**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      DC 20549**










**FORM
      10-Q**





(Mark
      One)


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





For
      the
      quarterly period ended  September 30,
      2008


OR


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





For
      the
      transition period
      from to




Commission
      file number 0-17706





QNB
      Corp.


(Exact
      Name of Registrant as Specified in Its Charter)





Pennsylvania
            23-2318082(State
                or Other Jurisdiction of Incorporation or Organization)
            (I.R.S.
                Employer Identification No.)15
                North Third Street, Quakertown, PA
            18951-9005(Address
                of Principal Executive Offices)
            (Zip
                Code)





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




Not
      Applicable


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





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





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





Large
                accelerated filer ̈
            Accelerated
                filerþNon-accelerated
                filer ̈
            Smaller
                Reporting Company ̈





Indicate
      by check mark whether the Registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).      Yes   ̈  No  þ





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 October 31, 2008Common
                Stock, par value $.625
            3,136,423





**QNB
      CORP. AND SUBSIDIARY**


**FORM
      10-Q**


**QUARTER
      ENDED SEPTEMBER 30, 2008**





**INDEX**




**PART
      I - FINANCIAL INFORMATION**





**PAGE****ITEM
                1.**
            **CONSOLIDATED
                FINANCIAL STATEMENTS (Unaudited)**Consolidated
                Balance Sheets at September 30, 2008and
                December 31, 2007
            1Consolidated
                Statements of Income for the Three and NineMonths
                Ended September 30, 2008 and 2007
            2Consolidated
                Statement of Shareholders’ Equity for the NineMonths
                Ended September 30, 2008
            3Consolidated
                Statements of Cash Flows for the NineMonths
                Ended September 30, 2008 and 2007
            4Notes
                to Consolidated Financial Statements
            5**ITEM
                2.**
            **MANAGEMENT'S
                DISCUSSION AND ANALYSIS OF FINANCIAL****CONDITION
                AND RESULTS OF OPERATIONS**
            16**ITEM
                3.**
            **QUANTITATIVE
                AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**
            48**ITEM
                4.**
            **CONTROLS
                AND PROCEDURES**
            48**PART
                II - OTHER INFORMATION****ITEM
                1.**
            **LEGAL
                PROCEEDINGS**
            49**ITEM
                1A.**
            **RISK
                FACTORS**
            49**ITEM
                2.**
            **UNREGISTERED
                SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**
            49**ITEM
                3.**
            **DEFAULTS
                UPON SENIOR SECURITIES**
            49**ITEM
                4.**
            **SUBMISSIONS
                OF MATTERS TO A VOTE OF SECURITY HOLDERS**
            49**ITEM
                5.**
            **OTHER
                INFORMATION**
            49**ITEM
                6.**
            **EXHIBITS**
            49**SIGNATURES****CERTIFICATIONS**







*QNB
        Corp. and Subsidiary*
 
 CONSOLIDATED
        BALANCE SHEETS
 
 (in thousands, except share data)
                (unaudited)**September 30,**
                **2008**
              
              **December 31,**
                **2007****Assets**Cash
                  and due from banks
              
              $
              14,287
              
              $
              14,322Federal
                  funds sold
              
              
              –
              
              
              –Total
                  cash and cash equivalents
              
              
              14,287
              
              
              14,322Investment
                  securitiesAvailable-for-sale
                  (amortized cost $222,345 and $189,273)
              
              
              219,675
              
              
              191,552Held-to-maturity
                  (fair value $3,659 and $4,122)
              
              
              3,598
              
              
              3,981Non-marketable
                  equity securities
              
              
              1,342
              
              
              954Loans
                  held-for-sale
              
              
              –
              
              
              688Total
                  loans, net of unearned costs
              
              
              380,105
              
              
              381,016Allowance
                  for loan losses
              
              
              (3,492
              )
              
              (3,279
              )Net
                  loans
              
              
              376,613
              
              
              377,737Bank-owned
                  life insurance
              
              
              8,676
              
              
              8,651Premises
                  and equipment, net
              
              
              6,635
              
              
              6,728Accrued
                  interest receivable
              
              
              2,980
              
              
              2,742Other
                  assets
              
              
              4,521
              
              
              2,458Total
                  assets
              
              $
              638,327
              
              $
              609,813**Liabilities**DepositsDemand,
                  non-interest bearing
              
              $
              49,125
              
              $
              50,043Interest-bearing
                  demand
              
              
              99,816
              
              
              97,290Money
                  market
              
              
              46,646
              
              
              49,666Savings
              
              
              43,759
              
              
              42,075Time
              
              
              199,207
              
              
              190,461Time
                  of $100,000 or more
              
              
              88,366
              
              
              64,589Total
                  deposits
              
              
              526,919
              
              
              494,124Short-term
                  borrowings
              
              
              19,557
              
              
              33,990Long-term
                  debt
              
              
              35,000
              
              
              25,000Accrued
                  interest payable
              
              
              2,711
              
              
              2,344Other
                  liabilities
              
              
              1,843
              
              
              1,104Total
                  liabilities
              
              
              586,030
              
              
              556,562**Shareholders'
                  Equity**Common
                  stock, par value $.625 per share; authorized 10,000,000 shares;
                  3,243,109
                  and 3,241,390 shares issued; 3,136,423 and 3,134,704 shares
                  outstanding
              
              
              2,027
              
              
              2,026Surplus
              
              
              10,008
              
              
              9,933Retained
                  earnings
              
              
              43,518
              
              
              41,282Accumulated
                  other comprehensive (loss) income, net
              
              
              (1,762
              )
              
              1,504Treasury
                  stock, at cost; 106,686 shares
              
              
              (1,494
              )
              
              (1,494
              )Total
                  shareholders' equity
              
              
              52,297
              
              
              53,251Total
                  liabilities and shareholders' equity
              
              $
              638,327
              
              $
              609,813
 
 *The
        accompanying notes are an integral part of the unaudited consolidated financial
        statements.*
  -
            1
            -
 *QNB
          Corp. and Subsidiary*
 
 CONSOLIDATED
          STATE M ENTS
          O F INCO M E
 
 (in
                    thousands, except share data)(unaudited)**Three
                    Months**
                
                **Nine
                    Months****Ended
                    September 30,**
                
                **Ended
                    September 30,****2008**
                
                **2007**
                
                **2008**
                
                **2007****Interest
                    Income**Interest
                    and fees on loans
                
                $
                6,005
                
                $
                6,272
                
                $
                18,399
                
                $
                18,255Interest
                    and dividends on investment securities:Taxable
                
                
                2,291
                
                
                2,130
                
                
                6,491
                
                
                6,395Tax-exempt
                
                
                466
                
                
                426
                
                
                1,385
                
                
                1,291Interest
                    on Federal funds sold
                
                
                56
                
                
                173
                
                
                138
                
                
                290Interest
                    on interest-bearing balances and other interest income
                
                
                14
                
                
                39
                
                
                47
                
                
                159Total
                    interest income
                
                
                8,832
                
                
                9,040
                
                
                26,460
                
                
                26,390**Interest
                    Expense**Interest
                    on depositsInterest-bearing
                    demand
                
                
                276
                
                
                682
                
                
                784
                
                
                1,777Money
                    market
                
                
                198
                
                
                409
                
                
                693
                
                
                1,200Savings
                
                
                44
                
                
                44
                
                
                129
                
                
                134Time
                
                
                2,007
                
                
                2,171
                
                
                6,298
                
                
                6,146Time
                    of $100,000 or more
                
                
                768
                
                
                723
                
                
                2,340
                
                
                2,089Interest
                    on short-term borrowings
                
                
                113
                
                
                200
                
                
                379
                
                
                590Interest
                    on long-term debt
                
                
                381
                
                
                306
                
                
                1,122
                
                
                1,398Total
                    interest expense
                
                
                3,787
                
                
                4,535
                
                
                11,745
                
                
                13,334Net
                    interest income
                
                
                5,045
                
                
                4,505
                
                
                14,715
                
                
                13,056Provision
                    for loan losses
                
                
                150
                
                
                150
                
                
                575
                
                
                375Net
                    interest income after provision for loan losses
                
                
                4,895
                
                
                4,355
                
                
                14,140
                
                
                12,681**Non-Interest
                    Income**Fees
                    for services to customers
                
                
                474
                
                
                469
                
                
                1,347
                
                
                1,360ATM
                    and debit card income
                
                
                237
                
                
                226
                
                
                698
                
                
                633Income
                    on bank-owned life insurance
                
                
                63
                
                
                64
                
                
                233
                
                
                195Mortgage
                    servicing fees
                
                
                31
                
                
                28
                
                
                72
                
                
                78Net
                    gain on sale of loans
                
                
                13
                
                
                50
                
                
                85
                
                
                78Net
                    (loss) gain on investment securities available-for-sale
                
                
                (103
                )
                
                –
                
                
                1
                
                
                (2,469
                )Other
                    operating income
                
                
                100
                
                
                152
                
                
                592
                
                
                382Total
                    non-interest income
                
                
                815
                
                
                989
                
                
                3,028
                
                
                257**Non-Interest
                    Expense**Salaries
                    and employee benefits
                
                
                1,999
                
                
                1,826
                
                
                5,925
                
                
                5,554Net
                    occupancy expense
                
                
                324
                
                
                311
                
                
                997
                
                
                911Furniture
                    and equipment expense
                
                
                295
                
                
                257
                
                
                870
                
                
                774Marketing
                    expense
                
                
                171
                
                
                156
                
                
                496
                
                
                480Third
                    party services
                
                
                196
                
                
                181
                
                
                589
                
                
                547Telephone,
                    postage and supplies expense
                
                
                158
                
                
                134
                
                
                462
                
                
                399State
                    taxes
                
                
                121
                
                
                122
                
                
                381
                
                
                366Loss
                    on prepayment of FederalHomeLoanBank
                    advances
                
                
                –
                
                
                –
                
                
                –
                
                
                740Other
                    expense
                
                
                404
                
                
                340
                
                
                1,074
                
                
                1,030Total
                    non-interest expense
                
                
                3,668
                
                
                3,327
                
                
                10,794
                
                
                10,801Income
                    before income taxes
                
                
                2,042
                
                
                2,017
                
                
                6,374
                
                
                2,137Provision
                    for income taxes
                
                
                476
                
                
                463
                
                
                1,492
                
                
                111**Net
                    Income**
                
                $
                1,566
                
                $
                1,554
                
                $
                4,882
                
                $
                2,026**Earnings
                    Per Share - Basic**
                
                $
                .50
                
                $
                .50
                
                $
                1.56
                
                $
                .65**Earnings
                    Per Share - Diluted**
                
                $
                .50
                
                $
                .49
                
                $
                1.54
                
                $
                .64**Cash
                    Dividends Per Share**
                
                $
                .23
                
                $
                .22
                
                $
                .69
                
                $
                .66
 *The
            accompanying notes are an integral part of the unaudited consolidated
            financial
            statements.*
  -
              2
              -
 *QNB
            Corp. and Subsidiary*
 
 CONSOLIDATED
            STATE M ENT
            O F SHA R EHOLDE R S ' E QU IT Y
 **Accumulated****Other****Number**
                    
                    
                    
                    **Comprehensive**(in thousands, except share data)
                    
                    **of Shares**
                    
                    **Comprehensive**
                    
                    **Income**
                    
                    **Common**
                    
                    
                    
                    **Retained**
                    
                    **Treasury**(unaudited)
                    
                    **Outstanding**
                    
                    **Income**
                    
                    **(Loss)**
                    
                    **Stock**
                    
                    **Surplus**
                    
                    **Earnings**
                    
                    **Stock**
                    
                    **Total**Balance,
                        December 31, 2007
                    
                    
                    3,134,704
                    
                    
                    
                    
                    $
                    1,504
                    
                    $
                    2,026
                    
                    $
                    9,933
                    
                    $
                    41,282
                    
                    $
                    (1,494
                    )
                    $
                    53,251Net
                        income
                    
                    
                    –
                    
                    $
                    4,882
                    
                    
                    –
                    
                    
                    –
                    
                    
                    –
                    
                    
                    4,882
                    
                    
                    –
                    
                    
                    4,882Other
                        comprehensive loss, net of taxesUnrealized
                        holding losses on investment securities available-for-sale
                    
                    
                    –
                    
                    
                    (3,265
                    )Reclassification
                        adjustment for gains included in net income
                    
                    
                    –
                    
                    
                    (1
                    )Other
                        comprehensive loss
                    
                    
                    –
                    
                    
                    (3,266
                    )
                    
                    (3,266
                    )
                    
                    –
                    
                    
                    –
                    
                    
                    –
                    
                    
                    –
                    
                    
                    (3,266
                    )Comprehensive
                        income
                    
                    
                    –
                    
                    $
                    1,616
                    
                    
                    –
                    
                    
                    –
                    
                    
                    –
                    
                    
                    –
                    
                    
                    –
                    
                    
                    –Cash
                        dividends declared ($.69 per share)
                    
                    
                    –
                    
                    
                    
                    
                    
                    –
                    
                    
                    –
                    
                    
                    –
                    
                    
                    (2,165
                    )
                    
                    –
                    
                    
                    (2,165
                    )Stock
                        issue - Employee stock purchase plan
                    
                    
                    1,719
                    
                    
                    
                    
                    
                    –
                    
                    
                    1
                    
                    
                    31
                    
                    
                    –
                    
                    
                    –
                    
                    
                    32Stock-based
                        compensation expense
                    
                    
                    –
                    
                    
                    
                    
                    
                    –
                    
                    
                    –
                    
                    
                    44
                    
                    
                    –
                    
                    
                    –
                    
                    
                    44Cumulative
                        effect of adoption of new accounting principle - accounting for
                        deferred compensation aspects of split dollar life insurance
                        arrangements
                        (EITF 06-4)
                    
                    
                    –
                    
                    
                    
                    
                    
                    –
                    
                    
                    –
                    
                    
                    –
                    
                    
                    (481
                    )
                    
                    –
                    
                    
                    (481
                    )Balance,
                        September 30, 2008
                    
                    
                    3,136,423
                    
                    
                    
                    
                    $
                    (1,762
                    )
                    $
                    2,027
                    
                    $
                    10,008
                    
                    $
                    43,518
                    
                    $
                    (1,494
                    )
                    $
                    52,297  *The
                accompanying notes are an integral part of the unaudited consolidated
                financial
                statements.*
  -
                  3
                  -
 
 *QNB
            Corp. and Subsidiary*
 
 CONSOLIDATED
            STATE M ENTS
            O F CASH F LOWS
 (in
                        thousands)(unaudited)**Nine
                        Months Ended September 30,**
                    
                    **2008**
                    
                    **2007****Operating
                        Activities**Net
                        income
                    
                    $
                    4,882
                    
                    $
                    2,026Adjustments
                        to reconcile net income to net cash provided by operating
                        activitiesDepreciation
                        and amortization
                    
                    
                    625
                    
                    
                    547Provision
                        for loan losses
                    
                    
                    575
                    
                    
                    375Net
                        securities (gains) losses
                    
                    
                    (1
                    )
                    
                    2,469Gain
                        on sale of equity investment
                    
                    
                    (175
                    )
                    
                    –Net
                        gain on sale of loans
                    
                    
                    (85
                    )
                    
                    (78
                    )Net
                        loss on disposal of premises and equipment
                    
                    
                    3
                    
                    
                    1Net
                        gain on sale of repossessed assets
                    
                    
                    (19
                    )
                    
                    (2
                    )Proceeds
                        from sales of residential mortgages
                    
                    
                    7,661
                    
                    
                    4,895Originations
                        of residential mortgages held-for-sale
                    
                    
                    (6,946
                    )
                    
                    (4,716
                    )Income
                        on bank-owned life insurance
                    
                    
                    (233
                    )
                    
                    (195
                    )Life
                        insurance premiums
                    
                    
                    (16
                    )
                    
                    (21
                    )Stock-based
                        compensation expense
                    
                    
                    44
                    
                    
                    77Deferred
                        income tax benefit
                    
                    
                    (57
                    )
                    
                    (106
                    )Net
                        increase (decrease) in income taxes payable
                    
                    
                    153
                    
                    
                    (209
                    )Net
                        increase in accrued interest receivable
                    
                    
                    (238
                    )
                    
                    (214
                    )Amortization
                        of mortgage servicing rights and identifiable intangible
                        assets
                    
                    
                    60
                    
                    
                    89Net
                        amortization of premiums and discounts on investment
                        securities
                    
                    
                    (157
                    )
                    
                    (27
                    )Net
                        increase (decrease) in accrued interest payable
                    
                    
                    367
                    
                    
                    (200
                    )Increase
                        in other assets
                    
                    
                    (274
                    )
                    
                    (382
                    )Increase
                        in other liabilities
                    
                    
                    190
                    
                    
                    194Net
                        cash provided by operating activities
                    
                    
                    6,359
                    
                    
                    4,523**Investing
                        Activities**Proceeds
                        from maturities and calls of investment securities
                        available-for-sale
                    
                    
                    30,133
                    
                    
                    23,769held-to-maturity
                    
                    
                    380
                    
                    
                    920Proceeds
                        from sales of investment securities available-for-sale
                    
                    
                    3,964
                    
                    
                    102,007Purchase
                        of investment securities available-for-sale
                    
                    
                    (67,008
                    )
                    
                    (94,168
                    )Proceeds
                        from sale of equity investment
                    
                    
                    175
                    
                    
                    –Proceeds
                        from sales of non-marketable equity securities
                    
                    
                    332
                    
                    
                    2,846Purchase
                        of non-marketable equity securities
                    
                    
                    (720
                    )
                    
                    (649
                    )Net
                        decrease (increase) in loans
                    
                    
                    59
                    
                    
                    (23,732
                    )Net
                        purchases of premises and equipment
                    
                    
                    (535
                    )
                    
                    (614
                    )Redemption
                        of bank owned life insurance investment
                    
                    
                    224
                    
                    
                    86Proceeds
                        from sale of repossessed assets
                    
                    
                    373
                    
                    
                    92Net
                        cash (used) provided by investing activities
                    
                    
                    (32,623
                    )
                    
                    10,557**Financing
                        Activities**Net
                        (decrease) increase in non-interest bearing deposits
                    
                    
                    (918
                    )
                    
                    3,692Net
                        increase (decrease) in interest-bearing non-maturity
                        deposits
                    
                    
                    1,190
                    
                    
                    (3,977
                    )Net
                        increase in time deposits
                    
                    
                    32,523
                    
                    
                    15,902Net
                        decrease in short-term borrowings
                    
                    
                    (14,433
                    )
                    
                    (9,124
                    )Repayment
                        of long-term debt
                    
                    
                    –
                    
                    
                    (52,000
                    )Proceeds
                        from issuance of long-term debt
                    
                    
                    10,000
                    
                    
                    25,000Cash
                        dividends paid
                    
                    
                    (2,165
                    )
                    
                    (2,066
                    )Proceeds
                        from issuance of common stock
                    
                    
                    32
                    
                    
                    36Net
                        cash (used) provided by financing activities
                    
                    
                    26,229
                    
                    
                    (22,537
                    )Decrease
                        in cash and cash equivalents
                    
                    
                    (35
                    )
                    
                    (7,457
                    )Cash
                        and cash equivalents at beginning of year
                    
                    
                    14,322
                    
                    
                    24,103Cash
                        and cash equivalents at end of period
                    
                    $
                    14,287
                    
                    $
                    16,646**Supplemental
                        Cash Flow Disclosures**Interest
                        paid
                    
                    $
                    11,378
                    
                    $
                    13,534Income
                        taxes paid
                    
                    
                    1,380
                    
                    
                    410Non-Cash
                        TransactionsChange
                        in net unrealized holding (losses) gains, net of taxes, on
                        available-for-sale securities
                    
                    
                    (3,266
                    )
                    
                    1,390Transfer
                        of loans to repossessed assets
                    
                    
                    490
                    
                    
                    103
 *The
              accompanying notes are an integral part of the unaudited consolidated
              financial
              statements.*
  -
                4
                -




**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2008 AND 2007, AND DECEMBER 31, 2007**


**(Unaudited)**


1.
      BASIS
      OF PRESENTATION





The
      accompanying unaudited consolidated financial statements include the accounts
      of
      QNB Corp. and its wholly-owned subsidiary, QNB Bank (the Bank). The consolidated
      entity is referred to herein as “QNB” or the “Company”. All significant
      intercompany accounts and transactions are eliminated in the consolidated
      financial statements.





