UNITED
STATES


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 endedJune 30, 2010


OR


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





For the
transition period from  to





Commission
file number 0-17706





QNB Corp.(Exact
      Name of Registrant as Specified in Its
Charter)





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





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





Not ApplicableFormer
      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 requiredto filesuch reports), and (2) has
been subject to such filing requirements for the past 90
days.  YesþNo ̈





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).  Yes  ̈   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
      filer   ̈Non-accelerated
      filer   ̈
              Smaller Reporting
      Companyþ





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





Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.





Class
              
              Outstanding at August 9, 2010Common
      Stock, par value $0.625
              
              3,108,268





QNB
CORP. AND SUBSIDIARY


FORM
10-Q


QUARTER
ENDED JUNE 30, 2010





INDEX




PAGEPART
      I - FINANCIAL INFORMATIONITEM
      1.
                                  CONSOLIDATED
      FINANCIAL STATEMENTS (Unaudited)Consolidated
      Balance Sheets at June 30, 2010and
      December 31, 2009
                                  3Consolidated
      Statements of Income for the Three and SixMonths
      Ended June 30, 2010 and 2009
                                  4Consolidated
      Statement of Shareholders’ Equity for the SixMonths
      Ended June 30, 2010
                                  5Consolidated
      Statements of Cash Flows for the SixMonths
      Ended June 30, 2010 and 2009
                                  6Notes
      to Consolidated Financial Statements
                                  7ITEM
      2.
                                  MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIALCONDITION
      AND RESULTS OF OPERATIONS
                                  28ITEM
      3.
                                  QUANTITATIVE
      AND QUALITATIVE DISCLOSURE ABOUTMARKET
      RISK
                                  59ITEM
      4.
                                  CONTROLS
      AND PROCEDURES
                                  59PART
      II - OTHER INFORMATIONITEM
      1.
                                  LEGAL
      PROCEEDINGS
                                  60ITEM
      1A.
                                  RISK
      FACTORS
                                  60ITEM
      2.
                                  UNREGISTERED
      SALES OF EQUITY SECURITIES ANDUSE
      OF PROCEEDS
                                  60ITEM
      3.
                                  DEFAULTS
      UPON SENIOR SECURITIES
                                  60ITEM
      4.
                                  REMOVED
      AND RESERVED
                                  60ITEM
      5.
                                  OTHER
      INFORMATION
                                  60ITEM
      6.
                                  EXHIBITS
                                  61SIGNATURESCERTIFICATIONS




- 2
-




QNB Corp. and SubsidiaryCONSOLIDATED
      BALANCE SHEETS
 (in
      thousands, except share data)(unaudited)June
      30,
                                              
                                              
                                              December
      31,2010
                                              
                                              
                                              2009AssetsCash
      and due from banks
                                              
                                              $
                                              10,341
                                              
                                              
                                              $
                                              8,841Interest-bearing
      deposits in banks
                                              
                                              
                                              7,340
                                              
                                              
                                              
                                              22,158Total
      cash and cash equivalents
                                              
                                              
                                              17,681
                                              
                                              
                                              
                                              30,999Investment
      securitiesAvailable-for-sale
      (amortized cost $256,031 and $254,251)
                                              
                                              
                                              261,872
                                              
                                              
                                              
                                              256,862Held-to-maturity
      (fair value $2,951 and $3,471)
                                              
                                              
                                              2,847
                                              
                                              
                                              
                                              3,347Restricted
      investment in bank stocks
                                              
                                              
                                              2,291
                                              
                                              
                                              
                                              2,291Loans
      held-for-sale
                                              
                                              
                                              377
                                              
                                              
                                              
                                              534Loans
      receivable
                                              
                                              
                                              474,678
                                              
                                              
                                              
                                              449,421Allowance
      for loan losses
                                              
                                              
                                              (7,009
                                              )
                                              
                                              
                                              (6,217
                                              )Net
      loans
                                              
                                              
                                              467,669
                                              
                                              
                                              
                                              443,204Bank-owned
      life insurance
                                              
                                              
                                              9,246
                                              
                                              
                                              
                                              9,109Premises
      and equipment, net
                                              
                                              
                                              6,211
                                              
                                              
                                              
                                              6,248Accrued
      interest receivable
                                              
                                              
                                              2,717
                                              
                                              
                                              
                                              2,848Other
      assets
                                              
                                              
                                              5,204
                                              
                                              
                                              
                                              6,984Total
      assets
                                              
                                              $
                                              776,115
                                              
                                              
                                              $
                                              762,426LiabilitiesDepositsDemand,
      non-interest bearing
                                              
                                              $
                                              59,235
                                              
                                              
                                              $
                                              53,930Interest-bearing
      demand
                                              
                                              
                                              116,251
                                              
                                              
                                              
                                              120,554Money
      market
                                              
                                              
                                              70,672
                                              
                                              
                                              
                                              70,165Savings
                                              
                                              
                                              94,525
                                              
                                              
                                              
                                              68,358Time
                                              
                                              
                                              210,269
                                              
                                              
                                              
                                              215,155Time
      of $100,000 or more
                                              
                                              
                                              107,018
                                              
                                              
                                              
                                              105,941Total
      deposits
                                              
                                              
                                              657,970
                                              
                                              
                                              
                                              634,103Short-term
      borrowings
                                              
                                              
                                              34,059
                                              
                                              
                                              
                                              28,433Long-term
      debt
                                              
                                              
                                              20,000
                                              
                                              
                                              
                                              35,000Accrued
      interest payable
                                              
                                              
                                              1,255
                                              
                                              
                                              
                                              1,565Other
      liabilities
                                              
                                              
                                              1,703
                                              
                                              
                                              
                                              6,899Total
      liabilities
                                              
                                              
                                              714,987
                                              
                                              
                                              
                                              706,000Shareholders'
      EquityCommon
      stock, par value $0.625 per share; authorized 10,000,000 shares; 3,272,837
      shares and 3,257,794 shares issued; 3,108,268 and 3,093,225 shares
      outstanding
                                              
                                              
                                              2,046
                                              
                                              
                                              
                                              2,036Surplus
                                              
                                              
                                              10,479
                                              
                                              
                                              
                                              10,221Retained
      earnings
                                              
                                              
                                              47,224
                                              
                                              
                                              
                                              44,922Accumulated
      other comprehensive income, net
                                              
                                              
                                              3,855
                                              
                                              
                                              
                                              1,723Treasury
      stock, at cost; 164,569 shares
                                              
                                              
                                              (2,476
                                              )
                                              
                                              
                                              (2,476
                                              )Total
      shareholders' equity
                                              
                                              
                                              61,128
                                              
                                              
                                              
                                              56,426Total
      liabilities and shareholders' equity
                                              
                                              $
                                              776,115
                                              
                                              
                                              $
                                              762,426
 
 The
accompanying notes are an integral part of the unaudited consolidated financial
statements.
  - 3
-
 
 QNB Corp. and SubsidiaryCONSOLIDATED STATEMENTS OF INCOME
                                                                      
                                                                      (in thousands, except share data)(unaudited)Three Months
                                                                      
                                                                      
                                                                      Six MonthsEnded June 30,
                                                                      
                                                                      
                                                                      Ended June 30,2010
                                                                      
                                                                      
                                                                      2009
                                                                      
                                                                      
                                                                      2010
                                                                      
                                                                      
                                                                      2009Interest
      IncomeInterest
      and fees on loans
                                                                      
                                                                      $
                                                                      6,635
                                                                      
                                                                      
                                                                      $
                                                                      6,149
                                                                      
                                                                      
                                                                      $
                                                                      12,994
                                                                      
                                                                      
                                                                      $
                                                                      12,062Interest
      and dividends on investment securities:Taxable
                                                                      
                                                                      
                                                                      1,815
                                                                      
                                                                      
                                                                      
                                                                      2,178
                                                                      
                                                                      
                                                                      
                                                                      3,689
                                                                      
                                                                      
                                                                      
                                                                      4,380Tax-exempt
                                                                      
                                                                      
                                                                      590
                                                                      
                                                                      
                                                                      
                                                                      529
                                                                      
                                                                      
                                                                      
                                                                      1,175
                                                                      
                                                                      
                                                                      
                                                                      1,038Interest
      on Federal funds sold
                                                                      
                                                                      
                                                                      –
                                                                      
                                                                      
                                                                      
                                                                      1
                                                                      
                                                                      
                                                                      
                                                                      –
                                                                      
                                                                      
                                                                      
                                                                      2Interest
      on interest-bearing balances and other interest income
                                                                      
                                                                      
                                                                      9
                                                                      
                                                                      
                                                                      
                                                                      2
                                                                      
                                                                      
                                                                      
                                                                      19
                                                                      
                                                                      
                                                                      
                                                                      3Total
      interest income
                                                                      
                                                                      
                                                                      9,049
                                                                      
                                                                      
                                                                      
                                                                      8,859
                                                                      
                                                                      
                                                                      
                                                                      17,877
                                                                      
                                                                      
                                                                      
                                                                      17,485Interest
      ExpenseInterest
      on depositsInterest-bearing
      demand
                                                                      
                                                                      
                                                                      245
                                                                      
                                                                      
                                                                      
                                                                      173
                                                                      
                                                                      
                                                                      
                                                                      467
                                                                      
                                                                      
                                                                      
                                                                      327Money
      market
                                                                      
                                                                      
                                                                      161
                                                                      
                                                                      
                                                                      
                                                                      177
                                                                      
                                                                      
                                                                      
                                                                      327
                                                                      
                                                                      
                                                                      
                                                                      341Savings
                                                                      
                                                                      
                                                                      180
                                                                      
                                                                      
                                                                      
                                                                      31
                                                                      
                                                                      
                                                                      
                                                                      321
                                                                      
                                                                      
                                                                      
                                                                      59Time
                                                                      
                                                                      
                                                                      1,122
                                                                      
                                                                      
                                                                      
                                                                      1,819
                                                                      
                                                                      
                                                                      
                                                                      2,394
                                                                      
                                                                      
                                                                      
                                                                      3,668Time
      of $100,000 or more
                                                                      
                                                                      
                                                                      587
                                                                      
                                                                      
                                                                      
                                                                      910
                                                                      
                                                                      
                                                                      
                                                                      1,223
                                                                      
                                                                      
                                                                      
                                                                      1,830Interest
      on short-term borrowings
                                                                      
                                                                      
                                                                      67
                                                                      
                                                                      
                                                                      
                                                                      53
                                                                      
                                                                      
                                                                      
                                                                      120
                                                                      
                                                                      
                                                                      
                                                                      109Interest
      on long-term debt
                                                                      
                                                                      
                                                                      252
                                                                      
                                                                      
                                                                      
                                                                      376
                                                                      
                                                                      
                                                                      
                                                                      566
                                                                      
                                                                      
                                                                      
                                                                      750Total
      interest expense
                                                                      
                                                                      
                                                                      2,614
                                                                      
                                                                      
                                                                      
                                                                      3,539
                                                                      
                                                                      
                                                                      
                                                                      5,418
                                                                      
                                                                      
                                                                      
                                                                      7,084Net
      interest income
                                                                      
                                                                      
                                                                      6,435
                                                                      
                                                                      
                                                                      
                                                                      5,320
                                                                      
                                                                      
                                                                      
                                                                      12,459
                                                                      
                                                                      
                                                                      
                                                                      10,401Provision
      for loan losses
                                                                      
                                                                      
                                                                      700
                                                                      
                                                                      
                                                                      
                                                                      500
                                                                      
                                                                      
                                                                      
                                                                      1,400
                                                                      
                                                                      
                                                                      
                                                                      1,100Net
      interest income after provision for loan losses
                                                                      
                                                                      
                                                                      5,735
                                                                      
                                                                      
                                                                      
                                                                      4,820
                                                                      
                                                                      
                                                                      
                                                                      11,059
                                                                      
                                                                      
                                                                      
                                                                      9,301Non-Interest
      IncomeTotal
      other-than-temporary impairment losses on investment
      securities
                                                                      
                                                                      
                                                                      (68
                                                                      )
                                                                      
                                                                      
                                                                      (182
                                                                      )
                                                                      
                                                                      
                                                                      (253
                                                                      )
                                                                      
                                                                      
                                                                      (571
                                                                      )Less:
      Portion of loss recognized in other comprehensive income (before
      taxes)
                                                                      
                                                                      
                                                                      –
                                                                      
                                                                      
                                                                      
                                                                      48
                                                                      
                                                                      
                                                                      
                                                                      27
                                                                      
                                                                      
                                                                      
                                                                      48Net
      other-than-temporary impairment losses on investment
      securities
                                                                      
                                                                      
                                                                      (68
                                                                      )
                                                                      
                                                                      
                                                                      (134
                                                                      )
                                                                      
                                                                      
                                                                      (226
                                                                      )
                                                                      
                                                                      
                                                                      (523
                                                                      )Net
      gain on sale of investment securities
                                                                      
                                                                      
                                                                      1
                                                                      
                                                                      
                                                                      
                                                                      108
                                                                      
                                                                      
                                                                      
                                                                      295
                                                                      
                                                                      
                                                                      
                                                                      243Net
      (loss) gain on investment securities
                                                                      
                                                                      
                                                                      (67
                                                                      )
                                                                      
                                                                      
                                                                      (26
                                                                      )
                                                                      
                                                                      
                                                                      69
                                                                      
                                                                      
                                                                      
                                                                      (280
                                                                      )Fees
      for services to customers
                                                                      
                                                                      
                                                                      406
                                                                      
                                                                      
                                                                      
                                                                      423
                                                                      
                                                                      
                                                                      
                                                                      811
                                                                      
                                                                      
                                                                      
                                                                      818ATM
      and debit card
                                                                      
                                                                      
                                                                      314
                                                                      
                                                                      
                                                                      
                                                                      256
                                                                      
                                                                      
                                                                      
                                                                      585
                                                                      
                                                                      
                                                                      
                                                                      484Bank-owned
      life insurance
                                                                      
                                                                      
                                                                      68
                                                                      
                                                                      
                                                                      
                                                                      66
                                                                      
                                                                      
                                                                      
                                                                      132
                                                                      
                                                                      
                                                                      
                                                                      137Mortgage
      servicing fees
                                                                      
                                                                      
                                                                      23
                                                                      
                                                                      
                                                                      
                                                                      25
                                                                      
                                                                      
                                                                      
                                                                      55
                                                                      
                                                                      
                                                                      
                                                                      61Net
      gain on sale of loans
                                                                      
                                                                      
                                                                      142
                                                                      
                                                                      
                                                                      
                                                                      234
                                                                      
                                                                      
                                                                      
                                                                      217
                                                                      
                                                                      
                                                                      
                                                                      402Other
                                                                      
                                                                      
                                                                      141
                                                                      
                                                                      
                                                                      
                                                                      89
                                                                      
                                                                      
                                                                      
                                                                      290
                                                                      
                                                                      
                                                                      
                                                                      178Total
      non-interest income
                                                                      
                                                                      
                                                                      1,027
                                                                      
                                                                      
                                                                      
                                                                      1,067
                                                                      
                                                                      
                                                                      
                                                                      2,159
                                                                      
                                                                      
                                                                      
                                                                      1,800Non-Interest
      ExpenseSalaries
      and employee benefits
                                                                      
                                                                      
                                                                      2,167
                                                                      
                                                                      
                                                                      
                                                                      2,078
                                                                      
                                                                      
                                                                      
                                                                      4,304
                                                                      
                                                                      
                                                                      
                                                                      4,156Net
      occupancy
                                                                      
                                                                      
                                                                      360
                                                                      
                                                                      
                                                                      
                                                                      335
                                                                      
                                                                      
                                                                      
                                                                      729
                                                                      
                                                                      
                                                                      
                                                                      688Furniture
      and equipment
                                                                      
                                                                      
                                                                      288
                                                                      
                                                                      
                                                                      
                                                                      309
                                                                      
                                                                      
                                                                      
                                                                      570
                                                                      
                                                                      
                                                                      
                                                                      605Marketing
                                                                      
                                                                      
                                                                      199
                                                                      
                                                                      
                                                                      
                                                                      189
                                                                      
                                                                      
                                                                      
                                                                      360
                                                                      
                                                                      
                                                                      
                                                                      364Third
      party services
                                                                      
                                                                      
                                                                      290
                                                                      
                                                                      
                                                                      
                                                                      267
                                                                      
                                                                      
                                                                      
                                                                      563
                                                                      
                                                                      
                                                                      
                                                                      497Telephone,
      postage and supplies
                                                                      
                                                                      
                                                                      142
                                                                      
                                                                      
                                                                      
                                                                      156
                                                                      
                                                                      
                                                                      
                                                                      299
                                                                      
                                                                      
                                                                      
                                                                      305State
      taxes
                                                                      
                                                                      
                                                                      139
                                                                      
                                                                      
                                                                      
                                                                      133
                                                                      
                                                                      
                                                                      
                                                                      279
                                                                      
                                                                      
                                                                      
                                                                      268FDIC
      insurance premiums
                                                                      
                                                                      
                                                                      257
                                                                      
                                                                      
                                                                      
                                                                      539
                                                                      
                                                                      
                                                                      
                                                                      511
                                                                      
                                                                      
                                                                      
                                                                      732Other
                                                                      
                                                                      
                                                                      399
                                                                      
                                                                      
                                                                      
                                                                      378
                                                                      
                                                                      
                                                                      
                                                                      744
                                                                      
                                                                      
                                                                      
                                                                      698Total
      non-interest expense
                                                                      
                                                                      
                                                                      4,241
                                                                      
                                                                      
                                                                      
                                                                      4,384
                                                                      
                                                                      
                                                                      
                                                                      8,359
                                                                      
                                                                      
                                                                      
                                                                      8,313Income
      before income taxes
                                                                      
                                                                      
                                                                      2,521
                                                                      
                                                                      
                                                                      
                                                                      1,503
                                                                      
                                                                      
                                                                      
                                                                      4,859
                                                                      
                                                                      
                                                                      
                                                                      2,788Provision
      for income taxes
                                                                      
                                                                      
                                                                      558
                                                                      
                                                                      
                                                                      
                                                                      276
                                                                      
                                                                      
                                                                      
                                                                      1,070
                                                                      
                                                                      
                                                                      
                                                                      467Net
      Income
                                                                      
                                                                      $
                                                                      1,963
                                                                      
                                                                      
                                                                      $
                                                                      1,227
                                                                      
                                                                      
                                                                      $
                                                                      3,789
                                                                      
                                                                      
                                                                      $
                                                                      2,321Earnings
      Per Share - Basic
                                                                      
                                                                      $
                                                                      0.63
                                                                      
                                                                      
                                                                      $
                                                                      0.40
                                                                      
                                                                      
                                                                      $
                                                                      1.22
                                                                      
                                                                      
                                                                      $
                                                                      0.75Earnings
      Per Share - Diluted
                                                                      
                                                                      $
                                                                      0.63
                                                                      
                                                                      
                                                                      $
                                                                      0.40
                                                                      
                                                                      
                                                                      $
                                                                      1.22
                                                                      
                                                                      
                                                                      $
                                                                      0.75Cash
      Dividends Per Share
                                                                      
                                                                      $
                                                                      0.24
                                                                      
                                                                      
                                                                      $
                                                                      0.24
                                                                      
                                                                      
                                                                      $
                                                                      0.48
                                                                      
                                                                      
                                                                      $
                                                                      0.48
 
 The
accompanying notes are an integral part of the unaudited consolidated financial
statements.
  - 4
-
 
 QNB Corp. and SubsidiaryCONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
 
 AccumulatedNumber
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    Other(in thousands, except share data)
                                                    
                                                    of Shares
                                                    
                                                    
                                                    Common
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    Retained
                                                    
                                                    
                                                    Comprehesive
                                                    
                                                    
                                                    Treasury(unaudited)
                                                    
                                                    Outstanding
                                                    
                                                    
                                                    Stock
                                                    
                                                    
                                                    Surplus
                                                    
                                                    
                                                    Earnings
                                                    
                                                    
                                                    Income
                                                    
                                                    
                                                    Stock
                                                    
                                                    
                                                    TotalBalance,
      December 31, 2009
                                                    
                                                    
                                                    3,093,225
                                                    
                                                    
                                                    $
                                                    2,036
                                                    
                                                    
                                                    $
                                                    10,221
                                                    
                                                    
                                                    $
                                                    44,922
                                                    
                                                    
                                                    $
                                                    1,723
                                                    
                                                    
                                                    $
                                                    (2,476
                                                    )
                                                    
                                                    $
                                                    56,426Comprehensive
      income:Net
      Income
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    3,789
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    3,789Other
      comprehensive income
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    2,132
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    2,132Total
      comprehensive income
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    5,921Cash
      dividends paid ($0.48 per share)
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    (1,487
                                                    )
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    (1,487
                                                    )Stock
      issued - employee stock purchase plan
                                                    
                                                    
                                                    2,253
                                                    
                                                    
                                                    
                                                    1
                                                    
                                                    
                                                    
                                                    33
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    34Stock
      issued in connection with dividend reinvestmentand
      stock purchase plan
                                                    
                                                    
                                                    11,570
                                                    
                                                    
                                                    
                                                    8
                                                    
                                                    
                                                    
                                                    201
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    209Stock
      issued for options exercised
                                                    
                                                    
                                                    1,220
                                                    
                                                    
                                                    
                                                    1
                                                    
                                                    
                                                    
                                                    (1
                                                    )
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –Stock-based
      compensation expense
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    25
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    –
                                                    
                                                    
                                                    
                                                    25Balance,
      June 30, 2010
                                                    
                                                    
                                                    3,108,268
                                                    
                                                    
                                                    $
                                                    2,046
                                                    
                                                    
                                                    $
                                                    10,479
                                                    
                                                    
                                                    $
                                                    47,224
                                                    
                                                    
                                                    $
                                                    3,855
                                                    
                                                    
                                                    $
                                                    (2,476
                                                    )
                                                    
                                                    $
                                                    61,128
 
 The
accompanying notes are an integral part of the unaudited consolidated financial
statements.
  - 5
-
 
 QNB
      Corp. and SubsidiaryCONSOLIDATED
      STATEMENTS OF CASH FLOWS
                                                            
                                                            (in
      thousands)(unaudited)Six Months Ended June 30,
                                                            
                                                            2010
                                                            
                                                            
                                                            2009Operating
      ActivitiesNet
      income
                                                            
                                                            $
                                                            3,789
                                                            
                                                            
                                                            $
                                                            2,321Adjustments
      to reconcile net income to net cash provided by operating
      activitiesDepreciation
      and amortization
                                                            
                                                            
                                                            400
                                                            
                                                            
                                                            
                                                            445Provision
      for loan losses
                                                            
                                                            
                                                            1,400
                                                            
                                                            
                                                            
                                                            1,100Net
      (gain) loss on investment securities
                                                            
                                                            
                                                            (69
                                                            )
                                                            
                                                            
                                                            280Net
      loss on sale of repossessed assets
                                                            
                                                            
                                                            –
                                                            
                                                            
                                                            
                                                            101Net
      gain on sale of loans
                                                            
                                                            
                                                            (217
                                                            )
                                                            
                                                            
                                                            (402
                                                            )Loss
      on disposal of premises and equipment
                                                            
                                                            
                                                            1
                                                            
                                                            
                                                            
                                                            –Proceeds
      from sales of residential mortgages
                                                            
                                                            
                                                            5,386
                                                            
                                                            
                                                            
                                                            17,948Originations
      of residential mortgages held-for-sale
                                                            
                                                            
                                                            (5,012
                                                            )
                                                            
                                                            
                                                            (18,037
                                                            )Income
      on bank-owned life insurance
                                                            
                                                            
                                                            (132
                                                            )
                                                            
                                                            
                                                            (137
                                                            )Life
      insurance premium expense
                                                            
                                                            
                                                            (5
                                                            )
                                                            
                                                            
                                                            (5
                                                            )Stock-based
      compensation expense
                                                            
                                                            
                                                            25
                                                            
                                                            
                                                            
                                                            29Deferred
      income tax benefit
                                                            
                                                            
                                                            (272
                                                            )
                                                            
                                                            
                                                            (313
                                                            )Net
      increase (decrease) in income taxes payable
                                                            
                                                            
                                                            191
                                                            
                                                            
                                                            
                                                            (126
                                                            )Net
      decrease in accrued interest receivable
                                                            
                                                            
                                                            131
                                                            
                                                            
                                                            
                                                            53Amortization
      of mortgage servicing rights and change in valuation
    allowance
                                                            
                                                            
                                                            48
                                                            
                                                            
                                                            
                                                            30Net
      amortization (accretion) of premiums and discounts on investment
      securities
                                                            
                                                            
                                                            416
                                                            
                                                            
                                                            
                                                            (13
                                                            )Net
      (decrease) increase in accrued interest payable
                                                            
                                                            
                                                            (310
                                                            )
                                                            
                                                            
                                                            921Decrease
      in other assets
                                                            
                                                            
                                                            813
                                                            
                                                            
                                                            
                                                            351(Decrease)
      increase in other liabilities
                                                            
                                                            
                                                            (323
                                                            )
                                                            
                                                            
                                                            287Net
      cash provided by operating activities
                                                            
                                                            
                                                            6,260
                                                            
                                                            
                                                            
                                                            4,833Investing
      ActivitiesProceeds
      from maturities and calls of investment securitiesavailable-for-sale
                                                            
                                                            
                                                            69,446
                                                            
                                                            
                                                            
                                                            50,281held-to-maturity
                                                            
                                                            
                                                            500
                                                            
                                                            
                                                            
                                                            250Proceeds
      from sales of investment securitiesavailable-for-sale
                                                            
                                                            
                                                            2,476
                                                            
                                                            
                                                            
                                                            6,310Purchase
      of investment securitiesavailable-for-sale
                                                            
                                                            
                                                            (79,047
                                                            )
                                                            
                                                            
                                                            (75,414
                                                            )Net
      increase in loans
                                                            
                                                            
                                                            (25,969
                                                            )
                                                            
                                                            
                                                            (32,771
                                                            )Net
      purchases of premises and equipment
                                                            
                                                            
                                                            (364
                                                            )
                                                            
                                                            
                                                            (208
                                                            )Proceeds
      from sale of repossessed assets
                                                            
                                                            
                                                            131
                                                            
                                                            
                                                            
                                                            315Net
      cash used by investing activities
                                                            
                                                            
                                                            (32,827
                                                            )
                                                            
                                                            
                                                            (51,237
                                                            )Financing
      ActivitiesNet
      increase in non-interest bearing deposits
                                                            
                                                            
                                                            5,305
                                                            
                                                            
                                                            
                                                            3,860Net
      increase in interest-bearing non-maturity deposits
                                                            
                                                            
                                                            22,371
                                                            
                                                            
                                                            
                                                            27,685Net
      (decrease) increase in time deposits
                                                            
                                                            
                                                            (3,809
                                                            )
                                                            
                                                            
                                                            19,619Repayments
      of long-term debt
                                                            
                                                            
                                                            (15,000
                                                            )
                                                            
                                                            
                                                            –Net
      increase in short-term borrowings
                                                            
                                                            
                                                            5,626
                                                            
                                                            
                                                            
                                                            1,180Tax
      benefit from employee stock transactions
                                                            
                                                            
                                                            –
                                                            
                                                            
                                                            
                                                            6Cash
      dividends paid, net of reinvestment
                                                            
                                                            
                                                            (1,416
                                                            )
                                                            
                                                            
                                                            (1,488
                                                            )Purchase
      of treasury stock
                                                            
                                                            
                                                            –
                                                            
                                                            
                                                            
                                                            (866
                                                            )Proceeds
      from issuance of common stock
                                                            
                                                            
                                                            172
                                                            
                                                            
                                                            
                                                            56Net
      cash provided by financing activities
                                                            
                                                            
                                                            13,249
                                                            
                                                            
                                                            
                                                            50,052(Decrease)
      increase in cash and cash equivalents
                                                            
                                                            
                                                            (13,318
                                                            )
                                                            
                                                            
                                                            3,648Cash
      and cash equivalents at beginning of year
                                                            
                                                            
                                                            30,999
                                                            
                                                            
                                                            
                                                            16,451Cash
      and cash equivalents at end of period
                                                            
                                                            $
                                                            17,681
                                                            
                                                            
                                                            $
                                                            20,099Supplemental
      Cash Flow DisclosuresInterest
      paid
                                                            
                                                            $
                                                            5,728
                                                            
                                                            
                                                            $
                                                            6,163Income
      taxes paid
                                                            
                                                            
                                                            1,150
                                                            
                                                            
                                                            
                                                            884Non-Cash
      TransactionsTransfer
      of loans to repossessed assets
                                                            
                                                            
                                                            104
                                                            
                                                            
                                                            
                                                            477Unsettled
      trades to purchase securities
                                                            
                                                            
                                                            –
                                                            
                                                            
                                                            
                                                            16
 
 The
accompanying notes are an integral part of the unaudited consolidated financial
statements.
  - 6
-




QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





1.
BASIS OF PRESENTATION





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





These
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and notes thereto included in QNB's 2009
Annual Report incorporated in the Form 10-K. Operating results for the three-
and six-month periods ended June 30, 2010 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2010.





