loans, loans past due 90 days or more, other real estate
      owned and other repossessed assets) amounted to .02 percent and .00 percent
      of
      total assets at June 30, 2006 and 2005, respectively. This compares to .002
      percent at December 31, 2005. There were no non-accrual loans at June 30, 2006,
      December 31, 2005 or June 30, 2005. QNB did not have any other real estate
      owned
      as of June 30, 2006, December 31, 2005 or June 30, 2005. There were no
      repossessed assets as of June 30, 2006 or December 31, 2005. Repossessed assets
      were $4,000 at June 30, 2005.





There
      were no restructured loans as of June 30, 2006, December 31, 2005 or June 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 $2,549,000 and $2,526,000 at June 30, 2006 and
      December 31, 2005, respectively. The ratio of the allowance to total loans
      was
      .77 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.





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. There were no
      loans considered impaired at June 30, 2006 and 2005.





Management
      in determining the allowance for loan losses makes significant estimates.
      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 was $951,000 for the second quarter of 2006. This compares
      to a loss of $172,000 for the same period in 2005. Excluding the $1,253,000
      impairment charge included in net gains and losses on investment securities
      during the second quarter of 2005, total non-interest income was $1,081,000
      during that


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


**NON-INTEREST
      INCOME (Continued)**





period.
      Included in non-interest income, under the category other income, during the
      second quarter of 2005 was two non-operating items: life insurance proceeds
      of
      $61,000 and a sales tax refund of $45,000.





For
      the
      six-month period, total non-interest income increased $662,000, to $2,159,000.
      Excluding gains and losses on securities and loans, non-interest income for
      the
      six-month period decreased $258,000. In addition to the two non-operating items
      mentioned previously, non-interest income during the first half of 2005 included
      a $209,000 gain on the liquidation of assets relinquished by a borrower. This
      item was also in the category of other income.





Fees
      for
      services to customers are primarily comprised of service charges on deposit
      accounts. These fees increased $12,000, or 2.7 percent, to $464,000 when
      comparing the two quarters and $13,000, or 1.5 percent, to $904,000 when
      comparing the six-month periods. Overdraft income increased $22,000 for the
      three-month period and $33,000 for the six-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 $16,000 for the three- and
      six-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 reduction in fee income of $6,000 and
      $13,000, respectively, when comparing the three- and six-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 $195,000 for the second quarter of 2006, an increase
      of
      $24,000, or 14.0 percent, from the amount recorded during the second quarter
      of
      2005. Income from ATM and debit cards was $379,000 and $330,000 for the six
      months ended June 30, 2006 and 2005, respectively. Debit card income increased
      $20,000, or 16.5 percent, to $141,000 for the three-month period and $41,000,
      or
      17.7 percent, to $273,000 for the six-month period. 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 consumer 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 $13,000,
      respectively, when comparing the respective three- and six-month periods.
      Partially offsetting these positive variances was a reduction in ATM surcharge
      income of $2,000 and $4,000, respectively, for the three- and six-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 $62,000
      and $64,000 for the three months ended June 30, 2006 and 2005, respectively.
      For
      the six-month period, earnings on these policies decreased $4,000, to $123,000.
      The insurance carriers reset the rates on these policies annually. The decline
      in income is a result of a lower earnings rate resulting from the lower interest
      rate environment at the last reset date.





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-month periods ended June 30, 2006 and 2005 were
      $25,000 and $12,000, respectively, and $48,000 and $36,000 for the respective
      six-month periods. The