These
      consolidated financial statements should be read in conjunction with the audited
      consolidated financial statements and notes thereto included in QNB's 2007
      Annual Report incorporated in the Form 10-K. Operating results for the three-
      and nine-month periods ended September 30, 2008 are not necessarily indicative
      of the results that may be expected for the year ending December 31, 2008.





The
      unaudited consolidated financial statements reflect all adjustments which,
      in
      the opinion of management, are necessary for a fair presentation of the results
      of operations for the interim periods and are of a normal and recurring nature.
      Certain items in the 2007 consolidated financial statements have been
      reclassified to conform to the 2008 financial statement presentation format.





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.





2.
      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 accounts for all awards granted under stock-based
      compensation plans in accordance with Financial
      Accounting Standards Board (FASB) Statement No. 123R, *Share-Based
      Payment* (FASB
      No.
      123R). Compensation cost has been measured using the fair value of an award
      on
      the grant date and is recognized over the service period, which is usually
      the
      vesting period.





Stock-based
      compensation expense was approximately $14,000 and $20,000 for the three months
      ended September 30, 2008 and 2007, respectively, and $44,000 and $77,000 for
      the
      nine months ended September 30, 2008 and 2007, respectively. As
      of
      September 30, 2008, there was approximately $65,000 of unrecognized compensation
      cost related to unvested share-based compensation awards granted that is
      expected to be recognized over the next 2.25 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 September 30, 2008, there
      were 225,058 options granted, 9,994 options forfeited, 37,441 options exercised
      and 177,623 options outstanding under this Plan. The 1998 Plan expired on March
      10, 2008, therefore no further options can be granted under this Plan.


-
            5
            -


**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2008 AND 2007, AND DECEMBER 31, 2007**


**(Unaudited)**


2.
      STOCK-BASED COMPENSATION (Continued):





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 September 30, 2008, there were 43,700 options granted and
      outstanding under this Plan. The 2005 Plan expires March 15, 2015.





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 nine months ended September 30:




Options
                granted
            
            2008
            
            2007Risk-free
                interest rate
            
            
            3.00
            %
            
            4.74
            %Dividend
                yield
            
            
            3.64
            
            
            3.50Volatility
            
            
            18.46
            
            
            15.99Expected
                life
            
            
            5
            yrs.
            
            5
            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.





The
      fair
      market value of options granted in the first nine months of 2008 and 2007 was
      $2.63 and $3.57, respectively.





Stock
      option activity during the nine months ended September 30, 2008 is as
      follows:





WeightedWeighted
            
            AverageAverage
            
            Remaining
            
            AggregateNumber of
            
            Exercise
            
            Contractual
            
            IntrinsicOptions
            
            Price
            
            Term (in yrs.)
            
            ValueOutstanding
                at January 1, 2008
            
            
            203,923
            
            $
            20.56
            
            
            3.9Exercised
            
            
            -
            
            
            -Granted
            
            
            17,400
            
            $
            21.00Outstanding
                at September 30, 2008
            
            
            221,323
            
            $
            20.60
            
            
            3.3
            
            $
            505Exercisable
                at September 30, 2008
            
            
            169,123
            
            $
            19.53
            
            
            3.2
            
            $
            505




-
          6
          -


**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2008 AND 2007, AND DECEMBER 31, 2007**


**(Unaudited)**





3.
      SHARE
      REPURCHASE PLAN





On
      January 24, 2008, QNB announced that the Board of Directors authorized the
      repurchase of up to 50,000 shares of its common stock in open market or
      privately negotiated transactions. The repurchase authorization does not bear
      a
      termination date. QNB has not repurchased any shares to date under this
      authorization.





4.
      EARNINGS PER SHARE





The
      following sets forth the computation of basic and diluted earnings per
      share:





For the Three Months
            
            For the Nine MonthsEnded September 30,
            
            Ended September 30,2008
            
            2007
            
            2008
            
            2007Numerator
                for basic and diluted earnings per share: net income
            
            $
            1,566
            
            $
            1,554
            
            $
            4,882
            
            $
            2,026Denominator
                for basic earnings per share: weighted average shares
                outstanding
            
            
            3,136,423
            
            
            3,130,300
            
            
            3,135,451
            
            
            3,129,359Effect
                of dilutive securities: employee stock options
            
            
            25,417
            
            
            45,871
            
            
            28,702
            
            
            45,152Denominator
                for diluted earnings per share: adjusted weighted average shares
                outstanding
            
            
            3,161,840
            
            
            3,176,171
            
            
            3,164,153
            
            
            3,174,511Earnings
                per share-basic
            
            $
            0.50
            
            $
            0.50
            
            $
            1.56
            
            $
            0.65Earnings
                per share-diluted
            
            $
            0.50
            
            $
            0.49
            
            $
            1.54
            
            $
            0.64




There
      were 121,600 and 87,100 stock options that were anti-dilutive for the three-
      and
      nine-month periods ended September 30, 2008, respectively. There were 69,700
      stock options that were anti-dilutive for each of the three- and nine-month
      periods ended September 30, 2007. These stock options were not included in
      the
      above calculation.


-
          7
          -


**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2008 AND 2007, AND DECEMBER 31, 2007**


**(Unaudited)**


5.
      COMPREHENSIVE INCOME





For
      QNB,
      the sole component of other comprehensive income (loss) is the unrealized
      holding gains and losses on available-for-sale investment
      securities.





The
      following shows the components and activity of comprehensive income during
      the
      periods ended


September
      30, 2008 and 2007:





For
                the Three Months
            
            For
                the Nine MonthsEnded
                September 30,
            
            Ended
                September 30,2008
            
            2007
            
            2008
            
            2007Unrealized
                holding (losses) gains arising during the period on securities
                available-for-sale [net of tax benefit (tax expense) of $483, $(609),
                $1,682 and $124, respectively]
            
            $
            (938
            )
            $
            1,183
            
            $
            (3,265
            )
            $
            (240
            )Reclassification
                adjustment for losses (gains) included in net income [net of tax
                benefit
                of $(35), $0, $0 and $(839), respectively]
            
            
            68
            
            
            -
            
            
            (1
            )
            
            1,630Net
                change in unrealized gains and losses during the period
            
            
            (870
            )
            
            1,183
            
            
            (3,266
            )
            
            1,390Accumulated
                other comprehensive (loss) income, beginning of period
            
            
            (892
            )
            
            (608
            )
            
            1,504
            
            
            (815
            )Accumulated
                other comprehensive (loss) income, end of period
            
            $
            (1,762
            )
            $
            575
            
            $
            (1,762
            )
            $
            575Net
                income
            
            $
            1,566
            
            $
            1,554
            
            $
            4,882
            
            $
            2,026Other
                comprehensive income, net of tax:Unrealized
                holding (losses) gains arising during the period [net of tax benefit
                (tax
                expense) of $448, $(609), $1,682 and $(715), respectively]
            
            
            (870
            )
            
            1,183
            
            
            (3,266
            )
            
            1,390Comprehensive
                income
            
            $
            696
            
            $
            2,737
            
            $
            1,616
            
            $
            3,416




-
          8
          -


**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2008 AND 2007, AND DECEMBER 31, 2007**


**(Unaudited)**


6.
      FAIR
      VALUE MEASUREMENTS





In
      September 2006, the FASB issued FASB No. 157, *Fair
      Value Measurements* ,
      to
      provide consistency and comparability in determining fair value measurements
      and
      to provide for expanded disclosures about fair value measurements. The
      definition of fair value maintains the exchange price notion in earlier
      definitions of fair value but focuses on the exit price of the asset or
      liability. The exit price is the price that would be received to sell the asset
      or paid to transfer the liability adjusted for certain inherent risks and
      restrictions. Expanded disclosures are also required about the use of fair
      value
      to measure assets and liabilities.





As
      required by FASB No. 157, each financial asset and liability must be identified
      as having been valued according to specified level of input, 1, 2 or 3.





·
            Level
                1 – Inputs are quoted prices (unadjusted) in active markets for
                identical assets or liabilities that QNB has the ability to access
                at the
                measurement date.


·
            Level
                2 – Significant other observable inputs other than quoted prices
                included in Level 1 that are observable for the asset, either directly
                or
                indirectly. Level 2 inputs include quoted prices for similar assets
                in
                active markets, and inputs other than quoted prices that are observable
                for the asset or liability.


·
            Level
                3 – Significant unobservable inputs for the asset, and include
                situations where there is little, if any, market activity for the
                asset or
                liability.





In
      certain cases, the inputs used to measure fair value may fall into different
      levels of the fair value hierarchy. In such cases, the level in the fair value
      hierarchy, within which the fair value measurement in its entirety falls, has
      been determined based on the lowest level input that is significant to the
      fair
      value measurement in its entirety. QNB’s assessment of the significance of a
      particular input to the fair value measurement in its entirety requires
      judgment, and considers factors specific to the asset.





The
      measurement of fair value should be consistent with one of the following
      valuation techniques: market approach, income approach, and/or cost approach.
      The market approach uses prices and other relevant information generated by
      market transactions involving identical or comparable assets or liabilities
      (including a business). For example, valuation techniques consistent with the
      market approach often use market multiples derived from a set of comparables.
      Multiples might lie in ranges with a different multiple for each comparable.
      The
      selection of where within the range the appropriate multiple falls requires
      judgment, considering factors specific to the measurement (qualitative and
      quantitative). Valuation techniques consistent with the market approach include
      matrix pricing. Matrix pricing is a mathematical technique used principally
      to
      value debt securities without relying exclusively on quoted prices for the
      specific securities, but rather by relying on the security’s relationship to
      other benchmark quoted securities.




QNB
      used
      the following methods and significant assumptions to estimate the fair value
      of
      each type of financial instrument.




Securities
      available-for-sale: The fair
      value for securities available-for-sale are determined by quoted market prices
      (Level 1). For securities where quoted prices are not available, fair values
      are
      calculated based on market prices of similar securities (Level 2). For
      securities where quoted market prices of similar securities are not available,
      fair values are calculated using discounted cash flows or other market
      indicators (Level 3).


-
          9
          -


**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2008 AND 2007, AND DECEMBER 31, 2007**


**(Unaudited)**




6.
      FAIR
      VALUE MEASUREMENTS (Continued)





Impaired
      Loans: QNB
      considers a loan impaired when it is probable that the Company will be unable
      to
      collect all amounts due according to the contractual terms of the note
      agreement, including principal and interest. Management has determined that
      commercial purpose loan relationships that are on nonaccrual status meet this
      impaired loan definition, with the amount of impairment based upon the estimated
      fair value of the collateral for collateral-dependent loans, or alternatively,
      the present value of the expected future cash flows discounted at the loan’s
      effective interest rate. Appraised values are generally used on real estate
      collateral-dependent impaired loans, which the Company classifies as a
      Level 3 nonrecurring fair value measurement. The present value of the
      expected future cash flows of an impaired loan is also classified as a
      Level 3 measurement.




The
      following table presents information about QNB’s assets measured at fair value
      on a recurring and nonrecurring basis as of September 30, 2008 and indicates
      the
      fair value hierarchy of the valuation techniques utilized by QNB to determine
      such fair value:




**Quoted Prices in**
            
            **Significant****Active Markets**
            
            **Other**
            
            **Significant****for Identical**
            
            **Observable**
            
            **Unobservable**
            
            **Balance as of****Assets**
            
            **Input**
            
            **Inputs**
            
            **September 30,****(Level 1)**
            
            **(Level 2)**
            
            **(Level 3)**
            
            **2008*****Recurring basis:***Securities
                available-for-sale
            
            $
            3,945
            
            $
            212,569
            
            $
            3,161
            
            $
            219,675***Nonrecurring
                basis:***Impaired
                loans
            
            $
            -
            
            $
            -
            
            $
            384
            
            $
            384




The
      table
      below presents a reconciliation of all assets measured at fair value on a
      recurring basis using significant unobservable inputs (Level 3) for the quarter
      ended September 30, 2008:





**Fair Value****Measurements Using****Significant****Unobservable Inputs****(Level 3)****Securities available-****for-****sale**Beginning
                balance, July 1, 2008
            
            $
            3,581Purchases,
                issuances and settlements
            
            
            (69
            )Total
                gains or losses (realized/unrealized)Included
                in earnings
            
            
            -Included
                in other comprehensive income
            
            
            (351
            )Transfers
                in and/or out of Level 3
            
            
            -Ending
                balance, September 30, 2008
            
            $
            3,161




-
          10
          -


**QNB
        CORP. AND SUBSIDIARY**
 
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 AND 2007, AND DECEMBER 31, 2007**
 **(Unaudited)**





There
      were no gains or losses for the period included in earnings attributable to
      the
      change in unrealized gains or losses relating to the available-for-sale
      securities above with fair value measurements utilizing significant unobservable
      inputs.





Securities
      available-for-sale with fair value Level 3 measurements consist of pools of
      trust preferred securities. The market for trust preferred securities
      issued by Banks and Insurance companies has become inactive in response to
      the
      global credit crisis. Bid-ask spreads on these types of securities have widened
      significantly and the volume of trades has been virtually non-existent during
      2008. QNB holds some of these investment securities in our
      available-for-sale portfolio and chose to value them using Level 3 inputs
      at September 30, 2008. We determined that significant adjustments
      using unobservable inputs were required to determine the fair value of
      these securities at the measurement date which resulted in a Level 3 price.
      The
      pricing for these securities utilized a discount rate from the Bloomberg
      Fair Value Index yield curve for single issuer trust preferred securities with
      similar ratings, interest rates and maturity dates (an observable input). 
In addition, a 150 basis point liquidity premium was utilized to take into
      account nonperformance and liquidity risk (a management estimate and thus an
      unobservable input). Both the yield to maturity as well as the yield to auction
      call were considered, with the ultimate pricing using an average of these
      two.





7.
      LOANS





The
      following table presents loans by category as of September 30, 2008 and December
      31, 2007:





September 30,
              2008
            
            December 31,
              2007Commercial and industrial
            
            $
            83,456
            
            $
            88,445Construction
            
            
            26,270
            
            
            23,959Agricultural
            
            
            -
            
            
            25Real
                estate-commercial
            
            
            132,041
            
            
            131,392Real
                estate-residential
            
            
            120,338
            
            
            119,172Consumer
            
            
            4,799
            
            
            4,442Indirect
                lease financing
            
            
            13,042
            
            
            13,431Total
                loans
            
            
            379,946
            
            
            380,866Net
                unearned costs (fees)
            
            
            159
            
            
            150Total
                loans, net
            
            $
            380,105
            
            $
            381,016


-
          11
          -


**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2008 AND 2007, AND DECEMBER 31, 2007**


**(Unaudited)**


8.
      INTANGIBLE ASSETS:





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





Nine Months Ended
            
            Year EndedSeptember 30,
            
            December 31,2008
            
            2007Mortgage
                servicing rights beginning balance
            
            $
            451
            
            $
            472Mortgage
                servicing rights capitalized
            
            
            58
            
            
            49Mortgage
                servicing rights amortized
            
            
            (60
            )
            
            (70
            )Fair
                market value adjustments
            
            
            -
            
            
            -Mortgage
                servicing rights ending balance
            
            $
            449
            
            $
            451Mortgage
                loans serviced for others
            
            $
            69,206
            
            $
            69,194Amortization
                expense of intangibles
            
            $
            60
            
            $
            113





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 12/31/08
            
            $
            81For
                the Year Ended 12/31/09
            
            
            80For
                the Year Ended 12/31/10
            
            
            69For
                the Year Ended 12/31/11
            
            
            57For
                the Year Ended 12/31/12
            
            
            47





9.
      OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS AND GUARANTEES





QNB
      is a
      party to financial instruments with off-balance-sheet risk in the normal course
      of business to meet the financing needs of its customers. These financial
      instruments include commitments to extend credit and letters of credit. These
      instruments involve, to varying degrees, elements of credit and interest rate
      risk in excess of the amount recognized in the balance sheets. The Bank's
      exposure to credit loss in the event of nonperformance by the other party to
      the
      financial instrument for commitments to extend credit and letters of credit
      is
      represented by the contractual amount of those instruments. The Bank uses the
      same lending standards and policies in making commitments and conditional
      obligations as it does for on-balance sheet instruments. The activity is
      controlled through credit approvals, control limits, and monitoring
      procedures.