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.




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.





The
Company has evaluated events and transactions occurring subsequent to the
balance sheet date of June 30, 2010, for items that should potentially be
recognized or disclosed in these financial statements.





2.
RECENT ACCOUNTING PRONOUNCEMENTS





In
October 2009, the Financial Accounting Standards Board (FASB) issued Accounting
Standards Update (ASU) 2009-16, Transfers and Servicing (Topic 860)
– Accounting for Transfers of Financial Assets. The amendments in this
update improve financial reporting by eliminating the exceptions for qualifying
special-purpose entities from the consolidation guidance and the exception that
permitted sale accounting for certain mortgage securitizations when a transferor
has not surrendered control over the transferred financial assets. In addition,
the amendments require enhanced disclosures about the risks that a transferor
continues to be exposed to because of its continuing involvement in transferred
financial assets. Comparability and consistency in accounting for transferred
financial assets will also be improved through clarifications of the
requirements for isolation and limitations on portions of financial assets that
are eligible for sale accounting. This update is effective at the start of a
reporting entity’s first fiscal year beginning after November 15, 2009. Early
application is not permitted. The adoption of ASU 2009-16 did not have a
material impact on the Company’s financial position or results of
operations.





The FASB
has issued ASU 2010-06, Fair
Value Measurements and Disclosures (Topic 820): Improving Disclosure about Fair
Value Measurements. This ASU requires some additional disclosures and
clarifies some existing disclosure requirements about fair value measurements as
set forth in Codification Subtopic 820-10. The FASB‘s objective is to improve
these disclosures and, thus, increase transparency in financial reporting.
Specifically, ASU 2010-06 amends Codification Subtopic 820-10 to now
require:


·
            A
      reporting entity to disclose separately the amounts of significant
      transfers in and out of Level 1 and Level 2 fair value measurements and
      describe the reasons for the transfers;
and


·
            In
      the reconciliation for fair value measurements using significant
      unobservable inputs, a reporting entity should present separately
      information about purchases, sales, issuances, and
      settlements.


- 7
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





2.
RECENT ACCOUNTING PRONOUNCEMENTS (Continued)





In
addition, ASU 2010-06 clarifies the requirements of the following existing
disclosures:


·
            For
      purposes of reporting fair value measurements for each class of assets and
      liabilities, a reporting entity needs to use judgment in determining the
      appropriate classes of assets and liabilities;
  and


·
            A
      reporting entity should provide disclosures about the valuation techniques
      and inputs used to measure fair value for both recurring and nonrecurring
      fair value measurements.


ASU
2010-06 is effective for interim and annual reporting periods beginning after
December 15, 2009, except for the disclosures about purchases, sales, issuance,
and settlements in the roll forward of activity in Level 3 fair value
measurements. Those disclosures are effective for fiscal years after December
15, 2010 and for interim periods within those fiscal years. Early adoption is
permitted. The Company has adopted the required portions of ASU 2009-16
effective January 1, 2010 and has included the required
disclosures.





In April
2010, FASB issued ASU 2010-18, Receivables (Topic 310): Effect of a
Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a
Single Asset,codifies the consensus reached in EITF Issue No. 09-I,
“Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted
for as a Single Asset.” The amendments to the Codification provide that
modifications of loans that are accounted for within a pool under Subtopic
310-30 do not result in the removal of those loans from the pool even if the
modification of those loans would otherwise be considered a troubled debt
restructuring. An entity will continue to be required to consider whether the
pool of assets in which the loan is included is impaired if expected cash flows
for the pool change. ASU 2010-18 does not affect the accounting for loans under
the scope of Subtopic 310-30 that are not accounted for within pools. Loans
accounted for individually under Subtopic 310-30 continue to be subject to the
troubled debt restructuring accounting provisions within Subtopic 310-40. ASU
2010-18 is effective prospectively for modifications of loans accounted for
within pools under Subtopic 310-30 occurring in the first interim or annual
period ending on or after July 15, 2010. Early application is permitted. Upon
initial adoption of ASU 2010-18, an entity may make a one-time election to
terminate accounting for loans as a pool under Subtopic 310-30. This election
may be applied on a pool-by-pool basis and does not preclude an entity from
applying pool accounting to subsequent acquisitions of loans with credit
deterioration. The adoption of ASU 2010-18 is not expected to have a material
impact on the Company’s financial position or results of
operations.





In July
2010, FASB issued ASU 2010-20, Receivables (Topic 310): Disclosures
about the Credit Quality of Financing Receivables and the Allowance for Credit
Losses, which is intended to help investors assess the credit risk of a
company’s receivables portfolio and the adequacy of its allowance for credit
losses held against the portfolios by expanding credit risk
disclosures. This ASU requires more information about the credit quality of
financing receivables in the disclosures to financial statements, such as aging
information and credit quality indicators. Both new and existing disclosures
must be disaggregated by portfolio segment or class. The disaggregation of
information will be based on how a company develops its allowance for credit
losses and how it manages its credit exposure. The amendments in this Update
apply to all entities with financing receivables. Financing receivables include
loans and trade accounts receivable. However, short-term trade accounts
receivable, receivables measured at fair value or lower of cost or fair value,
and debt securities are exempt from these disclosure amendments. The
effective date of ASU 2010-20 differs for public and nonpublic companies. For
QNB, the amendments that require disclosures as of the end of a reporting period
are effective for periods ending on or after December 15, 2010. The amendments
that require disclosures about activity that occurs during a reporting period
are effective for periods beginning on or after December 15, 2010.





3.
STOCK-BASED COMPENSATION AND SHAREHOLDERS’ EQUITY





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. 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.


- 8
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




3.
STOCK-BASED COMPENSATION AND SHAREHOLDERS’ EQUITY (Continued)





Stock-based
compensation expense was approximately $15,000 and $16,000 for the three months
ended June 30, 2010 and 2009, respectively, and $25,000 and $29,000 for the six
months ended June 30, 2010 and 2009, respectively. As of June 30, 2010, there
was approximately $66,000 of unrecognized compensation cost related to unvested
share-based compensation awards granted that is expected to be recognized over
the next 31 months.





Options
are granted to certain employees at prices equal to the market value of the
stock on the date the options are granted. The 1998 Plan authorizes the issuance
of 220,500 shares. The time period during which any option is exercisable under
the Plan is determined by the committee but shall not commence before the
expiration of six months after the date of grant or continue beyond the
expiration of ten years after the date the option is awarded. The granted
options vest ratably over a three-year period. As of June 30, 2010, there were
225,058 options granted, 14,844 options forfeited, 81,050 options exercised and
129,164 options outstanding under this Plan. The 1998 Plan expired on March 10,
2008, therefore no further options can be granted under this Plan.





The 2005
Plan authorizes the issuance of 200,000 shares. The terms of the 2005 Plan are
identical to the 1998 Plan, except options expire five years after the grant
date. As of June 30, 2010, there were 80,700 options granted, 8,500 options
forfeited and 72,200 options 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 six months ended June 30:





Options
      granted
                        
                        2010
                        
                        
                        2009Risk-free
      interest rate
                        
                        
                        2.32
                        %
                        
                        
                        1.48
                        %Dividend
      yield
                        
                        
                        5.28
                        
                        
                        
                        4.80Volatility
                        
                        
                        27.50
                        
                        
                        
                        25.04Expected
      life (years)
                        
                        
                        5.00
                        
                        
                        
                        5.00





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 2010 and 2009 was $2.50 and $2.17,
respectively.




- 9
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




3.
STOCK-BASED COMPENSATION AND SHAREHOLDERS’ EQUITY (Continued)





Stock
option activity during the six months ended June 30, 2010 is as
follows:


Number
                                                of Options
                                              
                                              
                                              Weighted
                                                Average
                                                Exercise Price
                                              
                                              
                                              Weighted
                                                Average
                                                Remaining
                                                Contractual
                                                Term (in yrs.)
                                              
                                              
                                              Aggregate
                                                Intrinsic
                                                ValueOutstanding
      at January 1, 2010
                                              
                                              
                                              200,802
                                              
                                              
                                              $
                                              21.36Exercised
                                              
                                              
                                              (5,292
                                              )
                                              
                                              
                                              13.09Forfeited
                                              
                                              
                                              (11,146
                                              )
                                              
                                              
                                              19.11Granted
                                              
                                              
                                              17,000
                                              
                                              
                                              
                                              17.25Outstanding
      at June 30, 2010
                                              
                                              
                                              201,364
                                              
                                              
                                              $
                                              21.36
                                              
                                              
                                              
                                              2.5
                                              
                                              
                                              $
                                              346Exercisable
      at June 30, 2010
                                              
                                              
                                              152,714
                                              
                                              
                                              $
                                              22.32
                                              
                                              
                                              
                                              2.1
                                              
                                              
                                              $
                                              259





4. SHARE REPURCHASE
PLAN





The Board
of Directors has authorized the repurchase of up to 100,000 shares of its common
stock in open market or privately negotiated transactions. The repurchase
authorization does not bear a termination date. There were no shares repurchased
during the six months ended June 30, 2010. As of June 30, 2010, 57,883 shares
were repurchased under this authorization at an average price of $16.97 and a
total cost of $982,000.





5.
EARNINGS PER SHARE





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


For the Three Months
                                
                                
                                For the Six MonthsEnded June 30,
                                
                                
                                Ended June 30,2010
                                
                                
                                2009
                                
                                
                                2010
                                
                                
                                2009Numerator
      for basic and diluted earnings per share – net income
                                
                                $
                                1,963
                                
                                
                                $
                                1,227
                                
                                
                                $
                                3,789
                                
                                
                                $
                                2,321Denominator
      for basic earnings per share - weighted average shares
      outstanding
                                
                                
                                3,099,852
                                
                                
                                
                                3,084,824
                                
                                
                                
                                3,097,208
                                
                                
                                
                                3,099,198Effect
      of dilutive securities - employee stock options
                                
                                
                                13,615
                                
                                
                                
                                11,012
                                
                                
                                
                                10,475
                                
                                
                                
                                10,415Denominator
      for diluted earnings per share – adjusted weighted average shares
      outstanding
                                
                                
                                3,113,467
                                
                                
                                
                                3,095,836
                                
                                
                                
                                3,107,683
                                
                                
                                
                                3,109,613Earnings
      per share-basic
                                
                                $
                                0.63
                                
                                
                                $
                                0.40
                                
                                
                                $
                                1.22
                                
                                
                                $
                                0.75Earnings
      per share-diluted
                                
                                $
                                0.63
                                
                                
                                $
                                0.40
                                
                                
                                $
                                1.22
                                
                                
                                $
                                0.75





There
were 113,300 and 147,300 stock options that were anti-dilutive for the three-
and six-month periods ended June 30, 2010, respectively. There were 138,800
stock options that were anti-dilutive for each of the three- and six-month
periods ended June 30, 2009. These stock options were not included in the above
calculation.


- 10
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




6.
COMPREHENSIVE INCOME





For QNB,
the sole component of other comprehensive income 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 June 30, 2010 and 2009:


Three Months Ended
                                  
                                  June 30,
                                    2010
                                  
                                  
                                  June 30,
                                    2009Unrealized
      holding gains (losses) arising during the period
                                  
                                  $
                                  2,208
                                  
                                  
                                  $
                                  (759
                                  )Unrealized
      losses related to factors other than credit arising during the
      period
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (48
                                  )Reclassification
      adjustment for gains included in net income
                                  
                                  
                                  (1
                                  )
                                  
                                  
                                  (108
                                  )Reclassification
      adjustment for OTTI losses included in net income
                                  
                                  
                                  68
                                  
                                  
                                  
                                  134Net
      unrealized gains (losses)
                                  
                                  
                                  2,275
                                  
                                  
                                  
                                  (781
                                  )Tax
      effect
                                  
                                  
                                  (774
                                  )
                                  
                                  
                                  265Other
      comprehensive income (loss), net of tax
                                  
                                  
                                  1,501
                                  
                                  
                                  
                                  (516
                                  )Net
      income
                                  
                                  
                                  1,963
                                  
                                  
                                  
                                  1,227Total
      comprehensive income
                                  
                                  $
                                  3,464
                                  
                                  
                                  $
                                  711


Six Months Ended
                                  
                                  June 30,
                                    2010
                                  
                                  
                                  June 30,
                                    2009Unrealized
      holding gains (losses) arising during the period
                                  
                                  $
                                  3,326
                                  
                                  
                                  $
                                  (472
                                  )Unrealized
      losses related to factors other than credit arising during the
      period
                                  
                                  
                                  (27
                                  )
                                  
                                  
                                  (48
                                  )Reclassification
      adjustment for gains included in net income
                                  
                                  
                                  (295
                                  )
                                  
                                  
                                  (243
                                  )Reclassification
      adjustment for OTTI losses included in net income
                                  
                                  
                                  226
                                  
                                  
                                  
                                  523Net
      unrealized gains (losses)
                                  
                                  
                                  3,230
                                  
                                  
                                  
                                  (240
                                  )Tax
      effect
                                  
                                  
                                  (1,098
                                  )
                                  
                                  
                                  81Other
      comprehensive income (loss), net of tax
                                  
                                  
                                  2,132
                                  
                                  
                                  
                                  (159
                                  )Net
      income
                                  
                                  
                                  3,789
                                  
                                  
                                  
                                  2,321Total
      comprehensive income
                                  
                                  $
                                  5,921
                                  
                                  
                                  $
                                  2,162


- 11
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




7.
INVESTMENT SECURITIES





The
amortized cost and estimated fair values of investment securities
available-for-sale at June 30, 2010 and December 31, 2009 were as
follows:





Available-for-SaleJune 30, 2010Gross
                                  
                                  
                                  GrossAggregate
                                  
                                  
                                  unrealized
                                  
                                  
                                  unrealized holding lossesfair
                                  
                                  
                                  holding
                                  
                                  
                                  Non-credit
                                  
                                  
                                  
                                  
                                  
                                  Amortizedvalue
                                  
                                  
                                  gains
                                  
                                  
                                  OTTI
                                  
                                  
                                  Other
                                  
                                  
                                  costU.S.
      Treasury
                                  
                                  $
                                  5,020
                                  
                                  
                                  $
                                  12
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  $
                                  5,008U.S.
      Government agencies
                                  
                                  
                                  50,628
                                  
                                  
                                  
                                  577
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  50,051State
      and municipal securities
                                  
                                  
                                  57,922
                                  
                                  
                                  
                                  1,595
                                  
                                  
                                  
                                  -
                                  
                                  
                                  $
                                  91
                                  
                                  
                                  
                                  56,418U.S.
      Government agencies and sponsored enterprises (GSEs) -
      residentialMortgage-backed
      securities
                                  
                                  
                                  69,725
                                  
                                  
                                  
                                  3,350
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  8
                                  
                                  
                                  
                                  66,383Collateralized
      mortgage obligations (CMOs)
                                  
                                  
                                  73,222
                                  
                                  
                                  
                                  2,470
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  70,752Other
      debt securities
                                  
                                  
                                  2,225
                                  
                                  
                                  
                                  80
                                  
                                  
                                  $
                                  1,596
                                  
                                  
                                  
                                  552
                                  
                                  
                                  
                                  4,293Equity
      securities
                                  
                                  
                                  3,130
                                  
                                  
                                  
                                  154
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  150
                                  
                                  
                                  
                                  3,126Total
      investment securities available-for-sale
                                  
                                  $
                                  261,872
                                  
                                  
                                  $
                                  8,238
                                  
                                  
                                  $
                                  1,596
                                  
                                  
                                  $
                                  801
                                  
                                  
                                  $
                                  256,031


December 31, 2009Gross
                                    
                                    
                                    GrossAggregate
                                    
                                    
                                    unrealized
                                    
                                    
                                    unrealized holding lossesfair
                                    
                                    
                                    holding
                                    
                                    
                                    Non-credit
                                    
                                    
                                    
                                    
                                    
                                    Amortizedvalue
                                    
                                    
                                    gains
                                    
                                    
                                    OTTI
                                    
                                    
                                    Other
                                    
                                    
                                    costU.S.
      Treasury
                                    
                                    $
                                    5,013
                                    
                                    
                                    $
                                    2
                                    
                                    
                                    
                                    -
                                    
                                    
                                    $
                                    1
                                    
                                    
                                    $
                                    5,012U.S.
      Government agencies
                                    
                                    
                                    69,731
                                    
                                    
                                    
                                    261
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    316
                                    
                                    
                                    
                                    69,786State
      and municipal securities
                                    
                                    
                                    54,160
                                    
                                    
                                    
                                    1,287
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    59
                                    
                                    
                                    
                                    52,932U.S.
      Government agencies and sponsored enterprises (GSEs) -
      residential
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    -Mortgage-backed
      securities
                                    
                                    
                                    61,649
                                    
                                    
                                    
                                    2,215
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    69
                                    
                                    
                                    
                                    59,503Collateralized
      mortgage obligations (CMOs)
                                    
                                    
                                    61,317
                                    
                                    
                                    
                                    1,787
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    60
                                    
                                    
                                    
                                    59,590Other
      debt securities
                                    
                                    
                                    1,533
                                    
                                    
                                    
                                    78
                                    
                                    
                                    $
                                    2,410
                                    
                                    
                                    
                                    655
                                    
                                    
                                    
                                    4,520Equity
      securities
                                    
                                    
                                    3,459
                                    
                                    
                                    
                                    565
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    14
                                    
                                    
                                    
                                    2,908Total
      investment securities available-for-sale
                                    
                                    $
                                    256,862
                                    
                                    
                                    $
                                    6,195
                                    
                                    
                                    $
                                    2,410
                                    
                                    
                                    $
                                    1,174
                                    
                                    
                                    $
                                    254,251





The
amortized cost and estimated fair value of securities available-for-sale by
contractual maturity at June 30, 2010 are shown in the following table. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties. Securities are assigned to categories based on contractual maturity
except for mortgage-backed securities and CMOs which are based on the estimated
average life of these securities.


Aggregate
                                  
                                  
                                  Amortizedfair value
                                  
                                  
                                  costDue
      in one year or less
                                  
                                  $
                                  29,335
                                  
                                  
                                  $
                                  28,392Due
      after one year through five years
                                  
                                  
                                  147,827
                                  
                                  
                                  
                                  142,507Due
      after five years through ten years
                                  
                                  
                                  45,564
                                  
                                  
                                  
                                  44,615Due
      after ten years
                                  
                                  
                                  36,016
                                  
                                  
                                  
                                  37,391Equity
      securities
                                  
                                  
                                  3,130
                                  
                                  
                                  
                                  3,126Total
      investment securities available-for-sale
                                  
                                  $
                                  261,872
                                  
                                  
                                  $
                                  256,031


- 12
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




7.
INVESTMENT SECURITIES (Continued)





Proceeds
from sales of investment securities available-for-sale were $2,476,000 and
$6,310,000 for the six months ended June 30, 2010 and 2009,
respectively.





At June
30, 2010 and December 31, 2009, investment securities available-for-sale
totaling $120,803,000 and $133,136,000, respectively, were pledged as collateral
for repurchase agreements and deposits of public funds.





The
following table presents information related to the Company’s gains and losses
on the sales of equity and debt securities, and losses recognized for the
other-than-temporary impairment of these investments. Gains and losses on
available-for-sale securities are computed on the specific identification method
and included in non-interest income. Gross realized losses on equity and debt
securities are net of other-than-temporary impairment charges:


Six months ended June 30, 2010:Other-than-Gross
                                
                                
                                Gross
                                
                                
                                temporaryRealized
                                
                                
                                Realized
                                
                                
                                impairment
                                
                                
                                Net gainsGains
                                
                                
                                Losses
                                
                                
                                losses
                                
                                
                                (losses)Equity
      securities
                                
                                $
                                287
                                
                                
                                $
                                -
                                
                                
                                $
                                -
                                
                                
                                $
                                287Debt
      securities
                                
                                
                                10
                                
                                
                                
                                (2
                                )
                                
                                
                                (226
                                )
                                
                                
                                (218
                                )Total
                                
                                $
                                297
                                
                                
                                $
                                (2
                                )
                                
                                $
                                (226
                                )
                                
                                $
                                69


Six months ended June, 2009:Other-than-Gross
                                
                                
                                Gross
                                
                                
                                temporaryRealized
                                
                                
                                Realized
                                
                                
                                impairment
                                
                                
                                Net gainsGains
                                
                                
                                Losses
                                
                                
                                losses
                                
                                
                                (losses)Equity
      securities
                                
                                $
                                107
                                
                                
                                $
                                -
                                
                                
                                $
                                (515
                                )
                                
                                $
                                (408
                                )Debt
      securities
                                
                                
                                136
                                
                                
                                
                                -
                                
                                
                                
                                (8
                                )
                                
                                
                                128Total
                                
                                $
                                243
                                
                                
                                $
                                -
                                
                                
                                $
                                (523
                                )
                                
                                $
                                (280
                                )





All
other-than-temporary impairment (OTTI) writedowns on equity securities were on
marketable equity securities held at the Corp. All OTTI writedowns on debt
securities were on pooled trust preferred securities, which are included in the
other debt securities category, held at the Bank.





The tax
expense applicable to the net realized gains for the six months ended June 30,
2010 was $23,000. The tax benefit applicable to the net realized losses for the
six months ended June 30, 2009 amounted to $95,000.




- 13
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




7.
INVESTMENT SECURITIES (Continued)





QNB
recognizes OTTI for debt securities classified as available-for-sale in
accordance with FASB ASC 320, Investments – Debt and Equity
Securities, which requires that we assess whether we intend to sell or it
is more likely than not that the Company will be required to sell a security
before recovery of its amortized cost basis less any current-period credit
losses. For debt securities that are considered other-than-temporarily impaired
and that we do not intend to sell and will not be required to sell prior to
recovery of our amortized coast basis, the amount of the impairment is separated
into the amount that is credit related (credit loss component) and the amount
due to all other factors. The credit loss component is recognized in earnings
and is the difference between the security’s amortized cost basis and the
present value of its expected future cash flows discounted at the security’s
effective yield. The remaining difference between the security’s fair value and
the present value of future expected cash flows is due to factors that are not
credit related and, therefore, is not required to be recognized as a loss in the
income statement, but is recognized in other comprehensive income. For equity
securities, once a decline in value is determined to be other-than-temporary,
the value of the equity security is reduced to fair value and a corresponding
charge to earnings is recognized. QNB believes that we will fully collect the
carrying value of securities on which we have recorded a non-credit related
impairment in other comprehensive income.





The table
below presents a rollforward of the credit loss component recognized in
earnings. The credit loss component of the amortized cost represents the
difference between the present value of expected future cash flows and the
amortized cost basis of the security prior to considering credit losses. The
beginning balance represents the credit loss component for debt securities for
which OTTI occurred prior to January 1, 2010. OTTI recognized in earnings in
2010 for credit-impaired debt securities is presented as additions in two
components based upon whether the current period is the first time the debt
security was credit-impaired (initial credit impairment) or is not the first
time the debt security was credit-impaired (subsequent credit impairments). If
we sell, intend to sell or believe we will be required to sell previously
credit-impaired debt securities, an OTTI write-down is recognized in earnings
equal to the entire difference between the security’s amortized cost basis and
its fair value. The following table presents a summary of the cumulative credit
related other-than-temporary impairment charges recognized as components of
earnings for debt securities still held by QNB:


Three Months
                                  Ended
                                  June 30, 2010
                                
                                
                                Six Months
                                  Ended
                                  June 30, 2010Balance,
      beginning of period
                                
                                $
                                1,160
                                
                                
                                $
                                1,002Additions:Initial
      credit impairments
                                
                                
                                -
                                
                                
                                
                                -Subsequent
      credit impairments
                                
                                
                                68
                                
                                
                                
                                226Balance,
      end of period
                                
                                $
                                1,228
                                
                                
                                $
                                1,228





The
amortized cost and estimated fair values of investment securities
held-to-maturity at June 30, 2010 and December 31, 2009 were as
follows:





Held-To-MaturityJune 30, 2010
                                
                                
                                December 31, 2009Gross
                                
                                
                                Gross
                                
                                
                                
                                
                                
                                
                                
                                
                                Gross
                                
                                
                                Grossunrealized
                                
                                
                                unrealized
                                
                                
                                Aggregate
                                
                                
                                
                                
                                
                                unrealized
                                
                                
                                unrealized
                                
                                
                                AggregateAmortized
                                
                                
                                holding
                                
                                
                                holding
                                
                                
                                fair
                                
                                
                                Amortized
                                
                                
                                holding
                                
                                
                                holding
                                
                                
                                faircost
                                
                                
                                gains
                                
                                
                                losses
                                
                                
                                value
                                
                                
                                cost
                                
                                
                                gains
                                
                                
                                losses
                                
                                
                                valueState
      and municipal securities
                                
                                $
                                2,847
                                
                                
                                $
                                104
                                
                                
                                
                                -
                                
                                
                                $
                                2,951
                                
                                
                                $
                                3,347
                                
                                
                                $
                                124
                                
                                
                                $
                                -
                                
                                
                                $
                                3,471




- 14
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




7.
INVESTMENT SECURITIES (Continued)





The
amortized cost and estimated fair value of securities held-to-maturity by
contractual maturity at June 30, 2010 are shown in the following table. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.


Aggregate
                                    
                                    
                                    Amortizedfair value
                                    
                                    
                                    costDue
      in one year or less
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Due
      after one year through five years
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Due
      after five years through ten years
                                    
                                    $
                                    2,951
                                    
                                    
                                    $
                                    2,847Due
      after ten years
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Total
      investment securities held-to-maturity
                                    
                                    $
                                    2,951
                                    
                                    
                                    $
                                    2,847





There
were no sales of investment securities classified as held-to-maturity during the
six months ended June 30, 2010 or 2009.





The
following table indicates the length of time individual securities have been in
a continuous unrealized loss position at June 30, 2010 and December 31,
2009:


June 30, 2010Less than 12 months
                                        
                                        
                                        12 months or longer
                                        
                                        
                                        TotalNo. of
                                        
                                        
                                        Fair
                                        
                                        
                                        Unrealized
                                        
                                        
                                        Fair
                                        
                                        
                                        Unrealized
                                        
                                        
                                        Fair
                                        
                                        
                                        Unrealizedsecurities
                                        
                                        
                                        value
                                        
                                        
                                        losses
                                        
                                        
                                        value
                                        
                                        
                                        losses
                                        
                                        
                                        value
                                        
                                        
                                        lossesState
      and municipal securities
                                        
                                        
                                        12
                                        
                                        
                                        $
                                        5,323
                                        
                                        
                                        $
                                        89
                                        
                                        
                                        $
                                        495
                                        
                                        
                                        $
                                        2
                                        
                                        
                                        
                                        5,818
                                        
                                        
                                        
                                        91Mortgage-backed
      securities
                                        
                                        
                                        1
                                        
                                        
                                        
                                        928
                                        
                                        
                                        
                                        8
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        928
                                        
                                        
                                        
                                        8Other
      debt securities
                                        
                                        
                                        8
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,698
                                        
                                        
                                        
                                        2,148
                                        
                                        
                                        
                                        1,698
                                        
                                        
                                        
                                        2,148Equity
      securities
                                        
                                        
                                        15
                                        
                                        
                                        
                                        1,808
                                        
                                        
                                        
                                        150
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,808
                                        
                                        
                                        
                                        150Total
                                        
                                        
                                        36
                                        
                                        
                                        $
                                        8,059
                                        
                                        
                                        $
                                        247
                                        
                                        
                                        $
                                        2,193
                                        
                                        
                                        $
                                        2,150
                                        
                                        
                                        $
                                        10,252
                                        
                                        
                                        $
                                        2,397


December 31, 2009Less than 12 months
                                          
                                          
                                          12 months or longer
                                          
                                          
                                          TotalNo. of
                                          
                                          
                                          Fair
                                          
                                          
                                          Unrealized
                                          
                                          
                                          Fair
                                          
                                          
                                          Unrealized
                                          
                                          
                                          Fair
                                          
                                          
                                          Unrealizedsecurities
                                          
                                          
                                          value
                                          
                                          
                                          losses
                                          
                                          
                                          value
                                          
                                          
                                          losses
                                          
                                          
                                          value
                                          
                                          
                                          lossesU.S.
      Treasuries
                                          
                                          
                                          3
                                          
                                          
                                          $
                                          2,509
                                          
                                          
                                          $
                                          1
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          2,509
                                          
                                          
                                          $
                                          1U.S.
      Government agencies
                                          
                                          
                                          24
                                          
                                          
                                          
                                          28,675
                                          
                                          
                                          
                                          316
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          28,675
                                          
                                          
                                          
                                          316State
      and municipal securities
                                          
                                          
                                          17
                                          
                                          
                                          
                                          6,309
                                          
                                          
                                          
                                          45
                                          
                                          
                                          $
                                          659
                                          
                                          
                                          $
                                          14
                                          
                                          
                                          
                                          6,968
                                          
                                          
                                          
                                          59Mortgage-backed
      securities
                                          
                                          
                                          5
                                          
                                          
                                          
                                          6,934
                                          
                                          
                                          
                                          69
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          6,934
                                          
                                          
                                          
                                          69Collateralized
      mortgage obligations (CMOs)
                                          
                                          
                                          6
                                          
                                          
                                          
                                          6,929
                                          
                                          
                                          
                                          60
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          6,929
                                          
                                          
                                          
                                          60Other
      debt securities
                                          
                                          
                                          8
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          1,008
                                          
                                          
                                          
                                          3,065
                                          
                                          
                                          
                                          1,008
                                          
                                          
                                          
                                          3,065Equity
      securities
                                          
                                          
                                          4
                                          
                                          
                                          
                                          392
                                          
                                          
                                          
                                          4
                                          
                                          
                                          
                                          137
                                          
                                          
                                          
                                          10
                                          
                                          
                                          
                                          529
                                          
                                          
                                          
                                          14Total
                                          
                                          
                                          67
                                          
                                          
                                          $
                                          51,748
                                          
                                          
                                          $
                                          495
                                          
                                          
                                          $
                                          1,804
                                          
                                          
                                          $
                                          3,089
                                          
                                          
                                          $
                                          53,552
                                          
                                          
                                          $
                                          3,584


- 15
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




7.
INVESTMENT SECURITIES (Continued)





Management
evaluates debt securities, which are comprised of U.S. Government Agencies,
state and municipalities, mortgage-backed securities, CMOs and other issuers,
for other-than-temporary impairment and considers the current economic
conditions, the length of time and the extent to which the fair value has been
less than cost, interest rates and the bond rating of each security. The
unrealized losses at June 30, 2010 in state and municipal securities and
mortgage-backed securities are primarily the result of interest rate
fluctuations. If held to maturity, these bonds will mature at par, and QNB will
not realize a loss. The Company has the intent to hold the securities and does
not believe it will be required to sell the securities before recovery
occurs.