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


**NON-INTEREST
      INCOME (Continued)**





higher
      income in 2006 is primarily the result of a reduction in amortization expense
      when comparing the periods as well as impairment charges recorded in 2005.
      Amortization expense for the three-month periods ended June 30, 2006 and 2005
      was $22,000 and $30,000, respectively. For the respective six-month periods,
      amortization expense was $47,000 and $59,000, 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. There was no valuation allowance necessary
      for
      either the three- or six-month periods in 2006. Included in the three- and
      six-month periods of 2005 were a positive $6,000 and a negative $1,000
      adjustment to the valuation allowance. The average balance of mortgages serviced
      for others was $74,041,000 for the second quarter of 2006 compared to
      $77,445,000 for the second quarter of 2005, a decrease of 4.4 percent. The
      average balance of mortgages serviced was approximately $75,124,000 for the
      six-month period ended June 30, 2006, compared to $77,916,000 for the first
      six
      months of 2005, a decrease of 3.6 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 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 $60,000 and $(1,189,000)
      for the three-month periods ended June 30, 2006 and 2005, respectively. In
      the
      second quarter of 2005, QNB determined that certain unrealized losses on
      perpetual preferred stock of FNMA and FHLMC was other-than-temporary in
      accordance with FASB 115 *Accounting
      for Certain Investments in Debt and Equity Securities* and the
      SEC’s Staff Accounting Bulletin No. 59 *Accounting
      for Non-current Marketable Equity Securities* .
      An
      impairment charge of $1,253,000 was recorded to write-down these investments
      to
      their fair values. Excluding the impairment charge, QNB recorded net gains
      on
      the sale of securities of $64,000 during the second quarter of 2005, net losses
      on the sale of fixed income securities of $26,000 and gains from the equity
      portfolio of $90,000. The gains recorded during the second quarter of 2006
      were
      a result of the sale of equity securities.





Net
      security gains/(losses) were $415,000 and $(576,000) for the six-month periods
      ended June 30, 2006 and 2005, respectively. Of the gains recorded in 2006,
      $258,000 was from the marketable equity securities portfolio at the Corporation
      and $157,000 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 the 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 discussed above, QNB recorded net securities gains of
      $677,000 during the first six months of 2005, $244,000 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 $11,000 and $60,000 for
      the
      quarters ended June 30, 2006 and 2005, respectively. For the six-month periods
      ended June 30, 2006 and 2005, net gains on the sale of loans were $24,000 and
      $95,000, 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 were $9,000 and
      $25,000


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**QNB
      CORP. AND SUBSIDIARY**


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


**NON-INTEREST
      INCOME (Continued)**





related
      to the recognition of mortgage servicing assets. Included
      in the gains on the sale of residential mortgages in the six-month periods
      were
      $16,000 and $39,000, respectively, related to the recognition of mortgage
      servicing assets. During the second quarter of 2005 longer term interest rates,
      particularly the 10-year Treasury rate, declined, providing consumers another
      opportunity to refinance their mortgages. This rate environment also provided
      QNB the opportunity to sell these loans at a larger profit. This environment
      was
      in contrast to the mortgage interest environment of 2006 which, for the most
      part, has seen mortgage rates continually increase. Proceeds from the sale
      of
      mortgages were $1,200,000 and $3,328,000 for the second quarter of 2006 and
      2005, respectively. For the six-month periods, proceeds from the sale of
      residential mortgage loans amounted to $2,140,000 and $5,233,000, respectively.





Other
      operating income decreased $124,000, to $134,000, during the second quarter
      of
      2006. The non-operating items mentioned earlier accounted for $106,000 of the
      decrease. In addition, trust and retail brokerage income declined $22,000 and
      dividend income from QNB’s membership in Laurel Abstract Company LLC, a title
      insurance company, declined $9,000. During the fourth quarter of 2005, QNB
      made
      the decision to stop offering trust services and to focus its attention to
      retail brokerage and wealth management services through its relationship with
      Raymond James Financial Services, Inc. The decline in income from the title
      company was a result of the slowdown in mortgage activity. Partially offsetting
      these declines was an $8,000 increase in merchant income and an $8,000 increase
      in official check fee income. QNB has been very successful in 2006 in obtaining
      new merchants. The increase in official check fee income was a result of higher
      short-term interest rates.





For
      the
      six-month period, other operating income decreased $328,000, or 55.2 percent,
      to
      $266,000. The non-operating items discussed previously account for $315,000
      of
      the decrease when comparing the six-month periods. In addition, trust and retail
      brokerage income declined $38,000 and income from the title company declined
      $9,000. Partially offsetting these declines was a $14,000 increase in merchant
      income and a $17,000 increase in official check fee income.