-
          12
          -


**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2008 AND 2007, AND DECEMBER 31, 2007**


**(Unaudited)**


9.
      OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS AND GUARANTEES (Continued)





A
      summary
      of the Bank's financial instrument commitments is as follows:





September 30,
            
            December 31,2008
            
            2007Commitments
                to extend credit and unused lines of credit
            
            $
            91,960
            
            $
            77,264Standby
                letters of credit
            
            
            2,689
            
            
            3,760$
            94,649
            
            $
            81,024





Commitments
      to extend credit are agreements to lend to a customer as long as there is no
      violation of any condition established in the contract. Commitments generally
      have fixed expiration dates or other termination clauses and may require payment
      of a fee. Since some of the commitments are expected to expire without being
      drawn upon, the total commitment amount does not necessarily represent future
      cash requirements. QNB evaluates each customer's credit worthiness on a
      case-by-case basis. The amount of collateral obtained, if deemed necessary
      by
      QNB upon extension of credit, is based on management's credit evaluation of
      the
      customer and generally consists of real estate.





QNB
      does
      not issue any guarantees that would require liability recognition or disclosure,
      other than its standby letters of credit. Standby letters of credit written
      are
      conditional commitments issued to guarantee the performance of a customer to
      a
      third party. Generally, all letters of credit, when issued, have expiration
      dates within one year. The credit risk involved in issuing letters of credit
      is
      essentially the same as those that are involved in extending loan facilities
      to
      customers. The Bank, generally, holds collateral and/or personal guarantees
      supporting these commitments. Management believes that the proceeds obtained
      through a liquidation of collateral and the enforcement of guarantees would
      be
      sufficient to cover the potential amount of future payments required under
      the
      corresponding guarantees. The current amount of the liability as of September
      30, 2008 and December 31, 2007 for guarantees under standby letters of credit
      issued is not material.





10.
      RECENT ACCOUNTING PRONOUNCEMENTS





In
      September 2006, the FASB reached consensus on the guidance provided by Emerging
      Issues Task Force Issue 06-4 (EITF 06-4), *Accounting
      for Deferred Compensation and Postretirement Benefit Aspects of Endorsement
      Split-Dollar Life Insurance Arrangements* .
      The
      guidance is applicable to endorsement split dollar life insurance arrangements,
      whereby the employer owns and controls the insurance policy, that are associated
      with a postretirement benefit. EITF 06-4 requires that for a split-dollar life
      insurance arrangement within the scope of the Issue, an employer should
      recognize a liability for future benefits in accordance with FASB No. 106 (if,
      in substance, a postretirement benefit plan exists) or Accounting Principles
      Board Opinion No. 12 (if the arrangement is, in substance, an individual
      deferred compensation contract) based on the substantive agreement with the
      employee. EITF 06-4 is effective for fiscal years beginning after December
      15,
      2007. As a result of adopting this standard, QNB recorded a cumulative effect
      adjustment of $481,000 to retained earnings effective January 1, 2008. In
      addition, the expense recorded in the first nine months of 2008 was
      approximately $33,000.


-
          13
          -


**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2008 AND 2007, AND DECEMBER 31, 2007**


**(Unaudited)**


10.
      RECENT ACCOUNTING PRONOUNCEMENTS (Continued)





In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for Financial Assets and Financial Liabilities-Including
      an
      amendment of FASB Statement No. 115* .
      SFAS
      No. 159 permits entities to choose to measure many financial instruments and
      certain other items at fair value. Unrealized gains and losses on items for
      which the fair value option has been elected will be recognized in earnings
      at
      each subsequent reporting date. SFAS No. 159 was effective for QNB on January
      1,
      2008. QNB did not elect to measure any items at fair value, therefore the
      adoption of SFAS No. 159 did not have an impact on our consolidated financial
      statements.





FASB
      Statement No. 141(R) *Business
      Combinations* was
      issued in December of 2007. This Statement establishes principles and
      requirements for how the acquirer of a business recognizes and measures in
      its
      financial statements the identifiable assets acquired, the liabilities assumed,
      and any noncontrolling interest in the acquiree. The Statement also provides
      guidance for recognizing and measuring the goodwill acquired in the business
      combination and determines what information to disclose to enable users of
      the
      financial statements to evaluate the nature and financial effects of the
      business combination. The guidance will become effective as of the beginning
      of
      a company’s fiscal year beginning after December 15, 2008. This new
      pronouncement will impact QNB’s accounting for business combinations completed
      beginning January 1, 2009.





In
      March
      2008, the FASB issued Statement No. 161, *Disclosures
      about Derivative Instruments and Hedging Activities—an amendment of FASB
      Statement No. 133* (Statement 161).  Statement 161 requires entities that utilize
      derivative instruments to provide qualitative disclosures about their objectives
      and strategies for using such instruments, as well as any details of
      credit-risk-related contingent features contained within
      derivatives.  Statement 161 also requires entities to disclose
      additional information about the amounts and location of derivatives located
      within the financial statements, how the provisions of SFAS 133 have been
      applied, and the impact that hedges have on an entity’s financial position,
      financial performance, and cash flows.  Statement 161 is effective for
      fiscal years and interim periods beginning after November 15, 2008, with early
      application encouraged.  The implementation of this standard will not
      have any impact on QNB’s consolidated financial position and results of
      operations.





In
      May
      2008, the FASB issued SFAS No. 162, *The
      Hierarchy of Generally Accepted Accounting Principles* .
      This
      Statement identifies the sources of accounting principles and the framework
      for
      selecting the principles used in the preparation of financial statements. This
      Statement is effective 60 days following the SEC’s approval of the Public
      Company Accounting Oversight Board amendments to AU Section 411, *The
      Meaning of Present Fairly in Conformity with Generally Accepted Accounting
      Principles* .
      The
      implementation of this standard will not have a material impact on QNB’s
      consolidated financial position and results of operations.





In
      September 2008, the FASB issued FSP 133-1 and FIN 45-4, *Disclosures
      about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement
      No. 133 and FASB Interpretation No. 45; and Clarification of the Effective
      Date
      of FASB Statement No. 161* (FSP
      133-1 and FIN 45-4). FSP 133-1 and FIN 45-4 amends and enhances disclosure
      requirements for sellers of credit derivatives and financial guarantees. It
      also
      clarifies that the disclosure requirements of SFAS No. 161 are effective for
      quarterly periods beginning after November 15, 2008, and fiscal years that
      include those periods. FSP 133-1 and FIN 45-4 is effective for reporting periods
      (annual or interim) ending after November 15, 2008. The implementation of this
      standard will not have any impact on QNB’s consolidated financial position and
      results of operations.


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          14
          -


**QNB
      CORP. AND SUBSIDIARY**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**SEPTEMBER
      30, 2008 AND 2007, AND DECEMBER 31, 2007**


**(Unaudited)**


10.
      RECENT ACCOUNTING PRONOUNCEMENTS (Continued)





In
      October 2008, the FASB issued FSP SFAS No. 157-3, *Determining
      the Fair Value of a Financial Asset When The Market for That Asset Is Not
      Active* (FSP 157-3), to clarify the application of the provisions of SFAS 157
      in an inactive market and how an entity would determine fair value in an
      inactive market. FSP 157-3 is effective immediately and applies to our
      September 30, 2008 financial statements. QNB has applied the provisions of
      FSP 157-3 to its financial statements as of and for the period ended
      September 30, 2008. At September 30, 2008, the Company determined that
      no active market existed for available-for-sale securities with an amortized
      cost of $5,111,000. The Company has estimated fair values of such investment
      securities through the use of unobservable inputs. As a result, the Company
      reports these securities in the Level 3 category and estimated that the fair
      values of such securities was $3,161,000 at September 30,
      2008.


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          15
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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**


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





QNB
      Corp.
      is a bank holding company headquartered in Quakertown, Pennsylvania. QNB Corp.,
      through its wholly-owned subsidiary, QNB 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” or
      the “Company”.





Prior
      to
      December 28, 2007, the Bank was a national banking association organized in
      1877
      as The Quakertown National Bank. As The Quakertown National Bank, it was
      chartered under the National Banking Act and was subject to Federal and state
      laws applicable to commercial banks. Effective December 28, 2007, the Bank
      became a Pennsylvania chartered commercial bank and changed its name to QNB
      Bank.





Tabular
      information presented throughout management’s discussion and analysis, other
      than share and per share data, is presented in thousands of dollars.





**Forward-Looking
      Statements**





In
      addition to historical information, this document contains forward-looking
      statements. Forward-looking statements are typically identified by words or
      phrases such as “believe,” “expect,” “anticipate,” “intend,” “estimate,”
“project” and variations of such words and similar expressions, or future or
      conditional verbs such as “will,” “would,” “should,” “could,” “may” or similar
      expressions. The U.S. Private Securities Litigation Reform Act of 1995 provides
      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 Company and its subsidiary and could cause
      those results to differ materially from those expressed in the forward-looking
      statements contained or incorporated by reference in this document. These
      factors include, but are not limited, to the following:





·
            Volatility
                in interest rates and shape of the yield
                curve;


·
            Credit
                risk;


·
            Liquidity
                risk;


·
            Operating,
                legal and regulatory risks;


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


·
            The
                risk that the analysis of these risks and forces could be incorrect,
                and/or that the strategies developed to address them could be
                unsuccessful.





QNB
      cautions that these forward-looking statements are subject to numerous
      assumptions, risks and uncertainties, all of which change over time, and QNB
      assumes no duty to update forward-looking statements. Management cautions
      readers not to place undue reliance on any forward-looking statements. These
      statements speak only as of the date of this Quarterly Report on Form 10-Q,
      even
      if subsequently made available by QNB on its website or otherwise, and they
      advise readers that various factors, including those described above, could
      affect QNB’s financial performance and could cause actual results or
      circumstances for future periods to differ materially from those anticipated
      or
      projected. Except as required by law, QNB does not undertake, and specifically
      disclaims any obligation, to publicly release any revisions to any
      forward-looking statements to reflect the occurrence of anticipated or
      unanticipated events or circumstances after the date of this Quarterly Report
      on
      Form 10-Q.


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          16
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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**




**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 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 provision for loan losses is
      charged to earnings to maintain the total allowance for loan losses at a level
      considered necessary by management.





The
      allowance for loan losses is based on management’s continuous 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 or the present value of future cash flows for
      non-collateral dependent loans. 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.


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          17
          -






**QNB
      CORP. AND SUBSIDIARY**




**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





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


**Allowance
      for Loan Losses (Continued)**





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 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.
      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 the 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.
      As a result of sharp declines in the equity markets, QNB recorded an
      other-than-temporary impairment charge of $103,000 in the third quarter of
      2008
      and $301,000 for the nine months ended September 30, 2008 related to several
      equity securities held by the Company. QNB recorded an other-than-temporary
      impairment charge of $2,758,000 as of March 31, 2007. These securities
      identified as impaired as of March 31, 2007 were subsequently sold in April
      2007.




-
          18
          -




**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**RESULTS
      OF OPERATIONS - OVERVIEW**





QNB
      Corp.
      earns its net income primarily through its subsidiary, QNB Bank. Net interest
      income, or the spread between the interest, dividends and fees earned on loans
      and investment securities and the expense incurred on deposits and other
      interest-bearing liabilities, is the primary source of operating income for
      QNB.
      QNB seeks to achieve sustainable and consistent earnings growth while
      maintaining adequate levels of capital and liquidity and limiting its exposure
      to credit and interest rate risk levels approved by the Board of Directors.
      Due
      to its limited geographic area, comprised principally of 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. During the third
      quarter QNB announced that it was expanding its presence in Lehigh County by
      opening a branch in the fast growing areas of Wescosville and Emmaus. This
      location is expected to open in November 2008.





QNB
      reported net income for the third quarter of 2008 of $1,566,000, or $.50 per
      share on a diluted basis. These results compare to net income of $1,554,000,
      or
      $.49 per share on a diluted basis, for the same period in 2007. For the nine
      months ended September 30, 2008, net income was $4,882,000, or $1.54 per share
      on a diluted basis, compared to net income of $2,026,000, or $.64 per share
      on a
      diluted basis, for the comparable period in 2007. Net income for the first
      nine
      months of 2008 represents record nine-month performance for the
      Company.





The
      results for the quarter reflect an increase in net interest income offset by
      lower non-interest income and higher non-interest expenses, while the results
      for the nine-month period ended September 2008 reflect the benefits of the
      restructuring transactions executed in 2007, as well as the impact of an
      increase in the net interest margin resulting primarily from lower customer
      deposit costs. In April 2007, the Company restructured its balance sheet by
      selling approximately $92,000,000 of lower yielding securities, that had been
      identified as other-than-temporarily impaired in the first quarter of 2007,
      and
      by prepaying $50,000,000 of higher costing Federal Home Loan Bank (FHLB)
      advances. The purpose of the restructuring transactions was to improve the
      Bank’s net interest margin on a going-forward basis and to increase net interest
      income and net income.





An
      increase in the net interest margin combined with growth in earning assets
      resulted in net interest income increasing $540,000, or 12.0%, to $5,045,000
      for
      the three months ended September 30, 2008 compared to the same period in 2007.
      The net interest margin for the third quarter of 2008 was 3.49% compared to
      3.36% for the third quarter of 2007. The 13 basis point increase in the net
      interest margin is primarily the result of lower customer deposit costs
      resulting from market interest rates declining significantly in combination
      with
      the short-term repricing structure of the deposit base. The cost of
      interest-bearing deposits was 2.74% for the third quarter of 2008 compared
      with
      3.54% for the third quarter of 2007. This decline in the cost of deposits more
      than offset the decline in the yield on earning assets which decreased from
      6.49% for the third quarter of 2007 to 5.94% for the third quarter of 2008.





Average
      earning assets increased 7.3% to $616,597,000 for the third quarter of 2008
      compared to $574,747,000 for the third quarter of 2007, with average loans
      increasing 3.6% and average investment securities increasing 15.8%. The growth
      in the investment portfolio was primarily in high quality U.S. Government agency
      and agency mortgage-backed securities.


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          19
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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





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





The
      increase in average earning assets was principally funded through deposit
      growth. Average total deposits increased $27,566,000, or 5.5% to $531,891,000,
      when comparing the two quarters. The growth in deposits when comparing the
      third
      quarter of 2008 and the third quarter of 2007 was organic growth mostly
      unrelated to the seasonal deposit activity of municipal deposit customers.
      QNB
      acts as a depository for many school districts and municipalities whose balances
      are volatile during the third quarter, as school taxes are received. The timing
      of both the receipt and disbursement of these funds impacts the average balance.
      When comparing the third quarter of 2008 with the third quarter of 2007, average
      interest-bearing municipal demand accounts decreased $2,562,000 to $50,019,000.
      These municipal deposits did impact the growth in deposits when comparing the
      second quarter of 2008 to the third quarter of 2008. As a comparison, average
      total deposits were $512,090,000 for the second quarter of 2008 with municipal
      interest-bearing demand accounts representing $37,897,000 of the total balance.





When
      comparing the nine-month periods net interest income increased $1,659,000,
      or
      12.7%. Contributing to this increase was a 25 basis point increase in the net
      interest margin and a 4.1% increase in average earning assets. The net interest
      margin was 3.54% for the first nine months of 2008 compared with 3.29% for
      the
      same period in 2007. Average loans increased 5.5% when comparing the nine-month
      periods. A significant factor in the increase in net interest income and the
      net
      interest margin when comparing the nine-month periods was the positive impact
      of
      the restructuring transactions achieved in April 2007. As a result of these
      transactions QNB was able to increase its average yield on the investment
      portfolio while decreasing its costs of long-term debt, thereby increasing
      its
      net interest margin and net interest income.





A
      slowdown in the local and regional economy and a softening of the residential
      real estate market has resulted in an increase in job losses and lower home
      values. These factors combined with higher energy and food costs and instability
      in financial markets has had a negative impact on both consumers and small
      businesses and has contributed to an increase in the amount of loans
      charged-off, particularly in the purchased lease portfolio. This increase in
      the
      amount of loans charged-off, a slight increase in non-performing loans and
      the
      inherent risk related to loan growth contributed to management’s decision to
      increase the provision for loan losses in 2008 by $200,000 to $575,000 when
      comparing the nine-month periods ended September 30, 2008 and September 30,
      2007. For both three-month periods ended September 30, 2008 and 2007 the
      provision for loan losses was $150,000.





Total
      non-performing loans, which represent loans on non-accrual status and loans
      past
      due more than 90 days, were $1,190,000, or .31% of total loans, at September
      30,
      2008 compared with $1,084,000, or .30% of total loans, at September 30, 2007.
      The third quarter of 2008 amount also represents a slight increase in
      non-performing loans from the $823,000, or .21% of total loans, reported at
      June
      30, 2008. While this represents a slight increase in non-performing loans,
      QNB’s
      non-performing loans to total loans experience compares favorably with the
      average for Pennsylvania commercial banks with assets between $500 million
      and
      $1 billion at .90% of total loans as reported by the FDIC using June 30, 2008
      data. QNB’s allowance for loan losses of $3,492,000 represents .92% of total
      loans at September 30, 2008 compared to an allowance for loan losses of
      $3,001,000, or .82% of total loans, at September 30, 2007.