The
Company’s investment in marketable equity securities primarily consists of
investments in large cap stock companies. These equity securities are analyzed
for impairment on an ongoing basis. Management believes these equity securities
will recover in the foreseeable future. QNB evaluated the near-term prospects of
the issuers in relation to the severity and duration of the impairment. Based on
that evaluation and the Company’s ability and intent to hold those securities
for a reasonable period of time sufficient for a forecasted recovery of fair
value, the Company does not consider these equity securities to be
other-than-temporarily impaired.





All of
the securities in the other debt securities category with unrealized losses
greater than twelve months as of June 30, 2010 are pooled trust preferred
security issues. QNB holds eight of these securities with an amortized cost of
$3,846,000 and a fair value of $1,698,000. All of the trust preferred securities
are available-for-sale securities and are carried at fair value. The following
table provides additional information related to pooled trust preferred
securities as of June 30, 2010:


Deal
                                          
                                          Class
                                          
                                          Book
                                            value
                                          
                                          
                                          Fair
                                            value
                                          
                                          
                                          Unreal-
                                            ized loss
                                          
                                          
                                          Realized
                                            OTTI
                                            Credit
                                            Loss
                                            (YTD
                                            2010)
                                          
                                          
                                          Moody's
                                            /Fitch
                                            ratings
                                          
                                          
                                          Current
                                            number
                                            of banks
                                          
                                          
                                          Current
                                            number of
                                            insurance
                                            companies
                                          
                                          
                                          Actual
                                            deferrals and
                                            defaults as a %
                                            of total
                                            collateral
                                          
                                          
                                          Total
                                            performing
                                            collateral as a
                                            % of
                                            outstanding
                                            bondsPreTSL
      IV
                                          
                                          Mezzanine*
                                          
                                          $
                                          243
                                          
                                          
                                          $
                                          159
                                          
                                          
                                          $
                                          (84
                                          )
                                          
                                          $
                                          -
                                          
                                          
                                          Ca/CCC
                                          
                                          
                                          
                                          5
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          27.1
                                          %
                                          
                                          
                                          123.7
                                          %PreTSL
      V
                                          
                                          Mezzanine*
                                          
                                          
                                          206
                                          
                                          
                                          
                                          159
                                          
                                          
                                          
                                          (47
                                          )
                                          
                                          
                                          (20
                                          )
                                          
                                          Ba3/C
                                          
                                          
                                          
                                          2
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          43.1
                                          %
                                          
                                          
                                          94.7
                                          %PreTSL
      VI
                                          
                                          Mezzanine*
                                          
                                          
                                          121
                                          
                                          
                                          
                                          108
                                          
                                          
                                          
                                          (13
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          Caa1/CC
                                          
                                          
                                          
                                          5
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          81.0
                                          %
                                          
                                          
                                          50.1
                                          %PreTSL
      XVII
                                          
                                          Mezzanine
                                          
                                          
                                          752
                                          
                                          
                                          
                                          205
                                          
                                          
                                          
                                          (547
                                          )
                                          
                                          
                                          (197
                                          )
                                          
                                          Ca/C
                                          
                                          
                                          
                                          47
                                          
                                          
                                          
                                          6
                                          
                                          
                                          
                                          24.0
                                          %
                                          
                                          
                                          84.6
                                          %PreTSL
      XIX
                                          
                                          Mezzanine
                                          
                                          
                                          988
                                          
                                          
                                          
                                          436
                                          
                                          
                                          
                                          (552
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          Ca/C
                                          
                                          
                                          
                                          52
                                          
                                          
                                          
                                          14
                                          
                                          
                                          
                                          23.2
                                          %
                                          
                                          
                                          85.2
                                          %PreTSL
      XXV
                                          
                                          Mezzanine
                                          
                                          
                                          766
                                          
                                          
                                          
                                          179
                                          
                                          
                                          
                                          (587
                                          )
                                          
                                          
                                          (9
                                          )
                                          
                                          
                                          C/C
                                          
                                          
                                          
                                          60
                                          
                                          
                                          
                                          8
                                          
                                          
                                          
                                          31.0
                                          %
                                          
                                          
                                          78.3
                                          %PreTSL
      XXVI
                                          
                                          Mezzanine
                                          
                                          
                                          469
                                          
                                          
                                          
                                          201
                                          
                                          
                                          
                                          (268
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          C/C
                                          
                                          
                                          
                                          54
                                          
                                          
                                          
                                          10
                                          
                                          
                                          
                                          31.5
                                          %
                                          
                                          
                                          77.8
                                          %PreTSL
      XXVI
                                          
                                          Mezzanine
                                          
                                          
                                          301
                                          
                                          
                                          
                                          251
                                          
                                          
                                          
                                          (50
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          C/C
                                          
                                          
                                          
                                          54
                                          
                                          
                                          
                                          10
                                          
                                          
                                          
                                          31.5
                                          %
                                          
                                          
                                          77.8
                                          %$
                                          3,846
                                          
                                          
                                          $
                                          1,698
                                          
                                          
                                          $
                                          (2,148
                                          )
                                          
                                          $
                                          (226
                                          )


Mezzanine*
- only class of bonds still outstanding (represents the senior-most obligation
of the trust)





The
market for these securities at June 30, 2010 is not active and markets for
similar securities are also not active. The inactivity was evidenced first by a
significant widening of the bid-ask spread in the brokered markets in which
pooled trust preferred securities trade and then by a significant decrease in
the volume of trades relative to historical levels. The new issue market is also
inactive and the market values for these securities (and any securities other
than those issued or guaranteed by U.S. Government agencies) are depressed
relative to historical levels. In today’s market, a low market price for a
particular bond may only provide evidence of a recent widening of corporate
spreads in general versus being an indicator of credit problems with a
particular issuer. Lack of liquidity in the market for trust preferred
collateralized debt obligations, credit rating downgrades and market
uncertainties related to the financial industry are factors contributing to the
impairment of these securities. Although these securities are classified as
available-for-sale, the Company has the intent to hold the securities and does
not believe it will be required to sell the securities before recovery occurs.
As illustrated in the table above, these securities are comprised mainly of
securities issued by banks, and to a lesser degree, insurance companies. QNB
owns the mezzanine tranches of these securities.


- 16
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




7.
INVESTMENT SECURITIES (Continued)





On a
quarterly basis we evaluate our debt securities for OTTI, which involves the use
of a third-party valuation firm to assist management with the valuation. When
evaluating these investments a credit related portion and a non-credit related
portion of OTTI are determined. The credit related portion is recognized in
earnings and represents the expected shortfall in future cash flows. The
non-credit related portion is recognized in other comprehensive income and
represents the difference between the fair value adjustment for the security and
the amount of credit related impairment. For the three and six months ended June
30, 2010 $68,000 and $226,000, respectively, in other-than-temporary impairment
charges representing credit impairment were recognized on our pooled trust
preferred collateralized debt obligations. A discounted cash flow analysis
provides the best estimate of credit related OTTI for these securities.
Additional information related to this analysis follows:





All of
the pooled trust preferred collateralized debt obligations held by QNB are rated
lower than AA and are measured for OTTI within the scope of ASC 325 (formerly
known as EITF 99-20), Recognition of Interest Income and
Impairment on Purchased Beneficial Interests and Beneficial Interests That
Continue to be Held by a Transferor in Securitized Financial Assets, and
Amendments to the Impairment
Guidance of EITF Issue No. 99-20(formerly known as EITF
99-20-1). QNB performs a discounted cash flow analysis on all of its
impaired debt securities to determine if the amortized cost basis of an impaired
security will be recovered. In determining whether a credit loss exists, QNB
uses its best estimate of the present value of cash flows expected to be
collected from the debt security and discounts them at the current accretable
yield. The discounted cash flow analysis is considered to be the primary
evidence when determining whether credit related other-than-temporary impairment
exists.





Results
of a discounted cash flow test are significantly affected by other variables
such as the estimate of future cash flows (including prepayments), credit
worthiness of the underlying banks and insurance companies and determination of
probability and severity of default of the underlying collateral. The following
provides additional information for each of these variables:




·
            Estimate
      of Future Cash Flows – Cash flows are constructed in an INTEX desktop
      valuation model. INTEX is a proprietary cash flow model recognized as the
      industry standard for analyzing all types of structured debt products. It
      includes each deal’s structural features updated with trustee information,
      including asset-by-asset detail, as it becomes available. The modeled cash
      flows are then used to determine if all the scheduled principal and
      interest payments of the investments will be returned. For purposes of the
      cash flow analysis, relatively modest rates of prepayment were forecasted
      (ranging from 0-2%).




·
            Credit
      Analysis – A quarterly credit evaluation is performed for the companies
      comprising the collateral across the various pooled trust preferred
      securities. This credit evaluation considers all available evidence and
      focuses on capitalization, asset quality, profitability, liquidity, stock
      price performance, whether the institution has received TARP funding and
      whether the institution has shown the ability to raise
      capital.




·
            Probability
      of Default – A near-term probability of default is determined for each
      issuer based on its financial condition and is used to calculate the
      expected impact of future deferrals and defaults on the expected cash
      flows. Each issuer in the collateral pool is assigned a near-term
      probability of default based on individual performance and financial
      characteristics. Various studies suggest that the rate of bank failures
      between 1934 and 2008 were approximately 0.36%. Future defaults on the
      individual banks in the analysis are assumed at 1% for 2011 (approximately
      three times historical norms), 0.75% for 2012 (two times historical
      levels) and for 2013 and beyond the rate used is calculated based upon
      individual issuers estimated CAMEL rating as projected by VERIBANC®.
      Banks in the pool are assigned a probability of default based on their
      unique credit characteristics and market
  indicators.




·
            Severity
      of Loss – In addition to the probability of default discussed above, a
      severity of loss (projected recovery) is determined in all cases. In the
      current analysis, the severity of loss ranges from 0% to 100% depending on
      the estimated credit worthiness of the individual issuer, with a 95%
      severity of loss utilized for deferrals projected in 2011 and
      thereafter.




- 17
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




7.
INVESTMENT SECURITIES (Continued)





In
addition to the above factors, the evaluation of impairment also includes a
stress test analysis which provides an estimate of future risk for each tranche.
This stressed breakpoint is then compared to the level of assets with credit
concerns in each tranche. This comparison allows management to identify those
pools that are at a greater risk for a future adverse change in cash flows so
that we can monitor the asset quality in those pools more closely for potential
deterioration of credit quality.





Based
upon the analysis performed by management as of June 30, 2010, the expected
principal shortfall on two out of eight pooled trust preferred securities have
resulted in a $68,000 credit related OTTI charge in the second quarter of 2010.
For the six-month period ended June 30, 2010 total credit related OTTI charges
of $226,000 were recorded on three pooled trust preferred securities. This
compares to credit related OTTI charges of $8,000 for the three and six months
ended June 30, 2009 and $1,002,000 for the year ended December 31,
2009.





8.
LOANS & ALLOWANCE FOR LOAN LOSSES





The
following table presents loans by category as of June 30, 2010 and December 31,
2009:


June 30, 2010
                                
                                
                                December 31, 2009Commercial
      and industrial
                                
                                $
                                108,525
                                
                                
                                $
                                104,523Construction
                                
                                
                                23,598
                                
                                
                                
                                27,567Real
      estate-commercial
                                
                                
                                196,809
                                
                                
                                
                                173,019Real
      estate-residential
                                
                                
                                131,284
                                
                                
                                
                                128,825Consumer
                                
                                
                                3,048
                                
                                
                                
                                3,702Indirect
      lease financing
                                
                                
                                11,427
                                
                                
                                
                                11,826Total
      loans
                                
                                
                                474,691
                                
                                
                                
                                449,462Net
      unearned fees
                                
                                
                                (13
                                )
                                
                                
                                (41
                                )Loans
      receivable
                                
                                $
                                474,678
                                
                                
                                $
                                449,421





Activity
in the allowance for loan losses is shown below:


Three Months Ended
                                            
                                            
                                            Six Months EndedJune 30,
                                            
                                            
                                            June 30,2010
                                            
                                            
                                            2009
                                            
                                            
                                            2010
                                            
                                            
                                            2009Balance
      at beginning of period
                                            
                                            $
                                            6,357
                                            
                                            
                                            $
                                            4,220
                                            
                                            
                                            $
                                            6,217
                                            
                                            
                                            $
                                            3,836Charge-offs
                                            
                                            
                                            (179
                                            )
                                            
                                            
                                            (164
                                            )
                                            
                                            
                                            (778
                                            )
                                            
                                            
                                            (407
                                            )Recoveries
                                            
                                            
                                            131
                                            
                                            
                                            
                                            28
                                            
                                            
                                            
                                            170
                                            
                                            
                                            
                                            55Net
      charge-offs
                                            
                                            
                                            (48
                                            )
                                            
                                            
                                            (136
                                            )
                                            
                                            
                                            (608
                                            )
                                            
                                            
                                            (352
                                            )Provision
      for loan losses
                                            
                                            
                                            700
                                            
                                            
                                            
                                            500
                                            
                                            
                                            
                                            1,400
                                            
                                            
                                            
                                            1,100Balance
      at end of period
                                            
                                            $
                                            7,009
                                            
                                            
                                            $
                                            4,584
                                            
                                            
                                            $
                                            7,009
                                            
                                            
                                            $
                                            4,584


- 18
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




8.
LOANS & ALLOWANCE FOR LOAN LOSSES (Continued)





A loan is
considered impaired when it is probable that interest and principal will not be
collected according to the contractual terms of the loan agreement. Information
with respect to loans that are considered to be impaired at June 30, 2010 and
December 31, 2009 is as follows:


At June 30, 2010
                              
                              
                              At December 31, 2009Balance
                              
                              
                              Specific
                                reserve
                              
                              
                              Balance
                              
                              
                              Specific
                                reserveRecorded
      investment in impaired loans at period-end subject to a specific reserve
      for loan losses and corresponding specific reserve
                              
                              $
                              4,139
                              
                              
                              $
                              398
                              
                              
                              $
                              1,077
                              
                              
                              $
                              528Recorded
      investment in impaired loans at period-end requiring no specific reserve
      for loan losses
                              
                              
                              3,423
                              
                              
                              
                              
                              
                              
                              
                              4,622Recorded
      investment in impaired loans at period-end
                              
                              $
                              7,562
                              
                              
                              
                              
                              
                              
                              $
                              5,699





9.
FAIR VALUE MEASUREMENTS AND DISCLOSURES





Financial
Accounting Standards Board (FASB) ASC 820, Fair Value Measurements and
Disclosures, defines fair value as an exit price, representing the amount
that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants (fair values are not adjusted
for transaction costs). ASC 820 also establishes a framework (fair value
hierarchy) for measuring fair value under GAAP, and expands disclosures about
fair value measurements.





ASC 820
establishes a fair value hierarchy that prioritizes the inputs to valuation
methods used to measure fair value. The hierarchy gives the highest priority to
unadjusted quoted prices in active markets for identical assets or liabilities
(Level 1 measurements) and the lowest priority to unobservable inputs (Level 3
measurements). The three levels of the fair value hierarchy are as
follows:





Level 1:
              Unadjusted
      quoted prices in active markets that are accessible at the measurement
      date for identical, unrestricted assets or
  liabilities.


Level 2:
              Quoted
      prices in markets that are not active, or inputs that are observable
      either directly or indirectly, for substantially the full term of the
      asset or liability.


Level 3:
              Prices
      or valuation techniques that require inputs that are both significant to
      the fair value measurement and unobservable (i.e., supported with little
      or no market activity).





An
asset’s or liability’s level within the fair value hierarchy is based on the
lowest level of input that is significant to the fair value
measurement.





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


- 19
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




9.
FAIR VALUE MEASUREMENTS AND DISCLOSURES (Continued)





For
financial assets measured at fair value on a recurring basis, the fair value
measurements by level within the fair value hierarchy used were as
follows:


June 30, 2010
                            
                            Quoted Prices in
                              Active Markets for
                              Identical Assets
                              (Level 1)
                            
                            
                            Significant Other
                              Observable Input
                              (Level 2)
                            
                            
                            Significant
                              Unobservable
                              Inputs (Level 3)
                            
                            
                            Balance at End of
                              PeriodSecurities
      available-for-saleU.S.
      Treasury
                            
                            $
                            5,020
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            $
                            5,020U.S.
      Government agencies
                            
                            
                            -
                            
                            
                            $
                            50,628
                            
                            
                            
                            -
                            
                            
                            
                            50,628State
      and municipal securities
                            
                            
                            -
                            
                            
                            
                            57,922
                            
                            
                            
                            -
                            
                            
                            
                            57,922U.S.
      Government agencies and sponsored enterprises (GSEs) -
      residentialMortgage-backed
      securities
                            
                            
                            -
                            
                            
                            
                            69,725
                            
                            
                            
                            -
                            
                            
                            
                            69,725Collateralized
      mortgage obligations (CMOs)
                            
                            
                            -
                            
                            
                            
                            73,222
                            
                            
                            
                            -
                            
                            
                            
                            73,222Other
      debt securities
                            
                            
                            -
                            
                            
                            
                            527
                            
                            
                            $
                            1,698
                            
                            
                            
                            2,225Equity
      securities
                            
                            
                            3,130
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            3,130Total
                            
                            $
                            8,150
                            
                            
                            $
                            252,024
                            
                            
                            $
                            1,698
                            
                            
                            $
                            261,872


December 31, 2009
                              
                              Quoted Prices in
                                Active Markets for
                                Identical Assets
                                (Level 1)
                              
                              
                              Significant Other
                                Observable Input
                                (Level 2)
                              
                              
                              Significant
                                Unobservable
                                Inputs (Level 3)
                              
                              
                              Balance at End of
                                PeriodSecurities
      available-for-saleU.S.
      Treasury
                              
                              $
                              5,013
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              $
                              5,013U.S.
      Government agencies
                              
                              
                              -
                              
                              
                              $
                              69,731
                              
                              
                              
                              -
                              
                              
                              
                              69,731State
      and municipal securities
                              
                              
                              -
                              
                              
                              
                              54,160
                              
                              
                              
                              -
                              
                              
                              
                              54,160U.S.
      Government agencies and sponsored enterprises (GSEs) -
      residentialMortgage-backed
      securities
                              
                              
                              -
                              
                              
                              
                              61,649
                              
                              
                              
                              -
                              
                              
                              
                              61,649Collateralized
      mortgage obligations (CMOs)
                              
                              
                              -
                              
                              
                              
                              61,317
                              
                              
                              
                              -
                              
                              
                              
                              61,317Other
      debt securities
                              
                              
                              -
                              
                              
                              
                              525
                              
                              
                              $
                              1,008
                              
                              
                              
                              1,533Equity
      securities
                              
                              
                              3,459
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              3,459Total
                              
                              $
                              8,472
                              
                              
                              $
                              247,382
                              
                              
                              $
                              1,008
                              
                              
                              $
                              256,862





There
were no transfers in and out of Level 1 and Level 2 fair value measurements
during the period ended June 30, 2010.





The
following table presents additional information about the securities
available-for-sale measured at fair value on a recurring basis and for which QNB
utilized significant unobservable inputs (Level 3 inputs) to determine fair
value:


- 20
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)


Balance at
                          March 31
                        
                        
                        Total
                          Unrealized
                          Gains
                        
                        
                        Total
                          Realized
                          Losses
                        
                        
                        Purchases
                          (Sales or
                          Paydowns)
                        
                        
                        Balance at
                          June 30For
      the Three Months Ended June 30, 2010Securities
      available-for-sale
                        
                        $
                        1,135
                        
                        
                        $
                        631
                        
                        
                        $
                        (68
                        )
                        
                        $
                        -
                        
                        
                        $
                        1,698For
      the Three Months Ended June 30, 2009Securities
      available-for-sale
                        
                        $
                        712
                        
                        
                        $
                        122
                        
                        
                        $
                        (8
                        )
                        
                        $
                        3
                        
                        
                        $
                        829


Balance at
                          December 31
                        
                        
                        Total
                          Unrealized
                          Gains or
                          (Losses)
                        
                        
                        Total
                          Realized
                          Losses
                        
                        
                        Purchases
                          (Sales or
                          Paydowns)
                        
                        
                        Balance at
                          June 30For
      the Six Months Ended June 30, 2010Securities
      available-for-sale
                        
                        $
                        1,008
                        
                        
                        $
                        917
                        
                        
                        $
                        (226
                        )
                        
                        $
                        (1
                        )
                        
                        $
                        1,698For
      the Six Months Ended June 30, 2009Securities
      available-for-sale
                        
                        $
                        1,963
                        
                        
                        $
                        (1,130
                        )
                        
                        $
                        (8
                        )
                        
                        $
                        4
                        
                        
                        $
                        829





There
were no transfers in or out of level 3 for the six months ended June 30, 2010
and 2009. There were $68,000 and $226,000 of losses included in earnings
attributable to the change in unrealized gains or losses relating to the
available-for-sale securities above with fair value measurements utilizing
significant unobservable inputs for the three and six-month periods ended June
30, 2010, respectively. The amount included in earnings for 2009 was $8,000 for
both the three and six-month periods ended June 30.





The Level
3 securities consist of eight collateralized debt obligation securities that are
backed by trust preferred securities issued by banks, thrifts, and insurance
companies (PreTSLs). The market for these securities at June 30, 2010 is not
active and markets for similar securities are also not active. The inactivity
was evidenced first by a significant widening of the bid-ask spread in the
brokered markets in which PreTSLs trade and then by a significant decrease in
the volume of trades relative to historical levels. The new issue market is also
inactive and there are currently very few market participants who are willing
and or able to transact for these securities.





Given
conditions in the debt markets today and the absence of observable transactions
in the secondary and new issue markets, we determined:


·
            The
      few observable transactions and market quotations that are available are
      not reliable for purposes of determining fair value at June 30,
      2010;


·
            An
      income valuation approach technique (present value technique) that
      maximizes the use of relevant observable inputs and minimizes the use of
      unobservable inputs will be equally or more representative of fair value
      than the market approach valuation technique used at prior measurement
      dates; and


·
            PreTSLs
      will be classified within Level 3 of the fair value hierarchy because
      significant adjustments are required to determine fair value at the
      measurement date.





The Bank
is aware of several factors indicating that recent transactions of PreTSL
securities are not orderly including an increased spread between bid/ask prices,
lower sales transaction volumes for these types of securities, and a lack of new
issuances. As a result, the Bank engaged an independent third party to value the
securities using a discounted cash flow analysis. The estimated cash flows are
based on specific assumptions about defaults, deferrals and prepayments of the
trust preferred securities underlying each PreTSL. The resulting collateral cash
flows are allocated to the bond waterfall using the INTEX desktop valuation
model.


- 21
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




9.
FAIR VALUE MEASUREMENTS AND DISCLOSURES (Continued)





The
estimates for the conditional default rates (CDR) are based on the payment
characteristics of the trust preferred securities themselves (e.g. current,
deferred, or defaulted) as well as the financial condition of the trust
preferred issuers in the pool. A near-term CDR for each issuer in the pool is
estimated based on their financial condition using key financial ratios relating
to the financial institution’s capitalization, asset quality, profitability and
liquidity. Default rates are modeled to migrate to three times historic norms
for 2011 and two times historic levels throughout 2012. In 2013 and beyond the
CDR rate is calculated based upon individual issuers estimated CAMEL rating as
projected by VERIBANC®.





The base
loss severity assumption is 95 percent. The severity factor for near-term CDRs
is vectored to reflect the relative expected performance of the institutions
modeled to default, with lower forecasted severities used for the higher quality
institutions. The long-term loss severity is modeled at 95%.





Prepayments
are modeled to take into account the disruption in the asset-backed securities
marketplace and the lack of new trust preferred issuances. Relatively modest
rates of prepayment were modeled going forward (2%).





The
internal rate of return is the pre-tax yield used to discount the best estimate
of future cash flows after credit losses. The cash flows have been discounted
using estimated market discount rates of 3 month LIBOR plus spreads ranging from
6.85% to 10.64%. The determination of appropriate market discount rates involved
the consideration of the following:


·
            the
      time value of money


·
            the
      price for bearing uncertainty in cash
flows


·
            other
      factors that would be considered by market
  participants


The
analysis of discount rates involved the review of corporate bond spreads for
banks, U.S. Treasury yields, credit default swap rates for financial companies
(utilized as a proxy for credit), the swap/LIBOR yield curve and the
characteristics of the individual securities being valued.





For
assets measured at fair value on a non-recurring basis, the fair value
measurements by level within the fair value hierarchy are as
follows:


Quoted Prices in
                          Active Markets for
                          Identical Assets
                          (Level 1)
                        
                        
                        Significant Other
                          Observable Input
                          (Level 2)
                        
                        
                        Significant
                          Unobservable
                          Inputs (Level 3)
                        
                        
                        Balance at End of
                          PeriodJune
      30, 2010Mortgage
      servicing rights
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        510
                        
                        
                        $
                        510Impaired
      loans, net
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        3,741
                        
                        
                        
                        3,741December
      31, 2009Mortgage
      servicing rights
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        519
                        
                        
                        $
                        519Impaired
      loans
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        549
                        
                        
                        
                        549Foreclosed
      assets
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        67
                        
                        
                        
                        67





The
following information should not be interpreted as an estimate of the fair value
of the entire Company since a fair value calculation is only provided for a
limited portion of QNB’s assets and liabilities. Due to a wide range of
valuation techniques and the degree of subjectivity used in making the
estimates, comparisons between QNB’s disclosures and those of other companies
may not be meaningful.




- 22
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




9.
FAIR VALUE MEASUREMENTS AND DISCLOSURES (Continued)





The
following methods and assumptions were used to estimate the fair values of each
major classification of financial instrument and non-financial asset at June 30,
2010 and December 31, 2009:





Cash and due from banks,
interest-bearing deposits in banks, Federal funds sold, accrued interest
receivable and accrued interest payable (carried at cost): The carrying
amounts reported in the balance sheet approximate those assets’ fair
value.





Investment securities
available for sale (carried at fair value) and held-to-maturity (carried at
amortized cost): The fair value of securities are determined by obtaining
quoted market prices on nationally recognized securities exchanges (Level 1), or
matrix pricing (Level 2), which is a mathematical technique used widely in the
industry to value debt securities without relying exclusively on quoted market
prices for the specific securities but rather by relying on the securities’
relationship to other benchmark quoted prices. For certain securities which are
not traded in active markets or are subject to transfer restrictions, valuations
are adjusted to reflect illiquidity and/or non-transferability, and such
adjustments are generally based on available market evidence (Level 3). In the
absence of such evidence, management’s best estimate is used. Management’s best
estimate consists of both internal and external support on certain Level 3
investments. Cash flow models using a present value formula that includes
assumptions market participants would use along with indicative exit pricing
obtained from broker/dealers (where available) were used to support fair values
of certain Level 3 investments.