**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 $3,282,000 for the
      quarter ended June 30, 2006 represents a decrease of $34,000, or 1.0 percent,
      from levels reported in the second quarter of 2005. Total non-interest expense
      for the six months ended June 30, 2006 was $6,518,000, a decrease of $34,000,
      or
      .5 percent, over 2005 levels.





Salaries
      and benefits is the largest component of non-interest expense. Salaries and
      benefits expense decreased $49,000, or 2.6 percent, to $1,814,000 for the
      quarter ended June 30, 2006 compared to the same quarter in 2005. Salary expense
      decreased $30,000, or 2.0 percent, during the period to $1,455,000, while
      benefits expense decreased $19,000, or 5.0 percent, to $359,000. Included in
      salary expense for the second quarter of 2006 was $31,000 in stock option
      expense associated with the adoption of FASB No. 123r. Excluding the impact
      of
      the stock option expense, salary expense decreased 4.1 percent when comparing
      the three-month periods. Merit and promotional increases were offset by a
      decrease in the number of employees. The number of full time-equivalent
      employees decreased by eight when comparing the second quarter of 2006 and
      2005.
      With regard to benefits, retirement plan expense declined by $11,000 when
      comparing the two quarters while payroll taxes and medical premiums declined
      by
      approximately $3,000 each. The use of forfeitures from the unvested portion
      of
      terminated employees balances accounts for $8,000 of the decrease
      in


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


**NON-INTEREST
      EXPENSE (Continued)**





retirement
      plan expense. The reduction in payroll tax expense and medical costs reflects
      the decline in the number of employees.





For
      the
      six-month period ended June 30, 2006 salaries and benefits expense decreased
      $81,000, to $3,619,000, compared to the same period in 2005. Salary expense
      decreased by $71,000, or 2.4 percent, while benefits expense decreased by
      $10,000, or 1.3 percent, when comparing the two periods. Included in salary
      expense for the six months ended June 30, 2005 was an accrual of $40,000 related
      to the incentive compensation plan. There has been no accrual for 2006. Included
      in salary expense for the first six months of 2006 was $58,000 in stock option
      expense associated with the adoption of FASB No. 123r. Excluding the impact
      of
      the accruals for the incentive compensation plan and the stock option expense,
      salary expense decreased 3.1 percent for the six-month period. The number of
      full time-equivalent employees decreased by seven when comparing the six-month
      periods. Payroll tax expense declined by $10,000 when comparing the six-month
      periods, accounting for the decline in benefits expense.





Net
      occupancy expense increased $24,000 to $296,000, when comparing the second
      quarter of 2006 to the second quarter of 2005. For the six-month period, net
      occupancy expense increased $22,000 to $575,000. Contributing to the increase
      in
      both the three and six-month periods was higher costs related to building
      maintenance, utilities and real estate taxes.





Furniture
      and equipment expense decreased $36,000, or 12.4 percent, to $255,000 when
      comparing the three-month periods ended June 30, 2006 and 2005 and decreased
      $87,000, or 15.2 percent, to $486,000 when comparing the six-month periods.
      D epreciation
      on furniture and equipment and amortization of software costs declined by
      $36,000 for the three-month period and $92,000 for the six-month period.
      Hardware and software associated with the bank’s core computer system acquired
      in 2000 became fully depreciated in 2005. The decline in depreciation expense
      was lower in the second quarter of 2006 than the first quarter of 2006, as
      some
      hardware associated with the computer system was replaced during the second
      quarter of 2006. Net occupancy expense and furniture and equipment expense
      is
      expected to increase during the second half of the year relative to the first
      half due to the impact of the renovations to the lending center, which was
      completed in June.





Marketing
      expense decreased $12,000 to $144,000, for the quarter ended June 30, 2006
      and
      $9,000 to $297,000, for the six-month period. Sales promotion expense decreased
      $6,000 when comparing both the three and six-month periods. During the second
      quarter of 2005, QNB purchased several items for use and distribution in the
      community to promote various products and services offered. Also, when comparing
      the six-month periods, advertising expense increased $18,000 as QNB increased
      its use of billboards and television for product advertising. Donations
      decreased $29,000 when comparing the six-month periods, as the first quarter
      of
      2005 included several one-time contributions for special projects. QNB
      contributes to not-for-profit organizations, clubs and community events in
      the
      local communities it serves.