Total
      non-interest income for the third quarter of 2008 was $815,000, a decline from
      the $989,000 reported for the same period in 2007. The primary difference is
      related to activity in the investment securities portfolio and the loans
      held-for-sale portfolio. During the third quarter of 2008, QNB recorded $103,000
      of securities losses related to an other-than-temporary impairment charge on
      two
      holdings in the equity investment portfolio. Also with the slowdown in the
      residential mortgage market, gains on the sale of loans declined from $50,000
      for the third quarter of 2007 to $13,000 for the same period in 2008. In
      addition, losses on the sale of repossessed assets were $21,000 for the third
      quarter of 2008 compared with gains of $15,000 for the same period in 2007.




-
          20
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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





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





For
      the
      nine-month period ended September 30, 2008 total non-interest income was
      $3,028,000 compared to $257,000 for the first nine months of 2007. Positively
      impacting non-interest income for the first nine months of 2008 was the first
      quarter recognition of $230,000 of
      income
      as a result of the Visa initial public offering comprised of a $175,000 gain
      related to the mandatory redemption of shares of restricted common stock in
      Visa
      and $55,000 of income related to the reversal of liabilities recorded in the
      fourth quarter of 2007 to fund settlements of, or judgments in, indemnified
      litigation involving Visa. Total
      non-interest income, excluding the impact of the Visa items noted above and
      net
      investment securities gains of $1,000, would have been $2,797,000 for the first
      nine months of 2008. This compares favorably to total non-interest income of
      $2,726,000 for the first nine months of 2007, excluding the other-than-temporary
      impairment charge of $2,758,000 recorded in the first quarter of 2007 and
      realized security gains of $289,000.





Total
      non-interest expense was $3,668,000 for the third quarter of 2008 compared
      to
      $3,327,000 for the third quarter of 2007. Higher personnel costs contributed
      to
      the increase in non-interest expense for the quarter. Salary and benefit expense
      increased $173,000, or 9.5%, when comparing the periods. An accrual for
      incentive compensation and an accrual for post retirement life insurance
      benefits contributed $51,000 and $13,000, respectively, to the increase. An
      increase in the number of employees and higher medical and dental premiums
      also
      contributed to the rise in salary and benefits expense. Net occupancy and
      furniture and equipment expense increased $51,000, when comparing the
      three-month periods, reflecting an increase in depreciation expense, utility
      costs and maintenance expense. In addition, Federal Deposit Insurance
      Corporation (FDIC), premiums increased $67,000 when comparing the third quarter
      of 2008 to the third quarter of 2007. During 2007, QNB had a credit from prior
      year payments that was used to offset the premiums. The remainder of the credit
      was utilized in early 2008.





For
      the
      nine-month period ended September 30, 2008 total non-interest expense was
      $10,794,000. This compares to total non-interest expense of $10,801,000 for
      the
      same period in 2007, which included recognition of a $740,000 prepayment penalty
      on the FHLB advances. Excluding this charge total non-interest expense for
      the
      nine-month period of 2007 would have been $10,061,000.  Salary
      and benefits expense increased $371,000, or 6.7%, to $5,925,000, compared to
      the
      same period in 2007. Salary expense increased by $288,000, or 6.4%, while
      benefits expense increased by $83,000, or 7.7%, when comparing the two periods.
      The accrual for incentive compensation in 2008 contributed $142,000 to the
      increase in salary expense. Stock compensation expense was $44,000 and $77,000,
      for the respective nine-month periods ended September 30, 2008 and 2007. Base
      salary expense increased by 4.6% when comparing the nine-month periods.
      Contributing to the increase in benefits expense was an expense of $33,000
      related to the adoption of EITF 06-04 for the accounting for post retirement
      life insurance benefits. Net occupancy and furniture and equipment expense
      increased $182,000 when comparing the nine-month periods, again resulting from
      increases in depreciation expense, utility costs, building and equipment
      maintenance costs and branch rent expense. When comparing the nine-month
      periods, FDIC insurance premiums increased by $147,000. This was partially
      offset by savings of $72,000 resulting from the change in the charter of the
      Bank from being a nationally chartered bank to a state chartered
      bank.





The
      prepayment of the FHLB advances resulted in the recognition of an after-tax
      charge of $488,000, or $.16 on a diluted basis, for the second quarter of 2007
      while the impairment charge resulted in a reduction of net income of $1,820,000,
      or $.57 on a diluted basis, for the first quarter of 2007. Excluding the impact
      of the impairment charge and the prepayment penalty, net income for the
      nine-month period ended September 30, 2007 would have been $4,334,000, or $1.37
      per share on a diluted basis.




-
          21
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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





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





QNB
      operates in an attractive market for financial services but also 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 customer service, including local
      decision-making on loans, the establishment of long-term customer relationships
      and customer loyalty, products and services designed to address the specific
      needs of our customers and technology, including internet-banking and electronic
      bill pay.





These
      items noted in the foregoing overview, as well as others, will be discussed
      and
      analyzed more thoroughly in the next sections.


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          22
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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**Average
      Balances, Rate, and Interest Income and Expense Summary (** ***Tax-Equivalent
      Basis*** **)**


**Three Months Ended****September 30, 2008**
              
              **September 30, 2007****Average**
              
              **Average**
              
              
              
              **Average**
              
              **Average****Balance**
              
              **Rate**
              
              **Interest**
              
              **Balance**
              
              **Rate**
              
              **Interest****Assets**Federal
                  funds sold
              
              $
              11,136
              
              
              1.99
              %
              $
              56
              
              $
              13,435
              
              
              5.12
              %
              $
              173Investment
                  securities:U.S.
                  Treasury
              
              
              5,167
              
              
              3.46
              %
              
              45
              
              
              5,084
              
              
              4.76
              %
              
              61U.S.
                  Government agencies
              
              
              42,786
              
              
              4.93
              %
              
              527
              
              
              34,636
              
              
              5.56
              %
              
              481State
                  and municipal
              
              
              43,641
              
              
              6.48
              %
              
              707
              
              
              39,074
              
              
              6.60
              %
              
              645Mortgage-backed
                  and CMOs
              
              
              111,769
              
              
              5.39
              %
              
              1,507
              
              
              94,130
              
              
              5.57
              %
              
              1,312Domestic
                  debt (fixed and variable)
              
              
              11,612
              
              
              5.86
              %
              
              170
              
              
              14,708
              
              
              6.99
              %
              
              257Mutual
                  fund
              
              
              3,201
              
              
              2.60
              %
              
              21
              
              
              -
              
              
              0.00
              %
              
              -Equities
              
              
              4,168
              
              
              2.61
              %
              
              27
              
              
              4,384
              
              
              2.38
              %
              
              27Total
                  investment securities
              
              
              222,344
              
              
              5.40
              %
              
              3,004
              
              
              192,016
              
              
              5.80
              %
              
              2,783Loans:Commercial
                  real estate
              
              
              182,712
              
              
              6.57
              %
              
              3,015
              
              
              167,335
              
              
              6.85
              %
              
              2,889Residential
                  real estate
              
              
              21,426
              
              
              6.07
              %
              
              325
              
              
              23,883
              
              
              6.00
              %
              
              358Home
                  equity loans
              
              
              68,223
              
              
              5.81
              %
              
              996
              
              
              69,770
              
              
              6.54
              %
              
              1,150Commercial
                  and industrial
              
              
              67,073
              
              
              5.84
              %
              
              984
              
              
              63,159
              
              
              7.35
              %
              
              1,170Indirect
                  lease financing
              
              
              12,952
              
              
              9.49
              %
              
              308
              
              
              13,757
              
              
              9.48
              %
              
              326Consumer
                  loans
              
              
              4,687
              
              
              11.91
              %
              
              140
              
              
              4,675
              
              
              10.54
              %
              
              124Tax-exempt
                  loans
              
              
              23,685
              
              
              6.03
              %
              
              359
              
              
              24,819
              
              
              6.17
              %
              
              386Total
                  loans, net of unearned income*
              
              
              380,758
              
              
              6.40
              %
              
              6,127
              
              
              367,398
              
              
              6.91
              %
              
              6,403Other
                  earning assets
              
              
              2,359
              
              
              2.38
              %
              
              14
              
              
              1,898
              
              
              8.19
              %
              
              39Total
                  earning assets
              
              
              616,597
              
              
              5.94
              %
              
              9,201
              
              
              574,747
              
              
              6.49
              %
              
              9,398Cash
                  and due from banks
              
              
              11,825
              
              
              
              
              
              
              
              
              12,231Allowance
                  for loan losses
              
              
              (3,493
              )
              
              
              
              
              
              
              
              (2,929
              )Other
                  assets
              
              
              22,116
              
              
              
              
              
              
              
              
              21,936Total
                  assets
              
              $
              647,045
              
              
              
              
              
              
              
              $
              605,985**Liabilities
                  and Shareholders' Equity**Interest-bearing
                  deposits:Interest-bearing
                  demand
              
              $
              58,772
              
              
              0.32
              %
              
              47
              
              $
              54,339
              
              
              0.18
              %
              
              25Municipals
              
              
              50,019
              
              
              1.82
              %
              
              229
              
              
              52,581
              
              
              4.96
              %
              
              657Money
                  market
              
              
              47,254
              
              
              1.67
              %
              
              198
              
              
              52,624
              
              
              3.09
              %
              
              409Savings
              
              
              44,456
              
              
              0.39
              %
              
              44
              
              
              44,712
              
              
              0.39
              %
              
              44Time
              
              
              200,341
              
              
              3.99
              %
              
              2,007
              
              
              187,873
              
              
              4.59
              %
              
              2,171Time
                  over $100,000
              
              
              77,019
              
              
              3.97
              %
              
              768
              
              
              60,093
              
              
              4.77
              %
              
              723Total
                  interest-bearing deposits
              
              
              477,861
              
              
              2.74
              %
              
              3,293
              
              
              452,222
              
              
              3.54
              %
              
              4,029Short-term
                  borrowings
              
              
              21,487
              
              
              2.09
              %
              
              113
              
              
              22,164
              
              
              3.57
              %
              
              200Long-term
                  debt
              
              
              35,000
              
              
              4.27
              %
              
              381
              
              
              25,000
              
              
              4.78
              %
              
              306Total
                  interest-bearing liabilities
              
              
              534,348
              
              
              2.82
              %
              
              3,787
              
              
              499,386
              
              
              3.60
              %
              
              4,535Non-interest-bearing
                  deposits
              
              
              54,030
              
              
              
              
              
              
              
              
              52,103Other
                  liabilities
              
              
              4,749
              
              
              
              
              
              
              
              
              3,387Shareholders'
                  equity
              
              
              53,918
              
              
              
              
              
              
              
              
              51,109Total
                  liabilities and shareholders' equity
              
              $
              647,045
              
              
              
              
              
              
              
              $
              605,985Net
                  interest rate spread
              
              
              
              
              
              3.12
              %
              
              
              
              
              
              
              
              2.89
              %Margin/net
                  interest income
              
              
              
              
              
              3.49
              %
              $
              5,414
              
              
              
              
              
              3.36
              %
              $
              4,863


Tax-exempt
      securities and loans were adjusted to a tax-equivalent basis and are based
      on
      the marginal Federal corporate tax rate of 34 percent.


Non-accrual
      loans are included in earning assets.


*
      Includes loans held-for-sale


-
          23
          -


**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**




**Average
        Balances, Rate, and Interest Income and Expense Summary (** ***Tax-Equivalent
        Basis*** **)**




**Nine Months Ended****September 30, 2008**
            
            **September 30, 2007****Average**
            
            **Average**
            
            
            
            **Average**
            
            **Average****Balance**
            
            **Rate**
            
            **Interest**
            
            **Balance**
            
            **Rate**
            
            **Interest****Assets**Federal
                funds sold
            
            $
            8,244
            
            
            2.23
            %
            $
            138
            
            $
            7
                ,491
            
            
            5.17
            %
            $
            290Investment
                securities:U.S.
                Treasury
            
            
            5,106
            
            
            3.72
            %
            
            142
            
            
            5,093
            
            
            4.73
            %
            
            180U.S.
                Government agencies
            
            
            34,158
            
            
            5.21
            %
            
            1,335
            
            
            32,971
            
            
            5.54
            %
            
            1,370State
                and municipal
            
            
            42,887
            
            
            6.53
            %
            
            2,099
            
            
            39,474
            
            
            6.61
            %
            
            1,956Mortgage-backed
                and CMOs
            
            
            105,062
            
            
            5.49
            %
            
            4
                ,325
            
            
            105,699
            
            
            5.07
            %
            
            4,023Domestic
                debt (fixed and variable)
            
            
            13,063
            
            
            6.19
            %
            
            607
            
            
            14,360
            
            
            7.10
            %
            
            764Mutual
                fund
            
            
            1,075
            
            
            2.60
            %
            
            21
            
            
            -
            
            
            0.00
            %
            
            -Equities
            
            
            4,213
            
            
            2.63
            %
            
            83
            
            
            4,317
            
            
            2.46
            %
            
            80Total
                investment securities
            
            
            205,564
            
            
            5.59
            %
            
            8,612
            
            
            201,914
            
            
            5.53
            %
            
            8,373Loans:Commercial
                real estate
            
            
            180,844
            
            
            6.77
            %
            
            9,162
            
            
            163,642
            
            
            6.82
            %
            
            8,346Residential
                real estate
            
            
            21,726
            
            
            6.14
            %
            
            1,000
            
            
            25,185
            
            
            5.94
            %
            
            1,121Home
                equity loans
            
            
            68,224
            
            
            5.92
            %
            
            3,024
            
            
            69,495
            
            
            6.51
            %
            
            3,386Commercial
                and industrial
            
            
            68,567
            
            
            6.15
            %
            
            3,156
            
            
            60,910
            
            
            7.36
            %
            
            3,352Indirect
                lease financing
            
            
            12,919
            
            
            9.77
            %
            
            946
            
            
            13,560
            
            
            9.51
            %
            
            967Consumer
                loans
            
            
            4,492
            
            
            11.51
            %
            
            387
            
            
            4,755
            
            
            10.40
            %
            
            370Tax-exempt
                loans
            
            
            24,144
            
            
            6.07
            %
            
            1,097
            
            
            23,486
            
            
            6.15
            %
            
            1,080Total
                loans, net of unearned income*
            
            
            380,916
            
            
            6.58
            %
            
            18,772
            
            
            361,033
            
            
            6.90
            %
            
            18,622Other
                earning assets
            
            
            2,295
            
            
            2.76
            %
            
            47
            
            
            3,007
            
            
            7.06
            %
            
            159Total
                earning assets
            
            
            597,019
            
            
            6.17
            %
            
            27,569
            
            
            573,445
            
            
            6.40
            %
            
            27,444Cash
                and due from banks
            
            
            10,693
            
            
            
            
            
            
            
            
            11,495Allowance
                for loan losses
            
            
            (3,405
            )
            
            
            
            
            
            
            
            (2,813
            )Other
                assets
            
            
            21,873
            
            
            
            
            
            
            
            
            21,699Total
                assets
            
            $
            626,180
            
            
            
            
            
            
            
            $
            603,826**Liabilities
                and Shareholders' Equity**Interest-bearing
                deposits:Interest-bearing
                demand
            
            $
            56,812
            
            
            0.21
            %
            
            92
            
            $
            55,023
            
            
            0.19
            %
            
            76Municipals
            
            
            41,477
            
            
            2.23
            %
            
            692
            
            
            45,603
            
            
            4.99
            %
            
            1,701Money
                market
            
            
            48,511
            
            
            1.91
            %
            
            693
            
            
            52,139
            
            
            3.08
            %
            
            1,200Savings
            
            
            43,957
            
            
            0.39
            %
            
            129
            
            
            45,767
            
            
            0.39
            %
            
            134Time
            
            
            198,123
            
            
            4.25
            %
            
            6,298
            
            
            183,111
            
            
            4.49
            %
            
            6,146Time
                over $100,000
            
            
            72,751
            
            
            4.30
            %
            
            2,340
            
            
            58,839
            
            
            4.75
            %
            
            2,089Total
                interest-bearing deposits
            
            
            461,631
            
            
            2.96
            %
            
            10,244
            
            
            440,482
            
            
            3.44
            %
            
            11,346Short-term
                borrowings
            
            
            21,347
            
            
            2.37
            %
            
            379
            
            
            22,085
            
            
            3.57
            %
            
            590Long-term
                debt
            
            
            34,380
            
            
            4.29
            %
            
            1,122
            
            
            35,337
            
            
            5.22
            %
            
            1,398Total
                interest-bearing liabilities
            
            
            517,358
            
            
            3.03
            %
            
            11,745
            
            
            497,904
            
            
            3.58
            %
            
            13,334Non-interest-bearing
                deposits
            
            
            51,266
            
            
            
            
            
            
            
            
            51,358Other
                liabilities
            
            
            4,528
            
            
            
            
            
            
            
            
            3,510Shareholders'
                equity
            
            
            53,028
            
            
            
            
            
            
            
            
            51,054Total
                liabilities and shareholders' equity
            
            $
            626,180
            
            
            
            
            
            
            
            $
            603,826Net
                interest rate spread
            
            
            
            
            
            3.14
            %
            
            
            
            
            
            
            
            2.82
            %Margin/net
                interest income
            
            
            
            
            
            3.54
            %
            $
            15,824
            
            
            
            
            
            3.29
            %
            $
            14,110


Tax-exempt
      securities and loans were adjusted to a tax-equivalent basis and are based
      on
      the marginal Federal corporate tax rate of 34 percent.


Non-accrual
      loans are included in earning assets.


*
      Includes loans held-for-sale


-
          24
          -


**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**Rate/Volume
      Analysis.** The
      following table shows the fully taxable equivalent effect of changes in volumes
      and rates on interest income and interest expense. Changes in net interest
      income that could not be specifically identified as either a rate or volume
      change were allocated to changes in volume.