At June
30, 2010, the Company determined that no active market existed for pooled trust
preferred securities with an amortized cost of $3,846,000 and an estimated fair
value of $1,698,000. At December 31, 2009, the Company determined that no active
market existed for pooled trust preferred securities with an amortized cost of
$4,073,000 and an estimated fair value of $1,008,000.





Restricted investment in
bank stocks (carried at cost): The fair value of stock in Atlantic
Central Bankers Bank and the Federal Home Loan Bank is the carrying amount,
based on redemption provisions, and considers the limited marketability of such
securities.





Loans Held for Sale (carried
at lower of cost or fair value): The fair value of loans held for sale is
determined, when possible, using quoted secondary market prices. If no such
quoted prices exist, the fair value of a loan is determined using quoted prices
for a similar loan or loans, adjusted for the specific attributes of that
loan.





Loans Receivable (carried at
cost): The fair values of loans are estimated using discounted cash flow
analyses, using market rates at the balance sheet date that reflect the credit
and interest rate-risk inherent in the loans. Projected future cash flows are
calculated based upon contractual maturity or call dates, projected repayments
and prepayments of principal. Generally, for variable rate loans that reprice
frequently and with no significant change in credit risk, fair values are based
on carrying values.





Impaired Loans (generally
carried at fair value): Impaired loans are loans, in which the Company
has measured impairment generally based on the fair value of the loan’s
collateral. Fair value is generally determined based upon independent
third-party appraisals of the properties, or discounted cash flows based upon
the expected proceeds. These assets are included as Level 3 fair values, based
upon the lowest level of input that is significant to the fair value
measurements. The fair value of impaired loans as of June 30, 2010 consists of
loan balances of $4,139,000 less a valuation allowance of $398,000. The fair
value of impaired loans as of December 31, 2009 consists of loan balances of
$1,077,000 less a valuation allowance of $528,000.





Mortgage Servicing Rights
(carried at lower of cost or fair value): The fair value of mortgage
servicing rights is based on a valuation model that calculates the present value
of estimated net servicing income. The mortgage servicing rights are startified
into tranches based on predominant characteristics, such as interest rate, loan
type and investor type. The valuation incorporates assumptions that market
participants would use in estimating future net servicing
income.


- 23
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




9.
FAIR VALUE MEASUREMENTS AND DISCLOSURES (Continued)





Certain
tranches of mortgage servicing rights, which are carried at lower of cost or
fair value, were written down to fair value during the quarter. The ending
valuation allowance is $8,000 at June 30, 2010.





Foreclosed assets (other
real estate owned and repossessed assets): Foreclosed assets are the only
non-financial assets valued on a non-recurring basis which are held by the
Company at fair value, less cost to sell. At foreclosure or repossession, if the
fair value, less estimated costs to sell, of the collateral acquired (real
estate, vehicles, equipment) is less than the Company’s recorded investment in
the related loan, a write-down is recognized through a charge to the allowance
for loan losses. Additionally, valuations are periodically performed by
management and any subsequent reduction in value is recognized by a charge to
income. The fair value of foreclosed assets held-for-sale is estimated using
Level 3 inputs based on observable market data.





Deposit liabilities (carried
at cost): The fair value of deposits with no stated maturity (e.g. demand
deposits, interest-bearing demand accounts, money market accounts and savings
accounts) are by definition, equal to the amount payable on demand at the
reporting date (i.e. their carrying amounts). This approach to estimating fair
value excludes the significant benefit that results from the low-cost funding
provided by such deposit liabilities, as compared to alternative sources of
funding. Deposits with a stated maturity (time deposits) have been valued using
the present value of cash flows discounted at rates approximating the current
market for similar deposits.





Short-term borrowings
(carried at cost): The carrying amount of short-term borrowings
approximates their fair values.





Long-term debt (carried at
cost): The fair values of FHLB advances and securities sold under
agreements to repurchase are estimated using discounted cash flow analysis,
based on quoted prices for new long-term debt with similar credit risk
characteristics, terms and remaining maturity. These prices obtained from this
active market represent a fair value that is deemed to represent the transfer
price if the liability were assumed by a third party.





Off-balance-sheet
instruments (disclosed at cost): The fair values for the Bank’s
off-balance sheet instruments (lending commitments and letters of credit) are
based on fees currently charged in the market to enter into similar agreements,
taking into account, the remaining terms of the agreements and the
counterparties’ credit standing.





Management
uses its best judgment in estimating the fair value of the Company’s financial
instruments; however, there are inherent weaknesses in any estimation technique.
Therefore, for substantially all financial instruments, the fair value estimates
herein are not necessarily indicative of the amounts the Company could have
realized in a sales transaction on the dates indicated. The estimated fair value
amounts have been measured as of the respective period ends and have not been
re-evaluated or updated for purposes of these financial statements subsequent to
those respective dates. As such, the estimated fair values of these financial
instruments subsequent to the respective reporting dates may be different than
the amounts reported at each period end.




- 24
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




9.
FAIR VALUE MEASUREMENTS AND DISCLOSURES (Continued)





The
estimated fair values and carrying amounts of the Company’s financial
instruments are summarized as follows:





June 30, 2010
                                  
                                  
                                  December 31, 2009Carrying
                                  
                                  
                                  Estimated
                                  
                                  
                                  Carrying
                                  
                                  
                                  EstimatedAmount
                                  
                                  
                                  Fair Value
                                  
                                  
                                  Amount
                                  
                                  
                                  Fair ValueFinancial
      AssetsCash
      and due from banks
                                  
                                  $
                                  10,341
                                  
                                  
                                  $
                                  10,341
                                  
                                  
                                  $
                                  8,841
                                  
                                  
                                  $
                                  8,841Interest-bearing
      deposits in banks
                                  
                                  
                                  7,340
                                  
                                  
                                  
                                  7,340
                                  
                                  
                                  
                                  22,158
                                  
                                  
                                  
                                  22,158Investment
      securities available-for-sale
                                  
                                  
                                  261,872
                                  
                                  
                                  
                                  261,872
                                  
                                  
                                  
                                  256,862
                                  
                                  
                                  
                                  256,862Investment
      securities held-to-maturity
                                  
                                  
                                  2,847
                                  
                                  
                                  
                                  2,951
                                  
                                  
                                  
                                  3,347
                                  
                                  
                                  
                                  3,471Restricted
      investment in bank stocks
                                  
                                  
                                  2,291
                                  
                                  
                                  
                                  2,291
                                  
                                  
                                  
                                  2,291
                                  
                                  
                                  
                                  2,291Loans
      held-for-sale
                                  
                                  
                                  377
                                  
                                  
                                  
                                  396
                                  
                                  
                                  
                                  534
                                  
                                  
                                  
                                  537Net
      loans
                                  
                                  
                                  467,669
                                  
                                  
                                  
                                  450,009
                                  
                                  
                                  
                                  443,204
                                  
                                  
                                  
                                  423,036Mortgage
      servicing rights
                                  
                                  
                                  510
                                  
                                  
                                  
                                  597
                                  
                                  
                                  
                                  519
                                  
                                  
                                  
                                  637Accrued
      interest receivable
                                  
                                  
                                  2,717
                                  
                                  
                                  
                                  2,717
                                  
                                  
                                  
                                  2,848
                                  
                                  
                                  
                                  2,848Financial
      LiabilitiesDeposits
      with no stated maturities
                                  
                                  
                                  340,683
                                  
                                  
                                  
                                  340,683
                                  
                                  
                                  
                                  313,007
                                  
                                  
                                  
                                  313,007Deposits
      with stated maturities
                                  
                                  
                                  317,287
                                  
                                  
                                  
                                  319,891
                                  
                                  
                                  
                                  321,096
                                  
                                  
                                  
                                  323,437Short-term
      borrowings
                                  
                                  
                                  34,059
                                  
                                  
                                  
                                  34,059
                                  
                                  
                                  
                                  28,433
                                  
                                  
                                  
                                  28,433Long-term
      debt
                                  
                                  
                                  20,000
                                  
                                  
                                  
                                  21,563
                                  
                                  
                                  
                                  35,000
                                  
                                  
                                  
                                  36,559Accrued
      interest payable
                                  
                                  
                                  1,255
                                  
                                  
                                  
                                  1,255
                                  
                                  
                                  
                                  1,565
                                  
                                  
                                  
                                  1,565





The
estimated fair value of QNB’s off-balance sheet financial instruments is as
follows:


June 30, 2010
                                          
                                          
                                          December 31, 2009Notional
                                          
                                          
                                          Estimated
                                          
                                          
                                          Notional
                                          
                                          
                                          EstimatedAmount
                                          
                                          
                                          Fair Value
                                          
                                          
                                          Amount
                                          
                                          
                                          Fair ValueCommitments
      to extend credit
                                          
                                          $
                                          101,190
                                          
                                          
                                          $
                                          -
                                          
                                          
                                          $
                                          99,119
                                          
                                          
                                          $
                                          -Standby
      letters of credit
                                          
                                          
                                          12,958
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          14,071
                                          
                                          
                                          
                                          -


- 25
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




10.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS AND GUARANTEES





In the
normal course of business there are various legal proceedings, commitments, and
contingent liabilities which are not reflected in the financial statements.
Management does not anticipate any material losses as a result of these
transactions and activities. They include, among other things, commitments to
extend credit and standby letters of credit. The maximum exposure to credit
loss, which represents the possibility of sustaining a loss due to the failure
of the other parties to a financial instrument to perform according to the terms
of the contract, is represented by the contractual amount of these instruments.
QNB uses the same lending standards and policies in making credit commitments as
it does for on-balance sheet instruments. The activity is controlled through
credit approvals, control limits, and monitoring procedures.





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


June 30, 2010
                                
                                
                                December 31, 2009Commitments
      to extend credit and unused lines of credit
                                
                                $
                                101,190
                                
                                
                                $
                                99,119Standby
      letters of credit
                                
                                
                                12,958
                                
                                
                                
                                14,071$
                                114,148
                                
                                
                                $
                                113,190





Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require the
payment of a fee. Since many of the commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. QNB evaluates each customer’s creditworthiness on a
case-by-case basis.





Standby
letters of credit are conditional commitments issued by the Bank to guarantee
the financial or performance obligation of a customer to a third party. QNB’s
exposure to credit loss in the event of nonperformance by the other party to the
financial instrument for standby letters of credit is represented by the
contractual amount of those instruments. The Bank uses the same credit policies
in making conditional obligations as it does for on-balance sheet instruments.
These standby letters of credit expire within three years. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending other loan commitments. The Bank requires collateral and personal
guarantees supporting these letters of credit as deemed necessary. Management
believes that the proceeds obtained through a liquidation of such collateral and
the enforcement of personal guarantees would be sufficient to cover the maximum
potential amount of future payments required under the corresponding guarantees.
The amount of the liability as of June 30, 2010 and December 31, 2009 for
guarantees under standby letters of credit issued is not material.





The
amount of collateral obtained for letters of credit and commitments to extend
credit is based on management’s credit evaluation of the customer. Collateral
varies, but may include real estate, accounts receivable, marketable securities,
pledged deposits, inventory or equipment.





11.
REGULATORY RESTRICTIONS





Dividends
payable by the Company and the Bank are subject to various limitations imposed
by statutes, regulations and policies adopted by bank regulatory agencies. Under
Pennsylvania banking law, the Bank is subject to certain restrictions on the
amount of dividends that it may declare without prior regulatory approval. Under
Federal Reserve regulations, the Bank is limited as to the amount it may lend
affiliates, including the Company, unless such loans are collateralized by
specific obligations.




- 26
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




11.
REGULATORY RESTRICTIONS (Continued)





Both the
Company and the Bank are subject to regulatory capital requirements administered
by Federal banking agencies. Failure to meet minimum capital requirements can
initiate actions by regulators that could have an effect on the financial
statements. Under the framework for prompt corrective action, both the Company
and the Bank must meet capital guidelines that involve quantitative measures of
their assets, liabilities, and certain off-balance-sheet items. The capital
amounts and classification are also subject to qualitative judgments by the
regulators. Management believes, as of June 30, 2010, that the Company and the
Bank met capital adequacy requirements to which they were subject.





As of the
most recent notification, the primary regulator of the Bank considered it to be
“well capitalized” under the regulatory framework. There are no conditions or
events since that notification that management believes have changed the
classification. To be categorized as well capitalized, the Company and the Bank
must maintain minimum ratios as set forth in the table below.





The
Company and the Bank’s actual capital amounts and ratios are presented as
follows:


Capital LevelsActual
                                      
                                      
                                      Adequately Capitalized
                                      
                                      
                                      Well CapitalizedAs of June 30, 2010
                                      
                                      Amount
                                      
                                      
                                      Ratio
                                      
                                      
                                      Amount
                                      
                                      
                                      Ratio
                                      
                                      
                                      Amount
                                      
                                      
                                      RatioTotal
      Risk-Based Capital (to Risk Weighted Assets)Consolidated
                                      
                                      $
                                      64,119
                                      
                                      
                                      
                                      11.64
                                      %
                                      
                                      $
                                      44,062
                                      
                                      
                                      
                                      8.00
                                      %
                                      
                                      
                                      N/A
                                      
                                      
                                      
                                      N/ABank
                                      
                                      
                                      60,455
                                      
                                      
                                      
                                      11.04
                                      %
                                      
                                      
                                      43,790
                                      
                                      
                                      
                                      8.00
                                      %
                                      
                                      $
                                      54,737
                                      
                                      
                                      
                                      10.00
                                      %Tier
      I Capital (to Risk Weighted Assets)Consolidated
                                      
                                      
                                      57,273
                                      
                                      
                                      
                                      10.40
                                      %
                                      
                                      
                                      22,031
                                      
                                      
                                      
                                      4.00
                                      %
                                      
                                      
                                      N/A
                                      
                                      
                                      
                                      N/ABank
                                      
                                      
                                      53,611
                                      
                                      
                                      
                                      9.79
                                      %
                                      
                                      
                                      21,895
                                      
                                      
                                      
                                      4.00
                                      %
                                      
                                      
                                      32,842
                                      
                                      
                                      
                                      6.00
                                      %Tier
      I Capital (to Average Assets)Consolidated
                                      
                                      
                                      57,273
                                      
                                      
                                      
                                      7.44
                                      %
                                      
                                      
                                      30,782
                                      
                                      
                                      
                                      4.00
                                      %
                                      
                                      
                                      N/A
                                      
                                      
                                      
                                      N/ABank
                                      
                                      
                                      53,611
                                      
                                      
                                      
                                      7.00
                                      %
                                      
                                      
                                      30,646
                                      
                                      
                                      
                                      4.00
                                      %
                                      
                                      
                                      38,307
                                      
                                      
                                      
                                      5.00
                                      %


Capital LevelsActual
                                      
                                      
                                      Adequately Capitalized
                                      
                                      
                                      Well CapitalizedAs of December 31, 2009
                                      
                                      Amount
                                      
                                      
                                      Ratio
                                      
                                      
                                      Amount
                                      
                                      
                                      Ratio
                                      
                                      
                                      Amount
                                      
                                      
                                      RatioTotal
      Risk-Based Capital (to Risk Weighted Assets)Consolidated
                                      
                                      $
                                      61,168
                                      
                                      
                                      
                                      11.51
                                      %
                                      
                                      $
                                      42,504
                                      
                                      
                                      
                                      8.00
                                      %
                                      
                                      
                                      N/A
                                      
                                      
                                      
                                      N/ABank
                                      
                                      
                                      57,436
                                      
                                      
                                      
                                      10.89
                                      %
                                      
                                      
                                      42,212
                                      
                                      
                                      
                                      8.00
                                      %
                                      
                                      $
                                      52,765
                                      
                                      
                                      
                                      10.00
                                      %Tier
      I Capital (to Risk Weighted Assets)Consolidated
                                      
                                      
                                      54,703
                                      
                                      
                                      
                                      10.30
                                      %
                                      
                                      
                                      21,252
                                      
                                      
                                      
                                      4.00
                                      %
                                      
                                      
                                      N/A
                                      
                                      
                                      
                                      N/ABank
                                      
                                      
                                      51,219
                                      
                                      
                                      
                                      9.71
                                      %
                                      
                                      
                                      21,106
                                      
                                      
                                      
                                      4.00
                                      %
                                      
                                      
                                      31,659
                                      
                                      
                                      
                                      6.00
                                      %Tier
      I Capital (to Average Assets)Consolidated
                                      
                                      
                                      54,703
                                      
                                      
                                      
                                      7.34
                                      %
                                      
                                      
                                      29,822
                                      
                                      
                                      
                                      4.00
                                      %
                                      
                                      
                                      N/A
                                      
                                      
                                      
                                      N/ABank
                                      
                                      
                                      51,219
                                      
                                      
                                      
                                      6.90
                                      %
                                      
                                      
                                      29,679
                                      
                                      
                                      
                                      4.00
                                      %
                                      
                                      
                                      37,099
                                      
                                      
                                      
                                      5.00
                                      %




- 27
-


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.
(herein referred to as QNB or the Company) is a bank holding company
headquartered in Quakertown, Pennsylvania. The Company, 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.





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, and including
the risk factors identified in Item 1A of QNB’s 2009 Form 10-K, 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 the Company’s line of
      business;


·
            The
      risk that the Federal Deposit Insurance Corporation (FDIC) could levy
      additional insurance assessments on all insured institutions in order to
      replenish the Deposit Insurance Fund based on the level of bank failures
      in the future; and


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





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


- 28
-


QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





RECENT
LEGISLATION AFFECTING THE FINANCIAL SERVICES INDUSTRY





The
Dodd-Frank Wall Street Reform and consumer protection Act (the “Dodd-Frank Act”)
was signed into law on July 21, 2010. The Dodd-Frank Act contains numerous and
wide-ranging reforms to the structure and operation of the U.S. financial
system. Among the Dodd-Frank Act’s significant regulatory changes are
(i) the imposition of more stringent capital requirements on bank holding
companies by, among other things, imposing leverage ratios and prohibiting new
trust preferred issuances from counting as Tier 1 capital; (ii) making
permanent the temporary increase in FDIC deposit insurance coverage from
$100,000 to $250,000 and providing for unlimited deposit insurance on
noninterest-bearing transaction accounts, together with an increase in the
minimum Deposit Insurance Fund reserve requirement and a change in the
assessment base from deposits to net assets; (iii) the creation of the
Consumer Financial Protection Bureau, a new financial consumer protection
agency, which is empowered to promulgate new consumer protection regulations and
revise existing regulations in many areas of consumer compliance;
(iv) provisions eliminating the federal prohibitions on paying interest on
demand deposits, thus allowing businesses to have interest bearing checking
accounts, effective one year after the date of enactment; (v) increased
regulation of derivatives and hedging transactions and restrictions on an
institution’s ability to engage in certain proprietary trading and investing
activities; (vi) limitations on debit card interchange fees; (vii) the
imposition of new disclosure and other requirements related to corporate
governance and executive compensation; and (viii) the creation of the
Financial Stability Oversight Council, with responsibility for identifying and
monitoring systemic risks posed by financial firms, activities and
practices.





QNB is
currently evaluating the potential impact of the Dodd-Frank Act on its business,
financial condition and results of operations. Management expects that some
provisions of the Dodd-Frank Act may have adverse effects on QNB, such as the
cost of complying with numerous new regulations and disclosure and reporting
requirements mandated by the Dodd-Frank Act. Portions of the Dodd-Frank Act
become effective at different times, and many of the Dodd-Frank Act’s provisions
consist of general statements directing various regulators to issue more
detailed rules. Consequently, the full scope of the Dodd-Frank Act’s impact on
the financial system in general and QNB in particular cannot be predicted at
this time.





CRITICAL
ACCOUNTING POLICIES AND ESTIMATES





The
discussion and analysis of the financial condition and results of operations are
based on the consolidated financial statements of QNB, which are prepared in
accordance with U.S. generally accepted accounting principles (GAAP) and
predominant practices within the banking industry. The preparation of these
consolidated financial statements requires QNB to make estimates and judgments
that affect the reported amounts of assets, liabilities, revenues and expenses,
and related disclosure of contingent assets and liabilities. QNB evaluates
estimates on an on-going basis, including those related to the determination of
the allowance for loan losses, the determination of the valuation of other real
estate owned and foreclosed assets, other-than-temporary impairments on
investment securities, the determination of impairment of restricted bank stock,
the valuation of deferred tax assets, stock-based compensation and income taxes.
QNB bases its estimates on historical experience and various other factors and
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.





Other-Than-Temporary
Investment Security Impairment


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




- 29
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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 (Continued)





Effective
April 1, 2009, the Company adopted new accounting guidance related to
recognition and presentation of other-than-temporary impairment. This accounting
guidance amends the recognition guidance for other-than-temporary impairments of
debt securities and expands the financial statement disclosures for
other-than-temporary impairment losses on debt securities. The recent guidance
replaced the “intent and ability” indication in previous guidance by specifying
that (a) if a company does not have the intent to sell a debt security prior to
recovery and (b) it is more likely than not that it will not have to sell the
debt security prior to recovery, the security would not be considered
other-than-temporarily impaired unless there is a credit loss. When an entity
does not intend to sell the security, and it is more likely than not, the entity
will not have to sell the security before recovery of its cost basis, it will
recognize the credit component of an other-than-temporary impairment of a debt
security in earnings and the remaining portion in other comprehensive income.
For held-to-maturity debt securities, the amount of an other-than-temporary
impairment recorded in other comprehensive income for the noncredit portion of a
previous other-than-temporary impairment should be amortized prospectively over
the remaining life of the security on the basis of the timing of future
estimated cash flows of the security.





During
the second quarter of 2010 QNB recorded a credit related other-than-temporary
impairment charge of $68,000 on two of its pooled trust preferred securities.
For the same period in 2009, the Company recorded $134,000 of
other-than-temporary impairment charges:  $8,000 related to one trust
preferred security issue and $126,000 related to losses in the equity securities
portfolio. For the six month period ended June 30, 2010, the Company recorded
$226,000 of other-than-temporary charges on three of its trust preferred
securities. For the same period in 2009, the Company recorded $523,000 of
other-than-temporary impairment charges:  $8,000 related to one trust
preferred security issue and $515,000 related to losses in the equity securities
portfolio.





Impairment
of Restricted Investment in Bank Stocks


Restricted
bank stock is comprised of restricted stock of the Federal Home Loan Bank of
Pittsburgh (FHLB) and the Atlantic Central Bankers Bank. Federal law requires a
member institution of the FHLB to hold stock of its district bank according to a
predetermined formula.





In
December 2008, the FHLB of Pittsburgh notified member banks that it was
suspending dividend payments and the repurchase of capital stock to preserve
capital. Management’s determination of whether these investments are impaired is
based on their assessment of the ultimate recoverability of their cost rather
than by recognizing temporary declines in value. The determination of whether a
decline affects the ultimate recoverability of their cost is influenced by
criteria such as (1) the significance of the decline in net assets of the FHLB
as compared to the capital stock amount for the FHLB and the
length of time this situation has persisted, (2) commitments by the FHLB to make
payments required by law or regulation and the level of such payments in
relation to the operating performance of the FHLB, and (3) the impact of
legislative and regulatory changes on institutions and, accordingly, on the
customer base of the FHLB. Management believes no impairment charge is necessary
related to the restricted stock as of June 30, 2010.





Allowance
for Loan Losses


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





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


- 30
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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 (Continued)





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





In
addition, various regulatory agencies, as an integral part of their examination
process, periodically review QNB’s allowance for loan losses. Such agencies may
require QNB to recognize additions to the allowance based on their judgments
about information available to them at the time of their
examination.





Management
believes that it uses the best information available to make determinations
about the adequacy of the allowance and that it has established its existing
allowance for loan losses in accordance with GAAP. If circumstances differ
substantially from the assumptions used in making determinations, future
adjustments to the allowance for loan losses may be necessary and results of
operations could be affected. Because future events affecting borrowers and
collateral cannot be predicted with certainty, increases to the allowance may be
necessary should the quality of any loans deteriorate as a result of the factors
discussed above.





Foreclosed
Assets


Assets
acquired through, or in lieu of, loan foreclosure are held-for-sale and are
initially recorded at fair value less cost to sell at the date of foreclosure,
establishing a new cost basis. Subsequent to foreclosure, valuations are
periodically performed by management and the assets are carried at the lower of
carrying amount or fair value less cost to sell. Revenue and expenses and
changes in the valuation allowance are included in net expenses from foreclosed
assets.





Stock-Based
Compensation


At June
30, 2010, QNB sponsored stock-based compensation plans, administered by a board
committee, under which both qualified and non-qualified stock options may be
granted periodically to certain employees. QNB accounts for all awards granted
under stock-based compensation plans in accordance with ASC 718,
Compensation-Stock Compensation. Compensation cost has been measured using the
fair value of an award on the grant date and is recognized over the service
period, which is usually the vesting period. The fair value of each option is
amortized into compensation expense on a straight-line basis between the grant
date for the option and each vesting date. QNB estimates the fair value of stock
options on the date of the grant using the Black-Scholes option pricing model.
The model requires the use of numerous assumptions, many of which are highly
subjective in nature.





Income
Taxes


QNB
accounts for income taxes under the asset/liability method in accordance with
income tax accounting guidance, ASC 740, Income Taxes. Deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases, as well as operating loss and
tax credit carryforwards. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. A valuation allowance is
established against deferred tax assets when, in the judgment of management, it
is more likely than not that such deferred tax assets will not become available.
Because the judgment about the level of future taxable income is dependent 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.




- 31
-


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 to 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 consistently high level of service at all points of
contact.





QNB
reported net income for the second quarter of 2010 of $1,963,000, or $0.63 per
share on a diluted basis. This compares to $1,227,000, or $0.40 per share on a
diluted basis, for the same period in 2009. For the six month period ended June
30, 2010, QNB reported net income of $3,789,000, or $1.22 per share on a diluted
basis. This compares to net income of $2,321,000, or $0.75 per shared on a
diluted basis, for the six month period ended June 30, 2009. The results for
both the three and six month periods represent record earnings for
QNB.





Net
interest income increased $1,115,000, or 21.0%, to $6,435,000 for the second
quarter of 2010 compared to the second quarter of 2009 resulting from an
increase in interest income of $190,000, or 2.1%, and a reduction in interest
expense of $925,000, or 26.1%. Net interest income for the second quarter of
2010 also reflects an improvement of $411,000, or 6.8% when compared to the
first quarter of 2010. The net interest margin increased to 3.74% for the second
quarter of 2010 compared to 3.40% for the second quarter of 2009 and 3.64% for
the first quarter of 2010. The improvement in net interest income and the net
interest margin compared with both the second quarter of 2009 and the first
quarter of 2010 primarily resulted from the impact of lower deposit costs
somewhat offset by lower yields on loans and investment securities. The interest
rate paid on interest bearing deposits declined by 81 basis points to 1.52% for
the second quarter of 2010 compared to the second quarter of 2009 and decreased
by 16 basis points when compared with the first quarter of 2010. The decline in
the rate paid on deposits largely resulted from the repricing of time deposits
at lower market rates. In addition to the continued decline in the cost of
deposits, a change in the mix of deposits from higher-cost time deposits to
lower-cost transaction accounts has also contributed to the increase in the net
interest margin. The historically low level of treasury rates and the prime
lending rate continue to impact the rates earned on loans and investment
securities as well as the rates paid on deposits.





Average
earning assets grew by $65,285,000, or 9.7%, with average loans increasing 9.7%,
average investment securities increasing 6.1% and other earning assets
(including interest-bearing deposits at the Federal Reserve Bank) increasing
257.3% when comparing the second quarter of 2010 to the same period in 2009. The
growth in loans was mainly related to real estate secured commercial loans and
to a lesser degree commercial and industrial loans and tax-exempt loans. The
growth in the investment portfolio was primarily in high-quality U.S. Government
agency securities, tax-exempt state and municipal securities and mortgage-backed
and CMO securities. On the funding side, average deposits increased $70,937,000,
or 12.0%, with average transaction accounts increasing 32.1%, or $83,417,000.
The growth in interest-bearing checking accounts and savings accounts is largely
due to the success of QNB’s two newest high-rate deposit products, QNB-Rewards
Checking and Online eSavings. The Online eSavings account was introduced in the
second quarter of 2009 and continues to experience significant growth. This
product had balances totaling $42,253,000 as of June 30, 2010 compared to
$31,625,000 at the end of March 2010.





Net
interest income increased $2,058,000, or 19.8%, to $12,459,000 comparing the
first six months of 2010 and 2009. Over this time period, average loans and
investment securities increased 9.9% and 9.4%, respectively, and average total
deposits increased 13.8%. The net interest margin for the first half of 2010 was
3.69% compared to 3.44% for the first half of 2009, with lower funding costs
again being the primary factor in the improvement.