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 $196,000 in the second quarter of 2006 compared to $168,000
      for the second quarter of 2005. For the six-month period, third party services
      increased $56,000, to $365,000. The increase in expense is primarily related
      to
      the use of consultants for special projects and increases in legal and internal
      and external auditing fees. Legal expense increased $15,000 and $22,000 when
      comparing the respective three- and six-month periods. In addition, with the
      elimination of the fee charged to consumers for the use of internet bill pay
      services, QNB has


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


**NON-INTEREST
      EXPENSE (Continued)**





experienced
      rapid growth in this service. As a result, the fees paid to the vendor who
      processes these payments have increased by $8,000 for the three-month period
      and
      $15,000 for the six-month period.





Telephone,
      postage and supplies expense increased $23,000 for the quarter to $136,000
      and
      $40,000 for the six-month period to $276,000. Postage expense increased $10,000
      and $17,000 during these respective 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 $5,000
      when comparing the two quarters and $19,000 when comparing the six-month
      periods. Contributing to this increase were costs for ATM cards and costs
      related to supplies for the new lending 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. State tax expense was $114,000 for both three-month periods
      and $227,000 for the six-month period, an increase of $10,000 compared to the
      same period in 2005. The shares tax increased $9,000 for the quarter and $18,000
      for the six-month period, a result of the increase in the Bank’s equity. This
      increase was offset by a decrease in the capital stock tax paid by the
      Corporation of $9,000 for the quarter and $8,000 for the six-month
      period.




**INCOME
      TAXES**





QNB
      utilizes an asset and liability approach for financial accounting and reporting
      of income taxes. As of June 30, 2006, QNB's net deferred tax asset was
      $2,450,000. The primary components of deferred taxes are a deferred tax asset
      of
      $812,000 relating to the allowance for loan losses and a deferred tax asset
      of
      $1,798,000 resulting from the FASB No. 115 adjustment for available-for-sale
      securities. As of June 30, 2005, QNB's net deferred tax asset was $292,000
      comprised of deferred tax assets of $729,000 related to the allowance for loan
      losses and $481,000 related to impaired securities. Partially offsetting this
      was a deferred tax liability of $542,000 resulting from the FASB No. 115
      adjustment for available-for-sale investment securities. Rising interest rates
      over the past year have had a negative impact on the market value of the
      available-for-sale investment portfolio and have created an unrealized loss
      in
      the portfolio and a deferred tax asset as of June 30, 2006 as compared to an
      unrealized gain and a deferred tax liability at June 30, 2005.





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 $85,000
      of this valuation allowance was reversed during the first half 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 $352,000, or 21.3 percent, for the
      three-month period ended June 30, 2006, and $140,000, or 22.5 percent, for
      the
      same period in 2005. For the six-month periods, applicable income taxes and
      effective tax rates were $632,000, or 17.5 percent, and $739,000, or 23.5
      percent, respectively. 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.


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


**FINANCIAL
      CONDITION ANALYSIS**





The
      balance sheet analysis compares average balance sheet data for the six months
      ended June 30, 2006 and 2005, as well as the period ended balances as of June
      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 six-month period ended June 30, 2006 increased $558,000,
      or .1 percent, to $548,102,000 from $547,544,000 for the six months ended June
      30, 2005. Average loans increased $44,797,000, or 16.6 percent, while average
      investments decreased $40,691,000, or 15.2 percent. Average Federal funds sold
      decreased $3,440,000 when comparing these same periods. The growth in average
      loans during the past year was funded primarily through the reduction of the
      investment portfolio.