**Three Months Ended**
            
            **Nine Months Ended****September 30, 2008 compared**
            
            **September 30, 2008 compared****to September 30, 2007**
            
            **to September 30, 2007**Total
            
            Due to change in:
            
            Total
            
            Due to change in:Change
            
            Volume
            
            Rate
            
            Change
            
            Volume
            
            Rate**Interest
                income:**Federal
                funds sold
            
            $
            (117
            )
            $
            (29
            )
            $
            (88
            )
            $
            (152
            )
            $
            30
            
            $
            (182
            )Investment
                securities:U.S.
                Treasury
            
            
            (16
            )
            
            1
            
            
            (17
            )
            
            (38
            )
            
            -
            
            
            (38
            )U.S.
                Government agencies
            
            
            46
            
            
            113
            
            
            (67
            )
            
            (35
            )
            
            49
            
            
            (84
            )State
                and municipal
            
            
            62
            
            
            76
            
            
            (14
            )
            
            143
            
            
            169
            
            
            (26
            )Mortgage-backed
                and CMOs
            
            
            195
            
            
            245
            
            
            (50
            )
            
            302
            
            
            (24
            )
            
            326Domestic
                debt (fixed and variable)
            
            
            (87
            )
            
            (54
            )
            
            (33
            )
            
            (157
            )
            
            (69
            )
            
            (88
            )Mutual
                fund
            
            
            21
            
            
            21
            
            
            -
            
            
            21
            
            
            21
            
            
            -Equities
            
            
            -
            
            
            (2
            )
            
            2
            
            
            3
            
            
            (2
            )
            
            5Loans:Commercial
                real estate
            
            
            126
            
            
            257
            
            
            (131
            )
            
            816
            
            
            886
            
            
            (70
            )Residential
                real estate
            
            
            (33
            )
            
            (37
            )
            
            4
            
            
            (121
            )
            
            (154
            )
            
            33Home
                equity loans
            
            
            (154
            )
            
            (29
            )
            
            (125
            )
            
            (362
            )
            
            (59
            )
            
            (303
            )Commercial
                and industrial
            
            
            (186
            )
            
            69
            
            
            (255
            )
            
            (196
            )
            
            424
            
            
            (620
            )Indirect
                lease financing
            
            
            (18
            )
            
            (19
            )
            
            1
            
            
            (21
            )
            
            (46
            )
            
            25Consumer
                loans
            
            
            16
            
            
            -
            
            
            16
            
            
            17
            
            
            (20
            )
            
            37Tax-exempt
                loans
            
            
            (27
            )
            
            (19
            )
            
            (
                8
            )
            
            17
            
            
            32
            
            
            (15
            )Other
                earning assets
            
            
            (25
            )
            
            9
            
            
            (
                34
            )
            
            (112
            )
            
            (38
            )
            
            (74
            )Total
                interest income
            
            
            (197
            )
            
            602
            
            
            (
                799
            )
            
            125
            
            
            1,199
            
            
            (1,074
            )**Interest
                expense:**Interest-bearing
                demand
            
            
            22
            
            
            1
            
            
            21
            
            
            16
            
            
            3
            
            
            13Municipals
            
            
            (428
            )
            
            (33
            )
            
            (
                395
            )
            
            (1,009
            )
            
            (153
            )
            
            (856
            )Money
                market
            
            
            (211
            )
            
            (42
            )
            
            (
                169
            )
            
            (507
            )
            
            (83
            )
            
            (424
            )Savings
            
            
            -
            
            
            -
            
            
            -
            
            
            (5
            )
            
            (5
            )
            
            -Time
            
            
            (164
            )
            
            138
            
            
            (302
            )
            
            152
            
            
            510
            
            
            (358
            )Time
                over $100,000
            
            
            45
            
            
            200
            
            
            (
                155
            )
            
            251
            
            
            496
            
            
            (245
            )Short-term
                borrowings
            
            
            (87
            )
            
            (
                7
            )
            
            (80
            )
            
            (211
            )
            
            (19
            )
            
            (192
            )Long-term
                debt
            
            
            75
            
            
            121
            
            
            (
                46
            )
            
            (276
            )
            
            (33
            )
            
            (243
            )Total
                interest expense
            
            
            (748
            )
            
            378
            
            
            (
                1,126
            )
            
            (1,589
            )
            
            716
            
            
            (2,305
            )**Net
                interest income**
            
            **$**
            551
            
            $
            224
            
            $
            327
            
            $
            1,714
            
            $
            483
            
            $
            1,231




-
          25
          -


**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**NET
      INTEREST INCOME**





The
      following table presents the adjustment to convert net interest income to net
      interest income on a fully taxable equivalent basis for the three- and
      nine-month periods ended September 30, 2008 and 2007.





For the Three Months
            
            For the Nine MonthsEnded September 30,
            
            Ended September 30,2008
            
            2007
            
            2008
            
            2007Total
                interest income
            
            $
            8,832
            
            $
            9,040
            
            $
            26,460
            
            $
            26,390Total
                interest expense
            
            
            3,787
            
            
            4,535
            
            
            11,745
            
            
            13,334Net
                interest income
            
            
            5,045
            
            
            4,505
            
            
            14,715
            
            
            13,056Tax
                equivalent adjustment
            
            
            369
            
            
            358
            
            
            1,109
            
            
            1,054Net
                interest income (fully taxable equivalent)
            
            $
            5,414
            
            $
            4,863
            
            $
            15,824
            
            $
            14,110




Net
      interest income is the primary source of operating income for QNB. Net interest
      income is interest income, dividends, and fees on earning assets, less interest
      expense incurred on funding sources. Earning assets primarily include loans,
      investment securities and Federal funds sold. Sources used to fund these assets
      include deposits and borrowed funds. Net interest income is affected by changes
      in interest rates, the volume and mix of earning assets and interest-bearing
      liabilities, and the amount of earning assets funded by non-interest bearing
      deposits.





For
      purposes of this discussion, interest income and the average yield earned on
      loans and investment securities are adjusted to a tax-equivalent basis as
      detailed in the tables that appear on pages 23 and 24. This adjustment to
      interest income is made for analysis purposes only. Interest income is increased
      by the amount of savings of Federal income taxes, which QNB realizes by
      investing in certain tax-exempt state and municipal securities and by making
      loans to certain tax-exempt organizations. In this way, the ultimate economic
      impact of earnings from various assets can be more easily compared.




The
      net
      interest rate spread is the difference between average rates received on earning
      assets and average rates paid on interest-bearing liabilities, while the net
      interest rate margin, which includes interest-free sources of funds, is net
      interest income expressed as a percentage of average interest-earning assets.





Net
      interest income increased $540,000, or 12.0%, to $5,045,000 for the third
      quarter of 2008, compared to $4,505,000 for the quarter ended September 30,
      2007. On a tax-equivalent basis, net interest income increased 11.3%, from
      $4,863,000 for the three months ended September 30, 2007 to $5,414,000 for
      the
      same period ended September 30, 2008, reflecting a 13 basis point increase
      in
      the net interest margin as well as growth in earning assets. The net interest
      margin was 3.49% for the third quarter of 2008 compared to 3.36% for the third
      quarter of 2007. The increase in the net interest margin is primarily the result
      of lower customer deposit costs resulting from market interest rates declining.
      Average earning assets increased $41,850,000, or 7.3%, with average loans
      increasing 3.6% and average investment securities increasing 15.8%.




-
          26
          -




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


**NET
      INTEREST INCOME (Continued)**





QNB’s
      interest sensitivity position also contributed to the increase in net interest
      income and the net interest margin. QNB has a negative gap position in a
      one-year time frame, which results when the amount
      of
      interest rate sensitive liabilities (deposits and debt) exceeds interest rate
      sensitive assets (loans and investment securities). As a result of this
      position, QNB’s cost of interest-bearing liabilities has declined to a greater
      degree than the yield on its earnings assets, as the Federal Reserve
      Bank’s Open Market Committee (Fed) picked up the pace of reducing the Federal
      funds target rate in response to liquidity issues in the world’s financial
      markets, a nationwide housing slowdown and growing concerns of a recession.
      The
      Fed reduced the Federal
      funds target rate by 125 basis points in January, 75 basis points in March
      and
      another 25 basis points at the end of April bringing the target rate to 2.00%.
      The Prime lending rate followed in step and was at 5.00% as of September 30,
      2008. The average Federal funds target rate for the third quarter of 2008 was
      2.00% compared to 5.18% for the third quarter of 2007. In response to actions
      by
      the Fed, economic concerns in the United States and around the world and
      liquidity issues in the credit markets, the Treasury yield curve has steepened
      since December 31, 2007 as short-term rates have declined more than longer
      term
      rates. The 2-year Treasury note has declined 105 basis points since the end
      of
      the year to 2.00% at September 30, 2008, while the 10-year Treasury note has
      declined 19 basis points over the same period to 3.85%. The short end of the
      yield curve declined significantly during the quarter as liquidity and financial
      market strains caused a flight to quality and the U.S. T-bill became the safe
      haven. As of September 30, 2008 the 3-month T-bill yield was .92% and was,
      at
      times during the quarter, even lower. In October 2008, the Fed cut the Federal
      funds target rate twice more, each time by 50 basis points, bringing the target
      rate to 1.00% as of October 31, 2008.





The
      yield
      on earning assets on a tax-equivalent basis decreased 55 basis points from
      6.49%
      for the third quarter of 2007 to 5.94% for the third quarter of 2008. Interest
      income on investment securities increased $221,000 when comparing the two
      quarters as the $30,328,000 increase in balances offset the 40 basis point
      decline in the average yield of the portfolio. The average yield on the
      investment portfolio was 5.40% for the third quarter of 2008 compared with
      5.80%
      for the third quarter of 2007. Contributing to the decline in the yield on
      the
      portfolio was the investment of short-term deposits into short-term lower
      yielding investment securities. During the third quarter of each year QNB
      receives seasonal tax deposits of local school districts and municipalities.
      These deposits are short-term in nature, from overnight to five month
      maturities. These funds were primarily invested in money market mutual funds
      at
      a yield of 2.60% and discount callable agency securities with a yield of 3.65%,
      both significantly below the yield of the remaining portfolio. The current
      economic environment also contributed to the growth in the investment portfolio
      as slower loan growth has resulted in excess deposits being invested in
      securities. The growth in the investment portfolio was primarily in high quality
      U.S. government agency and agency mortgage-backed securities. The yield on
      the
      portfolio is anticipated to continue to decline as cash flow from the portfolio
      is reinvested at current market rates which are below the current portfolio
      yield.





Income
      on
      loans decreased $276,000 when comparing the two quarters as the impact of
      declining interest rates could not be overcome by higher balances. The yield
      on
      loans decreased 51 basis points to 6.40% when comparing the third quarter of
      2007 to the same period in 2008. The decline in the yield on the loan portfolio
      reflects the impact of lower interest rates, primarily loans indexed to the
      Prime lending rate such as commercial and industrial loans and home equity
      lines
      of credit. Reducing the impact of the decline in interest rates on loan yields
      through September 30, 2008 is the structure of the loan portfolio, which has
      a
      significant portion of fixed-rate and adjustable-rate loans with fixed-rate
      terms for three to ten years.




-
          27
          -




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


**NET
      INTEREST INCOME (Continued)**





Income
      on
      commercial real estate loans increased $126,000, with average balances
      increasing $15,377,000, or 9.2%. The yield on commercial real estate loans
      was
      6.57% for the third quarter of 2008, a
      decline
      of 28 basis points from the 6.85% reported for the third quarter of 2007.
      Interest on commercial and industrial loans decreased $186,000 with the impact
      of the increase in average balances being offset by the impact of the decline
      in
      yield. Average commercial and industrial loans increased $3,914,000, or 6.2%,
      when comparing the two quarters, contributing an additional $69,000 in interest
      income. The average yield on these loans decreased 151 basis points to 5.84%
      resulting in a reduction in interest income of $255,000. The commercial and
      industrial loan category was impacted the most by the action by the Fed to
      lower
      interest rates since a large portion of this category of loans is indexed to
      the
      Prime rate. The action by the Fed in October will result in a further reduction
      in interest income on these loans.





Residential
      mortgage and home equity loan activity continues to be slow because of issues
      in
      the residential real estate market. While QNB does not originate or hold
      sub-prime mortgages, or any of the other high-risk mortgage products, it has
      been impacted by the overall downturn in the residential housing market. Income
      on residential real estate loans declined by $33,000 when comparing the two
      quarters, as the slight increase in yield could not offset a decline in
      balances. The average balance of residential mortgages declined $2,457,000,
      or
      10.3%, when comparing the two quarters while the average yield increased by
      7
      basis points. Mortgage rates did not decline to the magnitude that Treasury
      rates declined as spreads widened on mortgage loans and mortgage-backed
      securities due to issues in the credit markets. QNB sells most of the fixed
      rate
      loans it originates, especially in the low rate environment that currently
      exists. Income on home equity loans declined by $154,000, or 13.4%, when
      comparing the third quarter of 2008 to the same period in 2007. Over this same
      time period average home equity loans decreased 2.2%, to $68,223,000, while
      the
      yield on the home equity portfolio decreased 73 basis points to 5.81%. The
      demand for home equity loans has declined as home values have stabilized or
      fallen and homeowners have already borrowed against the equity in their homes.
      Included in the home equity portfolio are floating rate home equity lines tied
      to the Prime lending rate. These loans have contributed to the decline in the
      yield in the home equity portfolio. This yield will be further negatively
      impacted in the fourth quarter as a result of the Fed action in
      October.





Income
      on
      the indirect lease financing portfolio declined $18,000, or 5.5%, to $308,000.
      A
      reduction in average balances of $805,000, or 5.9%, combined with the reversal
      of interest on loans charged-off or placed on nonaccrual status contributed
      to
      the decline in income.





Interest
      income on Federal funds sold decreased $117,000 when comparing the two quarters,
      a result of both a 313 basis point decline in rate and a $2,299,000 decrease
      in
      average balances. The average yield on Federal funds sold decreased from 5.12%
      for the third quarter of 2007 to 1.99% for the third quarter of 2008, reflecting
      the actions by the Fed, beginning in the third quarter of 2007, to reduce the
      Federal funds target rate. Impacting the volume of Federal funds sold was the
      decision by management to invest some of the short-term excess funds in AAA
      rated money market mutual funds which were yielding approximately 60 basis
      points more than Federal funds.




-
          28
          -




**QNB
      CORP. AND SUBSIDIARY**


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


**NET
      INTEREST INCOME (Continued)**





For
      the
      most part, earning assets are funded by deposits, which increased when comparing
      the two quarters. Average
      deposits increased $27,566,000, or 5.5%, to $531,891,000 for the third quarter
      of 2008, with the growth occurring in higher cost time deposits, which increased
      $29,394,000, or 11.9%, to $277,360,000 and in interest-bearing demand accounts
      which increased $4,433,000, or 8.2%, to $58,772,000. The average balance of
      all
      other categories of deposits declined when comparing the two quarters with
      average municipal interest-bearing demand accounts decreasing $2,562,000, or
      4.9%, and average money market accounts declining $5,370,000, or 10.2%. These
      types of accounts are sensitive to changes in interest rates and have been
      impacted the most by the decline in interest rates since a significant portion
      of these balances are indexed to the Federal funds rate.





While
      total income on earning assets on a tax-equivalent basis decreased $197,000
      when
      comparing the third quarter of 2008 to the third quarter of 2007, total interest
      expense declined $748,000. Interest expense on total deposits decreased
      $736,000, while interest expense on borrowed funds decreased $12,000 when
      comparing the two quarters. The rate paid on interest-bearing liabilities
      decreased 78 basis points from 3.60% for the third quarter of 2007 to 2.82%
      for
      the third quarter of 2008. During this same period, the rate paid on
      interest-bearing deposits decreased 80 basis points from 3.54% to 2.74%.





The
      decrease in interest expense on total deposits was primarily the result of
      volume and rate decreases on municipal interest-bearing demand deposits and
      money market accounts as discussed above. Interest expense on municipal
      interest-bearing demand deposits and money market accounts declined $428,000
      and
      $211,000, respectively. The interest rate paid on municipal interest-bearing
      demand accounts decreased from 4.96% for the third quarter of 2008 to 1.82%
      for
      the third quarter of 2008. Most of these accounts are tied directly to the
      Federal funds rate with some having rate floors of 1.50%. The interest rate
      paid
      on money market accounts was 3.09% for the third quarter of 2007 and 1.67%
      for
      the third quarter of 2008, a decline of 142 basis points. Included in total
      money market balances is the Select money market account, a higher yielding
      money market product that pays a tiered rate based on account balances. QNB
      maintained a rate close to 4.00% for balances over $75,000 for most of 2007.
      With the sharp decline in short-term interest rates during 2008, the rates
      paid
      on the Select money market account have declined as well.





Interest
      expense on interest-bearing demand accounts increased $22,000 to $47,000 when
      comparing the two quarters. During the third quarter of 2008 QNB introduced
      eRewards checking, a high rate checking account paying 4.01% interest on
      balances up to $25,000. In order to receive this rate a customer must receive
      an
      electronic statement, have one direct deposit or other ACH transaction and
      perform at least 12 check card transactions per statement cycle. At September
      30, 2008 this product had a balance of $4,527,000. For the quarter the average
      balance in the product was $2,591,000 and the related interest expense was
      $23,000 for an average yield of 3.56%. This was the primary contributor to
      the
      increase in yield on total interest-bearing demand accounts from .18% for the
      third quarter of 2007 to .32% for the third quarter of 2008. It is anticipated
      that this product will result in the movement of balances from lower yielding
      deposit accounts to this product but will also result in obtaining new customers
      and additional deposits of existing customers.




-
          29
          -




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


**NET
      INTEREST INCOME (Continued)**





When
      comparing the two quarters, interest expense on time deposits decreased
      $119,000. 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,
      however, the maturity and repricing characteristics of time deposits tend to
      be
      shorter. Over the course of 2008 a significant amount of time deposits have
      repriced lower as rates have declined. The average rate paid on time deposits
      decreased from 4.63% to 3.98% when comparing the two periods and as a result
      interest expense declined by $457,000. Partially offsetting the impact of lower
      rates was $338,000 in expense related to the 11.9% increase in average balances.