- 32
-


QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





RESULTS
OF OPERATIONS – OVERVIEW (Continued)





As a
result of continued loan growth, higher than normal levels of net charge-offs,
further increases in non-performing and delinquent loans and continued concerns
over current economic conditions, QNB continues to closely monitor the quality
of the loan portfolio and has increased the allowance for loan losses to reflect
the changes in the portfolio. QNB recorded a provision for loan losses of
$700,000 in the second quarter of 2010 and $1,400,000 for the first half of
2010. This compares to a provision of $500,000 for the second quarter of 2009
and $1,100,000 for the first half 2009. Net loan charge-offs were $48,000 for
the quarter ended June 30, 2010 and $608,000 for the first half of 2010 compared
with $136,000 for the second quarter of 2009 and $352,000 for the first half of
2009.





Total
non-performing loans, which represent loans on non-accrual status, loans past
due more than 90 days and still accruing interest, and restructured loans were
$7,748,000, or 1.63% of total loans, at June 30, 2010, compared to $4,203,000,
or 0.96% of total loans, at June 30, 2009 and $6,102,000, or 1.36% of total
loans at December 31, 2009. Total delinquent loans, which include loans that are
thirty days or more past due and non-accrual loans, increased to 2.46% of total
loans at June 30, 2010, compared with 1.45% and 2.17% of total loans at June 30,
2009 and December 31, 2009, respectively. QNB’s non-performing loan and total
delinquent loan ratios continue to compare favorably with the average for
Pennsylvania commercial banks with assets between $500 million and $1 billion,
as reported by the FDIC using March 31, 2010 data, the most recent available.
The total non-performing loan and total delinquent loan ratios for the
Pennsylvania commercial banks noted above were 2.62% and 3.71% of total loans,
respectively, as of March 31, 2010.





QNB’s
allowance for loan losses of $7,009,000 represents 1.48% of total loans at June
30, 2010 compared to an allowance for loan losses of $4,584,000, or 1.05% of
total loans at June 30, 2009 and $6,217,000, or 1.38% of total loans at December
31, 2009. Other real estate owned and other repossessed assets were $40,000 at
June 30, 2010 compared with $380,000 at June 30, 2009 and $67,000 at December
31, 2009.





Total
non-interest income was $1,027,000 for the second quarter of 2010, a decrease of
$40,000 compared with the same period in 2009. Gains on the sale of residential
mortgages decreased $92,000 comparing these same periods. The low interest rate
environment continues to result in mortgage refinancing activity although at a
significantly lower level than early 2009. Net losses on investment securities
increased $41,000. Partially offsetting these items was an increase of $58,000
in ATM and debit card income and a decrease of $66,000 in losses on the sale of
other real estate owned and repossessed assets.





As noted
previously, activity in the investment securities portfolio contributed $41,000
to the decrease in non-interest income. In the second quarter of 2010, there was
a $1,000 gain recognized on the sale of several securities. This was offset by
$68,000 of credit related other-than-temporary impairment (OTTI) charges on two
pooled trust preferred securities resulting in a net loss of $67,000 for the
2010 quarter. In the second quarter of 2009 investment securities activity
resulted in a $26,000 net loss and included $134,000 of credit related OTTI
charges in the carrying value of holdings ($126,000 related to equity holdings
and $8,000 related to one pooled trust preferred security) and $108,000 of gains
realized on the sale of several equity securities.





Total
non-interest income for the six month periods ended June 30, 2010 and 2009 was
$2,159,000 and $1,800,000, respectively. Non-interest income for the first half
of 2010, excluding net investment securities gains of $69,000, totaled
$2,090,000 compared to $2,080,000 for the first half of 2009, excluding net
investment securities losses of $280,000. Net securities gains for 2010 include
credit related OTTI charges of $226,000 on three pooled trust preferred
securities and net gains of $295,000 on the sale of investments, primarily
equity securities. The net securities losses for 2009 include a $515,000 charge
related to OTTI in the carrying value of holdings in the equity investment
portfolio and an $8,000 OTTI charge on one of the Company’s pooled trust
preferred securities. These charges were partially offset by realized gains of
$243,000 on the sale of equity securities and several higher-yielding corporate
bonds sold to reduce credit risk in the portfolio. A slowdown in residential
mortgage activity for the first six months of 2010 resulted in gains on sales of
residential mortgage loans decreasing $185,000 to $217,000. Increases in
merchant income, ATM and debit card income contributed $120,000 in additional
non-interest income when comparing the six-month periods. Losses on the sale of
other real estate owned and repossessed assets decreased $101,000 when comparing
the six-month periods.


- 33
-


QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





RESULTS
OF OPERATIONS – OVERVIEW (Continued)





Total
non-interest expense was $4,241,000 for the second quarter of 2010, a decrease
of $143,000 from the second quarter of 2009. The largest contributing factor to
the decline in non-interest expense was FDIC insurance premium expense which
decreased $282,000, to $257,000, comparing the second quarter of 2010 to 2009.
The higher expense in 2009 was primarily the result of the special assessment
levied on all insured institutions by the FDIC in order to replenish its Deposit
Insurance Fund. QNB’s portion of the special assessment was $332,000.
Significant growth in deposits combined with a slightly higher assessment rate
has resulted in an increase in the ongoing quarterly assessment expense.
Partially offsetting the decrease in noninterest expense resulting from FDIC
insurance premiums were increases in salary and benefit expense of $89,000, or
4.3%. An increase in payroll and related taxes and higher medical premium
expense were the primary contributors.





Total
non-interest expense was $8,359,000 for the six month period ended June 30,
2010. This represents an increase of $46,000 from the same period in 2009.
Increased salary and employee benefits expense of $148,000, or 3.6%, and higher
third-party services, including legal and consulting expense, which increased
$66,000 were offset by lower FDIC premiums of $221,000.





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


- 34
-


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
                                                                                        
                                                                                        June 30, 2010
                                                                                        
                                                                                        
                                                                                        June 30, 2009Average
                                                                                        
                                                                                        
                                                                                        Average
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        Average
                                                                                        
                                                                                        
                                                                                        AverageBalance
                                                                                        
                                                                                        
                                                                                        Rate
                                                                                        
                                                                                        
                                                                                        Interest
                                                                                        
                                                                                        
                                                                                        Balance
                                                                                        
                                                                                        
                                                                                        Rate
                                                                                        
                                                                                        
                                                                                        InterestAssetsFederal
      funds sold
                                                                                        
                                                                                        $
                                                                                        -
                                                                                        
                                                                                        
                                                                                        
                                                                                        0.00
                                                                                        %
                                                                                        
                                                                                        $
                                                                                        -
                                                                                        
                                                                                        
                                                                                        $
                                                                                        2,497
                                                                                        
                                                                                        
                                                                                        
                                                                                        0.13
                                                                                        %
                                                                                        
                                                                                        $
                                                                                        1Investment
      securities:U.S.
      Treasury
                                                                                        
                                                                                        
                                                                                        5,011
                                                                                        
                                                                                        
                                                                                        
                                                                                        0.56
                                                                                        %
                                                                                        
                                                                                        
                                                                                        7
                                                                                        
                                                                                        
                                                                                        
                                                                                        5,040
                                                                                        
                                                                                        
                                                                                        
                                                                                        1.60
                                                                                        %
                                                                                        
                                                                                        
                                                                                        20U.S.
      Government agencies
                                                                                        
                                                                                        
                                                                                        54,037
                                                                                        
                                                                                        
                                                                                        
                                                                                        3.26
                                                                                        %
                                                                                        
                                                                                        
                                                                                        440
                                                                                        
                                                                                        
                                                                                        
                                                                                        45,474
                                                                                        
                                                                                        
                                                                                        
                                                                                        4.36
                                                                                        %
                                                                                        
                                                                                        
                                                                                        496State
      and municipal
                                                                                        
                                                                                        
                                                                                        57,066
                                                                                        
                                                                                        
                                                                                        
                                                                                        6.27
                                                                                        %
                                                                                        
                                                                                        
                                                                                        894
                                                                                        
                                                                                        
                                                                                        
                                                                                        48,561
                                                                                        
                                                                                        
                                                                                        
                                                                                        6.60
                                                                                        %
                                                                                        
                                                                                        
                                                                                        802Mortgage-backed
      and CMOs
                                                                                        
                                                                                        
                                                                                        134,769
                                                                                        
                                                                                        
                                                                                        
                                                                                        3.96
                                                                                        %
                                                                                        
                                                                                        
                                                                                        1,336
                                                                                        
                                                                                        
                                                                                        
                                                                                        128,372
                                                                                        
                                                                                        
                                                                                        
                                                                                        4.94
                                                                                        %
                                                                                        
                                                                                        
                                                                                        1,584Corporate
      bonds (fixed and variable)
                                                                                        
                                                                                        
                                                                                        4,360
                                                                                        
                                                                                        
                                                                                        
                                                                                        1.13
                                                                                        %
                                                                                        
                                                                                        
                                                                                        12
                                                                                        
                                                                                        
                                                                                        
                                                                                        5,566
                                                                                        
                                                                                        
                                                                                        
                                                                                        3.42
                                                                                        %
                                                                                        
                                                                                        
                                                                                        47Money
      market mutual funds
                                                                                        
                                                                                        
                                                                                        -
                                                                                        
                                                                                        
                                                                                        
                                                                                        0.00
                                                                                        %
                                                                                        
                                                                                        
                                                                                        -
                                                                                        
                                                                                        
                                                                                        
                                                                                        7,314
                                                                                        
                                                                                        
                                                                                        
                                                                                        0.64
                                                                                        %
                                                                                        
                                                                                        
                                                                                        12Equities
                                                                                        
                                                                                        
                                                                                        2,983
                                                                                        
                                                                                        
                                                                                        
                                                                                        3.85
                                                                                        %
                                                                                        
                                                                                        
                                                                                        28
                                                                                        
                                                                                        
                                                                                        
                                                                                        3,160
                                                                                        
                                                                                        
                                                                                        
                                                                                        3.23
                                                                                        %
                                                                                        
                                                                                        
                                                                                        25Total
      investment securities
                                                                                        
                                                                                        
                                                                                        258,226
                                                                                        
                                                                                        
                                                                                        
                                                                                        4.21
                                                                                        %
                                                                                        
                                                                                        
                                                                                        2,717
                                                                                        
                                                                                        
                                                                                        
                                                                                        243,487
                                                                                        
                                                                                        
                                                                                        
                                                                                        4.91
                                                                                        %
                                                                                        
                                                                                        
                                                                                        2,986Loans:Commercial
      real estate
                                                                                        
                                                                                        
                                                                                        251,140
                                                                                        
                                                                                        
                                                                                        
                                                                                        5.90
                                                                                        %
                                                                                        
                                                                                        
                                                                                        3,692
                                                                                        
                                                                                        
                                                                                        
                                                                                        217,305
                                                                                        
                                                                                        
                                                                                        
                                                                                        6.15
                                                                                        %
                                                                                        
                                                                                        
                                                                                        3,334Residential
      real estate
                                                                                        
                                                                                        
                                                                                        25,015
                                                                                        
                                                                                        
                                                                                        
                                                                                        5.81
                                                                                        %
                                                                                        
                                                                                        
                                                                                        363
                                                                                        
                                                                                        
                                                                                        
                                                                                        24,738
                                                                                        
                                                                                        
                                                                                        
                                                                                        5.92
                                                                                        %
                                                                                        
                                                                                        
                                                                                        366Home
      equity loans
                                                                                        
                                                                                        
                                                                                        60,435
                                                                                        
                                                                                        
                                                                                        
                                                                                        5.13
                                                                                        %
                                                                                        
                                                                                        
                                                                                        774
                                                                                        
                                                                                        
                                                                                        
                                                                                        65,112
                                                                                        
                                                                                        
                                                                                        
                                                                                        5.11
                                                                                        %
                                                                                        
                                                                                        
                                                                                        830Commercial
      and industrial
                                                                                        
                                                                                        
                                                                                        81,661
                                                                                        
                                                                                        
                                                                                        
                                                                                        5.23
                                                                                        %
                                                                                        
                                                                                        
                                                                                        1,066
                                                                                        
                                                                                        
                                                                                        
                                                                                        74,192
                                                                                        
                                                                                        
                                                                                        
                                                                                        5.11
                                                                                        %
                                                                                        
                                                                                        
                                                                                        945Indirect
      lease financing
                                                                                        
                                                                                        
                                                                                        13,941
                                                                                        
                                                                                        
                                                                                        
                                                                                        9.13
                                                                                        %
                                                                                        
                                                                                        
                                                                                        318
                                                                                        
                                                                                        
                                                                                        
                                                                                        14,651
                                                                                        
                                                                                        
                                                                                        
                                                                                        9.05
                                                                                        %
                                                                                        
                                                                                        
                                                                                        331Consumer
      loans
                                                                                        
                                                                                        
                                                                                        3,295
                                                                                        
                                                                                        
                                                                                        
                                                                                        14.53
                                                                                        %
                                                                                        
                                                                                        
                                                                                        119
                                                                                        
                                                                                        
                                                                                        
                                                                                        3,946
                                                                                        
                                                                                        
                                                                                        
                                                                                        10.10
                                                                                        %
                                                                                        
                                                                                        
                                                                                        99Tax-exempt
      loans
                                                                                        
                                                                                        
                                                                                        30,613
                                                                                        
                                                                                        
                                                                                        
                                                                                        6.01
                                                                                        %
                                                                                        
                                                                                        
                                                                                        459
                                                                                        
                                                                                        
                                                                                        
                                                                                        24,750
                                                                                        
                                                                                        
                                                                                        
                                                                                        6.00
                                                                                        %
                                                                                        
                                                                                        
                                                                                        370Total
      loans, net of unearned income*
                                                                                        
                                                                                        
                                                                                        466,100
                                                                                        
                                                                                        
                                                                                        
                                                                                        5.84
                                                                                        %
                                                                                        
                                                                                        
                                                                                        6,791
                                                                                        
                                                                                        
                                                                                        
                                                                                        424,694
                                                                                        
                                                                                        
                                                                                        
                                                                                        5.93
                                                                                        %
                                                                                        
                                                                                        
                                                                                        6,275Other
      earning assets
                                                                                        
                                                                                        
                                                                                        16,159
                                                                                        
                                                                                        
                                                                                        
                                                                                        0.23
                                                                                        %
                                                                                        
                                                                                        
                                                                                        9
                                                                                        
                                                                                        
                                                                                        
                                                                                        4,522
                                                                                        
                                                                                        
                                                                                        
                                                                                        0.11
                                                                                        %
                                                                                        
                                                                                        
                                                                                        2Total
      earning assets
                                                                                        
                                                                                        
                                                                                        740,485
                                                                                        
                                                                                        
                                                                                        
                                                                                        5.16
                                                                                        %
                                                                                        
                                                                                        
                                                                                        9,517
                                                                                        
                                                                                        
                                                                                        
                                                                                        675,200
                                                                                        
                                                                                        
                                                                                        
                                                                                        5.50
                                                                                        %
                                                                                        
                                                                                        
                                                                                        9,264Cash
      and due from banks
                                                                                        
                                                                                        
                                                                                        9,866
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        9,442Allowance
      for loan losses
                                                                                        
                                                                                        
                                                                                        (6,702
                                                                                        )
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        (4,384
                                                                                        )Other
      assets
                                                                                        
                                                                                        
                                                                                        25,890
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        22,407Total
      assets
                                                                                        
                                                                                        $
                                                                                        769,539
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        $
                                                                                        702,665Liabilities
      and Shareholders' EquityInterest-bearing
      deposits:Interest-bearing
      demand
                                                                                        
                                                                                        $
                                                                                        85,940
                                                                                        
                                                                                        
                                                                                        
                                                                                        0.70
                                                                                        %
                                                                                        
                                                                                        
                                                                                        151
                                                                                        
                                                                                        
                                                                                        $
                                                                                        69,888
                                                                                        
                                                                                        
                                                                                        
                                                                                        0.52
                                                                                        %
                                                                                        
                                                                                        
                                                                                        90Municipals
                                                                                        
                                                                                        
                                                                                        33,708
                                                                                        
                                                                                        
                                                                                        
                                                                                        1.11
                                                                                        %
                                                                                        
                                                                                        
                                                                                        94
                                                                                        
                                                                                        
                                                                                        
                                                                                        28,772
                                                                                        
                                                                                        
                                                                                        
                                                                                        1.15
                                                                                        %
                                                                                        
                                                                                        
                                                                                        83Money
      market
                                                                                        
                                                                                        
                                                                                        77,608
                                                                                        
                                                                                        
                                                                                        
                                                                                        0.83
                                                                                        %
                                                                                        
                                                                                        
                                                                                        161
                                                                                        
                                                                                        
                                                                                        
                                                                                        56,864
                                                                                        
                                                                                        
                                                                                        
                                                                                        1.25
                                                                                        %
                                                                                        
                                                                                        
                                                                                        177Savings
                                                                                        
                                                                                        
                                                                                        89,185
                                                                                        
                                                                                        
                                                                                        
                                                                                        0.81
                                                                                        %
                                                                                        
                                                                                        
                                                                                        180
                                                                                        
                                                                                        
                                                                                        
                                                                                        49,269
                                                                                        
                                                                                        
                                                                                        
                                                                                        0.25
                                                                                        %
                                                                                        
                                                                                        
                                                                                        31Time
                                                                                        
                                                                                        
                                                                                        212,906
                                                                                        
                                                                                        
                                                                                        
                                                                                        2.12
                                                                                        %
                                                                                        
                                                                                        
                                                                                        1,122
                                                                                        
                                                                                        
                                                                                        
                                                                                        222,081
                                                                                        
                                                                                        
                                                                                        
                                                                                        3.28
                                                                                        %
                                                                                        
                                                                                        
                                                                                        1,819Time
      of $100,000 or more
                                                                                        
                                                                                        
                                                                                        105,810
                                                                                        
                                                                                        
                                                                                        
                                                                                        2.23
                                                                                        %
                                                                                        
                                                                                        
                                                                                        587
                                                                                        
                                                                                        
                                                                                        
                                                                                        109,115
                                                                                        
                                                                                        
                                                                                        
                                                                                        3.35
                                                                                        %
                                                                                        
                                                                                        
                                                                                        910Total
      interest-bearing deposits
                                                                                        
                                                                                        
                                                                                        605,157
                                                                                        
                                                                                        
                                                                                        
                                                                                        1.52
                                                                                        %
                                                                                        
                                                                                        
                                                                                        2,295
                                                                                        
                                                                                        
                                                                                        
                                                                                        535,989
                                                                                        
                                                                                        
                                                                                        
                                                                                        2.33
                                                                                        %
                                                                                        
                                                                                        
                                                                                        3,110Short-term
      borrowings
                                                                                        
                                                                                        
                                                                                        26,305
                                                                                        
                                                                                        
                                                                                        
                                                                                        1.02
                                                                                        %
                                                                                        
                                                                                        
                                                                                        67
                                                                                        
                                                                                        
                                                                                        
                                                                                        17,244
                                                                                        
                                                                                        
                                                                                        
                                                                                        1.24
                                                                                        %
                                                                                        
                                                                                        
                                                                                        53Long-term
      debt
                                                                                        
                                                                                        
                                                                                        20,989
                                                                                        
                                                                                        
                                                                                        
                                                                                        4.76
                                                                                        %
                                                                                        
                                                                                        
                                                                                        252
                                                                                        
                                                                                        
                                                                                        
                                                                                        35,000
                                                                                        
                                                                                        
                                                                                        
                                                                                        4.26
                                                                                        %
                                                                                        
                                                                                        
                                                                                        376Total
      interest-bearing liabilities
                                                                                        
                                                                                        
                                                                                        652,451
                                                                                        
                                                                                        
                                                                                        
                                                                                        1.61
                                                                                        %
                                                                                        
                                                                                        
                                                                                        2,614
                                                                                        
                                                                                        
                                                                                        
                                                                                        588,233
                                                                                        
                                                                                        
                                                                                        
                                                                                        2.41
                                                                                        %
                                                                                        
                                                                                        
                                                                                        3,539Non-interest-bearing
      deposits
                                                                                        
                                                                                        
                                                                                        56,891
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        55,122Other
      liabilities
                                                                                        
                                                                                        
                                                                                        3,292
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        4,869Shareholders'
      equity
                                                                                        
                                                                                        
                                                                                        56,905
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        54,441Total
      liabilities and shareholders' equity
                                                                                        
                                                                                        $
                                                                                        769,539
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        $
                                                                                        702,665Net
      interest rate spread
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        3.55
                                                                                        %
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        3.09
                                                                                        %Margin/net
      interest income
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        3.74
                                                                                        %
                                                                                        
                                                                                        $
                                                                                        6,903
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        
                                                                                        3.40
                                                                                        %
                                                                                        
                                                                                        $
                                                                                        5,725


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 and investment securities are included in earning assets.


*
Includes loans held-for-sale


- 35
-


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)Six Months Ended
                                                                                                                            
                                                                                                                            June 30, 2010
                                                                                                                            
                                                                                                                            
                                                                                                                            June 30, 2009Average
                                                                                                                            
                                                                                                                            
                                                                                                                            Average
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            Average
                                                                                                                            
                                                                                                                            
                                                                                                                            AverageBalance
                                                                                                                            
                                                                                                                            
                                                                                                                            Rate
                                                                                                                            
                                                                                                                            
                                                                                                                            Interest
                                                                                                                            
                                                                                                                            
                                                                                                                            Balance
                                                                                                                            
                                                                                                                            
                                                                                                                            Rate
                                                                                                                            
                                                                                                                            
                                                                                                                            InterestAssetsFederal
      funds sold
                                                                                                                            
                                                                                                                            $
                                                                                                                            -
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            0.00
                                                                                                                            %
                                                                                                                            
                                                                                                                            $
                                                                                                                            -
                                                                                                                            
                                                                                                                            
                                                                                                                            $
                                                                                                                            1,999
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            0.15
                                                                                                                            %
                                                                                                                            
                                                                                                                            $
                                                                                                                            2Investment
      securities:U.S.
      Treasury
                                                                                                                            
                                                                                                                            
                                                                                                                            5,018
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            0.57
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            14
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5,052
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            1.60
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            40U.S.
      Government agencies
                                                                                                                            
                                                                                                                            
                                                                                                                            58,775
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            3.34
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            981
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            41,302
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            4.54
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            938State
      and municipal
                                                                                                                            
                                                                                                                            
                                                                                                                            56,486
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            6.31
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            1,781
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            48,149
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            6.53
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            1,573Mortgage-backed
      and CMOs
                                                                                                                            
                                                                                                                            
                                                                                                                            127,724
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            4.12
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            2,628
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            123,760
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5.19
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            3,209Corporate
      bonds (fixed and variable)
                                                                                                                            
                                                                                                                            
                                                                                                                            4,438
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            1.19
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            27
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            6,521
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            4.14
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            135Money
      market mutual funds
                                                                                                                            
                                                                                                                            
                                                                                                                            -
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            0.00
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            -
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5,367
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            0.76
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            20Equities
                                                                                                                            
                                                                                                                            
                                                                                                                            2,907
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            3.76
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            54
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            3,312
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            3.13
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            51Total
      investment securities
                                                                                                                            
                                                                                                                            
                                                                                                                            255,348
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            4.30
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            5,485
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            233,463
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5.11
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            5,966Loans:Commercial
      real estate
                                                                                                                            
                                                                                                                            
                                                                                                                            245,395
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5.96
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            7,247
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            209,396
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            6.21
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            6,450Residential
      real estate
                                                                                                                            
                                                                                                                            
                                                                                                                            24,657
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5.76
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            711
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            24,464
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5.98
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            731Home
      equity loans
                                                                                                                            
                                                                                                                            
                                                                                                                            61,078
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5.11
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            1,547
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            66,337
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5.18
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            1,705Commercial
      and industrial
                                                                                                                            
                                                                                                                            
                                                                                                                            80,935
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5.21
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            2,089
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            73,114
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5.02
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            1,822Indirect
      lease financing
                                                                                                                            
                                                                                                                            
                                                                                                                            13,949
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            8.79
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            613
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            14,941
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            8.74
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            653Consumer
      loans
                                                                                                                            
                                                                                                                            
                                                                                                                            3,434
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            13.08
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            223
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            4,109
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            10.23
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            208Tax-exempt
      loans
                                                                                                                            
                                                                                                                            
                                                                                                                            29,176
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5.90
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            854
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            25,086
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            6.00
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            747Total
      loans, net of unearned income*
                                                                                                                            
                                                                                                                            
                                                                                                                            458,624
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5.84
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            13,284
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            417,447
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5.95
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            12,316Other
      earning assets
                                                                                                                            
                                                                                                                            
                                                                                                                            16,569
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            0.23
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            19
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            4,021
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            0.13
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            3Total
      earning assets
                                                                                                                            
                                                                                                                            
                                                                                                                            730,541
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5.19
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            18,788
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            656,930
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            5.61
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            18,287Cash
      and due from banks
                                                                                                                            
                                                                                                                            
                                                                                                                            9,610
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            9,627Allowance
      for loan losses
                                                                                                                            
                                                                                                                            
                                                                                                                            (6,476
                                                                                                                            )
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            (4,156
                                                                                                                            )Other
      assets
                                                                                                                            
                                                                                                                            
                                                                                                                            25,923
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            22,053Total
      assets
                                                                                                                            
                                                                                                                            $
                                                                                                                            759,598
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            $
                                                                                                                            684,454Liabilities
      and Shareholders' EquityInterest-bearing
      deposits:Interest-bearing
      demand
                                                                                                                            
                                                                                                                            $
                                                                                                                            83,878
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            0.70
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            289
                                                                                                                            
                                                                                                                            
                                                                                                                            $
                                                                                                                            67,210
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            0.50
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            168Municipals
                                                                                                                            
                                                                                                                            
                                                                                                                            34,010
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            1.05
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            178
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            27,200
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            1.18
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            159Money
      market
                                                                                                                            
                                                                                                                            
                                                                                                                            74,905
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            0.88
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            327
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            52,489
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            1.31
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            341Savings
                                                                                                                            
                                                                                                                            
                                                                                                                            81,904
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            0.79
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            321
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            47,042
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            0.25
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            59Time
                                                                                                                            
                                                                                                                            
                                                                                                                            215,061
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            2.24
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            2,394
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            218,608
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            3.38
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            3,668Time
      of $100,000 or more
                                                                                                                            
                                                                                                                            
                                                                                                                            106,212
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            2.32
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            1,223
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            107,176
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            3.44
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            1,830Total
      interest-bearing deposits
                                                                                                                            
                                                                                                                            
                                                                                                                            595,970
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            1.60
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            4,732
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            519,725
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            2.42
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            6,225Short-term
      borrowings
                                                                                                                            
                                                                                                                            
                                                                                                                            24,457
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            0.99
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            120
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            17,862
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            1.23
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            109Long-term
      debt
                                                                                                                            
                                                                                                                            
                                                                                                                            23,978
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            4.70
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            566
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            35,000
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            4.27
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            750Total
      interest-bearing liabilities
                                                                                                                            
                                                                                                                            
                                                                                                                            644,405
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            1.70
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            5,418
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            572,587
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            2.49
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            7,084Non-interest-bearing
      deposits
                                                                                                                            
                                                                                                                            
                                                                                                                            55,508
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            52,862Other
      liabilities
                                                                                                                            
                                                                                                                            
                                                                                                                            3,411
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            4,583Shareholders'
      equity
                                                                                                                            
                                                                                                                            
                                                                                                                            56,274
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            54,422Total
      liabilities and shareholders' equity
                                                                                                                            
                                                                                                                            $
                                                                                                                            759,598
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            $
                                                                                                                            684,454Net
      interest rate spread
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            3.49
                                                                                                                            %
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            3.12
                                                                                                                            %Margin/net
      interest income
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            3.69
                                                                                                                            %
                                                                                                                            
                                                                                                                            $
                                                                                                                            13,370
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            
                                                                                                                            3.44
                                                                                                                            %
                                                                                                                            
                                                                                                                            $
                                                                                                                            11,203


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 and investment securities are included in earning assets.