Total
      loans have increased 21.8 percent between June 30, 2006 and June 30, 2005 and
      10.4 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 $30,417,000 when comparing the first half
      of
      2006 to the first half of 2005. Most of the 16.9 percent growth in average
      commercial loans is in loans secured by real estate, either commercial or
      residential properties, which increased $16,373,000. Of this increase
      $13,015,000, or 79.5 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. Most of the $6,471,000 in 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
      possibility of further rate increases combined with 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
      $7,573,000, or 58.0 percent, when comparing the two quarters.





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 $7,599,000 when
      comparing the six-month periods. QNB began purchasing these loans in the second
      quarter of 2005.





Average
      home equity loans and residential mortgage loans increased $5,622,000 and
      $1,368,000, respectively, when comparing the first half of 2006 to the first
      half of 2005. The 9.4 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 the fixed-rate home equity
      term loan. This product became more attractive to consumers as the prime rate
      rose during 2005 and led many to refinance their floating-rate lines into
      fixed-rate home equity loans. QNB has been aggressive in pricing it fixed-rate
      home equity loans relative to the market.


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


**FINANCIAL
      CONDITION ANALYSIS (Continued)**





Total
      average deposits decreased $9,545,000, or 2.0 percent, to $458,066,000 for
      the
      first half of 2006 compared to the first half of 2005. Money market account
      balances decreased $12,136,000 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 $9,666,000, or 40.8 percent, to $33,358,000. 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 $5,120,000, or 9.2 percent,
      when
      comparing the six-month periods as some customers sought out the 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 $6,179,000 when
      comparing the two periods. The growth in interest-bearing demand deposits is
      centered in the deposits of local municipalities.





Increasing
      time deposit balances continues to be a challenge because of the rate
      competition for such deposits, particularly with maturities between eight months
      through two years. Matching or beating competitors’ rates could have a negative
      impact on the net interest margin. Average time deposits increased $1,663,000,
      or .8 percent, to $207,854,000 on average for the six 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 $7,994,000 when comparing the two periods with repurchase
      agreements, a sweep product for commercial customers, increasing $6,019,000
      on
      average.





Total
      assets at June 30, 2006 were $591,492,000, compared with $582,205,000 at
      December 31, 2005, an increase of 1.6 percent. The composition of the asset
      side
      of the balance sheet shifted from year-end with total loans increasing
      $31,301,000 between December 31, 2005 and June 30, 2006. In contrast, total
      investment securities declined by $23,385,000 between these dates. Premises
      and
      equipment increased $1,058,000 primarily as a result of the cost of renovations
      and furniture for the lending center. Other assets increased $1,370,000 from
      December 2005 to June 2006 with deferred tax assets increasing by $1,098,000.
      The increase in deferred tax assets is a result of the change in the FASB No.
      115 adjustment for available-for-sale securities caused by rising interest
      rates.





On
      the
      liability side, total deposits increased by $3,918,000, or .9 percent, since
      year-end. The composition of the deposits changed slightly as declines in
      interest-bearing demand accounts of $4,587,000 and time deposits of $5,844,000
      was offset by growth of $13,657,000 in money market accounts. Treasury Select
      money market balances increased $16,629,000 between December 31, 2005 and June
      30, 2006.





Short-term
      borrowings increased $5,117,000 between December 31, 2005 and June 30, 2006,
      as
      repurchase agreement balances increased $5,588,000 while Federal funds purchased
      decreased by $470,000.





At
      June
      30, 2006, the fair value of investment securities available-for-sale was
      $209,893,000, or $5,289,000 below the amortized cost of $215,182,000. This
      compares to a fair value of $233,275,000, or $1,912,000


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


**FINANCIAL
      CONDITION ANALYSIS (Continued)**





below
      the
      amortized cost of $235,187,000, at December 31, 2005. An unrealized holding
      loss, net of taxes, of $3,491,000 was recorded as a decrease to shareholders’
equity at June 30, 2006, while an unrealized holding loss of $1,262,000 was
      recorded as a decrease to shareholders' equity at December 31, 2005. The
      increase in interest rates since December 31, 2005 has contributed to the
      further decline in the market value of the investment portfolio.