The
      competition for deposits, especially time deposits, led to significantly higher
      rates being paid on these products in 2007. Like other financial institutions,
      QNB, as a result of consumer demand and the need to retain deposits, offered
      relatively short maturity time deposits at attractive rates. Most consumers
      were
      looking for short maturity time deposits in anticipation of short-term rates
      continuing to increase. With interest rates declining in the latter part of
      2007, the expectation was for time deposit rates to fall; however, this
      reduction was slow to occur as the competition was still offering high rate
      time
      deposits.





With
      the
      unprecedented move by the Fed during the first quarter of 2008, the rates on
      time deposits being offered did decline significantly. Approximately
      $226,937,000, or 78.9%, of time deposits at September 30, 2008 will reprice
      or
      mature over the next 12 months of which $99,507,000, or 34.6%, will mature
      or
      reprice before December 31, 2008. The average rate paid on the time deposits
      maturing or repricing over the last quarter of 2008 is approximately 4.17%.
      Given the short-term nature of QNB’s time deposit portfolio and the current
      rates being offered, it is likely that the average rate paid on time deposits
      should continue to decline over the next couple of quarters as higher costing
      time deposits originated in 2007 or early 2008 are repriced lower. There are
      still a few competitors who are offering above market rates on time deposits
      which could have an impact on the rate QNB needs to pay to retain these
      deposits. To date QNB has been extremely successful in retaining and growing
      these balances.





Contributing
      to the decrease in total interest expense was a reduction in interest expense
      on
      short-term borrowings of $87,000. Short-term borrowings are primarily comprised
      of repurchase agreements (a sweep product for commercial customers). While
      not
      directly indexed to the Federal funds rate, the rate paid on these
      accounts moves closely with the Federal funds rate and as a result declined
      when
      comparing the two quarters. The average rate paid on short-term borrowings
      declined from 3.57% for the third quarter of 2007 to 2.09% for the third quarter
      of 2008.





The
      average balance of long-term debt was $35,000,000 for the third quarter of
      2008
      compared with $25 ,000,000
      for the third quarter of 2007, while the average rate paid decreased to 4.27%
      from 4.78% when comparing the same periods. Two events contributed to the
      decline in the average rate paid on long-term debt: the April 2007 balance
      sheet
      restructuring in which QNB prepaid $50,000,000 of FHLB advances with a cost
      of
      5.55% and replaced half with a $25,000,000 repurchase agreement with a cost
      of
      4.78% and the borrowing by QNB in January 2008 of $10,000,000 from the FHLB
      at a
      cost of 2.97% for two years. At the time, this type of wholesale funding was
      a
      better alternative to higher costing time deposits and overnight funding.




-
          30
          -




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


**NET
      INTEREST INCOME (Continued)**





For
      the
      nine-month period ended September 30, 2008, net interest income increased
      $1,659,000, or 12.7%, to $14,715,000. On a tax-equivalent basis net interest
      income increased $1,714,000, or 12.1%. Average earning assets increased
      $23,574,000, or 4.1%, while the net interest margin increased 25 basis points.
      The net interest margin on a tax-equivalent basis was 3.54% for the nine-month
      period ended September 30, 2008 compared with 3.29% for the same period in
      2007.
      The improvement in net interest income and the net interest margin reflects
      the
      benefits of the 2007 restructuring transactions as well as a decrease in the
      cost of interest-bearing liabilities resulting from the Company’s interest rate
      sensitivity position and the decline in the Federal funds rate and market
      interest rates.





Total
      interest income on a tax-equivalent basis increased $125,000, from $27,444,000
      to $27,569,000, when comparing the nine-month periods ended September 30, 2007
      to September 30, 2008. The increase in interest income was primarily a result
      of
      the growth in earning assets outpacing the impact of the decline in interest
      rates. Volume growth contributed an additional $1,199,000 of interest income
      offsetting the decline in interest income of $1,074,000 resulting from lower
      interest rates. Average loans increased 5.5%, to $380,916,000, with average
      commercial real estate loans increasing $17,202,000, or 10.5%, and average
      commercial and industrial loans increasing $7,657,000, or 12.6%, when comparing
      the nine-month periods. Over this same period average investment securities
      increased 1.8%, to $205,564,000. Most of the growth in investment securities
      occurred during the second and third quarters of 2008. The yield on earning
      assets decreased from 6.40% to 6.17% for the nine-month periods with the yield
      on loans decreasing from 6.90% to 6.58% during this time. The yield on
      investments increased from 5.53% to 5.59% when comparing the nine-month periods.
      The increase in the yield on the investment portfolio when comparing the
      nine-month periods reflects the benefit of the restructuring transaction. During
      the second quarter of 2008, QNB recorded approximately $169,000 of additional
      loan income related to the recognition of a prepayment penalty on a commercial
      loan that paid off early as well as the recovery of interest and late charges
      on
      three non-accrual loans that paid off during the quarter. Excluding the impact
      of the nonrecurring loan income during the second quarter of 2008 the yield
      on
      loans would have been 6.52%, the yield on earning assets would have been 6.13%
      and the net interest margin would have been 3.50% for the nine-month period
      ended September 30, 2008.





Total
      interest expense decreased $1,589,000, from $13,334,000 for the nine-month
      period ended September 30, 2007 to $11,745,000, for the nine-month period ended
      September 30, 2008. Approximately $2,305,000 of the decrease in interest expense
      was a result of lower rates paid on deposits and borrowed funds. This was
      partially offset by an increase in interest expense of $716,000 resulting
      primarily from deposit growth. Interest expense on municipal interest-bearing
      demand deposits declined $1,009,000, resulting from a 276 basis point decline
      in
      the average rate paid and a $4,126,000, or 9.0%, decline in average balances.
      As
      mentioned previously a significant portion of these deposits are indexed to
      the
      Federal funds rate. Interest expense on money market accounts declined $507,000,
      resulting from a $3,628,000, or 7.0%, decline in average balances and a 117
      basis point decline in the average rate paid. The interest rate paid on money
      market accounts decreased from 3.08% for the first nine months of 2007 to 1.91%
      for the first nine months of 2008.





The
      growth in total deposits was centered in time deposits which increased
      $28,924,000, or 12.0%, when comparing the nine-month periods. Interest expense
      on time deposits increased $403,000 with the impact of the increase in average
      balances contributing $1,006,000 to the increase in interest expense. The
      average rate paid on time deposits decreased 29 basis points to 4.26%, resulting
      in a reduction of interest expense of $603,000 when comparing the nine-month
      periods.




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          31
          -




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


**NET
      INTEREST INCOME (Continued)**





Interest
      expense on short-term borrowings decreased $211,000 primarily as a result of
      a
      decline in the rates paid. The average rate paid decreased from 3.57% for the
      nine months of 2007 to 2.37% for the first nine months of 2008. As a result
      of
      the payoff of higher costing FHLB advances and the use of the lower costing
      repurchase agreements and FHLB borrowings as discussed earlier, interest expense
      on long-term debt decreased $276,000 when comparing the nine-month periods.
      The
      average outstanding balance decreased from $35,337,000 to $34,380,000 while
      the
      average rate paid decreased from 5.22% to 4.29%, respectively, when comparing
      these periods.




**PROVISION
      FOR LOAN LOSSES**





The
      provision for loan losses represents management's determination of the amount
      necessary to be charged to operations to maintain the allowance for loan losses
      at 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,
      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 that considers a numbers 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, in terms of industry,
      collateral and size of the credit, and national and local economic trends and
      conditions. Other tools include ratio analysis and peer group
      analysis.





A
      slowdown in the local and regional economy and a softening of the residential
      real estate market has resulted in an increase in job losses and lower home
      values. These factors combined with higher energy and food costs and instability
      in financial markets has had a negative impact on both consumers and small
      businesses and has contributed to an increase in the amount of loans
      charged-off, particularly in the purchased lease portfolio. This increase in
      the
      amount of loans charged-off, a slight increase in non-performing loans and
      the
      inherent risk related to loan growth contributed to management’s decision to
      increase the provision for loan losses in 2008 by $200,000 to $575,000 when
      comparing the nine-month periods ended September 30 2008 and September 30,
      2007.
      For both three-month periods ended September 30, 2008 and 2007 the provision
      for
      loan losses was $150,000. The need for a provision was determined by the
      analysis described above and resulted in an allowance for loan losses that
      management believes is adequate in relation to the estimate of known and
      inherent losses in the portfolio.




QNB
      had
      net charge-offs of $131,000 during the third quarter of 2008 compared with
      $21,000 for the third quarter of 2007. For the nine-month periods ended
      September 30, 2008 and 2007, QNB had net charge-offs of $362,000 and $103,000,
      respectively. Included in net charge-offs for the three- and nine-month periods
      of 2008 were $112,000 and $299,000 of loans in the purchased lease portfolio.
      This portfolio contains loans to businesses in the trucking and construction
      industries which have been hit hard by the increase in fuel costs and the
      slowdown in the economy.




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          32
          -




**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**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 .21% and .19% of total assets
      at
      September 30, 2008 and 2007, respectively. These levels compare to .27% at
      December 31, 2007. QNB’s non-performing loans (non-accrual loans and loans past
      due 90 days or more) were .31% and .30% of total loans at September 30, 2008
      and
      2007, respectively and .42% as of December 31, 2007. These percentages compare
      favorably with the average for Pennsylvania commercial banks with assets between
      $500 million and $1 billion at 0.90% of total loans as reported by the FDIC
      using June 30, 2008 data. Included in non-performing loans are non-accrual
      loans
      of $1,120,000, $1,397,000 and $774,000 at September 30, 2008, December 31,
      2007,
      and September 30, 2007, respectively. Loans
      past due 90 days or more and still accruing were $70,000, $218,000 and $310,000,
      respectively, at these same period-ends.





Delinquent
      loans include loans past due more than 30 days, including non-performing loans
      (loans past due 90 days and still accruing interest and loans on a nonaccrual
      basis). Total delinquent loans at September 30, 2008, December 31, 2007 and
      September 30, 2007 represent .90%, .98% and .65% of total loans, respectively.
      Total delinquent loans improved since March 31, 2008 when delinquent loans
      represented 1.08% of total loans. As of September 30, 2008, 7.10% of the
      indirect lease portfolio was past due more than 30 days. This compares to 8.32%
      at December 31, 2007 and 4.68% at September 30, 2007. The delinquency as of
      March 31, 2008 in the indirect lease portfolio was 13.04%. The asset quality
      of
      the commercial loan portfolio, the largest component of total loans,
      representing approximately 72% of total loans, declined during the third quarter
      of 2008. Total delinquent commercial loans were .53% of total commercial loans
      at September 30, 2008 compared with .22% at June 30, 2008. This also compares
      to
      .47% and .64% at December 31, 2007 and September 30, 2007, respectively.
      Delinquent loans on one to four unit residential mortgages and home equity
      loans
      increased to 1.13% of balances at September 30, 2008 compared with .89% at
      June
      30, 2008 and .63% at September 30, 2007. It does represent an improvement
      compared with 1.37% at December 31, 2007.





QNB
      did
      not have any other real estate owned as of September 30, 2008, December 31,
      2007
      or September 30, 2007. Repossessed assets consisting of vehicles and equipment
      were $142,000, $6,000 and $54,000 at these same respective dates.





There
      were no restructured loans as of September 30, 2008, December 31, 2007 or
      September 30, 2007, respectively, 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.





A
      loan is
      considered impaired, based on current information and events, if it is probable
      that QNB will be unable to collect the scheduled payments of principal or
      interest when due according to the contractual terms of the loan agreement.
      The
      measurement of impaired loans is generally based on the present value of
      expected future cash flows discounted at the historical effective interest
      rate,
      except that all collateral-dependent loans are measured for impairment based
      on
      the fair value of the collateral. At
      September 30, 2008, December 31, 2007 and September 30, 2007, the recorded
      investment in loans for which impairment had been recognized in accordance
      with
      FASB Statement No. 114, *Accounting
      by Creditors for Impairment of a Loan—an amendment of FASB Statements No. 5 and
      15* , totaled
      $965,000, $961,000 and $774,000, respectively, of which $272,000, $847,000
      and
      $774,000 respectively, required no specific allowance for loan losses. The
      recorded investment in impaired loans requiring a specific allowance for loan
      losses was $693,000, $114,000 and $0 at September 30, 2008, December 31, 2007
      and September 30, 2007, respectively. At September 30, 2008, December 31, 2007
      and September 30, 2007 the related allowance for loan losses associated with
      these loans was $309,000, $57,000 and $0, respectively.


-
          33
          -





**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**PROVISION
      FOR LOAN LOSSES (Continued)**





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





The
      allowance for loan losses was $3,492,000, $3,279,000 and $3,001,000 at September
      30, 2008, December 31, 2007 and September 30, 2007, respectively. The ratio
      of
      the allowance to total loans was .92%, .86% and .82% at the respective period
      end dates. The increase in the ratio reflects the increase in the provision
      for
      loan losses recorded during the fourth quarter of 2007 and the first nine months
      of 2008. The ratio, at .92%, is at a level that QNB management believes is
      presently adequate based on its analysis.





Since
      the
      allowance for loan losses is dependent, to a great extent, on conditions that
      may be beyond QNB’s control, it is at least reasonably possible that
      management’s estimates of the allowance for loan losses and actual results could
      differ. In addition, various regulatory agencies, as an integral part of their
      examination process, periodically review QNB’s allowance for losses on loans.
      Such agencies may require QNB to recognize changes to the allowance based on
      their judgments about information available to them at the time of their
      examination.





**NON-INTEREST
      INCOME**





QNB,
      through its core banking business, generates various fees and service charges.
      Total non-interest income includes service charges on deposit accounts, ATM
      and
      check card income, income on bank-owned life insurance, mortgage servicing
      fees,
      trading account gains and losses and gains and losses on the sale of investment
      securities and residential mortgage loans.





Total
      non-interest income for the third quarter of 2008 was $815,000, a decline from
      the $989,000 reported for the same period in 2007. During the third quarter
      of
      2008, QNB recorded $103,000 of securities losses related to an
      other-than-temporary impairment charge on two holdings in the equity investment
      portfolio. Also, with the slowdown in the residential mortgage market, gains
      on
      the sale of loans declined from $50,000 for the third quarter of 2007 to $13,000
      for the same period in 2008. In addition, losses on the sale of repossessed
      assets were $21,000 for the third quarter of 2008 compared with gains of $15,000
      for the same period in 2007. For the nine-month period ending September 30,
      2008
      total non-interest income was $3,028,000 compared to $257,000 for the first
      nine
      months of 2007. Positively impacting non-interest income for the first nine
      months of 2008 was the first quarter recognition of $230,000 of
      income
      as a result of the Visa initial public offering comprised of a $175,000 gain
      related to the mandatory redemption of shares of restricted common stock in
      Visa
      and $55,000 of income related to the reversal of liabilities recorded in the
      fourth quarter of 2007 to fund settlements of, or judgments in, indemnified
      litigation involving Visa. Total
      non-interest income, excluding the impact of the Visa items noted above and
      net
      investment securities gains of $1,000, would have been $2,797,000 for the first
      nine months of 2008. This compares favorably to total non-interest income of
      $2,726,000 for the first nine months of 2007, excluding the other-than-temporary
      impairment charge of $2,758,000 recorded in the first quarter of 2007 and net
      realized security gains of $289,000.


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          34
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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**NON-INTEREST
      INCOME (Continued)**





Fees
      for
      services to customers are primarily comprised of service charges on deposit
      accounts. These fees increased $5,000, or 1.1%, to $474,000, when comparing
      the
      two quarters and decreased $13,000, or 1.0%, to $1,347,000, when comparing
      the
      nine-month periods. Overdraft income decreased $2,000 for the three-month period
      and $24,000 for the nine-month period. These variances are a result of volume
      fluctuations as the per item charge has remained the same. Fees on business
      checking accounts increased $6,000 for the three-month period and $17,000 for
      the nine-month period. This increase reflects the impact of a lower earnings
      credit rate in 2008 compared to 2007, resulting from the decline in short-term
      interest rates. These credits are applied against service charges incurred.





ATM
      and
      debit card income is primarily comprised of transaction income on debit and
      ATM
      cards and ATM surcharge income for the use of QNB ATM machines by non-QNB
      customers. ATM and debit card income was $237,000 for the third quarter of
      2008,
      an increase of $11,000, or 4.9%, from the amount recorded during the third
      quarter of 2007. Income from ATM and debit cards was $698,000 and $633,000
      for
      the nine months ended September 30, 2008 and 2007, respectively, an increase
      of
      10.3%. Debit card income increased $3,000, or 1.8%, to $170,000, for the
      three-month period and $39,000, or 8.4%, to $501,000, for the nine-month period.
      While both consumers and businesses have increased their reliance on the card
      as
      a means of paying for goods and services, it appears that the small percentage
      increase when comparing the quarters reflects the reduction in spending by
      both
      segments as the economy contracts. In addition, an increase in PIN-based
      transactions resulted in additional interchange income of $9,000 and $30,000,
      respectively, when comparing the respective three- and nine-month periods.
      During the third quarter of 2008, QNB introduced eRewards checking, a high
      yield
      checking account which requires a minimum of twelve debit card transactions
      per
      statement cycle to receive the high interest rate. This may result in an
      increase in debit card income, helping offset the impact of a slowdown in
      spending.





Income
      on
      bank-owned life insurance represents the earnings and death benefits on life
      insurance policies in which the Bank is the beneficiary. Income on these
      policies was $63,000 and $64,000 for the three months ended September 30, 2008
      and 2007, respectively. For the nine-month period, income on these policies
      increased $38,000, to $233,000. Life insurance death benefit income was $48,000
      for the nine-month period ended September 30, 2008 compared with $6,000 for
      same
      period in 2008. The insurance carriers reset the rates on these policies
      annually taking into consideration the interest rate environment as well as
      mortality costs. The existing policies have rate floors which minimize how
      low
      the earnings rate can go. Some of these policies are currently at their
      floor.