*
Includes loans held-for-sale




- 36
-


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
                                                                                  
                                                                                  
                                                                                  Six Months EndedJune 30, 2010 compared
                                                                                  
                                                                                  
                                                                                  June 30, 2010 comparedto June 30, 2009
                                                                                  
                                                                                  
                                                                                  to June 30, 2009Total
                                                                                  
                                                                                  
                                                                                  Due to change in:
                                                                                  
                                                                                  
                                                                                  Total
                                                                                  
                                                                                  
                                                                                  Due to change in:Change
                                                                                  
                                                                                  
                                                                                  Volume
                                                                                  
                                                                                  
                                                                                  Rate
                                                                                  
                                                                                  
                                                                                  Change
                                                                                  
                                                                                  
                                                                                  Volume
                                                                                  
                                                                                  
                                                                                  RateInterest
      income:Federal
      funds sold
                                                                                  
                                                                                  $
                                                                                  (1
                                                                                  )
                                                                                  
                                                                                  $
                                                                                  (1
                                                                                  )
                                                                                  
                                                                                  $
                                                                                  -
                                                                                  
                                                                                  
                                                                                  $
                                                                                  (2
                                                                                  )
                                                                                  
                                                                                  $
                                                                                  (2
                                                                                  )
                                                                                  
                                                                                  $
                                                                                  -Investment
      securities:U.S.
      Treasury
                                                                                  
                                                                                  
                                                                                  (13
                                                                                  )
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  (13
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (26
                                                                                  )
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  (26
                                                                                  )U.S.
      Government agencies
                                                                                  
                                                                                  
                                                                                  (56
                                                                                  )
                                                                                  
                                                                                  
                                                                                  94
                                                                                  
                                                                                  
                                                                                  
                                                                                  (150
                                                                                  )
                                                                                  
                                                                                  
                                                                                  43
                                                                                  
                                                                                  
                                                                                  
                                                                                  397
                                                                                  
                                                                                  
                                                                                  
                                                                                  (354
                                                                                  )State
      and municipal
                                                                                  
                                                                                  
                                                                                  92
                                                                                  
                                                                                  
                                                                                  
                                                                                  140
                                                                                  
                                                                                  
                                                                                  
                                                                                  (48
                                                                                  )
                                                                                  
                                                                                  
                                                                                  208
                                                                                  
                                                                                  
                                                                                  
                                                                                  272
                                                                                  
                                                                                  
                                                                                  
                                                                                  (64
                                                                                  )Mortgage-backed
      and CMOs
                                                                                  
                                                                                  
                                                                                  (248
                                                                                  )
                                                                                  
                                                                                  
                                                                                  79
                                                                                  
                                                                                  
                                                                                  
                                                                                  (327
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (581
                                                                                  )
                                                                                  
                                                                                  
                                                                                  103
                                                                                  
                                                                                  
                                                                                  
                                                                                  (684
                                                                                  )Corporate
      bonds (fixed and variable)
                                                                                  
                                                                                  
                                                                                  (35
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (10
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (25
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (108
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (43
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (65
                                                                                  )Money
      market mutual funds
                                                                                  
                                                                                  
                                                                                  (12
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (12
                                                                                  )
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  (20
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (20
                                                                                  )
                                                                                  
                                                                                  
                                                                                  -Equities
                                                                                  
                                                                                  
                                                                                  3
                                                                                  
                                                                                  
                                                                                  
                                                                                  (2
                                                                                  )
                                                                                  
                                                                                  
                                                                                  5
                                                                                  
                                                                                  
                                                                                  
                                                                                  3
                                                                                  
                                                                                  
                                                                                  
                                                                                  (6
                                                                                  )
                                                                                  
                                                                                  
                                                                                  9Loans:Commercial
      real estate
                                                                                  
                                                                                  
                                                                                  358
                                                                                  
                                                                                  
                                                                                  
                                                                                  519
                                                                                  
                                                                                  
                                                                                  
                                                                                  (161
                                                                                  )
                                                                                  
                                                                                  
                                                                                  797
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,109
                                                                                  
                                                                                  
                                                                                  
                                                                                  (312
                                                                                  )Residential
      real estate
                                                                                  
                                                                                  
                                                                                  (3
                                                                                  )
                                                                                  
                                                                                  
                                                                                  4
                                                                                  
                                                                                  
                                                                                  
                                                                                  (7
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (20
                                                                                  )
                                                                                  
                                                                                  
                                                                                  7
                                                                                  
                                                                                  
                                                                                  
                                                                                  (27
                                                                                  )Home
      equity loans
                                                                                  
                                                                                  
                                                                                  (56
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (59
                                                                                  )
                                                                                  
                                                                                  
                                                                                  3
                                                                                  
                                                                                  
                                                                                  
                                                                                  (158
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (135
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (23
                                                                                  )Commercial
      and industrial
                                                                                  
                                                                                  
                                                                                  121
                                                                                  
                                                                                  
                                                                                  
                                                                                  96
                                                                                  
                                                                                  
                                                                                  
                                                                                  25
                                                                                  
                                                                                  
                                                                                  
                                                                                  267
                                                                                  
                                                                                  
                                                                                  
                                                                                  195
                                                                                  
                                                                                  
                                                                                  
                                                                                  72Indirect
      lease financing
                                                                                  
                                                                                  
                                                                                  (13
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (16
                                                                                  )
                                                                                  
                                                                                  
                                                                                  3
                                                                                  
                                                                                  
                                                                                  
                                                                                  (40
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (44
                                                                                  )
                                                                                  
                                                                                  
                                                                                  4Consumer
      loans
                                                                                  
                                                                                  
                                                                                  20
                                                                                  
                                                                                  
                                                                                  
                                                                                  (16
                                                                                  )
                                                                                  
                                                                                  
                                                                                  36
                                                                                  
                                                                                  
                                                                                  
                                                                                  15
                                                                                  
                                                                                  
                                                                                  
                                                                                  (34
                                                                                  )
                                                                                  
                                                                                  
                                                                                  49Tax-exempt
      loans
                                                                                  
                                                                                  
                                                                                  89
                                                                                  
                                                                                  
                                                                                  
                                                                                  88
                                                                                  
                                                                                  
                                                                                  
                                                                                  1
                                                                                  
                                                                                  
                                                                                  
                                                                                  107
                                                                                  
                                                                                  
                                                                                  
                                                                                  121
                                                                                  
                                                                                  
                                                                                  
                                                                                  (14
                                                                                  )Other
      earning assets
                                                                                  
                                                                                  
                                                                                  7
                                                                                  
                                                                                  
                                                                                  
                                                                                  2
                                                                                  
                                                                                  
                                                                                  
                                                                                  5
                                                                                  
                                                                                  
                                                                                  
                                                                                  16
                                                                                  
                                                                                  
                                                                                  
                                                                                  8
                                                                                  
                                                                                  
                                                                                  
                                                                                  8Total
      interest income
                                                                                  
                                                                                  
                                                                                  253
                                                                                  
                                                                                  
                                                                                  
                                                                                  906
                                                                                  
                                                                                  
                                                                                  
                                                                                  (653
                                                                                  )
                                                                                  
                                                                                  
                                                                                  501
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,928
                                                                                  
                                                                                  
                                                                                  
                                                                                  (1,427
                                                                                  )Interest
      expense:Interest-bearing
      demand
                                                                                  
                                                                                  
                                                                                  61
                                                                                  
                                                                                  
                                                                                  
                                                                                  21
                                                                                  
                                                                                  
                                                                                  
                                                                                  40
                                                                                  
                                                                                  
                                                                                  
                                                                                  121
                                                                                  
                                                                                  
                                                                                  
                                                                                  41
                                                                                  
                                                                                  
                                                                                  
                                                                                  80Municipals
                                                                                  
                                                                                  
                                                                                  11
                                                                                  
                                                                                  
                                                                                  
                                                                                  14
                                                                                  
                                                                                  
                                                                                  
                                                                                  (3
                                                                                  )
                                                                                  
                                                                                  
                                                                                  19
                                                                                  
                                                                                  
                                                                                  
                                                                                  40
                                                                                  
                                                                                  
                                                                                  
                                                                                  (21
                                                                                  )Money
      market
                                                                                  
                                                                                  
                                                                                  (16
                                                                                  )
                                                                                  
                                                                                  
                                                                                  65
                                                                                  
                                                                                  
                                                                                  
                                                                                  (81
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (14
                                                                                  )
                                                                                  
                                                                                  
                                                                                  145
                                                                                  
                                                                                  
                                                                                  
                                                                                  (159
                                                                                  )Savings
                                                                                  
                                                                                  
                                                                                  149
                                                                                  
                                                                                  
                                                                                  
                                                                                  26
                                                                                  
                                                                                  
                                                                                  
                                                                                  123
                                                                                  
                                                                                  
                                                                                  
                                                                                  262
                                                                                  
                                                                                  
                                                                                  
                                                                                  43
                                                                                  
                                                                                  
                                                                                  
                                                                                  219Time
                                                                                  
                                                                                  
                                                                                  (697
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (76
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (621
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (1,274
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (60
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (1,214
                                                                                  )Time
      of $100,000 or more
                                                                                  
                                                                                  
                                                                                  (323
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (28
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (295
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (607
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (17
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (590
                                                                                  )Short-term
      borrowings
                                                                                  
                                                                                  
                                                                                  14
                                                                                  
                                                                                  
                                                                                  
                                                                                  28
                                                                                  
                                                                                  
                                                                                  
                                                                                  (14
                                                                                  )
                                                                                  
                                                                                  
                                                                                  11
                                                                                  
                                                                                  
                                                                                  
                                                                                  41
                                                                                  
                                                                                  
                                                                                  
                                                                                  (30
                                                                                  )Long-term
      debt
                                                                                  
                                                                                  
                                                                                  (124
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (150
                                                                                  )
                                                                                  
                                                                                  
                                                                                  26
                                                                                  
                                                                                  
                                                                                  
                                                                                  (184
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (235
                                                                                  )
                                                                                  
                                                                                  
                                                                                  51Total
      interest expense
                                                                                  
                                                                                  
                                                                                  (925
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (100
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (825
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (1,666
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (2
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (1,664
                                                                                  )Net
      interest income
                                                                                  
                                                                                  $
                                                                                  1,178
                                                                                  
                                                                                  
                                                                                  $
                                                                                  1,006
                                                                                  
                                                                                  
                                                                                  $
                                                                                  172
                                                                                  
                                                                                  
                                                                                  $
                                                                                  2,167
                                                                                  
                                                                                  
                                                                                  $
                                                                                  1,930
                                                                                  
                                                                                  
                                                                                  $
                                                                                  237




- 37
-


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 six month
periods ended June 30, 2010 and 2009.


For the Three Months
                                    
                                    
                                    For the Six MonthsEnded June 30,
                                    
                                    
                                    Ended June 30,2010
                                    
                                    
                                    2009
                                    
                                    
                                    2010
                                    
                                    
                                    2009Total
      interest income
                                    
                                    $
                                    9,049
                                    
                                    
                                    $
                                    8,859
                                    
                                    
                                    $
                                    17,877
                                    
                                    
                                    $
                                    17,485Total
      interest expense
                                    
                                    
                                    2,614
                                    
                                    
                                    
                                    3,539
                                    
                                    
                                    
                                    5,418
                                    
                                    
                                    
                                    7,084Net
      interest income
                                    
                                    
                                    6,435
                                    
                                    
                                    
                                    5,320
                                    
                                    
                                    
                                    12,459
                                    
                                    
                                    
                                    10,401Tax-equivalent
      adjustment
                                    
                                    
                                    468
                                    
                                    
                                    
                                    405
                                    
                                    
                                    
                                    911
                                    
                                    
                                    
                                    802Net
      interest income (fully taxable-equivalent)
                                    
                                    $
                                    6,903
                                    
                                    
                                    $
                                    5,725
                                    
                                    
                                    $
                                    13,370
                                    
                                    
                                    $
                                    11,203





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





For
purposes of this discussion, interest income and the average yield earned on
loans and investment securities are adjusted to a tax-equivalent basis as
detailed in the tables that appear on pages 35 through 37. 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.





Quarter
to Quarter Comparison





Net
interest income increased $1,115,000, or 21.0%, to $6,435,000 for the second
quarter of 2010 compared to the second quarter of 2009. Net interest income for
the second quarter of 2010 also reflects an improvement of $411,000, or 6.8%
when compared to the first quarter of 2010. On a tax-equivalent basis, net
interest income increased $1,178,000, or 20.6%, from $5,725,000 for the three
months ended June 30, 2009 to $6,903,000 for the same period ended June 30,
2010.





Several
factors contributed to the significant increase in net interest income. Strong
growth in deposits and the deployment of these deposits into commercial loans
contributed to the growth in tax-equivalent interest income of $253,000, or
2.7%. Total average deposits increased $70,937,000, or 12.0%, to $662,048,000
when comparing the three months ended June 30, 2010 and June 30, 2009. Over this
same time period total average loans increased $41,406,000, or 9.7%, and total
average investment securities increased $14,739,000, or 6.1%. Another
significant factor in the increase in net interest income was the decrease in
interest expense resulting from a change in the mix of deposit types as well as
the pricing of new and reinvested time deposits at lower market rates. Interest
expense declined by $925,000, or 26.1%, when comparing the two quarters. As a
result of these factors the net interest margin improved to 3.74% for the second
quarter of 2010 compared to 3.40% for the second quarter of 2009 and 3.64% for
the first quarter of 2010.


- 38
-


QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NET
INTEREST INCOME (Continued)





While the
economy has shown signs of improvement, issues in the residential and commercial
real estate markets persist as do high levels of unemployment. As a result of
these factors, as well as concerns over the stability of some European
economies, interest rates, while extremely volatile, remain at historically low
levels. These low levels of interest rates have been in place since 2008 and
have resulted in lower yields earned on both loans and investment securities as
well as lower rates paid on deposits and borrowed funds.





The yield
on earning assets on a tax-equivalent basis decreased 34 basis points from 5.50%
for the second quarter of 2009 to 5.16% for the second quarter of 2010. The
yield of 5.16% for the second quarter of 2010 represents a decrease of six basis
points from the 5.22% reported for the first quarter of 2010. The yield on
earning assets has held up fairly well as a result of the ability to grow loans
at reasonable returns. This has been able to somewhat offset the decline in the
yield on the investment portfolio which has seen a significant amount of higher
yielding securities get called or prepay and reinvested at much lower
rates.





In
comparison, the rate paid on interest-bearing liabilities decreased 80 basis
points from 2.41% for the second quarter of 2009 to 1.61% for the second quarter
of 2010 and decreased 18 basis points when compared to 1.79% reported in the
first quarter of 2010.





Interest
income on investment securities decreased $269,000 when comparing the two
quarters as the increase in average balances could only partially offset the 70
basis point decline in the average yield of the portfolio. The average yield on
the investment portfolio was 4.21% for the second quarter of 2010 compared with
4.91% for the second quarter of 2009. As noted above, the decline in the yield
on the investment portfolio is primarily the result of the extended period of
low interest rates which has resulted in an increase in cash flow from the
investment portfolio as prepayments speeds on mortgage-backed securities and
CMOs ramped-up as did the amount of calls of agency and municipal securities.
The reinvestment of these funds were generally in securities that had lower
yields than what they replaced. The growth in the investment portfolio was
primarily in high quality U.S. Government agency and agency issued
mortgage-backed and CMO securities as well as in tax-exempt State and municipal
bonds. Income on Government agency securities decreased $56,000, as the 18.8%
growth in average balances was offset by a 110 basis point decline in the yield
from 4.36% for the second quarter of 2009 to 3.26% for the same period in 2010.
Most of the bonds in the agency portfolio have call features ranging from three
months to five years, many of which were exercised as a result of the low
interest rate environment. The proceeds from these called bonds were reinvested
in securities with significantly lower yields. Interest income on
mortgage-backed securities and CMOs decreased $248,000 with lower yields being
the primary factor. The yield on the mortgage-backed portfolio decreased 98
basis points from 4.94% to 3.96% when comparing the second quarter of 2009 and
2010. Interest on tax-exempt municipal securities increased $92,000 with higher
balances accounting for $140,000 of additional income. Municipal bonds yields
did not decline to the same degree as yields on other types of securities. As a
result QNB expanded its purchase of municipal bonds, with average balances
increasing $8,505,000 or 17.5% to $57,066,000 for the second quarter of 2010.
The yield on the state and municipal portfolio decreased from 6.60% for the
second quarter of 2009 to 6.27% for the second quarter of 2010.





To reduce
credit risk in the portfolio QNB has proactively sold over the past two years
corporate bonds issued by financial institutions, nonagency issued CMOs and
noninvestment grade and nonrated state and municipal bonds. These sales
generally resulted in the recording of gains but usually also resulted in the
selling of some higher yielding bonds. The corporate bond portfolio is currently
comprised primarily of pooled trust preferred securities, most of which are on
nonaccrual status. Interest on corporate bonds declined by $35,000 with the
nonaccrual status of the trust preferred securities accounting for much of the
difference.





With the
issues in the economy and indications that the Federal Reserve Open Market
Committee will continue to keep its target rate at between 0.0% and 0.25% for an
extended period of time, treasury yields have fallen even further with the 10
year rate declining below 3.0%. When combined with spread tightening on agency
bonds, mortgage securities and municipal securities, yields on investment
securities are anemic. As a result the yield on the total investment portfolio
is anticipated to continue to decline as cash flow from the portfolio, as well
as excess liquidity, is reinvested at current market rates which are
significantly below the projected portfolio yield at June 30, 2010 of
4.17%.




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QNB
CORP. AND SUBSIDIARY




MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NET
INTEREST INCOME (Continued)





Income on
loans increased $516,000 to $6,791,000 when comparing the second quarters of
2010 and 2009 as the impact of declining interest rates was offset by the growth
in the portfolio. Average loans increased $41,406,000, or 9.7%, and this volume
increase contributed an additional $616,000 in interest income. The yield on
loans decreased only nine basis points, to 5.84% when comparing the same
periods, resulting in a reduction in interest income of $100,000. The yield on
loans did not decline when comparing the second quarter of 2010 to the first
quarter of 2010. Reducing the impact of the decline in interest rates on loan
yields 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. Also helping to stabilize the yield was the implementation of interest
rate floors on some variable rate commercial loans and home equity lines of
credit. The rate earned on loans has not fallen to the degree that the rate
earned on investment securities, which are more closely tied to the treasury
yield curve.





Most of
the growth in the loan portfolio, both in terms of balances and interest income,
was in the category of commercial real estate loans. This category of loans
includes commercial purpose loans secured by either commercial properties such
as office buildings, factories, warehouses, medical facilities and retail
establishments, or residential real estate, usually the residence of the
business owner. The category also includes construction and land development
loans. Income on these loans increased $358,000, with average balances
increasing $33,835,000, or 15.6%, to $251,140,000, for the three months ended
June 30, 2010. The yield on commercial real estate loans was 5.90% for the
second quarter of 2010, a decline of 25 basis points from the 6.15% reported for
the second quarter of 2009. Interest on commercial and industrial loans, the
second largest category, increased $121,000 with a positive impact from both the
growth in balances and the increase in the yield. Average commercial and
industrial loans increased $7,469,000, or 10.1%, to $81,661,000 for the second
quarter of 2010, contributing an additional $96,000 in interest income. The
average yield on these loans increased 12 basis points to 5.23% resulting in an
increase in income of $25,000. The implementation of interest rate floors on
loans in this category, primarily lines of credit indexed to the prime rate, was
a major factor in the improvement in the yield.





Income on
home equity loans declined by $56,000 when comparing the second quarter of 2010
and 2009. Over this same time period average home equity loans decreased
$4,677,000, or 7.2%, to $60,435,000, while the yield on the home equity
portfolio increased two basis points to 5.13%. The demand for home equity loans
has declined as home values have fallen preventing some homeowners from having
equity in their homes to borrow against while others have taken advantage of the
low interest rates on mortgages and refinanced their home equity loans into a
new mortgage. Included in the home equity portfolio are floating rate home
equity lines tied to the prime lending rate. The average balance of these loans
increased by $3,024,000, or 14.0%, to $24,611,000 for the second quarter of
2010. In contrast, average fixed rate home equity loans declined by $7,701,000,
or 17.7%, to $35,824,000. Customers who are opening home equity loans are
choosing the floating rate option indexed to prime even with a rate floor
because the rate is currently significantly lower than a fixed rate home equity
loan. In an attempt to boost demand, QNB has been offering an attractive fixed
rate home equity loan promotion. This promotion which began during the second
quarter of 2010 has had limited success, an indication of lack of demand by
consumers.





Income on
other earning assets is comprised of interest on deposits in correspondent
banks, primarily the Federal Reserve Bank and dividends on restricted
investments in bank stocks, primarily the Federal Home Loan Bank of Pittsburgh
(FHLB). Income on other earning assets increased from $2,000 for the second
quarter of 2009 to $9,000 for the second quarter of 2010. Beginning in December
2008, the Fed began paying 0.25% on balances in excess of required reserves.
With this rate being above what could be earned on selling Federal funds or
investing in AAA rated money market mutual funds excess liquidity was housed at
the Fed. The average balance held at the Federal Reserve Bank was $13,719,000
for the three months ended June 30, 2010 compared with $1,321,000 for the second
quarter of 2009. In December 2008, the FHLB notified member banks that it was
suspending dividend payments to preserve capital. There was no dividend income
from the FHLB in either the second quarter of 2010 or 2009.


- 40
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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 on average by
$70,937,000, or 12.0%, to $662,048,000, when comparing the second quarters of
2010 and 2009. It appears that customers continue to seek the safety of FDIC
insured deposits and the stability of a strong local community bank as opposed
to the volatility of the equity markets and the uncertainty of the larger
regional and national banks. On October 3, 2008, in response to the ongoing
economic crisis affecting the financial services industry, the Emergency
Economic Stabilization Act of 2008 was enacted which temporarily raised the
basic limit on FDIC coverage from $100,000 to $250,000 per depositor until
December 31, 2009. However, legislation was passed during the second quarter of
2009 that extended the higher coverage through December 31, 2013. As part of the
Financial Reform legislation recently passed the $250,000 coverage was made
permanent. In addition, on October 13, 2008, the FDIC established a program
under which the FDIC will fully guarantee all non-interest bearing transaction
accounts until December 31, 2009 (the “Transaction Account Guarantee Program”).
On August 26, 2009 the FDIC amended the program to extend the date six months
until June 30, 2010 to those institutions that do not opt out of participating.
On April 19, 2010 the program was extended again until December 31, 2010. QNB is
participating in the Transaction Account Guarantee Program. To participate in
this program QNB pays a fee of 15 basis points. These programs likely
contributed to the growth in deposits.





While
total income on earning assets on a tax-equivalent basis increased $253,000 when
comparing the second quarter of 2010 to the second quarter of 2009, total
interest expense declined $925,000. Interest expense on total deposits decreased
$815,000 while interest expense on borrowed funds decreased $110,000 when
comparing the two quarters. The rate paid on interest-bearing liabilities
decreased 80 basis points from 2.41% for the second quarter of 2009 to 1.61% for
the second quarter of 2010. During this same period, the rate paid on
interest-bearing deposits decreased 81 basis points from 2.33% to
1.52%.





All
categories of average deposits, except for time deposits, increased when
comparing the second quarter of 2010 to the same period in 2009. Unlike prior
years the growth was not centered in time deposits but in interest-bearing
demand, money market and savings deposits, accounts with greater liquidity.
Average interest-bearing demand accounts increased $16,052,000, or 23.0%, to
$85,940,000 for the three months ended June 30, 2010 compared to the three
months ended June 30, 2009. Interest expense on interest-bearing demand accounts
increased from $90,000 for the second quarter of 2009 to $151,000 for the second
quarter of 2010 while the average rate paid increased from 0.52% to 0.70%. The
increase in the average rate paid reflects a change in the mix of accounts
included in interest-bearing demand accounts. Included in this category is
QNB-Rewards checking, a high rate checking account. For the second quarter of
2009 the product paid a yield of 3.25% on balances up to $25,000. This yield was
reduced on February 10, 2010 to 2.75%. In order to receive the high 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. For the second quarter of 2010, the average balance in the product was
$26,125,000 and the related interest expense was $142,000 for an average yield
of 2.18%. This lower rate than the 2.75% reflects the lower rate paid on
accounts that do not meet the qualifications or on balances in excess of $25,000
which pay 1.01%. In comparison the average balance for the second quarter of
2009 was $12,621,000 with a related interest expense of $82,000 and an average
rate paid of 2.61%. Even with the drop in the rate paid, it is anticipated that
this product will continue to 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. This product also
generates fee income through the use of the check card.





Interest
expense on municipal interest-bearing demand accounts increased from $83,000 for
the second quarter of 2009 to $94,000 for the same period in 2010. The increase
in interest expense was the result of volume growth as the average balance of
municipal interest-bearing demand accounts increased $4,936,000, or 17.2%. The
impact on interest expense of the increase in balances was partially offset by a
decline in the average interest rate paid on these accounts from 1.15% for the
second quarter of 2009 to 1.11% for the second quarter of 2010. Most of these
accounts are tied directly to the Federal funds rate with some having rate
floors between 0.50% and 1.50%. The balances in many of these accounts are
seasonal in nature and are dependant upon the timing of the receipt of taxes and
the disbursement by the schools and municipalities.


- 41
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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NET
INTEREST INCOME (Continued)





Average
money market accounts increased $20,744,000, or 36.5%, to $77,608,000 for the
second quarter of 2010 compared with the second quarter of 2009. Despite the
significant increase in balances, interest expense on money market accounts
decreased $16,000 to $161,000 for the second quarter of 2010 compared to the
first quarter of 2009. Interest  expense related to the increase in
average balances was $65,000 while the decline in the rate paid had the impact
of decreasing interest expense by $81,000. The average interest rate paid on
money market accounts was 1.25% for the second quarter of 2009 and 0.83% for the
second quarter of 2010, a decline of 42 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. With the sharp
decline in short-term interest rates, the rates paid on the Select money market
account have declined as well. The growth in balances is in both consumer and
business accounts and appears to reflect the desire for safety, liquidity and a
rate comparable with short-term time deposits.





During
the second quarter of 2009 QNB introduced an online only eSavings account to
compete with other online savings accounts. This product was introduced at a
yield of 1.85% and has been extremely successful having grown to $42,253,000 at
June 30, 2010. The eSavings yield was reduced to 1.60% on March 17, 2010. The
average balance of this product was $36,724,000 for the second quarter of 2010
and contributed to the $39,916,000, or 81.0%, increase in total average savings
accounts when comparing the second quarters of 2010 and 2009. Average statement
savings accounts also increased $3,597,000, or 7.5%, when comparing the same
periods. As a result of the eSavings product the average rate paid on savings
accounts increased 56 basis points from 0.25% for the second quarter of 2009 to
0.81% for the second quarter of 2010.





The
repricing of time deposits at lower rates over the past year has had the
greatest impact on total interest expense when comparing the two quarters. Total
interest expense on time deposits decreased $1,020,000, or 37.4%, to $1,709,000
for the second quarter of 2010. Average total time deposits decreased by
$12,480,000, or 3.8%, to $318,716,000 for the second quarter of 2010. Similar to
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 2009 and the first half of 2010 a significant amount of time
deposits have repriced lower as rates have declined. The average rate paid on
time deposits decreased from 3.30% to 2.15% when comparing the second quarter of
2009 to the same period in 2010.





Approximately
$222,195,000, or 70.0%, of time deposits at June 30, 2010 will reprice or mature
over the next 12 months. The average rate paid on these time deposits is
approximately 1.93%. During the third quarter of 2010 approximately $33,574,000
of time deposits yielding 1.64% will mature. 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 decline slightly through the
remainder of 2010 as higher costing time deposits are repriced
lower.





Short-term
borrowings are primarily comprised of sweep accounts structured as repurchase
agreements with our commercial customers. Interest expense on short-term
borrowings increased by $14,000 to $67,000 when comparing the two quarters.
During this period average balances increased $9,061,000, or 52.5% to
$26,305,000 while the average rate paid declined from 1.24% to
1.02%.





Contributing
to the decrease in total interest expense was a reduction in interest expense on
long-term debt of $124,000. In January 2010, $10,000,000 in FHLB advances at a
rate of 2.97% matured and were repaid. In addition, in April 2010 another
$5,000,000 of debt at a rate of 4.90% matured and was repaid resulting in the
reduction in expense. Since the average rate paid on the debt that was repaid
was lower than the remaining debt the average rate paid increased from 4.26% for
the second quarter of 2009 to 4.76% for the second quarter of 2010. The average
balances declined from $35,000,000 for the second quarter of 2009 to $20,989,000
for the second quarter of 2010.





Six
Month Comparison





For the
six-month period ended June 30, 2010 tax-equivalent net interest income
increased $2,167,000, or 19.3%. Average earning assets increased $73,611,000, or
11.2%, to $730,541,000 with average loans and investment securities increasing
9.9% and 9.4%, respectively. Average total deposits increased $78,891,000, or
13.8%, to $651,478,000 for the six month period ended June 30, 2010 compared to
the same period in 2009. The net interest margin on a tax-equivalent basis was
3.69% for the six-month period ended June 30, 2010 compared with 3.44% for the
same period in 2009.


- 42
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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NET
INTEREST INCOME (Continued)





Total
interest income on a tax-equivalent basis increased $501,000, from $18,287,000
to $18,788,000, when comparing the six-month periods ended June 30, 2009 and
June 30, 2010 as the additional interest income generated from the growth in
earning assets offset the impact of declining yields on those assets. Interest
income increased $1,928,000 as a result of volume increases but declined
$1,427,000 as a result of lower yields. Average loans increased $41,177,000 to
$458,624,000, with average commercial real estate loans increasing $35,999,000,
or 17.2%, and average commercial and industrial loans increasing $7,821,000, or
10.7%, when comparing the six-month periods. As a result of the efforts of our
seasoned lending professionals, QNB has been able to win quality commercial
relationships from our local competitors.