The
      available-for-sale portfolio had a weighted average maturity of approximately
      4
      years, 11 months at June 30, 2006 and 4 years, 5 months at December 31, 2005.
      The weighted average tax-equivalent yield was 5.01 percent and 4.87 percent
      at
      June 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 June
      30,
      2006 and December 31, 2005, QNB had securities classified as held-to-maturity
      with an amortized cost of $5,894,000 and $5,897,000 and a market value of
      $6,005,000 and $6,082,000, respectively. The held-to-maturity portfolio had
      a
      weighted average maturity of approximately 7 years, 6 months at June 30, 2006
      and 3 years, 10 months at December 31, 2005. The weighted average tax-equivalent
      yield was 6.77 percent at June 30, 2006 and 6.78 percent at December 31, 2005.
      The increase in the weighted average maturity is a result of the increase in
      interest rates. Bonds that were anticipated to be called are now expected to
      go
      to their maturity date.





**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 an attempt to match the volatility, seasonality, interest
      sensitivity and growth trends of its loans and deposits. 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 a two $10,000,000 unsecured Federal funds lines granted by
      correspondent banks. In addition, the Bank has a maximum borrowing capacity
      with
      the FHLB of approximately $239,896,000. At June 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 $229,522,000 and $254,216,000 at June 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 half
      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. Total loans increased by
      $31,301,000, or 10.4 percent, during the first half of the year. This was funded
      primarily through the investment portfolio


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


**LIQUIDITY
      (Continued)**





whose
      balances decreased by $23,385,000 from December 31, 2005 to June 30, 2006.
      An
      increase in deposits and repurchase agreement balances also helped fund the
      loan
      growth.





Approximately
      $76,570,000 and $68,917,000 of available-for-sale securities at June 30, 2006
      and December 31, 2005, respectively, were pledged as collateral for repurchase
      agreements and deposits of public funds. In addition, under 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 to slow during the second half of the year.
      In addition, the deposit balances held by school districts should increase
      during the third quarter as real estate taxes are collected.





**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 June 30,
      2006 was $46,510,000, or 7.86 percent of total assets. This compares to
      shareholders' equity of $46,564,000, or 8.00 percent of total assets, at
      December 31, 2005. Shareholders’ equity at June 30, 2006 included a negative
      adjustment of $3,491,000 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 8.45 percent and 8.21
      percent at June 30, 2006 and December 31, 2005. The increase in the ratio was
      a
      result of the rate of capital retention exceeding the rate of asset growth.
      Total assets increased 1.60 percent between December 31, 2005 and June 30,
      2006,
      while shareholders’ equity, excluding the net unrealized holding losses,
      increased 4.55 percent.





Shareholders'
      equity averaged $48,922,000 for the first six months of 2006 and $46,580,000
      during all of 2005, an increase of 5.03 percent. The ratio of average total
      equity to average total assets increased to 8.38 percent for the first half
      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 13.02 percent and 13.04 percent, a total
      risk-based ratio of 13.70 percent and 13.77 percent and a leverage ratio of
      8.48
      percent and 8.15 percent at June 30, 2006 and December 31, 2005, respectively.
      The slight decrease in the risk-based capital ratios reflects the increase
      in
      risk weighed assets, resulting principally from a shift in assets from
      investment securities to loans, at a faster growth rate than the growth in
      risk-based capital, while the increase in the leverage ratio reflects the growth
      in Tier I capital exceeding the growth in average assets.


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**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 June 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 stated maturities 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 June 30, 2006, interest-earning assets scheduled to mature or likely
      to
      be called, repriced or repaid in one year were $169,541,000. Interest-sensitive
      liabilities scheduled to mature or reprice within one year were $275,131,000.
      The one-year cumulative gap, which reflects QNB’s interest sensitivity over a
      period of time, was a negative


$105,590,000
      at June 30, 2006. The cumulative one-year gap equals -18.66 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 a result
      of
      changes in the repricing and maturity structure of both the assets and
      liabilities. On the asset side, the amount of assets maturing or repricing
      declined by $10,472,000 from December 31, 2005 to June 30, 2006. This decrease
      was primarily caused by the extension of the average life of the portfolio
      resulting from an increase in interest rates. Higher interest rates cause the
      prepayments on mortgage-backed securities and CMOs to slow. On the liability
      side, the amount of time deposits maturing or repricing in less than one year
      increased significantly. At June 30, 2006 $132,711,000, or 64.7 percent, of
      total time deposits was scheduled to reprice or mature in the next twelve
      months. This level compares to $95,840,000, or 45.4 percent, of total
      time