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 rights to service financial assets that are
      retained in a transfer of assets in the form of a servicing asset. The servicing
      asset is amortized in proportion to and over the period of net servicing income
      or loss. On a quarterly basis, servicing assets are assessed for impairment
      based on their fair value. Mortgage servicing fees for the three-month periods
      ended September 30, 2008 and 2007 were $31,000 and $28,000, respectively. For
      the nine-month periods ended September 30, 2008 and 2007 mortgage servicing
      fees
      were $72,000 and $78,000, respectively. There was no valuation allowance
      necessary in any of the periods. Amortization expense for both three-month
      periods ended September 30, 2008 and 2007 was $14,000. For the respective
      nine-month periods amortization expense was $60,000 and $51,000. Mortgage
      refinancing activity increased slightly during the first nine months of 2008
      as
      residential mortgage rates declined in response to falling Treasury market
      rates. However, during the third quarter of 2008, mortgage activity slowed
      as
      turmoil in the credit and equity markets, declining home values and concerns
      of
      an economic recession had a negative impact on consumer confidence and the
      housing market. The average balance of mortgages serviced for others was
      $69,788,000 for the third quarter of 2008 compared to $68,534,000 for the third
      quarter of 2007, an increase of 1.8%. The average balance of mortgages serviced
      was approximately $69,729,000 for the nine-month period ended September 30,
      2008
      compared to $69,412,000 for the first nine months of 2007. The timing of
      mortgage payments and delinquencies also impacts the amount of servicing fees
      recorded.


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          35
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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**NON-INTEREST
      INCOME (Continued)**





The
      net
      gain on the sale of residential mortgage loans was $13,000 and $50,000 for
      the
      quarters ended September 30, 2008 and 2007, respectively, and $85,000 and
      $78,000 for the respective nine-month periods. 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. Included
      in the gains on the sale of residential mortgages for the three-month periods
      were $5,000 and $20,000, respectively, related to the recognition of mortgage
      servicing assets. These
      amounts were $58,000 and $37,000 for the nine-months ended September 30, 2008
      and 2007, respectively. Proceeds from the sale of mortgages were $613,000 and
      $2,642,000 for the third quarter of 2008 and 2007, respectively. For the
      nine-month periods, proceeds from the sale of residential mortgage loans
      amounted to $7,661,000 and $4,895,000, respectively. The lower amount of gains
      and activity during the third quarter of 2008 is a reflection of the economic
      environment as discussed above.





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. In addition, QNB
      has
      an equity portfolio consisting primarily of large cap companies. This portfolio
      had a book value of $4,079,000 and a market value of $3,946,000 at September
      30,
      2008.





For
      the
      three months ended September 30, 2008, QNB recorded net securities losses of
      $103,000. There were no securities gains or losses during the third quarter
      of
      2007. With the decline in stock values during 2008, QNB had to record other
      than
      temporary impairment charges in its portfolio of equity securities, accounting
      for the $103,000 loss during the third quarter.





For
      the
      nine-months ended September 30, 2008, QNB recorded a net gain on investment
      securities of $1,000. Included in this amount were realized gains on the sale
      of
      debt and equity securities of $67,000 and $235,000, respectively. These gains
      were offset by impairment charges in the equity portfolio totaling $301,000.
      For
      the nine-months ended September 30, 2007, QNB recorded a net loss on investment
      securities of $2,469,000. Excluding the impairment loss of $2,758,000, gains
      on
      the sale of investment securities were $289,000. Included in the $289,000 of
      gains for 2007 were $260,000 of gains from the marketable equity portfolio.
      Net
      gains on the sale of debt securities for the first nine months of 2007 were
      $29,000. With the further sharp decline in the stock markets during October
      2008, QNB will continue to analyze the equity portfolio for additional
      impairment charges during the fourth quarter.





Other
      operating income was $100,000 for the third quarter of 2008, a decrease of
      $52,000 when compared to the third quarter of 2007. L osses
      on
      the sale of repossessed assets were $21,000 for the third quarter of 2008
      compared with gains of $15,000 for the same period in 2007. The repossessed
      assets consist primarily of equipment and vehicles related to the purchased
      lease portfolio. When
      repossessed the loans are written down through the allowance for loan losses
      to
      an estimated fair value less the cost to sell. Further gains and losses are
      recorded at the time of sale. Also
      contributing to the reduction in other operating income was a reduction of
      $20,000 in commissions and income related to an outsourced official check
      program. This income is derived from both the balances and interest rate earned.
      Both rate and volume have declined when comparing the two quarters. Retail
      brokerage income, merchant income and title insurance income declined $6,000,
      $7,000 and $6,000, respectively, all a function of the economy. These decreases
      in income were partially offset by a sales tax refund of $24,000 during the
      third quarter of 2008.


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          36
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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**NON-INTEREST
      INCOME (Continued)**





For
      the
      nine-month period ended September 30, 2008, other operating income was $592,000.
      Excluding the impact of the Visa transactions, other operating income was
      $362,000 for the first nine months of 2008 compared to $382,000 for the first
      nine months of 2007. When comparing the nine-month periods official check income
      declined by $44,000. Merchant income and retail brokerage income declined by
      $9,000 and $5,000, respectively, over the same periods. Partially offsetting
      these declines in income were higher gains on the sale of repossessed assets
      of
      $17,000 and an increase in commissions for the origination of reverse mortgages
      of $8,000. Pennsylvania sales and use tax refunds were $24,000 for 2008 compared
      with $5,000 for 2007.





**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 was $3,668,000 for the
      third quarter of 2008 compared to $3,327,000 for the third quarter of 2007.
      For
      the nine-month period ended September 30, 2008 total non-interest expense was
      $10,794,000. This compares to total non-interest expense of $10,801,000, which
      included recognition of a $740,000 prepayment penalty on the FHLB advances.
      Excluding this charge total non-interest expense for the nine-month period
      of
      2007 would have been $10,061,000.





Salaries
      and benefits is the largest component of non-interest expense. Salaries and
      benefits expense increased $173,000, or 9.5%, to $1,999,000 for the quarter
      ended September 30, 2008 compared to the same quarter in 2007. Salary expense
      increased $132,000, or 8.8%, during the period to $1,628,000. Contributing
      to
      this increase was a $47,000 accrual for incentive compensation. Also, included
      in salary expense for the third quarter of 2008 and 2007, was $14,000 and
      $20,000, respectively in stock option compensation expense. Base salary expense
      increased by 5.9% when comparing the three-month periods. Merit and promotional
      raises along with additional commercial lending and credit administration
      personnel contributed to the increase in base salary expense when comparing
      the
      third quarter of 2008 and 2007. When comparing the two quarters, benefits
      expense increased by $41,000, or 12.4%, to $371,000. During the third quarter
      of
      2008, QNB recorded an expense of $13,000 related to EITF 06-04, *Accounting
      for Deferred Compensation and Postretirement Benefit Aspects of Endorsement
      Split-Dollar Life Insurance* ,
      which
      was adopted January 1, 2008. Also contributing to the increase in benefit
      expense was $10,000 in additional medical and dental costs, $9,000 in higher
      payroll tax expense and a $6,000 increase in retirement plan costs.





For
      the
      nine-month period ended September 30, 2008, salaries and benefits expense
      increased $371,000, or 6.7%, to $5,925,000, compared to the same period in
      2007.
      Salary expense increased by $288,000, or 6.4%, while benefits expense increased
      by $83,000, or 7.7%, when comparing the two periods. The accrual for incentive
      compensation in 2008 contributed $142,000 to the increase in salary expense.
      Stock compensation expense was $44,000 and $77,000, for the respective
      nine-month periods ended September 30, 2008 and 2007. Base salary expense
      increased by 4.6% when comparing the nine-month periods. Payroll tax expense
      and
      retirement plan expense increased by $20,000 and $13,000, respectively, when
      comparing the nine-month periods. An increase in medical and dental premiums,
      net of employee contributions, accounted for $20,000 of the increase in total
      benefits expense. Also contributing to the increase in benefits expense was
      an
      expense of $33,000 related to the adoption of EITF 06-04 as discussed
      above.




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          37
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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**NON-INTEREST
      EXPENSE (Continued)**





Net
      occupancy expense increased $13,000, to $324,000, when comparing the third
      quarter of 2008 to the third quarter of 2007. For the nine-month period, net
      occupancy expense increased $86,000, to $997,000. Contributing to the increase
      for the three-month period were higher depreciation costs related to building
      and leasehold improvements of $10,000 and higher utilities costs of $7,000.
      For
      the nine-month period depreciation on building and leasehold improvements
      increased $31,000, utilities costs increased $21,000, branch rent increased
      $13,000 and building repairs and maintenance increased $15,000. Renovations
      to
      the Downtown office contributed to the increase in building depreciation
      expense. An increase in rates charged by utility companies accounted for the
      higher utility costs. The increase in branch rent when comparing the nine-month
      periods relates to an increase in rent for the operations center’s parking
      facility and leases for the location of two ATM sites at a local shopping center
      deployed during the third quarter of 2007.





Furniture
      and equipment expense increased $38,000, or 14.8%, to $295,000, when comparing
      the three-month periods ended September 30, 2008 and 2007 and increased $96,000,
      or 12.4%, to $870,000, when comparing the nine-month periods. Depreciation
      and
      amortization expense contributed $18,000 and $47,000 of the increase for the
      respective three- and nine-month periods. Projects related to branch deposit
      capture, electronic statement delivery, document imaging, loan administration
      and eRewards checking were completed during the past year and contributed to
      the
      increase in depreciation and amortization expense. In addition, new furniture
      and equipment was purchased as part of the renovations to the Downtown office.
      Also contributing to the increase in furniture and equipment expense were higher
      costs associated with equipment maintenance of $13,000 and $24,000 for the
      respective three- and nine-month periods as well as an increase in equipment
      rentals of $1,000 and $10,000 for the same periods. The
      increase in equipment maintenance expense relates to new contracts on some
      of
      the above mentioned projects as well as price increases on existing contracts.
      The increase in equipment rental expense relates to the two new ATMs noted
      above.





Marketing
      expense increased $15,000, to $171,000 for the quarter ended September 30,
      2008
      and $16,000, to $496,000, for the nine-month period ended September 30, 2008.
      Expenses related to sales promotion, including the rebranding of the Quakertown
      National Bank as QNB Bank, contributed $21,000 to the increase in marketing
      expense for the three-month period and $36,000 when comparing the nine-month
      periods. For the nine-month period donation expense increased $14,000. These
      increases were partially offset by a reduction in advertising costs of $12,000
      for the quarter and $30,000 for the nine-month period.





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 and $181,000 for the respective three-month periods ended
      September 30, 2008 and 2007. Human resource consulting costs, eRewards checking
      commissions, software installation costs, and higher correspondent banking
      contributed to the increase when comparing the two quarters. For the nine-month
      period, third-party services increased $42,000 to $589,000. This increase
      related primarily to data conversion expenses for IT projects, increased fees
      for correspondent banking services, higher statement printing and mailing
      expenses, new third-party service subscriptions for peer group information
      and
      employee benefits administration.  These increases offset a reduction in
      expenses paid to third-party consultants of approximately
      $18,000.


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          38
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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**NON-INTEREST
      EXPENSE (Continued)**





Telephone,
      postage and supplies expense increased $24,000 for the quarter to $158,000,
      and
      $63,000 for the nine-month period to $462,000. For the quarter, telephone
      expense increased $26,000 due to the installation of new telephone lines and
      redundancy costs during the testing period. Supply expense increased $34,000
      and
      along with the increase in telephone costs noted contributed to the increase
      when comparing the nine-month periods. The increase in supply costs relates
      primarily to the rebranding of QNB Bank. This included the purchase of new
      supplies including plastics for debit cards and obsolescence costs related
      to
      the Quakertown National Bank supplies.





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 $121,000 for the third quarter of
      2008,
      a decrease of $1,000. An $8,000 increase in Pennsylvania shares tax resulting
      from an increase in the Bank’s equity was offset by a $9,000 reduction in the
      Pennsylvania capital stock tax. For the nine-month period State taxes increased
      $15,000 to $381,000 with the shares tax increasing $25,000 and the capital
      stock
      tax decreasing $10,000.




Other
      operating expense was $404,000 for the three months ended September 30, 2008.
      This represents a $64,000 increase from the $340,000 reported for the three
      months ended September 30, 2007. FDIC premiums increased $67,000 when comparing
      the three-month periods. During 2007 QNB had a credit from prior year payments
      that was used to offset the premiums. This credit was completely utilized in
      early 2008. This was partially offset by a $23,000 reduction in regulatory
      assessment costs, a savings resulting from the change in charter from a National
      bank to a State chartered bank. Costs related to the repossession of loan
      collateral increased $23,000 when comparing the two quarters. Amortization
      expense of core deposit intangibles was $0 for the third quarter of 2008
      compared to $13,000 for the third quarter of 2007. See Note 8 to the financial
      statements.





For
      the
      nine-month periods ended September 30, 2008 and 2007 other expense was
      $1,074,000 and $1,030,000, respectively. Expense related to FDIC premiums
      increased $147,000 when comparing the nine-month periods. Expenses related
      to
      the checkcard program increased $21,000 and repossession costs increased $20,000
      when comparing the periods. These increases were partially offset by declines
      in
      regulatory expense of $72,000, amortization of core deposit intangible expense
      of $36,000 fraudulent check card expense of $21,000 and courier expense of
      $17,000. The reduction in courier expense reflects efficiencies gained through
      the remote branch capture system.





**INCOME
      TAXES**





QNB
      utilizes an asset and liability approach for financial accounting and reporting
      of income taxes. As of September 30, 2008, QNB’s net deferred tax asset was
      $2,296,000. The primary components of deferred taxes are a deferred tax asset
      of
      $1,187,000 related to the allowance for loan losses, a deferred tax asset of
      $908,000 resulting from unrealized losses on available-for-sale securities
      and a
      deferred tax asset of $171,000 related to impaired securities. As of September
      30, 2007, QNB's net deferred tax asset was $695,000 comprised of deferred tax
      assets of $1,020,000 related to the allowance for loan losses, a deferred tax
      asset of $52,000 related to impaired securities and a deferred tax liability
      of
      $297,000 related to unrealized gains on available-for-sale
      securities.




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          39
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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**INCOME
      TAXES (Continued)**





The
      realizability of deferred tax assets is dependent upon a variety of factors
      including the generation of future taxable income, the existence of taxes paid
      and recoverable, the reversal of deferred tax liabilities and tax planning
      strategies. Based upon these and other factors, management believes it is more
      likely than not that QNB will realize the benefits of these remaining deferred
      tax assets. The net deferred tax asset is included in other assets on the
      consolidated balance sheet.





Applicable
      income taxes and effective tax rates were $476,000, or 23.3%, for the
      three-month period ended September 30, 2008, and $463,000, or 23.0%, for the
      same period in 2007. For the nine-month period ended September 30, 2008
      applicable income taxes and the effective tax rate were $1,492,000, or 23.4%.
      For the nine-month period ended September 30, 2007 the provision for income
      taxes was $111,000 and the corresponding effective tax rate was 5.2%. The low
      effective tax rate for the nine-month period of 2007 is primarily the result
      of
      the charges related to the restructuring transactions, involving the sale of
      securities and the prepayment of FHLB advances, which reduced the amount of
      taxable income and as a result, tax-exempt income from loans and securities
      comprised a higher proportion of pre-tax income.





**FINANCIAL
      CONDITION ANALYSIS**





The
      balance sheet analysis compares average balance sheet data for the nine months
      ended September 30, 2008 and 2007, as well as the period ended balances as
      of
      September 30, 2008 and December 31, 2007.





Average
      earning assets for the nine-month period ended September 30, 2008 increased
      $23,574,000, or 4.1%, to $597,019,000 from $573,445,000 for the nine months
      ended September 30, 2007. The mix of earning assets changed slightly when
      comparing the two periods. Average loans increased $19,883,000, or 5.5%, while
      average investments increased $3,650,000, or 1.8%. Average Federal funds sold
      increased $753,000 when comparing these same periods.





QNB’s
      primary business is accepting deposits and making loans to meet the credit
      needs
      of the communities it serves. Loans are the most significant component of
      earning assets and growth in loans to small businesses and residents of these
      communities has been a primary focus of QNB. QNB has been successful in
      achieving growth in total loans, while at the same time maintaining asset
      quality. Inherent within the lending function is the evaluation and acceptance
      of credit risk and interest rate risk. QNB manages credit risk associated with
      its lending activities through portfolio diversification, underwriting policies
      and procedures and loan monitoring practices.





Total
      loans increased 3.6% between September 30, 2007 and September 30, 2008 but
      decreased .2% since December 31, 2007. The slower rate of growth since September
      30, 2007 as compared to the average rate of growth
      when comparing the nine-month periods reflects the significant amount of loans
      originated during the first third of 2007 as well as the slowdown in growth
      in
      the local and regional economy over the past year.





Average
      total commercial loans increased $25,517,000 when comparing the first nine
      months of 2008 to the same period in 2007. Most of the 10.3% growth in average
      commercial loans was in loans secured by real estate, either commercial or
      residential properties, which increased $17,202,000. Commercial and industrial
      loans represent commercial purpose loans that are either secured by collateral
      other than real estate or unsecured. Many of these loans are for operating
      lines
      of credit. Average commercial and industrial loans increased $7,657,000, or
      12.6%, when comparing the nine-month periods. Also contributing to the growth
      in
      total commercial loans was a small increase in tax-exempt loans. Average
      tax-exempt loans increased $658,000, or 2.8%, when comparing the nine-month
      periods. With the slowdown in the economy and uncertainty when the economy
      will
      improve, some businesses are being cautious in investing in new equipment,
      inventory or projects. This is having an impact on loan demand.




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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**FINANCIAL
      CONDITION ANALYSIS (Continued)**





Indirect
      lease financing receivables represent loans to small businesses that are
      collateralized by equipment. These loans tend to have higher risk
      characteristics but generally provide higher rates of return. 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 Pennsylvania and states contiguous to Pennsylvania.
      QNB is not the lessor and does not service these loans. Average indirect lease
      financing loans decreased $641,000, or 4.7%, when comparing the nine-month
      periods. The slowing local and regional economy and an increase in delinquency
      rates have negatively impacted the volume of indirect lease financing
      receivables purchased over the past year.