Over this
same period average investment securities increased $21,885,000, to $255,348,000
with all of the growth occurring in U.S. Government agency bonds, agency issued
mortgage-backed securities and tax-exempt municipal bonds. The yield on earning
assets decreased from 5.61% to 5.19% for the six-month periods with the yield on
loans decreasing from 5.95% to 5.84% during this time. The yield on investments
decreased from 5.11% to 4.30% when comparing the six-month periods. As discussed
previously, the decline in yields reflects the impact of historically low levels
of interest rates over the past two years. The impact has been more significant
on the investment portfolio as many of the bonds have call features which have
been exercised by the issuers or are subject to prepayments as mortgages are
refinanced.





Total
interest expense decreased $1,666,000, from $7,084,000 for the six-month period
ended June 30, 2009 to $5,418,000, for the six-month period ended June 30, 2010.
Approximately all of the decrease in interest expense was a result of lower
rates paid on deposits, especially time deposits. Interest expense on
interest-bearing deposits declined by $1,493,000 with interest expense on time
deposits declining $1,881,000. The average rate paid on time deposits decreased
113 basis points to 2.27% from 3.40% when comparing the six-month periods ended
June 30, 2010 and 2009. The average balance of total time deposits declined
$4,511,000, or 1.39% to $321,273,000 for the six months ended June 30, 2010
compared with the similar 2009 period.





While the
average balances on time deposits declined when comparing the six-month periods,
the average balances of transaction accounts increased significantly as
customers sought the liquidity of these accounts as well as the higher rate
being offered on the QNB-Rewards checking product and the eSavings product.
Interest expense on interest-bearing demand deposits increased $121,000,
resulting from both a $16,668,000, or 24.8%, increase in average balances and a
20 basis point increase in the average rate paid. The interest rate paid on
interest-bearing demand accounts increased from 0.50% for the first half of 2009
to 0.70% for the first half of 2010. As mentioned previously the QNB-Rewards
checking account was the primary factor in both the growth in total
interest-bearing demand deposits as well as the increase in the rate paid.
Interest expense on money market accounts declined $14,000, as lower rates paid
more than offset the significant increase in average balances. Average money
market balances increased $22,416,000, or 42.7% while the average rate paid
declined from 1.31% for the first half of 2009 to .88% for the first half of
2010. Interest expense on savings accounts increased $262,000 when comparing the
six-month periods. Average savings account balances increased $34,862,000, or
74.1% to $81,904.000 while the average rate paid increased from 0.25% to
0.79%.





Also
contributing to the reduction in interest expense when comparing the six-month
periods was the repayment of long-term debt as discussed earlier. Interest
expense on long-term debt declined by $184,000 as the average balance declined
from $35,000,000 for the first six months of 2009 to $23,978,000 for the first
six-months of 2010.





PROVISION
FOR LOAN LOSSES





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


- 43
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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





PROVISION
FOR LOAN LOSSES (Continued)





Management
believes that it uses the best information available to make determinations
about the adequacy of the allowance and that it has established its existing
allowance for loan losses in accordance with U.S. generally accepted accounting
principles (GAAP). The determination of an appropriate level for the allowance
for loan losses is based upon an analysis of the risks inherent in QNB’s loan
portfolio. Management, in determining the allowance for loan losses, makes
significant estimates and assumptions. Since the allowance for loan losses is
dependent, to a great extent, on conditions that may be beyond QNB’s control, it
is at least reasonably possible that management’s estimates of the allowance for
loan losses and actual results could differ. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
QNB’s allowance for losses on loans. Such agencies may require QNB to recognize
changes to the allowance based on their judgments about information available to
them at the time of their examination.





Management
conducts a quarterly analysis of the appropriateness of the allowance for loan
losses. This analysis that considers a number of relevant factors including:
historical loan loss experience, general economic conditions, levels of and
trends in delinquent and non-performing loans, levels of classified loans,
trends in the growth rate of loans and concentrations of credit.





QNB
utilizes a risk weighting system that assigns a risk code to every commercial
loan. This risk weighting system is supplemented with a program that encourages
account officers to identify potentially deteriorating loan situations. The
officer analysis program is used to complement the on-going analysis of the loan
portfolio performed during the loan review function. In addition, QNB has a
committee that meets quarterly to review the appropriateness of the allowance
for loan losses based on the current and projected status of all relevant
factors pertaining to the loan portfolio.





As a
result of continued loan growth, higher than normal levels of net charge-offs,
further increases in non-performing and delinquent loans and continued concerns
over current economic conditions, QNB continues to closely monitor the quality
of the loan portfolio and has increased the allowance for loan losses to reflect
the changes in the portfolio. QNB recorded a provision for loan losses of
$700,000 in the second quarter of 2010 and $1,400,000 for the first half of
2010. This compares to a provision of $500,000 for the second quarter of 2009
and $1,100,000 for the first half 2009.





Net loan
charge-offs were $48,000, or 0.04% (annualized) of average total loans for the
second quarter of 2010 compared with $136,000, or 0.13% (annualized) of average
total loans for the second quarter of 2009. Included in net charge-offs for the
second quarter of 2010 were recoveries of $131,000 which were almost all from
the indirect lease financing portfolio. This portfolio includes loans to
businesses in the trucking and construction industries which were negatively
impacted by the slowdown in the economy over the past two years. For the six
month periods ended June 30, 2010 and 2009 net loan charge-offs were $608,000,
or 0.27% (annualized) and $352,000, or 0.17% (annualized). Of the charge-offs
for the first half of 2010, $350,000 relates to a commercial borrower whose loan
was secured by business assets.





As
referenced in the following table, the levels of non-performing and delinquent
loans have trended higher over the past year. This is primarily a result of the
difficult economic environment over the past two years and reflects
deterioration in the financial performance of some of our commercial customers.
At June 30, 2010 non-performing loans totaled $7,748,000, as compared with
$6,102,000 at December 31, 2009 and $4,203,000 at June 30, 2009. When compared
to total loans, non-performing loans have risen from 0.96% at June 30, 2009 and
1.36% at December 2009 to 1.63% at June 30, 2010. Despite the increase in
non-performing loans over the past year QNB’s non-performing loans to total
loans ratio continues to compare favorably with the average 2.62% of total loans
for Pennsylvania commercial banks with assets between $500 million and $1
billion as reported by the FDIC using March 31, 2010 data, the most recent
available.





Delinquent
loans are considered performing loans and exclude non-accrual loans,
restructured loans and loans 90 days or more past due and still accruing
interest (all of which are considered non-performing loans). Total delinquent
loans at June 30, 2010, December 31, 2009 and June 30, 2009 represent 0.94%,
0.89% and 0.93% of total loans, respectively.


- 44
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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





PROVISION
FOR LOAN LOSSES (Continued)





QNB’s
allowance for loan losses of $7,009,000 represents 1.48% of total loans at June
30, 2010 compared to an allowance for loan losses of $4,584,000, or 1.05% of
total loans at June 30, 2009 and $6,217,000, or 1.38% of total loans at December
31, 2009. The ratio is at a level that QNB management believes is adequate as of
June 30, 2010 based on its analysis of known and inherent losses in the
portfolio.





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.
Impaired loans are primarily those classified as non-accrual or restructured.
The measurement of impaired loans is generally based on the present value of
expected future cash flows discounted at the effective interest rate, except
that all collateral-dependent loans are measured for impairment based on the
fair value of the collateral. At June 30, 2010 and December 31, 2009, the
recorded investment in impaired loans totaled $7,562,000 and $5,699,000,
respectively, of which $3,423,000 and $4,622,000, respectively, required no
specific allowance for loan losses. The recorded investment in impaired loans
requiring a specific allowance for loan losses was $4,139,000 and $1,077,000 at
June 30, 2010 and December 31, 2009, respectively. At June 30, 2010 and December
31, 2009 the related allowance for loan losses associated with these loans was
$398,000 and $528,000, respectively. Most of the loans that have been identified
as impaired are collateral-dependent.





The
following table shows asset quality indicators for the periods
presented:


6/30/10
                              
                              
                              3/31/10
                              
                              
                              12/31/09
                              
                              
                              9/30/09
                              
                              
                              6/30/09Non-performing
      loans
                              
                              $
                              7,748
                              
                              
                              $
                              5,894
                              
                              
                              $
                              6,102
                              
                              
                              $
                              5,199
                              
                              
                              $
                              4,203Non-performing
      loans to total loans
                              
                              
                              1.63
                              %
                              
                              
                              1.29
                              %
                              
                              
                              1.36
                              %
                              
                              
                              1.19
                              %
                              
                              
                              0.96
                              %Delinquent
      loans (30-89 days past due), not included above
                              
                              $
                              4,448
                              
                              
                              $
                              5,677
                              
                              
                              $
                              4,015
                              
                              
                              $
                              5,210
                              
                              
                              $
                              4,049Delinquent
      loans to total loans
                              
                              
                              0.94
                              %
                              
                              
                              1.24
                              %
                              
                              
                              0.89
                              %
                              
                              
                              1.19
                              %
                              
                              
                              0.93
                              %Total
      delinquent and non-performing loans
                              
                              $
                              12,196
                              
                              
                              $
                              11,571
                              
                              
                              $
                              10,117
                              
                              
                              $
                              10,409
                              
                              
                              $
                              8,252Total
      delinquent and non-performing loans to total loans
                              
                              
                              2.57
                              %
                              
                              
                              2.54
                              %
                              
                              
                              2.25
                              %
                              
                              
                              2.38
                              %
                              
                              
                              1.89
                              %Non-performing
      assets
                              
                              $
                              9,327
                              
                              
                              $
                              6,932
                              
                              
                              $
                              7,032
                              
                              
                              $
                              6,285
                              
                              
                              $
                              4,583Non-performing
      assets to total assets
                              
                              
                              1.20
                              %
                              
                              
                              0.90
                              %
                              
                              
                              0.92
                              %
                              
                              
                              0.86
                              %
                              
                              
                              0.64
                              %





- 45
-


QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





PROVISION
FOR LOAN LOSSES (Continued)





The
following table shows detailed information and ratios pertaining to the
Company’s loan and asset quality:


June 30, 2010
                                          
                                          
                                          December 31, 2009Loans
      past due 90 days or more and still accruing interest
                                          
                                          $
                                          62
                                          
                                          
                                          $
                                          759Non-accrual
      loans
                                          
                                          
                                          7,180
                                          
                                          
                                          
                                          3,086Restructured
      loans, not included above
                                          
                                          
                                          506
                                          
                                          
                                          
                                          2,257Total
      non-performing loans
                                          
                                          $
                                          7,748
                                          
                                          
                                          $
                                          6,102Other
      real estate owned and repossessed assets
                                          
                                          
                                          40
                                          
                                          
                                          
                                          67Non-accrual
      pooled trust preferred securities
                                          
                                          
                                          1,539
                                          
                                          
                                          
                                          863Total
      non-performing assets
                                          
                                          $
                                          9,327
                                          
                                          
                                          $
                                          7,032Average
      total loans (YTD average)
                                          
                                          $
                                          458,624
                                          
                                          
                                          $
                                          427,924Total
      loans, including loans held for sale
                                          
                                          
                                          475,055
                                          
                                          
                                          
                                          449,421Allowance
      for loan losses
                                          
                                          
                                          7,009
                                          
                                          
                                          
                                          6,217Allowance
      for loan losses to:Non-performing
      loans
                                          
                                          
                                          90.46
                                          %
                                          
                                          
                                          101.88
                                          %Total
      loans
                                          
                                          
                                          1.48
                                          %
                                          
                                          
                                          1.38
                                          %Average
      total loans
                                          
                                          
                                          1.53
                                          %
                                          
                                          
                                          1.45
                                          %Non-performing
      loans / Loans
                                          
                                          
                                          1.63
                                          %
                                          
                                          
                                          1.36
                                          %Non-performing
      assets / Assets
                                          
                                          
                                          1.20
                                          %
                                          
                                          
                                          0.92
                                          %





An
analysis of loan charge-offs for the three and six months ended June 30, 2010
compared to 2009 is as follows:





For the Three Months
                        
                        
                        For the Six MonthsEnded June 30,
                        
                        
                        Ended June 30,2010
                        
                        
                        2009
                        
                        
                        2010
                        
                        
                        2009Net
      charge-offs
                        
                        $
                        48
                        
                        
                        $
                        136
                        
                        
                        $
                        608
                        
                        
                        $
                        352Net
      charge-offs (annualized) to:Total
      loans
                        
                        
                        0.04
                        %
                        
                        
                        0.12
                        %
                        
                        
                        0.26
                        %
                        
                        
                        0.16
                        %Average
      total loans
                        
                        
                        0.04
                        %
                        
                        
                        0.13
                        %
                        
                        
                        0.27
                        %
                        
                        
                        0.17
                        %Allowance
      for loan losses
                        
                        
                        2.78
                        %
                        
                        
                        11.86
                        %
                        
                        
                        17.50
                        %
                        
                        
                        15.45
                        %




- 46
-


QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NON-INTEREST
INCOME


Non-Interest Income ComparisonThree Months Ended
                                                                                                                      
                                                                                                                      
                                                                                                                      Change from
                                                                                                                      
                                                                                                                      
                                                                                                                      Six Months Ended
                                                                                                                      
                                                                                                                      
                                                                                                                      Change fromJune 30,
                                                                                                                      
                                                                                                                      
                                                                                                                      Prior Year
                                                                                                                      
                                                                                                                      
                                                                                                                      June 30,
                                                                                                                      
                                                                                                                      
                                                                                                                      Prior Year2010
                                                                                                                      
                                                                                                                      
                                                                                                                      2009
                                                                                                                      
                                                                                                                      
                                                                                                                      Amount
                                                                                                                      
                                                                                                                      
                                                                                                                      Percent
                                                                                                                      
                                                                                                                      
                                                                                                                      2010
                                                                                                                      
                                                                                                                      
                                                                                                                      2009
                                                                                                                      
                                                                                                                      
                                                                                                                      Amount
                                                                                                                      
                                                                                                                      
                                                                                                                      PercentFees
      for services to customers
                                                                                                                      
                                                                                                                      $
                                                                                                                      406
                                                                                                                      
                                                                                                                      
                                                                                                                      $
                                                                                                                      423
                                                                                                                      
                                                                                                                      
                                                                                                                      $
                                                                                                                      (17
                                                                                                                      )
                                                                                                                      
                                                                                                                      
                                                                                                                      -4.0
                                                                                                                      %
                                                                                                                      
                                                                                                                      $
                                                                                                                      811
                                                                                                                      
                                                                                                                      
                                                                                                                      $
                                                                                                                      818
                                                                                                                      
                                                                                                                      
                                                                                                                      $
                                                                                                                      (7
                                                                                                                      )
                                                                                                                      
                                                                                                                      
                                                                                                                      -0.9
                                                                                                                      %ATM
      and debit card
                                                                                                                      
                                                                                                                      
                                                                                                                      314
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      256
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      58
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      22.7
                                                                                                                      %
                                                                                                                      
                                                                                                                      
                                                                                                                      585
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      484
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      101
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      20.9
                                                                                                                      %Bank-owned
      life insurance
                                                                                                                      
                                                                                                                      
                                                                                                                      68
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      66
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      2
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      3.0
                                                                                                                      %
                                                                                                                      
                                                                                                                      
                                                                                                                      132
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      137
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      (5
                                                                                                                      )
                                                                                                                      
                                                                                                                      
                                                                                                                      -3.6
                                                                                                                      %Mortgage
      servicing fees
                                                                                                                      
                                                                                                                      
                                                                                                                      23
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      25
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      (2
                                                                                                                      )
                                                                                                                      
                                                                                                                      
                                                                                                                      -8.0
                                                                                                                      %
                                                                                                                      
                                                                                                                      
                                                                                                                      55
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      61
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      (6
                                                                                                                      )
                                                                                                                      
                                                                                                                      
                                                                                                                      -9.8
                                                                                                                      %Net
      gain on sale of loans
                                                                                                                      
                                                                                                                      
                                                                                                                      142
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      234
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      (92
                                                                                                                      )
                                                                                                                      
                                                                                                                      
                                                                                                                      -39.3
                                                                                                                      %
                                                                                                                      
                                                                                                                      
                                                                                                                      217
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      402
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      (185
                                                                                                                      )
                                                                                                                      
                                                                                                                      
                                                                                                                      -46.0
                                                                                                                      %Net
      gain (loss) on investment securities
                                                                                                                      
                                                                                                                      
                                                                                                                      (67
                                                                                                                      )
                                                                                                                      
                                                                                                                      
                                                                                                                      (26
                                                                                                                      )
                                                                                                                      
                                                                                                                      
                                                                                                                      (41
                                                                                                                      )
                                                                                                                      
                                                                                                                      
                                                                                                                      -157.7
                                                                                                                      %
                                                                                                                      
                                                                                                                      
                                                                                                                      69
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      (280
                                                                                                                      )
                                                                                                                      
                                                                                                                      
                                                                                                                      349
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      124.6
                                                                                                                      %Other
                                                                                                                      
                                                                                                                      
                                                                                                                      141
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      89
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      52
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      58.4
                                                                                                                      %
                                                                                                                      
                                                                                                                      
                                                                                                                      290
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      178
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      112
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      62.9
                                                                                                                      %Total
                                                                                                                      
                                                                                                                      $
                                                                                                                      1,027
                                                                                                                      
                                                                                                                      
                                                                                                                      $
                                                                                                                      1,067
                                                                                                                      
                                                                                                                      
                                                                                                                      $
                                                                                                                      (40
                                                                                                                      )
                                                                                                                      
                                                                                                                      
                                                                                                                      -3.7
                                                                                                                      %
                                                                                                                      
                                                                                                                      $
                                                                                                                      2,159
                                                                                                                      
                                                                                                                      
                                                                                                                      $
                                                                                                                      1,800
                                                                                                                      
                                                                                                                      
                                                                                                                      $
                                                                                                                      359
                                                                                                                      
                                                                                                                      
                                                                                                                      
                                                                                                                      19.9
                                                                                                                      %





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,
gains and losses on the sale of investment securities and residential mortgage
loans.





Total
non-interest income was $1,027,000 for the second quarter of 2010, a decrease of
$40,000 compared with the same period in 2009. Gains on the sale of residential
mortgages decreased $92,000 comparing these same periods. The low interest rate
environment continues to result in mortgage refinancing activity although at a
significantly lower level than early 2009. In addition, net losses on investment
securities increased $41,000. Partially offsetting these items was an increase
of $58,000 in ATM and debit card income and a decrease of $66,000 in losses on
the sale of other real estate owned and repossessed assets.





Fees for
services to customers are primarily comprised of service charges on deposit
accounts. These fees decreased $17,000, or 4.0%, to $406,000 when comparing the
three-month periods. Overdraft income decreased $32,000 for the three-month
period as a result of a decline in the volume of overdrafts coupled with QNB
reducing the per item charge for overdrafts by $2.00, to $35, during March of
this year. Fees on business checking accounts increased $9,000 for the
three-month period. This increase reflects the impact of a lower earnings credit
rate in the second quarter of 2010 as compared to the second quarter of 2009,
resulting from the significant 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 cards
and ATM cards and ATM surcharge income for the use of QNB’s ATM machines by
non-QNB customers. ATM and debit card income was $314,000 for the second quarter
of 2010, an increase of $58,000, or 22.7%, from the amount recorded during the
second quarter of 2009. This primarily reflects growth in ATM and debit card
transactions. Helping to contribute to the growth in debit card transactions is
the growth in the QNB-Rewards checking product, a high-yield checking account
which requires a minimum of twelve debit card transactions per statement cycle
to receive the high interest rate.





When QNB
sells its residential mortgages in the secondary market, it retains servicing
rights. A normal servicing fee is retained on all mortgage loans sold and
serviced. QNB recognizes its obligation to service financial assets that are
retained in a transfer of assets in the form of a servicing asset. The servicing
asset is amortized in proportion to, and over, the period of net servicing
income or loss. On a quarterly basis, servicing assets are assessed for
impairment based on their fair value. The timing of mortgage payments and
delinquencies also impacts the amount of servicing fees
recorded.


- 47
-


QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NON-INTEREST
INCOME (Continued)





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 and changes in spread
relationships in different sectors and for liquidity purposes. Management
continually reviews strategies that will result in an increase in the yield or
improvement in the structure of the investment portfolio.





As noted
previously, activity in the investment securities portfolio contributed $41,000
to the decrease in non-interest income. In the second quarter of 2010, there was
a $1,000 gain recognized on the sale of several securities. This was offset by
$68,000 of credit related other-than-temporary impairment (OTTI) charges on two
pooled trust preferred securities resulting in a net loss of $67,000 for the
2010 quarter. In the second quarter of 2009 investment securities activity
resulted in a $26,000 net loss and included $134,000 of credit related OTTI
charges in the carrying value of holdings ($126,000 related to equity holdings
and $8,000 related to one pooled trust preferred security) partially offset by
$108,000 of gains realized on the sale of several equity
securities.




The net
gain on the sale of residential mortgage loans was $142,000 and $234,000 for the
quarters ended June 30, 2010 and 2009, respectively. This $92,000 decrease in
the net gain on sale of loans was a result of decreased refinancing activity.
Many customers who were able to refinance have already refinanced due to the low
interest rate environment that has existed for over a year. 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 in these periods were $23,000 and
$76,000, respectively, related to the recognition of mortgage servicing assets.
Proceeds from the sale of residential mortgages were $3,073,000 and $10,263,000
for the second quarters of 2010 and 2009, respectively.





Other
income was $141,000 for the second quarter of 2010 and $89,000 for the same
period during 2009. The majority of the difference was attributable to the
following:


·
              During
      2009 there was a valuation writedown of $66,000 on other real estate
      owned; no such writedown in
2010.


·
              Income
      from investment in title insurance company decreased by $16,000 as a
      result of decreased mortgage
activity.


·
              Merchant
      income increased $9,000, or 14.3%, for the three-month period primarily
      due to new merchant accounts being
obtained.


·
              Gain
      on sale of repossessed assets was $7,000 lower than the second quarter of
      2009.





Total
non-interest income for the six month periods ended June 30, 2010 and 2009 was
$2,159,000 and $1,800,000, respectively. Non-interest income for the first half
of 2010, excluding net investment securities gains of $69,000, totaled
$2,090,000 compared to $2,080,000 for the first half of 2009, excluding net
investment securities losses of $280,000.





For the
six-month period, gains on the sale of residential mortgages decreased $185,000
to $217,000 as mortgage originations and sales volume decreased. Included in the
gains on the sale of residential mortgages in these periods were $40,000 and
$134,000, respectively, related to the recognition of mortgage servicing assets.
Proceeds from the sale of residential mortgages were $5,386,000 and $17,948,000
for the first six months of 2010 and 2009, respectively.





Fees for
services to customers decreased $7,000, or 0.9%, to $811,000 for the six months
ended June 30, 2010. For similar reasons as those discussed for the quarter,
overdraft income declined $30,000 while fees on business checking accounts and
internet banking fees increased $15,000 and $7,000, respectively when comparing
the six-month periods.





ATM and
debit card income was $585,000 for the first six months of 2010, an increase of
$101,000, or 20.9%, from the amount recorded during the first six months of
2009. The reason for the growth is attributable to the same reasons discussed
previously for the quarter.


- 48
-


QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NON-INTEREST
INCOME (Continued)





Net
securities gains for 2010 include credit related OTTI charges of $226,000 on
three pooled trust preferred securities and net gains of $295,000 on the sale of
investments, primarily equity securities. The net securities losses for 2009
include a $515,000 charge related to OTTI in the carrying value of holdings in
the equity investment portfolio and an $8,000 OTTI charge on one of the
Company’s pooled trust preferred securities. These charges were partially offset
by gains of $107,000 recognized on the sale of equity securities and gains of
$136,000 on the sale of several higher-yielding corporate bonds sold to reduce
credit risk in the portfolio.





Other
income was $290,000 for the first six months of 2010 and $178,000 for the same
period during 2009. The majority of the difference was caused by the
following:


·
              During
      2009 there was a valuation writedown of $66,000 on other real estate
      owned; no such writedown in
2010


·
              There
      was no net loss on the sale of repossessed assets for the first six months
      of 2010 compared to a net loss of $35,000 during the same period in
      2009.


·
              Merchant
      income increased $19,000, or 17.2%, for the first six months of 2010
      primarily due to new merchant accounts being
  obtained.


·
              Income
      from investment in title insurance company decreased by $16,000 as a
      result of decreased mortgage
activity.




NON-INTEREST
EXPENSE


Non-Interest Expense ComparisonThree Months Ended
                                                                                
                                                                                
                                                                                Change from
                                                                                
                                                                                
                                                                                Six Months Ended
                                                                                
                                                                                
                                                                                Change fromJune 30,
                                                                                
                                                                                
                                                                                Prior Year
                                                                                
                                                                                
                                                                                June 30,
                                                                                
                                                                                
                                                                                Prior Year2010
                                                                                
                                                                                
                                                                                2009
                                                                                
                                                                                
                                                                                Amount
                                                                                
                                                                                
                                                                                Percent
                                                                                
                                                                                
                                                                                2010
                                                                                
                                                                                
                                                                                2009
                                                                                
                                                                                
                                                                                Amount
                                                                                
                                                                                
                                                                                PercentSalaries
      and employee benefits
                                                                                
                                                                                $
                                                                                2,167
                                                                                
                                                                                
                                                                                $
                                                                                2,078
                                                                                
                                                                                
                                                                                $
                                                                                89
                                                                                
                                                                                
                                                                                
                                                                                4.3
                                                                                %
                                                                                
                                                                                $
                                                                                4,304
                                                                                
                                                                                
                                                                                $
                                                                                4,156
                                                                                
                                                                                
                                                                                $
                                                                                148
                                                                                
                                                                                
                                                                                
                                                                                3.6
                                                                                %Net
      occumpancy
                                                                                
                                                                                
                                                                                360
                                                                                
                                                                                
                                                                                
                                                                                335
                                                                                
                                                                                
                                                                                
                                                                                25
                                                                                
                                                                                
                                                                                
                                                                                7.5
                                                                                %
                                                                                
                                                                                
                                                                                729
                                                                                
                                                                                
                                                                                
                                                                                688
                                                                                
                                                                                
                                                                                
                                                                                41
                                                                                
                                                                                
                                                                                
                                                                                6.0
                                                                                %Furniture
      and equipment
                                                                                
                                                                                
                                                                                288
                                                                                
                                                                                
                                                                                
                                                                                309
                                                                                
                                                                                
                                                                                
                                                                                (21
                                                                                )
                                                                                
                                                                                
                                                                                -6.8
                                                                                %
                                                                                
                                                                                
                                                                                570
                                                                                
                                                                                
                                                                                
                                                                                605
                                                                                
                                                                                
                                                                                
                                                                                (35
                                                                                )
                                                                                
                                                                                
                                                                                -5.8
                                                                                %Marketing
                                                                                
                                                                                
                                                                                199
                                                                                
                                                                                
                                                                                
                                                                                189
                                                                                
                                                                                
                                                                                
                                                                                10
                                                                                
                                                                                
                                                                                
                                                                                5.3
                                                                                %
                                                                                
                                                                                
                                                                                360
                                                                                
                                                                                
                                                                                
                                                                                364
                                                                                
                                                                                
                                                                                
                                                                                (4
                                                                                )
                                                                                
                                                                                
                                                                                -1.1
                                                                                %Third-party
      services
                                                                                
                                                                                
                                                                                290
                                                                                
                                                                                
                                                                                
                                                                                267
                                                                                
                                                                                
                                                                                
                                                                                23
                                                                                
                                                                                
                                                                                
                                                                                8.6
                                                                                %
                                                                                
                                                                                
                                                                                563
                                                                                
                                                                                
                                                                                
                                                                                497
                                                                                
                                                                                
                                                                                
                                                                                66
                                                                                
                                                                                
                                                                                
                                                                                13.3
                                                                                %Telephone,
      postage and supplies
                                                                                
                                                                                
                                                                                142
                                                                                
                                                                                
                                                                                
                                                                                156
                                                                                
                                                                                
                                                                                
                                                                                (14
                                                                                )
                                                                                
                                                                                
                                                                                -9.0
                                                                                %
                                                                                
                                                                                
                                                                                299
                                                                                
                                                                                
                                                                                
                                                                                305
                                                                                
                                                                                
                                                                                
                                                                                (6
                                                                                )
                                                                                
                                                                                
                                                                                -2.0
                                                                                %State
      taxes
                                                                                
                                                                                
                                                                                139
                                                                                
                                                                                
                                                                                
                                                                                133
                                                                                
                                                                                
                                                                                
                                                                                6
                                                                                
                                                                                
                                                                                
                                                                                4.5
                                                                                %
                                                                                
                                                                                
                                                                                279
                                                                                
                                                                                
                                                                                
                                                                                268
                                                                                
                                                                                
                                                                                
                                                                                11
                                                                                
                                                                                
                                                                                
                                                                                4.1
                                                                                %FDIC
      insurance premiums
                                                                                
                                                                                
                                                                                257
                                                                                
                                                                                
                                                                                
                                                                                539
                                                                                
                                                                                
                                                                                
                                                                                (282
                                                                                )
                                                                                
                                                                                
                                                                                -52.3
                                                                                %
                                                                                
                                                                                
                                                                                511
                                                                                
                                                                                
                                                                                
                                                                                732
                                                                                
                                                                                
                                                                                
                                                                                (221
                                                                                )
                                                                                
                                                                                
                                                                                -30.2
                                                                                %Other
                                                                                
                                                                                
                                                                                399
                                                                                
                                                                                
                                                                                
                                                                                378
                                                                                
                                                                                
                                                                                
                                                                                21
                                                                                
                                                                                
                                                                                
                                                                                5.6
                                                                                %
                                                                                
                                                                                
                                                                                744
                                                                                
                                                                                
                                                                                
                                                                                698
                                                                                
                                                                                
                                                                                
                                                                                46
                                                                                
                                                                                
                                                                                
                                                                                6.6
                                                                                %Total
                                                                                
                                                                                $
                                                                                4,241
                                                                                
                                                                                
                                                                                $
                                                                                4,384
                                                                                
                                                                                
                                                                                $
                                                                                (143
                                                                                )
                                                                                
                                                                                
                                                                                -3.3
                                                                                %
                                                                                
                                                                                $
                                                                                8,359
                                                                                
                                                                                
                                                                                $
                                                                                8,313
                                                                                
                                                                                
                                                                                $
                                                                                46
                                                                                
                                                                                
                                                                                
                                                                                0.6
                                                                                %





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 $4,241,000 for the
second quarter of 2010, a decrease of $143,000 from the second quarter of
2009.