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


**INTEREST
      RATE SENSITIVITY (Continued)**





deposits
      at December 31, 2005. In addition, balances in the Treasury Select Money Market
      account increased by $16,629,000 between December 31, 2005 and June 30, 2006.
      Both of these events reflect consumers desire to invest in shorter term
      investments whose rates have already increased significantly and which could
      increase further if market rates continue to increase. 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 June 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 35.





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. This is consistent
      with
      the results of the gap analysis. However, in the 200 basis point down scenario,
      net interest income declines, reflecting the hypothetical interest rate floors
      on interest-bearing transaction accounts, regular money market accounts and
      savings accounts. 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 June 30, 2006, QNB did not have any hedging
      transactions in place such as interest rate swaps, caps or floors.


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**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
            
            $
            13,452
            
            $
            (2,594
            )
            
            (16.17
            )%+200
                Basis Points
            
            
            14,224
            
            
            (1,822
            )
            
            (11.35
            )+100
                Basis Points
            
            
            15,178
            
            
            (868
            )
            
            (5.41
            )FLAT
                RATE
            
            
            16,046
            
            
            —
            
            
            —-100
                Basis Points
            
            
            16,339
            
            
            293
            
            
            1.83-200
                Basis Points
            
            
            15,993
            
            
            (53
            )
            
            (.33
            )




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**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.


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**QNB
      CORP. AND SUBSIDIARY**





**PART
      II. OTHER INFORMATION**





**JUNE
      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




The
      2006
      Annual Meeting (the Meeting) of the shareholders of QNB Corp. (the Registrant)
      was held on May 16, 2006. Notice of the Meeting was mailed to shareholders
      of
      record on or about April 17, 2006, together with proxy solicitation materials
      prepared in accordance with Section 14(a) of the Securities Exchange Act of
      1934, as amended, and the regulations promulgated thereunder.




The
      Meeting was held for the following purposes:




(1)
            To
                elect three (3) Directors


(2)
            To
                approve the Corporation’s 2006 Employee Stock Purchase
                Plan





There
      was
      no solicitation in opposition to the nominees of the Board of Directors for
      election to the Board of Directors and all such nominees were elected. The
      number of votes cast for or withheld for each of the nominees for election
      to
      the Board of Directors was as follows:





Nominee
            
            For
            
            WithholdThomas
                J. Bisko
            
            
            2,639,073
            
            
            9,566Dennis
                Helf
            
            
            2,639,043
            
            
            9,596G.
                Arden Link
            
            
            2,635,409
            
            
            13,230





The
      continuing directors of the Registrant are:




Norman
      L.
      Baringer Charles M. Meredith, III, Gary S. Parzych, Kenneth F. Brown, Anna
      Mae
      Papso, Henry L. Rosenberger, and Edgar L. Stauffer




T he
      2006
      Employee Stock Purchase Plan was approved as presented. The number of votes
      cast
      for, against or withheld, as well as the number of abstentions for the adoption
      of the plan were as follows:





Adoption
            
            For
            
            Against
            
            Abstain2006
                Employee Stock Purchase Plan
            
            
            2,140,139
            
            
            116,088
            
            
            21,726




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Item
              5.
            Other
                Information




None.




Item
              6.
            Exhibits




Exhibit
              3(i)
            Articles
                of Incorporation of Registrant, as amended. (Incorporated by reference
                to
                Exhibit3(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




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**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: August
              9, 2006
            By:
            /s/ Thomas
              J.
              BiskoName:  
                Thomas J. Bisko
              Title:    
                President and CEO  Date: August
              9, 2006
            By:
            /s/ Bret
              H.
              KrevolinName:  
                Bret H. Krevolin
              Title:    
                Chief Financial Officer




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