Average
      residential mortgage loans decreased $3,459,000, or 13.7%, when comparing the
      first nine months of 2008 to the first nine months of 2007. The slowdown in
      the
      housing market and QNB’s decision to sell most originations of 1-4 family
      residential mortgages in the secondary market has contributed to the decline
      in
      the residential mortgage loan portfolio.





We
      currently hold 8 pooled trust preferred security issues with a book value of
      $5,111,000 and a fair value of $3,161,000. All of our trust preferred securities
      are available-for-sale securities and are carried at fair value with changes
      in
      fair value being reflected on the balance sheet (and equity) and changes being
      reflected in other comprehensive income. These securities are comprised mainly
      of securities issued by financial institutions, and to a lesser degree,
      insurance companies. We own the mezzanine tranches of these securities. The
      securities that we own are structured so that the senior and mezzanine tranches
      are protected from defaults by over-collateralization and cash flow default
      protection provided by subordinated tranches, with senior tranches having the
      greatest level of protection and mezzanine tranches subordinated to the senior
      tranches.





All
      of
      our pool trust preferred securities are rated lower than AA and are subject
      to
      the guidance of EITF 99-20. We have tested various scenarios of cash flows
      for
      these trust preferred securities, including various default and deferral
      scenarios of the issuers to determine if there is possible impairment. We did
      not incur any other than temporary impairment charges on any of these trust
      preferred securities during the third quarter; however, these are the securities
      that we are monitoring most closely for potential other than temporary
      impairment. It is possible that future calculations could require the recording
      of an other than temporary impairment charge through earnings. Of these
      securities, trust preferred securities with a book value of $2,472,000 and
      a
      fair value of $1,376,000 were downgraded to Baa2 by Moody’s during the quarter
      and are the securities that are most susceptible to other than temporary
      impairment in the future.




-
          41
          -


**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**FINANCIAL
      CONDITION ANALYSIS (Continued)**





The
      mix
      of deposits continued to be impacted by the reaction of customers to changes
      in
      interest rates on various products and by rates paid by the competition. Total
      average deposits increased $21,057,000, or 4.3%, to $512,897,000 for the first
      nine months of 2008 compared to the same period in 2007. Consistent with
      customers looking for the highest rate for the shortest term, the growth
      achieved in total average deposits was in time deposits which increased
      $28,924,000, or 12.0%, when comparing the same periods. Of this increase
      $13,912,000 was in time deposits over $100,000 which averaged $72,751,000 for
      the first nine months of 2008. The growth in this category of deposits has
      continued with time deposits of $100,000 or more having a balance of $88,366,000
      as of September 30, 2008, compared with $64,589,000 at December 31, 2007.
      Included in this category is $8,000,000 received in September, 2008 from a
      local
      school district. These funds have a maturity of approximately five months and
      were matched against short-term investment securities with call dates
      approximating the maturity of the time deposit. Most of the growth in time
      deposits occurred in the maturity range of greater than 6 months through 18
      months, which QNB promoted in response to customers’ preferences and
      competitors’ offerings.





The
      average balances of all other deposits types, except for interest-bearing demand
      deposits, declined when comparing the first nine months of 2008 to the same
      period in 2007. Average interest-bearing demand accounts increased 3.3% while
      average non-interest bearing demand accounts declined by .2%. Average municipal
      interest-bearing demand deposit accounts decreased by 9.0% when comparing the
      nine-month periods. The average balance in these accounts is impacted by the
      timing of receiving the tax deposits of the schools and municipalities and
      the
      length of time the funds stay in the bank prior to being withdrawn for operating
      purposes or deployed in alternative investments. Average money market account
      balances decreased 7.0% and average savings accounts decreased 4.0% when
      comparing the periods. The interest rate paid on money market accounts declined
      significantly over the past year as treasury rates have declined. As a result
      many customers moved these liquid funds into higher yielding short-term time
      deposits, contributing to the increase in these balances.





Total
      assets at September 30, 2008 were $638,327,000, compared with $609,813,000
      at
      December 31, 2007, an increase of 4.7%. Most of the growth in total assets
      since
      December 31, 2007 was in investment securities which increased $27,740,000.
      Other assets increased by $2,063,000, primarily an increase in deferred tax
      assets resulting from the change in unrealized gains and losses in the
      available-for-sale investment portfolio. The balances in the other categories
      of
      assets, including loans, remained relatively unchanged when comparing September
      30, 2008 to December 31, 2007.




On
      the
      liability side, total deposits increased by $32,795,000, or 6.6%, since
      year-end. Time deposits continued to be the product of choice, increasing
      $32,523,000 since December 31, 2007 with time deposits of $100,000 or more
      increasing $23,777,000.





Non-interest
      bearing demand accounts decreased $918,000 while interest-bearing demand
      accounts, including municipal accounts, increased by $2,526,000 to $99,816,000.
      Interest-bearing municipal balances increased by $1,772,000 when comparing
      September 30, 2008 to December 31, 2007. Also included in interest-bearing
      demand accounts is the eReward checking product. This product, introduced in
      July 2008, is a high rate checking account paying 4.01% interest on balances
      up
      to $25,000. In order to receive this rate a customer must receive an electronic
      statement, have one direct deposit or other ACH transaction and perform at
      least
      12 check card transactions per statement cycle. At September 30, 2008 eReward
      checking balances were $4,527,000. Transaction account balances discussed above
      can be volatile depending on the timing of deposits and
      withdrawals.




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          42
          -


**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**FINANCIAL
      CONDITION ANALYSIS (Continued)**





Money
      market accounts declined $3,020,000 to $46,646,000 at September 30, 2008 while
      savings accounts increased $1,684,000 from $42,075,000 at December 31, 2007
      to
      $43,759,000 at September 30, 2008.





When
      comparing December 31, 2007 to September 30, 2008, short-term borrowing declined
      from $33,990,000 to $19,557,000. Commercial sweep accounts recorded as
      repurchase agreements declined by $14,521,000 to $14,944,000 at September 30,
      2008. Some of the decline in the commercial sweep accounts is a result of funds
      being moved to higher paying time deposit accounts over $100,000, as these
      offered higher rates than the sweep product.





**LIQUIDITY**





Liquidity
      represents an institution’s ability to generate cash or otherwise obtain funds
      at reasonable rates to satisfy commitments to borrowers and demands of
      depositors. QNB manages its mix of cash, Federal funds sold and investment
      securities in order to match the volatility, seasonality, interest sensitivity
      and growth trends of its loans and deposits. Liquidity is provided from asset
      sources through maturities and repayments of loans and investment securities.
      The portfolio of investment securities classified as available-for-sale and
      QNB's policy of selling certain residential mortgage originations in the
      secondary market also provide sources of liquidity. Additional sources of
      liquidity are provided by the Bank’s membership
      in the Federal Home Loan Bank of Pittsburgh (FHLB) and two unsecured Federal
      funds lines granted by correspondent banks totaling $21,000,000. At September
      30, 2008, the Bank has a maximum borrowing capacity with the FHLB of
      approximately $188,903,000.





Cash
      and
      due from banks, Federal funds sold, available-for-sale securities and loans
      held-for-sale totaled $233,962,000 and $206,562,000 at September 30, 2008 and
      December 31, 2007, respectively. The increase in liquid sources is primarily
      the
      result of an increase in the available-for-sale securities portfolio. These
      sources should be adequate to meet normal fluctuations in loan demand and
      deposit withdrawals. Average Federal funds purchased were $155,000 for the
      third
      quarter of 2008 and $790,000 for the first nine months of 2008. These levels
      compare to $38,000 and $482,000 for the same periods in 2007. During the first
      quarter of 2008, QNB used its Federal funds line to prefund the purchase of
      investment securities in anticipation of declining interest rates and to fund
      seasonal deposit withdrawals. The maximum balance of Federal funds purchased
      during the first nine months of 2008 was $14,617,000. The Federal funds purchase
      line was paid down with $10,000,000 of borrowings from the FHLB with a rate
      of
      2.97% and a two year maturity. At September 30, 2008, QNB had $4,013,000 of
      outstanding borrowings under one of its Federal funds lines.





Approximately
      $107,953,000 and $107,750,000 of available-for-sale securities at September
      30,
      2008 and December 31, 2007, 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. As mentioned above, QNB had
      $10,000,000 of outstanding borrowings under the FHLB credit facility at
      September 30, 2008.




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          43
          -


**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**CAPITAL
      ADEQUACY**





A
      strong
      capital position is fundamental to support continued growth and profitability
      and to serve the needs of depositors. QNB's shareholders' equity at September
      30, 2008 was $52,297,000, or 8.19% of total assets, compared to shareholders'
      equity of $53,251,000, or 8.73% of total assets, at December 31, 2007.
      Shareholders’ equity at September 30, 2008 included a negative adjustment of
      $1,762,000 related to unrealized holding losses, net of taxes, on investment
      securities available-for-sale while shareholders’ equity at December 31, 2007
      included a positive adjustment of $1,504,000 related to unrealized holding
      gains, net of taxes, on investment securities available-for-sale. Without the
      FASB No. 115 available-for-sale adjustments, shareholders' equity to total
      assets would have been 8.47% and 8.49% at September 30, 2008 and December 31,
      2007, respectively. The adoption of EITF 06-04, *Accounting
      for Deferred Compensation and Postretirement Benefit Aspects of Endorsement
      Split-Dollar Life Insurance Arrangements* on
      January 1, 2008 resulted in the recognition of a cumulative effect adjustment
      to
      retained earnings of $481,000.





Shareholders'
      equity averaged $53,028,000 for the first nine months of 2008 and $51,299,000
      during all of 2007, an increase of 3.4%. The ratio of average total equity
      to
      average total assets was 8.47% for the first nine months of 2008 compared to
      8.51% for all of 2007.





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% for Tier I, 8.00% for the total
      risk-based capital and 4.00% for leverage. Under the requirements, QNB had
      a
      Tier I capital ratio of 12.09% and 12.25%, a total risk-based ratio of 12.87%
      and 13.06% and a leverage ratio of 8.34% and 8.64% at September 30, 2008 and
      December 31, 2007, respectively.





The
      Federal Deposit Insurance Corporation Improvement Act of 1991 established five
      capital level designations ranging from "well capitalized" to "critically
      undercapitalized." At September 30, 2008 and December 31, 2007, QNB met the
      "well capitalized" criteria which requires minimum Tier I and total risk-based
      capital ratios of 6.00% and 10.00%, respectively, and a leverage ratio of
      5.00%.





**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. QNB’s 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.




-
          44
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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**INTEREST
      RATE SENSITIVITY (Continued)**





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.
      Interest-bearing demand accounts, money market accounts and savings 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 or borrowed funds 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.





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





QNB
      primarily focuses on the management of the one-year interest rate sensitivity
      gap. At September 30, 2008, interest-earning assets scheduled to mature or
      likely to be called, repriced or repaid in one year were $254,995,000.
      Interest-sensitive liabilities scheduled to mature or reprice within one year
      were $353,211,000. The one-year cumulative gap, which reflects QNB’s interest
      sensitivity over a period of time, was a negative $98,216,000 at September
      30,
      2008. The cumulative one-year gap equals -15.9% of total rate sensitive assets.
      This gap position compares to a negative gap position of $129,740,000, or
      -22.2%, of total rate sensitive assets, at December 31, 2007. The negative
      gap
      position is primarily the result of customers’ preference for keeping maturities
      on time deposits short. This preference was met as banks, including the Bank,
      tended to offer the highest yielding time deposits in the maturity range of
      six
      months through 18 months. At September 30, 2008, $226,937,000, or 78.9%, of
      total time deposits were scheduled to reprice or mature in the next twelve
      months compared to $199,383,000, or 78.2%, of total time deposits at December
      31, 2007. Also contributing to the negative gap position are the municipal
      accounts which are indexed to the Federal funds rate and the Select money market
      product, while not indexed directly with the Federal funds rate, moves closely
      with changes in that rate. On the liability side, the increase in short maturity
      time deposits between December 31, 2007 and September 30, 2008 was partially
      offset by a $14,521,000 decline in commercial sweep accounts reported in
      short-term borrowings. On the asset side, the amount of assets maturing or
      repricing increased by $44,192,000 from December 31, 2007 to September 30,
      2008.
      Investment securities and loans, that reprice or mature in the next twelve
      months, increased by $19,774,000 and $23,733,000, respectively, when comparing
      the same two time periods. With the decline in interest rates the projected
      cash
      flow from the investment portfolio has increased as bonds with call dates are
      more likely to be called and prepayments from mortgage-backed securities should
      increase as well. In addition, as mentioned previously, QNB purchased $8,000,000
      in callable agency bonds that have call dates in early 2009 to match against
      the
      short-term time deposits of a school district. On the loan side, prepayments
      of
      loans may increase as borrowers seek lower interest rates in the current
      environment. In addition, more borrowers are taking floating rate loans indexed
      to the Prime lending rate in light of how low that rate currently is. As rates
      start to increase it is likely that these same borrowers will switch from a
      floating or adjustable rate loans to a loan with a longer fixed rate. This
      is
      what occurred when rates were at these levels in the past.




-
          45
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**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**INTEREST
      RATE SENSITIVITY (Continued)**





With
      the
      decline in interest rates, QNB’s cost of funds should continue to decline in the
      short-run as the maturing time deposits reprice at lower rates. The challenge
      will be to retain these deposits given the competitive environment. Also, there
      are some deposit accounts and products that are at their floor and therefore
      QNB
      will not be able to benefit from the latest drop in the Federal funds rate.
      In
      this lower interest rate environment, the repricing characteristics of
      investments and loans will likely shorten as prepayment speeds increase
      resulting in more funds being invested at lower yields.





QNB
      also
      uses a simulation model to assess the impact of changes in interest rates on
      net
      interest income. The model reflects management’s assumptions related to asset
      yields and rates paid on liabilities, deposit sensitivity, and the size,
      composition and maturity or repricing characteristics of the balance sheet.
      The
      assumptions are based on what management believes at that time to be the most
      likely interest rate environment. Management also evaluates the impact of higher
      and lower interest rates by simulating the impact on net interest income of
      changing rates. While management performs rate shocks of 100, 200 and 300
      basis
      points, it believes, that given the level of interest rates at September 30,
      2008, that it is unlikely that
      interest rates would decline by 200 or 300 basis points. The simulation results
      can be found in the chart below.





Net
      interest income declines in a falling rate environment. This result reflects
      the
      interest rate floors on some municipal interest-bearing demand accounts,
      hypothetical interest rate floors on interest-bearing transaction accounts,
      regular money market accounts and savings accounts. In addition, in a lower
      rate
      environment, the cash flow or repricing characteristics from both the loan
      and
      investment portfolios would increase and be reinvested at lower rates. Loan
      customers would either refinance their fixed rate loans at lower rates or
      request rate reductions on their existing loans. The decline in net income
      as
      rates fall 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, the timing of the rate change,
      or
      interest rate floors. Net interest income also declines as rates increase which
      is consistent with the GAP analysis. In a rising rate environment a greater
      amount of interest-bearing liabilities will reprice higher compared to earning
      assets thereby reducing net interest income and the net interest margin.





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. At September 30, 2008, QNB did not
      have any hedging transactions in place such as interest rate swaps, caps or
      floors.




-
          46
          -


**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





**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
            
            $
            18,961
            
            $
            (1,127
            )
            
            (5.6
            )%+200
                Basis Points
            
            
            19,425
            
            
            (663
            )
            
            (3.3
            )+100
                Basis Points
            
            
            19,880
            
            
            (208
            )
            
            (1.0
            )FLAT
                RATE
            
            
            20,088
            
            
            -
            
            
            --100
                Basis Points
            
            
            19,687
            
            
            (401
            )
            
            (2.0
            )-200
                Basis Points
            
            
            18,390
            
            
            (1,698
            )
            
            (8.5
            )


-
          47
          -





**QNB
      CORP. AND SUBSIDIARY**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL**


**CONDITION
      AND RESULTS OF OPERATIONS**





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





The
      information required in response to this item 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 control over financial reporting during the
      fiscal quarter covered by this report that have materially affected, or are
      reasonably likely to materially affect, our internal control over financial
      reporting.




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          48
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**QNB
      CORP. AND SUBSIDIARY**





**PART
      II. OTHER INFORMATION**





**SEPTEMBER
      30, 2008**


**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,
                  2007.**Item
                  2.**
              **Unregistered
                  Sales of Equity Securities and Use of
                  Proceeds**None.**Item
                  3.**
              **Default
                  Upon Senior Securities**None.**Item
                  4.**
              **Submission
                  of Matters to Vote of Security Holders**None**Item
                  5.**
              **Other
                  Information**None.**Item
                  6.**
              **Exhibits**





Exhibit
                3(i)
            Articles
                of Incorporation of Registrant, as amended. (Incorporated by reference
                to
                Exhibit 3(i) of Registrants Form DEF 14-A filed with the Commission
                on
                April 15, 2005).Exhibit
                3(ii)
            Bylaws
                of Registrant, as amended. (Incorporated by reference to Exhibit
                3(ii) of
                Registrants Form 8-K filed with the Commission on January 23,
                2006).Exhibit
                11
            Statement
                Re: Computation of Earnings Per Share. (Included in Part I, Item
                I,
                hereof.)Exhibit
                31.1
            Section
                302 Certification of President and CEOExhibit
                31.2
            Section
                302 Certification of Chief Financial OfficerExhibit
                32.1
            Section
                906 Certification of President and CEOExhibit
                32.2
            Section
                906 Certification of Chief Financial
                Officer




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          49
          -


**SIGNATURES**





Pursuant
      to the requirements of the Securities Exchange Act of 1934, the Registrant
      has
      duly caused this Report to be signed on its behalf by the undersigned, thereunto
      duly authorized.


QNB
                    Corp.Date:
                November
                    10, 2008
                
                
                By:/s/
                    Thomas J. BiskoThomas
                    J. BiskoPresident/CEODate:
                November
                    10, 2008
                
                
                By:/s/
                    Bret H. KrevolinBret
                    H. KrevolinChief
                    Financial Officer