- 49
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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NON-INTEREST
EXPENSE (Continued)





Salaries
and benefits is the largest component of non interest expense. Salaries and
benefits expense increased $89,000, or 4.3%, to $2,167,000 for the quarter ended
June 30, 2010 compared to the same quarter in 2009. Salary expense increased
$67,000, or 4.1%, during the period to $1,722,000. Included in salary and
benefit expense for the second quarter of 2009 were costs associated with the
Chief Operating Officer position. This position was vacant during the second
quarter of 2010. Merit increases, as well as an increase in the average number
of full-time equivalent employees accounts for the higher salary expense. The
average number of full time-equivalent employees increased by four, to 166, when
comparing the second quarter of 2010 and 2009. Comparing the two quarters,
benefits expense increased $22,000, or 5.0%, to $445,000. Increases in payroll
tax expense, retirement plan contribution expense and medical insurance premium
expense all contributed to the increase in benefit expense.





Net
occupancy expense increased $25,000, or 7.5%, to $360,000 for the second quarter
of 2010 while furniture and equipment expense declined by $21,000, or 6.8%, to
$288,000 for the same period. A decline in repairs and maintenance expense was
more than offset by higher branch rent related to the land lease for the
permanent site for the Wescosville branch and higher building security and
utilities expense. A reduction in depreciation expense contributed to the
decline in furniture and equipment expense.





FDIC
insurance premium expense decreased $282,000, to $257,000, comparing the second
quarter of 2010 to 2009. The higher expense in 2009 was primarily the result of
the special assessment levied on all insured institutions by the FDIC in order
to replenish its Deposit Insurance Fund. QNB’s portion of the special assessment
in 2009 was $332,000. Significant growth in deposits combined with a slightly
higher assessment rate and QNB’s participation in the FDIC’s Transaction Account
Guarantee Program has resulted in an increase in the ongoing quarterly
assessment expense.





Third-party
services are comprised of professional services, including legal, accounting,
auditing and consulting services, as well as fees paid to outside vendors for
support services of day-to-day operations. These support services include
correspondent banking services, statement printing and mailing, investment
security safekeeping and supply management services. Third-party services
expense increased $23,000 for the three months ended June 30, 2010 when
comparing the same period in 2009. Total expense was $290,000 for the second
quarter of 2010 compared to $267,000 for the second quarter of 2009. The largest
portion of the increase related higher legal expenses and consultant
expense.





State tax
expense represents the accrual 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 $139,000 for the second quarter of
2010, an increase of $6,000 compared to the same period in 2009. This increase
was a result of a higher shares tax resulting from an increase in the Bank’s
equity.





Other
expense increased $21,000 to $399,000 for the second quarter of 2010. The main
contributors to the increase in this category were as follows:


·
              Employee
      training decreased $20,000. Prior year included costs for service and
      sales training for branch and call center
  personnel.


·
              Expenses
      in connection with foreclosed real estate and repossessed assets increased
      $19,000


·
              Expenses
      related to the processing of check card transactions as well as the
      production of replacement cards decreased $21,000. Prior year included
      costs related to a security breach at a third-party
    processor


·
              Directors’
      fees increased $20,000 for the second quarter of 2010 when compared to the
      same period in 2009. This was partly attributable to an increase in the
      number of meetings held and a portion of the increase is a result of
      deferred loan fees decreasing by $11,000. These fees have the impact of
      offsetting a portion of the Directors’ fees for loans that require
      Director approval. These fees were lower than prior year due a lower level
      of loans requiring Director approval in the second quarter of
      2010.





Total
non-interest expense was $8,359,000 for the six-month period ended June 30, 2010
compared to $8,313,000 for the same period in 2009, an increase of
$46,000.


- 50
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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NON-INTEREST
EXPENSE (Continued)





Salaries
and benefits expense increased $148,000, or 3.6%, to $4,304,000 for the six
months ended June 30, 2010 compared to the same period in 2009. Salary expense
increased $105,000, or 3.2%, during the period to $3,407,000. Included in salary
and benefit expense for the first half of 2009 were costs associated with the
Chief Operating Officer position. This position was vacant during the first half
of 2010. The average number of full time-equivalent employees increased by five,
to 166, when comparing the periods. Benefits expense increased $43,000, or 5.0%,
to $897,000 when comparing the six month periods. Similar to the quarter,
increases in payroll tax expense, retirement plan contribution expense and
medical insurance premium expense contributed to the increase in benefit
expense.





Net
occupancy expense increased $41,000, or 6.0%, to $729,000 for the first half of
2010 while furniture and equipment expense declined by $35,000, or 5.8%, to
$570,000 for the same period. Similar to the second quarter of 2010, a decline
in repairs and maintenance expense was more than offset by higher branch rent
related to the land lease for the permanent site for the Wescosville branch and
higher building security and utilities expense. A reduction in depreciation
expense contributed to the decline in furniture and equipment
expense.





Third-party
service expense was $563,000 for the six month period ended June 30, 2010, an
increase of $66,000 from the same period in 2009. The largest portion of the
increase related to the following third-party services:


·
              Legal
      expense increased by $22,000 primarily as a result of loan collection
      costs.


·
              Consultant
      expense increased $20,000. During the first half of 2010 an independent
      third party was utilized to analyze and value the Bank’s pooled trust
      preferred securities on two occasions compared to one time in 2009. In
      addition a consultant was hired for leadership
  training.


·
              Costs
      associated with the registration, printing and mailing of the Dividend
      Reinvestment and Stock Purchase Plan contributed approximately $8,000 to
      the increase.





Other
expense increased $46,000 to $744,000 for the six months ended June 30, 2010
compared to the same period in 2009. The primary contributors to the increase in
this category were similar to the explanations for the increase in the quarterly
expense comparisons. The following items were the primary changes from prior
year:


·
              Employee
      training decreased $26,000. Prior year included higher costs for service
      and sales training for branch and call center
  personnel.


·
              Charge-offs
      related to fraudulent ATM and checkcard transactions increased
      $16,000.


·
              Refund
      of ATM fees related to the QNB-Rewards product increased
      $10,000.


·
              Directors’
      fees increased $29,000 for the second quarter of 2010 when compared to the
      same period in 2009. This was partly attributable to an increase in the
      number of meetings held and a portion of the increase is a result of
      deferred loan fees decreasing by $17,000. These fees have the impact of
      offsetting a portion of the Directors’ fees for loans that require
      Director approval. These fees were lower than prior year due a lower level
      of loans requiring Director approval during the first half of
      2010.




INCOME
TAXES





QNB
utilizes an asset and liability approach for financial accounting and reporting
of income taxes. As of June 30, 2010, QNB’s net deferred tax asset was $783,000.
The primary components of deferred taxes are a deferred tax asset of $2,383,000
relating to the allowance for loan losses, a deferred tax asset of $269,000
generated by OTTI charges on equity securities and a deferred tax asset of
$418,000 related to OTTI charges on trust preferred securities. Partially
offsetting these deferred tax assets was a deferred tax liability of $1,986,000
resulting from unrealized gains on available-for-sale securities. As of June 30,
2009, QNB’s net deferred tax asset was $1,954,000. The primary components of
deferred taxes are a deferred tax asset of $1,559,000 relating to the allowance
for loan losses, a deferred tax asset of $472,000 generated by OTTI charges on
equity securities, and a deferred tax asset of $202,000 resulting from
unrealized gains on available for sale securities.


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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 $558,000, or 22.1%, for the
three-month period ended June 30, 2010, and $276,000, or 18.4%, for the same
period in 2009. For the six-month periods ended June 30, 2010 and 2009
applicable income taxes and the effective tax rate were $1,070,000, or 22.0%,
and $467,000, or 16.8%, respectively. The higher effective tax rate for both
periods in 2010 is predominantly a result of tax-exempt income from loans and
securities comprising a lower proportion of pre-tax income.





FINANCIAL
CONDITION ANALYSIS





The
following balance sheet analysis compares average balance sheet data for the six
months ended June 30, 2010 and 2009, as well as the period ended balances as of
June 30, 2010 and December 31, 2009.





Average
earning assets for the six-month period ended June 30, 2010 increased
$73,611,000, or 11.2%, to $730,541,000 from $656,930,000 for the six months
ended June 30, 2009. The mix of earning assets changed slightly when comparing
the two periods. Average loans increased $41,177,000, or 9.9%, while average
investment securities increased $21,885,000, or 9.4%. Average loans represented
62.8% of earning assets for the first six months of 2010, while average
investment securities represented 35.0% of earning assets for the same period.
This compares to 63.5% and 35.5% for the first six months of 2009. Average other
earning assets increased $12,548,000, or 312.1%, when comparing these same
periods. Given the low yield on Federal funds sold and AAA rated money market
mutual funds, QNB has chosen to keep excess liquidity in an interest-bearing
account at the Federal Reserve Bank that pays a higher rate than these products
and also has a zero percent risk-weighting for risk based capital
purposes.





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 strong 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 9.0% between
June 30, 2009 and June 30, 2010 and increased 5.6% since December 31, 2009. The
growth in loans despite the economic environment reflects QNB’s commitment to
make credit available to its customers.





Average
total commercial loans increased $47,910,000 when comparing the first six months
of 2010 to the first six months of 2009. Most of the 15.6% growth in average
commercial loans was in loans secured by real estate, either commercial or
residential properties, which increased $35,999,000, or 17.2%, to $245,395,000.
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 $7,821,000, or 10.7%, when comparing the average balances for the six
month periods. Tax-exempt loans to local municipalities increased $4,090,000, or
16.3% to $29,176,000 during this same period.





Average
home equity loans continue to decline with average balances decreasing from
$66,337,000 for the first six months of 2009 to $61,078,000 for the first six
months of 2010. With the decline in mortgage interest rates that took place,
customers have paid down their home equity loans when they refinance their first
mortgage. The other impact of the low interest rate environment is movement from
fixed rate home equity loans to floating rate lines tied to prime rate. Fixed
rate home equity term loans declined by $9,053,000 to $36,731,000 when comparing
the six-month periods. In contrast average floating rate home equity lines have
increased by $3,794,000 comparing the same periods. The introduction of the
Equity Choice product, which allows both a floating rate line and fixed rate
carve out loans, contributed to this migration, as did the current low interest
rate on the variable rate product.


- 52
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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





FINANCIAL
CONDITION ANALYSIS (Continued)




Total
investment securities were $264,719,000 at June 30, 2010 and $260,209,000 at
December 31, 2009. The composition of the portfolio changed since December 31,
2009 with agency mortgage-backed and CMO securities increasing by $8,076,000 and
$11,905,000, respectively, when comparing December 31, 2009 and June 30, 2010.
These increases were offset by a decrease in U.S. Government agency bonds of
$19,103,000 when comparing the same periods. The agency bonds were callable
bonds that were called due to the low interest rate environment. The proceeds
were reinvested in agency mortgage-backed and CMO securities which will provide
ongoing cash flow to invest as rates increase. As a result of the change in the
composition of the portfolio as well as the lower interest rate environment and
the increase in prepayment speeds the average life of the portfolio has declined
from approximately 3 years 5 months at December 31, 2009 to approximately 3
years at June 30, 2010.





Collateralized
debt obligations (CDO) are securities derived from the packaging of various
assets with many backed by subprime mortgages. These instruments are complex and
difficult to value. QNB did a review of its mortgage related securities and
concluded that it has minimal exposure to subprime mortgages within its U.S.
government sponsored agency (GNMA, FHLMC and FNMA) mortgage-backed and CMO
portfolio. QNB does not own any non-agency mortgage security or CDOs backed by
subprime mortgages.





QNB does
own CDOs in the form of pooled trust preferred securities. These securities are
comprised mainly of securities issued by banks, and to a lesser degree,
insurance companies. QNB owns the mezzanine tranches of these securities. These
securities 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. QNB holds eight of these
securities with an amortized cost of $3,846,000 and a fair value of $1,698,000.
The market values for these securities are very depressed relative to historical
levels. A discounted cash flow analysis provides the best estimate of credit
related OTTI for these securities. During the first six months of 2010 a
$226,000 credit related OTTI charge was taken on three issues. As a result of
some improvement in the financial condition of some of the bank issuers in these
securities, including the ability for some of them to raise capital, the fair
value of the securities has improved since December 31, 2009 when the fair value
was $1,008,000. However, it is possible that future calculations could require
recording additional other-than-temporary impairment charges through
earnings.





For the
most part, earning assets are funded by deposits. Total average deposits
increased $78,891,000, or 13.8%, to $651,478,000 for the first six months of
2010 compared to the first six months of 2009. It appears that customers are
continuing to look for the safety of FDIC insured deposits and the stability of
a strong local community bank as opposed to the volatility of the equity markets
and the uncertainty of the larger regional and national banks. In addition, they
are looking for products that provide liquidity and an attractive interest
rate.





Most of
the increase in average deposits was in categories other than time deposits
which decreased $4,511,000, or 1.4%, to $321,273,000 for the first six months of
2010. Average interest-bearing demand and municipal accounts increased
$16,668,000, or 24.8%, and $6,810,000, or 25.0%, respectively, when comparing
the first six months of 2010 and 2009. The higher yielding QNB-Rewards checking
product is the primary factor behind the growth of the interest-bearing demand
accounts. Average money market and savings account balances increased
$22,416,000, or 42.7%, and $34,862,000, or 74.1%, respectively, when comparing
the same periods. The growth in savings accounts is largely due to the success
of QNB’s newest high-rate deposit product, Online eSavings.





Total
assets at June 30, 2010 were $776,115,000 compared with $762,426,000 at December
31, 2009, an increase of 1.8%. Impacting total assets was the repayment of
$10,000,000 in FHLB borrowings and $5,000,000 in repurchase agreements,
classified as long-term debt, which matured during the first six months of 2010.
Funding the growth in loans and investment securities previously discussed was
growth in deposits and short-term borrowings as well as the reduction in
interest-bearing deposits in banks. These balances, primarily held at the Fed,
declined from $22,158,000 at December 31, 2009 to $7,340,000 at June 30,
2010.


- 53
-


QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





FINANCIAL
CONDITION ANALYSIS (Continued)





On the
liability side, total deposits increased by $23,867,000, or 3.8%, since year-end
but have declined slightly since March 31, 2010. In comparison to prior periods
where the growth was centered in time deposits, the current growth reflects
increases in both lower-cost core deposits, including savings accounts. Savings
accounts increased $26,167,000, or 38.3%, to $94,525,000. The increase in
savings accounts was primarily in the Online eSavings product whose balances
increased from $19,944,000 at December 31, 2009 to $42,253,000 at June 30,
2010.





Short-term
borrowings increased $5,626,000 from $28,433,000 at December 31, 2009 to
$34,059,000 at June 30, 2010. The majority of these balances are commercial
sweep accounts which are volatile based on businesses receipt and disbursement
of funds. The category of other liabilities decreased from $6,899,000 at
December 31, 2009 to $1,703,000 at June 30, 2010. Included in the December 31,
2009 balance were unsettled trades of investment securities that settled in
January 2010.





LIQUIDITY





Liquidity
represents an institution’s ability to generate cash or otherwise obtain funds
at reasonable rates to satisfy demand for loans and deposit withdrawals. QNB
attempts to manage its mix of cash, Federal funds sold and investment securities
in order to match the volatility, seasonality, interest sensitivity and growth
trends of its loans and deposits. The Company manages its liquidity risk by
measuring and monitoring its liquidity sources and estimated funding needs.
Liquidity is provided from asset sources through 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.
Core deposits and cash management repurchase agreements have historically been
the most significant funding source for QNB. These deposits and repurchase
agreements are generated from a base of consumers, businesses and public funds
primarily located in the Company’s market area.





Additional
sources of liquidity are provided by the Bank’s membership in the FHLB. At June
30, 2010, the Bank had a maximum borrowing capacity with the FHLB of
approximately $199,400,000. The maximum borrowing capacity changes as a function
of qualifying collateral assets. In addition, the Bank maintains Federal funds
lines with two correspondent banks totaling $18,000,000. At June 30, 2010, there
were no outstanding borrowings under these lines. Future availability under
these lines is subject to the policies of the granting banks and may be
withdrawn.





Cash and
due from banks, interest-bearing deposits in banks, Federal funds sold,
investment securities available-for-sale and loans held-for-sale totaled
$279,930,000 and $288,395,000 at June 30, 2010 and December 31, 2009,
respectively. These sources should be adequate to meet normal fluctuations in
loan demand and deposit withdrawals. With the current low interest rate
environment, it is anticipated that the investment portfolio will continue to
provide significant liquidity as agency and municipal bonds are called and as
cash flow on mortgage-backed and CMO securities continues to be steady. In the
event that interest rates would increase the cash flow available from the
investment portfolio could decrease.





Approximately
$120,803,000 and $133,136,000 of available-for-sale securities at June 30, 2010
and December 31, 2009, respectively, were pledged as collateral for repurchase
agreements and deposits of public funds.





In 2008,
QNB opted into the FDIC’s Transaction Account Guarantee (TAG) program. This
program provides unlimited deposit insurance for non-interest bearing
transaction accounts. During the second quarter of 2010, the FDIC adopted a rule
extending the Transaction Account Guarantee (TAG) component of the Temporary
Liquidity Guarantee Program for six months, through December 31, 2010 for those
institutions that do not opt out. QNB continues to participate in the TAG
program.





As an
additional source of liquidity, QNB is a member of the Certificate of Deposit
Account Registry Service (CDARS) program offered by the Promontory
Interfinancial Network, LLC. CDARS is a funding and liquidity management tool
that is used by banks to access funds and manage their balance sheet. It enables
financial institutions to provide customers with full FDIC insurance on time
deposits over $250,000 that are placed in the program.


- 54
-


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 June 30,
2010 was $61,128,000, or 7.88% of total assets, compared to shareholders' equity
of $56,426,000, or 7.40% of total assets, at December 31, 2009. Shareholders’
equity at June 30, 2010 and December 31, 2009 included a positive adjustment of
$3,855,000 and $1,723,000, respectively, related to net unrealized holding
gains, net of taxes, on investment securities available-for-sale. Without these
adjustments, shareholders' equity to total assets would have been 7.38% and
7.17% at June 30, 2010 and December 31, 2009, respectively.





Average
shareholders' equity and average total assets were $56,274,000 and $759,598,000
for the first six months of 2010, an increase of 2.9% and 6.9%, respectively,
from the averages for the year ended December 31, 2009. The ratio of average
total equity to average total assets was 7.41% for the first six months of 2010
compared to 7.70% for all of 2009.





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
debt 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
following table sets forth consolidated information for QNB
Corp.:


Capital AnalysisJune 30, 2010
                                                                
                                                                
                                                                December 31, 2009Tier
      IShareholder's
      Equity
                                                                
                                                                $
                                                                61,128
                                                                
                                                                
                                                                $
                                                                56,426Net
      unrealized securities gains
                                                                
                                                                
                                                                (3,855
                                                                )
                                                                
                                                                
                                                                (1,723
                                                                )Net
      unrealized losses on available-for-sale equity securities
                                                                
                                                                
                                                                -
                                                                
                                                                
                                                                
                                                                -Total
      Tier I risk-based capital
                                                                
                                                                $
                                                                57,273
                                                                
                                                                
                                                                $
                                                                54,703Tier
      IIAllowable
      portion: Allowance for loan losses
                                                                
                                                                
                                                                6,844
                                                                
                                                                
                                                                
                                                                6,217Unrealized
      gains on equity securities
                                                                
                                                                
                                                                2
                                                                
                                                                
                                                                
                                                                248Total
      risk-based capital
                                                                
                                                                $
                                                                64,119
                                                                
                                                                
                                                                $
                                                                61,168Risk-weighted
      assets
                                                                
                                                                $
                                                                550,781
                                                                
                                                                
                                                                $
                                                                531,295Average
      assets
                                                                
                                                                $
                                                                769,539
                                                                
                                                                
                                                                $
                                                                745,551


Capital RatiosJune 30, 2010
                                            
                                            
                                            December 31, 2009Tier
      I capital/risk-weighted assets
                                            
                                            
                                            10.40
                                            %
                                            
                                            
                                            10.30
                                            %Total
      risk-based capital/risk-weighted assets
                                            
                                            
                                            11.64
                                            %
                                            
                                            
                                            11.51
                                            %Tier I capital/average assets (leverage
      ratio)
                                            
                                            
                                            7.44
                                            %
                                            
                                            
                                            7.34
                                            %




The
minimum regulatory capital ratios are 4.00% for Tier I, 8.00% for the total
risk-based capital and 4.00% for leverage. QNB had a Tier I capital ratio of
10.40% and 10.30%, a total risk-based ratio of 11.64% and 11.51% and a leverage
ratio of 7.44% and 7.34% at June 30, 2010 and December 31, 2009,
respectively.


- 55
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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





CAPITAL
ADEQUACY (Continued)





All
capital ratios have improved slightly from December 31, 2009 as the growth rate
of capital has exceeded the growth rate of average and risk-weighted assets.
During the first quarter of 2010, QNB began offering a Dividend Reinvestment and
Stock Purchase Plan (the “Plan”) to provide participants a convenient and
economical method for investing cash dividends paid on the Company’s common
stock in additional shares at a discount. The Plan also allows participants to
make additional cash purchases of stock at a discount. Stock purchases under the
Plan contributed $209,000 to capital for the first half of 2010.





The Board
of Directors has authorized the repurchase of up to 100,000 shares of its common
stock in open market or privately negotiated transactions. The repurchase
authorization does not bear a termination date. As of June 30, 2010, 57,883
shares were repurchased under this authorization at an average price of $16.97
and a total cost of $982,000. There were no shares repurchased under the plan
since the first quarter of 2009.





Also
impacting the regulatory capital ratios was an increase in risk-weighted assets
during the first half of 2010. Loan growth, primarily centered in commercial
loans, accounted for virtually all of the $19,486,000 growth in risk-weighted
assets. Continuing to impact risk-weighted assets is the $27,633,000 of
risk-weighted assets due to mezzanine tranches of pooled trust preferred
securities that were downgraded below investment grade during the first quarter
of 2009. Although the amortized cost of these securities was only $3,846,000 at
June 30, 2010, regulatory guidance required an additional $27,633,000 to be
included in risk-weighted assets. The Bank utilized the method as outlined in
the Call Report Instructions for an available-for-sale bond that has not
triggered the Low Level Exposure (LLE) rule. The mezzanine tranches of CDOs that
utilized this method of risk-weighting are five out of eight pooled trust
preferred securities (PreTSLs) held by the Bank as of June 30, 2010. The other 3
pooled trust preferred securities have only one tranche remaining so the
treatment noted above does not apply.





The
Federal Deposit Insurance Corporation Improvement Act of 1991 established five
capital level designations ranging from "well capitalized" to "critically
undercapitalized." At June 30, 2010 and December 31, 2009, management believes
that the Company and the Bank met all capital adequacy requirements to which
they are subject and have 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.





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.


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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





INTEREST
RATE SENSITIVITY (Continued)





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.
Generally a positive or asset sensitive position is beneficial in a rising rate
environment while a negative gap or liability sensitive position is beneficial
in a declining rate environment.





QNB
primarily focuses on the management of the one-year interest rate sensitivity
gap. The one-year cumulative gap, which reflects QNB’s interest sensitivity over
a period of time, was a negative $28,771,000 at June 30, 2010. The cumulative
one-year gap equals -3.80% of total rate sensitive assets. This position
compares to a negative gap position of $47,997,000, or -6.5% of total rate
sensitive assets, at December 31, 2009.





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 the interest rate environment at period end. Management
also evaluates the impact of higher and lower interest rates by simulating the
impact on net interest income of changing rates. While management performs rate
shocks of 100, 200 and 300 basis points, it believes that, given the level of
interest rates at June 30, 2010, 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
that income on earning assets would decline to a greater degree than the expense
associated with interest-bearing liabilities. 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 resulting in less
income. Loan customers would likely either refinance their fixed rate loans at
lower rates or request rate reductions on their existing loans. While interest
expense on time deposits would decrease, 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 would prevent a reduction in interest expense on these
accounts.





In a
rising rate environment net interest income increases as loans and investments
reprice more than rates on interest-bearing liabilities. The rate of increase in
net interest income declines the more rates increase because prepayments and
calls on investments and loans slow resulting in fewer amounts repricing at
higher rates. 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.





The
results of the simulation model are inconsistent with the anticipated results
from using GAP analysis and highlight some of the weakness of just using GAP
analysis which for example does not take into consideration that rates on
different products do not change by the same magnitude and does not take into
consideration interest rates floors and caps.





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 June 30, 2010, QNB did not have
any hedging transactions in place such as interest rate swaps, caps or
floors.


- 57
-


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
                            
                            $
                            28,195
                            
                            
                            
                            1,736
                            
                            
                            
                            6.6
                            %+200
      Basis Points
                            
                            
                            27,744
                            
                            
                            
                            1,285
                            
                            
                            
                            4.9+100
      Basis Points
                            
                            
                            27,197
                            
                            
                            
                            738
                            
                            
                            
                            2.8Flat
      Rate
                            
                            
                            26,459
                            
                            
                            
                            -
                            
                            
                            
                            --100
      Basis Points
                            
                            
                            25,575
                            
                            
                            
                            (884
                            )
                            
                            
                            (3.3
                            )




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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.




- 59
-





QNB
CORP. AND SUBSIDIARY





PART
II.  OTHER INFORMATION





JUNE
30, 2010





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, 2009.





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


Period
                                  
                                  TotalNumber
                                    of Shares
                                    Purchased
                                  
                                  
                                  Average Price
                                    Paid per Share
                                  
                                  
                                  Total Number
                                    of Shares
                                    Purchased as
                                    Part of Publicly
                                    Announced Plan
                                  
                                  
                                  Maximum
                                    Number of
                                    Shares that may
                                    yet be Purchased
                                    Under the PlanApril
      1, 2010 through April 30, 2010
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  42,117May
      1, 2010 through May 31, 2010
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  42,117June
      1, 2010 through June 30, 2010
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  42,117Total
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  42,117




(1)
            Transactions
      are reported as of settlement
dates.


(2)
            QNB’s
      current stock repurchase plan was approved by its Board of Directors and
      announced on January 24, 2008 and subsequently increased on February 9,
      2009.


(3)
            The
      total number of shares approved for repurchase under QNB’s current stock
      repurchase plan is 100,000.


(4)
            QNB’s
      current stock repurchase plan has no expiration
  date.


(5)
            QNB
      has no stock repurchase plan that it has determined to terminate or under
      which it does not  intend to make further
    purchases.




Item
      3.
            Default Upon Senior
      Securities


None.




Item
      4.
            (Removed and
      Reserved)




Item
      5.
            Other
      Information


None.




- 60
-


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




- 61
-


SIGNATURES





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





QNB
      Corp.Date:
                August 16, 2010
                
                By:
                /s/ Thomas J. BiskoThomas
      J. BiskoPresident/CEODate:
                August 16, 2010
                
                By:
                /s/ Bret H. KrevolinBret
      H. KrevolinChief
      Financial Officer